-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N6zZW21tzcwqAAtBe3uwfmyJggFpbEXVrdJAwEYo488wsQ/WgbIGiUEfpJ0oPyLa MxijhZT+iw4p9TV2gltSOA== 0001047469-99-015152.txt : 19990419 0001047469-99-015152.hdr.sgml : 19990419 ACCESSION NUMBER: 0001047469-99-015152 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 32 FILED AS OF DATE: 19990416 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFIC COMMUNITY BANKING GROUP CENTRAL INDEX KEY: 0001057159 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 330778067 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-76403 FILM NUMBER: 99595428 BUSINESS ADDRESS: STREET 1: 23332 MILL CREEK DR STREET 2: STE 230 CITY: LAGUNA HILLS STATE: CA ZIP: 92653 BUSINESS PHONE: 9494604540 MAIL ADDRESS: STREET 1: 23332 MILL CREEK DRIVE SUITE 230 CITY: LAGUNA HILLS STATE: CA ZIP: 92653 S-1 1 S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON , 1999 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- PACIFIC COMMUNITY BANKING GROUP (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 6712 33-0778067 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification No.)
-------------------------- 23332 MILL CREEK DRIVE, SUITE 230 LAGUNA HILLS, CALIFORNIA 92653 (949) 460-4540 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ------------------------------ E. LYNN CASWELL CHAIRMAN AND CHIEF EXECUTIVE OFFICER 23332 MILL CREEK DRIVE, SUITE 230 LAGUNA HILLS, CALIFORNIA 92653 (949) 460-4540 (Name, address, including zip code, and telephone number, including area code, of agent for service) ------------------------------ COPIES OF ALL COMMUNICATIONS TO BE SENT TO: HENRY M. FIELDS, ESQ. LOREN P. HANSEN, ESQ. PAUL H. IRVING, ESQ. ELLEN R. MARSHALL, ESQ. KNECHT & HANSEN MANATT, PHELPS & PHILLIPS, LLP CHARLES S. KAUFMAN, ESQ. 1301 DOVE STREET, SUITE 900 11355 WEST OLYMPIC BOULEVARD MORRISON & FOERSTER LLP NEWPORT BEACH, CALIFORNIA 92660 LOS ANGELES, CALIFORNIA 90064 555 WEST FIFTH STREET (949) 851-8070 (310) 312-4000 LOS ANGELES, CALIFORNIA 90013-1024 (213) 892-5200
-------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this registration statement. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. / / If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / -------------------------- CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING REGISTRATION SECURITIES TO BE REGISTERED REGISTERED (1) SHARE (1) PRICE (2) FEE (2) Common Stock, no par value......................... 4,255,000 shares $16.00 $68,080,000 $18,926.24
(1) Includes 555,000 shares which the Underwriters have options to purchase to cover, over-allotments, if any. (2) Estimated solely for purpose of calculating the amount of the registration fee. This estimate is made in accordance with Rule 457(c) under the Securities Act of 1933, as amended. -------------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SUBJECT TO COMPLETION. DATED , 1999 PROSPECTUS PACIFIC COMMUNITY BANKING GROUP [LOGO] SHARES OF COMMON STOCK $ PER SHARE Pacific Community Banking Group intends to operate as a bank holding company, which will serve communities primarily in Southern California. We are offering shares to be sold in the offering. The selling shareholders identified in this prospectus are selling shares. Pacific Community Banking Group will not receive any of the proceeds from the sale of shares by the selling shareholders.
THE OFFERING PER SHARE TOTAL - ---------------------------------------- ----------- --------- Public Offering Price................... $ $ Underwriting Discounts.................. $ $ Proceeds, before expenses, to Pacific Community Banking Group............... $ $ Proceeds, before expenses, to the selling shareholders.................. $ $
This is our initial public offering, and no market currently exists for our shares. The offering price may not reflect the market price of our shares after this offering. We anticipate that the initial public offering price will be between $15 and $16 per share. We have granted the Underwriters the right to purchase an additional shares from us to cover over-allotments. The underwriters expect to deliver shares of common stock to purchasers on or about , 1999. ------------------------ Proposed Trading Symbol: Nasdaq National Market--PCBG ------------------------ THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD PURCHASE SHARES ONLY IF YOU CAN AFFORD A COMPLETE LOSS OF YOUR INVESTMENT. PLEASE REFER TO "RISK FACTORS" COMMENCING ON PAGE 6. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. PLEASE NOTE THAT THESE SHARES ARE NOT SAVINGS OR DEPOSIT ACCOUNTS OR OTHER OBLIGATIONS OF ANY BANK OR NONBANK SUBSIDIARY OF ANY OF THE PARTIES, AND THE SHARES ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE BANK INSURANCE FUND OR ANY OTHER GOVERNMENTAL AGENCY. ------------------------ SUTRO & CO. INCORPORATED , 1999 THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION BECOMES EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED OR WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. [ARTWORK] CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS WHICH STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF COMMON STOCK OF THE COMPANY INCLUDING STABILIZING BIDS, SYNDICATE COVERING TRANSACTIONS OR THE IMPOSITION OF PENALTY BIDS. FOR A DISCUSSION OF THESE ACTIVITIES, PLEASE REFER TO "UNDERWRITING." SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. PROSPECTUS SUMMARY YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED INFORMATION AND THE FINANCIAL STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. PACIFIC COMMUNITY BANKING GROUP'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION ENTITLED "RISK FACTORS" BEGINNING ON PAGE 6. PACIFIC COMMUNITY BANKING GROUP A group of individual investors led by E. Lynn Caswell, an experienced California community banker, formed our company in 1997. Our goal is to become the preeminent financial services company for independent banks in high growth areas of Southern California, commencing with Riverside and San Bernardino counties. In pursuit of that goal, and in connection with this offering, we will acquire two community banks headquartered in Riverside county, California--The Bank of Hemet and Valley Bank. The service areas of these two banks overlap. After we acquire these banks, we plan to combine their operations under The Bank of Hemet charter and increase market share in the area they now serve. We then plan to use the Valley Bank charter to launch a new community bank in Orange County, California. The Bank of Hemet and Valley Bank primarily serve Riverside and San Bernardino counties, a region commonly known as the "Inland Empire." The Inland Empire will be the fastest growing U.S. primary metropolitan statistical area between the years 1993 to 2005, according to a 1996 report of the U.S. Department of Commerce. The department projects that population in the area will grow 32.4% during that period. Prior to these acquisitions, our company had no operations. As of December 31, 1998, we had $1.3 million in invested capital. 1 PROFILES OF THE BANK OF HEMET AND VALLEY BANK
THE BANK OF HEMET VALLEY BANK ---------------------------------- ---------------------------------- Total assets at December 31, 1998........ $253 million $85 million Headquarters............................. Hemet, California Moreno Valley, California Offices.................................. 5 branches in Riverside county 6 branches in Riverside and San Bernardino counties and 2 loan production offices, one in Moreno Valley and one in Portland, Oregon Principal service areas.................. Riverside, San Bernardino, Orange, Riverside and San Bernardino Los Angeles and San Diego counties, Portland, Oregon and counties southern Washington State Loan portfolio........................... High percentage of commercial real High percentage of real estate estate loans loans, with a significant portion in Small Business Administration loans Active subsidiaries...................... Data processing subsidiary none Charter.................................. California California Principal federal bank regulator......... FDIC FDIC
BUSINESS STRATEGY Our business strategy is to: - develop a banking presence primarily in high-growth areas of Southern California through the acquisition of strongly performing, well regarded community banks; - operate most acquired banks as separate subsidiaries to retain their boards of directors and the goodwill of the communities they serve; - consolidate operations of acquired banks which serve overlapping market areas; - form community banks in areas of Southern California that may have lost many of their independent community banks through consolidation, merger, acquisition and regulatory action; - cross-sell services of our constituent banks; - realize efficiencies by combining functions like financial administration, data processing, insurance, bonding, employee benefits and contracts for services; and - take advantage of the combined size and diversity of our constituent banks to access capital at lower costs. We believe that banking customers value doing business with locally managed institutions that can provide a full service commercial banking relationship, understand customers' financial needs and have the flexibility to customize products and services to meet those needs. We also believe that banks are better able to build successful customer relationships by 2 affiliating with a holding company that provides cost effective administrative support services while promoting bank autonomy and individualized service. Our principal executive offices are located at 23332 Mill Creek Drive, Suite 230, Laguna Hills, California 92653. Our telephone number is (949) 460-4540, and our facsimile number is (949) 458-2086. We were incorporated under the laws of California in October 1997. THE OFFERING Common stock offered by Pacific Community Banking Group......... shares(1) Common stock offered by the selling shareholders............ shares Common stock to be outstanding after this offering............. shares(2) Use of proceeds................... For working capital and general corporate purposes, and to compensate Sutro & Co. Incorporated for its advisory services in connection with the business combination of Pacific Community Banking Group, The Bank of Hemet and Valley Bank. For a more detailed discussion of how we expect to use these proceeds, please refer to "Use of Proceeds" on page 14. We will not receive any proceeds from the sale of stock by the selling shareholders.
- ------------------------ (1) Excludes shares of common stock issuable upon exercise of the underwriter's over-allotment option. (2) Based on the number of shares outstanding as of , 1999. This number includes 1,460,000 shares of preferred stock convertible into 119,829 shares of common stock, and shares to be issued in the business combination of Pacific Community Banking Group, The Bank of Hemet and Valley Bank. This number excludes (i) 1,308,000 warrants to purchase shares of common stock at an exercise price of 122% of the price per share in this offering, which, based on the expected offering price of $15.00 per share, would be $18.30 per share, and (ii) options to purchase 470,000 shares of common stock at an exercise price of the price per share in this offering, which is expected to be $15.00. This number also assumes that the Underwriters will not exercise their over-allotment option. 3 SUMMARY FINANCIAL INFORMATION Pacific Community Banking Group was formed in October 1997, for the sole purpose of acquiring community banking organizations. The following tables set forth summary financial data of Pacific Community Banking Group, The Bank of Hemet and Valley Bank. It includes pro forma data for the combined companies. The historical information presented below is from the financial statements of the respective companies, which have been audited by their independent public accountants, as indicated in their reports thereon included in this prospectus. The data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition" of each of the companies and their audited financial statements appearing in this prospectus.
AT OR FOR THE AT OR FOR THE PERIOD YEAR FROM INCEPTION PRO FORMA COMBINED ENDED (OCTOBER 17, 1997) AT OR FOR THE YEAR DECEMBER 31, TO ENDED 1998 DECEMBER 31, 1997 DECEMBER 31, 1998 ---------------- ------------------- ---------------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) PACIFIC COMMUNITY BANKING GROUP RESULTS OF OPERATIONS: Interest income..................................... $ -- $ -- $ 25,597 Interest expense.................................... -- -- 10,623 ------- ------ -------- Net interest income................................. -- -- 14,974 ------- ------ -------- Provision for loan losses........................... -- -- 200 Noninterest expense, net............................ 513 82 10,652 Net income (loss)................................... $ (513) $ (82) $ 2,034 Earnings (loss) per share........................... $ (51.34) $ (8.17) $ 0.51 BALANCE SHEET: Cash and cash equivalents........................... $ 396 $ 170 $ 37,048 Investment securities............................... -- -- 40,467 Loans and leases, net............................... -- -- 247,601 Other assets........................................ 205 27 23,473 ------- ------ -------- Total assets........................................ $ 601 $ 197 $ 348,589 ------- ------ -------- ------- ------ -------- Deposits............................................ $ -- $ -- $ 306,124 Accrued interest and other liabilities.............. 94 139 5,883 Stockholders' equity................................ 507 58 36,582 ------- ------ -------- Total liabilities and stockholders' equity.......... $ 601 $ 197 $ 348,589 ------- ------ -------- ------- ------ --------
4
AT OR FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) THE BANK OF HEMET RESULTS OF OPERATIONS: Interest income.......................................................... $ 19,416 $ 18,991 $ 19,127 Interest expense......................................................... 9,185 8,946 8,823 ---------- ---------- ---------- Net interest income...................................................... 10,231 10,045 10,304 ---------- ---------- ---------- Provision for loan losses................................................ -- 250 988 Noninterest expense, net................................................. 5,373 4,996 6,934 Net income............................................................... $ 2,823 $ 2,802 $ 1,373 BALANCE SHEET: Cash and cash equivalents................................................ $ 16,996 $ 19,521 $ 15,982 Investment securities.................................................... 24,882 24,833 24,779 Loans and leases, net.................................................... 205,570 190,171 185,200 Other assets............................................................. 5,429 6,798 8,296 ---------- ---------- ---------- Total assets............................................................. $ 252,877 $ 241,323 $ 234,257 ---------- ---------- ---------- ---------- ---------- ---------- Deposits................................................................. $ 230,853 $ 219,211 $ 212,268 Accrued interest and other liabilities................................... 1,468 1,884 1,887 Stockholders' equity..................................................... 21,024 20,228 20,102 ---------- ---------- ---------- Total liabilities and stockholders' equity............................... $ 252,877 $ 241,323 $ 234,257 ---------- ---------- ---------- ---------- ---------- ----------
AT OR FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) VALLEY BANK RESULTS OF OPERATIONS: Interest income.......................................................... $ 6,181 $ 5,978 $ 5,338 Interest expense......................................................... 1,438 1,282 1,119 ---------- ---------- ---------- Net interest income...................................................... 4,743 4,696 4,219 ---------- ---------- ---------- Provision for loan losses................................................ 200 980 360 Noninterest expense, net................................................. $ 3,170 $ 2,918 $ 3,076 Net income............................................................... 789 556 454 BALANCE SHEET: Cash and cash equivalents................................................ $ 20,265 $ 10,287 $ 10,860 Investment securities.................................................... 15,585 13,856 12,928 Loans and leases, net.................................................... 42,031 44,202 42,634 Other assets............................................................. 6,828 6,221 5,038 ---------- ---------- ---------- Total assets............................................................. $ 84,709 $ 74,566 $ 71,360 ---------- ---------- ---------- ---------- ---------- ---------- Deposits................................................................. $ 75,739 $ 66,239 $ 63,286 Accrued interest and other liabilities................................... 716 1,035 1,172 Stockholders' equity..................................................... 8,254 7,292 6,902 ---------- ---------- ---------- Total liabilities and stockholders' equity............................... $ 84,709 $ 74,566 $ 71,360 ---------- ---------- ---------- ---------- ---------- ----------
5 RISK FACTORS IN ADDITION TO THE OTHER INFORMATION WE PROVIDE IN THIS PROSPECTUS, YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS BEFORE DECIDING WHETHER TO INVEST IN OUR COMMON STOCK. THESE ARE NOT THE ONLY RISKS WE FACE. SOME RISKS ARE NOT YET KNOWN TO US AND THERE ARE OTHERS WE DO NOT CURRENTLY BELIEVE ARE MATERIAL BUT COULD LATER TURN OUT TO BE SO. ALL OF THESE COULD IMPAIR OUR BUSINESS, OPERATING RESULTS OR FINANCIAL CONDITION. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE BECAUSE OF GENERAL MARKET CONDITIONS OR IF ANY OR ALL OF THESE RISKS CAME TO PASS, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT. IN EVALUATING THE RISKS OF INVESTING IN US, YOU SHOULD ALSO EVALUATE THE OTHER INFORMATION SET FORTH IN THIS PROSPECTUS, INCLUDING OUR FINANCIAL STATEMENTS. WE WILL NEED TO INTEGRATE AND OPERATE THE BANKS THAT WE MAY ACQUIRE. If we cannot do so successfully, Pacific Community Banking Group will not succeed. Pacific Community Banking Group has no operating history. We formed in October 1997 to act as a bank holding company. We have agreed to acquire The Bank of Hemet and Valley Bank. Each of these banks has an operating history but not under our management. We may not be able to accomplish our business plan. Our business plan requires that: - We integrate The Bank of Hemet and Valley Bank effectively. We expect to increase the banks' profits by reducing costs, expanding services and integrating administrative functions. We may not be able to realize the operating efficiencies we expect. In addition, it may take longer than we expect to realize these efficiencies. If the integration of the banks does not proceed as anticipated, it could hurt our business. - We manage The Bank of Hemet and Valley Bank well. After Pacific Community Banking Group acquires the banks, the banks will hold substantially all of our assets and conduct substantially all of our business. If we cannot operate the banks successfully, it will hurt our business. Our business plan also provides that when we acquire additional banks, we integrate and manage their businesses effectively, too. We plan to acquire other banks and branches, if we can find appropriate acquisitions. We may not find appropriate banks or branches to acquire. If we do make acquisitions, in each future acquisition, we will face risks. If we cannot overcome these risks or any other problems encountered in connection with acquisitions, it could hurt our business. The risks of acquisitions, including the acquisitions of The Bank of Hemet and Valley Bank, include the following: - Management will have to divert their time from regular duties to integrating the new businesses; - The acquired banks may have unexpected problems with loans or legal liabilities; - We may lose the customers and employees of the acquired banks; - New management may not work smoothly with our established employees and customers; - The assimilation of new operations, sites and personnel could divert resources from regular banking operations; - The new banks or branches may not generate enough revenue to offset the acquisition costs; and 6 - We may have trouble maintaining uniform standards, controls, procedures and policies. WE MAY NOT BE ABLE TO FUND OUR PLANNED GROWTH. If adequate funds are not available on acceptable terms, we may not be able to fund our expansion, develop or enhance our products or services or respond to competitive pressures. Based on our current operating plan, we expect the net proceeds of the public offering of common stock of Pacific Community Banking Group, together with our other available funds, to be sufficient to acquire The Bank of Hemet and Valley Bank, provide working capital and fund our capital expenditures in the near future. We intend to grow by acquiring more bank assets. If the shareholders of the banks we seek to acquire will not accept our stock in exchange for their shares, we will need to raise additional capital to acquire more bank assets for cash. We may also need to raise additional capital if we seek to develop new or enhanced services, or to respond to competitive pressures. Market conditions may sometimes make it impossible to raise capital by selling our securities to the public or to private investors. We may be unable to obtain financing from other sources on acceptable terms. FUTURE SALES OF SECURITIES COULD DIMINISH THE INTERESTS OF OUR SHAREHOLDERS. If we raise additional funds by issuing equity or convertible debt securities, the percentage ownership of our shareholders will be diluted. Also, any new securities could have rights, preferences and privileges senior to those of our common stock. We currently do not have any commitments for additional financing. We cannot be certain that additional financing will be available in the future to the extent required or that, if available, it will be made on acceptable terms. WE DEPEND ON KEY EMPLOYEES. If we lost, or had an interruption in, their services, it could hurt our business, particularly if they went to work for competitors. Our future success depends on the continued contributions of our existing senior management personnel, particularly on the efforts of E. Lynn Caswell, the Chief Executive Officer and the Chairman of the Board of Pacific Community Banking Group, who will be Chairman of the Board of both The Bank of Hemet and Valley Bank. We will also depend on the continuing services of certain of the management and staff of The Bank of Hemet and Valley Bank. Mr. Caswell has an employment agreement with us, which includes provisions that would limit his ability to compete against us at another company. WE FACE STRONG COMPETITION. We will conduct our banking operations primarily in Riverside county and plan to expand elsewhere in and near Southern California if economic conditions permit. Increased competition in our markets may result in reduced loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer the banking services that we offer in our service area. These competitors include nationwide banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including savings and loans, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. Many of our most significant competitors have greater resources and capital than we will have. Their size gives them economies of scale and permits them to invest heavily in technology. We believe our non-bank competitors also generally have fewer regulatory constraints. 7 OUR SUCCESS DEPENDS ON ORIGINATING LOANS. Our competitors may offer better terms or better service, or respond to changing capital and other regulatory requirements better than we do. Some of our competitors make loans on terms that we consider risky and therefore will not match. Any of these competitive developments could hurt our business. Success in competing for loans depends on such factors as: - the quality of service to borrowers, especially the length of time it takes to process loans; - economic factors like interest rates; - the terms of the loans we offer, such as rate adjustment provisions, adjustment caps, loan maturities, loan-to-value ratios and loan fees; and - the size of the loans we are able to offer. ECONOMIC CONDITIONS IN SOUTHERN CALIFORNIA COULD HURT OUR BUSINESS. We focus our business in Southern California, primarily in Riverside county. In the early 1990's, the California economy experienced an economic recession that increased the level of delinquencies and losses for The Bank of Hemet, Valley Bank and many of the state's other financial institutions. Another recession could occur. An economic slow-down in Southern California could have the following consequences, any of which could hurt our business: - Loan delinquencies may increase; - Problem assets and foreclosures may increase; - Claims and lawsuits may increase; - Demand for the banks' products and services may decline; - Collateral for loans made by the banks, especially real estate, may decline in value, in turn reducing customers' borrowing power, reducing the value of assets associated with problem loans and reducing collateral coverage of the banks' existing loans. A DOWNTURN IN THE REAL ESTATE MARKET COULD HURT OUR BUSINESS. The banks' ability to recover on defaulted loans by selling the collateral on real estate secured loans would then be diminished, and we would be more likely to suffer losses on defaulted loans. As of December 31, 1998, approximately 95 percent of the value of The Bank of Hemet's loan portfolio and 70 percent of the value of Valley Bank's loan portfolio consisted of loans secured by various types of real estate. Most of The Bank of Hemet's and Valley Bank's real property collateral is located in Southern California. If there is a significant decline in real estate values, especially in California, the collateral for our loans will provide less security. ENVIRONMENTAL LAWS COULD FORCE THE BANKS TO PAY FOR ENVIRONMENTAL PROBLEMS. The cost of cleaning up or paying damages and penalties associated with environmental problems would hurt our business. When a borrower defaults on a loan secured by real property, the banks often purchase the property in foreclosure or accept a deed to the property surrendered by the borrower. The banks may also take over the management of commercial properties whose owners have defaulted on loans. The banks also own and lease premises where their branches and other facilities are located. While the banks have lending, foreclosure and facilities guidelines intended to exclude properties with an unreasonable risk of contamination, hazardous substances may exist on some of the properties that the banks 8 own, manage or occupy. The banks face the risk that environmental laws could force them to clean up the properties at their expense. It may cost much more to clean a property than the property is worth. The banks could also be liable for pollution generated by a borrower's operations if a bank took a role in managing those operations after a default. The banks may also find it difficult or impossible to sell contaminated properties. WE ARE EXPOSED TO THE RISKS OF NATURAL DISASTERS. A major earthquake could result in material loss to the banks. Our operations are concentrated in Southern California, especially Riverside county. A significant percentage of our loans will be secured by real estate. California is an earthquake-prone region. The San Andreas Fault runs directly through our service area. Both of the banks have a disaster-recovery plan with offsite data processing resources located in Scottsdale, Arizona. However, the banks' properties and most of the real and personal property securing loans in the banks' portfolios are in Southern California. Many of our borrowers could suffer uninsured property damage, experience interruption of their businesses or lose their jobs after an earthquake. Those borrowers might not be able to repay their loans, and the collateral for loans could decline significantly in value. Unlike a bank with operations that are more geographically diversified, we are vulnerable to greater losses if an earthquake, fire, flood or other natural catastrophe occurs in Southern California. LOAN LOSS RESERVES MAY NOT COVER ACTUAL LOAN LOSSES. If the actual loan losses exceed the amount reserved, it will hurt our business. The banks try to limit the risk that borrowers will fail to repay loans by carefully underwriting the loans. Losses nevertheless occur. The banks create reserves for estimated loan losses in their accounting records. They base these allowances on estimates of the following: - industry standards; - historical experience with our loans; - evaluation of current and predicted economic conditions; - regular reviews of the quality mix and size of the overall loan portfolio; - regular reviews of delinquencies; and - the quality of the collateral underlying their loans. OUR NON-PERFORMING ASSETS MAY INCREASE. If the level of non-performing assets rises in the future, it could hurt our business. Non-performing assets are mainly loans on which the borrowers are not making their required payments. Non-performing assets also include loans that have been restructured to permit the borrower to have smaller payments and real estate that has been acquired through foreclosure of unpaid loans. To the extent that assets are non-performing, the banks have less cash available for lending and other activities. GOVERNMENT GUARANTEED LOAN PROGRAMS MAY CHANGE, BE CURTAILED TEMPORARILY OR BE DISCONTINUED. If Valley Bank cannot continue making and selling government guaranteed loans, it could hurt our business. A major part of Valley Bank's business is the origination and sale of government guaranteed loans. From time to time, the government agencies that guarantee these loans reach their internal limits, and cease to guarantee loans for a stated time period. In addition, these agencies may change their rules for loans. Also, Congress may adopt legislation that would have the effect of discontinuing or changing the programs. Nongovernmental programs could replace government programs for some borrowers, but the 9 terms might not be equally acceptable. Therefore, if these changes occur, the volume of loans to small business, industrial and agricultural borrowers of the types that now qualify for government guaranteed loans could decline. Also, the profitability of these loans could decline. CHANGES IN INTEREST RATES AFFECT OUR PROFITABILITY. Changes in prevailing rates may hurt our business. We derive our income mainly from the difference or "spread" between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. In general, the wider the spread, the more we earn. When market rates of interest change, the values of our interest-earning assets and interest-bearing liabilities will have disproportionate changes in value that can dramatically reduce our spread. In addition, interest rates affect how much money we can lend. For example, when interest rates rise, loan originations tend to decrease. GOVERNMENTAL REGULATION MAY IMPAIR OUR OPERATIONS OR RESTRICT OUR GROWTH. If we fail to comply with the federal and state bank regulations, the regulators may limit our activities or growth, fine us or ultimately put us out of business. Banking laws and regulations change from time to time. Bank regulation can hinder our ability to compete with financial services companies that are not regulated or are less regulated. In addition, bank regulators impose material compliance costs on us. Federal and state bank regulatory agencies regulate many aspects of our operations. These areas include: - the capital we must maintain; - the kinds of activities we can engage in; - the kinds and amounts of investments we can make; - the locations of our offices; - how much interest we can pay on demand deposits; - insurance of our deposits and the premiums we must pay for this insurance; and - how much cash we must set aside as reserves for deposits. IF VALLEY BANK FAILS TO MEET ITS COMMITMENTS TO BANK REGULATORS, IT COULD HURT OUR BUSINESS. In October, 1998 the board of directors of Valley Bank adopted resolutions committing to accomplish certain goals. If the regulators are not satisfied with Valley Bank's progress, they could impose more severe restrictions, fine the bank or take other regulatory action, which could hurt our business. The commitments include: - to develop a formal written testing plan for Year 2000 issues; - to maintain capital equal to 8% of Valley Bank's adjusted total assets; - to improve asset quality; - to improve earnings; - to adopt procedures to ensure compliance with applicable law and regulations; and - to obtain prior FDIC approval for new directors and senior officers. 10 Valley Bank's management believes that Valley Bank is in compliance in these matters. However, Valley Bank may not continue to meet these requirements. ACQUISITIONS FOR CASH COULD REDUCE OUR EARNINGS AND REDUCE THE PRICE OF OUR STOCK. When we seek to acquire a bank in the future, the bank's shareholders may not accept our stock in exchange for their shares. In that case, we could raise capital and try to acquire the bank for cash. If we are successful in acquiring a bank for either cash or stock, for several years a portion of the purchase price, referred to as goodwill, may be reported on our financial statements each year as an expense. That would reduce the size of our reported earnings, which, in turn, could reduce the price of our common stock. THE BANKS HAVE YEAR 2000 RISKS. If the banks, their vendors, customers or other third parties suffer a computer failure, it could hurt our business. After the acquisition transaction is completed, we will rely primarily on the data processing systems, hardware and software of The Bank of Hemet and Valley Bank to conduct our operations. Each of the banks has taken steps to make its own information and environmental systems Year 2000 compliant by the third quarter of 1999. Each has also developed contingency plans to reduce the impact of any failures which may occur. However, each also relies heavily on the information systems of vendors, customers and other third parties. These third parties may not become Year 2000 compliant soon enough. Moreover, the contingency and remediation efforts of the two banks may not succeed. For more information on the specific steps that the banks are taking, please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations of Bank of Hemet--Year 2000 Compliance" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of Valley Bank--Year 2000 Compliance" below. BANKLINK CORPORATION'S SYSTEMS MAY BECOME OBSOLETE. BankLink Corporation is The Bank of Hemet's subsidiary that does data processing and item processing for several banks, including The Bank of Hemet. If its systems do not remain competitive, it may lose customers. However, the cost of upgrading systems to remain competitive may be a financial burden. The ability of BankLink Corporation to remain as the service provider for these banks depends on its continuing ability to offer competitive services. WE HAVE TO DEFEND A LAWSUIT. The Bank of Hemet is currently the defendant in a class action lawsuit. If this lawsuit is lost or settled, to the extent that insurance does not cover the cost, it will hurt our business. After Pacific Community Banking Group acquires The Bank of Hemet, it will be at risk for the future results of this lawsuit. The lawsuit relates to The Bank of Hemet's 1992 acquisition of Inland Savings and Loan Association. The class action plaintiffs allege that the bank improperly adjusted the value of The Bank of Hemet preferred stock that was issued to the plaintiffs when The Bank of Hemet acquired Inland Savings and Loan Association. On January 14, 1999, the court certified the case as a class action. The complaint alleges breach of contract, and breach of fiduciary duty, and seeks compensatory damages in excess of $2 million, together with punitive damages. The Bank of Hemet does not believe that the plaintiffs' claims have any merit. It is vigorously defending against these claims and has filed a motion for summary judgment on the breach of fiduciary duty claim. The Bank of Hemet further believes that a substantial portion of the costs of any judgment relating to damages other than punitive damages will be paid by its insurance company. The 11 Bank of Hemet has not established a reserve in its consolidated financial statements for a possible loss caused by this lawsuit. AN ACTIVE TRADING MARKET FOR OUR STOCK MAY NOT DEVELOP. Any reduction in the number of firms making a trading market in our stock may impair your ability to sell your shares of common stock. If that happens after this offering, you may encounter delay or have to accept a reduced price when you sell our securities. We plan to have our common stock listed on the Nasdaq National Market after this offering. Sutro & Co. Incorporated has indicated that it intends to act as a market maker of our common stock as long as the volume of trading and other market-making considerations justify it. We cannot be sure how active the trading market for our common stock will be after the initial public offering. THE PRICE OF OUR COMMON STOCK MAY CHANGE WIDELY. The initial public offering price of Pacific Community Banking Group's common stock results from negotiations between us and the underwriters. Given the lack of any trading history of our common stock and our inability to predict where our common stock will trade in the future, we cannot be sure that the initial public offering price of our common stock will approximate the trading price of our common stock after this offering. The price of our common stock may fluctuate widely, depending on many factors. Some of these factors have little to do with our operating results or our intrinsic worth. For example, the market value of our common stock may be affected by the trading volume of the shares, announcements of expanded services by us or our competitors, general banks in the banking industry, general price and volume fluctuations in the stock market, acquisitions of related companies, variations in quarterly operating results, and the dilutive effects of future issuances of common or convertible preferred stock. Also, if the trading market for our common stock remains limited, that may exaggerate changes in market value, leading to more price volatility than would occur in a more active trading market. OUR ABILITY TO PAY DIVIDENDS IS LIMITED. We do not intend to pay dividends on Pacific Community Banking Group's common stock for the foreseeable future. Instead, we intend to reinvest our earnings in our business. In addition, to pay dividends to our shareholders, Pacific Community Banking Group would need to obtain funds from our bank subsidiaries. Their ability, in turn, to pay dividends to us is limited by California law and federal banking law. In particular, neither bank may pay a dividend that exceeds the lesser of either of the following: - the bank's retained earnings; or - the bank's net income for its last three fiscal years, minus the amount of any prior dividend during those three years. With the approval of the regulators, a bank may pay dividends above those amounts, but not more than the greater of the bank's retained earnings, its net income for its last fiscal year, or its net income for the current fiscal year. Even if one of the banks were able to meet the dividend test described above, it might not be able to pay dividends if the result would cause its capital to fall below federal capital standards that apply to banks. SUBSTANTIAL SALES OF OUR COMMON STOCK COULD ADVERSELY AFFECT OUR STOCK PRICE. Sales of substantial amounts of Pacific Community Banking Group's common stock in the public market after the completion of the initial public offering could hurt the market price of our common stock. Some shares of our common stock are subject to a contractual lock-up 12 agreement. Under this agreement, shareholders will be restricted from selling their shares for either 90 or 180 days. Still, sales of substantial amounts of common stock after this offering could cause the price of Pacific Community Banking Group's common stock to decline. That could reduce our ability to raise capital by issuing additional common stock. At the completion of the initial public offering and the bank acquisitions, various shares of common stock will be subject to possible sale and issue by Pacific Community Banking Group. The sale of those shares could dilute the already issued common stock. For example, after the closing of this offering and the bank acquisitions: - In connection with the acquisitions of both The Bank of Hemet and Valley Bank, the shareholders of those banks will receive warrants to purchase our common stock, and shares of our common stock will be issued whenever those warrants are exercised. - Mr. Caswell's employment agreement provides that at the close of the acquisitions and public offering, he will be granted options to purchase up to 250,000 shares or 5% of our common stock, whichever is greater. - We intend to grant stock options to employees, consultants and directors of Pacific Community Banking Group, The Bank of Hemet and Valley Bank. Additional shares of common stock will be issued when these people exercise their options. - We intend to pursue acquisitions of other financial institutions from time to time in exchange for the issuance of additional shares of our common stock or other securities convertible into or exercisable for our common stock. - We will be authorized under our articles of incorporation to issue additional shares of common stock, and preferred stock that may be convertible into common stock, without further shareholder approval. BANK REGULATORY LAWS COULD DISCOURAGE CHANGES IN OUR OWNERSHIP. These regulations would delay and possibly discourage a potential acquiror who would have been willing to pay a premium price to amass a large block of our common stock. That in turn could decrease the value of our common stock. Before anyone can buy enough voting stock to exercise control over a bank holding company like us, bank regulators must approve the acquisition. A shareholder must apply for regulatory approval to own 10 percent or more of our common stock, unless the shareholder can show that he or she will not actually exert control over us. In no case can a shareholder own more than 25 percent of our stock without applying for regulatory approval. PROVISIONS IN OUR CHARTER DOCUMENTS AND AGREEMENTS WE HAVE MADE WILL DELAY OR PREVENT CHANGES IN CONTROL OF OUR CORPORATION OR OUR MANAGEMENT. These provisions make it more difficult for another company to acquire us, which could reduce the market price of our common stock. These provisions include the following: - A provision requiring a two-thirds vote when shareholders approve certain business combinations, approve certain amendments to the charter and bylaws and take action by written consent; - A requirement that shareholders give advance notice of matters to be raised at a meeting of shareholders; and - Staggered terms of office for members of the board of directors. 13 Contractual arrangements that impede changes in control include severance agreements for our executive officers and commitments to issue options. FORWARD-LOOKING STATEMENTS Some of the statements under "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this Prospectus constitute forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by the forward-looking statements. These factors include, among other things, those listed under "Risk Factors" and elsewhere in this prospectus. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential," or "continue" or the negative of such terms and other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor anyone else assume responsibility for the accuracy and completeness of such statements. We are under no duty to update any of the forward-looking statements after the date of this prospectus. USE OF PROCEEDS We estimate that our net proceeds from the sale of shares by us in this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us Pacific Community Banking Group, will be $3.3 million ($11.0 million if the underwriters exercise their over-allotment option in-full) at an assumed initial public offering price of $15 per share. We intend to use the net proceeds for working capital and general corporate purposes, and to pay a fee of $750,000 to Sutro & Co. Incorporated as compensation for its advisory services in our acquisitions of The Bank of Hemet and Valley Bank. Until they are needed, the net proceeds will be invested in short-term, investment grade, interest-bearing obligations. We will not receive any proceeds from the sale of shares by the selling shareholders. Please refer to "Principal and Selling Shareholders" on page 104. DIVIDEND POLICY Pacific Community Banking Group has never declared or paid dividends on its common stock and anticipates that all earnings will be retained for use in its business. The payment of any future dividends will be at the discretion of the board of directors. Please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations." 14 CAPITALIZATION THROUGHOUT THIS PROSPECTUS, WHEN CALCULATING NUMBERS OF SHARES AND NUMBERS "PER SHARE" WE HAVE ASSUMED THAT THE UNDERWRITERS WILL NOT EXERCISE THEIR OVERALLOTMENT OPTION, EXCEPT WHERE WE STATE THAT WE INCLUDED THE OVER-ALLOTMENT OPTION IN THE CALCULATIONS. The following table sets forth (i) the capitalization of Pacific Community Banking Group as of December 31, 1998, after giving effect to the business combination of Pacific Community Banking Group, The Bank of Hemet and Valley Bank, and (ii) the capitalization of Pacific Community Banking Group as adjusted to give effect to the sale of 562,000 shares of common stock and automatic conversion of 1,305,000 shares of preferred stock into 106,000 shares of common stock offered by Pacific Community Banking Group at the initial public offering price of $15.00 per share and the application of the net proceeds after deducting the underwriting discount and estimated offering expenses. Please refer to "Use of Proceeds" for additional information about the planned use of proceeds of this offering. This table should be read in conjunction with the "Unaudited Summary Pro Forma Combined Financial Information" and the Consolidated Financial Statements included in this prospectus.
DECEMBER 31, 1998 -------------------------- PRO FORMA PRO FORMA AS AS COMBINED ADJUSTED(4) ----------- ------------- (DOLLARS IN THOUSANDS) Preferred stock; no par value, 100,000,000 shares authorized, pro forma as combined and as adjusted Series A: 1,085,000 shares authorized, 724,000 outstanding, pro forma as combined and none, pro forma as adjusted(1,2)............................................. $ 724 $ -- Series B: 375,000 shares authorized, 375,000 outstanding, pro forma as combined and none, pro forma as adjusted(1,2)................................................. 375 -- Common stock, no par value: 100,000,000 shares authorized; 3,957,912 shares outstanding, pro forma as combined and 4,519,464, pro forma as adjusted(1,3,4)...... 21,162 25,572 Retained earnings.................................................................... 14,321 14,321 ----------- ------------- Total stockholders' equity........................................................... 36,582 39,893 ----------- ------------- Total capitalization................................................................. $ 36,582 $ 39,893 ----------- ------------- ----------- -------------
- ------------------------ (1) Reflects the conversion of common stock subscriptions totaling $1,305,000 as of December 31, 1998, $1,099,000 of which had been paid, into shares of Pacific Community Banking Group Series A and B Preferred Stock. (2) Excludes $361,000 of preferred stock subscriptions which were received after December 31, 1998. (3) Excludes 1,308,000 warrants for the purchase of common stock issued in connection with the business combination with Valley Bank and The Bank of Hemet. (4) Includes $3,311,000 to give effect to the net proceeds from the sale of approximately 562,000 shares of common stock offered through this prospectus as well as conversion of all shares of Series A and Series B preferred stock into common stock effective at the closing of the offering. 15 DILUTION As of December 31, 1998, Pacific Community Banking Group had a pro forma net tangible book value of approximately $25,211,000, or $6.37 per share of common stock, after giving effect to the business combination of The Bank of Hemet, Valley Bank and Pacific Community Banking Group. Pro forma net tangible book value per share represents total tangible assets less total liabilities, divided by the number of shares of common stock outstanding at that date. Without taking into account any other changes in the pro forma net tangible book value after December 31, 1998 other than to give effect to the receipt by Pacific Community Banking Group of the net proceeds to Pacific Community Banking Group from the sale of approximately 562,000 shares of common stock offered at the initial public offering price of $15.00 per share, the pro forma net tangible book value at December 31, 1998 would have been approximately $28,522,000 or $6.31 per share. This represents an immediate decrease in net tangible book value of $.06 per share to existing shareholders and an immediate dilution of $8.69 per share to new investors purchasing shares of common stock in this offering. The following table illustrates this per share dilution: Initial public offering price per share..................... $ 15.00 --------- Pro forma net tangible book value per share............... $ 6.37 --------- Decrease per share attributable to new investors.......... (.06) --------- Pro forma net tangible book value per share after this offering.................................................. 6.31 --------- Dilution per share to new investors......................... $ 8.69 --------- ---------
The following table summarizes, on a pro forma basis, as of December 31, 1998, the differences between the number of shares of common stock purchased from Pacific Community Banking Group, the aggregate consideration and the average price per share from existing shareholders and from new investors purchasing shares of common stock in this offering. Sales by the selling shareholders in this offering will reduce the number of shares of common stock held by existing shareholders to a total of between 819,000 and 1,206,000 shares, or between approximately 18% and 27% (approximately 16% to 24% if the underwriters' over-allotment option is exercised in full) of the total number of shares of common stock outstanding after this offering. Please refer to "Principal and Selling Shareholders" on page .
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE ----------------------- -------------------------- PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- ----------- ------------- ----------- ----------- Existing shareholders, pro forma as combined(1)..... 3,957,912 87.6% $ 25,211,000 75.0% $ 6.37 New investors....................................... 561,551 12.4% 8,423,000 25.0 15.00 ---------- ----- ------------- ----- Total........................................... 4,519,464 100.0% $ 33,634,000 100.0% ---------- ----- ------------- ----- ---------- ----- ------------- -----
- ------------------------ (1) Includes holders of preferred stock that will automatically convert to common stock upon completion of this offering. This information assumes no exercise of the Underwriter's over-allotment option and no exercise of stock options or warrants that will be outstanding after this offering. 16 REGULATORY CAPITAL AND LEVERAGE RATIO The following table illustrates the actual regulatory capital and leverage ratios of The Bank of Hemet and Valley Bank and the pro forma regulatory capital and leverage ratios of Pacific Community Banking Group, in each case, as of December 31, 1998. The pro forma ratios are stated after giving effect to this offering and the acquisitions, assuming approximately $3.3 million in net proceeds is raised in this offering; all of which is held in cash or cash equivalent investments. Please refer to "Unaudited Pro Forma Combined Financial Data" and the assumptions set forth therein.
AT DECEMBER 31, 1998 --------------------------------------------- TIER 1 RISK- TOTAL RISK- LEVERAGE BASED BASED RATIO CAPITAL RATIO CAPITAL RATIO ----------- --------------- --------------- The Bank of Hemet......................................................... 8.31% 9.99% 11.06% Valley Bank............................................................... 10.20 15.50 16.70 Minimum regulatory requirement for a "well-capitalized" bank(1)........... 5.00 6.00 10.00 Minimum regulatory capital for a bank(1).................................. 4.00 4.00 8.00 Pro forma for Pacific Community Banking Group after the offering and acquisitions............................................................ 7.55 9.56 10.81 ----- ----- ----- Minimum regulatory requirement for a well-capitalized holding company(2).............................................................. 5.00 6.00 10.00 ----- ----- ----- Minimum regulatory capital for a holding company(2)....................... 4.00 4.00 8.00
- ------------------------ (1) Pursuant to regulations of the FDIC. Please refer to "Supervision and Regulation--Capital Standards." (2) Pursuant to regulations of the FRB. Please refer to "Supervision and Regulation--Capital Standards." THE ACQUISITIONS The Bank of Hemet acquisition and the Valley Bank acquisition are independent transactions. A majority of the shares of common stock of The Bank of Hemet must be voted in favor of the Bank of Hemet acquisition before that acquisition can close. Two-thirds of the shares of common stock of Valley Bank must be voted in favor of the Valley Bank acquisition before that acquisition can close. If either of the acquisitions fails to be approved by the requisite number of shareholders or Pacific Community Banking Group determines that either will not close for any other reason, you will receive additional disclosure before the closing of this offering. Pacific Community Banking Group expects, however, that neither acquisition will close unless both close. GENERAL Pacific Community Banking Group and The Bank of Hemet have entered into an agreement under which Pacific Community Banking Group agreed to acquire The Bank of Hemet for approximately 2,870,540 shares of Pacific Community Banking Group common stock plus warrants exercisable into approximately 876,000 shares of Pacific Community Banking Group common stock. For detailed information about the terms of this agreement, please refer to the section entitled "The Bank of Hemet Agreement," beginning on page below. 17 Pacific Community Banking Group and Valley Bank have entered into an agreement under which Pacific Community Banking Group agreed to acquire Valley Bank for approximately 781,271 shares of Pacific Community Banking Group common stock, and warrants exercisable into approximately 432,000 shares of Pacific Community Banking Group common stock. For detailed information about the terms of this agreement, please refer to the section entitled "The Valley Bank Agreement," below. To accomplish the acquisitions, Pacific Community Banking Group will establish two subsidiaries, PCBG Merger Corporation and Interim Valley Bank. PCBG Merger Corporation will merge with and into The Bank of Hemet, with The Bank of Hemet to be the surviving corporation in the merger. Simultaneously, Valley Bank will merge with and into Interim Valley Bank, with Interim Valley Bank to be the surviving corporation. The name of "Interim Valley Bank" will then be changed to "Valley Bank." Pacific Community Banking Group intends The Bank of Hemet to continue as a California corporation wholly owned by Pacific Community Banking Group, retaining its articles of incorporation and bylaws as well as certain of its officers and directors. Pacific Community Banking Group expects to combine most of the assets and liabilities of Valley Bank with those of The Bank of Hemet in the near future, most likely within six months of the completion of the acquisitions, operating the combined bank under the Bank of Hemet's charter. Pacific Community Banking Group then intends to relocate Valley Bank with its remaining assets to Orange county and allow Valley Bank to develop a banking business under its existing charter. Pacific Community Banking Group intends to consummate The Bank of Hemet and Valley Bank acquisitions simultaneously by June 28, 1999. This offering is made for two purposes: (1) New shares are being sold by Pacific Community Banking Group to raise capital for ongoing operations and to pay certain fees incurred in connection with the acquisitions; and (2) former shareholders of The Bank of Hemet and Valley Bank are selling some of the shares they will receive in the acquisitions. To accomplish the closing of the acquisitions and this offering, Pacific Community Banking Group will not commence this offering until the requisite approval of shareholders and all other required preconditions to the acquisitions (except the payment of the purchase price) have been satisfied or waived. Pacific Community Banking Group is not obligated to complete either of the acquisitions unless all conditions to completion of this offering have been satisfied or waived. By the terms of the Bank of Hemet agreement and the Valley Bank agreement, neither acquisition is dependent on the other. However, each acquisition is conditioned upon the satisfaction or waiver of all conditions to completion of the offering. If either acquisition fails to receive the required shareholder approval, or if either bank is not obligated to close because of failure of some other precondition, then Pacific Community Banking Group will disclose those facts before the closing of this offering, including circulating a revised prospectus. If as a result this offering cannot be completed, then any obligation of Pacific Community Banking Group to complete the acquisitions will terminate. Sutro & Co. Incorporated has advised Pacific Community Banking Group in connection with identifying The Bank of Hemet and Valley Bank and negotiating the acquisitions. As compensation for these services, Sutro & Co. Incorporated will receive a fee of $750,000 on the closing of the acquisitions. 18 UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION The following unaudited pro forma combined statement of operations reflects the business combination of The Bank of Hemet, Valley Bank, and Pacific Community Banking Group as if it had occurred on January 1, 1998. The following unaudited pro forma combined balance sheet reflects the business combination as if it had occurred as of December 31, 1998. Under generally accepted accounting principles, the business combination is treated as an acquisition of Pacific Community Banking Group and Valley Bank by The Bank of Hemet using the purchase method of accounting. The pro forma financial information gives effect to the business combination consistent with such principles. The historical financial information of Pacific Community Banking Group, The Bank of Hemet, and Valley Bank for the year ended December 31, 1998 has been derived from their respective financial statements included in this prospectus. The pro forma financial information should be read in conjunction with the accompanying notes thereto and with the financial statements of the respective companies. The pro forma combined financial information does not purport to be indicative of operating results which would have been achieved had the acquisitions occurred on the dates indicated and should not be construed as representative of future operating results. In the opinion of Pacific Community Banking Group's management, all adjustments have been made to reflect the effects of the acquisitions. 19 PRO FORMA COMBINED STATEMENTS OF OPERATIONS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
HISTORICAL--YEAR ENDED DECEMBER 31, 1998 PRO FORMA ------------------------------------- COMBINED-- PACIFIC THE BANK YEAR ENDED COMMUNITY OF VALLEY PRO FORMA DECEMBER 31, BANKING GROUP HEMET BANK ADJUSTMENTS 1998 --------------- --------- --------- ----------- ------------ Interest income......................................... $ -- $ 19,416 $ 6,181 $ -- $ 25,597 Interest expense........................................ -- 9,185 1,438 -- 10,623 ----- --------- --------- ----------- ------------ Net interest income................................... 10,231 4,743 14,974 Provision for loan losses............................... -- -- 200 -- 200 ----- --------- --------- ----------- ------------ Net interest income after provision................... -- 10,231 4,543 -- 14,774 Noninterest income...................................... -- 1,363 2,915 -- 4,278 Noninterest expense Salaries and employee benefits........................ -- 3,735 3,272 682(1) 7,689 Premises and equipment................................ -- 1,066 921 -- 1,987 Other real estate owned, net.......................... -- (101) 41 -- (60) Other expenses........................................ 513 2,036 1,851 914(2) 5,314 ----- --------- --------- ----------- ------------ Total noninterest expense........................... 513 6,736 6,085 1,596 14,930 ----- --------- --------- ----------- ------------ Income before income taxes.............................. (513) 4,858 1,373 (1,596) 4,122 Provision for income taxes.............................. -- 2,035 584 (531)(3) 2,088 ----- --------- --------- ----------- ------------ Net income (loss)................................... $ (513) $ 2,823 $ 789 $ (1,065) $ 2,034 ----- --------- --------- ----------- ------------ ----- --------- --------- ----------- ------------ Pro forma net income per share.......................... $ 0.51(4) ------------ ------------ Pro forma shares outstanding............................ 3,957,912(4) ------------ ------------
- ------------------------ (1) Reflects a provision for compensation due to certain former officers of The Bank of Hemet, which vests in full as of the closing of the business combination. (2) Reflects amortization of goodwill and other intangible assets resulting from the acquisitions as if they had been completed as of the first day of the period presented. Goodwill is amortized using a 25-year life, and other intangible assets, which consist primarily of a core deposits intangible, are amortized based on the expected runoff of the related deposits. The estimated runoff of such deposits will result in amortization of the balance of the core deposits intangible asset on an accelerated basis over a period of ten years. (3) Reflects the income tax effect of the pro forma adjustments at an effective rate of 40% for the amortization of the core deposits intangible and the additional compensation due to the former officers of the Bank of Hemet. (4) Pro forma net income per share is calculated on a fully diluted basis. Pro forma weighted average shares outstanding is calculated giving effect to the conversion of The Bank of Hemet common stock to Pacific Community Banking Group common stock at a conversion ratio of 3.4 to one, the shares of Pacific Community Banking Group common stock issuable pursuant to the acquisition of Valley Bank, and the conversion of all shares of Pacific Community Banking Group preferred stock into shares of common stock. 20 PRO FORMA COMBINED BALANCE SHEET (UNAUDITED) (IN THOUSANDS)
HISTORICAL--DECEMBER 31, 1998 ------------------------------------ PACIFIC PRO FORMA COMMUNITY COMBINED-- BANKING THE BANK VALLEY PRO FORMA DECEMBER 31, GROUP OF HEMET BANK ADJUSTMENTS 1998 ----------- ---------- ----------- ----------- ------------ Cash and due from banks....................... $ 396 $ 6,496 $ 6,485 $ (609)(1) $ 12,768 Federal funds sold............................ -- 10,500 13,780 -- 24,280 ----------- ---------- ----------- ----------- ------------ Total cash and cash equivalents............. 396 16,996 20,265 (609) 37,048 ----------- ---------- ----------- ----------- ------------ Investment securities......................... -- 24,882 15,585 -- 40,467 Loans and leases.............................. -- 207,802 43,149 -- 250,951 Allowance for loan losses..................... -- (2,232) (1,118) -- (3,350) ----------- ---------- ----------- ----------- ------------ Loans and leases, net....................... -- 205,570 42,031 -- 247,601 ----------- ---------- ----------- ----------- ------------ Premises and equipment, net................... 6 1,541 2,158 -- 3,705 Accrued interest receivable................... -- 1,140 611 -- 1,751 Other real estate owned....................... -- 77 1,749 -- 1,826 Other assets.................................. 199 2,671 2,310 (360)(2) 4,820 Goodwill and other intangible assets.......... -- -- -- 11,371(3) 11,371 ----------- ---------- ----------- ----------- ------------ Total assets.................................. $ 601 $ 252,877 $ 84,709 $ 10,402 $ 348,589 ----------- ---------- ----------- ----------- ------------ ----------- ---------- ----------- ----------- ------------ Deposits Noninterest bearing demand deposits......... $ -- $ 33,975 $ 20,061 $ -- $ 54,036 Savings and interest-bearing demand deposits.................................. -- 71,389 39,228 -- 110,617 Time deposits............................... -- 125,021 16,450 -- 141,471 Accrued interest and liabilities.............. 94 1,468 716 3,605 2,4 5,883 Stockholders' equity Common stock, no par value.................. 3 3,666 5,570 11,923(5) 21,162 Preferred stock............................. 1,099 -- -- -- 1,099 Retained earnings........................... (595) 17,358 2,684 (5,126)(5) 14,321 ----------- ---------- ----------- ----------- ------------ Total stockholders' equity.................. 507 21,024 8,254 6,797 36,582 ----------- ---------- ----------- ----------- ------------ Total liabilities and equity.................. $ 601 $ 252,877 $ 84,709 $ 10,402 $ 348,589 ----------- ---------- ----------- ----------- ------------ ----------- ---------- ----------- ----------- ------------
- ------------------------ (1) Reflects a special dividend of $0.52 per common share of Valley Bank, payable at the closing of the acquisition. (2) To record a deferred tax liability of approximately $2,160,000 related to the value attributable to a core deposits intangible asset, which was recorded in accrued interest and other liabilities net of a deferred tax asset of $730,000, as well as deferred taxes of $570,000 relating to the severance obligations discussed below. Also includes reclassification of $200,000 of capitalized acquisition costs to goodwill and other intangible assets. (3) To record the purchase of Valley Bank and Pacific Community Banking Group, which results in the allocation of the excess of the purchase price over their net identifiable assets of $9,700,000 and $1,671,000, respectively, to goodwill and other intangible assets. 21 (4) To record a liability of $682,000 to certain former officers of The Bank of Hemet, which was formerly payable beginning at the respective officer's retirement date, but which vests in full as of the closing of the business combination, and to record severance costs at Valley Bank of $743,000. Additionally, includes an accrual for acquisition fees of $750,000 payable upon completion of the acquisitions. (5) To provide for adjustments related to the application of purchase accounting, which includes the recognition of value for the warrants issued to Valley Bank at $3 per warrant, and to eliminate the equity accounts of the subsidiaries. Additionally, to adjust equity accounts for the warrants issued to shareholders of The Bank of Hemet, the value for which is charged to retained earnings, with a corresponding increase to common equity. 22 PACIFIC COMMUNITY BANKING GROUP SELECTED FINANCIAL INFORMATION The following table sets forth selected financial data of Pacific Community Banking Group. The information presented below is from Pacific Community Banking Group's financial statements, which have been audited by Arthur Andersen LLP, independent public accountants, as indicated in its report thereon included in this prospectus. The data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Pacific Community Banking Group's audited financial statements appearing in this prospectus.
AT OR FOR PERIOD FROM INCEPTION AT OR FOR (OCTOBER 17, YEAR ENDED 1997) TO DECEMBER 31, DECEMBER 31, 1998 1997 -------------- -------------- OPERATIONS: Revenues.................................................... $ -- $ -- General and administrative expenses......................... 525,568 82,477 Interest income............................................. 11,326 -- -------------- -------------- Net loss before taxes....................................... 514,242 82,477 Provision for income taxes.................................. 800 800 -------------- -------------- Net loss.................................................. $ 513,442 $ 81,677 -------------- -------------- -------------- -------------- ASSETS: Cash........................................................ $ 395,948 $ 170,131 Prepaid expenses............................................ 1,333 -- Capitalized acquisition and offering costs.................. 198,127 26,814 Equipment and furniture, net of depreciation................ 5,638 -- -------------- -------------- Total Assets.............................................. $ 601,046 $ 196,945 -------------- -------------- -------------- -------------- LIABILITIES AND SHAREHOLDERS' EQUITY: Accounts payable............................................ $ 94,429 $ 54,112 Refundable common stock subscriptions....................... -- 85,000 Total shareholders' equity.................................. 506,617 57,833 -------------- -------------- Total liabilities and shareholders' equity................ $ 601,046 $ 196,945 -------------- -------------- -------------- -------------- PER SHARE DATA: Weighted average shares outstanding......................... 10,000 10,000 Basic and diluted earnings (loss) per share................. $ (51.34) $ (8.17) Common stock book value..................................... $ 50.66 $ 5.78 Common stock dividends declared............................. $ -- $ --
23 PACIFIC COMMUNITY BANKING GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. PACIFIC COMMUNITY BANKING GROUP'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THE SECTION ENTITLED "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. RESULTS OF OPERATIONS Pacific Community Banking Group was formed in 1997 for the purpose of becoming a multi-bank, community oriented, independent bank holding company that will own a number of community banks, predominantly in high-growth areas of Southern California. Since inception, Pacific Community Banking Group has investigated a number of banks for possible acquisition. These discussions have resulted in acquisition agreements with The Bank of Hemet and Valley Bank. Until these proposed acquisitions are completed, Pacific Community Banking Group will have had no revenue-generating operations. Since its founding, Pacific Community Banking Group's only income has been interest earned on investments and deposits. Nearly all of its expenses have been used for organizational purposes in connection with proposed acquisition opportunities and the initial public offering of its stock. CAPITAL CONTRIBUTIONS The holders of Pacific Community Banking Group's common stock have provided approximately $2,500, and the holders of Pacific Community Banking Group's convertible preferred stock have provided capital of approximately $1.4 million, in each case to fund the costs associated with identifying and acquiring selected community banks and raising the funds for the initial acquisitions and operations. For more information about the holders of this preferred stock and their interests in Pacific Community Banking Group after the acquisitions, please refer to the section entitled "Principal and Selling Shareholders" on page 104. LIQUIDITY AND CAPITAL RESOURCES Based on its current operating plan, Pacific Community Banking Group believes that the net proceeds of the public offering of its common stock, together with its available funds, are sufficient to provide working capital and fund capital expenditures in the near future. Pacific Community Banking Group currently plans to acquire other banks. If it is unable to make future acquisitions by exchanging its securities for those of the acquired banks, Pacific Community Banking Group may need additional capital to make these acquisitions or to increase the size of its operations. If so, Pacific Community Banking Group may seek to raise capital through sales of its securities to private investors or to the public. These sales may not be feasible at times because of market conditions. There is no guarantee that Pacific Community Banking Group will acquire other banks. YEAR 2000 COMPLIANCE Since the formation of Pacific Community Banking Group, information technology has not played an important role in its operations. These operations have consisted of 24 investigating and negotiating potential bank acquisitions. Pacific Community Banking Group has acquired all of its computer hardware and software since October, 1997 and believes its systems are Year 2000 compliant. This hardware and software consists only of personal computers used for word processing and spreadsheet calculations. If, notwithstanding the assurances received from vendors regarding the fact that these computers are Year 2000 compliant, they prove to be noncompliant, as a contingency, Pacific Community Banking Group could obtain word processing and spreadsheet capabilities from third party services. After the acquisitions, Pacific Community Banking Group will not perform data processing services for its banking subsidiaries. Rather, The Bank of Hemet will continue to conduct data processing operations through its subsidiary, BankLink Corporation. Valley Bank will initially perform its own data processing but will become a customer of BankLink Corporation for data processing shortly after the acquisitions. For information on Year 2000 compliance issues for the banks, including their contingency plans, please refer to the sections entitled "The Bank of Hemet Management's Discussion and Analysis of Financial Condition--Year 2000 Compliance," beginning on page 41, and "Valley Bank Management's Discussion and Analysis of Financial Condition--Year 2000 Compliance," beginning on page 74. BUSINESS OF PACIFIC COMMUNITY BANKING GROUP GENERAL A private group of investors led by E. Lynn Caswell, an experienced California community banker, formed our company in 1997. Our company was formed to become a multi-bank, community oriented, independent bank holding company, which intends to acquire a select number of community banks, predominantly in high-growth areas of Southern California. We intend to find strategically located community banks, each of which has a successful history and a favorable image in its market area. Where appropriate we will consolidate the operations of acquired banks, but generally each bank will retain its separate market identity. We plan to achieve economies of management and scale by combining some administrative and support functions, such as financial administration, data processing, insurance, bonding, employee benefits and contracts for services. Since inception, we have investigated a number of banks for possible acquisition, and have initiated discussions with several banks. These discussions have resulted in acquisition agreements with The Bank of Hemet and Valley Bank, which are described elsewhere in this prospectus. We intend to continue discussing potential acquisitions with other banks where those discussions are appropriate. BUSINESS STRATEGY We base our business philosophy on the belief that banking customers value doing business with locally managed institutions that can provide a full service commercial banking relationship through an understanding of the customer's financial needs and the flexibility to customize products and services to meet those needs. We also believe that banks can better build successful customer relationships by affiliating with a holding company that provides cost effective administrative support services while promoting bank autonomy and flexibility. To implement this philosophy, we intend to operate some of our acquired banks as separate subsidiaries and retain their independent names along with their individual boards of directors. We expect that many of our acquired banks, such as The Bank of Hemet and Valley 25 Bank, will have established strong reputations and customer followings in their respective market areas through attention to client service and an understanding of client needs. Where market overlap makes a consolidation of operations among existing banks more cost-efficient, as is the case with Valley Bank and The Bank of Hemet, we intend to take the corporate action necessary to consolidate their operations. In addition, where we perceive that a community lacks a strong independent community bank and would be an appropriate market for one, we intend to form a new bank to fill that community need. We intend to develop a community bank in Orange county, based on our perception that Orange county is one such community. We intend to keep client service decisions and day-to-day operations at the bank level. But we also plan to offer the advantages of affiliation with a multi-bank holding company by providing improved access to the capital markets and expanded client support services, such as financial administration, management and accounting services. In addition, our centralized administration, including support in credit policy formulation and review, investment management, data processing, employee benefits, accounting, insurance and other specialized support functions will allow the banks to focus on client service. Our goal is to become the preeminent financial services company for independent banks in high growth areas of Southern California, commencing with Riverside and San Bernardino counties. Our business strategy is to increase our market share within the communities we serve through internal growth after we acquire The Bank of Hemet and Valley Bank. We will also pursue opportunities to expand our market share through select acquisitions and development of banks that complement our existing businesses. THE INLAND EMPIRE Riverside and San Bernardino counties are commonly referred to as the "Inland Empire." This region is experiencing dramatic population and economic growth. The Inland Empire will be the fastest growing U.S. primary metropolitan statistical area during the years 1993 to 2005, according to a 1996 report of the U.S. Department of Commerce. The Department of Commerce projects that population in the area will grow 32.4% during that period. EMPLOYEES At December 31, 1998, we had two employees, one of whom was an executive officer. Neither is represented by a union or covered by a collective bargaining agreement. We believe our employee relations are excellent. PREMISES We lease approximately 1,050 square feet of space in an executive office suite in Laguna Hills, California. The lease will expire in June 1999. Lease payments include various office support services, and average approximately $3,000 per month. These premises are not large enough for our future needs. We expect to move into larger premises. 26 SUPERVISION AND REGULATION As a bank holding company, we will, upon acquisition of The Bank of Hemet and Valley Bank, become subject to many governmental rules that affect our operations. For a description of the laws and regulations that will apply to Pacific Community Banking Group, please refer to the section entitled "Supervision and Regulation," starting on page 107. LITIGATION We have not become involved in any litigation, and know of no threatened litigation against us that would be material to our operations. 27 THE BANK OF HEMET SELECTED FINANCIAL DATA The following tables present selected historical consolidated financial data, including per share information, for The Bank of Hemet. The following financial data should be read in conjunction with the consolidated financial statements of The Bank of Hemet included or incorporated by reference in this prospectus.
AT OR FOR THE YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE INFORMATION) RESULTS OF OPERATIONS Interest income........................................ $ 19,416 $ 18,991 $ 19,127 $ 19,386 $ 16,601 Interest expense....................................... 9,185 8,946 8,823 9,102 6,615 Net interest income.................................... 10,231 10,045 10,304 10,284 9,986 Provision for loan and lease losses.................... -- 250 988 120 1,500 Noninterest income..................................... 1,363 1,204 1,248 1,218 1,933 Noninterest expense.................................... 6,736 6,200 8,182 7,368 9,197 Net income............................................. 2,823 2,802 1,373 2,321 609 BALANCE SHEET (END OF PERIOD) Total assets........................................... $ 252,877 $ 241,323 $ 234,257 $ 227,955 $ 223,772 Total loans............................................ 207,802 192,287 187,441 185,717 185,746 Allowance for loan and lease losses.................... 2,232 2,116 2,241 2,135 2,609 Nonperforming loans(1)................................. 1,581 2,902 2,993 2,460 3,188 Other real estate owned................................ 77 779 2,180 3,908 2,719 Total deposits......................................... 230,385 219,211 212,268 207,425 203,583 Shareholders' equity................................... 21,024 20,228 20,102 19,078 17,670 BALANCE SHEET (PERIOD AVERAGE) Total assets........................................... $ 248,297 $ 236,297 $ 231,532 $ 227,438 $ 221,431 Total loans............................................ 196,675 187,298 184,307 183,632 185,708 Earning assets......................................... 238,910 226,311 219,822 216,052 207,672 Total deposits......................................... 226,228 214,291 209,938 207,323 200,000 Shareholders' equity................................... 20,594 20,146 20,130 18,695 18,335 CAPITAL RATIOS Leverage ratio......................................... 8.31% 8.53% 8.66% 8.21% 7.98% Tier 1 risk-based capital.............................. 9.99 10.43 10.77 10.29 9.81 Total risk-based capital............................... 11.06 11.53 11.97 11.44 11.07 ASSET QUALITY RATIOS Nonperforming loans/total loans(1)..................... 0.76% 1.51% 1.60% 1.32% 1.72% Nonperforming assets/total assets(2)................... 0.66 1.53 2.21 2.79 2.64 Allowance for loan losses/nonperforming loans.......... 141.16 72.90 74.86 86.78 81.84 Allowance for loan losses/total loans.................. 1.07 1.10 1.20 1.15 1.40 PERFORMANCE RATIOS Return on average assets............................... 1.14% 1.19% 0.59% 1.02% 0.27% Return on average equity............................... 13.71 13.91 6.82 12.42 3.32 Net interest margin(3)................................. 4.28 4.44 4.69 4.76 4.81 Net interest spread(4)................................. 3.37 3.55 3.90 4.05 4.29 Average total loans to average deposits................ 86.94 87.40 87.79 88.57 92.85 Efficiency ratio(5).................................... 58.10 55.11 70.83 64.06 77.16 PER SHARE INFORMATION Basic earnings(6)...................................... $ 3.34 $ 3.25 $ 1.53 $ 2.73 $ 0.74 Diluted earnings(7).................................... $ 3.23 $ 3.15 $ 1.53 $ 2.70 $ 0.70 Common stock dividends declared........................ $ 2.40 $ 1.50 $ 1.00 $ 1.00 $ 0.25 Dividend payout ratio(8)............................... 71.8% 46.2% 65.4% 36.6% 33.7% Common stock book value................................ $ 24.90 $ 23.96 $ 22.46 $ 23.03 $ 21.86 Common shares outstanding at period end(9)............. 844,278 844,278 894,901 828,398 807,594 Weighted average common shares outstanding(10)......... 844,278 863,262 881,705 813,661 806,244
- -------------------------- (1) Nonperforming loans consist of loans on nonaccrual and loans past due 90 days or more. (2) Nonperforming assets consist of nonperforming loans and other real estate owned. 28 (3) Net interest margin is net interest income expressed as a percentage of average total interest-earning assets. (4) Net interest spread is the difference between the yield on average total interest-earning assets and cost of average total interest-bearing liabilities. (5) The efficiency ratio is the ratio of noninterest expense to the sum of net interest income before provision for loan losses and total noninterest income. (6) Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period. (7) Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into the common stock or resulted in the issuance of common stock that then shared in earnings. (8) The dividend payout ratio consists of the common stock dividends paid per share of common stock divided by basic earnings per share of common stock. (9) Based on shares outstanding at period end, excluding shares issuable upon exercise of outstanding options. (10) Weighted average number of shares of common stock outstanding for the period, excluding shares issuable upon exercise of outstanding options. 29 THE BANK OF HEMET MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE BANK OF HEMET'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THE SECTION ENTITLED "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to The Bank of Hemet and its subsidiaries' financial condition, operating results, asset and liability management, liquidity and capital resources. Averages presented in the tables are daily average balances. The following discussion should be read in conjunction with the consolidated financial statements of The Bank of Hemet. FINANCIAL CONDITION Total assets at December 31, 1998 equaled $252.9 million, an increase of $11.6 million, or 4.8%, over total assets of $241.3 million at December 31, 1997. Total loans equaled $207.8 million at December 31, 1998, an increase of $15.5 million, or 8.1%, over total loans of $192.3 million at December 31, 1997. This increase was partially offset by a decrease in cash and cash equivalents, accrued interest receivable and other real estate owned ("OREO"). The loan to deposit ratio grew to 90.2% at year-end 1998, from 87.7% at year-end 1997. The ratio of average total loans to average deposits, however, remained in a relatively narrow range, equaling 86.9% in 1998, compared with 87.4% in 1997 and 87.8% in 1996. The Bank of Hemet continued to decrease its nonperforming loans. At December 31, 1998, nonperforming loans equaled $1.6 million, or 0.76% of total loans. This represented a reduction of $1.3 million, or 45.5%, from nonperforming loans of $2.9 million (1.51% of total loans) at December 31, 1997. In turn, the year-end 1997 level of nonperforming loans represented a reduction of $91,000, or 3.04%, from nonperforming loans of $3.0 million (1.60% of total loans) at December 31, 1996. The allowance for loan and lease losses equaled $2.2 million at December 31, 1998, compared with an allowance of $2.1 million at December 31, 1997. The allowance at December 31, 1998 represented 1.07% of total loans, compared with 1.10% of total loans at December 31, 1997 and 1.20% at December 31, 1996. Net recoveries during 1998 were $116,000 compared to net charge-offs of $375,000 in 1997 and $882,000 in 1996. In addition, the allowance for loan and lease losses represented 141.2% of nonperforming loans at December 31, 1998, compared with 72.9% at December 31, 1997 and 74.9% at December 31, 1996. The Bank of Hemet also showed significant improvement in reducing levels of OREO in 1998. OREO decreased by $702,000, or 90.1%, to $77,000, the lowest level of OREO in five years. OREO equaled $779,000 at December 31, 1997 and $2.2 million at December 31, 1996. These foregoing developments resulted in an improvement of the ratio of earning assets to total average assets over the last three years. For 1998, the ratio equaled 96.2%, compared with 95.8% for 1997 and 94.9% for 1996. 30 Deposits were $230.4 million at December 31, 1998, an increase of $11.2 million, or 5.1%, over deposits of $219.2 million at December 31, 1997. The increase was primarily as a result of increases in noninterest bearing demand deposits of 15.9% and savings and interest bearing demand deposits of 13.4%. Average interest bearing deposits represented 85.3% of average total deposits for 1998 compared with 86.1% in 1997. Total shareholders' equity was $21.0 million at December 31, 1998, an increase of $796,000, or 3.9%, from $20.2 million at December 31, 1997. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 OVERVIEW. The Bank of Hemet reported net income for 1998 of $2.8 million compared with $2.8 million in 1997 and $1.4 million in 1996. The return on average assets was 1.14% in 1998 compared with 1.19% in 1997 and 0.59% in 1996. The Bank of Hemet's return on average equity was 13.71% for 1998, 13.91% for 1997 and 6.82% for 1996. Basic earnings per share equaled $3.34 in 1998 compared with $3.25 in 1997 and $1.53 in 1996. Diluted earnings per share equaled $3.23 in 1998 compared with $3.15 in 1997 and $1.53 in 1996. Cash dividends were declared at $2.40 per share for 1998, $1.50 per share for 1997 and $1.00 per share for 1996. This resulted in dividend payout ratios (common stock dividends declared per share divided by basic earnings per share) of 71.8% in 1998, 46.2% in 1997 and 65.4% in 1996. NET INTEREST INCOME. Net interest income is the primary source of operating income of the bank. Net interest income represents the difference between the interest income from earning assets and the interest paid on interest-bearing liabilities. Net interest income for 1998 increased $186,000, or 1.9%, to $10.2 million when compared with 1997. The increase in 1998 was primarily attributable to an increase in loan volume, partially offset by reduced loan yields and a lower net interest spread. The net interest spread, which represents the average yield earned on interest earning assets less the average yield paid on interest bearing liabilities, decreased to 3.37% in 1998 from 3.55% in 1997. Net interest income for 1997 decreased $259,000 to $10.0 million, or 2.5%, when compared with net interest income of $10.3 million for 1996. The decrease in 1997 was primarily attributable to reduced loan yields and a lower net interest spread, partially offset by increased loan volume. The net interest spread decreased to 3.55% in 1997 from 3.90% in 1996. AVERAGE BALANCES AND RATES EARNED AND PAID. The following table presents, for the periods indicated, consolidated average balance sheet information for The Bank of Hemet, together with interest rates earned and paid on the various sources and uses of its funds. The table is 31 arranged to group the elements of earning assets and interest-bearing liabilities, as these items represent the major sources of income and expense.
YEAR ENDED DECEMBER 31, -------------------------------------------------------------------------------------------- 1998 1997 1996 ------------------------------- ----------------------------------- ---------------------- INTEREST RATES INTEREST RATES INTEREST AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ BALANCE EXPENSE PAID BALANCE EXPENSE PAID BALANCE EXPENSE --------- --------- --------- --------- ----------- ----------- --------- ----------- (DOLLARS IN THOUSANDS) ASSETS Federal funds sold............. $ 13,183 $ 704 5.34% $ 10,432 $ 563 5.40% $ 9,675 $ 509 Investment securities(1)....... 29,052 1,610 5.54 28,581 1,633 5.71 25,840 1,416 Total loans(2)(3).............. 196,675 17,102 8.70 187,298 16,795 8.97 184,307 17,202 --------- --------- --------- ----------- --------- ----------- Total earning assets......... $ 238,910 $ 19,416 8.13% $ 226,311 $ 18,991 8.39% $ 219,822 $ 19,127 Allowance for loan and lease losses....................... (2,111) (2,116) (2,108) Cash and due from banks........ 5,742 5,405 5,301 Premises and equipment......... 1,614 1,531 1,618 Interest receivable and other assets....................... 4,142 5,166 6,899 --------- --------- --------- Total assets................. $ 248,297 $ 236,297 $ 231,532 --------- --------- --------- --------- --------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing demand deposits..................... $ 14,204 $ 152 1.07% $ 13,722 $ 151 1.10% $ 14,837 $ 168 Money market deposits.......... 3,970 108 2.72 4,660 128 2.75 5,393 152 Savings deposits............... 48,793 1,955 4.01 47,468 1,949 4.11 41,968 1,709 Time deposits of $100,000 or more......................... 9,036 501 5.54 8,662 489 5.65 15,537 891 Time deposits under $100,000... 116,876 6,469 5.53 109,948 6,214 5.65 106,222 5,903 Other borrowings............... -- -- -- 249 15 6.02 -- -- --------- --------- --------- ----------- --------- ----------- Total interest bearing liabilities.................. $ 192,879 $ 9,185 4.76% $ 184,709 $ 8,946 4.84% $ 183,957 $ 8,823 Noninterest bearing demand deposits..................... 33,349 29,831 25,981 Other liabilities.............. 1,475 1,611 1,464 Shareholders' equity........... 20,594 20,146 20,130 --------- --------- --------- Total liabilities and shareholders' equity....... $ 248,297 $ 236,297 $ 231,532 --------- --------- --------- --------- --------- --------- Net interest income............ $ 10,231 $ 10,045 $ 10,304 --------- ----------- ----------- --------- ----------- ----------- Net interest spread(4)......... 3.37% 3.55% Net interest margin(5)......... 4.28% 4.44% RATES EARNED/ PAID ----------- ASSETS Federal funds sold............. 5.26% Investment securities(1)....... 5.48 Total loans(2)(3).............. 9.33 Total earning assets......... 8.70% Allowance for loan and lease losses....................... Cash and due from banks........ Premises and equipment......... Interest receivable and other assets....................... Total assets................. LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing demand deposits..................... 1.13% Money market deposits.......... 2.82 Savings deposits............... 4.07 Time deposits of $100,000 or more......................... 5.73 Time deposits under $100,000... 5.56 Other borrowings............... -- Total interest bearing liabilities.................. 4.80% Noninterest bearing demand deposits..................... Other liabilities.............. Shareholders' equity........... Total liabilities and shareholders' equity....... Net interest income............ Net interest spread(4)......... 3.90% Net interest margin(5)......... 4.69%
- ------------------------------ (1) There are no tax exempt investment securities in the investment securities portfolio for any of the reported years. (2) Average balances are presented net of deferred loan origination fees. Nonaccruing loans of $2.4 million for 1998, $3.2 million for 1997 and $2.9 million for 1996 are included in the table for computational purposes. (3) Loan origination fees are included in interest income as adjustments of the loan yields over the life of the loan using the interest method. Loan interest income includes loan fees of $532,000 for 1998, $457,000 for 1997 and $642,000 for 1996. (4) Net interest spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities. (5) Net interest margin is computed by dividing net interest income by total average earning assets. NET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE. The following table sets forth, for the periods indicated, a summary of the changes in average asset and liability balances and interest earned and paid resulting from changes in average asset and liability balances 32 ("volume") and changes in average interest rates. The changes in interest due to both rate and volume are designated as "Mix."
1997 COMPARED WITH 1996 INCREASE 1998 COMPARED WITH 1997 (DECREASE) INCREASE (DECREASE) DUE TO CHANGE IN: DUE TO CHANGE IN: ------------------------------------------------ ----------- AVERAGE AVERAGE AVERAGE VOLUME RATE MIX TOTAL VOLUME ----------- ----------- --- ----- ----------- (DOLLARS IN THOUSANDS) INCREASE (DECREASE) IN INTEREST INCOME Federal funds sold......................................... $ 149 $ (6) $ (2) $ 141 $ 40 Investment securities(1)................................... 27 (49) (1) (23) 151 Loans(2)(3)................................................ 841 (509) (25) 307 279 ----------- ----- --- ----- ----- Total.................................................... $ 1,017 $ (564) $ (28) $ 425 $ 470 ----------- ----- --- ----- ----- ----------- ----- --- ----- ----- INCREASE (DECREASE) IN INTEREST EXPENSE Interest bearing demand deposits........................... $ 5 $ (4) $ 0 $ 1 $ (12) Money market deposits...................................... (19) (1) 0 (20) (21) Savings deposits........................................... 54 (47) (1) 6 224 Time deposits of $100,000 or more.......................... 21 (9) (0) 12 (394) Time deposits under $100,000............................... 391 (128) (8) 255 207 Other borrowings........................................... (15) (15) 15 (15) 0 ----------- ----- --- ----- ----- Total.................................................... 437 (204) 6 239 4 ----------- ----- --- ----- ----- TOTAL CHANGE IN NET INTEREST INCOME.................... $ 580 $ (360) $ (34) $ 186 $ 466 ----------- ----- --- ----- ----- ----------- ----- --- ----- ----- AVERAGE RATE MIX TOTAL ----------- --- --------- INCREASE (DECREASE) IN INTEREST INCOME Federal funds sold......................................... $ 13 $ 1 $ 54 Investment securities(1)................................... 60 6 217 Loans(2)(3)................................................ (675) (11) (407) ----- --- --------- Total.................................................... $ (602) $ (4) $ (136) ----- --- --------- ----- --- --------- INCREASE (DECREASE) IN INTEREST EXPENSE Interest bearing demand deposits........................... $ (5) $ 0 $ (17) Money market deposits...................................... (4) 1 (24) Savings deposits........................................... 14 2 240 Time deposits of $100,000 or more.......................... (14) 6 (402) Time deposits under $100,000............................... 100 4 311 Other borrowings........................................... 0 15 15 ----- --- --------- Total.................................................... 91 28 123 ----- --- --------- TOTAL CHANGE IN NET INTEREST INCOME.................... $ (693) $ (32) $ (259) ----- --- --------- ----- --- ---------
- ------------------------------ (1) There are no tax exempt investment securities in the investment securities portfolio for any of the reported years. (2) Average balances are presented net of deferred loan origination fees. Nonaccruing loans of $2.4 million for 1998, $3.2 million for 1997 and $2.9 million for 1996 are included in the table for computational purposes. (3) Loan origination fees are included in interest income as adjustments of the loan yields over the life of the loan using the interest method. Loan income includes loan fees of $532,000 for 1998, $457,000 for 1997 and $642,000 for 1996. PROVISION FOR LOAN AND LEASE LOSSES. The provision for loan and lease losses charged to operations reflects management's judgment of the adequacy of the allowance for loan and lease losses. The provision is determined through periodic analysis, which includes a detailed review of the classification and categorization of problem loans to be charged off; an assessment of the overall quality and collectability of the portfolio; and consideration of the loan loss experience, trends in problem loans and concentrations of credit risk, evaluation of collateral, as well as current and expected economic conditions, particularly in segments of The Bank of Hemet's market area. Such reviews also assist management in establishing the recommended level of the allowance for loan and lease losses. The Bank of Hemet's board of directors approves the adequacy of the allowance for loan and lease losses on a quarterly basis. For 1998, The Bank of Hemet recorded no provision for loan and lease losses, compared with provisions of $250,000 for 1997 and $988,000 for 1996. In 1998 net recoveries totaled $116,000, compared with net charge-offs of $375,000 in 1997 and $882,000 in 1996. The lack of a provision in 1998 and the substantial decrease in the provision in 1997 over 1996 reflected management's view of the improved asset quality of The Bank of Hemet's loan portfolio, which benefited from strengthening of the Southern California economy. NONINTEREST INCOME. Noninterest income for 1998 increased $159,000, or 13.2%, to $1.4 million, compared with $1.2 million for 1997. The increase in 1998 was principally attributable to increased data processing fees generated by BankLink Corporation, partially 33 offset by a reduction in fees earned for the servicing of certain real estate secured loans for third parties, and a reduction in fees and service charges on deposits. Noninterest income in 1997 remained at the same level, $1.2 million, as in 1996. The lack of change was attributable to a decrease in revenue from processing of merchant credit card drafts and a reduction in fees earned for the servicing of certain real estate secured loans for third parties, offset by increased data processing fees generated by BankLink Corporation. NONINTEREST EXPENSE. Noninterest expense for 1998 was $6.7 million, compared with $6.2 million for 1997 and $8.2 million for 1996. The principal components of the increase in 1998 were: - Salaries and employee benefits. Salaries and employee benefits increased in 1998 by $273,000, or 7.9%, as The Bank of Hemet increased the number of full time equivalent employees to 86 at December 31, 1998 from 77 at December 31, 1997. - OREO expenses. OREO expenses for 1998 resulted in a net credit of $101,000. The primary components of the credit were net gains on the sale of OREO properties of $173,000, partially offset by OREO holding costs of $61,000 and OREO writedowns of $11,000. However, the 1998 net credit was below that of $187,000 for 1997, contributing to the increase in such noninterest expenses. The net credit for 1997 benefited, in particular, from the reversal of an OREO loss reserve of $182,000 and net gains on the sale of OREO of $128,000, offset by OREO holding costs of $123,000. - Premises and equipment expenses. Premises and equipment expense increased $79,000, or 8.0%, in 1998 over 1997, primarily as a result of increased equipment depreciation and maintenance expense. - Other expenses. Other expenses increased in 1998 by $98,000, or 5.1%. This category of expense includes services for data and item processing, FDIC and other insurance expense, professional fees and other miscellaneous expense. The increase in 1998 is mainly the result of increased fees paid to third parties for analyzed business deposit accounts and increased professional fees. In 1997, noninterest expense decreased by 24.2% over its 1996 level. The principal component of the decrease was OREO expenses. This expense category decreased by $1.4 million in 1997 as a result of a decrease in writedowns of $1.2 million, decreased carrying costs of $179,000 and an increase in gains on sale of OREO of $91,000. Other expenses also decreased in 1997 compared with 1996. The decrease in other expenses for 1997 of $359,000 is mainly the result of a special one-time assessment of $402,000 in 1996 on deposits acquired from a savings and loan association in 1992. The special assessment was part of a deposit insurance recapitalization plan enacted by Congress, and applied to all institutions holding deposits derived from savings institutions. Other expenses related to the processing of merchant credit card drafts also decreased. These decreases were partially offset by an increase in 1997 of professional fees related to litigation. Salaries and employee benefits also decreased in 1997 by $178,000, or 4.9% as a result of an operational restructuring commencing the second quarter of 1996, designed to streamline branch operations and support staff. Premises and equipment expense also decreased slightly in 1997 over 1996, primarily by reason of reduced depreciation expense related to BankLink Corporation's mainframe computer. 34 The Bank of Hemet's efficiency ratio--which is the ratio of noninterest expense to the sum of net interest income before provision for loan losses and total noninterest income--was 58.1% in 1998, compared with 55.1% in 1997 and 70.8% in 1996. The improvement in the ratio in 1997 and 1998, over 1996 reflects primarily the significant reduction in OREO expenses from the levels experienced in 1996. PROVISION FOR INCOME TAXES. The Bank of Hemet's provision for income taxes was $2.0 million in 1998, $2.0 million in 1997 and $1.0 million in 1996. These changes corresponded directly to changes in pre-tax income. The effective income tax rate was 41.9% in 1998 compared with 41.6% in 1997 and 42.4% in 1996. NET INCOME. Net income in 1998 remained at the 1997 level of $2.8 million. In 1998, The Bank of Hemet experienced increases in net interest income of $186,000, primarily from increased loan volume. Noninterest income increased by $159,000, primarily from The Bank of Hemet's data processing subsidiary. In addition, the provision for loan and lease losses decreased by $250,000 as no provision was taken in 1998. However, these favorable developments were almost entirely offset by increased noninterest expenses of $536,000, primarily relating to increases in salaries and employee benefits. In 1997, net income increased $1.4 million, or 104.1%, to $2.8 million from the 1996 level of $1.4 million. This increase was attributable to two major components. First, noninterest expense decreased by approximately $2.0 million, or 24.2%, principally as a result of reductions in expenses associated with the disposition of OREO, as explained above. Second, the provision for loan losses decreased by $738,000, or 74.7%. These increases were partially offset by decreases in net interest income and noninterest income. SUMMARY SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following table presents a summary of selected quarterly financial data, which should be read in conjunction with The Bank of Hemet's consolidated financial statements and notes thereto included elsewhere in this prospectus. In the opinion of management, this information has been prepared on the same basis as the consolidated financial statements appearing elsewhere in this prospectus, and includes all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the unaudited results set forth herein. The operating results for any quarter are not necessarily indicative of results for any subsequent period or for the entire year.
FOR THE QUARTER ENDED ----------------------------------------------------------------------------------- DECEMBER SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE 1998 1998 1998 1998 1997 1997 1997 ----------- ----------- --------- --------- ----------- ----------- --------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net interest income.................... $ 2,491 $ 2,596 $ 2,573 $ 2,571 $ 2,530 $ 2,475 $ 2,582 Provision for loan and lease losses.... (125) -- 125 -- 190 60 -- Net income............................. 789 694 661 679 741 645 743 Basic earnings per share(1)............ $ 0.94 $ 0.82 $ 0.78 $ 0.80 $ 0.88 $ 0.77 $ 0.85 Diluted earnings per share(2).......... $ 0.91 $ 0.79 $ 0.75 $ 0.78 $ 0.84 $ 0.74 $ 0.83 MARCH 1997 --------- Net interest income.................... $ 2,458 Provision for loan and lease losses.... -- Net income............................. 673 Basic earnings per share(1)............ $ 0.75 Diluted earnings per share(2).......... $ 0.74
- ------------------------ (1) Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period. 35 (2) Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into the common stock or resulted in the issuance of common stock that then shared in earnings. ASSET AND LIABILITY MANAGEMENT Asset and liability management is an integral part of managing a banking institution's primary source of income, net interest income. The Bank of Hemet manages the balance between rate-sensitive assets and rate-sensitive liabilities being repriced in any given period with the objective of stabilizing net interest income during periods of fluctuating interest rates. The Bank of Hemet considers its rate-sensitive assets to be those which either contain a provision to adjust the interest rate or mature within one year. These assets include certain loans and investment securities and federal funds sold. Rate-sensitive liabilities are those which allow for periodic interest rate changes within one year: they include maturing time certificates, savings deposits, money market and interest-bearing demand deposits. The difference between the aggregate amount of assets and liabilities that reprice or mature within various time frames is called the "gap." Generally, if repricing assets exceed repricing liabilities in a time period, The Bank of Hemet would be deemed to be asset-sensitive--a "positive gap." If repricing liabilities exceed repricing assets in a time period, The Bank of Hemet would be deemed to be liability-sensitive--a "negative gap." A positive gap will generally produce a higher net interest margin in a rising rate environment and a lower net interest margin in a declining rate environment. Conversely, a negative gap will generally produce a lower net interest margin in a rising rate environment and a higher net interest margin in a declining rate environment. However, because interest rates for different asset and liability products offered by depository institutions respond in a different manner, both in terms of the responsiveness, as well as the extent of responsiveness to changes in interest rate environment, the gap is only a general indicator of interest sensitivity. Generally, The Bank of Hemet seeks to maintain a balanced position in which there is a narrow range of asset or liability sensitivity within a one-year period. This kind of balanced position, in principle, should ensure net interest margin stability in times of volatile interest rates. This balanced position is accomplished through maintaining a significant level of loans, investment securities and deposits available for repricing or maturity within one year. The following table sets forth the interest rate sensitivity of The Bank of Hemet's interest-earning assets and interest-bearing liabilities at December 31, 1998, using the interest rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered 36 rate-sensitive within a specified period when it can be repriced or matures within its contractual terms.
AMOUNTS MATURING OR REPRICING ----------------------------------------------- AFTER 3 BUT AFTER 1 BUT WITHIN 3 WITHIN 12 WITHIN 5 AFTER 5 NONINTEREST- MONTHS MONTHS YEARS YEARS BEARING TOTAL ---------- ----------- ----------- --------- ----------- ---------- (DOLLARS IN THOUSANDS) ASSETS Federal funds sold...................... $ 10,500 $ 0 $ 0 $ 0 $ 0 $ 10,500 Investment securities................... 2,882 16,000 6,000 0 0 24,882 Loans (1)............................... 83,518 61,381 52,942 9,179 0 207,020 Other-interest bearing assets........... 5 0 0 0 0 5 ---------- ----------- ----------- --------- ----------- ---------- Total earning assets................ 96,905 77,381 58,942 9,179 0 242,407 Noninterest-bearing assets and allowances for loan and lease losses................................ 0 0 0 0 10,470 10,470 ---------- ----------- ----------- --------- ----------- ---------- Total assets........................ $ 96,905 $ 77,381 $ 58,942 $ 9,179 $ 10,470 $ 252,877 ---------- ----------- ----------- --------- ----------- ---------- ---------- ----------- ----------- --------- ----------- ---------- LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing demand, money market and savings deposits.................. $ 71,389 $ 0 $ 0 $ 0 $ 0 $ 71,389 Time deposits of $100,000 or more....... 2,641 4,625 875 0 0 8,141 Time deposits under $100,000............ 29,684 80,143 7,024 29 0 116,880 Other interest-bearing liabilities...... 0 0 0 0 0 0 ---------- ----------- ----------- --------- ----------- ---------- Total interest bearing liabilities.. $ 103,714 $ 84,768 $ 7,899 $ 29 0 $ 196,410 Other liabilities and shareholders' equity................................ 0 0 0 0 56,467 56,467 ---------- ----------- ----------- --------- ----------- ---------- Total liabilities and shareholders' equity............................ $ 103,714 $ 84,768 $ 7,899 $ 29 $ 56,467 $ 252,877 ---------- ----------- ----------- --------- ----------- ---------- ---------- ----------- ----------- --------- ----------- ---------- Incremental gap......................... $ (6,809) $ (7,387) $ 51,043 $ 9,150 $ (45,997) Cumulative gap.......................... $ (6,809) $ (14,196) $ 36,847 $ 45,997 Cumulative gap/earning assets........... (2.8%) (5.9%) 15.2% 19.0% Cumulative gap/total assets............. (2.7%) (5.6%) 14.6% 18.2%
- ------------------------ (1) Loan amounts do not include nonaccrual loans of $1.6 million. The majority of The Bank of Hemet's loan portfolio, excluding nonaccrual loans, continues to consist of floating or adjustable rate loans. The percentage of such loans decreased to 86.7% at December 31, 1998 from 87.5% at December 31, 1997. Noninterest bearing demand deposits as a percentage of total deposits increased to 14.8% at December 31, 1998 from 13.4% at December 31, 1997. The Bank of Hemet's policy is to maintain a ratio of rate sensitive assets less rate sensitive liabilities in a range between -10% and +10% of total assets for assets and liabilities repricing within three months, and after three months but within 12 months. At December 31, 1998, the amount of rate sensitive liabilities that reprice within one year exceeded rate sensitive assets by $14.2 million, or negative 5.6% of total assets. In other words, The Bank of Hemet was liability-sensitive with a negative cumulative one-year gap of $14.2 million at December 31, 1998. In general, based upon The Bank of Hemet's mix of deposits, loans and investments, increases in interest rates would be expected to result in a decrease in The Bank of Hemet's net interest margin. 37 The interest rate gaps reported in the table above arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made for changes in interest rates and market outlook, positions at the end of any period may not be reflective of The Bank of Hemet's interest rate sensitivity in subsequent periods. Active management dictates that longer-term economic views are balanced against prospects for short-term interest rate changes in all repricing intervals. For purposes of the analysis above, repricing of fixed-rate instruments is based upon the contractual maturity of the applicable instruments. Actual payment patterns may differ from contractual payment patterns. The change in net interest margin may not always follow the general expectations of an asset-sensitive or liability-sensitive balance sheet during periods of changing interest rates, because interest rates earned or paid may change by differing increments and at different time intervals for each type of interest-sensitive asset and liability. As a result of these factors, at any given time, The Bank of Hemet may be more sensitive or less sensitive to changes in interest rates than indicated in the above table. MARKET RISK Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rate and other market changes. Market risk is attributed to all market risk sensitive financial instruments, including investment securities, loans, deposits and borrowings. The Bank of Hemet does not engage in trading activities for its own account and does not participate in foreign currency transactions for its own account. Accordingly, The Bank of Hemet's exposure to market risk is primarily a function of its asset and liability management activities. The principal market risk to The Bank of Hemet is the interest rate risk inherent in its lending, investing and deposit-taking activities. This is because interest-earning assets and interest-bearing liabilities of the bank do not change at the same speed, to the same extent or on the same basis. The Bank of Hemet's interest rate sensitivity analysis is discussed in the preceding section. The table on page 37 measures The Bank of Hemet's interest rate sensitivity gap, in other words, the difference between earning assets and liabilities maturing or repricing within specified periods. However, gap analysis has significant limitations as a method for measuring interest rate risk since changes in interest rates do not affect all categories of assets and liabilities in the same way or at the same time. Further, it has limitations in helping The Bank of Hemet to manage the difference in behavior of lending and funding rates--so-called "basis risk." To address the limitations inherent in gap analysis, The Bank of Hemet monitors its expected change in earnings based on changes in interest rates through a detailed model. This model's estimate of interest rate sensitivity takes into account the differing time intervals and differing rate change increments of each type of interest-sensitive asset and liability. It then measures the projected impact of changes in market interest rates on The Bank of Hemet's return on equity. Based upon the December 31, 1998 mix of interest-sensitive assets and liabilities, given an immediate and sustained increase in the federal funds rate (and other key rates indexes) of 2%, this model estimates The Bank of Hemet's cumulative return on equity over the next year would increase by about .35%. However, the actual return on equity might decrease by about .35% in response to a 2% decrease in these key rates. 38 LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY. In order to maintain adequate liquidity, The Bank of Hemet must have sufficient resources available at all times to meet its cash flow requirements. The need for liquidity in a banking institution arises principally to provide for deposit withdrawals, the credit needs of its customers and to take advantage of investment opportunities as they arise. A financial institution may achieve desired liquidity from both assets and liabilities. The Bank of Hemet considers cash and deposits held in other banks, federal funds sold, other short term investments, maturing loans and investments, payments of principal and interest on loans and investments as sources of asset liquidity. Deposit growth and access to borrowing lines of credit and market sources of funds are considered by The Bank of Hemet as sources of liability liquidity. The Bank of Hemet reviews its liquidity position on a regular basis based upon its current position and expected trends as mentioned above. Liquid assets include cash and deposits in other banks, unpledged securities and federal funds sold. The Bank of Hemet's liquid assets totaled $31.9 million (12.6% of total assets) at December 31, 1998, compared with $37.4 million (15.5% of total assets) at December 31, 1997. Liquidity is also affected by the collateral requirements of public deposits and certain borrowings. Total pledged securities were $10.0 million at December 31, 1998 compared with $7.0 million at December 31, 1997 and $7.0 million at December 31, 1996. Management believes that The Bank of Hemet maintains adequate amounts of liquid assets and has adequate borrowing lines of credit with the Federal Home Loan Bank and others to meet its liquidity needs. The Bank of Hemet's liquidity might be insufficient if deposit withdrawals were to exceed anticipated levels. Deposit withdrawals can increase if an insured depository financial institution experiences financial difficulties or receives adverse publicity for other reasons, or if its pricing, products or services are not competitive with those offered by other institutions. The Bank of Hemet's primary sources of liquidity include liquid assets and a stable deposit base. To supplement these, The Bank of Hemet maintains a borrowing line of credit with the Federal Home Loan Bank of San Francisco in the amount of $14.2 million as of December 31, 1998. This line is secured by approved residential and commercial real estate mortgage loans totaling $21.3 million as of December 31, 1998. At December 31, 1998, there were no advances outstanding under this line of credit, and the line was not used during 1998. Additionally, The Bank of Hemet has available reverse repurchase agreement lines of credit with two broker-dealers aggregating $30.0 million at December 31, 1998. These lines are subject to normal terms for such arrangements. These lines were not used during 1998 or 1996. In 1997, the average amount outstanding under them was $249,000, and the maximum amount outstanding was $3.9 million. At December 31, 1998, marketable securities with a market value of approximately $14.0 million were available for the reverse repurchase lines of credit. CAPITAL. Capital serves as a source of funds and helps protect creditors and uninsured depositors against potential losses. The primary source of capital for The Bank of Hemet has been internally generated capital through retained earnings. The Bank of Hemet's shareholders' equity increased $796,000, or 3.9%, to $21.0 million at December 31, 1998 from $20.2 million at December 31, 1997. The increase resulted from net income of $2.8 million, partially offset by dividends of $2.0 million. 39 In May 1997, The Bank of Hemet concluded an issuer tender offer, which resulted in the repurchase of 50,626 shares of common stock at the offering price of $27.00 a share, for a total of $1.4 million. Federal regulations establish guidelines for calculating risk-adjusted capital ratios. These guidelines establish a systematic approach of assigning risk weights to bank assets and off-balance sheet items making the regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Under these regulations, banks are required to maintain a total risk-based capital ratio of 8.0%; that is, "Tier 1" plus "Tier 2" capital must equal at least 8.0% of risk-weighted assets plus off-balance sheet items, and Tier 1 capital (primarily shareholders' equity) must constitute at least 50% of qualifying capital. Tier 1 capital consists primarily of shareholders' equity excluding goodwill, and Tier 2 capital includes subordinated debt and, subject to a limit of 1.25% of risk-weighted assets, the allowance for loan and lease losses. At December 31, 1998, The Bank of Hemet had a Tier 1 risk-based capital ratio of 9.99% and a total risk-based capital ratio of 11.06%. In addition, regulators have adopted a minimum leverage capital ratio standard. This standard is designed to ensure that all financial institutions, irrespective of their risk profile, maintain minimum levels of core capital, which by definition excludes the allowance for loan and lease losses. These minimum standards for top-rated institutions may be as low as 3%; however, regulatory agencies have stated that most institutions should maintain ratios at least 1 to 2 percentage points above the 3% minimum. At December 31, 1998, the Bank's leverage capital ratio equaled 8.31%. Banks with Tier 1 risk-based capital of 6.0%, total-risk-based capital of at least 10.0% and a leverage capital ratio of at least 5% are considered "well capitalized" by federal banking agencies. The Bank of Hemet's policy is not to declare any dividends that would cause its leverage capital ratio to be below 8.00% or its total risk-based capital ratio to be below 10%. The following table summarizes the minimum capital ratios required by current FDIC regulations, the ratios at which a bank is considered well-capitalized by the FDIC, and the capital ratios of The Bank of Hemet at December 31, 1998, 1997 and 1996.
REGULATORY CAPITAL REQUIREMENTS THE BANK OF HEMET AT DECEMBER 31, -------------------------------- ------------------------------- MINIMUM WELL-CAPITALIZED 1998 1997 1996 ------------- ----------------- --------- --------- --------- Tier-1 risk-based capital................................... 4.0% 6.0% 9.99% 10.43% 10.77% Total risk-based capital.................................... 8.0% 10.0% 11.06% 11.53% 11.97% Leverage capital ratio(1)................................... 4.0% 5.0% 8.31% 8.53% 8.66%
- ------------------------ (1) Tier 1 capital to total quarterly average assets. Failure to meet minimum capital requirements can trigger mandatory actions by the regulators that, if undertaken, could have a material effect on The Bank of Hemet's financial statements and operations. IMPACT OF INFLATION The financial statements and related financial data presented in this prospectus have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without 40 considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates are likely to have a more significant impact on a financial institution's performance than the effects of general levels of inflation. During periods of inflation, interest rates do not necessarily move in the same direction or with the same magnitude as the price of goods and services. The Bank of Hemet seeks to manage its interest sensitivity gap to minimize the potential adverse effect of inflation and other market forces on its net interest income and capital. Financial institutions are also affected by inflation's impact on noninterest expenses, such as salaries and occupancy expenses. During 1996, 1997 and 1998, inflation remained relatively stable, and The Bank of Hemet's level of noninterest expense was relatively unaffected by inflation. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." This statement provides that all enterprises report comprehensive income as a measure of overall performance. This new standard is effective for 1998 and did not have a material effect on the current disclosures of The Bank of Hemet. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement changes the way public companies report selected information about segments of their business in their annual financial statements and require them to report selected segment information in their quarterly reports issued to shareholders. This new standard is effective for 1998 and did not have a material effect on the current disclosures of The Bank of Hemet. In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard is effective for 2000 and is not expected to have a material impact on the financial statements of The Bank of Hemet. In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." SFAS No. 134 amends SFAS No. 65, "Accounting for Certain Mortgage Banking Activities," which establishes accounting and reporting standards for certain activities of mortgage banking enterprises and other enterprises that conduct operations that are substantially similar. SFAS No. 134 requires that after the securitization of mortgage loans held for sale, the resulting mortgage-backed securities and other retained interests should be classified in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," based on its ability and intent to sell or hold these investments. This new standard is effective for 1999 and is not expected to have a material impact on the financial statements of The Bank of Hemet. YEAR 2000 COMPLIANCE OVERVIEW. The Year 2000 problem arises when computer programs have been written using two digits rather than four to define the applicable year. As a result, date-sensitive hardware and software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or other disruption of operations and impede normal business activities. 41 In June 1996, the Federal Financial Institutions Examination Council ("FFIEC") alerted the banking industry of the serious challenges that would be encountered with Year 2000 issues. The FDIC has also implemented a plan to require compliance with Year 2000 issues and regularly examines the progress of banks, including The Bank of Hemet and its subsidiary, BankLink Corporation. STATE OF READINESS OF THE BANK OF HEMET AND BANKLINK CORPORATION. OVERALL PLAN. In accordance with FDIC guidelines, The Bank of Hemet and BankLink Corporation have developed a comprehensive plan to deal with the Year 2000 issue. The Bank of Hemet and BankLink Corporation believe the plan, if properly implemented, will result in timely and adequate modifications of its systems and technology and those of its outside vendors to address Year 2000 issues appropriately. The plan has five phases: - Awareness--defining the Year 2000 problem, gaining support and resources, developing a plan, and establishing a project team. - Assessment--assessing the size and complexity of the project, and identifying all systems affected by the Year 2000 date change. - Renovation--hardware and software upgrades, and outside vendor certifications. - Validation--testing systems including connections with other systems, and acceptance of such by internal and external users. - Implementation--developing a contingency plan. Except as indicated hereafter, The Bank of Hemet has substantially completed the five phases of its plan. However, to ensure success, The Bank of Hemet plans to: - engage in ongoing discussions with outside vendors to determine if they have been successful in validating their compliance with their Year 2000 plans; - use its best efforts to ensure that new systems or subsequent changes in existing systems are verified as Year 2000 compliant; - test certain third-party systems which have computerized interfaces with The Bank of Hemet and BankLink Corporation's systems; and - continue to refine its contingency plan. The Bank of Hemet and BankLink Corporation rely substantially on outside vendors to provide computer hardware and software systems for their operations. Consequently, the Year 2000 plan places heavy emphasis on compliance by outside vendors. The plan prioritizes outside vendors by the degree of dependence on the computer systems they provide. The plan also addresses customer capabilities to become Year 2000 compliant. Finally, the plan requires review of non-information technology systems, such as alarm systems. The Bank of Hemet's Audit Committee has engaged the services of an independent consultant to review the overall Year 2000 project. The consultant has been requested to emphasize testing of vendor-reliant, mission-critical systems and to assist in the development of a contingency plan. VENDORS. The Bank of Hemet and BankLink Corporation rely heavily on outside vendors to provide the hardware and software used in their computer operations. To determine the readiness of outside vendors, The Bank of Hemet and BankLink Corporation have solicited written communications from each major outside vendor about its compliance with Year 2000. 42 Most outside vendors have responded that they are Year 2000 compliant. For those outside vendors who provide mission critical systems and have certified these systems as Year 2000 compliant, The Bank of Hemet and BankLink Corporation have conducted in-house testing of these systems, using various Year 2000-critical dates. The testing has included the creation of a duplicate database on BankLink Corporation's mainframe computer used for Year 2000 testing purposes. For those outside vendors that have responded they are working toward Year 2000 compliance and that The Bank of Hemet and BankLink Corporation have determined to be significant, The Bank of Hemet and BankLink Corporation will follow up on a regular basis throughout 1999. These outside vendors have advised The Bank of Hemet and BankLink Corporation that they expect to be Year 2000 compliant prior to December 31, 1999, and there are no Year 2000 compliance issues which appear to be unresolvable by that date. For such outside vendors that provide mission critical systems, The Bank of Hemet and BankLink Corporation will be conducting ongoing testing to validate Year 2000 compliance. The Bank of Hemet and BankLink Corporation have determined that other outside vendors will not have a material impact on their operations, whether or not they are Year 2000 compliant. CUSTOMERS. The Bank of Hemet has sent a questionnaire to each of its significant borrowers and depositors to determine the extent of risk created by any failure by them to remediate their own Year 2000 issues. Most customers have responded. Each borrower and depositor is categorized according to its state of readiness based on its response to the questionnaire and The Bank of Hemet's review of the customer. The Bank of Hemet has also taken steps to ensure liquidity for depositors with high Year 2000 risks. It will make a reassessment on each customer's risk on a regular basis. BankLink Corporation has organized a client bank information group to exchange Year 2000 readiness and testing information. NON-INFORMATION TECHNOLOGY SYSTEMS. The Bank of Hemet and BankLink Corporation have tested their non-information technology systems, such as microprocessors controlling its environmental and alarm systems, and found them to be Year 2000 compliant. COSTS TO ADDRESS YEAR 2000 ISSUES FOR THE BANK OF HEMET AND BANKLINK CORPORATION. Some of The Bank of Hemet's and BankLink Corporation's computer hardware and software applications were modified or replaced in order to maintain their functionality as the year 2000 approaches. The Bank of Hemet and BankLink Corporation have spent approximately $120,000 as of December 31, 1998 to address Year 2000 issues and estimates their total expenditures over the two-year period 1998 through 1999 to be approximately $200,000. This estimate includes some costs, such as the purchase of computer hardware and software upgrades, that will qualify as depreciable assets for accounting purposes, with the related depreciation expense recognized over the estimated useful lives of the applicable assets. However, the majority of costs, including in-house staff time, will be expensed as incurred, in compliance with generally accepted accounting principles. BankLink Corporation expects to recover a portion of its total costs by recognizing non-interest income over the fifteen month period ending December 31, 1999 from fees charged to its client banks for Year 2000 testing and other costs incurred. The Bank of Hemet does not anticipate that any of these costs will materially impact its consolidated results of operations in any one reporting period. In light of the complexity of the Year 2000 problem and its potential impact on both The Bank of Hemet and BankLink Corporation and third parties that interact with them, there 43 can be no assurance that the costs associated with the Year 2000 issue will be as estimated. The Bank of Hemet and BankLink Corporation do not intend to obtain insurance against any Year 2000 risks. RISKS OF THE YEAR 2000 ISSUES FOR THE BANK OF HEMET AND BANKLINK CORPORATION. Management believes that it is likely that the foregoing efforts will be successful. However, it is possible that necessary remediation of vendor-reliant systems may not be completed in a timely manner, or third-party systems with which The Bank of Hemet and BankLink Corporation have computerized interfaces may create Year 2000 issues. It is also possible that the expenses or liabilities to which The Bank of Hemet and BankLink Corporation may become subject as a result of such issues could be material. Any such event or occurrence could have a material adverse effect on The Bank of Hemet's and BankLink Corporation's business, prospects, operating results and financial condition. Ultimately, the potential impact of the Year 2000 issue on The Bank of Hemet and BankLink Corporation will depend on a series of complex factors, including the following: - the corrective measures undertaken by The Bank of Hemet and BankLink Corporation themselves; - the measures undertaken by outside vendors to become Year 2000 compliant; - the accuracy of representations made by outside vendors to The Bank of Hemet and BankLink Corporation concerning their state of readiness; - the degree of compliance by governmental agencies, businesses (including telephone and other utility companies), and other entities which engage in essential communications or third-party computerized interfaces with The Bank of Hemet and BankLink Corporation and its customers; and - the degree of compliance by customers. At worst, The Bank of Hemet's and BankLink Corporation's customers and outside vendors will face severe Year 2000 issues. Large customers negatively affected by Year 2000 issues could lead to deposit outflows or increased risk in collecting loans. The Bank of Hemet and BankLink Corporation may also be required to replace noncompliant outside vendors with more expensive Year 2000 compliant outside vendors. The Bank of Hemet and BankLink Corporation have taken steps to avail themselves of the safe harbor provision of the newly enacted Year 2000 Information and Readiness Disclosure Act by clearly labeling written communications to customers and vendors as a "Year 2000 Readiness Disclosure," thereby promoting a prompt, candid and thorough exchange of information on Year 2000 readiness and limiting liability for any errors. CONTINGENCY PLANS OF THE BANK OF HEMET AND BANKLINK CORPORATION. The Bank of Hemet and BankLink Corporation have created a contingency plan to take effect should there be circumstances preventing timely implementation. If those outside vendors do not demonstrate compliance by a certain date, The Bank of Hemet and BankLink Corporation will seek alternatives in accordance with its contingency plan. Outside vendors of mission critical systems are major U.S. companies, and management has assessed the relevant financial and operational capabilities of their hardware and software to provide Year 2000 processing. The time frame to convert to another outside vendor in the Year 2000 is relatively long, and therefore the ability to obtain replacement outside vendors will be limited. 44 In addition, for each mission critical system, The Bank of Hemet and BankLink Corporation have identified alternate procedures to achieve a successful resumption of business in case its computer systems, or those of its mission critical outside vendors, fail. The alternative procedures include development of a manual process for implementing the system and identifying alternative outside vendors. BUSINESS OF THE BANK OF HEMET GENERAL The Bank of Hemet is a California community bank headquartered in Hemet, California. In addition to its headquarters, The Bank of Hemet maintains five branches in Riverside county. Riverside county and neighboring San Bernardino county are experiencing significant population and economic growth. The Bank of Hemet's primary service area is the area of California commonly referred to as the Inland Empire, a region primarily consisting of Riverside and San Bernardino counties. These counties are experiencing significant population and economic growth, much of which has been fueled by the migration of manufacturing, distribution and export service firms from adjacent Los Angeles, Orange and San Diego counties. The Bank of Hemet was incorporated in 1974 under the California General Corporation Law and is licensed by the California Department of Financial Institutions to conduct a general banking business. Its deposits are insured up to the applicable legal limits by the FDIC. The Bank of Hemet is not a member of the Federal Reserve System. The Bank of Hemet emphasizes community-based commercial banking. It serves small-to-medium size businesses, professionals, retired individuals and residents in the Hemet area, as well as businesses and real estate owners/developers primarily throughout Riverside, San Bernardino, Orange, Los Angeles and San Diego counties. The Bank of Hemet also makes commercial real estate loans meeting its underwriting criteria in the San Francisco bay area, in the Sacramento area and in other areas outside of its primary service area, including Arizona. The Bank of Hemet offers a full range of commercial, real estate, personal, home improvement, automobile and other installment and term loans. The Bank of Hemet's primary lending focus has historically been and continues to be commercial real estate and construction lending. Deposit services offered by The Bank of Hemet include personal and business checking and savings accounts, money market deposit accounts, certificates of deposit, and individual retirement accounts. Other operational services include safe deposit boxes, travelers checks, wire transfers, overdraft lines of credit, electronic banking for businesses, 24-hour telephone banking, merchant bankcard, automated clearing house origination, automatic teller machines on the Instant Teller and Cirrus networks and other standard depository functions. The Bank of Hemet's wholly owned subsidiary, BankLink Corporation, provides data processing services to The Bank of Hemet and eight other banks and item processing services to The Bank of Hemet and three other banks. At December 31, 1998, BankLink Corporation had total assets of $931,000 and pre-tax earnings for the year ended December 31, 1998 of $146,000. The Bank has four other subsidiaries that are not active. 45 BUSINESS STRATEGY The Bank of Hemet's business strategy is to: - maintain asset quality; - increase the volume and diversity of good quality, mini-perm real estate and commercial loans; - remix its deposit base to lower its cost of funds; - provide high quality value based banking services and products to its customers; - continue a pace of moderate growth; and - increase operating efficiencies. The Bank of Hemet has focused on, and will continue to focus on, marketing efforts to implement is business strategy. These efforts include obtaining increased loan and deposit business from existing customers, word-of-mouth referrals, advertising and personal solicitation of customers by officers, directors and stockholders. Management assigns responsibility to all loan and business development officers to make regular calls on potential customers and obtain referrals from existing customers. The Bank of Hemet directs promotional efforts toward individuals and small-to-medium sized businesses. PREMISES The following table sets forth information about The Bank of Hemet's banking offices.
TYPE OF OWNED/ LOCATION OFFICE LEASED SIZE SINCE - -------------------------------------------------------------- ---------------- --------- ------------ --------- 1600 East Florida Avenue, Hemet............................... Main branch Leased 7,200 sq./ft 1988 1555 W. Florida Avenue, Hemet................................. Branch Leased 5,300 sq./ft 1986 1497 S. San Jacinto Street, San Jacinto....................... Branch Leased 3,300 sq./ft 1992 56525 Highway 371, Anza....................................... Branch Owned 1,920 sq./ft 1992 3545 Central Avenue, Riverside................................ Branch(1) Leased 4,600 sq./ft 1993 3715 Sunnyside Drive, Riverside............................... Branch and Owned 7,100 sq./ 1993 Administrative ft(3) offices(2)
- ------------------------ (1) The bank does not currently accept deposits at this location. These are the premises of The Bank of Hemet's wholly owned data processing subsidiary, BankLink Corporation. (2) These premises are occupied by The Bank of Hemet's loan department, note department, and finance department. (3) Includes enclosed parking area. Aggregate annual rentals for The Bank of Hemet and its subsidiaries for leased premises were $376,000 for the year ended December 31, 1998. 46 INVESTMENT PORTFOLIO The following table sets forth the book values of securities at the dates indicated. Under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," The Bank of Hemet has designated all of its U.S. government securities and other securities as "held-to-maturity." The Bank of Hemet does not have any tax exempt securities in its investment portfolio.
1998 1997 1996 --------- --------- --------- (DOLLARS IN THOUSANDS) U.S. government agencies(1)...................................................... $ 24,000 $ 24,000 $ 23,996 Other securities(2).............................................................. 882 833 783 --------- --------- --------- Total............................................................................ $ 24,882 $ 24,833 $ 24,779
- ------------------------ (1) At December 31, 1998, $10.0 million of these securities were pledged to secure public funds deposited with The Bank of Hemet, compared with $7.0 million at December 31, 1997 and $7.0 million at December 31, 1996. (2) Consists of perpetual preferred stock of the Federal Home Loan Bank of San Francisco. The following table sets forth the maturities of The Bank of Hemet's investment securities at December 31, 1998 and the weighted average yields of those securities calculated on the basis of the cost and effective yields based on the scheduled maturity of each security.
AFTER ONE TO AFTER FIVE TO ONE YEAR OR LESS FIVE YEARS TEN YEARS AFTER TEN YEARS ---------------------- ---------------------- ------------------------ ------------------------ AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD --------- ----- --------- ----- ----------- ----- ----------- ----- (DOLLARS IN THOUSANDS) U.S. government agencies................ $ 18,000 5.08% $ 6,000 5.04% 0 0.00% $ 0 0.00% Other securities(1)....... 0 0.00 0 0.00 0 0.00 882 5.86 --------- --- --------- --- ----- --- ----- --- Total..................... $ 18,000 5.08% $ 6,000 5.04% 0 0.00% $ 882 5.86% --------- --------- ----- --------- --------- ----- Estimated fair value...... $ 18,005 $ 5,997 $ 882 --------- --------- ----- --------- --------- ----- TOTAL ---------------------- AMOUNT YIELD --------- ----- U.S. government agencies................ $ 24,000 5.07% Other securities(1)....... 882 5.86 --------- --- Total..................... $ 24,882 5.09% --------- --------- Estimated fair value...... $ 24,884 --------- ---------
- ------------------------ (1) Consists of perpetual preferred stock of the Federal Home Loan Bank of San Francisco. The Bank of Hemet does not own securities of a single issuer (other than U.S. government agencies) whose aggregate book value is in excess of 10% of its total equity. LENDING ACTIVITIES The Bank of Hemet originates loans for its own portfolio. Lending activities include commercial real estate mortgage, real estate construction, commercial and consumer loans. The Bank of Hemet's primary asset category continues to be its loan portfolio, which comprised 79.2% of average total assets in 1998. At December 31, 1998, The Bank of Hemet had no foreign loans outstanding and has not engaged in the business of making foreign loans. 47 LOAN PORTFOLIO COMPOSITION OF LOANS. The following table shows the composition of loans by type of loan or type of borrower at the dates indicated.
DECEMBER 31, ---------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS) Real estate--construction............................ $ 1,941 $ 6,627 $ 8,268 $ 12,169 $ 6,885 Real estate--mortgage(1)............................. 195,248 174,897 167,979 163,684 164,784 Commercial........................................... 10,016 10,033 10,401 8,525 11,762 Consumer............................................. 1,002 1,065 1,043 1,264 1,542 Municipal leases..................................... -0- -0- 24 292 833 All other loans...................................... 391 411 482 489 761 ---------- ---------- ---------- ---------- ---------- Total loans........................................ 208,598 193,033 188,197 186,423 186,567 ---------- ---------- ---------- ---------- ---------- Deferred origination fees.......................... (796) (746) (756) (706) (821) ---------- ---------- ---------- ---------- ---------- Total loans.......................................... $ 207,802 $ 192,287 $ 187,441 $ 185,717 $ 185,746 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
- ------------------------ (1) Includes commercial real estate and residential mortgage loans. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES. The following table shows the maturity distribution of the loan portfolio excluding nonaccrual loans and deferred origination fees at December 31, 1998, and the loan portfolio's sensitivity to changes in interest rates. The principal balances of loans due after one year are indicated by both fixed and floating rate categories.
FLOATING AFTER ONE RATE: FIXED RATE: WITHIN ONE BUT WITHIN AFTER DUE AFTER DUE AFTER YEAR FIVE YEARS FIVE YEARS ONE YEAR ONE YEAR(1) ---------- ----------- ----------- ---------- ----------- (IN THOUSANDS) Real estate--construction............................. $ 1,941 $ 0 $ 0 $ 0 $ 0 Real estate--mortgage................................. 10,786 89,783 93,101 162,982 19,902 Commercial............................................ 7,449 2,568 0 2,035 533 Consumer.............................................. 491 353 158 36 475 Municipal leases...................................... 0 0 0 0 0 All other loans....................................... 391 0 0 0 0 ---------- ----------- ----------- ---------- ----------- Total............................................. $ 21,058 $ 92,704 $ 93,259 $ 165,053 $ 20,910 ---------- ----------- ----------- ---------- ----------- ---------- ----------- ----------- ---------- -----------
- ------------------------ (1) Includes real estate mortgage floating rate loans of $8,773,000 which are accruing interest at floor rates. LOANS SECURED BY REAL ESTATE At December 31, 1998, $197.2 million, or approximately 94.5% of The Bank of Hemet's loans were secured by first deed of trust on real estate. The concentration in loans secured by real estate is monitored on a quarterly basis and taken into account in the computation of the adequacy of the allowance for loan and lease losses. The non-residential real estate loan portfolio is segregated into various categories on which annual concentration limits are recommended by management and approved by the board of directors. The categories include 48 industrial, medical office, commercial office, mini-storage and retail. "Retail" is further broken down into subcategories, including anchored, automotive, office and strip center. Additionally, the portfolio is geographically categorized by state and county. The three largest categories of loans secured by real estate are shown in the following table:
AMOUNT AT PERCENTAGE OF DECEMBER 31, LOANS TYPE OF REAL ESTATE LOAN 1998 IN PORTFOLIO - ----------------------------------------------------------------- ------------ --------------- (DOLLARS IN THOUSANDS) Commercial mortgage loans........................................ $ 166,179 79.7% Residential mortgage loans....................................... 29,069 13.9 Construction loans............................................... 1,941 .09 ------------ --- Total real estate loans.......................................... $ 197,189 94.5% ------------ --- ------------ ---
COMMERCIAL MORTGAGE LOANS. The Bank of Hemet provides intermediate term commercial real estate loans collateralized by first deeds of trust on real property. Approximately one percent of the commercial mortgage portfolio consists of loans made outside California. Within California, at December 31, 1998, approximately 43% of commercial mortgage loans were secured by real property in Riverside county, 28% in Orange county, 11% in San Bernardino county and 7% in Los Angeles county. The value of real estate collateral is supported by formal appraisals in compliance with applicable federal regulations. Generally, these types of loans are made for a period of up to five years, loan-to-value ratios are 65% or less, and debt coverage ratios, 1.30:1 or better. The loans generally carry adjustable interest rates indexed to the one-year or, to a lesser extent, the three- or five-year Treasury constant maturity index. Rate adjustments vary from quarterly to five years. Amortization may be up to 30 years. Repayment on loans secured by such properties depends on successful operation and management of the collateral properties. The value of the collateral is also subject to the real estate market and general economic conditions. The Bank of Hemet attempts to address these risks through its underwriting criteria, including the loan-to-value ratios and debt service coverages described above. The collateral quality and type must meet The Bank of Hemet's standards, the property must have quality leases extended beyond the maturity date, if applicable, and the borrower/guarantor must have strong liquidity. The Bank of Hemet generally requires continuing guaranties from borrowers/owners. All of the properties securing The Bank of Hemet's real estate portfolio are inspected by The Bank of Hemet's lending administration personnel before the loan is made. The Bank of Hemet requires title insurance insuring the status of its lien on all of the real estate secured loans. The Bank of Hemet also requires that fire and extended coverage casualty insurance (and, if the property is in a flood zone, flood insurance) is maintained in an amount at least equal to the outstanding loan balance, subject to applicable law that in some circumstances may limit the required amount of hazard insurance to the cost to replace the insured improvements. RESIDENTIAL MORTGAGE LOANS. As of December 31, 1998, the total of all residential mortgage loans held in portfolio by The Bank of Hemet was $29.1 million, or 13.9% of total loans. The portfolio is primarily secured by first deeds of trust on single-family residences 49 located in the Riverside and San Bernardino counties of California. Approximately $25.1 million or 86.4% of this portfolio consists of variable rate loans. From time to time, The Bank of Hemet has originated first mortgages for resale on the secondary market to Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA). However, since 1995 The Bank of Hemet has chosen not to originate residential mortgage loans either for its own portfolio or for sale in the secondary market due to competitive issues. The Bank of Hemet retains the servicing rights to the loans sold. Servicing arrangements provide for The Bank of Hemet to maintain 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 of Hemet receives as compensation a servicing fee based on the principal balance of the outstanding loans. Servicing fee income amounted to $57,000 during 1998, and the total unpaid principal balance of the mortgage servicing portfolio amounted to approximately $18.3 million at December 31, 1998. REAL ESTATE CONSTRUCTION LOANS. The Bank of Hemet finances the construction of residential, commercial and industrial properties. The Bank of Hemet's construction loans typically have the following characteristics: - First mortgages on the collateral real estate; - Maturities of one year or less; - A floating rate of interest based on the Bank of America prime rate; - Minimum cash equity of 30% of project cost; - Reserve for anticipated interest costs during construction; - Loan-to-value ratios generally not exceeding 65%; and - Recourse against the borrower or a guarantor in the event of a default. For commercial and industrial properties, The Bank of Hemet typically issues a stand-by commitment for a "take-out" mini-perm loan on the property. The Bank of Hemet does not participate in joint ventures or take an equity interest in connection with its construction lending. Construction loans involve additional risks compared with loans secured by existing improved real property. These include: - The uncertain value of the project prior to completion; - The inherent uncertainty in estimating construction costs; - Possible difficulties encountered by municipal or other governmental regulation during construction; and - The inherent uncertainty of the market value of the completed project. As a result of these uncertainties, repayment depends, in large part, on the success of the ultimate project. If The Bank of Hemet is forced to foreclose on a project before or at completion because of a default, The Bank of Hemet may not be able to recover all of the unpaid balance of the loan and its accrued interest, as well as the related foreclosure and 50 holding costs. In addition, The Bank of Hemet may find it necessary to pay additional amounts to complete a project and may have to hold the property for an indeterminate time. Further, future local or national economic could have an adverse impact on the potential success of construction projects financed by The Bank of Hemet and on collateral securing these loans. COMMERCIAL LOANS At December 31, 1998, approximately $10.0 million, or 4.8% of The Bank of Hemet's total loan portfolio, consisted of commercial loans. The Bank of Hemet provides intermediate and short-term commercial loans that are either unsecured, partially secured or fully secured. The majority of these loans are in Riverside and San Bernardino counties. Loan maturities range from 90 days to five years. The Bank of Hemet requires complete re-analysis before making any extension. The Bank of Hemet makes these loans to individuals, professionals and businesses. The Bank of Hemet takes collateral whenever possible regardless of the loan purpose. Collateral may include cash, liens on accounts receivable and/or equipment. As a matter of policy, the Bank requires all principals of a business to be guarantors on all commercial loans. All borrowers must demonstrate the ability to service and repay not only The Bank of Hemet debt but all outstanding debt, on the basis of historical cash flow or conversion of assets. CONSUMER LOANS As of December 31, 1998, the total of all consumer loans held by The Bank of Hemet was $1.0 million or .5% of total loans. Consumer loans may be secured or unsecured, and are extended for a variety of purposes, including the purchase or finance of automobiles, home improvement, home equity lines and overdraft protection. Consumer loan underwriting standards include an examination of the applicant's credit history and payment record on other debts and an evaluation of his or her ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary importance, the underwriting process also includes a comparison of the value of the security, if any, to the proposed loan amount. Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because the collateral is more likely to suffer damage, loss or depreciation. The remaining deficiency often does not warrant further collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability. Furthermore, various federal and state laws, including federal and state bankruptcy and insolvency laws, often limit the amount that the lender can recover on these loans. OFF-BALANCE SHEET COMMITMENTS The Bank of Hemet may issue formal commitments or lines of credit to a limited number of well-established, financially responsible, local commercial enterprises. Such commitments can be either secured or unsecured. These commitments may take the form of revolving lines 51 of credit, letters of credit, real estate construction or real estate mortgage loans. Standby letters of credit are conditional commitments issued by The Bank of Hemet to guarantee the performance of a customer to a third party. The Bank of Hemet does not enter into any interest rate swaps or caps, or forward or future contracts. The following table shows the distribution of The Bank of Hemet's undisbursed loan commitments at the dates indicated.
AT DECEMBER 31, -------------------- 1998 1997 --------- --------- (IN THOUSANDS) Real estate--construction................................................ $ 2,404 $ 2,160 Real estate--mortgage.................................................... 1,472 822 Standby letters of credit................................................ 1,116 282 Undisbursed lines of credit.............................................. 5,876 6,436 --------- --------- Total.................................................................... $ 10,868 $ 9,700 --------- --------- --------- ---------
LENDING PROCEDURES AND CREDIT APPROVAL PROCESS The board of directors' loan committee approves all loans in excess of $500,000 and reviews all loans under $500,000. Lending limits are authorized for the Chief Executive Officer and the Chief Credit Officer by the loan committee through authority delegated by the board of directors of The Bank of Hemet. The directors' loan committee approves all loans which would create a total borrower liability in excess of a lending officer's lending authority. The Chief Credit Officer is responsible for evaluating the authority limits for individual credit officers and recommends lending limits to the board of directors for approval. The highest individual lending authority in The Bank of Hemet is currently $500,000, which requires the approval and signature of the Chief Credit Officer. The second highest lending authority is $150,000 for the manager of the real estate loan department. All other individual lending authorities are substantially less, with the next largest authority being $100,000. At December 31, 1998, The Bank of Hemet's authorized legal lending limits were approximately $3.5 million for unsecured loans and approximately $5.8 million for secured loans. Legal lending limits are calculated in conformance with California law, which prohibits a bank from lending to any one individual or entity or its related interests an aggregate amount which exceeds 15% of primary capital plus the allowance for loan and lease losses on an unsecured basis and 25% on a secured basis. The Bank of Hemet's primary capital plus allowance for loan and lease losses at December 31, 1998 totaled $23.3 million. The Bank of Hemet's largest borrower as of December 31, 1998 had an aggregate loan liability totaling $5.8 million. The Bank of Hemet seeks to mitigate the risks inherent in its loan portfolio by adhering to certain underwriting practices. These practices include analysis of prior credit histories, financial statements, tax returns and cash flow projections, valuation of collateral based on reports of independent appraisers and verification of liquid assets. Although management believes that its underwriting criteria are appropriate for the various kinds of loans it makes, The Bank of Hemet may incur losses on loans which meet its underwriting criteria, and these 52 losses may exceed the amounts set aside as reserves for such losses in the allowance for loan and lease losses. ASSET QUALITY NONPERFORMING ASSETS. Nonperforming assets include nonperforming loans and other real estate owned ("OREO"). NONPERFORMING LOANS. Nonperforming loans are those which the borrower fails to perform in accordance with the original terms of the obligation and fall into one of two categories: - Nonaccrual loans. The Bank of Hemet generally places loans on nonaccrual status when interest or principal payments become 90 days or more past due unless the outstanding principal and interest is well-secured and, in the opinion of management, is deemed in the process of collection. When loans are placed on nonaccrual status, accrued but unpaid interest is reversed against the current year's income. The Bank of Hemet may treat payments on nonaccrual loans as interest income or return of principal depending upon management's opinion of the ultimate risk of loss on the individual loan. Cash payments are treated as interest income where management believes the remaining principal balance is fully collectible. Additionally, The Bank of Hemet may place loans not 90 days past due on nonaccrual status if management reasonably believes the borrower will not be able to comply with the contractual loan repayment terms and collection of principal or interest is in question. - Accruing loans 90 days or more past due. The Bank of Hemet classifies a loan in this category when the borrower is more than 90 days late in making a payment of principal or interest but the loan has not been placed on nonaccrual status. Nearly all nonperforming loans during the periods reported were secured by first deeds of trust on real property. The collateral securing these nonperforming loans at December 31, 1998 may not be sufficient to prevent losses on such loans. OTHER REAL ESTATE OWNED ("OREO"). This category of nonperforming assets consists of real estate to which The Bank of Hemet has taken title by reason of foreclosure or by taking a deed in lieu of foreclosure from the borrower. The Bank of Hemet has been actively managing its OREO while attempting to expeditiously dispose of the properties. At December 31, 1998, the bank owned one OREO property, consisting of a single family residence valued at $77,000. For a more complete discussion of changes in OREO during the last three years, please refer to "The Bank of Hemet Management's Discussion and Analysis of Results of Operations--Noninterest Expense." 53 The following table summarizes The Bank of Hemet's nonperforming assets at the dates indicated.
DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (DOLLARS IN THOUSANDS) Nonaccrual loans(1).............................................. $ 1,578 $ 2,902 $ 2,976 $ 2,446 $ 3,188 Loans past due 90 days or more................................... 3 -- 17 14 -- Total nonperforming loans........................................ 1,581 2,902 2,993 2,460 3,188 Other real estate owned.......................................... 77 779 2,180 3,908 2,719 --------- --------- --------- --------- --------- Total nonperforming assets....................................... $ 1,658 $ 3,681 $ 5,173 $ 6,368 $ 5,907 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Nonperforming loans as a percent of total loans.................. 0.76% 1.51% 1.60% 1.32% 1.72% Nonperforming assets as a percent of total assets................ 0.66% 1.53% 2.21% 2.79% 2.64%
- ------------------------ (1) Interest income in the amount of $277,000 would have accrued during 1998 on loans on nonaccrual status if interest had been accrued. Income of $115,000 was in fact recognized on nonaccrual loans in 1998 based on receipt of actual interest payments. IMPAIRED LOANS. Management defines impaired loans, regardless of past due status on loans, as those on which principal and interest are not expected to be collected under the original contractual loan repayment terms. The Bank of Hemet charges off an impaired loan at the time management believes it has exhausted the collection process. The Bank of Hemet values impaired loans based on the present value of future cash flows discounted at the loan's effective rate, the loan's observable market price or the fair value of collateral if the loan is collateral-dependent. Impaired loans at December 31, 1998 were $3.3 million ($1.6 million of which were also nonaccrual loans). On account of these impaired loans, The Bank of Hemet had an allowance for loan and lease losses of $287,000 at December 31, 1998. The average outstanding principal balance of impaired loans was $4.0 million during 1998. Substantially all of the impaired loans at December 31, 1998 were collateral dependent and management measured them using the fair value of the collateral. SUBSTANDARD AND DOUBTFUL LOANS. The Bank of Hemet classifies loans as "substandard" in accordance with regulatory requirements when they are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral for loan, if any. Substandard loans generally have a well-defined weaknesses that jeopardize repayment. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. The Bank of Hemet classifies loans as "doubtful," in accordance with regulatory requirements, when the loans have the inherent weaknesses of substandard loans and, in addition, the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. However, in such loans, certain important and reasonably specific pending factors may work to the advantage and strengthening of the asset. Accordingly, with respect to such loans, the estimated loss is deferred until its more exact status may be determined. RESTRUCTURED LOANS. The Bank of Hemet considers restructured loans as loans on which interest accrues at a below market rate or on which certain principal has been forgiven to help the borrower make final repayment of the loan. Any interest previously accrued, but not 54 yet collected, is reversed against current income when the loan is placed in this category. Interest is then reported on a cash basis until the borrower establishes an ability to service the restructured loans in accordance with its terms. The Bank of Hemet does not have any loans categorized as restructured loans. Except as disclosed above, there were no assets as of December 31, 1998 where known information about possible credit problems of borrowers caused management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms. However, it is always possible that current credit problems may exist that may not have been discovered by management. Given the high percentage of The Bank of Hemet's loans that are secured by real estate, the real estate market in Southern California and the overall economy in The Bank of Hemet's market area are likely to continue to have a significant effect on the quality of The Bank of Hemet's assets in the future. ALLOWANCES AND PROVISIONS FOR LOAN AND LEASE LOSSES The following table sets forth an analysis of the allowance for loan and lease losses and provisions for loan and lease losses for the periods indicated.
DECEMBER 31, ---------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Balance at beginning of period....................... $ 2,116 $ 2,241 $ 2,135 $ 2,609 $ 2,520 Loans charged off: Real estate--construction.......................... -- -- -- -- 625 Real estate--mortgage.............................. 139 274 562 179 776 Commercial......................................... -- 159 272 348 43 Consumer........................................... 43 18 68 90 17 ---------- ---------- ---------- ---------- ---------- Total charge-offs................................ 182 451 902 617 1,461 Recoveries: Real estate--construction.......................... -- -- -- -- -- Real estate--mortgage.............................. 225 57 16 18 9 Commercial......................................... 47 10 2 -- 35 Consumer........................................... 26 9 2 5 6 ---------- ---------- ---------- ---------- ---------- Total recoveries................................. 298 76 20 23 50 ---------- ---------- ---------- ---------- ---------- Net charge-offs...................................... (116) 375 882 594 1,411 ---------- ---------- ---------- ---------- ---------- Provision for possible loans losses.................. -- 250 988 120 1,500 ---------- ---------- ---------- ---------- ---------- Balance at end of period............................. $ 2,232 $ 2,116 $ 2,241 $ 2,135 $ 2,609 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Average total loans outstanding(1)................... $ 196,675 $ 187,298 $ 184,307 $ 183,632 $ 185,708 Total loans at end of period(1).................... 207,802 192,287 187,441 185,717 185,746 Net charge-offs/average loans outstanding............ (0.06)% 0.20% 0.48% 0.32% 0.76% Allowance at end of period/loans outstanding......... 1.07% 1.10% 1.20% 1.15% 1.40% Allowance/nonperforming loans........................ 141.16% 72.90% 74.86% 86.78% 81.84%
- ------------------------ (1) Net of deferred loan origination fees. The Bank of Hemet maintains an allowance for loan and lease losses at a level considered by management to be adequate to cover the inherent risks of loss associated with its loan portfolio under prevailing and anticipated economic conditions. In determining the 55 adequacy of the allowance, management takes into consideration primarily the credit quality of the portfolio and prior loan loss experience. The specific calculation of the allowance for loan and lease losses is based on the risk rating system that The Bank of Hemet uses to grade its loans. This system classifies all loans into one of eight grades according to a risk-rating matrix that evaluates each of the five following factors: - the dependability of the primary repayment source; - the dependability of the secondary repayment source; - the value of the collateral in relation to the size of the loan, and the liquidity of the collateral; - the character/relationship of the borrower; and - the strength, stability and potential of the industry in which the borrower is operating. Different reserve percentages are assigned to each different class of loan, as summarized in the following table.
LOAN GRADE RESERVE PERCENTAGE - ---------------------------------- -------------------------------------- Class I ("Pass)................... 0.10% Class II ("Pass")................. 0.20% Class III ("Pass")................ Historical loan loss experience factor Class IV ("Watch")................ Calculated on a loan by loan basis Class V ("Special Mention")....... Calculated on a loan by loan basis Class VI ("Substandard').......... Calculated on a loan by loan basis Class VII ("Doubtful")............ Minimum of 50.00% Class VIII ("Loss")............... 100.00%
Management assigns reserve percentages to the first two classes, reflecting management's judgment of the likelihood of loss in each risk category. For the third grade, in which most "pass loans" fall, management assigns a reserve percentage to each of the following kinds of loans: commercial loans, commercial real estate loans, residential real estate loans, construction loans and consumer loans. The reserve percentage represents the historical loss rate on this category of loans for the preceding 36 months. For the next three categories, management assigns specific reserves based on a risk analysis of each loan. The Bank of Hemet's board of directors approves the adequacy of the allowance for loan and lease losses on a quarterly basis. The balance in the allowance is affected by amounts provided from operations, amounts charged-off and recoveries of previously charged-off loans. For 1998, The Bank of Hemet recorded no provision for loan and lease losses, compared with provisions of $250,000 for 1997 and $988,000 for 1996. The lack of a provision in 1998 resulted from management's determination, in accordance with the policy discussed above, that the allowance was adequate at December 31, 1998. In fact, the allowance had grown in 1998 by reason of net recoveries on loans previously charged-off in the amount of $116,000, compared with net charge-offs of $375,000 in 1997 and $882,000 in 1996. These trends reflected, among other factors, the strengthening of the Southern California economy. The decreased provision in 1997 as compared with 1996 reflected the significant decrease in net charge-offs during 1997 as 56 compared with 1996. The increased provision in 1996 mainly resulted from the decline in real estate collateral value for one borrower in that year. At December 31, 1998 the allowance for loan and lease losses stood at $2.2 million or 1.07% of total loans outstanding, compared with $2.1 million or 1.10% of total loans outstanding at December 31, 1997, and $2.2 million, or 1.20% of total loans outstanding at December 31, 1996. Management anticipates the continued stabilization of the economy in segments of The Bank of Hemet's market area. However, underlying trends in the economic cycle will influence credit quality, particularly in Southern California. Management cannot completely predict these trends. Consequently, The Bank of Hemet may sustain loan losses, in any particular period, that are sizable in relation to the allowance for loan and lease losses. Additionally, a subsequent evaluation of the loan portfolio, in light of factors then prevailing, by The Bank of Hemet and its regulators may indicate a requirement for increases in the allowance for loan and lease losses through charges to the provision for loan and lease losses. The following table summarizes a breakdown of the allowance for loan and lease losses by loan category and the allocation in each category as a percentage of total loans in each category at the dates indicated:
DECEMBER 31, ---------------------------------------------------------------------- 1998 1997 1996 ---------------------- ---------------------- ---------------------- % OF LOANS % OF LOANS % OF LOANS IN IN IN AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY --------- ----------- --------- ----------- --------- ----------- (DOLLARS IN THOUSANDS) Real estate--construction...................... $ 3 0.1% $ 66 3.1% $ 83 3.7% Real estate--mortgage.......................... 2,042 91.5 1,984 93.8 2,082 92.9 Commercial..................................... 171 7.7 47 2.2 56 2.5 Consumer loans................................. 16 0.7 19 0.9 20 0.9 --------- ----- --------- ----- --------- ----- Total........................................ $ 2,232 100.0% $ 2,116 100.0% $ 2,241 100.0% --------- ----- --------- ----- --------- ----- --------- ----- --------- ----- --------- -----
Allocations of the loan and lease losses by category are not available in The Bank of Hemet's records for 1995 and 1994. However, real-estate mortgage loans constituted 87.8% of The Bank of Hemet's portfolio in 1995 and 88.3% in 1994. Accordingly, management believes that more than 90% of the allowance in 1995 and 1994 was allocable to real-estate mortgage loans as it was in 1998, 1997 and 1996. The allocation of the allowance to loan and lease categories is an estimate by management of the relative risk characteristics of loans in those categories. Losses in one or more loan categories may exceed the portion of the allowance allocated to that category or even exceed the entire allowance. The Bank of Hemet did not make an allocation of loan loss reserves by loan category in 1995 or 1994. DEPOSITS Deposits are The Bank of Hemet's primary source of funds. At December 31, 1998, The Bank of Hemet had a deposit mix of 54.3% in time deposits, 29.4% in savings and interest-bearing checking accounts, 14.7% in noninterest-bearing demand accounts and 1.6% in money market accounts. 57 Noninterest-bearing demand deposits enhance The Bank of Hemet's net interest income by lowering its costs of funds. The Bank is committed to continuing its recent efforts to increase core deposits through increased business development efforts, diversification of its customer base, product line enhancements and superior customer service. Currently, deposits from the local market area are increasing, thus decreasing reliance on potentially unstable sources of funds. The Bank of Hemet obtains deposits primarily from the communities it serves. No material portion of its deposits has been obtained from or is dependent on any one person or industry. The Bank of Hemet's business is not seasonal in nature. The Bank of Hemet accepts deposits in excess of $100,000 from customers. These deposits are priced to remain competitive. At December 31, 1998, The Bank of Hemet had no brokered deposits. The following table sets forth the average balances and the average rates paid for the major categories of deposits for the dates indicated:
DECEMBER 31, ------------------------------------------------------------------------- 1998 1997 1996 ----------------------- ----------------------- ----------------------- AVERAGE AVERAGE AVERAGE AVERAGE RATE AVERAGE RATE AVERAGE RATE BALANCE PAID BALANCE PAID BALANCE PAID ---------- ----------- ---------- ----------- ---------- ----------- (DOLLARS IN THOUSANDS) Noninterest-bearing demand...................... $ 33,349 --% $ 29,831 --% $ 25,981 --% Interest-bearing demand......................... 14,204 1.07 13,722 1.10 14,837 1.13 Money market deposits........................... 3,970 2.72 4,660 2.75 5,393 2.82 Savings deposits................................ 48,793 4.01 47,468 4.11 41,968 4.07 Time deposits of $100,000 or more............... 9,036 5.54 8,662 5.65 15,537 5.73 Time deposits under $100,000.................... 116,876 5.53 109,948 5.65 106,222 5.56 ---------- ---------- ---------- Total average deposits.......................... $ 226,228 4.06 $ 214,291 4.17 $ 209,938 4.20 ---------- ---------- ---------- ---------- ---------- ----------
MATURITIES OF TIME CERTIFICATES OF DEPOSIT Maturities of time certificates of deposits outstanding at December 31, 1998 are summarized as follows:
$100,000 LESS THAN OR MORE $100,000 ----------- ---------- (IN THOUSANDS) Three months or less........................................................................ $ 2,642 $ 29,684 Over three to six months.................................................................... 1,649 26,310 Over six to twelve months................................................................... 2,976 53,833 Over twelve months.......................................................................... 874 7,053 ----------- ---------- Total....................................................................................... $ 8,141 $ 116,880 ----------- ---------- ----------- ----------
58 DATA PROCESSING SERVICES--BANKLINK CORPORATION BankLink Corporation, a wholly owned subsidiary of The Bank of Hemet located in Riverside, California, provides data processing services and item processing services to The Bank of Hemet and other financial institutions. BankLink Corporation currently serves nine client banks. BankLink Corporation uses Information Technology Incorporated (ITI) application software systems to provide high volume processing capabilities and systems support services for deposit and loan transactions, treasury functions and loan servicing. These services encompass all of the normal banking applications, including accounts payable, fixed assets, ACH origination, automated exception processing, asset liability, corporate cash management, voice response systems, and account analysis. For the year ended December 31, 1998, BankLink Corporation had revenues from its operations of $1.1 million. SUPERVISION AND REGULATION As a California licensed FDIC insured bank, The Bank of Hemet is subject to many governmental rules that affect its operations. For a description of the laws and regulations that apply to The Bank of Hemet, please refer to the section entitled "Supervision and Regulation," starting on page 107. COMPETITION The Bank of Hemet considers its primary service area to include Riverside and San Bernardino counties of California. The banking business is highly competitive in California, including this region. A number of major banks and savings and loans associations have offices in this area. They currently dominate loan and deposit origination. The Bank of Hemet also competes for deposits and loans with finance companies, industrial loan companies, securities and brokerage companies, mortgage companies, insurance companies, money market funds, credit unions and other financial institutions. Major banks and savings and loans associations exercise certain competitive advantages over community banks like The Bank of Hemet. They can finance extensive advertising campaigns and offer the convenience of many retail outlets. Many offer services, such as trust and international banking services, which The Bank of Hemet does not offer directly. They can invest greater resources in technology, which may afford them economies of scale, particularly with respect to consumer financial services, by reason of their larger customer bases. In addition, these larger institutions likely have lower costs of capital and substantially higher lending limits. To compete with larger financial institutions, The Bank of Hemet relies upon responsive handling of customer needs, local promotional activity, and personal contacts by its officers, directors and staff. For customers whose loan demands exceed The Bank of Hemet's lending limits, The Bank of Hemet seeks to arrange funding on a participation basis with its correspondent banks or other independent commercial banks. The Bank of Hemet also assists customers requiring services not offered by it to obtain such services from its correspondent banks. In commercial real estate lending, The Bank of Hemet competes against larger institutions. Management seeks to assert its competitive advantage in this market through its 59 depth of experience and ability to respond in customized ways to the needs of its customers. In its deposit gathering, The Bank of Hemet competes by having convenient branches located in areas of high bank deposits per person, and by providing consumer-friendly environments at those branches. EMPLOYEES At December 31, 1998, The Bank of Hemet employed a total of 86 full-time equivalent employees, including four executive officers. None is presently represented by a union or covered by a collective bargaining agreement. The Bank of Hemet believes its employee relations are excellent. LITIGATION In April 1997, litigation relating to the acquisition of Inland Savings and Loan in 1992 by The Bank of Hemet was filed against The Bank of Hemet and certain of its directors. The legal action alleges improper adjustments to the value of the preferred stock of The Bank of Hemet issued to Inland Savings and Loan shareholders in connection with the 1992 acquisition. The named plaintiffs have sued on behalf of a class consisting of former owners of preferred stock of The Bank of Hemet. The action alleges breach of contract and breach of fiduciary duty and seeks compensatory damages in excess of $2 million, together with punitive damages. In 1998, the court granted The Bank of Hemet's motion to remove the fraud cause of action. On January 14, 1999, the court certified the case as a class action. The bank contends that the allegations in the case are without merit, and intends to vigorously defend against these claims. Any potential losses to The Bank of Hemet as a result of this action are not reasonably estimable, and accordingly no reserve for loss has been established in The Bank of Hemet's consolidated financial statements. Any losses which might be suffered by The Bank of Hemet related to this proceeding could impact The Bank of Hemet's future profitability. From time to time, The Bank of Hemet is involved in other litigation as an incident to its business. In the opinion of management, no such other pending or threatened litigation is likely to have a material adverse effect on The Bank of Hemet's financial condition or results of operations. INSURANCE The Bank of Hemet maintains financial institution bond and commercial insurance at levels deemed adequate by The Bank of Hemet's management to protect it from certain damage. 60 VALLEY BANK SELECTED FINANCIAL DATA Set forth below is the selected financial data and operating data of Valley Bank for the periods indicated, which have been derived from Valley Bank's audited financial statements. The selected financial data set forth below should be read in conjunction with Valley Bank's financial statements included elsewhere in this prospectus and "Valley Bank Management's Discussion and Analysis of Financial Condition and Results of Operations."
AT OR FOR THE YEAR ENDED DECEMBER 31, -------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ (DOLLARS IN THOUSANDS EXCEPT PER SHARE INFORMATION) RESULTS OF OPERATIONS Interest income............................ $ 6,181 $ 5,978 $ 5,338 $ 4,954 $ 4,237 Interest expense........................... 1,438 1,282 1,119 1,007 857 Net interest income........................ 4,743 4,696 4,219 3,947 3,380 Provision for loan and lease losses........ 200 980 360 610 160 Noninterest income......................... 2,915 2,719 2,135 2,170 1,895 Noninterest expense........................ 6,085 5,637 5,211 4,902 4,484 Provision for income taxes................. 584 242 329 199 210 Net income................................. 789 556 454 406 421 BALANCE SHEET (END OF PERIOD) Total assets............................... $ 84,709 $ 74,566 $ 71,070 $ 65,989 $ 64,868 Total loans................................ 43,149 45,260 42,999 34,292 32,882 Allowance for loan and lease losses........ 1,118 1,058 756 497 574 Nonperforming loans........................ 5,008 3,227 1,245 1,235 3,173 Other real estate owned.................... 1,749 1,711 1,144 2,555 1,143 Total deposits............................. 75,739 66,239 63,286 59,001 58,334 Shareholders' equity....................... 8,254 7,292 6,902 6,762 6,356 BALANCE SHEET (PERIOD AVERAGE) Total assets............................... $ 81,248 $ 74,409 $ 69,940 $ 66,525 $ 65,101 Total loans................................ 48,512 43,921 41,649 34,552 28,678 Earning assets............................. 70,839 64,794 61,116 55,776 54,013 Total deposits............................. 72,434 66,267 62,517 59,496 58,275 Shareholders' equity....................... 7,716 6,972 6,796 6,505 5,182 CAPITAL RATIOS Leverage ratio............................. 10.20% 9.80% 9.70% 10.20% 9.80% Tier 1 risk-based capital.................. 15.50 13.50 13.90 15.70 15.80 Total risk-based capital................... 16.70 14.50 14.90 14.50 17.00 ASSET QUALITY RATIOS Nonperforming loans/total loans(1)......... 11.61% 7.13% 2.90% 3.60% 9.65% Nonperforming assets/total assets(2)....... 7.98 6.62 3.36 5.74 6.65 Allowance for loan losses/ nonperforming loans.................................... 22.32 32.79 60.72 40.24 18.09 Allowance for loan losses/total loans...... 2.59 2.34 1.76 1.45 1.75
61
AT OR FOR THE YEAR ENDED DECEMBER 31, -------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ (DOLLARS IN THOUSANDS EXCEPT PER SHARE INFORMATION) PERFORMANCE RATIOS Return on average assets................... 0.97% 0.75% 0.65% 0.61% 0.65% Return on average equity................... 10.23 7.97 6.68 6.24 8.12 Net interest margin(3)..................... 6.77 7.28 6.96 6.89 6.26 Net interest spread(4)..................... 6.12 6.63 6.57 6.39 5.90 Average loans to average deposits.......... 66.97 66.28 66.62 58.07 49.21 Efficiency ratio(5)........................ 79.46 76.02 82.01 80.14 85.00 PER SHARE INFORMATION Basic earnings(6).......................... $ 0.73 $ 0.53 $ 0.41 $ 0.35 $ 0.36 Diluted earnings(7)........................ $ 0.65 $ 0.51 $ 0.41 $ 0.34 $ 0.36 Dividends declared......................... $ -- $ -- $ -- $ -- $ -- Dividend payout ratio(8)................... --% --% --% --% --% Book value................................. $ 7.04 $ 6.22 $ 5.93 $ 5.81 $ 5.46 Shares outstanding at period end(9)........ 1,171,906 1,171,906 1,164,034 1,164,034 1,164,034 Weighted average shares outstanding(9)..... 1,084,112 1,055,293 1,094,211 1,164,034 1,164,034
- ------------------------ (1) Nonperforming loans consist of loans on nonaccrual, loans past due 90 days or more and restructured loans. (2) Nonperforming assets consist of nonperforming loans and other real estate owned. (3) Net interest margin is net interest income expressed as a percentage of average total interest-earning assets. (4) Net interest spread is the difference between the yield on average total interest-earning assets and cost of average total interest-bearing liabilities. (5) The efficiency ratio is the ratio of noninterest expense to the sum of net interest income before provision for loan losses and total noninterest income. (6) Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period. (7) Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into the common stock or resulted in the issuance of common stock that then shared in earnings. (8) The dividend payout ratio consists of the dividends paid per share divided by basic earnings per share. (9) Shares outstanding at period end include unearned ESOP shares and exclude shares issuable upon exercise of outstanding options. Weighted average shares outstanding, used to calculate earnings per share, do not include unearned ESOP shares. 62 VALLEY BANK MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. VALLEY BANK'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THE SECTION ENTITLED "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to Valley Bank's financial condition, operating results, asset and liability management, liquidity and capital resources. The following discussion should be read in conjunction with the financial statements of Valley Bank. FINANCIAL CONDITION Total assets at December 31, 1998 were $84.7 million compared to $74.6 million at December 31, 1997, up approximately 13.6%. This increase is attributable to an $9.0 million increase in federal funds sold, a $1.7 million increase in securities, a $998,000 increase in cash due from banks, and a $382,000 increase in other assets, offset by a $2.8 million decrease in net loans. Total deposits increased from $66.2 million as of December 31, 1997 to $75.7 million as of December 31, 1998. Stockholders' equity was $8.3 million at December 31, 1998, up from its $7.3 million level a year earlier, owing primarily to net income of $789,000 and a decrease in the amount of unearned Employee Stock Ownership Plan shares of $108,000. Valley Bank's loan portfolio (including loans held for sale of $594,000) decreased by approximately $2.2 million during the fiscal year ended December 31, 1998. The largest components of this decrease were in residential lending, which decreased $2.3 million from $7.1 million in 1997 to $4.8 million in 1998, and loans secured by unimproved residential lots, which decreased $1.5 million from $6.4 million in 1997 to $4.9 million in 1998. These decreases were partially offset by increases of $907,000 and $796,000 in commercial and industrial loans and government guaranteed loans, respectively. The loan portfolio decrease was also attributable to an increase in the sale of government guaranteed loans, from $12.0 million in 1997 to $14.6 million in 1998. As the economy in Southern California continues to improve, there is a greater demand for both business and construction lending, thus allowing the Bank the opportunity to originate loans to finance these demands. Loan demand in the Pacific Northwest has remained strong and steady during the past two years. Valley Bank expects loan demand in its market areas to remain strong. Because Valley Bank expects to continue to sell government guaranteed loans in the secondary market, strong loan originations will not necessarily result in increases in the size of its loan portfolio. 63 ANALYSIS OF FINANCIAL CONDITION The following table sets forth the average balances of each principal category of Valley Bank's assets, liabilities and capital accounts for the periods indicated, as well as the percentage of each category to total assets for the periods indicated. Average balances used throughout this prospectus are based on daily averages.
FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------- 1998 1997 1996 ---------------------- ---------------------- ---------------------- PERCENT OF PERCENT OF PERCENT OF AVERAGE TOTAL AVERAGE TOTAL AVERAGE TOTAL BALANCE ASSETS BALANCE ASSETS BALANCE ASSETS --------- ----------- --------- ----------- --------- ----------- (DOLLARS IN THOUSANDS) Assets: Cash and due from banks............................. $ 5,883 7.2% $ 5,584 7.5% $ 5,076 7.3% Federal funds sold.................................. 8,631 10.6 6,506 8.7 5,060 7.2 Investment securities--taxable...................... 12,022 14.8 12,246 16.5 11,804 16.9 Investment securities--non-taxable.................. 987 1.2 1,474 2.0 1,976 2.8 Loans, net of allowance for loan losses and net of deferred loan fees and unearned income............ 47,436 58.4 42,925 57.7 40,996 58.6 Premises and equipment.............................. 2,185 2.7 2,184 2.9 2,280 3.3 Other assets........................................ 4,104 5.1 3,490 4.7 2,748 3.9 --------- ----- --------- ----- --------- ----- Total assets...................................... $ 81,248 100.0% $ 74,409 100.0% $ 69,940 100.0% --------- ----- --------- ----- --------- ----- --------- ----- --------- ----- --------- ----- Liabilities and shareholders' equity: Deposits: Demand............................................ $ 19,212 23.7% $ 18,098 24.3% $ 16,502 23.6% Savings and interest-bearing demand............... 38,063 46.8 35,773 48.1 35,553 50.8 Time deposits of $100,000 or more................. 2,909 3.6 1,761 2.4 1,625 2.3 Time deposits under $100,000...................... 12,250 15.1 10,635 14.3 8,837 12.7 --------- ----- --------- ----- --------- ----- Total deposits.................................... 72,434 89.2 66,267 89.1 62,517 89.4 Accrued interest payable and other liabilities...... 1,098 1.3 1,170 1.6 627 0.9 --------- ----- --------- ----- --------- ----- Total liabilities................................. 73,532 90.5 67,437 90.7 63,144 90.3 Common stock........................................ 5,860 7.2 5,761 7.7 5,544 7.9 Retained earnings................................... 1,856 2.3 1,211 1.6 1,252 1.8 --------- ----- --------- ----- --------- ----- Total shareholders' equity........................ 7,716 9.5 6,972 9.3 6,796 9.7 --------- ----- --------- ----- --------- ----- Total liabilities and shareholders' equity........ $ 81,248 100.0% $ 74,409 100.0% $ 69,940 100.0% --------- ----- --------- ----- --------- ----- --------- ----- --------- ----- --------- -----
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 OVERVIEW. Net income for 1998 was $789,000 compared with $556,000 in 1997 and $454,000 in 1996. Basic earnings per share were $0.73 in 1998 compared with $0.53 in 1997 and $0.41 in 1996. The return on average assets was 0.97% in 1998 compared with 0.75% in 1997 and 0.65% in 1996. Valley Bank's return on average equity was 10.23% for 1998, 7.97% for 1997 and 6.68% for 1996. Factors that significantly affected net income for 1998 as compared to 1997 included a reduction of $780,000 in the provision for loan and lease loss reserves, a gain on the sale of loans of $285,000, an increase in legal and professional expenses of $334,000 and a significant recovery that offset OREO expenses for the year. 64 NET INTEREST INCOME. Total interest and fee income on earning assets increased to $6.2 million from $6.0 million, or 3.4%, in 1998 compared with 1997. Net interest income increased to $4.8 million from $4.7 million, or 1.0%, in 1998 from 1997. Average interest-earning assets in 1998 were $70.8 million compared with $64.8 million in 1997, an increase of $6.0 million or 9.3%. The 1998 increase in interest income was primarily the result of the growth in interest-earning assets. The 1997 increase in interest income was also attributable to growth in interest-earning assets. Total average interest-bearing liabilities in 1998 were $53.7 million compared with $48.7 million in 1997, an increase of $5.0 million, or 10.3%. This amount reflects a significant increase in lower cost deposit accounts, primarily NOW accounts, as a result of consolidation in the local banking market. Total interest expense increased from $1.3 million to $1.4 million, or 12.2%, in 1998 compared with 1997 and increased from $1.1 million to $1.3 million, or 14.6% in 1997 compared with 1996. This was largely the result of the 10.3% increase in 1998 and 5.2% increase in 1997 in the amount of interest-bearing liabilities. Valley Bank's net interest margin was 6.77% for 1998, compared with 7.28% for 1997 and 6.96% for 1996. The reduction in net interest margin in 1998, as compared with 1997, was a direct result of the prime rate and federal funds rate reductions experienced in 1998. These rate reductions affected the rates received on Valley Bank's loan portfolio and other assets more than they affected the interest paid by it on deposits and other liabilities. Despite reduction in its net interest margin, Valley Bank's overall net interest income increased, primarily as a result of an increase in its volume of earning assets. The increase in net interest margin in 1997, as compared with 1996, was the direct result of the increase in the amount of loans outstanding. 65 AVERAGE BALANCES AND RATES EARNED AND PAID. The following table presents, for the periods indicated, average balance sheet information for Valley Bank, together with interest rates earned and paid on the various sources and uses of its funds. The table is arranged to group the elements of interest-earning assets and interest-bearing liabilities, these items being the major sources of income and expense. Nonaccruing loans are included in the calculation of average loan balances, but the nonaccrued interest thereon is excluded.
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1998 1997 1996 ----------------------------------- ----------------------------------- --------- RATES RATES AVERAGE INCOME/ EARNED/ AVERAGE INCOME/ EARNED/ AVERAGE BALANCE EXPENSE PAID BALANCE EXPENSE PAID BALANCE --------- ----------- ----------- --------- ----------- ----------- --------- (DOLLARS IN THOUSANDS) ASSETS Investments(1): Federal funds sold.................... $ 8,631 $ 444 5.14% $ 6,506 $ 354 5.44% $ 5,060 Securities, taxable................... 12,022 724 6.02% 12,246 764 6.24% 11,804 Securities, nontaxable................ 987 54 5.47% 1,474 76 5.16% 1,976 --------- ----------- --------- ----------- --------- Total investments................... $ 21,640 $ 1,222 5.65% $ 20,226 $ 1,194 5.90% $ 18,840 --------- ----------- --------- ----------- --------- Loans(2): Commercial............................ 3,892 339 8.71% 2,273 220 9.68% 2,051 Real estate........................... 44,174 4,567 10.34% 41,199 4,511 10.95% 39,203 Installment........................... 446 53 11.88% 449 53 11.80% 395 --------- ----------- --------- ----------- --------- Total loans....................... $ 48,512 $ 4,959 10.22% $ 43,921 $ 4,784 10.89% $ 41,649 Cash value of life insurance.......... 687 52 7.57% 647 23 3.55% 627 --------- ----------- --------- ----------- --------- Total earning assets.................. $ 70,839 $ 6,233 8.80% $ 64,794 $ 6,001 9.26% $ 61,116 ----------- ----------- Non earning assets: Allowance for loan and lease losses... (1,076) (996) (653) Cash and due from banks............... 5,883 5,584 5,076 Premises and equipment................ 2,185 2,184 2,280 Interest receivable and other assets............................... 3,417 2,843 2,121 --------- --------- --------- Total assets...................... $ 81,248 $ 74,409 $ 69,940 --------- --------- --------- --------- --------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing deposits: NOW................................. 19,297 200 1.04% 17,373 180 1.04% 16,652 Savings............................. 11,505 229 1.99% 11,220 223 1.99% 11,080 Money market........................ 7,261 181 2.49% 7,180 176 2.45% 7,821 Certificates of deposit under $100,000.......................... 12,250 629 5.13% 10,635 534 5.02% 8,837 Certificates of deposit of $100,000 or more........................... 2,909 148 5.09% 1,761 114 6.47% 1,625 --------- ----------- --------- ----------- --------- Total interest bearing deposits... 53,222 1,387 2.61% 48,169 1,227 2.55% 46,015 Other borrowings.................... 527 51 9.68% 561 55 9.80% 327 --------- ----------- --------- ----------- --------- Total interest bearing liabilities..................... 53,749 $ 1,438 2.68% 48,730 $ 1,282 2.63% 46,342 ----------- ----------- Non-interest bearing deposits......... 19,212 18,098 16,502 Other liabilities..................... 571 609 300 Stockholders' equity.................. 7,716 6,972 6,796 --------- --------- --------- Total liabilities and stockholders' equity............................ $ 81,248 $ 74,709 $ 69,940 --------- --------- --------- --------- --------- --------- Net interest income................... $ 4,795 $ 4,719 Net interest spread(3)................ 6.12% 6.63% Net interest margin(4)................ 6.77% 7.28% RATES INCOME/ EARNED/ EXPENSE PAID ----------- ----------- ASSETS Investments(1): Federal funds sold.................... $ 269 5.32% Securities, taxable................... 703 5.96% Securities, nontaxable................ 100 5.06% ----------- Total investments................... $ 1,072 5.69% ----------- Loans(2): Commercial............................ 216 10.53% Real estate........................... 4,004 10.39% Installment........................... 46 11.55% ----------- Total loans....................... $ 4,266 10.41% Cash value of life insurance.......... 33 5.28% ----------- Total earning assets.................. $ 5,371 8.98% ----------- Non earning assets: Allowance for loan and lease losses... Cash and due from banks............... Premises and equipment................ Interest receivable and other assets............................... Total assets...................... LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing deposits: NOW................................. 173 1.04% Savings............................. 227 2.05% Money market........................ 192 2.45% Certificates of deposit under $100,000.......................... 425 4.81% Certificates of deposit of $100,000 or more........................... 92 5.66% ----------- Total interest bearing deposits... 1,109 2.41% Other borrowings.................... 10 3.06% ----------- Total interest bearing liabilities..................... $ 1,119 2.41% ----------- Non-interest bearing deposits......... Other liabilities..................... Stockholders' equity.................. Total liabilities and stockholders' equity............................ Net interest income................... $ 4,252 Net interest spread(3)................ 6.57% Net interest margin(4)................ 6.96%
- -------------------------- (1) The yield for securities reflects that Valley Bank's entire investment portfolio is classified as held-to-maturity and is based on historical amortized cost balances. Municipal securities are not reported on a tax-exempt equivalent basis. (FOOTNOTES CONTINUED ON NEXT PAGE) 66 (2) Loans, net of unearned income, include non-accrual loans but do not reflect average reserves for possible loan losses. Loan fees of $307,000 in 1998, $417,000 in 1997 and $229,000 in 1996 are included in loan interest income. There were non-accruing loans totaling approximately $4,752,000 at December 31, 1998, $3,227,000 at December 31, 1997, and $1,245,000 at December 31, 1996. (3) Net interest spread is the difference between the yield on average total interest-earning assets and cost of average total interest-bearing liabilities. (4) Net interest margin is net interest income expressed as a percentage of average total interest-earning assets. NET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE. The following table sets forth, for the periods indicated, a summary of the changes in average asset and liability balances and interest earned and interest paid resulting from changes in average asset and liability balances (volume) and changes in average interest rates. The changes in interest due to both rate and volume have been allocated to the change in average rate. Nonaccruing loans are included in the table for computational purposes, but the nonaccrued interest thereon is excluded.
1998 COMPARED WITH 1997 1997 COMPARED WITH 1996 ----------------------------------- ------------------------ INCREASE (DECREASE) INCREASE (DECREASE) DUE TO CHANGE IN DUE TO CHANGE IN ----------------------------------- ------------------------ AVERAGE AVERAGE AVERAGE AVERAGE VOLUME RATE TOTAL VOLUME RATE ----------- ----------- --------- ----------- ----------- (IN THOUSANDS) (UNAUDITED) INCREASE (DECREASE) IN INTEREST AND FEE INCOME Investment securities: Federal funds sold......................................... $ 116 $ (26) $ 90 $ 77 $ 8 U.S. Treasury & U.S. government agency securities.......... (14) (26) (40) 26 35 State and political subdivisions........................... (25) 3 (22) (25) 1 ----- ----- --------- ----- ----- Total investment securities.............................. $ 77 $ (49) $ 28 $ 78 $ 44 ----- ----- --------- ----- ----- Loans: Commercial................................................. 157 (38) 119 24 (20) Real estate................................................ 326 (270) 56 204 303 Installment................................................ 0 0 0 6 1 ----- ----- --------- ----- ----- Total loans.............................................. 483 (308) 175 234 284 ----- ----- --------- ----- ----- Cash surrender value of life insurance..................... 1 28 29 1 (11) ----- ----- --------- ----- ----- Total earning assets....................................... $ 561 $ (329) $ 232 $ 313 $ 317 ----- ----- --------- ----- ----- INCREASE (DECREASE) IN INTEREST EXPENSE Interest bearing deposits: NOW...................................................... $ 20 $ 0 $ 20 $ 7 $ (0) Savings.................................................. 6 0 6 3 (7) Money market............................................. 2 3 5 (16) (0) Certificates of deposit under $100,000................... 81 14 95 86 23 Certificates of deposit of $100,000 or more.............. 74 (40) 34 8 14 ----- ----- --------- ----- ----- Total interest bearing deposits.......................... 183 (23) 160 88 30 Other borrowings........................................... (3) (1) (4) 7 38 ----- ----- --------- ----- ----- Total interest bearing liabilities......................... 180 (24) 156 95 68 ----- ----- --------- ----- ----- TOTAL CHANGE IN NET INTEREST INCOME...................... $ 381 $ (305) $ 76 $ 218 $ 249 ----- ----- --------- ----- ----- ----- ----- --------- ----- ----- TOTAL --------- INCREASE (DECREASE) IN INTEREST AND FEE INCOME Investment securities: Federal funds sold......................................... $ 85 U.S. Treasury & U.S. government agency securities.......... 61 State and political subdivisions........................... (24) --------- Total investment securities.............................. $ 122 --------- Loans: Commercial................................................. 4 Real estate................................................ 507 Installment................................................ 7 --------- Total loans.............................................. 518 --------- Cash surrender value of life insurance..................... (10) --------- Total earning assets....................................... $ 630 --------- INCREASE (DECREASE) IN INTEREST EXPENSE Interest bearing deposits: NOW...................................................... $ 7 Savings.................................................. (4) Money market............................................. (16) Certificates of deposit under $100,000................... 109 Certificates of deposit of $100,000 or more.............. 22 --------- Total interest bearing deposits.......................... 118 Other borrowings........................................... 45 --------- Total interest bearing liabilities......................... 163 --------- TOTAL CHANGE IN NET INTEREST INCOME...................... $ 467 --------- ---------
PROVISIONS FOR LOAN AND LEASE LOSSES. For 1998, Valley Bank recorded a provision for loan and lease losses of $200,000 compared with provisions of $980,000 for 1997 and $360,000 for 67 1996. In 1998 net charge offs totaled $140,000 compared with net charge offs of $678,000 for 1997 and $101,000 in 1996. The decreased provision in 1998 was the direct result of a large recovery received on a loan, which had been charged off in a prior year. The increased provision in 1997 was a result of an increased provision mandated by banking regulators relating to certain loans secured by unimproved real property in Fort Mohave, Arizona. NONINTEREST INCOME. Noninterest income in 1998 increased to $2.9 million from $2.7 million in 1997, an increase of $196,000 or 7.2%. The increase for 1998 is attributable primarily to the increase in the gain from sale of government guaranteed loans of $285,000, offset by a decrease in service charges and other fees of $144,000. Noninterest income in 1997 increased to $2.7 million from $2.1 million in 1996, an increase of $584,000 or 27.4%. The increase for 1997 is attributable primarily to the increase in gain on the sale of government guaranteed loans of $397,000 and the increase in service charges of $201,000. NONINTEREST EXPENSE. Noninterest expense in 1998 was $6.1 million, an increase of $448,000, or 7.9%, compared with 1997. Noninterest expense in 1997 was $5.6 million, an increase of $426,000, or 8.2%, compared with noninterest expense of $5.2 million in 1996. The principal component of noninterest expense was salaries and employee benefits, which increased to $3.3 million in 1998, from $3.0 million in 1997 and $2.6 million in 1996. Legal and professional fees increased $334,000 in 1998 with a portion of that increase being attributable to the merger with Pacific Community Banking Group. Expenses for other real estate owned decreased from $294,000 in 1997 to $41,000 in 1998 partially due to the receipt of reimbursements for other real estate owned expenses. Other expenses increased from $5.2 million in 1996 to $5.6 million in 1997 or 8.2%. This increase is due to an increase in salaries and employee benefits which was partially due to the opening of a new loan production office in Oregon, as well as other normal salary increases. In addition, other real estate owned expenses decreased from $401,000 in 1996 to $294,000 in 1997. PROVISION FOR INCOME TAXES. Valley Bank's provision for income taxes was $584,000 in 1998, $242,000 in 1997 and $329,000 in 1996. The effective income tax rate was 42.5% in 1998 compared with 30.3% in 1997 and 42.0% in 1996. In 1997, the decrease in effective income tax rate was primarily due to a decrease in the valuation allowance for deferred taxes of $134,000. The valuation allowance was reduced because management believes it is more likely than not that deferred tax assets will be realized. NET INCOME. Net income for 1998 was $789,000 compared with $556,000 in 1997 and $454,000 in 1996. Basic earnings per share were $0.73 in 1998 compared with $0.53 in 1997 and $0.41 in 1996. The return on average assets was 0.97% in 1998 compared with 0.75% in 1997 and 0.65% in 1996. Valley Bank's return on average equity was 10.23% for 1998, 7.97% for 1997 and 6.68% for 1996. Factors which significantly impacted net income for 1998 as compared to 1997 included a reduction of $780,000 in provisions for loan loss reserves, an increase in gain on the sale of loans of $285,000, an increase in legal and professional expenses of $334,000 and a significant recovery which offset the expense of holding foreclosed real estate (commonly referred to as other real estate owned, or OREO) for the year. SUMMARY SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following table presents a summary of selected quarterly financial data which should be read in conjunction with Valley Bank's financial statements included elsewhere in this 68 prospectus. In the opinion of management, this information has been prepared on the same basis as the Financial Statements appearing elsewhere in this prospectus, and includes all adjustments, consisting only of normal recurring adjustments necessary to present fairly the unaudited results set forth herein. The operating results for any quarter are not necessarily indicative of results for any subsequent period or for the entire year.
FOR THE QUARTER ENDED ----------------------------------------------------------------------------------- DECEMBER SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE 1998 1998 1998 1998 1997 1997 1997 ----------- ----------- --------- --------- ----------- ----------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net interest income..................... $ 1,009 $ 1,183 $ 1,320 $ 1,231 $ 1,274 $ 1,230 $ 1,204 Provision for loan losses............... 75 (125) 100 150 165 435 210 Net income (loss)....................... 59 208 531 (9) 65 99 173 Net income (loss) per share-- basic(1).............................. $ .06 $ .19 $ .49 $ (.01) $ .06 $ .09 $ .17 Net income (loss) per share-- diluted(2)............................ $ .05 $ .17 $ .44 $ (.01) $ .06 $ .09 $ .16 MARCH 1997 ----------- Net interest income..................... $ 988 Provision for loan losses............... 170 Net income (loss)....................... 219 Net income (loss) per share-- basic(1).............................. $ .21 Net income (loss) per share-- diluted(2)............................ $ .20
- ------------------------ (1) Net income (loss) per share--basic is based on the weighted average shares of common stock outstanding during the period. (2) Net income (loss) per share--diluted is based on the weighted average shares of common stock and common stock equivalents determined using the treasury stock method. ASSET AND LIABILITY MANAGEMENT Asset and liability management is an integral part of managing a banking institution's primary source of income, net interest income. Valley Bank manages the balance between rate-sensitive assets and rate-sensitive liabilities being repriced in any given period with the objective of stabilizing net interest income during periods of fluctuating interest rates. Valley Bank considers its rate-sensitive assets to be those which either contain a provision to adjust the interest rate periodically or mature within one year. These assets include certain loans and investment securities and federal funds sold. Rate-sensitive liabilities are those which allow for periodic interest rate changes within one year and include maturing time certificates, certain savings deposits and interest-bearing demand deposits. The difference between the aggregate amount of assets and liabilities that reprice within various time frames is called the "gap." Generally, if repricing assets exceed repricing liabilities in a time period Valley Bank would be deemed to be asset-sensitive. If repricing liabilities exceed repricing assets in a time period Valley Bank would be deemed to be liability-sensitive. Generally, Valley Bank seeks to maintain a balanced position whereby there is no significant asset or liability sensitivity within a one-year period to ensure net interest margin stability in times of volatile interest rates. This is accomplished through maintaining a significant level of loans, investment securities and deposits available for repricing within one year. 69 The following table sets forth the interest rate sensitivity of the bank's interest-earning assets and interest-bearing liabilities at December 31, 1998, using the interest rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered rate-sensitive within a specified period when it can be repriced or matures within its contractual terms.
AMOUNTS MATURING OR REPRICING ---------------------------------------------- AFTER 3 AFTER 1 WITHIN 3 BUT WITHIN BUT WITHIN AFTER 5 NONINTEREST MONTHS 12 MONTHS 5 YEARS YEARS BEARING TOTAL --------- ----------- ----------- --------- ----------- --------- (DOLLARS IN THOUSANDS) ASSETS Federal funds sold................................ $ 13,780 $ -- $ -- $ -- $ -- $ 13,780 Investment securities............................. 999 10,150 4,436 -- -- 15,585 Net loans......................................... 28,727 4,217 4,080 1,298 -- 38,322 Noninterest-bearing assets........................ -- -- -- -- 17,022 17,022 --------- ----------- ----------- --------- ----------- --------- Total earning assets.............................. $ 43,506 $ 14,367 $ 8,516 $ 1,298 $ 17,022 $ 84,709 --------- ----------- ----------- --------- ----------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY Noninterest-bearing deposits...................... -- -- -- -- 20,061 20,061 Interest-bearing deposits......................... 23,477 16,755 15,571 -- -- 55,803 Borrowings........................................ 478 -- -- -- -- 478 Other liabilities and stockholders' equity........ -- -- -- -- 8,367 8,367 --------- ----------- ----------- --------- ----------- --------- Total liabilities and stockholders' equity........ $ 23,955 $ 16,755 $ 15,571 $ -- $ 28,428 $ 84,709 --------- ----------- ----------- --------- ----------- --------- Incremental interest rate sensitivity gap......... $ 19,551 $ (2,388) $ (7,055) $ 1,298 Cumulative interest rate sensitivity gap.......... $ 19,551 $ 17,163 $ 10,108 $ 11,406 Cumulative interest rate sensitivity gap as a % of earning assets.................................. 28.9% 25.4% 14.9% 16.9%
- ------------------------ (1) Balance does not include non-accrual loans of $4,827,000. Valley Bank was asset-sensitive with a positive cumulative one-year gap of $17.2 million or 25.36% of interest-earnings assets at December 31, 1998. In general, based upon Valley Bank's mix of deposits, loans and investments, increases in interest rates would be expected to result in an increase in Valley Bank's net interest margin. The interest rate gaps reported in the tables arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate views and market outlook, positions at the end of any period may not be reflective of Valley Bank's interest rate sensitivity in subsequent periods. Active management dictates that longer-term economic views are balanced against prospects for short-term interest rate changes in all repricing intervals. For purposes of the analysis above, repricing of fixed-rate instruments is based upon the contractual maturity of the applicable instruments. Actual payment patterns may differ from contractual payment patterns. The change in net interest income may not always follow the general expectations of an asset-sensitive or liability-sensitive balance sheet during periods of changing interest rates, because interest rates earned or paid may change by differing increments and at different time intervals for each type of interest-sensitive asset and liability. As a result of these factors, at any given time, Valley Bank may be more sensitive or less sensitive to changes in interest rates than indicated in the above tables. Greater sensitivity would have a more adverse effect 70 on net interest margin if market interest rates were to increase, and a more favorable effect if rates were to decrease. MARKET RISK Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, exchange rates, commodity prices, equity prices and other market changes. Market risk is attributed to all market risk sensitive financial instruments, including investment securities, loans, deposits and borrowings. Valley Bank does not engage in trading activities for its own account and does not participate in foreign currency transactions for its own account. Accordingly, Valley Bank's exposure to market risk is primarily a function of its asset and liability management activities. The principal market risk to the bank is the interest rate risk inherent in its lending, investing and deposit-taking activities. This is because interest earning assets and interest-bearing liabilities of the bank do not change at the same speed, to the same extent or on the same basis. Valley Bank's interest rate sensitivity analysis is discussed in the preceding section. The table on page 70 measures the bank's interest rate sensitivity gap, in other words, the difference between earning assets and liabilities maturing or repricing within specified periods. However, gap analysis has significant limitations as a method for measuring interest rate risk since changes in interest rates do not affect all categories of assets and liabilities in the same way or at the same time. Further, it has limitations in helping Valley Bank to manage the difference in behavior of lending and funding rates--so-called "basis risk." To address the limitations inherent in gap analysis, Valley Bank monitors its expected change in earnings based on changes in interest rates through a detailed financial model. This model's estimate of interest rate sensitivity takes into account the differing time intervals and differing rate change increments of each type of interest-sensitive asset and liability. It then measures the projected impact of changes in market interest rates on Valley Bank's return on equity and return on average assets. Based upon the December 31, 1998 mix of interest-sensitive assets and liabilities, given an immediate and sustained increase in the prime rate of 1%, this model estimates Valley Bank's cumulative return on equity over the next year would increase by less than 5.3% and the cumulative return on average assets over the next year would increase by less than 0.5%, as compared with a flat interest rate environment. Given an immediate and sustained decrease in the prime rate of 1%, this model estimates Valley Bank's cumulative return on equity over the next year would decrease by less than 6.1% and the cumulative return on average assets would decrease by less than 0.6%, as compared with a flat interest rate environment. However, this model is based on a series of assumptions which may or may not come to pass. In the event of a 1% rise in interest rates, the actual return on equity and return on average assets might not increase at all, or might, in fact, decrease. Conversely, in the event of a 1% decline in interest rates, and the actual return on equity and return on average assets might not decrease at all, or might, in fact, increase. Further, the economic value of Valley Bank's loan and deposit portfolios would also change under the interest rate variances previously discussed. The amount of change would depend upon the profiles of each loan and deposit class, which include: the rate, the likelihood of prepayment 71 or repayment, whether its rate is fixed or floating, the maturity of the instrument and the particular circumstances of the customer. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY. In order to maintain adequate liquidity, Valley Bank must have sufficient resources available at all times to meet its cash flow requirements. The need for liquidity in a banking institution arises principally to provide for deposit withdrawals, the credit needs of its customers and to take advantage of investment opportunities as they arise. A company may achieve desired liquidity from both assets and liabilities. Valley Bank considers cash, federal funds sold, other short term investments, maturing loans and investments, payments of principal and interest on loans and investments and potential loan sales as sources of asset liquidity. Deposit growth and access to credit lines established with correspondent banks and market sources of funds are considered by Valley Bank as sources of liability liquidity. Valley Bank monitors its liquidity position daily. Valley Bank had liquid assets (cash, deposits in other financial institutions and investment securities) as a percent of total liabilities of 29.3% and 35.5% as of December 31, 1998 and 1997, respectively. While liquidity has marginally declined, management believes it is sufficient to meet current and anticipated funding needs. Liquid assets represented approximately 32.0% of total assets at December 31, 1998. Valley Bank's loan to deposit ratio was 57.0% and 68.3% as of December 31, 1998 and 1997, respectively. This means that there are less deposits invested in the loan portfolio, which tends to be a less liquid asset than a typical investment security. Valley Bank's primary sources of liquidity include liquid assets and a stable deposit base. To supplement these, Valley Bank maintains lines of credit with Union Bank of California in the amount of $1.5 million, and with the Federal Reserve Bank of San Francisco in an amount equal to the corresponding amount of eligible securities available for pledge (approximately $8.0 million at December 31, 1998). Management believes that Valley Bank maintains adequate amounts of liquid assets to meet its liquidity needs. Valley Bank's liquidity might be insufficient if deposit withdrawals were to exceed anticipated levels. Deposit withdrawals can increase if a company experiences financial difficulties or receives adverse publicity for other reasons, or if its pricing, products or services are not competitive with those offered by other institutions. CAPITAL. Capital serves as a source of funds and helps protect depositors against potential losses. The primary source of capital for Valley Bank has been internally generated capital through retained earnings. Valley Bank's shareholders' equity increased by $962,000, or 13.2% from December 31, 1997 to December 31, 1998. The increase was attributable to net income of $789,000 and an increase in ESOP shares released of $173,000. Federal regulations establish guidelines for calculating risk-adjusted capital ratios. These guidelines establish a systematic approach of assigning risk weights to bank assets and off-balance sheet items making capital requirements more sensitive to differences in risk profiles among banking organizations. Under these regulations, banks and bank holding companies are required to maintain a risk-based capital ratio of 8.0%; that is, "Tier 1" plus "Tier 2" capital must equal at least 8% of risk-weighted assets plus off-balance sheet items, and Tier 1 capital (primarily shareholders' equity) must constitute at least 50% of qualifying capital. Tier 1 capital consists primarily of shareholders' equity excluding good will, and Tier 2 capital includes subordinated debt and, subject to a limit of 1.25% of risk-weighted assets, the 72 allowance for loan and lease losses. It is Valley Bank's intention to maintain risk-based capital ratios at levels characterized as "well capitalized" for banking organizations: Tier 1 risk-based capital of 6% or above and total risk-based capital at 10% or above. At December 31, 1998, Valley Bank had a Tier 1 risk-based capital ratio of 15.5% and a total risk-based capital ratio of 16.7%. In addition, regulators have adopted a minimum leverage capital ratio standard. This standard is designed to ensure that all financial institutions, irrespective of their risk profile, maintain minimum levels of core capital, which by definition excludes the allowance for loan and lease losses. These minimum standards for top-rated institutions may be as low as 3%; however, regulatory agencies have stated that most institutions should maintain ratios at least 1 to 2 percentage points above the 3% minimum. It is Valley Bank's intention to maintain the leverage ratio above the 5% minimum for "well capitalized" banks. At December 31, 1998, Valley Bank's leverage capital ratio equaled 10.2%. Failure to meet minimum capital requirements can trigger mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a material effect on Valley Bank's financial statements and operations. Refer to "Risk Factors-- Government Regulation and Legislation" and "Regulation and Supervision." As part of its October 1998 resolution described elsewhere herein, Valley Bank's board of directors resolved to maintain capital at a minimum of $5.5 million, and at least 8% of assets. Please refer to "Risk Factors--If Valley Bank fails to meet its commitments to bank regulators, it could hurt our business" for a description of this resolution. For a presentation of the actual and pro forma capitalization of The Bank of Hemet and Valley Bank, refer to "Capitalization." IMPACT OF INFLATION The financial statements and related financial data presented in this prospectus have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates are likely to have a more significant impact on a financial institution's performance than the effects of general levels of inflation. During periods of inflation, interest rates do not necessarily move in the same direction or with the same magnitude as the price of goods and services. Valley Bank seeks to manage its interest sensitivity gap to minimize the potential adverse effect of inflation and other market forces on its net interest income and therefore on its earnings and capital. Financial institutions are also affected by inflation's impact on noninterest expenses, such as salaries and occupancy expenses. During 1996, 1997 and 1998, inflation remained relatively stable, and Valley Bank's level of noninterest expense was relatively unaffected by inflation. IMPACT OF PENDING ACCOUNTING PRONOUNCEMENTS In February 1998, the FASB issued SFAS 132, EMPLOYER'S DISCLOSURES ABOUT PENSIONS AND OTHER POST-RETIREMENT BENEFITS. This Statement standardizes the disclosure requirements for pensions and other post-retirement benefits to the extent practicable. This new standard is 73 effective for 1998 and did not have a material effect on the financial condition or results of operations of Valley Bank. In June 1998, the FASB issued SFAS 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard is effective for 2000 and is not expected to have a material impact on the financial statements of Valley Bank. In October 1998, the FASB issued SFAS No. 134, ACCOUNTING FOR MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF MORTGAGE LOANS HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE, (AN AMENDMENT OF FASB STATEMENT NO. 65). This Statement establishes accounting and reporting standards for certain activities of mortgage banking enterprises and other enterprises that conduct operations that are substantially similar to the primary operations of a mortgage banking enterprise. Statement No. 134 will be effective for the first fiscal quarter beginning after December 15, 1998. The Bank does not engage in mortgage banking activities. YEAR 2000 COMPLIANCE OVERVIEW. The Year 2000 problem arises when computer programs have been written using two digits rather than four to define the applicable year. As a result, date-sensitive software and/or hardware may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or other disruption of operations and impede normal business activities. In June 1996, the Federal Financial Institutions Examination Council ("FFIEC") alerted the banking industry of the serious challenges that would be encountered with Year 2000 issues. The Federal Deposit Insurance Corporation ("FDIC") has also implemented a plan to require compliance with Year 2000 issues and regularly examines our progress. STATE OF READINESS OF VALLEY BANK. OVERALL PLAN. Valley Bank has initiated an enterprise-wide program to prepare the bank's computer systems and applications for the year 2000. The Bank has examined its primary integrated bank operating system, Information Technology Inc. (ITI) and has been advised by the vendor that the software is year 2000 compliant. This advice was validated by a review of ITI by the Federal Financial Institutions Examination Council (FFIEC). This review was conducted by the FFIEC on January 20, 1998. The Bank determined, however, that its hardware, a mainframe computer, may not be compliant. As a result, the bank purchased, in December 1998, a previously owned vendor certified Year 2000 ready Unisys A-11 computer for data processing, at a cost of approximately $25,000. The computer has been installed, tested and is presently being utilized as the bank's mainframe. As a redundant validation regime, both the hardware and software were successfully Year 2000 tested during February and March, 1999. VENDORS. Valley Bank relies exclusively on outside vendors to provide the hardware and software used in its computer operations. To determine the readiness of vendors, Valley Bank has sent a letter to each vendor inquiring about its compliance with Year 2000. Many of the vendors have responded that they are Year 2000 compliant. Valley Bank has determined that some vendors will not have a material impact on the bank's operations, whether or not they 74 are Year 2000 compliant. In these two situations, no further work is performed. For those vendors that have responded they are working towards Year 2000 compliance and that Valley Bank has determined to be significant, the bank is following up on a regular basis through 1999. Most of these vendors have advised Valley Bank that they expect to be Year 2000 compliant prior to December 31, 1999. If critical vendors do not demonstrate compliance by a certain date, Valley Bank will seek other alternatives in accordance with its contingency plan. This may include seeking replacement vendors. CUSTOMERS. To determine the readiness of customers, Valley Bank has personally met with, and interviewed by way of a questionnaire, each of its significant borrowers and depositors to determine the extent of risk created by any failure by them to remediate their own Year 2000 issues. Each borrower and depositor is categorized as to its level of readiness and risk based on its response to the questionnaire. New borrowers and large depositors are screened utilizing the same questionnaire approach. In February, April and July of 1998 and April of 1999, Valley Bank has communicated by letter, to each of its depositors and borrowers, information about Year 2000 issues and problems, and furnished sources of information that they might utilize to address these issues and problems. Additional written communication is planned for 1999. Management and staff of Valley Bank have also served as speakers at community forums to raise the level of awareness of Year 2000 issues. COSTS TO ADDRESS YEAR 2000 ISSUES FOR VALLEY BANK. Some of Valley Bank's computer hardware and software applications were modified or replaced in order to maintain their functionality as the year 2000 approaches. Valley Bank has spent approximately $100,000 as of December 31, 1998 to address Year 2000 issues and estimates its total costs over the three-year period 1998 - 2000 to be approximately $150,000. In addition, staff time of approximately 1,000 hours has been devoted to these matters, with an additional 200 hours of time expected during the remainder of 1999. These costs have been paid for out of general operating funds. Valley Bank does not anticipate that any of these costs will materially impact its results of operations in any one reporting period. RISKS OF YEAR 2000 ISSUES FOR VALLEY BANK. Ultimately, the potential impact of the Year 2000 issue on Valley Bank will depend on a series of complex factors, including the following: - the corrective measures undertaken by Valley Bank itself; - the measures undertaken by third-party vendors to become Year 2000 compliant; - the accuracy of representations made by third-party vendors to Valley Bank concerning their state of readiness; - the degree of compliance by governmental agencies, businesses (including telephone companies), and other entities which engage in essential communications with Valley Bank; and - the degree of compliance of customers. At worst, Valley Bank's customers and vendors will face severe Year 2000 issues. In this case, Valley Bank may be unable to service its customers, and borrowers may become unable to pay back their loans. Valley Bank may also be required to replace non-compliant vendors with more expensive Year 2000-compliant vendors. At this time Valley Bank cannot determine 75 the financial effect on it if significant customer or vendor remediation efforts are not resolved in a timely manner. CONTINGENCY PLANS OF VALLEY BANK. Valley Bank has developed a business continuation contingency plan to provide service to customers should there be an environment in which electrical and communication services may not be available for a brief period of time after the century date change. The Bank's data processing system and other mission critical systems have been tested and are Year 2000 compliant. In the event its computer system or other mission critical system should fail, Valley Bank has alternate procedures to achieve a successful resumption of business. These alternative procedures include reverting to manual systems for processing some forms of work as well as contractual arrangements with Year 2000 compliant outside vendors for data processing. 76 BUSINESS OF VALLEY BANK GENERAL Valley Bank is a California community bank headquartered in Moreno Valley, California. In addition to its headquarters, Valley Bank maintains six branches in the Inland Empire and two loan production offices, one in Moreno Valley and the other in Portland, Oregon. Valley Bank was originally organized as a national banking association in 1960, and was reincorporated in 1980 under the California General Corporation Law as a state-licensed bank. It is licensed by the California Department of Financial Institutions. Its deposits are insured up to the applicable legal limits by the FDIC. As with many state chartered banks of its size in California, it is not a member of the Federal Reserve System. Moreno Valley is located in a region commonly referred to as the Inland Empire, an area southeast of Los Angeles county and northeast of San Diego county, consisting of Riverside and San Bernardino counties. These counties are experiencing significant population and economic growth, much of which has been fueled by the migration of manufacturing, distribution and export service firms from adjacent Los Angeles, Orange and San Diego counties. Valley Bank emphasizes community-based banking, concentrating on both business and individual customers. It serves small-to-medium size businesses, professionals, retired individuals and residents in the Inland Empire area, as well as businesses and real estate owners/developers throughout the Inland Empire, and makes loans guaranteed by the United States Small Business Administration (SBA loans) and by the U. S. Department of Agriculture's Business and Industry program (B&I loans) in the Inland Empire and in the vicinity of its Portland, Oregon loan office. Valley Bank offers a full complement of business lending activities which include SBA and B&I loans, term loans, commercial loans, construction financing, and domestic letters of credit. In the area of deposit services, Valley Bank offers business checking, savings, money market and time deposit accounts. Commercial loans may be unsecured or secured by real estate, equipment, accounts receivable, deposit accounts or any combination of such collateral. Historically, Valley Bank has primarily focused its lending on government guaranteed loans, construction and conventional loans secured by real estate, commercial loans and installment loans. This continues to be its focus. Valley Bank's consumer services complement its business emphasis by offering a range of personal and private banking financial services such as interest-bearing checking, fee-based checking, savings, money market accounts, and tailored time certificates of deposit. In the area of consumer loans, Valley Bank offers new and used automobile loans, home improvement loans, overdraft lines of credit, and unsecured personal loans. Other operational services include safe deposit boxes, night deposit facilities, travelers checks, wire transfers, cashier's checks, 24-hour access to banking information by telephone, 24-hour automatic teller machine availability on the Cirrus and Star networks and other standard depository functions. BUSINESS STRATEGY Valley Bank's business strategy is to support the banking needs of small businesses, mainly in the Inland Empire areas served by its branches and in the Portland, Oregon area served by its loan production office. To this end, Valley Bank offers an array of business 77 lending services including SBA and other government guaranteed loans, term loans, commercial notes, commercial real estate financing, construction loans, domestic letters of credit, and business, checking, savings, money market and time deposit accounts. Valley Bank has focused on marketing efforts to implement its business strategy of continuing to increase core deposits through business development efforts, diversifying its customer base, enhancing its product lines; and providing superior customer service. These efforts include obtaining increased loan and deposit business from existing customers, word-of-mouth referrals, a focused direct mail marketing program and personal solicitation of customers by officers, directors and stockholders. Management assigns responsibility to all loan and business development officers to make regular calls on potential customers and obtain referrals from existing customers. Valley Bank directs promotional efforts toward residents and small-to-medium sized businesses. Recognizing that its greatest strategic advantage is its niche experience with government guaranteed loans, Valley Bank emphasizes this business. It opened a loan production office in Portland, Oregon in 1996 after conducting a market research study. That office serves small businesses in the State of Oregon and in southern Washington. Valley Bank is considering further expansion of that business. PREMISES The following table sets forth information about Valley Bank's banking offices.
LOCATION TYPE OF OFFICE OWNED/LEASED SIZE SINCE - ---------------------------------------------------- ----------------------- ------------- ------------ --------- 24010 Sunnymead Boulevard, Moreno Valley..................................... Main branch Owned 9,000 sq/ft 1960 26670 McCall Boulevard, Sun City.................... Branch Owned 4,500 sq/ft 1975 16820 Van Buren Boulevard (Woodcrest), Riverside............................ Branch Owned 3,000 sq/ft 1976 22729 Barton Road, Grand Terrace.................... Branch Owned 3,000 sq/ft 1982 255 South Riverside Avenue, Rialto.................. Branch Owned 3,000 sq/ft 1987 211 East 4th Street, Perris......................... Branch Leased 3,000 sq/ft 1974 29614 Nuevo Road, Nuevo............................. Branch Leased 1,500 sq/ft 1990 24081 Postal Avenue, Moreno Valley.................. Loan production(1) Owned 2,600 sq/ft 1993 10180 S.W. Nimbus Avenue, Suite H-1, Portland, Oregon....................... Loan production(1) Leased 1,481 sq/ft 1996 25400 Allesandro Boulevard, Moreno Valley..................................... Administrative(1)(2) Leased 3,084 sq/ft 1993
- ------------------------ (1) Deposits are not accepted at this facility. (2) Data processing center. Aggregate annual rentals for Valley Bank for leased premises were $101,000 for the year ended December 31, 1998. Valley Bank considers its present facilities to be sufficient for its current operations. INVESTMENT PORTFOLIO The following table sets forth the book and market values of securities held for maturity at the dates indicated. Under Statement of Financial Accounting Standards No. 115, 78 "Accounting for Certain Investments in Debt and Equity Securities," Valley Bank has designated all of its investment securities listed as "held-to-maturity."
DECEMBER 31, ------------------------------- 1998 1997 1996 --------- --------- --------- (DOLLARS IN THOUSANDS) U.S. government agencies......................................................... $ 15,004 $ 11,957 $ 9,979 Mortgage-backed securities....................................................... -- 781 1,291 Securities, nontaxable........................................................... 581 1,118 1,658 --------- --------- --------- Total............................................................................ $ 15,585 $ 13,856 $ 12,928 --------- --------- --------- --------- --------- ---------
The following table sets forth the maturities of Valley Bank's investment securities at December 31, 1998 and the weighted average yields of such securities calculated on the basis of the cost and effective yields based on the scheduled maturity of each security. Yields on municipal securities have not been calculated on a tax-equivalent basis.
AFTER ONE TO FIVE AFTER FIVE TO TEN YEARS AFTER 10 WITHIN ONE YEAR YEARS YEARS ---------------------- ---------------------- ------------------------ ----------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT --------- ----- --------- ----- ----------- ----- ----------- (DOLLARS IN THOUSANDS) U.S. government agencies......... $ 10,999 5.5% $ 4,006 5.8% $ -- -- $ -- Securities, nontaxable........... $ 150 4.8% $ 430 6.1% $ -- -- $ -- --------- --------- --- --- Total............................ $ 11,149 5.5% $ 4,436 5.8% $ -- -- $ -- --------- --------- --- --- --------- --------- --- --- Estimated fair value............. $ 11,170 $ 4,472 $ -- $ -- --------- --------- --- --- --------- --------- --- --- TOTAL ---------------------- YIELD AMOUNT YIELD ----- --------- ----- U.S. government agencies......... -- $ 15,005 5.6% Securities, nontaxable........... -- 580 5.8% --------- Total............................ -- $ 15,585 5.6% --------- --------- Estimated fair value............. $ 15,642 --------- ---------
Valley Bank does not own securities of a single issuer whose aggregate book value is in excess of 10% of its total equity. LENDING ACTIVITIES Valley Bank originates and sells loans. Please refer to "--Lending Procedures and Loan Approval Process" for a description of applicable regulations which limit lending in relation to shareholders' equity. Valley Bank originates loans for its own portfolio and for sale in the secondary market. Lending activities include SBA and other government guaranteed loans, real estate construction loans, real estate mortgage loans, commercial loans and consumer installment loans. 79 LOAN PORTFOLIO COMPOSITION OF LOAN PORTFOLIO. The following table shows the composition of loans by type of loan or type of borrower at the date indicated:
DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (IN THOUSANDS) Real estate--construction......................................... $ 6,733 $ 6,873 $ 2,138 $ 1,943 $ 1,259 Real estate--residential.......................................... 4,848 7,116 8,552 9,745 6,398 Real estate--unimproved residential lots.......................... 4,898 6,369 7,963 501 1,569 Real estate--commercial........................................... 13,910 14,535 14,776 14,271 10,232 Commercial and industrial......................................... 2,653 1,746 1,908 1,638 4,579 Government guaranteed............................................. 9,173 8,377 6,681 5,591 8,549 Loans to individuals.............................................. 504 435 484 401 458 Loans held for sale............................................... 594 -- 670 379 -- --------- --------- --------- --------- --------- Total loans................................................... $ 43,313 $ 45,451 $ 43,172 $ 34,469 $ 33,044 --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES. The following table shows the maturity distribution of the loan portfolio at December 31, 1998, and the loan portfolio's sensitivity to changes in interest rates. Loans due after one year are shown in the fixed and floating rate categories.
FLOATING AFTER ONE BUT RATES FIXED RATES DUE WITHIN WITHIN AFTER DUE AFTER AFTER ONE YEAR FIVE YEARS FIVE YEARS ONE YEAR ONE YEAR --------- ------------- ----------- ------------- --------------- (IN THOUSANDS) Real estate--construction..................... $ 6,733 $ -- $ -- $ -- $ -- Real estate--residential...................... 573 775 3,500 3,702 573 Real estate--unimproved residential lots...... 1,842 1,638 1,418 362 2,694 Real estate--commercial....................... 1,543 1,152 11,215 12,011 356 Commercial and industrial..................... 1,340 887 426 1,067 246 Government guaranteed......................... -- 3 9,170 9,173 -- Loans to individuals.......................... 141 229 134 138 225 Loans held for sale........................... 594 -- -- -- -- --------- ------ ----------- ------------- ------ Total......................................... $ 12,766 $ 4,684 $ 25,863 $ 26,453 $ 4,094 --------- ------ ----------- ------------- ------ --------- ------ ----------- ------------- ------
GOVERNMENT GUARANTEED LOANS Valley Bank actively originates loans qualifying for guarantees issued by the United States Small Business Administration (the "SBA"), an independent agency of the federal government. The SBA guarantees on such loans currently range from 75% to 80% of the principal and accrued interest. Under certain circumstances, the guarantee of principal and interest may be less than 75%. The guaranteed percentage is less than 75% for loans over $1.0 million. Valley Bank generally limits the amount available to any one borrower under this program to $1.5 million. Valley Bank typically requires that SBA loans be secured by first or second lien deeds of trust on real property. Valley Bank also obtains additional collateral such as personal property or other real property. SBA loans have terms ranging from seven to 25 years depending on the use of the proceeds. To qualify for an SBA loan, a borrower must 80 demonstrate the capacity to service and repay the loan, exclusive of the collateral, on the basis of historical earnings or reliable projections. In 1997, Valley Bank expanded its government guaranteed loan program to include loans guaranteed by the U.S. Department of Agriculture under that department's business and industry ("B&I") loan program for rural areas. These loans tend to be larger than SBA loans, with different, but similar, rules for origination. During 1998 Valley Bank closed its first B&I loan, in the amount of $4.6 million, and concurrently sold the guaranteed portion of the loan. Valley Bank has several other B&I loans under review. Valley Bank generally sells substantially all of the guaranteed portion of the government guaranteed loans that it originates. Pursuant to a 1998 change in the governmental rules for SBA loans, Valley Bank has also commenced to sell the non-guaranteed portion of SBA loans, in some cases. In 1998, Valley Bank originated $13.9 million of government guaranteed loans (including its first B&I loan) and sold $14.6 million of government guaranteed loans. In 1997, Valley Bank originated $10.1 million of government guaranteed loans and sold $12.1 million of guaranteed loans. When Valley Bank sells a government guaranteed loan, it generally retains the obligation to repurchase the loan for 90 days after the sale, if the loan fails to comply with certain representations and warranties given by Valley Bank. Valley Bank retains the obligation to service the government guaranteed loans, for which it receives a servicing fee. Those portions of the sold government guaranteed loans that remain owned by Valley Bank, and those government guaranteed loans that have not yet been sold, are included in Valley Bank's balance sheet. At December 31, 1998, Valley Bank had $9.8 million in government guaranteed loans remaining on its balance sheet. At December 31, 1998, Valley Bank was servicing $28.6 million in government guaranteed loans that had been sold to others. LOANS SECURED BY REAL ESTATE At December 31, 1998, $30.4 million, or approximately 71% of Valley Bank's loans, were secured by real estate. The four largest categories were loans secured by commercial properties (32% of the loan portfolio), loans secured by residential properties (11% of the loan portfolio), construction loans (15% of the loan portfolio) and loans for unimproved residential lots (11% of the loan portfolio). All of the real estate construction and conventional loans are secured by deeds of trust or mortgages on underlying real estate. Real estate lending involves risks associated with the potential for decline in the value of underlying real estate collateral and the cash flow from income producing properties. Such declines in real estate values and cash flows can be caused by a number of factors, including adversity in general economic conditions, rising interest rates, changes in tax and other governmental policies affecting the holding real estate, environmental conditions, governmental and other use restrictions, development of competitive properties and increasing vacancy rates. Valley Bank's real estate dependence increases the risk of loss both in Valley Bank's loan portfolio and its holdings of other real estate owned when real estate values decline. COMMERCIAL MORTGAGE LOANS. Valley Bank provides intermediate and long-term commercial real estate loans. Collateral includes first deeds of trust on real property. Typically, real estate collateral is owner-occupied, and the value of the real estate collateral is 81 supported by formal appraisals in accordance with applicable regulations. The majority of the properties securing these loans are located in Riverside and San Bernardino counties. Valley Bank also provides commercial real estate loans principally secured by owner-occupied/rental commercial and industrial buildings. Generally, these types of loans are made for a period of up to twenty years, with monthly payments based on a portion of the principal plus interest and with a loan-to-value ratio of 70% or less, using an adjustable rate indexed to the prime rate (as appearing in the West Coast edition of THE WALL STREET JOURNAL). Valley Bank also offers fixed rate loans, but rate adjustments are typically required in intervals of one to five years. Amortization schedules for commercial loans generally do not exceed 20 years. Payments on loans secured by such properties are often dependent on successful operation or management of the properties. Repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. Valley Bank seeks to minimize these risks in a variety of ways, including limiting the size of such loans and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. When possible, Valley Bank also attempts to obtain loan guaranties from financially capable parties. Substantially all of the properties securing Valley Bank's real estate loans are inspected by Valley Bank's lending personnel before the loan is made. Valley Bank requires title insurance insuring the status of its lien on all of the real estate secured loans when a first trust deed on the real estate is taken as collateral. Valley Bank also requires that fire and extended coverage casualty insurance (and, if the property is in a flood zone, flood insurance) is maintained in an amount at least equal to the outstanding loan balance, subject to applicable law that in some circumstances may limit the required amount of hazard insurance to the cost to replace the insured improvements. Valley Bank's lending policies generally limit the loan-to-value ratio on mortgage loans secured by owner-occupied properties to 70% of the lesser of the appraised value or the purchase price. No assurance can be given that these procedures will protect the Bank against losses on loans secured by real property. Please refer to "Risk Factors--A downturn in the real estate market could hurt our business" for a discussion of the possible effects of a decline in real estate values. REAL ESTATE CONSTRUCTION LOANS. Valley Bank finances the construction of residential, commercial and industrial properties. To limit risks inherent in its construction loan portfolio, Valley Bank has restricted such lending to owner-builder construction loans. No assurance can be given pertaining to future conditions relating to the local economy nor its effect on the collateral values of such loans. Please refer to "Risk Factors--A downturn in the real estate market could hurt our business." for a discussion of the possible effects of a decline in real estate values. Valley Bank's construction loans typically have the following characteristics: - maturities of one year or less; - a floating rate of interest based on Valley Bank's base lending rate; - minimum cash equity of 20% to 30% of project cost; - advance of anticipated interest costs during construction; advance of fees; 82 - first lien position on the underlying real estate; - loan-to-value ratios generally not exceeding 70%; and - recourse against the borrower or a guarantor in the event of default. Valley Bank does not typically commit to make the permanent loan on the property unless the permanent loan is to be a government guaranteed loan. Valley Bank does not participate in joint ventures or take an equity interest in connection with its construction lending. Construction loans involve additional risks compared to loans secured by existing improved real property. These include the uncertain value of the project prior to completion; the inherent uncertainty in estimating construction costs (which is often beyond the control of the borrower); construction delays and cost overruns; possible difficulties encountered by municipal or other governmental regulation during siting or construction; and the difficulty in accurately evaluating the market value of the completed project. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If Valley Bank is forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that Valley Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as the related foreclosure and holding costs. In addition, Valley Bank may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminable period of time. Valley Bank has underwriting procedures designed to identify what it believes to be acceptable levels of risk in construction lending. Among other things, qualified and bonded third parties are engaged to provide progress reports and recommendations for construction disbursements. No assurance can be given that these procedures will prevent losses arising from the risks described above. LOANS ON UNIMPROVED RESIDENTIAL LOTS. Substantially all of the Valley Bank loans secured by unimproved residential lots relate to a single real estate project in Fort Mohave, Arizona. In 1996, Valley Bank acquired 200 loans, each secured by a residential lot in this project, at a cost of approximately $7.9 million. These loans were acquired in a swap transaction in which Valley Bank exchanged real property that it had previously acquired in foreclosure for these loans. Since the time of their acquisition, almost half of the loans have been repaid. As of December 31, 1998, 107 of these loans remain, in the aggregate amount of $4.8 million, or 11% of the loan portfolio. RESIDENTIAL MORTGAGE LOANS. Valley Bank originates fixed-rate mortgage loans secured by one-to-four family properties with amortization schedules of 15 to 30 years and maturities of up to five years. The loan fees charged, interest rates and other provisions of Valley Bank's residential loans are determined by an analysis of Valley Bank's cost of funds, cost of origination, cost of servicing, risk factors and portfolio needs. COMMERCIAL LOANS Valley Bank makes relatively few commercial loans, other than government guaranteed loans. The commercial loans are for intermediate and short-terms and may be unsecured, partially secured or fully secured. The majority of these loans are in Riverside county. Loan 83 maturities are normally 12 months. Valley Bank requires a complete re-analysis before considering any extension. Depending on the creditworthiness of the business, certain types of open-ended loans to $100,000 and non-open-ended renewable products are also available. Valley Bank makes these loans to any size business, and to businesses organized as sole proprietorships, partnerships and corporations. Most are to small businesses. In general, it is the intent of Valley Bank to take collateral whenever possible regardless of the loan purpose. Collateral may include liens on inventory, accounts receivable, fixtures and office furniture and equipment and, in some cases, leasehold improvements and real estate. As a matter of policy, the Bank requires all principals of a business to be co-obligors on all loan instruments and all significant stockholders of corporations to execute a specific debt guaranty. All borrowers must demonstrate the ability to service and repay not only Valley Bank debt but all outstanding business debt, exclusive of collateral, on the basis of historical earnings or reliable projections. LOANS TO INDIVIDUALS Loans to individuals, also termed consumer loans, are extended for a variety of purposes. Most are for the purchase of automobiles and other vehicles. Others include secured and unsecured personal loans, home improvement, equity lines, overdraft protection loans, and unsecured lines of credit. Valley Bank's underwriting standards for loans to individuals include an examination of the applicant's credit history and payment record on other debts and an evaluation of their ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary importance, the underwriting process also includes a comparison of the value of the security, if any, to the proposed loan amount. Most of Valley Bank's loans to individuals are repayable on an installment basis. Loans to individuals generally entail greater risk than do residential mortgage loans, particularly in the case of those loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because the collateral is more likely to suffer damage, loss or depreciation. The remaining deficiency often does not warrant further collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, the collection of loans to individuals is dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, various federal and state laws, including federal and state bankruptcy and insolvency laws often limit the amount which the lender can recover on loans to individuals. Loans to individuals may also give rise to claims and defenses by a consumer loan borrower against the lender on these loans, such as Valley Bank, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral. As of December 31, 1998, the total of all loans to individuals held by Valley Bank was $504,000 or 1.2% of total loans. OFF-BALANCE SHEET COMMITMENTS As part of its service to its small- to medium-sized business customers, Valley Bank from time to time issues formal commitments and lines of credit. These commitments can be either secured or unsecured. They may be in the form of revolving lines of credit for seasonal 84 working capital needs. However, these commitments may also take the form of letters of credit. Standby letters of credit are conditional commitments issued by Valley Bank to guarantee the performance of a customer to a third party. Valley Bank does not enter into any interest rate swaps or caps, or forward or future contracts. At December 31, 1998, Valley Bank had commitments to extend credit of approximately $2.6 million and obligations under standby letters of credit of approximately $178,000. The following table shows the distribution of Valley Bank's undisbursed loan commitments at the dates indicated.
AT DECEMBER 31, -------------------- 1998 1997 --------- --------- (IN THOUSANDS) Commitments to extend credit, including unsecured loan commitments............................. $ 2,582 $ 6,664 Standby letters of credit...................................................................... 178 212 --------- --------- Total.......................................................................................... $ 2,760 $ 6,876 --------- --------- --------- ---------
LENDING PROCEDURES AND LOAN APPROVAL PROCESS Loan applications may be approved by the board of directors' loan committee, by Valley Bank's management and lending officers, or by individual lending officers to the extent of their loan authority. Individual lending authority is granted to the Chief Executive Officer, the Senior Credit Officer, branch and department managers and other key lending officers. Loans for which direct and indirect borrower liability would exceed an individual's lending authority are referred to Valley Bank's management and, for those in excess of management's approval limits, to the loan committee. At December 31, 1998, Valley Bank's authorized legal lending limits were $1,405,000 for unsecured loans plus an additional $937,000 for certain secured loans. Legal lending limits are calculated in conformance with California law, which prohibits a bank from lending to any one individual or entity or its related interests an aggregate amount which exceeds 15% of primary capital plus the allowance for loan losses on an unsecured basis (plus an additional 10% on a secured basis). Valley Bank's primary capital plus allowance for loan losses at December 31, 1998 totaled $9.4 million. Valley Bank's largest borrower as of December 31, 1998 had an aggregate loan liability totaling $1.7 million in secured loans. The highest individual lending authority in Valley Bank is the combined administrative lending authority for unsecured and secured lending of $500,000, which requires the approval and signatures of the Chief Executive Officer and the Senior Credit Officer. The second highest lending authority is $250,000 for each of the Chief Executive Officer and the Senior Credit Officer, each acting singly. All other individual lending authority is substantially less, with the next largest authority for secured loans being $25,000. Lending limits are authorized for the Chief Executive Officer, the Senior Credit Officer and other officers by the board of directors of Valley Bank. The Senior Credit Officer is responsible for evaluating the authority limits for individual credit officers and recommends lending limits for all other officers to the board of directors for approval. 85 The review of each loan application includes the applicant's credit history, income level and cash flow analysis, financial condition and the value of any collateral to secure the loan (which, in the case of real estate loans over a certain amount, utilizes a review of an appraisal report prepared by an independent bank approved appraiser). With respect to any approved commercial or real estate loan, Valley Bank generally issues a written commitment to the applicant, setting forth the terms under which the loan will be extended. Valley Bank seeks to mitigate the risks inherent in its loan portfolio by adhering to certain underwriting practices. These practices include analysis of prior credit histories, financial statements, tax returns and cash flow projections of its potential borrowers, valuation of collateral based on reports of independent appraisers and audits of accounts receivable or inventory pledged as security. OTHER EARNING ASSETS The following table relates to other earning assets not disclosed previously for the dates indicated. This item consists of a salary continuation plan for Valley Bank's President. The plan is informally linked with universal life insurance policies for the salary continuation plan. Income from these policies is reflected in noninterest income.
AT DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Cash surrender value of life insurance................... $ 712,000 $ 661,000 $ 637,000 ---------- ---------- ---------- ---------- ---------- ----------
ASSET QUALITY NONPERFORMING ASSETS. Nonperforming assets include non performing loans and other real estate owned. NONPERFORMING LOANS. Nonperforming loans are those which the borrower fails to perform in accordance with the original terms of the obligation and fall into one of three categories: - Nonaccrual loans. Valley Bank generally places loans on nonaccrual status when interest or principal payments become 90 days or more past due unless the outstanding principal and interest is adequately secured and, in the opinion of management, is deemed in the process of collection. When loans are placed on nonaccrual status, accrued but unpaid interest is reversed against the current year's income. Interest income on nonaccrual loans is recorded on a cash basis. Valley Bank may treat payments as interest income or return of principal depending upon management's opinion of the ultimate risk of loss on the individual loan. Cash payments are treated as interest income where management believes the remaining principal balance is fully collectible. Additionally, Valley Bank may place loans that are not 90 days past due on nonaccrual status if management reasonably believes the borrower will not be able to comply with the contractual loan repayment terms and collection of principal or interest is in question. 86 - Loans 90 days or more past due. Valley Bank classifies a loan in this category when the borrower is more than 90 days late in making a payment of principal or interest. - Restructured loans. These are loans on which interest accrues at a below market rate or upon which certain principal has been forgiven so as to aid the borrower in the final repayment of the loan, with any interest previously accrued, but not yet collected, being reversed against current income. Interest is reported on a cash basis until the borrower's ability to service the restructured loan in accordance with its terms is established. OTHER REAL ESTATE OWNED (OREO). This category of nonperforming assets consists of real estate to which Valley Bank has taken title by reason of foreclosure or by taking a deed in lieu of foreclosure from the borrower. Before Valley Bank takes title to OREO, it generally obtains an environmental review. The following table summarizes Valley Bank's nonperforming assets at the dates indicated.
DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (DOLLARS IN THOUSANDS) Nonaccrual loans (1)............................................. $ 4,752 $ 3,227 $ 1,245 $ 1,110 $ 3,173 Loans past due 90 days or more................................... 256 -- -- 125 -- Restructured loans............................................... -- -- -- -- -- --------- --------- --------- --------- --------- Total nonperforming loans (1).................................. 5,008 3,227 1,245 1,235 3,173 Other real estate owned.......................................... 1,749 1,711 1,144 2,555 1,143 --------- --------- --------- --------- --------- Total nonperforming assets................................... $ 6,757 $ 4,938 $ 2,389 $ 3,790 $ 4,316 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Nonperforming loans as a percent of total loans.................. 11.61% 7.13% 2.90% 3.60% 9.65% Nonperforming assets as a percent of total assets................ 7.98% 6.62% 3.36% 5.74% 6.65%
- ------------------------ (1) Interest income during 1998 on loans on nonaccrual status would have been $424,000 if the loans had been accruing. Interest collected on these loans in 1998 was 0. At December 31, 1998, nonperforming assets represented 7.98% of total assets. Nonperforming loans that were secured by first deeds of trust on real property were $4.4 million at December 31, 1998, $1.9 million at December 31, 1997, $1.1 million at December 31, 1996, $1.2 million at December 31, 1995 and $3.1 million at December 31, 1994. Other forms of collateral such as inventory and equipment secured the remaining nonperforming loans as of each date. The collateral securing nonperforming loans may not be sufficient to prevent losses on such loans. Nonperforming loans have occurred mainly among the loans secured by real estate. During the early 1990's Valley Bank made many interim construction loans to builders building "on spec," that is, without a committed purchaser for the finished building. When recession hit Southern California, some borrowers abandoned their construction projects, and their loans became nonperforming. The Bank foreclosed, and then attempted to liquidate the resulting OREO property. The soft real estate market then prevailing, however, made sale difficult. As the economy improved in Southern California, sale of these properties became easier. During 1998, the remaining early-1990's nonperforming assets were resolved. 87 As of December 31, 1998, Valley Bank had approximately $4.8 million in non-performing non-accrual loans. As of March 31, 1999, Valley Bank had approximately $4.5 million in non-performing non-accrual loans. The largest non-performing loan, in the amount of approximately $1.6 million, is a construction loan secured by an eighty room motel on which construction is now complete. Valley Bank is a 53% participant in this loan and has taken the lead to bring it to resolution. Problems arose as a result of construction delays. The property is currently managed by a hotel management company. The hotel management company, which is also acting as the court-appointed receiver, has submitted cash flow statements indicating that the motel can be opened for business on approximately May 1, 1999. A second non-performing loan relationship is comprised of two construction loans, totaling approximately $900,000, secured by a service station/mini-mart/fast food facility. The SBA has provided a commitment to guarantee a permanent loan when construction is completed. At December 31, 1998, these loans were on non-accrual status. At March 31, 1999 these loans were placed on accrual status based on the SBA's confirmation of its takeout loan commitment. A third non-performing loan, in the amount of approximately $800,000, involves a loan made to renovate and convert a facility to a sports bar and restaurant. This loan is 100% guaranteed by the City of San Bernardino Economic Development Agency. After renovation, the lessee was unable to operate the facility successfully. The facility has now been leased to an experienced and successful southern California chain operator and an additional restructuring has been reached with the borrower/owner. A fourth non-performing loan, in the amount of approximately $700,000, involves a ten-unit low-income home development project in the city of Colton, California. Six homes have sold, two are expected to close escrow in the second quarter of 1999, one is utilized as a model home, and one remains unsold. In addition, the bank has located a buyer who has indicated his willingness to purchase the non-performing loan at a discount. The anticipated purchase price of the loan plus the anticipated net proceeds from the early second quarter home sale is expected to result in a loss of approximately $80,000, or approximately 50% of the loan loss reserve specifically allocated to this loan. A fifth non-performing loan, in the amount of approximately $1.1 million, involves a service station/car wash/mini-market operation. This loan was not considered a non-accrual loan at December 31, 1998, but was placed on non-accrual status during the first quarter of 1999. The City of San Bernardino Economic Development Agency is a guarantor. Valley Bank is now in the process of making demand on the city to bring the payments current and maintain them in that regard or to pay off the loan. As of December 31, 1998, Valley Bank had OREO of approximately $1.8 million. At March 31, 1999, Valley Bank had OREO of approximately $1.6 million. The first largest OREO property, with an approximate book balance of $400,000, is an office building located in the Moreno Valley area. The second largest OREO property, with an approximate book balance of $400,000, is a residential planned unit development located in the Hemet, California area. The third largest OREO property, with an approximate book balance of $275,000, is a land parcel located in Moreno Valley, California. 88 SUBSTANDARD AND DOUBTFUL LOANS. Valley Bank monitors all loans in the loan portfolio to identify problem credits. Additionally, as an integral part of the credit review process of Valley Bank, credit reviews are performed by an outside financial institution consulting firm semi-annually to assure accuracy of documentation and the identification of problem credits. Valley Bank and its loans are also reviewed by the FDIC and State of California Department of Financial Institutions during an annual safety and soundness examination. There are three classifications for problem loans: Substandard--An asset is classified as "substandard" if it is inadequately protected by the current sound worth and paying capacity of the obligor, or of the collateral pledged, if any. Credits in this category have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that Valley Bank will sustain some loss if the deficiencies are not corrected. Doubtful--An asset is classified as "doubtful" if it has all the weaknesses inherent in one classified "substandard," and has the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined. Loss--An asset is classified as a "loss" if it is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future. Any potential recovery is considered too small and the realization too distant in the future to justify retention as an asset on Valley Bank's books. Another category, designated as "special mention," is maintained for loans which do not currently expose Valley Bank to a significant degree of risk to warrant classification in a "substandard," "doubtful" or "loss" category, but do possess credit deficiencies or potential weaknesses deserving management's close attention. As of December 31, 1998, Valley Bank's classified loans consisted of $3.8 million in the "substandard" category and no loans in the "doubtful" category. Valley Bank's $3.8 million of loans classified as "substandard" consisted of $222,000 of performing loans and $3.6 million of non-accrual loans. Additionally, as of December 31, 1998, Valley Bank's loans categorized in the "special mention" category consisted of $2.4 million of performing loans. IMPAIRED LOANS. Valley Bank defines impaired loans, regardless of past due status, as those on which principal and interest are not expected to be collected under the original contractual loan repayment terms. Valley Bank charges off an impaired loan at the time management believes the collection process has been exhausted. Valley Bank measures impaired loans based on the present value of future cash flows discounted at the loan's effective rate, the loan's observable market price or the fair value of collateral if the loan is collateral-dependent. Impaired loans at December 31, 1998 were $3.9 million (all of which were also nonaccrual loans). Allowance for loan losses related to impaired loans was $502,000 at December 31, 1998. 89 Except as disclosed above, there were no assets as of December 31, 1998 where known information about possible credit problems of borrowers caused management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms. However, it is always possible that current credit problems may exist that may not have been discovered by management. Please refer to "--Allowance and Provisions for Loan Losses." ALLOWANCE AND PROVISIONS FOR LOAN LOSSES The following table sets forth an analysis of the allowance for loan losses and provisions for loan losses for the periods indicated.
DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (DOLLARS IN THOUSANDS) Balance at beginning of period............................. $ 1,058 $ 756 $ 497 $ 574 $ 1,047 --------- --------- --------- --------- --------- Loans charged off Real estate--construction................................ 0 0 0 0 225 Real estate--residential................................. 0 79 66 469 224 Real estate--unimproved residential lots................. 0 0 0 0 0 Real estate--commercial.................................. 0 0 55 355 248 Commercial and industrial................................ 9 26 0 1 4 Government guaranteed.................................... 403 653 0 0 0 Loans to individuals..................................... 0 1 0 0 82 --------- --------- --------- --------- --------- Total charge-offs.......................................... 412 759 121 825 783 --------- --------- --------- --------- --------- Recoveries Real estate--construction................................ 0 16 6 128 149 Real estate--residential................................. 225 46 13 6 0 Real estate--unimproved residential lots................. 0 0 0 0 0 Real estate--commercial.................................. 7 6 1 0 0 Commercial and industrial................................ 0 0 0 3 1 Government guaranteed.................................... 40 13 0 0 0 Loans to individuals..................................... 0 0 0 1 0 --------- --------- --------- --------- --------- Total recoveries........................................... 272 81 20 138 150 --------- --------- --------- --------- --------- Net charge-offs............................................ 140 678 101 687 633 Additions charged to operations............................ 200 980 360 610 160 --------- --------- --------- --------- --------- Balance at end of period................................... $ 1,118 $ 1,058 $ 756 $ 497 $ 574 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Average loans outstanding, gross........................... $ 48,512 $ 43,921 $ 41,649 $ 34,552 $ 28,678 --------- --------- --------- --------- --------- Total loans at end of period, gross........................ $ 43,313 $ 45,451 $ 43,172 $ 34,469 $ 33,044 --------- --------- --------- --------- --------- Net charge-offs/average loans outstanding.................. 0.29% 1.54% 0.24% 1.99% 2.21% Allowance at end of period/loans outstanding............... 2.59% 2.34% 1.76% 1.45% 1.75% Allowance/nonperforming loans.............................. 22.32% 32.79% 60.72% 40.24% 18.09%
Valley Bank maintains an allowance for loan losses at a level considered by management to be adequate to cover the inherent risks of loss associated with its loan portfolio under 90 prevailing and anticipated economic conditions. In determining the adequacy of the allowance for loan losses, management takes into consideration the following factors among others: - changes in lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices - changes in national and local economic and business conditions and developments, including the condition of various market segments - changes in the nature and volume of the portfolio - changes in the experience, ability, and depth of the lending management and staff - changes in the trend of the volume and severity of past due and classified loans - trends in the volume of non-accrual loans, troubled debt restructuring and other loan modifications - changes in the quality of the loan review system and degree of oversight by the institution's board of directors - the existence and effect of any concentrations of credit, and changes in the level of such concentrations - the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution's current portfolio Valley Bank follows the "Interagency Policy Statement on the Allowance for Loan and Lease Losses" and analyzes the Allowance for Loan Losses using the above factors on a quarterly basis. In addition, as an integral part of the semi-annual credit review process of Valley Bank, performed by an outside financial institution consulting firm, the Allowance for Loan Losses is reviewed for adequacy. Furthermore, the adequacy of the Allowance for Loan Losses is reviewed by FDIC and State of California Department of Financial Institutions in an annual safety and soundness examination. The FDIC and/or State of California Department of Financial Institutions may require Valley Bank to recognize additions to the Allowance for Loan Losses based upon its judgment of the information available to it at the time of its examination. Valley Bank was most recently examined by the FDIC and State of California Department of Financial Institutions on December 21, 1997. Valley Bank's Senior Credit Officer reports monthly to Valley Bank's board of directors and continuously reviews loan quality and loan classifications. Such reviews assist the Board in establishing the level of the allowance for loan and lease losses. Valley Bank's board of directors reviews the adequacy of the allowance on a monthly basis. Valley Bank uses a methodology known as migration analysis for assistance in determining the appropriate level of its allowance for loan losses. This method applies relevant risk factors to the entire loan portfolio, including nonperforming loans. The methodology is based, in part, on the Bank's loan grading and classification system. The Bank grades its loans through internal reviews and periodically subjects loans to external reviews which then are assessed by the Bank's board of directors. External credit reviews are performed on a semi-annual basis and the quality grading process occurs on a quarterly basis. The "migration" of loans from grade to grade is then tracked to help predict future losses and thus more accurately set allowance levels. Risk factors applied to the performing loan 91 portfolio are based on Valley Bank's past loss history considering the current portfolio's characteristics, current economic conditions and other relevant factors. General reserves are applied to various categories of loans at percentages ranging up to 50% based on the Bank's assessment of credit risks for each category. Risk factors are applied to the carrying value of each classified loan: - loans internally graded "Watch" or "Special Mention" carry a risk factor from 1.0% to 2.0%; - "Substandard" loans carry a risk factor that is typically 15%, but ranges from 0% (in the case of a government guaranteed loan on which the guarantee has not yet been honored) to 40% depending on collateral securing the loan, if any; - "Doubtful" loans carry a 50% risk factor; and - "Loss" loans are charged off 100%. In addition, a portion of the allowance is specially allocated to identified problem credits. The analysis also includes reference to factors such as the delinquency status of the loan portfolio, inherent risk by type of loans, industry statistical data, recommendations made by Valley Bank's regulatory authorities and outside loan reviewers, and current economic environment. Important components of the overall credit rating process are the asset quality rating process and the internal loan review process. The balance in the allowance is affected by amounts provided from operations, amounts charged off and recoveries of previously charged off loans. For 1998, Valley Bank recorded a provision for credit losses of $200,000 compared with provisions of $980,000 for 1997 and $360,000 for 1996. In 1998 net charge offs totaled $140,000, compared with net charge offs of $678,000 for 1997 and $101,000 in 1996. The relatively higher level of charge offs in 1997 reflected primarily government guaranteed loans that had been originated in previous years without sufficient attention to government requirements for documentation of lien positions and similar matters. The employee responsible for these oversights is no longer with Valley Bank, and the Bank has since implemented more stringent procedures for loan documentation. At December 31, 1998 the allowance for loan losses was $1.1 million or 2.59% of total loans outstanding, compared with $1.1 million or 2.34% of total loans outstanding at December 31, 1997. The allowance is based on estimates and ultimate future losses may vary from current estimates. Management anticipates the continued stabilization of the economy in segments of Valley Bank's market area. However, credit quality will be influenced by underlying trends in the economic cycle, particularly in Southern California, which management cannot completely predict. It is always possible that future economic or other factors may adversely affect Valley Bank's borrowers. As a result, Valley Bank may sustain loan losses, in any particular period, that are sizable in relation to the allowance, or exceed the allowance. In addition, Valley Bank's asset quality may deteriorate through a number of possible factors, including: - rapid growth; - failure to enforce underwriting standards; - failure to maintain appropriate underwriting standards; - failure to maintain an adequate number of qualified loan personnel; and 92 - failure to identify and monitor potential problem loans. Based on these and other factors, loan losses may be substantial in relation to the allowance, or exceed the allowance. Please refer to "Risk Factors--Loan loss reserves may not cover actual loan losses." The following table summarizes a breakdown of the allowance for loan losses by loan category and the allocation in each category as a percentage of total loans in each category at the dates indicated:
DECEMBER 31, ----------------------------------------------------------------------------------------------- 1998 1997 1996 1995 -------------------------- -------------------------- -------------------------- ----------- % OF LOANS % OF LOANS % OF LOANS IN AMOUNT IN CATEGORY AMOUNT IN CATEGORY AMOUNT CATEGORY AMOUNT ----------- ------------- ----------- ------------- ----------- ------------- ----------- (DOLLARS IN THOUSANDS) Real estate--construction.. $ 490 15.8% $ 141 15.1% $ 29 5.0% $ 28 Real estate--residential... 62 11.3 70 15.7 66 20.1 90 Real estate--unimproved residential lots...... 175 11.5 146 14.0 139 18.8 11 Real estate--commercial.... 200 32.5 423 32.0 303 34.8 201 Commercial and industrial............ 37 6.2 54 3.8 70 4.5 72 Government guaranteed... 150 21.5 213 18.4 141 15.7 89 Loans to individuals.... 4 1.2 11 1.0 8 1.1 6 ----------- ----- ----------- ----- ----- ----- ----- Total................... $ 1,118 100.0% $ 1,058 100.0% $ 756 100.0% $ 497 ----------- ----- ----------- ----- ----- ----- ----- ----------- ----- ----------- ----- ----- ----- ----- 1994 -------------------------- % OF LOANS IN % OF LOANS IN CATEGORY AMOUNT CATEGORY ------------- ----------- ------------- Real estate--construction.. 5.7% $ 22 3.8% Real estate--residential... 28.6 102 17.8 Real estate--unimproved residential lots...... 1.5 12 2.1 Real estate--commercial.... 41.8 210 36.6 Commercial and industrial............ 4.8 72 12.5 Government guaranteed... 16.4 148 25.8 Loans to individuals.... 1.2 8 1.4 ----- ----- ----- Total................... 100.0% $ 574 100.0% ----- ----- ----- ----- ----- -----
The allocation of the allowance to loan categories is an estimate by management of the relative risk characteristics of loans in those categories. Losses in one or more loan categories may exceed the portion of the allowance allocated to that category or even exceed the entire allowance. Please refer to "Risk Factors--Loan loss reserves may not cover actual loan losses." DEPOSITS Deposits are Valley Bank's primary source of funds. At December 31, 1998, Valley Bank had a deposit mix of 21.7% in time deposits, 41.7% in savings and interest-bearing checking accounts, 26.5% in noninterest-bearing demand accounts and 10.1% in money market accounts. Noninterest-bearing demand deposits enhance Valley Bank's net interest income by lowering its costs of funds. Valley Bank obtains deposits primarily from the communities it serves. No material portion of its deposits has been obtained from or is dependent on any one person or industry. Valley Bank's business is not seasonal in nature. Valley Bank accepts deposits in excess of $100,000 from customers. These deposits are priced to remain competitive. At December 31, 1998, Valley Bank had no brokered deposits. 93 The following table sets forth the average balances and the average rates paid for the major categories of deposits for the dates indicated:
DECEMBER 31, ----------------------------------------------------------------------------------------- 1998 1997 1996 1995 ------------------------ ------------------------ ------------------------ ----------- AVERAGE AVERAGE AVERAGE AVERAGE RATE AVERAGE RATE AVERAGE RATE AVERAGE BALANCE PAID BALANCE PAID BALANCE PAID BALANCE ----------- ----------- ----------- ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Demand accounts...................... $ 19,212 -- $ 18,098 -- $ 16,502 -- $ 15,591 Savings accounts..................... 11,505 1.99% 11,220 1.99% 11,080 2.05% 11,532 Money market accounts................ 7,261 2.49 7,180 2.45 7,821 2.45 8,636 NOW accounts......................... 19,297 1.04 17,373 1.04 16,652 1.04 14,937 Certificates of deposits under $100,000........................... 12,250 5.13 10,635 5.02 8,837 4.81 7,108 Certificates of deposits of $100,000 or more............................ 2,909 5.09 1,761 6.47 1,625 5.66 1,692 ----------- ----------- ----------- ----------- Total deposits....................... $ 72,434 1.91% $ 66,267 1.85% $ 62,517 1.79% $ 59,496 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- 1994 ------------------------ AVERAGE AVERAGE RATE AVERAGE RATE PAID BALANCE PAID ----------- ----------- ----------- Demand accounts...................... -- $ 14,594 -- Savings accounts..................... 1.99% 12,423 2.00% Money market accounts................ 2.45 9,583 2.16 NOW accounts......................... 1.05 14,254 1.08 Certificates of deposits under $100,000........................... 4.61 6,241 3.36 Certificates of deposits of $100,000 or more............................ 4.73 1,180 3.14 ----------- Total deposits....................... 1.69% $ 58,275 1.47% ----------- -----------
MATURITIES OF TIME CERTIFICATES OF DEPOSIT Maturities of time certificates of deposits outstanding at December 31, 1998 are summarized as follows:
LESS THAN $100,000 OR MORE $100,000 ----------------- ----------------- (IN THOUSANDS) Three months or less......................................................... $ 1,545 $ 6,048 Over three to twelve months.................................................. 898 5,924 Over twelve months........................................................... -- 2,035 ------ ------- Total........................................................................ $ 2,443 $ 14,007 ------ ------- ------ -------
SUPERVISION AND REGULATION As a California licensed FDIC insured bank, Valley Bank is subject to many governmental rules that affect its operations. For a description of the laws and regulations that apply to Valley Bank, please refer to the section entitled "Supervision and Regulation," starting on page . COMPETITION Valley Bank considers its primary service area to include Riverside and San Bernardino counties in California and, for government guaranteed loans, Portland, Oregon and parts of Washington. The Riverside and San Bernardino county region is commonly referred to the Inland Empire. The banking business in California is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks which have many offices operating over wide geographic areas. Valley Bank competes for deposits and loans principally with these banks, as well as with savings and loan associations, thrift and loan associations, credit unions, mortgage companies, insurance companies, and other lending institutions. Among the advantages certain of these institutions have over Valley Bank are their ability to finance extensive advertising campaigns and to allocate their investment assets to regions of highest yield and demand. Many of the major commercial banks operating in 94 Valley Bank's service areas are larger banks and, as such, possess certain competitive advantages over Valley Bank. By virtue of their greater total capitalization, these major commercial banks have substantially higher lending limits than Valley Bank. In addition, other entities (both public and private) seeking to raise capital through the issuance and sale of debt or equity securities will also compete with Valley Bank in the acquisition of deposits. Valley Bank also competes with money market funds and, to a lesser extent, other types of mutual funds. Valley Bank's marketing emphasis niche has been individual customers, as well as businesses in the professional, commercial and industrial fields. In order to compete with other financial institutions in its primary service areas, Valley Bank relies principally upon regional promotional activity, direct mail, and personal contacts by its officers. For clients whose loan demands exceed Valley Bank's lending limits, Valley Bank attempts to arrange for these loans on a participation basis with other banks and financial institutions. Valley Bank also assists clients requiring services not offered by Valley to obtain these services from its correspondent banks. EMPLOYEES At December 31, 1998, Valley Bank employed a total of 86 full-time equivalent employees, including three executive officers. None is presently represented by a union or covered by a collective bargaining agreement. Valley Bank believes its employee relations are excellent. LITIGATION From time to time, Valley Bank is involved in litigation as an incident to its business. In the opinion of management, no such pending or threatened litigation is likely to have a material adverse effect on Valley Bank's financial condition or results of operations. INSURANCE Valley Bank maintains financial institution bond and commercial insurance at levels deemed adequate by Valley Bank's management to protect it from certain damage. 95 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The names, ages and positions of Pacific Community Banking Group's directors and executive officers as of February 24, 1999 are as follows:
NAME AGE POSITION - ------------------------------------ --- ------------------------------------------------------------- E. Lynn Caswell (2)................. 53 Chairman and Chief Executive Officer and Chief Financial Officer Harold R. Williams, Jr.............. 52 Proposed Executive Vice President and proposed Chief Financial Officer and proposed Director Mitchell J. Allen (1) (2)........... 39 Director Alfred H. Jannard (2)............... 58 Director Carlos Saenz (2).................... 55 Director Henry E. Schielein (1) (2).......... 64 Director Marion V. Ashley.................... 63 Proposed Director James B. Jaqua...................... 56 Proposed Director N. Douglas Mills.................... 59 Proposed Director
- ------------------------ (1) Member of the audit committee (2) Member of the compensation committee MR. E. LYNN CASWELL, a founder of Pacific Community Banking Group, has served as Chairman, Chief Executive Officer and Chief Financial Officer since 1997. From 1996 until 1997, Mr. Caswell was Vice-Chairman of Western Bancorp (formerly Monarch Bancorp), a California bank-holding company. From July 1988 until February 1996, Mr. Caswell was President and Chief Executive Officer of Monarch Bancorp, and also Chairman of that company. Since January 1997 Mr. Caswell has been a member of the board of directors of the Federal Reserve Bank in San Francisco, Chairman of the Public Affairs and Information Committee and a member of the audit committee. Mr. Caswell has been a state chair of Southern California for the American Bankers' Association from June 1992 to October 1997, and has been a congressional legislative liaison for that organization since October 1992. Mr. Caswell has also been a member of the board of directors of the California Bankers' Association from May 1990 to May 1998, Mr. Caswell is also a member of the board of directors of the South Coast Medical Center in Laguna Beach, California, in which capacity he has served since October 1995. Mr. Caswell received a BSBA in marketing and finance from the University of Arkansas and a graduated from the Graduate School of Banking at McIntosh School of Business of the University of Virginia in 1979. He did post-graduate work both in 1981 at the Executive Management School at Stanford University and in 1984 in the Executive Management Program at the Wharton School of the University of Pennsylvania. MR. HAROLD R. WILLIAMS, JR. is our proposed Executive Vice President and proposed Chief Financial Officer and a proposed director. Since February 1996, Mr. Williams has been the Chief Operating and Financial Officer of The Bank of Hemet. He has been Corporate Secretary since 1997. He began his service with The Bank of Hemet in 1994 as the Senior Vice President and Chief Financial Officer. Prior to joining The Bank of Hemet, Mr. Williams 96 served for two years as the Executive Vice President, Chief Financial Officer, Secretary and a director of Commerce Bank and CommerceBancorp, the parent of Commerce Bank, Newport Beach. CommerceBancorp filed for dissolution under Chapter 7 of the Bankruptcy Code in 1994. Mr. Williams has over 27 years of business experience including 16 years in banking. He is a former senior manager with Price Waterhouse & Co., is a Certified Public Accountant and a member of the American Institute of Public Accountants and the California Society of Certified Public Accountants. Mr. Williams graduated in accounting and holds a Masters degree in Business Administration from Brigham Young University. MITCHELL J. ALLEN became a director in February 1999 when the board was expanded in anticipation of the public offering. Mr. Allen is also proposed to become a director of The Bank of Hemet. Since 1981, Mr. Allen has been Vice President of Allen Oldsmobile Cadillac, Inc. in Laguna Niguel, California. Mr. Allen is a graduate of the GM Dealership Academy in 1979. Mr. Allen is a member of the Tom Wilson Cabinet (Orange County Supervisor) and a director of the Orange County Marine Institute. MR. ALFRED H. JANNARD became a director in February 1999 when the board was expanded in anticipation of the public offering. Mr. Jannard is also proposed to become a director of The Bank of Hemet and Valley Bank. From 1991 until 1997, Mr. Jannard was a director of Monarch Bank and Monarch Bancorp in Laguna Niguel, California. From 1975 until 1995, Mr. Jannard was the owner of Niguel Pharmacy in Laguna Niguel, California. Mr. Jannard received a doctorate of pharmacy from the University of Southern California. MR. CARLOS SAENZ became a director in February 1999 when the board was expanded in anticipation of the public offering. Mr. Saenz is also proposed to become a director of The Bank of Hemet and Valley Bank. Since 1993, Mr. Saenz has served as the President and Chief Executive Officer of Gregg Realty & Investments, a real estate brokerage firm. Mr. Saenz has also been a commercial banking officer at Wells Fargo Bank and Southern California First National Bank in San Diego, California, and Mr. Saenz was a member of the Advisory board of directors of Landmark Bank, Anaheim, California from 1982 to 1986. Mr. Saenz received a Bachelor of Science Degree of Finance from San Diego State University. MR. HENRY E. SCHIELEIN became a director in February 1999 when the board was expanded in anticipation of the public offering. Mr. Schielein is also proposed to become director of The Bank of Hemet. Mr. Schielein served as a director of Monarch Bancorp and Monarch Bank from 1988 to 1993 and again from 1994 to 1997. Since 1994, Mr. Schielein has been President and Chief Operating Officer of The Balboa Bay Club, a California corporation that operates a private club and resort facility. From 1993 until 1994, Mr. Schielein was President of the Grand Waialea Resort in Maui, Hawaii. From October 1986 until May 1993, he was Vice President and general manager of the Ritz-Carlton Hotel in Laguna Niguel, California. Mr. Schielein is a certified hotel administrator. MR. MARION V. ASHLEY is a proposed director. Mr. Ashley has served as a director of Valley Bank since 1979 and as the Chairman of the Board of Valley Bank since 1992. Since June 1973, Mr. Ashley has been President and Chief Executive Officer of Ashley Capital, a real estate investment and development company. Mr. Ashley has also served as the President and Treasurer of County Lands, Inc., a real estate investment company, since June 1978. Mr. Ashley also served as the President and Treasurer and as a director of the Eastern Municipal Water District. Mr. Ashley is a 1958 graduate of San Diego State University and a licensed Certified Public Accountant since March 1969. Mr. Ashley served on the Riverside 97 County Planning Commission from 1973-1981, the last year as chairman. He is currently a member, and former chairman, of the Local Agency Formation Commission (LAFCO), having begun his service in 1993. MR. JAMES B. JAQUA is a proposed director. Since January 1994, Mr. Jaqua has been President, Chief Executive Officer and a director of The Bank of Hemet. Mr. Jaqua has over 30 years of banking experience, including six years at Wells Fargo Bank, and five years at a midwest bank holding company. Mr. Jaqua is a graduate of Stanford University. MR. N. DOUGLAS MILLS is a proposed director. Since July 1992, Mr. Mills has served as President, Chief Executive Officer and a director of Valley Bank. From 1986 until 1992, Mr. Mills served as President at Pacific Valley Bank, Modesto, California. Mr. Mills is a 1964 graduate of California State University, Fullerton, and a 1982 graduate of Pacific Coast Banking School, Seattle, Washington. COMMITTEES OF THE BOARD OF DIRECTORS In February 1999, the board established an audit committee and a compensation committee. The audit committee monitors the corporate financial reporting and internal and external audits of Pacific Community Banking Group. The audit committee currently consists of Mitchell Allen and Henry Schielein. The compensation committee makes recommendations regarding Pacific Community Banking Group's employee stock option plans and makes decisions concerning salaries and incentive compensation for employees and consultants of Pacific Community Banking Group. The compensation committee currently consists of E. Lynn Caswell, Mitchell Allen, Alfred Jannard, Carlos Saenz and Henry Schielein. DIRECTOR COMPENSATION Each director will receive annual grants of shares of common stock, equal in value to $2,000 per month. The value of the shares will be based on the market price on the last business day of each calendar quarter. Further, directors will receive cash payments of $250 per meeting for attendance at meetings of committees of the board, and $500 for attendance at special or unscheduled board meetings. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION No interlocking relationship exists between Pacific Community Banking Group's board of directors or compensation committee and any member of any company's board of directors or compensation committee, nor has any such interlocking relationship existed in the past. LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS Section 317 of the California General Corporations Law ("CGCL") authorizes a court to award, or a corporation's board of directors to grant, indemnity to directors, officers and employees in terms sufficiently broad to permit such indemnification under certain circumstances for liabilities (including reimbursement for expenses incurred) arising under the Securities Act. Articles V and VI of Pacific Community Banking Group's articles of incorporation and Article III of Pacific Community Banking Group's bylaws provide for indemnification of its directors, officers, employees and other agents to the fullest extent permitted by the CGCL. Insofar as indemnification for liabilities arising under the Securities 98 Act may be permitted to directors, officers and controlling persons of Pacific Community Banking Group pursuant to the foregoing provisions, or otherwise, Pacific Community Banking Group has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. At the present time, there is no pending litigation or proceeding involving a director, officer, employee or other agent of Pacific Community Banking Group in which indemnification would be required or permitted. Pacific Community Banking Group is not aware of any threatened litigation or proceeding that could result in a claim for such indemnification. EXECUTIVE COMPENSATION--SUMMARY COMPENSATION TABLE The following table sets forth all compensation paid by Pacific Community Banking Group, The Bank of Hemet or Valley Bank during fiscal 1998, 1997, and 1996 to (A) each of the individuals serving as Pacific Community Banking Group's, The Bank of Hemet's and Valley Bank's principal executive officers during fiscal 1998, (B) up to four other most highly compensated executive officers of Pacific Community Banking Group, The Bank of Hemet, Valley Bank and BankLink during fiscal 1998, and (C) up to two additional individuals who would have been among Pacific Community Banking Group's four most highly compensated executive officers, but for the fact that they were not serving as executive officers of Pacific Community Banking Group at the end of fiscal 1998 (collectively referred to as the "Named Executive Officers").
LONG-TERM COMPENSATION ----------------- ANNUAL COMPENSATION SECURITIES ALL OTHER ---------------------------------- UNDERLYING COMPENSATION NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS/SARS(#) ($) - ---------------------------------------------- --------- ----------- ---------- ----------------- ------------ E. Lynn Caswell .............................. 1998 $135,000 -- -- -- Chief Executive Officer, Chief Financial 1997 -- -- -- -- Officer and Chairman of the Board 1996 -- -- -- -- James B. Jaqua ............................... 1998 216,288 $ 130,000 -- $ -- President and Chief Executive Officer of The 1997 204,791 -- 6,000 -- Bank of Hemet 1996 192,708 100,000 -- -- N. Douglas Mills ............................. 1998 184,384 13,333 -- 51,156(1) President and Chief Executive Officer of 1997 185,646 -- -- 53,698(1) Valley Bank 1996 160,150 -- -- 47,257(1) Harold R. Williams, Jr. ...................... 1998 160,907 40,000 -- -- Chief Operating and Financial Officer of The 1997 151,640 35,000 6,000 -- Bank of Hemet 1996 143,325 35,000 -- --
- ------------------------ (1) Includes life insurance premiums, accruals under a retirement plan and purchases under an employee stock purchase plan. 99 OPTION GRANTS IN LAST FISCAL YEAR Pacific Community Banking Group did not grant any stock options or deferred stock units during fiscal year 1998. EMPLOYEE BENEFIT PLANS 1999 STOCK OPTION PLAN Subject to regulatory approval, the Pacific Community Banking Group board of directors and shareholders adopted the 1999 Stock Option Plan on February 23, 1999. This plan provides for the issuance of incentive stock options and non-statutory stock options for a period up to ten years of up to 1,350,000 shares of the Pacific Community Banking Group common stock to our directors and full-time salaried officers and employees, and consultants. The exercise price of options to be issued under this plan must be at least 100% percent of the fair market value of the common stock on the date the options are granted. Options granted are not transferable by the option holder during the holder's lifetime. In the event of termination of employment as a result of the option holder's disability or in the event of the option holder's death during the exercise period, the option will remain exercisable for up to one year, but not beyond the end of the original option term. If an option holder's employment is terminated, unless the termination is because of disability or death, or is for cause, the option holder has the right for three months to exercise the portion of the option that was exercisable immediately before the termination. If an option holder's employment is terminated for cause, except in the case of options granted to consultants or business advisors, the option holder will have the right for 30 days to exercise the portion of the option that was exercisable immediately before the termination. The options will be proportionately adjusted in the event of certain changes in the outstanding common stock of Pacific Community Banking Group, such as stock splits and dividends. The 1999 Stock Option Plan will terminate on February 23, 2009. Pacific Community Banking Group believes the stock options serve as effective performance-based incentives and expect to have a number of stock options equal to 10-20% of Pacific Community Banking Group common stock outstanding at any time. As of December 31, 1998, Pacific Community Banking Group has not granted any stock options under this plan. The board of directors has agreed to grant Mr. Caswell a ten-year incentive stock option for the greater of 250,000 shares of 5% of Pacific Community Banking Group outstanding shares, as provided in his employment contract. The board of directors intends to grant ten-year options to purchase 25,000 shares of common stock to each of the original four directors. The board of directors also intends to grant ten-year options to purchase 25,000 shares of common stock to its other employee and to grant ten-year options to purchase 25,000 and 20,000 shares of common stock to each of two consultants. Further, the employment agreement with Mr. Williams, described under "--Employment Agreements" below, provides for a grant to him of options to purchase 50,000 shares of common stock. All of these options will be exercisable at a price per share equal to the price at which shares are sold in the initial public offering. Except for our 1999 Stock Option Plan, we do not have any other long-term incentive plans. Directors will be paid as described under "--Director Compensation." 100 401(k) PLAN Each of the banks has a 401(k) plan, pursuant to which eligible employees may elect to reduce their current salary by up to the statutorily prescribed annual limit and have the amount of such reduction contributed to the 401(k) plan. Contributions to the 401(k) plans by the banks are discretionary, except there is a matching contribution in each plan that is required to be made by the bank. In the case of The Bank of Hemet, the bank makes a matching contribution equal to 40% of the amount contributed by the employee, up to a maximum of 5% so contributed. In the case of Valley Bank, the bank makes a matching contribution equal to 150% of the first 3% contributed by the employee, plus 50% of the next 3% contributed by the employee. Both of the 401(k) plans are intended to qualify under Section 401 of the Internal Revenue Code so that contributions to the 401(k) plan, and income earned on plan contributions, are not taxed until withdrawn from the 401(k) plan. During the initial period after the closing of the acquisitions, each bank will keep its 401(k) plan in place. Thereafter, Pacific Community Banking Group may consolidate the two plans into a single plan for the combined group of companies. No decision has been made as to the terms and form of such a combined plan. No such change will reduce benefits earned prior to the effective date of the change. Pacific Community Banking Group is committed to providing a program of benefits to the employees of each bank that is no less favorable, when considered in its entirety, than the program of the bank before the acquisition. VALLEY BANK EMPLOYEE STOCK OWNERSHIP PLAN Valley Bank also has an employee stock ownership plan ("ESOP"). Contributions to the ESOP are discretionary by the bank. The ESOP is intended to qualify under Section 401 of the Internal Revenue Code so that contributions to the ESOP, and income earned on plan contributions, are not taxed until withdrawn from the ESOP. The ESOP invests primarily in Valley Bank stock. As of December 31, 1998, the ESOP held 123,252 shares of Valley Bank stock. Of these shares, 38,458 shares had been released for allocation to the accounts of participants and 87,794 shares were unallocated. In the acquisition, the Valley Bank stock held by the ESOP will be exchanged for Pacific Community Banking Group stock. During the initial period after the closing of the acquisitions, the ESOP will remain in place as a plan of Valley Bank. Thereafter, Pacific Community Banking Group may consolidate the ESOP with the 401(k) plan, may amend it into a different type of tax-qualified plan, or may terminate the ESOP. No such change will reduce benefits earned under the ESOP prior to the effective date of the change. WELFARE PLANS Each of the banks maintains programs of health, dental, vision, disability and life insurance for its employees. Generally, participation in these plans is available to all full-time employees after a qualification period. During the initial period after the closing of the acquisitions, each bank will keep its welfare benefit plans in place. Thereafter, Pacific Community Banking Group may consolidate the plans into a single plan for the combined group of companies. No decision has been made as to the terms and form of such combined plans. Pacific Community Banking Group is committed to providing a program of benefits to the employees of each bank that is no less favorable, when considered in its entirety, than the programs of the banks before the acquisitions. 101 SEVERANCE PLANS Each of the banks has established a severance policy. Under The Bank of Hemet's severance policy, an employee who is terminated due to job elimination receives an amount equal to one week's salary for each full year of employment, up to a maximum of 26 weeks' salary. In the case of a change of control, an employee in good standing who is terminated within six months due to job elimination or layoff (if not offered a comparable position) receives between four and 26 weeks' salary, depending upon the job category and longevity of service. The proposed acquisition by Pacific Community Banking Group will be considered a change of control for this purpose. Under the Valley Bank severance policy, an eligible employee who remains with the bank and in good standing through the date of the acquisition by Pacific Community Banking Group and thereafter is terminated within three months, other than for cause (if not offered a comparable position) receives one week's salary for each completed year of service, up to a maximum of 15 weeks' salary. The employees eligible for severance benefits are regular full-time employees who are eligible for other benefit programs. Pacific Community Banking Group estimates that approximately $350,000 will be paid out under these severance plans as a result of terminations that occur following the acquisitions. Following the acquisitions, the banks will retain their respective severance policies until and unless changed by Pacific Community Banking Group. EMPLOYMENT AGREEMENTS Pacific Community Banking Group has entered into a five year and four month employment agreement with Mr. Caswell commencing September 1, 1997 at an initial base salary of $135,000 per annum. Mr. Caswell is entitled to increases based upon the Consumer Price Index, an annual bonus of not less than 10% of his base salary which certain profit goals are met and certain benefits including car allowance, health and life insurance, country club membership and the ability to participate in any bonus, pension or profit sharing plan that we establish in the future. Mr. Caswell has waived some of these benefits while Pacific Community Banking Group is in its period of inception. Mr. Caswell is also entitled to an income continuation policy in an amount of $60,000 per annum for a period of 15 years after retirement. Mr. Caswell is also entitled to a ten-year incentive stock options in an amount equal to the greater of 250,000 shares or 5% of Pacific Community Banking Group's outstanding common stock. Mr. Caswell will also receive certain benefits if he is terminated before the expiration of his employment agreement. Among these benefits, if Mr. Caswell is terminated without cause he has a right to receive the amount of salary, benefits, options and other allowances remaining on his contract, or two years of the salary, benefits, options and other allowances provided under the contract, whichever is greater. Under Mr. Caswell's employment agreement, if Pacific Community Banking Group undergoes a change in control, he will receive the amount of salary, benefits and other allowances remaining on the contract, or three years of the salary, benefits and other allowances provided under the contract, whichever is greater. For purposes of triggering this benefit, the employment agreement defines a change in control as a consolidation, dissolution or transfer of assets that fundamentally changes the structure of Pacific Community Banking Group, a change in ownership of 50% or more of Pacific Community Banking Group's 102 common stock, or a change in ownership of 20% or more of Pacific Community Banking Group common stock constituting an effective change in control of the corporation. Further, if Mr. Caswell is terminated when Pacific Community Banking Group is sold or merged with another company, or another triggering event occurs, as described above, all of Mr. Caswell's stock options will vest. Mr. Jaqua has entered into a consulting agreement with The Bank of Hemet under which he will serve as Chairman of and as a strategic business consultant to BankLink Corporation after the acquisition, and will serve as a director of Pacific Community Banking Group. He will receive director's fees for his services and will also receive commissions for some new business of BankLink. Mr. McDonough has entered into a consulting agreement with The Bank of Hemet under which he will serve as a business development consultant for two years after the acquisition and continue to serve as a director for that time, with a right to receive director's fees and medical benefits. Mr. Jaqua and Mr. McDonough have also each entered into noncompetition agreements with The Bank of Hemet. Mr. Jaqua will receive $500 per month for eight months then $12,000 per month for the next 28 months after the acquisition in exchange for agreeing not to compete with The Bank of Hemet in Riverside, San Bernardino or Orange counties for four years. Mr. McDonough will receive $2,500 per month for three years in exchange for agreeing not to compete with The Bank of Hemet in Riverside county for four years. Mr. Harold R. Williams, Jr., Chief Operating and Financial Officer of The Bank of Hemet, has an agreement that will become effective only if the acquisition of The Bank of Hemet by Pacific Community Banking Group is consummated. The agreement provides that Mr. Williams will serve as Executive Vice President and Chief Financial Officer of Pacific Community Banking Group and remain as Chief Operating and Financial Officer of The Bank of Hemet. The agreement will apply from the time of the consummation of the acquisition to December 31, 2002 and provides Mr. Williams with severance benefits if he is terminated by Pacific Community Banking Group or The Bank of Hemet, or if he terminates employment because of a reduction in salary or benefits or a material diminution in title, authority or responsibilities. If such a termination occurs within the first 12 months of the effective date of the agreement, Mr. Williams will receive 18 months of base salary, payable in a lump sum, and health and other benefits for 18 months. If such a termination occurs during the remaining term of the agreement, Mr. Williams will receive 12 months of base salary, payable in a lump sum, and health and other benefits for 12 months. Pacific Community Bank Group can reduce the severance benefits to the extent they are not deductible expenses under Section 280G of the Internal Revenue Code of 1986, as amended. The agreement also provides Mr. Williams with a bonus in the minimum amount of $60,000 payable February 29, 2000 and stock options for 50,000 shares of Pacific Community Banking Group common stock at an exercise price equal to the initial offering price of Pacific Community Banking Group common stock. N. Douglas Mills, President and Chief Executive Officer of Valley Bank, will likely retain these positions at Valley Bank until Pacific Community Banking Group combines the operations of Valley Bank with those of The Bank of Hemet. He has a severance agreement providing for an annual consulting fee of $55,800, payable monthly over a period of five years, which will take effect at that time. 103 CERTAIN TRANSACTIONS We expect to have banking transactions in the ordinary course of our business with our directors, officers and their associates. We intend that these transactions will be on substantially the same terms as those prevailing at the same time for comparable transactions with others, not involve more than the normal risk of collectability or present other unfavorable features. PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information with respect to beneficial ownership of Pacific Community Banking Group's common stock as of March 31, 1999, and is adjusted to reflect the sale of the shares offered in this prospectus. It shows interests of (A) each person, or group of affiliated persons, who is known by Pacific Community Banking Group to own beneficially more than 5% of Pacific Community Banking Group's common stock, (B) each of Pacific Community Banking Group's directors and proposed directors, (C) each of the Named Executive Officers and proposed Named Executive Officers, (D) all directors, proposed directors and executive officers as a group and (E) all other selling shareholders. We have assumed for the purposes of this calculation that the price to the public of the common stock in this offering will be $15.00 per share. Also, we have rounded down in computing the aggregate number of shares resulting from conversion of preferred stock and the exchange of shares with shareholders of The Bank of Hemet and Valley Bank.
SHARES OF COMMON STOCK SHARES OF COMMON STOCK BENEFICIALLY OWNED TO BE BENEFICIALLY OWNED BEFORE SALE UNDER THIS AFTER SALE UNDER THIS PROSPECTUS(1) SHARES TO PROSPECTUS(1)(2) ------------------------ BE ------------------------ NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE SOLD NUMBER PERCENTAGE - ---------------------------------------------------- --------- ------------- ----------- --------- ------------- E. Lynn Caswell, Chairman, Chief Executive Officer and Chief Financial Officer(3).................... 35,625 * -- 35,625 * Loren Hansen(4)..................................... 8,333 * -- 8,333 * Rice Brown(5)....................................... 6,250 * -- 6,250 * James Jaqua, Proposed Director(6)................... 547,583 13.79% 410,687(13) 136,896 13) 3.02% Alfred H. Jannard, Director(7)...................... 5,417 * -- 5,417 * N. Douglas Mills, Proposed Director(8).............. 119,848 3.02% 71,909(14) 47,939 14) 1.06% Carlos Saenz, Director(9)........................... 2,500 * -- 2,500 * Mitchell J. Allen, Director(9)...................... 2,500 * -- 2,500 * Henry E. Schielein, Director(10).................... 2,083 * -- 2,083 * Harold R. Williams, Proposed Executive Vice President and Proposed Chief Financial Officer and Proposed Director................................. 37,400 * 28,050(13) 9,350 13) * Marion V. Ashley, Proposed Director................. 67,993 1.71% 40,796(14) 27,197 14) * All directors, proposed directors and Executive Officers as a group(11 persons)................... Jack E. Gosch(18)(20)(24)........................... 367,635 11) 9.25% 275,726(15) 91,909 2.03% John B. Brudin(18)(20).............................. 242,957 11) 6.11% 182,218(15) 60,739 1.34% Clayton A. Record and Ella Mae Record(16)........... 193,327 11) 4.87% 144,995(15) 48,332 1.07% George Wilson(21)(25)............................... 89,654 12) 2.26% 53,792(11) 35,862 * Mark Nugent(22)(25)................................. 89,490 12) 2.25% 53,694(14) 35,796 * Dianna Williams(22)(25)............................. 87,097 12) 2.19% 52,258(14) 34,839 * Eric Hook(22)(25)................................... 82,237 12) 2.07% 49,342(14) 32,895 * Kenneth Ray(23)(26)................................. 72,295 12) 1.82% 43,379(14) 28,918 * Banque D'Orsay...................................... 108,800 11) 2.73% 81,600(15) 27,200 -- E. Kenneth Hyatt(18)................................ 109,479 11) 2.63% 78,359(15) 26,120 * Willow Decker(21)................................... 64,241 12) 1.62% 38,545(14) 25,696 *
104
SHARES OF COMMON STOCK SHARES OF COMMON STOCK BENEFICIALLY OWNED TO BE BENEFICIALLY OWNED BEFORE SALE UNDER THIS AFTER SALE UNDER THIS PROSPECTUS(1) SHARES TO PROSPECTUS(1)(2) ------------------------ BE ------------------------ NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE SOLD NUMBER PERCENTAGE - ---------------------------------------------------- --------- ------------- ----------- --------- ------------- John J. McDonough(18)............................... 73,953 11) 1.86% 55,465(15) 18,488 * Peggy J. Wilson(17)................................. 68,000 11) 1.71% 51,000(15) 17,000 All other selling shareholders, each owning less than 1% of the total voting power of Pacific Community Banking Group prior to this offering ( persons)...................................
- -------------------------- * Less than 1%. (1) We have determined beneficial ownership in accordance with the rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options or warrants held by that person that are currently exercisable within 60 days of March 31, 1999 are deemed outstanding. Such shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of each other person. Except as indicated in the footnote to this table and pursuant to applicable community property laws, each shareholder named in the table has sole voting power and investment power with respect to the shares set forth opposite such shareholder's name. (2) Assumes no exercise of underwriters' over-allotment option or warrants to purchase common stock. (3) Reflects the conversion of 307,500 shares of Series A preferred stock into 25,625 shares of common stock. (4) Reflects the conversion of 100,000 shares of Series A preferred stock into 8,333 shares of common stock. Loren Hansen's address is Knecht & Hansen, 1301 Dove Street, Suite 900, Newport Beach, California 92660. (5) Reflects the conversion of 75,000 shares of Series A preferred stock into 6,250 shares of common stock. Rice Brown's address is 27134 Paseo Espada, Suite 302, San Juan Capistrano, California 92675. (6) Reflects the conversion, upon the closing of The Bank of Hemet acquisition, of the following shares of The Bank of Hemet's common stock: 141,178 shares owned in the name of The Jaqua Trust of 1989, 7,243 shares of common stock owned in the name of James B. Jaqua IRA, 4,813 shares owned in the name of James B. Jaqua, and 4,467 shares owned in the name of M. Susan Jaqua IRA and options to purchase 2,400 shares of The Bank of Hemet's common stock. (7) Reflects the conversion of 65,000 shares of Series A preferred stock into 5,417 shares of common stock. (8) Reflects the conversion, upon the closing of the Valley Bank acquisition, of 5,081 shares of Valley Bank's common stock and options to purchase 110,250 shares of Valley Bank's common stock. (9) Reflects the conversion of 30,000 shares of Series A preferred stock into 2,500 shares of common stock. (10) Reflects the conversion of 25,000 shares of Series A preferred stock into 2,083 shares of common stock. (11) Reflects the conversion of all outstanding stock and options of The Bank of Hemet into shares of Pacific Community Banking Group common stock in the acquisition. (12) Reflects the conversion of all outstanding stock and options of Valley Bank into shares of Pacific Community Banking Group common stock in the acquisition. (13) Assumes that Messrs. Jaqua and Williams sell 75% of shares received in exchange for The Bank of Hemet stock and options. If they were to sell 88%, which is the maximum percentage that may be sold by all former The Bank of Hemet shareholders in the aggregate, Mr. Jaqua would sell 481,873 shares and would retain 65,710 shares, or 1.45%, and Mr. Williams would sell 32,912 shares and would retain 4,488 shares, or less than 1%. The exact numbers of shares sold and retained will depend upon the election that they make, as adjusted, if necessary, based on elections made by all other former shareholders of The Bank of Hemet, so that the aggregate percentage sold is between 75% and 88%. (14) Assumes that the shareholder sells 60% of shares received in exchange for Valley Bank stock and options. The exact number of shares sold and retained will depend upon the elections that they make, as adjusted, if necessary, based on elections made by all other former shareholders of Valley Bank, so that the aggregate percentage sold is 60%. 105 (15) Assumes that the shareholder sells 75% of shares received in exchange for The Bank of Hemet stock and options. The exact number of shares sold and retained will depend on the elections that they make, as adjusted, if necessary, based on elections made by all other former shareholders of The Bank of Hemet, so that the aggregate sold is between 75% and 88%. (16) As trustees for The Record 1990 Trust. Clayton A. Record, Jr. is a director of The Bank of Hemet. (17) As trustee, under an agreement dated September 1, 1993 executed by James H. Wilson. (18) The shareholder is a director of The Bank of Hemet. (19) The shareholder is an executive officer of The Bank of Hemet. (20) The shareholder is a principal shareholder of The Bank of Hemet. (21) The shareholder is a director of Valley Bank. (22) The shareholder is an executive officer of Valley Bank. (23) The shareholder is a principal shareholder of Valley Bank. (24) The amount includes 9,965 shares of The Bank of Hemet common stock owned by Jack Gosch Ford, Inc. Retirement Plan and Trust, and 6,575 of the The Bank of Hemet common stock owned by TASP, Incorporated, in all of which Mr. Gosch has shared ownership. (25) Includes 123,252 shares held as Joint Trustee of Valley Bank's ESOP. (26) Includes 17,103 shares held by Leota Phyllis Ray and Russell James Ray as conservators U/W Kenneth Leon Ray. 106 SUPERVISION AND REGULATION GENERAL Both federal and state law extensively regulate bank holding companies. This regulation is intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of shareholders of Pacific Community Banking Group. Set forth below is a summary description of the material laws and regulations which relate to the operations of the banks and will relate to the operations of Pacific Community Banking Group once its application to be a bank holding company is approved and the acquisitions are consummated. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. In recent years, significant legislative proposals and reforms affecting the financial services industry have been discussed and evaluated by Congress. These proposals include legislation to revise the Glass-Steagall Act and the Bank Holding Company Act of 1956, as amended (the "BHCA"), and to expand permissible activities for banks, principally to facilitate the convergence of commercial and investment banking. Certain proposals also sought to expand insurance activities of banks. It is unclear whether any of these proposals, or any form of them, will be introduced in the next Congress and become law. Consequently, it is not possible to determine what effect, if any, they may have on Pacific Community Banking Group and the banks that it will own. PACIFIC COMMUNITY BANKING GROUP Pacific Community Banking Group has applied to be a registered bank holding company. If the application is approved, it will be subject to regulation under the BHCA. Pacific Community Banking Group will be required to file with the Federal Reserve Board periodic reports and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may conduct examinations of Pacific Community Banking Group and its subsidiaries, which will include the banks. The Federal Reserve Board may require that Pacific Community Banking Group terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, Pacific Community Banking Group must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the BHCA and regulations adopted by the Federal Reserve Board, a bank holding company and its nonbanking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Further, Pacific Community Banking Group is required by the Federal Reserve Board to maintain certain levels of capital. Pacific Community Banking Group will be required to obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding 107 company. Prior approval of the Federal Reserve Board will also required for the merger or consolidation of Pacific Community Banking Group and another bank holding company. Pacific Community Banking Group will be prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, Pacific Community Banking Group, subject to the prior approval of the Federal Reserve Board, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. Pacific Community Banking Group will also be a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, Pacific Community Banking Group and its subsidiaries, including The Bank of Hemet and Valley Bank will be subject to examination by, and may be required to file reports with, the California Department of Financial Institutions. Pacific Community Banking Group has applied to have its securities registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. As such, Pacific Community Banking Group will be subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Exchange Act. THE BANKS The Bank of Hemet and Valley Bank, as California chartered banks, are subject to primary supervision, periodic examination, and regulation by the California Commissioner of Financial Institutions and the FDIC. To a lesser extent, the banks are also subject to certain regulations promulgated by the Federal Reserve Board. If, as a result of an examination of the banks, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the banks' operations are unsatisfactory or that the bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. These remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of either of the banks, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate 108 either of the banks deposit insurance, which for a California chartered bank would result in a revocation of the banks' charter. The California Commissioner of Financial Institution has many of the same remedial powers. Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the bank. State and federal statutes and regulations relate to many aspects of the banks' operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, the banks are required to maintain certain levels of capital. DIVIDENDS AND OTHER TRANSFERS OF FUNDS Dividends from the banks will constitute the principal source of income to Pacific Community Banking Group. Pacific Community Banking Group is a legal entity separate and distinct from the banks. The banks are subject to various statutory and regulatory restrictions on its ability to pay dividends, and will be subject to restrictions on the payment of dividends to Pacific Community Banking Group. In addition, the California Department of Financial Institutions and the Federal Reserve Board have the authority to prohibit the banks from paying dividends, depending upon the banks' financial condition, if the payment is deemed to constitute an unsafe or unsound practice. The FDIC and the California Commissioner of Financial Institutions also have authority to prohibit the banks from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC and the Commissioner could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. Further, the FDIC and the Federal Reserve Board have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction. Compliance with the standards set forth in those guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the banks or Pacific Community Banking Group may pay. An insured depository institution is prohibited from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after the transaction the institution would be undercapitalized. Please refer to "--Prompt Corrective Regulatory Action and Other Enforcement Mechanisms" and "--Capital Standards" for a discussion of these additional restrictions on capital distributions. The banks are subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, Pacific Community Banking Group or other affiliates, the purchase of, or investments in, stock or other securities of Pacific Community Banking Group, the taking of such securities as collateral for loans, and the purchase of assets of Pacific Community Banking Group or other affiliates. Such restrictions prevent Pacific Community Banking Group and the banks' other affiliates from borrowing from the banks unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the banks to or in Pacific Community Banking Group or to or in any other affiliate are limited, individually, to 10.0% of each bank's capital and surplus (as defined by federal regulations), and such secured loans 109 and investments are limited, in the aggregate, to 20.0% of each bank's capital and surplus (as defined by federal regulations). California law also imposes certain restrictions with respect to transactions involving Pacific Community Banking Group and other controlling persons of the banks. Additional restrictions on transactions with affiliates may be imposed on the bank under the prompt corrective action provisions of federal law. CAPITAL STANDARDS The Federal Reserve Board and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as commercial loans. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 1998, The Bank of Hemet exceeded the required ratios for classification as "well capitalized." At that date, Valley Bank was deemed for regulatory purposes to be "adequately capitalized" because it was designated a troubled institution for reasons unrelated to capital levels. An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not 110 treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency. SAFETY AND SOUNDNESS STANDARDS The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (A) internal controls, information systems and internal audit systems, (B) loan documentation, (C) credit underwriting, (D) asset growth, (E) earnings, and (F) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (A) conduct periodic asset quality reviews to identify problem assets, (B) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (C) compare problem asset totals to capital, (D) take appropriate corrective action to resolve problem assets, (E) consider the size and potential risks of material asset concentrations, and (F) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These new guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves. PREMIUMS FOR DEPOSIT INSURANCE The banks' deposit accounts are insured by the Bank Insurance Fund of the FDIC, up to the maximum permitted by law. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the institution's primary regulator. The FDIC charges an annual assessment for the insurance of deposits, which as of December 31, 1998, ranged from 0 to 27 basis points per $100 of insured deposits, based on the risk a particular institution poses to its deposit insurance fund. The risk classification is based on an institution's capital group and supervisory subgroup assignment. Pursuant to the Economic Growth and Paperwork Reduction Act of 1996, at January 1, 1997, the banks began paying, in addition to their normal deposit insurance premium as a member of the BIF, an amount equal to approximately 1.3 basis points per $100 of insured deposits toward the retirement of the Financing Corporation bonds issued in the 1980s to assist in the recovery of the savings and loan industry. Members of the Savings Association Insurance Fund, by contrast, pay, in addition to their normal deposit insurance premium, approximately 6.4 basis points. Under the Paperwork Reduction Act, the FDIC is not permitted to establish Savings Association Insurance Fund assessment rates that are lower than comparable Bank Insurance 111 Fund assessment rates. Beginning no later than January 1, 2000, the rate paid to retire the Financing Corporation Bonds will be equal for members of the Bank Insurance Fund and the Savings Association Insurance Fund. The Paperwork Reduction Act also provided for the merging of the Bank Insurance Fund and the Savings Association Insurance Fund by January 1, 1999 provided there were no financial institutions still chartered as savings associations at that time. However, as of January 1, 1999, there were still financial institutions chartered as savings associations. Should the insurance funds be merged before January 1, 2000, the rate paid by all members of this new fund to retire the Financing Corporation Bonds would be equal. INTERSTATE BANKING AND BRANCHING The Bank Holding Company Act permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including certain nationwide- and state-imposed concentration limits. The banks have the ability, subject to certain restrictions, to acquire by acquisition or merger branches outside their home state. The establishment of new interstate branches is also possible in those states with laws that expressly permit it. Interstate branches are subject to certain laws of the states in which they are located. Competition may increase further as banks branch across state lines and enter new markets. COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS The banks are subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The federal banking agencies may take compliance with those laws and CRA obligations into account when regulating and supervising other activities. A bank's compliance with its CRA obligations is based a performance-based evaluation system which bases CRA ratings on an institution's lending service and investment performance. When a bank holding company applies for approval to acquire a bank or other bank holding company, the Federal Reserve Board will review the assessment of each subsidiary bank of the applicant bank holding company, and those records may be the basis for denying the application. Based on examinations conducted August 24, 1998 for The Bank of Hemet and March 9, 1998 for Valley Bank, The Bank of Hemet was rated outstanding and Valley Bank was rated satisfactory in complying with their respective CRA obligations. YEAR 2000 COMPLIANCE The Federal Financial Institutions Examination Council issued an interagency statement to the chief executive officers of all federally supervised financial institutions regarding year 2000 project management awareness. It is expected that unless financial institutions address the technology issues relating to the coming of the year 2000, there will be major disruptions in the operations of financial institutions. The statement provides guidance to financial institutions, providers of data services, and all examining personnel of the federal banking 112 agencies regarding the year 2000 problem. The federal banking agencies intend to conduct year 2000 compliance examinations, and the failure to implement a year 2000 program may be seen by the federal banking agencies as an unsafe and unsound banking practice. If a federal banking agency determines that either of the banks is operating in an unsafe and unsound manner, that banks may be required to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action being taken, which may include a cease and desist order and fines. 113 DESCRIPTION OF CAPITAL STOCK Our authorized capital stock consists of 100,000,000 shares of common stock, no par value, and 100,000,000 shares of preferred stock, no par value. Immediately prior to the closing of this offering, 10,000 shares of our common stock, 1,085,000 shares of Series A preferred stock and 375,000 shares of Series B preferred stock will be issued and outstanding. The following summary description of our capital stock is qualified in its entirety by reference to our articles of incorporation and bylaws, copies of which are filed as exhibits to the registration statement of which this prospectus forms a part. COMMON STOCK As of March 31, 1999, we had 10,000 shares of common stock outstanding, held of record by one shareholder. The holders of our common stock are entitled to one vote, in person or by proxy, per share on any matter requiring shareholder action. Our articles do not provide for cumulative voting for any purpose so long as our stock is listed on Nasdaq. Holders of common stock are entitled to dividends when, as and if declared by the board of directors from funds legally available therefor (and after satisfaction of the prior rights of holders of outstanding preferred stock, if any) subject to certain restrictions on payment of dividends imposed by the California Corporations Code and other applicable regulatory limitations. Our ability to pay cash dividends is limited by the provisions of Section 500 of the California Corporations Code, which prohibits the payment of dividends unless (A) our retained earnings immediately prior to the distribution exceeds the amount of the distribution; (B) our assets exceed 1 1/4 times our liabilities; or (C) our current assets exceed our current liabilities, but if our average pre-tax earnings before interest expense for the two years preceding the distribution was less than our average interest expense for those years, our current assets must exceed 1 1/4 times our current liabilities. The holders of common stock have no preemptive or other subscription rights and there are no redemption, sinking fund or conversion privileges applicable to the common stock. Upon our liquidation, dissolution or winding up, holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities. PREFERRED STOCK As of March 31, 1999, we had 1,085,000 shares of Series A preferred stock outstanding, held of record by 18 shareholders. In addition, as of March 31, 1999, we had 375,000 shares of Series B preferred stock outstanding, held of record by 16 shareholders. The board of directors has the authority to issue 98,540,000 additional shares of preferred stock in one or more series and to fix the powers, designations, preferences and rights, and qualifications, limitations or restrictions thereof, without any further vote or action by our shareholders. The Series A preferred stock and the Series B preferred stock are currently the only series of preferred stock with designated terms. Each share of Series A preferred stock is convertible into shares of our common stock at a conversion price equal to 80% of the price of our common stock in our initial offering to the public. Each share of Series B preferred stock is convertible into shares of our common stock at a conversion price equal to 85% of the price of our common stock in our initial offering to the public. The holders of Series A and Series B preferred stock do not have voting rights and are not entitled to receive 114 dividends. On the closing of this offering, the preferred stock will automatically convert to common stock. We may issue Pacific Community Banking Group preferred stock from time to time in one or more series. The board is authorized to fix the number of shares of any series of preferred stock and to determine the designation of any such shares. The board is also authorized to determine or alter the rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued series of preferred stock and, within the limits and restrictions stated in any resolution or resolutions of the board of directors originally fixing the number of shares constituting any series, to increase or decrease (but not the number of shares of such series then outstanding) the number of shares of any series subsequent to the issue of shares of that series. Any issuance of preferred stock may adversely affect the rights of holders of our other securities. The effects might include (A) restrictions on common stock dividends if preferred stock dividends have not been paid; (B) dilution of the voting power and equity interest of holders of common stock to the extent that any preferred stock series has voting rights, or that any preferred stock shares are convertible into common stock, or (C) inability of current holders of common stock to share in our assets upon liquidation until satisfaction of any liquidation preferences granted to the holders of the preferred stock. Further, dividends payable on any newly issued series of preferred stock would reduce the amount of funds available for the payment of dividends on common stock, including the shares presently outstanding. Failure to make scheduled dividend or sinking fund payments on the preferred stock could, among other things, trigger restrictions on the payments of dividends on the common stock, including the shares presently outstanding, or temporarily deprive holders of common stock, including the shares presently outstanding, of certain voting rights. Also, certain fundamental matters requiring shareholder approval such as mergers, sales of assets and future amendments to the articles of incorporation may require approval by the separate vote of the holders of preferred stock, or in some cases by holders of shares in each class or series of preferred stock in addition to the approval of the holders of shares of common stock, including the shares presently outstanding, before we can taken any action. In the event of a proposed merger, tender offer or other attempt to gain control of us that the board did not approve, the board could authorize the issuance of preferred stock which could contain rights and preferences which could impede completion of the proposed merger, tender offer or other attempt to gain control of us. An effect of the issuance of preferred stock, therefore, may be to deter a future takeover attempt which some or a majority of the holders of common stock may deem to be in their best interests and in which holders of common stock may receive a premium for their shares over the then market price. We are not aware of any proposed or pending mergers, tender offers or other attempts to gain control of us. WARRANTS We have agreed to issue ten-year warrants that are exercisable at a price equal to 122% of this offering price to the shareholders and holders of options to purchase common stock of The Bank of Hemet and Valley Bank. Based on the number of outstanding shares of common stock of The Bank of Hemet and Valley Bank, and options to purchase shares of their common stock, and assuming the price to the public of our common stock in our initial public 115 offering is $15.00, approximately 1,308,000 warrants exercisable for the same number of shares of our common stock would be issued by us upon the completion of this offering and the acquisitions at an exercise price of $18.30 per share. NUMBER OF DIRECTORS Although the California General Corporation Law does not require us to maintain any specific range of number of directors, the number of directors may not be less than a stated minimum nor more than a stated maximum (which in no case shall be greater than two times the stated minimum minus one) with the exact number of directors to be fixed, within the limits specified. Our bylaws currently provide that the number of directors on our board may not be fewer than five nor more than nine, with the exact number of directors currently fixed at five. Effective immediately before the close, the number of directors may not be fewer than eight nor more than fifteen, with the exact number of directors fixed at nine. An additional four members will be appointed to our board of directors as described in this prospectus. OPTIONS Subject to regulatory approval, our board of directors and shareholders adopted the 1999 Stock Option Plan. Please refer to "Management--Employee Benefit Plans--1999 Stock Option Plan" for information regarding the provisions of this plan. 1,350,000 shares of our common stock have been reserved for issuance pursuant to this plan. Except for our stock option plan, we do not have any other long-term incentive plans. REGISTRATION RIGHTS We have granted registration rights under certain circumstances to the holders of approximately 119,828 shares of our common stock acquired upon conversion of the Series A and Series B preferred stock. Such registration rights are subject to exclusion if the managing underwriter advises us that marketing factors require a limitation on the number of shares to be underwritten. RESTRICTIONS ON ACQUISITION OF PACIFIC COMMUNITY BANKING GROUP The following discussion is a summary of certain provisions of California and Federal law and regulations and California corporate law relating to stock ownership and transfers, the board of directors and business combinations, all of which may be deemed to have "anti-takeover" effects. The description of these provisions is necessarily general and you should refer to the actual law and regulations. The Federal Change in Bank Control Act of 1978 prohibits a person or group of persons "acting in concert" from acquiring "control" of a bank holding company unless the Federal Reserve Bank (the "FRB") has been given 60 days' prior written notice of such proposed acquisition and within that time period the FRB has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued. An acquisition may be made prior to the expiration of the 116 disapproval period if the FRB issues written notice of its intent not to disapprove the action. Under a rebuttable presumption established by the FRB, the acquisition of more than 10% of a class of voting stock of a bank with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (such as our common stock), would, under the circumstances set forth in the presumption, constitute the acquisition of control. Under the California Financial Code, no person may, directly or indirectly, acquire control of a California licensed bank or a bank holding company unless the Commissioner of Financial Institutions has approved the acquisition of control. A person would be deemed to have acquired control of Pacific Community Banking Group under this state law if such person, directly or indirectly, has the power (A) to vote 25% or more of the voting power of Pacific Community Banking Group or (B) to direct or cause the direction of the management and policies of Pacific Community Banking Group. For purposes of this law, a person who directly or indirectly owns or controls 10% or more of Pacific Community Banking Group common stock would be presumed to control Pacific Community Banking Group. In addition, any "company" would be required to obtain the approval of the FRB under the Bank Holding Company Act of 1956, as amended, before acquiring 25% (5% in the case of an acquiror that is, or is deemed to be, a bank holding company) or more of the outstanding common stock of, or such lesser number of shares as constitute control over, Pacific Community Banking Group. CHANGE OF CONTROL PROVISIONS IN COMPANY'S ARTICLES OF INCORPORATION Our articles of incorporation contain certain provisions that deal with matters of corporate governance and certain rights of shareholders. The following discussion is a general summary of Pacific Community Banking Group's articles of incorporation and regulatory provisions relating to stock ownership and transfer, the board of directors and business combinations, which might be deemed to have a potential "anti-takeover" effect. These provisions may have the effect of discouraging a future takeover attempt which is not approved by the board of directors but which some of our individual shareholders may deem to be in their best interest or in which shareholders may receive a substantial premium for their shares over then current market prices. As a result, our shareholders who might desire to participate in such a transaction may not have an opportunity to do so. Such provisions also render the removal of an incumbent board of directors or management of Pacific Community Banking Group more difficult. The following description of certain of the amendments to our articles of incorporation is necessarily general, and reference should be made in each case to the articles of incorporation. CLASSIFICATION OF BOARD OF DIRECTORS. When and as so long as Pacific Community Banking Group's stock is listed on Nasdaq, our board of directors will be divided into two classes, each of which contain approximately one-half of the whole number of the members of the board. The members of each class will be elected for a term of two years, with the terms of office of all members of one class expiring each year so that approximately one-half of the total number of directors are elected each year. The classified board is intended to provide for continuity of our board of directors and to make it more difficult and time consuming for a shareholder group to fully use its voting power to gain control of the board of directors without consent of our incumbent board of directors. 117 AUTHORIZED SHARES. Our articles authorize the issuance of 100,000,000 shares of common stock and 100,000,000 shares of preferred stock. The shares of common stock and preferred stock were authorized in an amount greater than that to be issued to provide our board of directors with as much flexibility as possible to effect, among other transactions, financings, acquisitions, stock dividends, stock splits and the exercise of employee stock options. However, these additional authorized shares may also be used by the board of directors consistent with its fiduciary duty to deter future attempts to gain control of Pacific Community Banking Group. The board of directors also has sole authority to determine the terms of any one or more series of preferred stock, including voting rights, conversion rates, and liquidation preferences. As a result of the ability to fix voting rights for a series of preferred stock, the board has the power, to the extent consistent with its fiduciary duties, to issue a series of preferred stock to persons friendly to management in order to attempt to block a tender offer, merger or other transaction by which a third party seeks control of Pacific Community Banking Group, and thereby assist members of management to retain their positions. Our board has no present plans for the issuance of additional shares, other than the issuance of shares of Company common stock upon exercise of stock options. SHAREHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATION WITH PRINCIPAL SHAREHOLDERS. Our articles of incorporation require the approval of the holders of at least 66 2/3% of Company's outstanding shares of voting stock to approve certain "Business Combinations" (as defined in therein) involving a "Related Person" (as defined therein) except in cases where the proposed transaction has been approved in advance by a majority of those members of our board of directors who are unaffiliated with the Related Person and were directors prior to the time when the Related Person became a Related Person. The term "Related Person" is defined to include any individual, corporation, partnership or other entity (other than Pacific Community Banking Group or its subsidiary) which owns beneficially or controls, directly or indirectly, 10% or more of the outstanding shares of our voting stock or of an affiliate of such person or entity. This provision of our articles of incorporation applies to any "Business Combination," which is defined to include: (A) any merger or consolidation of Pacific Community Banking Group with or into any Related Person; (B) any sale, lease, exchange, mortgage, transfer, or other disposition of 25% or more of the assets of Pacific Community Banking Group or a subsidiary of Pacific Community Banking Group to a Related Person; (C) any merger or consolidation of a Related Person with or into Pacific Community Banking Group or a subsidiary of Pacific Community Banking Group; (D) any sale, lease, exchange, transfer, or other disposition of 25% or more of the assets of a Related Person to Pacific Community Banking Group or a subsidiary of Pacific Community Banking Group; (E) the issuance of any securities of Pacific Community Banking Group or a subsidiary of Pacific Community Banking Group to a Related Person; (F) the acquisition by Pacific Community Banking Group or a subsidiary of Pacific Community Banking Group of any securities of a Related Person; (G) any reclassification of common stock of Pacific Community Banking Group or any recapitalization involving the common stock of Pacific Community Banking Group; or (H) any agreement contract or other arrangement providing for any of the transactions described in the foregoing. Under California law, absent this provision, business combinations, including mergers, consolidations and sales of substantially all of the assets of a corporation must, subject to certain exceptions, be approved by the vote of the holders of a majority of the outstanding shares of our common stock and any other affected class of stock. The increased shareholder 118 vote required to approve a business combination may have the effect of foreclosing mergers and other business combinations which a majority of shareholders deem desirable and place the power to prevent such a merger or combination in the hands of a minority of shareholders. AMENDMENT OF ARTICLES OF INCORPORATION AND BYLAWS. Amendments to our articles must be approved by a majority vote of its board of directors and also by a majority of the outstanding shares of its voting stock, provided, however, that an affirmative vote of at least 66 2/3% of the outstanding voting stock entitled to vote (after giving effect to the provision limiting voting rights) is required to amend or repeal certain provisions of the Articles of Incorporation, including the provision limiting voting rights, the provisions relating to approval of certain business combinations, the number and classification of directors, director and officer indemnification by Pacific Community Banking Group and amendment of Pacific Community Banking Group's bylaws and articles of incorporation. Pacific Community Banking Group's bylaws may be amended by its board of directors, or by a vote of 66 2/3% of the total votes eligible to be voted at a duly constituted meeting of shareholders. SHAREHOLDER NOMINATIONS AND PROPOSALS. Our bylaws require a shareholder who intends to nominate a candidate for election to the board of directors to give not less than 10 days' advance notice to the Secretary of Pacific Community Banking Group. The articles of incorporation provide that a shareholder who desires to raise new business to provide certain information to Pacific Community Banking Group concerning the nature of the new business, the shareholder and the shareholder's interest in the business matter. Similarly, a shareholder wishing to nominate any person for election as a director must provide us with certain information concerning the nominee and the proposing shareholder. PURPOSE AND TAKEOVER DEFENSIVE EFFECTS OF COMPANY'S ARTICLES OF INCORPORATION. Our board of directors believes that the provisions described above are prudent and will reduce our vulnerability to takeover attempts and certain other transactions that have not been negotiated with and approved by its board of directors. The board of directors believes these provisions are in our best interest and in the best interest of Pacific Community Banking Group's shareholders. In the judgment of the board of directors, our board will be in the best position to determine the true value of Pacific Community Banking Group and to negotiate more effectively for what may be in the best interest of its shareholders. Accordingly, the board of directors believes that it is in the best interest of Pacific Community Banking Group and its shareholders to encourage potential acquirors to negotiate directly with the board of directors of Pacific Community Banking Group and that these provisions will encourage such negotiations and discourage hostile takeover attempts. It is also the view of the board of directors that these provisions should not discourage persons from proposing a merger or other transaction at a price reflective of the true value of Pacific Community Banking Group and which is in the best interest of all shareholders. Attempts to acquire control of financial institutions have recently become increasingly common. Takeover attempts which have not been negotiated with and approved by the board of directors present to shareholders the risks of a takeover on terms which may be less favorable than might otherwise be available. A transaction which is negotiated and approved by the board of directors, on the other hand, can be carefully planned and undertaken at an opportune time in order to obtain maximum value of Pacific Community Banking Group and its shareholders, with due consideration given to matters such as the management and 119 business of the acquiring corporation and maximum strategic development of Pacific Community Banking Group's assets. An unsolicited takeover proposal can seriously disrupt the business and management of a corporation and cause it to incur great expense. Although a tender offer or other takeover attempt may be made at a price substantially above the current market prices, such offers are sometimes made for less than all of the outstanding shares of a target company. As a result, shareholders may be presented with the alternative of partially liquidating their investment at a time that may be disadvantageous, or retaining their investment in an enterprise which is under different management and whose objectives may not be similar to those of the remaining shareholders. The concentration of control, which could result from a tender offer or other takeover attempt, could also deprive Pacific Community Banking Group's remaining shareholders of benefits of certain protective provisions of the Securities Exchange Act of 1934, if the number of beneficial owners became less than the 300 thereby allowing for deregistration under that act. Despite our belief as to the benefits to shareholders of these provisions of Pacific Community Banking Group's articles of incorporation, these provisions may also have the effect of discouraging a future takeover attempt which would not be approved by Pacific Community Banking Group's board, but pursuant to which shareholders may receive a substantial premium for their shares over then current market prices. As a result, shareholders who might desire to participate in such a transaction may not have any opportunity to do so. Such provisions will also render the removal of our board of directors and of management more difficult. Our board of directors, however, has concluded that the potential benefits outweigh the possible disadvantages. Pursuant to applicable law, at any annual or special meeting of its shareholders, we may adopt additional charter provisions regarding the acquisition of its equity securities that would be permitted for a California business corporation. We do not presently intend to propose the adoption of further restrictions on the acquisition of our equity securities. The cumulative effect of the restriction on acquisition of Pacific Community Banking Group contained in the articles of incorporation and bylaws, federal law and California law may be to discourage potential takeover attempts and perpetuate incumbent management, even though certain of our shareholders may deem a potential acquisition to be in their best interest, or deem existing management not to be acting in their best interests. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock and warrants is U.S. Stock Transfer Corporation. 120 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this offering, Pacific Community Banking Group will have approximately 4,532,000 shares of common stock outstanding assuming (A) no exercise of the underwriters' over-allotment option, and (B) the price to the public of our common stock in our initial public offering is $15.00. Effective upon the consummation of this offering, assuming no exercise of outstanding options, Pacific Community Banking Group will have outstanding options to purchase approximately 470,000 shares of common stock and warrants to purchase approximately 1,308,000 shares of its common stock. Of the common stock outstanding upon completion of this offering, the [ ] shares of common stock sold in this offering will be freely tradable without restriction or further registration under the Securities Act, except for any shares purchased by "affiliates" of Pacific Community Banking Group, as that term is defined under the Securities Act and the Regulations promulgated thereunder, and shares received in the acquisitions by some officers and directors of The Bank of Hemet and Valley Bank. The remaining [ ] shares of common stock held by officers, directors, employees, consultants and other shareholders of Pacific Community Banking Group were sold by Pacific Community Banking Group in reliance on exemptions from the registration requirements of the Securities Act and are "restricted securities" within the meaning of Rule 144 under the Securities Act and Rule 145 under the Securities Act. Any shares of common stock issued upon the exercise of options or warrants held by any of such persons will constitute restricted securities. Approximately [ ] of the outstanding shares of common stock that are restricted securities will be eligible for sale in the public market as of the date of this prospectus (the "Effective Date") in reliance on Rule 144(k) under the Securities Act. The remaining [ ] shares of common stock held by existing shareholders are subject to lock-up agreements with the Underwriter's representatives. Of the shares of common stock subject to lock-up agreements, approximately [ ] shares may not be sold or transferred until 90 days after the Effective Date and [ ] shares may not be sold or transferred until 180 days after the Effective Date. None of the shares subject to such lock-up agreements may be sold or transferred during the applicable lock-up period without the consent of the underwriters except for transfers pursuant to gifts or certain partnership distributions and similar transfers in which the transferee enters into a substantially similar lock-up agreement. Upon the expiration of the lock-up agreements, all of such locked-up shares will become eligible for sale subject to the provisions of the Rules 144(k), 144 or 701. The Underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to these lock-up agreements. In general, under Rules 144 and 145 as currently in effect, a person (or persons whose shares are aggregated), including an Affiliate, who has beneficially owned restricted securities for a period of at least one year from the later of the date such restricted securities were acquired from Pacific Community Banking Group or the date they were acquired from an affiliate, is entitled to sell, within any three-month period commencing 90 days after the Effective Date, a number of shares that does not exceed the greater of 1% of the then outstanding shares of common stock (approximately [ ] shares immediately after this offering) or the average weekly trading volume in the common stock during the four calendar weeks preceding such sale. Sales under Rule 144 are also subject to certain provisions relating to the number and notice of sale and the availability of current public information about Pacific Community Banking Group. 121 Further, under Rule 144(k), if a period of at least two years has elapsed between the later of the date restricted securities were acquired from Pacific Community Banking Group and the date they were acquired from an affiliate of Pacific Community Banking Group, a holder of such restricted securities who is not an affiliate at the time of the sale and has not been an affiliate for at least three months prior to the sale would be entitled to sell the shares immediately after the Effective Date without regard to the volume and manner of sale limitations described above. Any employee, director or consultant to Pacific Community Banking Group who purchased his or her shares pursuant to a written compensation plan or contract is entitled to rely on the resale provisions of Rule 701, which permits non-Affiliates to sell their Rule 701 shares beginning 90 days after the Effective Date without having to comply with the volume limitations and other restrictions of Rule 144 holding period restrictions. As of [ ], there were outstanding options to purchase approximately [ ] shares which under certain circumstances would be available for sale pursuant to Rule 701, of which approximately [ ] of the shares underlying such options are subject to lock-up agreements. Of the approximately [ ] total shares issuable upon exercise of outstanding options, approximately [ ] shares may not be sold or transferred until 90 days after the Effective Date and [ ] shares may not be sold or transferred until 180 days after the Effective Date. Options for approximately [ ] of the total [ ] shares were exercisable as of [December 31, 1998]. For information about the consequences of future sales of shares, please refer to "Risk Factors--Future sales of securities could diminish the interests of our shareholders" and "--Substantial sales of our common stock could adversely affect our stock price." Prior to this offering, there has been no public market for the common stock of Pacific Community Banking Group, and any sale of substantial amounts of common stock in the open market, or the availability of shares for sale, may adversely affect the market price of the common stock and the ability of Pacific Community Banking Group to raise funds through equity offerings in the future. As of the effective date of the registration statement of which this prospectus is a part, holders of 119,828 shares of common stock will be entitled to registration rights with respect to their shares. For a description of these rights and information about the consequences of their existence, please refer to "Description of Capital Stock--Registration Rights." 122 UNDERWRITING Subject to the terms and conditions set forth in an underwriting agreement between Sutro & Co. Incorporated, as Representative of the several underwriters, Pacific Community Banking Group and the selling shareholders, the underwriters named below (the "Underwriters") have severally agreed to purchase from Pacific Community Banking Group and the selling shareholders the aggregate number of shares of common stock set forth opposite each of their names:
NAME NUMBER OF SHARES - ----------------------------------------------------------------------------------------------- ----------------- Sutro & Co. Incorporated................................................................... Total:.........................................................................................
The underwriting agreement provides that the obligations of the Underwriters are subject to certain conditions precedent, including the absence of any material adverse change in Pacific Community Banking Group's business and the receipt of certain certificates, opinions and letters from Pacific Community Banking Group and its counsel and independent auditors and certificates, opinions and letters from officers of The Bank of Hemet and Valley Bank and their respective counsel and independent auditors. The nature of the Underwriters' obligations is such that the Underwriters are committed to purchase all shares of common stock offered hereby if any of such shares are purchased. The underwriting agreement also provides that Sutro & Co. Incorporated's legal counsel fees and costs, which the Representative estimates at approximately $225,000, shall be paid for by Pacific Community Banking Group. Sutro & Co. Incorporated estimates that it will incur approximately $90,000 of these fees and costs in connection with advice relating to the acquisitions. In addition, the underwriting agreement provides that Pacific Community Banking Group will reimburse the Underwriters for up to $15,000 of out-of-pocket expenses incurred in this offering unless Pacific Community Banking Group consents to a higher amount. Pacific Community Banking Group has also agreed to pay Sutro & Co. Incorporated an advisory fee of $750,000 in consideration of Sutro & Co. Incorporated's financial advisory services in connection with the acquisitions of The Bank of Hemet and Valley Bank as well as approximately $65,000 in fees relating to other services provided in connection with the acquisitions. The Underwriters propose to offer the shares of common stock directly to the public at the public offering price set forth on the cover page of this prospectus and to certain dealers at such price less a concession not in excess of $ per share. The Underwriters may allow, and such dealers may reallow, a concession not in excess of $ per share to certain other dealers. After the public offering of the shares, this offering price and other selling terms may be changed by the Underwriters. The underwriting discount for those shares sold by the Selling Shareholders will be paid for by Pacific Community Banking Group. Prior to this offering, there has been no public market for the common stock. Accordingly, the initial public offering price will be determined by negotiations among the representative of the Underwriters, representatives of the Selling Shareholders and Pacific 123 Community Banking Group. Among the factors which will be considered in such negotiations are the prevailing market conditions, the history of, and the prospects for, Pacific Community Banking Group and the banks and the industry in which they will compete, past and present operations of the banks, past and present earnings and prospects for future earnings, an assessment of management, the general condition of the securities market at the time of this offering and other factors deemed relevant. Pacific Community Banking Group has granted to the Underwriters an option, exercisable no later than 30 days after the date of this Prospectus, to purchase up to an aggregate of additional shares of common stock from Pacific Community Banking Group at the public offering price, less the underwriting discount set forth on the cover page of this prospectus. To the extent that the Underwriters exercise such option, the Underwriters will have a firm commitment to purchase such additional shares in approximately the same proportion that the number of shares of common stock to be purchased by each of them shown in the above table bears to the total number of shares of common stock offered hereby. Pacific Community Banking Group will be obligated, pursuant to the option, to sell such shares to the Underwriters to the extent the option is exercised. The Underwriters may exercise such option only to cover over-allotments made in connection with the sale of shares of common stock offered hereby. The offering of the shares is made for delivery when, as and if accepted by the Underwriters and subject to prior sale and to withdrawal, cancellation or modification of this offering without notice. The Underwriters reserve the right to reject an order for the purchase of shares in whole or in part. Pacific Community Banking Group and some of the selling shareholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, and to contribute to payments the Underwriters may be required to make in respect thereof. The executive officers, certain directors and certain other shareholders of Pacific Community Banking Group, The Bank of Hemet and Valley Bank, have agreed that they will not, without the prior written consent of Sutro & Co. Incorporated, offer, sell or otherwise dispose of any shares of common stock, options or warrants to acquire shares of common stock or securities exchangeable for or convertible into shares of common stock owned by them during either a 90-day or 180-day period following the effective date of this offering, except (A) sales made in connection with this offering; (B) the issuance of shares upon the exercise of options granted prior to the date hereof and the grant of additional options by Pacific Community Banking Group under its stock option plans; (C) to the holders of common stock of The Bank of Hemet and Valley Bank as described in the Prospectus; (D) to his or her immediate family; or (E) to a charitable organization; provided that the recipients thereof in (D) or (E) agree to be bound to the terms of the lock-up agreement to which these shareholders are bound. In general, the rules of the Securities and Exchange Commission will prohibit the Underwriters from making a market in Pacific Community Banking Group's common stock during the restricted period immediately preceding the pricing of the common stock offered hereby. The Commission has, however, adopted exemptions from these rules that permit passive market making under certain conditions. These rules permit an Underwriter to continue to make a market subject to the conditions, among others, that its bid not exceed 124 the highest bid by a market maker not connected with this offering and that its net purchases on any one trading day not exceed prescribed limits. Pursuant to these exemptions, the Underwriters, certain selling group members (if any) or their respective affiliates intend to engage in passive market making in the common stock during the restricted period. In connection with this offering, the Underwriters and other persons participating in this offering may engage in transactions that stabilize, maintain or otherwise affect the price of the common stock. Specifically, the Underwriters may over-allot in connection with this offering, creating a short position in the common stock for their own account. To cover over-allotments or to stabilize the price of the common stock, the Underwriters may bid for, and purchase, shares of the common stock in the open market. The Underwriters may also impose a penalty bid whereby the Underwriters may reclaim selling concessions allowed to other underwriters, if any, or dealers for distributing the common stock in this offering, if the Underwriters repurchase previously distributed common stock in transactions to cover their short position, in stabilization transactions or otherwise. Finally, the Underwriters may bid for, and purchase, shares of the common stock in market making transactions. These activities may stabilize or maintain the market price of the common stock above market levels that may otherwise prevail. The Underwriters are not required to engage in these activities, which may be effected on the Nasdaq Stock Market or otherwise, and may end any of these activities at any time. The Representative has advised Pacific Community Banking Group that the Underwriters do not intend to confirm sales to accounts over which they exercise discretionary authority. EXPERTS The financial statements for Pacific Community Banking Group and The Bank of Hemet included in this prospectus and elsewhere in the registration statement have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports dated February 26, 1999 and January 27, 1999, respectively, with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said reports. The balance sheets of Valley Bank as of December 31, 1998, 1997 and 1996 and the related statements of income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, and included in this Prospectus have been audited by McGladrey & Pullen, LLP, independent certified public accountants, incorporated by reference herein, upon the authority of said firm as experts in accounting and auditing. LEGAL MATTERS The validity of the common stock offered hereby will be passed upon by Morrison & Foerster LLP, Irvine, California. Certain other matters will be passed upon for Pacific Community Banking Group by Knecht & Hansen, Newport Beach, California. Certain matters in connection with this offering will be passed upon for the Underwriters by Manatt Phelps & Phillips, LLP, Los Angeles, California. Mr. Loren Hansen of the firm Knecht & Hansen has purchased an aggregate of 100,000 shares of Series A Preferred Stock which will automatically convert into 8,333 shares of common stock upon the closing of this offering. 125 ADDITIONAL INFORMATION Pacific Community Banking Group has filed with the Securities and Exchange Commission a registration statement on Form S-1 (together with all amendments and exhibits thereto, the "Registration Statement") under the Securities Act with respect to the shares of common stock offered hereby. This prospectus does not contain all of the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission. For further information with respect to Pacific Community Banking Group and the shares of common stock offered hereby, reference is made to the registration statement. Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete, and in each instance reference is made to the copy of such contract or other document filed as an exhibit to the registration statement, each such statement being qualified in all respects by such reference. Copies of such materials may be examined without charge at, or obtained upon payment of prescribed fees from, the Public Reference Section of the Commission at Room 1024 Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 (telephone 202- 942-8090), and at the Commission's regional offices located at 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and at 7 World Trade Center, 13th Floor, New York New York 10048. The Commission maintains a World Wide Website that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. Reports, proxy statements and other information concerning Pacific Community Banking Group may also be inspected at the National Association of Securities Dealers, Inc. at 1735 K Street, N.W., Washington D.C. 20006. 126 INDEX TO FINANCIAL STATEMENTS
PAGE NO. ----------- Pacific Community Banking Group Report of Arthur Andersen LLP, Independent Public Accountants....................................... F-2 Balance Sheets--December 31, 1998 and 1997.......................................................... F-3 Statements of Operations............................................................................ F-4 Statements of Shareholders' Equity.................................................................. F-5 Statements of Cash Flow............................................................................. F-6 Notes to Financial Statements....................................................................... F-7 The Bank of Hemet Report of Arthur Andersen LLP, Independent Public Accountants....................................... F-11 Consolidated Balance Sheets--December 31, 1998 and 1997............................................. F-12 Consolidated Statements of Operations............................................................... F-13 Consolidated Statements of Shareholders' Equity..................................................... F-14 Consolidated Statements of Cash Flow................................................................ F-15 Notes to Consolidated Financial Statements.......................................................... F-16 Valley Bank Report of McGladrey & Pullen, LLP Independent Auditors.............................................. F-34 Balance Sheets--December 31, 1998 and 1997.......................................................... F-35 Statements of Income................................................................................ F-36 Statements of Stockholders' Equity.................................................................. F-37 Statements of Cash Flows............................................................................ F-38 Notes to Financial Statements....................................................................... F-39
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Pacific Community Banking Group: We have audited the accompanying balance sheets of PACIFIC COMMUNITY BANKING GROUP (a California corporation) as of December 31, 1998 and 1997, and the related statements of operations, shareholders' equity and cash flows for the year ended December 31, 1998, and for the period from inception (October 17, 1997) to December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pacific Community Banking Group as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the year ended December 31, 1998 and the period from inception (October 17, 1997) to December 31, 1997 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Orange County, California February 26, 1999 F-2 PACIFIC COMMUNITY BANKING GROUP BALANCE SHEETS--DECEMBER 31, 1998 AND 1997
1998 1997 ------------ ----------- ASSETS CURRENT ASSETS: Cash................................................................................. $ 395,948 $ 170,131 Prepaid expenses..................................................................... 1,333 -- Capitalized acquisition and offering costs........................................... 198,127 26,814 ------------ ----------- Total current assets............................................................. 595,408 196,945 ------------ ----------- EQUIPMENT AND FURNITURE, at cost....................................................... 7,096 -- Less--accumulated depreciation....................................................... 1,458 -- ------------ ----------- 5,638 -- ------------ ----------- $ 601,046 $ 196,945 ------------ ----------- ------------ ----------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable..................................................................... $ 94,429 $ 54,112 Refundable common stock subscriptions................................................ -- 85,000 ------------ ----------- Total current liabilities.............................................................. 94,429 139,112 ------------ ----------- COMMITMENTS AND CONTINGENCIES (Note 5) SHAREHOLDERS' EQUITY: Preferred stock, no par value: Authorized--100,000,000 shares Issued and outstanding--no shares.................................................. -- -- Common stock, no par value: Authorized--100,000,000 shares Issued and outstanding-10,000 shares............................................... 2,500 2,500 Common stock subscriptions........................................................... 1,305,000 680,000 Common stock subscriptions receivable................................................ (205,764) (542,990) Accumulated deficit.................................................................. (595,119) (81,677) ------------ ----------- Total shareholders' equity............................................................. 506,617 57,833 ------------ ----------- $ 601,046 $ 196,945 ------------ ----------- ------------ -----------
The accompanying notes are an integral part of these balance sheets. F-3 PACIFIC COMMUNITY BANKING GROUP STATEMENTS OF OPERATIONS
INCEPTION (OCTOBER 17, YEAR ENDED 1997) DECEMBER 31, TO DECEMBER 31, 1998 1997 ------------ ---------------- REVENUES......................................................................... $ -- $ -- GENERAL AND ADMINISTRATIVE EXPENSES.............................................. 525,568 82,477 ------------ ------- Loss from operations......................................................... 525,568 82,477 INTEREST INCOME.................................................................. 11,326 -- ------------ ------- Net loss before taxes........................................................ 514,242 82,477 PROVISION FOR INCOME TAXES....................................................... 800 800 ------------ ------- Net loss..................................................................... $ 513,442 $ 81,677 ------------ ------- ------------ ------- Basic and diluted loss per share................................................. $ 51.34 $ 8.17 ------------ ------- ------------ ------- Weighted average shares outstanding.............................................. 10,000 10,000 ------------ ------- ------------ -------
The accompanying notes are an integral part of these statements. F-4 PACIFIC COMMUNITY BANKING GROUP STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON COMMON STOCK COMMON STOCK -------------------- STOCK SUBSCRIPTIONS ACCUMULATED TOTAL SHARES AMOUNT SUBSCRIPTIONS RECEIVABLE DEFICIT EQUITY --------- --------- ------------ ------------ ------------ ----------- BALANCE, October 17, 1997, (inception)................................... -- $ -- $ -- $ -- $ -- $ -- Common stock issuance....................... 10,000 2,500 -- -- -- 2,500 Common stock subscriptions.................. -- -- 680,000 (542,990) -- 137,010 Net loss.................................... -- -- -- -- (81,677) (81,677) --------- --------- ------------ ------------ ------------ ----------- BALANCE, December 31, 1997.................... 10,000 2,500 680,000 (542,990) (81,677) 57,833 Common stock subscriptions.................. -- -- 625,000 337,226 -- 962,226 Net loss.................................... -- -- -- -- (513,442) (513,442) --------- --------- ------------ ------------ ------------ ----------- BALANCE, December 31, 1998.................... 10,000 $ 2,500 $1,305,000 $ (205,764) $ (595,119) $ 506,617 --------- --------- ------------ ------------ ------------ ----------- --------- --------- ------------ ------------ ------------ -----------
The accompanying notes are an integral part of these statements. F-5 PACIFIC COMMUNITY BANKING GROUP STATEMENTS OF CASH FLOWS
INCEPTION YEAR ENDED (OCTOBER 17, 1997) DECEMBER 31, TO DECEMBER 31, 1998 1997 ------------ ------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss.................................................................... $ (513,442) $ (81,677) Adjustments to reconcile net loss to net cash used in operating activities-- Depreciation and amortization............................................. 1,458 -- Expenses recorded on issuance of stock subscriptions in exchange for services................................................................ 10,000 52,011 Changes in assets and liabilities: Increase in capitalized acquisition and offering costs.................... (171,313) (26,814) Increase in prepaid expenses.............................................. (1,333) -- Increase in accounts payable.............................................. 40,317 54,112 ------------ -------- Net cash used in operating activities................................... (634,313) (2,368) ------------ -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment and furniture.......................................... (7,096) -- ------------ -------- Net cash used in investing activities................................... (7,096) -- ------------ -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from the issuance of common stock, common stock subscriptions, and refundable common stock subscriptions..................................... 867,226 172,499 ------------ -------- Net cash provided by financing activities............................... 867,226 172,499 ------------ -------- NET INCREASE IN CASH.......................................................... 225,817 170,131 CASH, beginning of year....................................................... 170,131 -- ------------ -------- CASH, end of year............................................................. $ 395,948 $ 170,131 ------------ -------- ------------ --------
SUPPLEMENTAL DISCLOSURES OF NON CASH FINANCING ACTIVITIES: During 1997, common stock subscriptions in the amount of $52,011 were issued to an investor in exchange for payment of certain expenses. During 1998, common stock subscriptions in the amount of $10,000 were issued to a third party in exchange for services. The accompanying notes are an integral part of these statements. F-6 PACIFIC COMMUNITY BANKING GROUP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998 AND 1997 1. COMPANY BACKGROUND Pacific Community Banking Group (the Company), a California corporation, was formed on October 17, 1997, for the purpose of acquiring community banking organizations in the Southern California region. The Company has had no revenues to date. 2. ACQUISITION AGREEMENTS During 1998, the Company entered into definitive agreements for the acquisition of The Bank of Hemet ("Hemet") and Valley Bank ("Valley"), which were amended subsequently during 1999. The agreements are contingent upon the completion of an initial public offering ("IPO"). The agreements provide for the exchange of all of the outstanding stock of Hemet and Valley for common stock and for warrants to purchase common stock of the Company. The shareholders of Hemet will receive 3.4 shares of the Company's common stock and one warrant in exchange for each share held of Hemet common stock. The Valley shareholders will receive two-thirds of a share of Company common stock for each share held of Valley common stock. Additionally, the Valley shareholders will receive one warrant for the purchase of Company common stock for every three shares held of Valley common stock. The Hemet and Valley warrants will be exercisable at 122 percent of the IPO price, and have a contractual life of ten years. There can be no assurance that the Company's proposed public offering will be successful and that these acquisitions will be completed. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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. b. EQUIPMENT AND FURNITURE The Company provides for depreciation based on the estimated useful lives of depreciable assets using the straight-line method. Estimated useful lives are as follows: Computers and office equipment................. 3 years Furniture and fixtures......................... 7 years
Property additions are stated at acquisition cost. Upon retirement or disposal of depreciable assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in operations. F-7 PACIFIC COMMUNITY BANKING GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 c. CAPITALIZED ACQUISITION AND OFFERING COSTS Certain legal, accounting and underwriting fees incurred in connection with a proposed acquisition of certain businesses have been capitalized as of December 31, 1997. During 1998, the Company expensed the balance of these costs. In addition, the Company has capitalized costs related to its planned IPO. Capitalized offering costs will be recorded as a reduction of the proceeds received in the IPO or will be expensed should the IPO not be consummated. Capitalized offering costs are approximately $198,000 as of December 31, 1998. d. INCOME TAXES The Company accounts for income taxes using the asset and liability method as prescribed by Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws. e. EARNINGS PER SHARE The Company accounts for earnings per share in accordance with SFAS No. 128, "Earnings Per Share." This Statement requires the presentation of both basic and diluted net income per share for financial statement purposes. Basic net income per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding. Diluted net income per share includes the effect of potential common shares, including dilutive stock options using the treasury stock method. For the year ended December 31, 1998 and the period ended December 31, 1997, potential common shares were excluded from the calculation of diluted net income per share as their impact would be anti-dilutive. 4. INCOME TAXES No provision for federal income taxes has been recorded as the Company incurred net operating losses since inception. At December 31, 1998, the Company had approximately $595,000 and $297,000 of federal and state net operating loss carryforwards, respectively, available to offset future taxable income; which expire through 2017. Under the Tax Reform Act of 1986, the benefits from net operating losses carried forward may be impaired or limited in certain circumstances. Events which may cause limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50 percent over a three year period. Deferred tax assets totaling approximately $238,000 and $33,000 at December 31, 1998 and 1997, respectively, consist primarily of the tax effect of net operating loss carryforwards. The Company has provided a full valuation allowance against the F-8 PACIFIC COMMUNITY BANKING GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 deferred tax assets due to uncertainty regarding the Company's ability to generate sufficient income in future periods for such assets to be realized. 5. COMMITMENTS AND CONTINGENCIES LEASES The Company occupies its office premises under a noncancellable lease agreement which expires in June 1999. At December 31, 1998, future minimum lease commitments are as follows: Year ending December 31: 1999............................................................. $ 11,520 Thereafter....................................................... -- --------- Total future minimum lease payments................................ $ 11,520 --------- ---------
Rental expense for the year ended December 31, 1998 and for the period from inception to December 31, 1997 was approximately $32,000 and $7,000, respectively. EMPLOYMENT AND CONSULTING AGREEMENTS The Company entered into a five-year, four-month employment agreement with its Chief Executive Officer beginning on September 1, 1997. The agreement provides for an annual base salary that is adjusted for the Consumer Price Index, normal employee benefits, and an annual bonus at the discretion of the Board of Directors. The agreement also entitles the officer to 250,000 ten-year incentive stock options at an exercise price equal to the fair market value of the Company's common stock at the date of issuance, which would be issued after the closing of the IPO. Additionally, the agreement contains an income continuation provision, which will provide for payments of $60,000 per year for fifteen years, beginning at the employee's retirement date. This provision could take effect at the successful closing of the Company's first acquisition or merger. Upon implementation of this provision, the Company will accrue a liability for the present value of the amounts to ultimately be distributed. However, the employee has invoked a waiver clause within the agreement, and thus has elected to defer the implementation of the income continuation provision until such time as the Company can support such provision. On July 1, 1998, the Company entered into an agreement with a consultant to review certain loans being made by banks with which the Company has entered into definitive purchase agreements (Please refer to Note 2). The agreement, as amended, calls for the payment of a monthly retainer of $3,500 per month from July 1, 1998 through May 15, 1999, as well as reimbursement for all out-of-pocket business expenses. Payments made under this agreement have been recorded in capitalized acquisition and offering costs in the accompanying financial statements. F-9 PACIFIC COMMUNITY BANKING GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 6. COMMON STOCK SUBSCRIPTIONS The Company has entered into common stock subscription agreements ("the Agreements") with various investors who have contributed cash or services to the Company. The Agreements provide for the conversion of funds invested into shares of common stock of the Company. The conversion into common stock would be at a price equal to eighty percent of the IPO price, and the conversion will occur only under certain conditions, including the successful acquisition of a financial institution and the closing of an IPO. Under the terms of the Agreements, the funds invested could only be disbursed by the Company under certain conditions, which included the signing of a definitive acquisition agreement with a financial institution. As of December 31, 1997, under the terms of the Agreements, fifty percent of the invested funds were disbursable. The remaining fifty percent of invested funds is reflected as a liability in the accompanying financial statements. As of December 31, 1998, the conditions for full disbursement of invested funds had been met. As of the respective balance sheet dates, the total value of Agreements that have been signed is included in common stock subscriptions in the accompanying financial statements. The portion of the Agreements that has not been paid is recorded as a subscription receivable, an offset to the common stock subscriptions account. 7. SUBSEQUENT EVENTS (UNAUDITED) During March 1999, the Company amended its common stock subscription agreements. Funds that have been invested in the Company will be exchanged for one share of preferred stock for every dollar invested. Each share of preferred stock will automatically convert into shares of common stock upon the closing of the IPO. Initial founding investors will receive Series A Preferred Stock for all contributions, while subsequent investors will receive Series B Preferred Stock for their contributions. Series A Preferred Stock shall convert to common stock at a per share price of eighty percent of the IPO price per share. Series B Preferred Stock shall convert at a per share price of eighty-five percent of the IPO price per share. F-10 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders 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, 1998 and 1997, 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, 1998. 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 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 Hemet and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Orange County, California January 27, 1999 F-11 THE BANK OF HEMET AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS--DECEMBER 31, 1998 AND 1997
1998 1997 -------------- -------------- ASSETS CASH AND DUE FROM BANKS.......................................................... $ 6,496,000 $ 6,521,000 FEDERAL FUNDS SOLD............................................................... 10,500,000 13,000,000 -------------- -------------- Total Cash and Cash Equivalents.............................................. 16,996,000 19,521,000 INVESTMENT SECURITIES HELD TO MATURITY Market values of $24,884,000 in 1998 and $24,842,000 in 1997, respectively.......................................... 24,882,000 24,833,000 LOANS AND LEASES................................................................. 207,802,000 192,287,000 ALLOWANCE FOR LOAN AND LEASE LOSSES.............................................. (2,232,000) (2,116,000) -------------- -------------- Loans and Leases, net........................................................ 205,570,000 190,171,000 PREMISES AND EQUIPMENT, net...................................................... 1,541,000 1,637,000 ACCRUED INTEREST RECEIVABLE...................................................... 1,140,000 1,921,000 OTHER REAL ESTATE OWNED.......................................................... 77,000 779,000 OTHER ASSETS..................................................................... 2,671,000 2,461,000 -------------- -------------- $ 252,877,000 $ 241,323,000 -------------- -------------- -------------- -------------- LIABILITIES AND STOCKHOLDERS' EQUITY DEPOSITS Noninterest bearing demand deposits............................................ $ 33,975,000 $ 29,307,000 Savings and interest-bearing demand deposits................................... 67,720,000 59,702,000 Money market deposits.......................................................... 3,669,000 4,251,000 Time deposits of $100,000 or more.............................................. 8,141,000 9,149,000 Time deposits less than $100,000............................................... 116,880,000 116,802,000 -------------- -------------- Total Deposits............................................................... 230,385,000 219,211,000 ACCRUED INTEREST PAYABLE AND OTHER LIABILITIES................................... 1,468,000 1,884,000 -------------- -------------- 231,853,000 221,095,000 -------------- -------------- COMMITMENTS AND CONTINGENCIES (Note 6) STOCKHOLDERS' EQUITY Common stock, no par value--Authorized--20,000,000 shares Issued and outstanding--844,278......................................................... 3,666,000 3,666,000 Retained earnings.............................................................. 17,358,000 16,562,000 -------------- -------------- Total Stockholders' Equity................................................... 21,024,000 20,228,000 -------------- -------------- $ 252,877,000 $ 241,323,000 -------------- -------------- -------------- --------------
The accompanying notes are an integral part of these consolidated balance sheets. F-12 THE BANK OF HEMET AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------- ------------- ------------- INTEREST INCOME Loans, including fees............................................. $ 17,102,000 $ 16,795,000 $ 17,202,000 Investment securities............................................. 1,610,000 1,633,000 1,416,000 Federal funds sold................................................ 704,000 563,000 509,000 ------------- ------------- ------------- Total Interest Income........................................... 19,416,000 18,991,000 19,127,000 ------------- ------------- ------------- INTEREST EXPENSE Transaction and savings deposits.................................. 2,216,000 2,228,000 2,029,000 Time deposits of $100,000 or more................................. 501,000 489,000 891,000 Time deposits less than $100,000.................................. 6,468,000 6,214,000 5,903,000 Other borrowings.................................................. 0 15,000 0 ------------- ------------- ------------- Total Interest Expense.......................................... 9,185,000 8,946,000 8,823,000 ------------- ------------- ------------- Net Interest Income............................................. 10,231,000 10,045,000 10,304,000 PROVISION FOR LOAN AND LEASE LOSSES................................. 0 250,000 988,000 ------------- ------------- ------------- Net Interest Income after Provision for Loan and Lease Losses.............................................. 10,231,000 9,795,000 9,316,000 ------------- ------------- ------------- NONINTEREST INCOME Fees and service charges on deposits.............................. 518,000 554,000 588,000 Other charges and fees............................................ 118,000 149,000 205,000 Other income...................................................... 727,000 501,000 455,000 ------------- ------------- ------------- Total Noninterest Income........................................ 1,363,000 1,204,000 1,248,000 ------------- ------------- ------------- NONINTEREST EXPENSE Salaries and employee benefits.................................... 3,735,000 3,462,000 3,640,000 Premises and equipment............................................ 1,066,000 987,000 1,008,000 Other real estate owned, net...................................... (101,000) (187,000) 1,237,000 Other expenses.................................................... 2,036,000 1,938,000 2,297,000 ------------- ------------- ------------- Total Noninterest Expense....................................... 6,736,000 6,200,000 8,182,000 ------------- ------------- ------------- Income before Provision for Income Taxes........................ 4,858,000 4,799,000 2,382,000 PROVISION FOR INCOME TAXES.......................................... 2,035,000 1,997,000 1,009,000 ------------- ------------- ------------- Net Income...................................................... $ 2,823,000 $ 2,802,000 $ 1,373,000 ------------- ------------- ------------- ------------- ------------- ------------- EARNINGS PER SHARE Basic Earnings Per Share........................................ $ 3.34 $ 3.25 $ 1.53 Diluted Earnings Per Share...................................... $ 3.23 $ 3.15 $ 1.53
The accompanying notes are an integral part of these consolidated statements. F-13 THE BANK OF HEMET AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
COMMON STOCK ------------------------ RETAINED SHARES AMOUNT EARNINGS --------- ------------- ------------- BALANCE, December 31, 1995............................................... 828,398 $ 4,358,000 $ 14,721,000 Exercise of stock options, including tax benefit......................... 59,970 559,000 -- Amendment to preferred stock conversion (Note 9)......................... 6,536 147,000 (147,000) Common stock cash dividend at $1.00 per share............................ -- -- (882,000) Supplemental cash dividend at $0.19 per share (Note 9)................... -- -- (26,000) Net income for the year.................................................. -- -- 1,373,000 --------- ------------- ------------- BALANCE, December 31, 1996............................................... 894,904 5,064,000 15,039,000 Repurchased shares....................................................... (50,626) (1,398,000) -- Common stock cash dividend at $1.50 per share............................ -- -- (1,279,000) Net income for the year.................................................. -- -- 2,802,000 --------- ------------- ------------- BALANCE, December 31, 1997............................................... 844,278 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............................................... 844,278 $ 3,666,000 $ 17,358,000 --------- ------------- ------------- --------- ------------- -------------
The accompanying notes are an integral part of these consolidated statements. F-14 THE BANK OF HEMET AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income......................................................... $ 2,823,000 $ 2,802,000 $ 1,373,000 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation and amortization.................................... 299,000 259,000 287,000 Provision for possible loan and lease losses..................... 0 250,000 988,000 Deferred income tax (benefit).................................... 199,000 513,000 (407,000) Loss (gain) on sale and write-down of other real estate owned.... (162,000) (310,000) 936,000 Accretion of discount on investments............................. (36,000) (259,000) (182,000) Decrease (increase) in accrued interest receivable............... 781,000 1,000 (539,000) Increase in other assets......................................... (409,000) (304,000) (43,000) Increase (decrease) in accrued interest payable and other liabilities.................................................... (417,000) (2,000) 435,000 ------------- ------------- ------------- Net Cash Provided by Operating Activities...................... 3,078,000 2,950,000 2,848,000 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of investment securities................ 101,130,000 32,000,000 20,000,000 Purchases of investment securities............................... (101,142,000) (31,794,000) (22,037,000) Net increase in loans and leases................................. (16,125,000) (6,406,000) (3,453,000) Purchases of premises and equipment.............................. (203,000) (373,000) (162,000) Proceeds from sales of other real estate owned................... 1,589,000 2,896,000 1,640,000 ------------- ------------- ------------- Net Cash Used in Investing Activities.......................... (14,751,000) (3,677,000) (4,012,000) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand, savings, and money market deposits....... 12,104,000 1,699,000 10,676,000 Net increase (decrease) in time deposits......................... (929,000) 5,244,000 (5,834,000) Stock options exercised including tax benefit.................... 0 0 559,000 Cash dividends paid.............................................. (2,027,000) (1,279,000) (908,000) Cash paid for Tender Offer, including expenses................... 0 (1,398,000) 0 ------------- ------------- ------------- Net Cash Provided by Financing Activities...................... 9,148,000 4,266,000 4,493,000 ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................. (2,525,000) 3,539,000 3,329,000 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS, Beginning of Year......................... 19,521,000 15,982,000 12,653,000 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS, End of Year............................... $ 16,996,000 $ 19,521,000 $ 15,982,000 ------------- ------------- ------------- ------------- ------------- ------------- SUPPLEMENTAL INFORMATION Interest paid.................................................. $ 9,212,000 $ 8,919,000 $ 8,853,000 Income taxes paid.............................................. $ 2,105,000 $ 1,160,000 $ 995,000 Loans to Facilitate Sale of Other Real Estate Owned............ $ 37,000 $ 949,000 $ 398,000 Transfer from Loans to Other Real Estate Owned................. $ 726,000 $ 1,185,000 $ 847,000
The accompanying notes are an integral part of these consolidated statements. F-15 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997 AND 1996 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 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 generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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. Realized gains or losses recognized on sales of securities are based upon the adjusted cost and computed on the specific identification method and are booked in other income or other expense, as applicable. The Bank's intention is 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 AND LEASES Loans and leases are stated at the amount of unpaid principal, reduced by an allowance for loan and lease 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 recognized over the contractual life of the loan as a yield adjustment. As unearned revenue, the net unrecognized fees and costs are reported as reductions of the loan balance. Accrual of interest on loans and leases 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. F-16 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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. D. ALLOWANCE FOR LOAN AND LEASE LOSSES The allowance for loan and lease losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management makes periodic credit reviews of the loan and lease 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. CONSOLIDATED STATEMENTS OF CASH FLOWS 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. As more fully described in Note 9, 134,917 shares of Series C Preferred stock were automatically converted to 20,804 shares of the Bank's common stock on September 15, 1995 F-17 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) with a stated value of $465,000. In November 1996, an amendment to the conversion resulted in the issuance of an additional 6,533 in common shares and an increase in the stated value by $147,000. These are noncash transactions and are not reflected in the consolidated statement of cash flows. As a result of this amendment, a supplemental cash dividend and a special cash distribution to all former holders of Preferred stock in the amount of $26,000 was paid in November 1996. 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 written down to the fair value of the real estate to be acquired by a charge to the allowance for loan and lease 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 The FASB issued SFAS No. 128, "Earnings per Share" (EPS) effective for both interim and annual reporting periods ending after December 15, 1997. SFAS No. 128 replaces primary EPS with basic EPS, and fully diluted EPS with diluted EPS. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed in a similar manner as fully diluted EPS, and 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. All periods presented in the accompanying consolidated financial statements have been restated to conform with SFAS No. 128. The following is a reconciliation of the numerators and F-18 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) denominators used in the calculation of basic EPS and diluted EPS for the years ended December 31, 1998, 1997 and 1996.
EARNINGS SHARES EPS ------------ --------- --------- FOR THE YEAR ENDED 1998 Net Income...................................................................... $ 2,823,000 BASIC EARNINGS PER SHARE Income available to Common Stockholders......................................... 2,823,000 844,278 $ 3.34 --------- --------- EFFECT OF DILUTIVE SECURITIES Stock Options................................................................... 30,373 --------- DILUTED EARNINGS PER SHARE Income available to Common Stockholders and assumed conversions................. $ 2,823,000 874,651 $ 3.23 ------------ --------- --------- ------------ --------- --------- FOR THE YEAR ENDED 1997 Net Income...................................................................... $ 2,802,000 BASIC EARNINGS PER SHARE Income available to Common Stockholders......................................... 2,802,000 863,262 $ 3.25 --------- --------- EFFECT OF DILUTIVE SECURITIES Stock Options................................................................... 26,458 --------- DILUTED EARNINGS PER SHARE Income available to Common Stockholders and assumed conversions................. $ 2,802,000 889,720 $ 3.15 ------------ --------- --------- ------------ --------- --------- FOR THE YEAR ENDED 1996 Net Income...................................................................... $ 1,373,000 Less: Preferred stock cash dividend............................................. (26,000) ------------ BASIC EARNINGS PER SHARE Income available to Common Stockholders......................................... 1,347,000 881,705 $ 1.53 --------- --------- EFFECT OF DILUTIVE SECURITIES Stock Options................................................................... 12,118 Preferred Stock................................................................. 26,000 ------------ --------- DILUTED EARNINGS PER SHARE Income available to Common Stockholders and assumed conversions................. $ 1,373,000 893,823 $ 1.53 ------------ --------- --------- ------------ --------- ---------
In May 1997, the Bank concluded a Tender Offer which resulted in the repurchase of 50,626 shares of common stock at the offering price of $27.00 per share. The decrease to common stock was $1,367,000 plus offering costs of $31,000. F-19 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 within 60 days 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 $39,000, $29,000, and $31,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Bank is committed to pay $1,875,000 over the pay out periods of the plan. In 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation," which permits either adoption of the new standard's principles for recording the estimated value of stock-based compensation over the applicable vesting period, or permits continued application of existing accounting standards, with disclosure of any unrecorded cost under the new standard and the related effect on earnings per share. The Bank adopted SFAS No. 123 in 1996, and elected to adopt the disclosure provisions of the new standard only. As the Bank issued no stock-based compensation in 1996, adoption of this standard had no effect on the Bank's financial position or disclosures for the year ended December 31, 1996. During 1997, the Bank granted stock options as more fully described in Note 7. No stock-based compensation was issued in 1998. 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 40% of the first 5% of salary contributed using forfeitures and cash. Participants vest immediately in their own contributions with 100% vesting in Bank's contributions occurring after five years of credited service. The Bank's expense for contributions to this plan was $42,000 and $7,000 during 1998 and 1997, respectively. K. NEW ACCOUNTING PRONOUNCEMENTS AND RECLASSIFICATIONS In June 1997, the FASB issued SFAS Nos. 130 and 131, "Reporting Comprehensive Income" and "Disclosures about Segments of an Enterprise and Related Information." The Bank adopted SFAS Nos. 130 and 131 in 1998. As none of the Bank's accounts would create differences between reported net income and comprehensive income as defined by SFAS No. 130, adoption of this new standard has no impact on the Bank's results of operations or disclosures. Management does not believe that the adoption of SFAS No. 131 has a material impact on the Bank's current disclosure of its one operating segment of banking as described in Note 1.A. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for F-20 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) derivative instruments and for hedging activities. The new standard is effective for 2000 and is not expected to have a material impact on the Bank's financial statements. Certain reclassifications of prior years financial data have been made to conform to the current reporting practices of the Bank. 2. INVESTMENT SECURITIES HELD TO MATURITY The amortized cost and fair value of investment securities held to maturity are as follows at December 31, 1998 and 1997:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE ------------- ----------- ----------- ------------- DECEMBER 31, 1998 U.S. government agencies................................... $ 24,882,000 $ 6,000 $ (4,000) $ 24,884,000 ------------- ----------- ----------- ------------- ------------- ----------- ----------- ------------- DECEMBER 31, 1997 U.S. government agencies................................... $ 24,833,000 $ 10,000 $ (1,000) $ 24,842,000 ------------- ----------- ----------- ------------- ------------- ----------- ----------- -------------
Investment securities with a book value of $10,000,000 and $7,000,000 at December 31, 1998 and 1997, 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 $10,003,000 and $7,001,000 at December 31, 1998 and 1997, respectively. The amortized cost and fair values of investment securities held to maturity at December 31, 1998, by contractual maturity, are as follows:
AMORTIZED ESTIMATED COST FAIR VALUE ------------- ------------- Due in one year or less........................................ $ 18,000,000 $ 18,005,000 Due after one year through five years.......................... 6,000,000 5,997,000 Due after five years through ten years......................... -- -- Due after 10 years............................................. 882,000 882,000 ------------- ------------- Total...................................................... $ 24,882,000 $ 24,884,000 ------------- ------------- ------------- -------------
U.S. government agency securities of $882,000 at December 31, 1998 represent preferred stock of the Federal Home Loan Bank (FHLB), which has no maturity date. 3. LOANS AND LEASES, 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 F-21 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 3. LOANS AND LEASES, NET (CONTINUED) 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 and lease 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, 1998. The most significant category of collateral is real estate, principally commercial and industrial income-producing properties. At December 31, 1998, the Bank's loan portfolio included approximately $27,635,000 of fixed rate loans. The loan and lease portfolio consisted of the following at December 31, 1998 and 1997:
1998 1997 -------------- -------------- Commercial................................................... $ 10,016,000 $ 10,033,000 Real Estate.................................................. 197,189,000 181,524,000 Installment.................................................. 1,002,000 1,065,000 Lease finance receivables.................................... -- -- All other loans (including overdrafts)....................... 391,000 411,000 -------------- -------------- 208,598,000 193,033,000 Deferred loan origination fees, net.......................... (796,000) (746,000) -------------- -------------- 207,802,000 192,287,000 Allowance for loan and lease losses.......................... (2,232,000) (2,116,000) -------------- -------------- Total Loans and Leases, net.............................. $ 205,570,000 $ 190,171,000 -------------- -------------- -------------- --------------
Non-accruing loans totaled approximately $1,578,000 and $2,902,000 at December 31, 1998 and 1997, 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 $277,000, $391,000 and $302,000 for the years ended December 31, 1998, 1997 and 1996, respectively. At December 31, 1998 and 1997, 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, 1998 and 1997, loans that were considered impaired totaled $3,312,000 and $4,708,000, respectively, all of which had a related allowance for loan and lease loss aggregating $287,000 and $402,000, respectively. Impaired loans amounting to $1,578,000 and $2,902,000 were on a non-accruing basis at December 31, 1998 and 1997, 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, 1998, 1997 and 1996, the Bank recognized interest income on these impaired loans of $115,000, $390,000 and $159,000, respectively. The average outstanding principal balance of impaired loans was $4,010,000, $4,770,000 and $4,585,000 during 1998, 1997 and 1996, respectively. From time to time, the Bank has originated first and second mortgages for resale on the secondary market to Federal Home Loan Mortgage Corporation (FHLMC), and Federal F-22 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 3. LOANS AND LEASES, NET (CONTINUED) National Mortgage Association (FNMA). Any gains or losses on the sales of these loans are recognized at the time of sale. The Bank retains 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 $57,000 during 1998, $92,000 during 1997, and $108,000 during 1996. The total unpaid principal balance of the mortgage servicing portfolio amounted to approximately $18,333,000 and $23,617,000 at December 31, 1998 and 1997, respectively. The Bank has pledged certain qualifying residential loans amounting to $0 and $5,794,000 at December 31, 1998 and 1997, respectively, to secure public deposits, as required by state law. The activity in the allowance for loan and lease losses is summarized as follows:
1998 1997 1996 ------------ ------------ ------------ Balance at Beginning of Year........................ $ 2,116,000 $ 2,241,000 $ 2,135,000 Recoveries on loans previously charged off.......... 298,000 76,000 20,000 Loans charged off................................... (182,000) (451,000) (902,000) Provision charged to operating expense.............. -- 250,000 988,000 ------------ ------------ ------------ Balance at End of Year.............................. $ 2,232,000 $ 2,116,000 $ 2,241,000 ------------ ------------ ------------ ------------ ------------ ------------
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, 1998 and 1997. In management's opinion, these loans were made in the ordinary course of business at prevailing rates and terms. Total commitments for such loans amounted to $2,585,000 and $3,330,000 at December 31, 1998 and 1997, of which $237,000 and $425,000 were undisbursed, respectively. There were no new commitments on such loans, and expired loan commitments amounted to $160,000. Advances on existing commitments were $28,000 in 1998, with repayments of $585,000. F-23 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 4. PREMISES AND EQUIPMENT Major classifications of premises and equipment are summarized as follows:
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ Land.............................................................. $ 211,000 $ 211,000 Buildings......................................................... 985,000 983,000 Furniture and equipment........................................... 1,499,000 1,319,000 Leasehold improvements............................................ 355,000 343,000 ------------ ------------ 3,050,000 2,856,000 Less: Accumulated depreciation and amortization................... (1,509,000) (1,219,000) ------------ ------------ Total......................................................... $ 1,541,000 $ 1,637,000 ------------ ------------ ------------ ------------
The amount of depreciation and amortization included in operating expense was $299,000, $259,000, and $287,000 for the years ended December 31, 1998, 1997, and 1996, respectively. The Bank occupies its office premises under separate long-term, noncancellable leases which expire in various years through 2004. All leases are accounted for as operating leases. At December 31, 1998, future minimum lease commitments and future minimum sublease rental income under all noncancellable leases are as follows:
LEASE COMMITMENTS ------------- 1999........................................................................... $ 355,000 2000........................................................................... 354,000 2001........................................................................... 312,000 2002........................................................................... 203,000 2003........................................................................... 95,000 Succeeding Years............................................................... 5,000 ------------- Total........................................................................ $ 1,324,000 ------------- -------------
F-24 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 5. INCOME TAXES The current and deferred amounts of the provisions for (benefit from) income taxes for the years ended December 31, 1998, 1997, and 1996 consisted of the following:
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Current: Federal........................................... $ 1,320,000 $ 1,106,000 $ 1,059,000 State............................................. 516,000 378,000 357,000 ------------ ------------ ------------ Total........................................... 1,836,000 1,484,000 1,416,000 ------------ ------------ ------------ Deferred: Federal........................................... 197,000 353,000 (311,000) State............................................. 2,000 160,000 (96,000) ------------ ------------ ------------ Total........................................... 199,000 513,000 (407,000) ------------ ------------ ------------ $ 2,035,000 $ 1,997,000 $ 1,009,000 ------------ ------------ ------------ ------------ ------------ ------------
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, ----------------------------------- 1998 1997 1996 ---------- ---------- ----------- Expenses reported on a different basis for tax purposes.............................................. $ 231,000 $ 443,000 $ (342,000) Depreciation computed differently on tax returns than for financial statements.............................. (16,000) (3,000) (18,000) Deferred compensation................................... (16,000) (12,000) (13,000) Provision for loan and lease losses deducted in tax return over (under) amount charged for financial statement purposes.................................... 0 85,000 (34,000) ---------- ---------- ----------- $ 199,000 $ 513,000 $ (407,000) ---------- ---------- ----------- ---------- ---------- -----------
F-25 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 5. INCOME TAXES (CONTINUED) Total tax expense differed from the amount computed using the federal statutory rate as follows:
1998 1997 1996 ------------------------- ------------------------- ------------------------- PERCENT OF PERCENT OF PERCENT OF PRETAX PRETAX PRETAX AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME ------------ ----------- ------------ ----------- ------------ ----------- Tax expense at federal statutory rate................................. $ 1,652,000 34.0% $ 1,632,000 34.0% $ 810,000 34.0% State income tax, net of federal tax benefit.............................. 342,000 7.0 355,000 7.4 172,000 7.2 Tax exempt interest.................... 0 0.0 (1,000) (0.0) (4,000) (0.2) Other.................................. 41,000 0.9 11,000 0.2 31,000 1.4 ------------ --- ------------ --- ------------ --- Total................................ $ 2,035,000 41.9% $ 1,997,000 41.6% $ 1,009,000 42.4% ------------ --- ------------ --- ------------ --- ------------ --- ------------ --- ------------ ---
At December 31, 1998 and 1997, the components of the net deferred tax asset which is included in other assets on the accompanying consolidated balance sheets were as follows:
1998 1997 ---------- ------------ Allowance for loan and lease losses................................. $ 590,000 $ 590,000 Deferred compensation............................................... 245,000 229,000 Other real estate owned............................................. 0 13,000 State income tax.................................................... 175,000 128,000 Depreciation........................................................ 53,000 37,000 Other............................................................... (157,000) 108,000 ---------- ------------ Total............................................................. $ 906,000 $ 1,105,000 ---------- ------------ ---------- ------------
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 F-26 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 6. COMMITMENTS AND CONTINGENCIES (CONTINUED) 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. 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, 1998, the Bank had commitments to extend credit of approximately $9,752,000 and obligations under standby letters of credit of approximately $1,116,000. Management does not believe there will be any material losses as a result of these letters of credit and loan commitments. At December 31, 1998, the Bank has available a borrowing line of credit with the FHLB in the amount of $14,163,000 using previously approved residential and commercial real estate mortgage loans totaling $21,253,000 to secure the line of credit. There was no utilization of this line of credit during 1998. The Bank has available reverse repurchase lines of credit with two broker/dealers aggregating $30,000,000 at December 31, 1998. These lines are subject to normal terms for such arrangements. There was no utilization of these lines during 1998. At December 31, 1998, investment securities with a market value of approximately $14,000,000 were available for these reverse 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, 1998 and 1997 were $692,000 and $721,000, respectively. In April 1997, litigation relating to the acquisition of Inland Savings and Loan (Inland) was filed against the Bank and certain of its directors alleging improper adjustments to the value of the Bank's Preferred stock (see Note 9). The named plaintiffs have sued on behalf of a class consisting of former owners of the Bank's Preferred stock. The action alleges breach of contract and breach of fiduciary duty and seeks compensatory damages in excess of $2 million together with punitive damages. The Bank contends that these allegations are without merit, and intends to vigorously defend against these claims. Any potential losses to the Bank as a result of this action are not reasonably estimable, and accordingly no reserve for loss has been established in the accompanying consolidated financial statements. Any losses which might be suffered by the Bank related to this proceeding could impact the Bank's future profitability. F-27 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 6. COMMITMENTS AND CONTINGENCIES (CONTINUED) 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 In January 1987, the former Hemet Bancorp established a stock option plan (the 1987 Plan) which was assumed by the Bank that provides for the granting of incentive and nonqualified stock options to certain full-time salaried officers and management level employees. Additionally, in June 1994, the Bank established a second stock option plan (the 1994 Plan) which authorized the issuance of 75,000 shares, of which 31,000 shares were granted in 1994 and 21,000 shares were granted in 1997 to various officers of the Bank. As of December 31, 1998, there were no shares of common stock granted under the 1987 Plan. At December 31, 1998, 27,000 shares of common stock were reserved for grant under the 1994 Plan which includes 4,000 shares forfeited during 1996. 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. Transactions for the three years ended December 31, 1998, are as follows:
WEIGHTED AVERAGE OPTIONS EXERCISE PRICE OUTSTANDING PER SHARE ----------- --------------- Balance, December 31, 1995..................................... 89,938 $ 9.00 Options exercised (1987 Plan)................................ (58,938) $ 7.51 Options exercised (1994 Plan)................................ (1,032) $ 12.00 Options forfeited (1994 Plan)................................ (4,000) $ 12.00 Options granted.............................................. -- ----------- Balance, December 31, 1996..................................... 25,968 $ 12.00 Options exercised............................................ -- Options granted (1994 Plan).................................. 21,000 $ 22.50 ----------- Balance, December 31, 1997..................................... 46,968 $ 16.69 Options exercised............................................ -- Options granted (1994 Plan).................................. -- ----------- Balance, December 31, 1998..................................... 46,968 $ 16.69 ----------- ----------- Exercisable at December 31, 1998............................... 24,968 $ 13.77
The Bank accounts for options according to Accounting Principles Board Opinion No. 25, under which no compensation cost is recognized. The Bank's pro forma net income and diluted earnings per share assuming the Bank recorded compensation cost in 1998 and 1997 for the options granted in 1997 in accordance with SFAS No. 123 would not have a material effect on the Bank's consolidated results of operations. Pro forma disclosures are not F-28 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 7. STOCK OPTION PLAN (CONTINUED) presented for 1996 because there were no options granted during that year. Because 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. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1997: risk-free interest rate of 6.25%, dividend yield of 6%, expected life of 5 years, and expected volatility of 25%. 8. OTHER EXPENSES The following is a breakdown of other expenses for the years ended December 31, 1998, 1997 and 1996:
1998 1997 1996 ------------ ------------ ------------ Data processing and other outside services.......... $ 326,000 $ 363,000 $ 357,000 Deposit insurance assessments....................... 84,000 87,000 191,000 Special SAIF assessment............................. -- -- 402,000 Professional fees................................... 418,000 383,000 318,000 Office supplies, postage and telephone.............. 488,000 435,000 433,000 Other............................................... 720,000 670,000 596,000 ------------ ------------ ------------ Total............................................. $ 2,036,000 $ 1,938,000 $ 2,297,000 ------------ ------------ ------------ ------------ ------------ ------------
9. BUSINESS COMBINATIONS On October 16, 1992, the Bank acquired Inland Savings and Loan Association and subsidiaries in a business combination accounted for as a purchase under Accounting Principles Board Opinion No. 16. Inland Savings and Loan was primarily engaged in banking services. The shareholders of Inland Savings and Loan received .31474 shares of the Bank's Series 'C' Preferred stock (the Preferred stock) and .31474 shares of the Bank's common stock, for each share of Inland Savings and Loan stock. The Preferred stock had cumulative dividends of 5% per annum of the stock's stated value, payable semi-annually on the 15th of March and September each year. The stated value of the Preferred stock represented the original book value of the stock, less certain charges against that value, as defined and provided for in the purchase agreement and as detailed below. Charges against the stated value of the Preferred stock subsequent to 1992 represented period costs that were charged to operations as incurred and that were subsequently charged against the stated value of Preferred stock through an equity transfer from Preferred stock to retained earnings. Voting rights for the Preferred stock equaled 1/10 of a share of the Bank's common stock. The Preferred stock was automatically converted to the Bank's common stock on September 15, 1995 using a ratio of the Preferred stock's stated value to the Bank's adjusted F-29 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 9. BUSINESS COMBINATIONS (CONTINUED) net book value, as defined in the purchase agreement. The number of shares of common stock delivered upon the automatic conversion of Preferred stock was equal to .1542 shares of common stock for each share of Preferred stock for a total of 20,804 shares of common stock. In November 1996, an amendment to the conversion resulted in the issuance of an additional 6,533 in common shares, an increase in the stated value by $147,000 (principally related to the reversal of tax assessments), and a revised exchange ratio of .2027 shares of common stock for each share of Preferred stock. See Note 6 for a discussion of litigation regarding adjustments to the value of the Preferred stock. As a result of the mark-to-market analysis of the Inland Savings and Loan purchase, various asset and liability accounts were adjusted to appropriate market values. The significant valuations were in the areas of loans, other real estate owned, Bank premises, time deposits, other borrowings, and a core deposit intangible. Amortization of each of the mark-to-market valuation accounts is taken over their expected useful lives, as estimated in the original mark to market analysis. The Bank periodically reviews the estimated useful lives of the mark-to-market assets and liabilities and makes adjustments as necessary. 10. 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. 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 F-30 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 10. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) 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, 1998 and 1997 (see Note 6). F-31 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 10. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The estimated fair values of the Bank's financial instruments are as follows:
CARRYING VALUE FAIR VALUE -------------- -------------- DECEMBER 31, 1998 Financial Assets Cash and cash equivalents.................................. $ 16,996,000 $ 16,996,000 Investment securities...................................... 24,882,000 24,884,000 Loans and leases, net...................................... 205,570,000 207,369,000 Financial Liabilities Deposits................................................... 230,385,000 231,000,000 DECEMBER 31, 1997 Financial Assets Cash and cash equivalents.................................. $ 19,521,000 $ 19,521,000 Investment securities...................................... 24,833,000 24,842,000 Loans and leases, net...................................... 190,171,000 190,176,000 Financial Liabilities Deposits................................................... 219,211,000 219,283,000
11. REGULATORY MATTERS Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank is required to maintain certain minimum capital levels in relation to Bank assets. Under regulations, banks are categorized as critically undercapitalized, significantly undercapitalized, undercapitalized, adequately capitalized and well capitalized. 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. According to regulatory guidelines, the Bank is considered well capitalized as measured using a leverage ratio, as well as based on risk-weighting assets. F-32 THE BANK OF HEMET AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 11. REGULATORY MATTERS (CONTINUED) 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 ACTUAL CAPITALIZED TO BE WELL CAPITALIZED ------------------------ ------------------------ ------------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------------- --------- ------------- --------- ------------- --------- AS OF DECEMBER 31, 1998 Tier 1 Risk-Based Capital (To Risk Weighted Assets)..................... $ 21,024,000 9.99% $ 8,413,000 4.0% $ 12,621,000 6.0% Total Risk-Based Capital (To Risk Weighted Assets)..................... $ 23,257,000 11.06% $ 16,827,000 8.0% $ 21,036,000 10.0% Tier 1 Capital (To Average Assets)..... $ 21,024,000 8.31% $ 10,115,000 4.0% $ 12,645,000 5.0% AS OF DECEMBER 31, 1997 Tier 1 Risk-Based Capital (To Risk Weighted Assets)..................... $ 20,228,000 10.43% $ 7,753,000 4.0% $ 11,630,000 6.0% Total Risk-Based Capital (To Risk Weighted Assets)..................... $ 22,344,000 11.53% $ 15,507,000 8.0% $ 19,384,000 10.0% Tier 1 Capital (To Average Assets)..... $ 20,228,000 8.53% $ 9,486,000 4.0% $ 11,858,000 5.0%
12. SUBSEQUENT EVENT (UNAUDITED) On January 5, 1999, the Bank announced the signing of a revised definitive agreement with Pacific Community Banking Group ("PCBG") for the acquisition by PCBG of the Bank. The agreement provides for total consideration of $51.00 per share, as well as one PCBG warrant per share, upon consummation of the acquisition. The warrant will allow the holder to purchase one share of PCBG common stock during a ten-year period at an exercise price 22% above the initial public offering price of PCBG common stock. The price to be paid to each of the Bank's shareholders may be increased in accordance with a formula related to the aggregate net proceeds to be received by PCBG in the underwritten initial public offering. The consummation of the acquisition is subject to certain conditions including continuation of the Bank's operating results, regulatory and shareholder approval and certain other conditions. The acquisition is also subject to the successful completion of an underwritten initial public offering by PCBG whereby the proceeds of such offering will be used to make the cash payment to selling shareholders of the Bank and to purchase the outstanding shares of Valley Bank in Moreno Valley, California. The values allocated to the assets and liabilities of the Bank could be different than those included in these consolidated financial statements. F-33 INDEPENDENT AUDITOR'S REPORT To the Board of Directors Valley Bank Moreno Valley, California We have audited the accompanying balance sheets of Valley Bank as of December 31, 1998 and 1997, and the related statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Valley Bank as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. McGLADREY & PULLEN, LLP San Bernardino, California January 15, 1999 F-34 VALLEY BANK BALANCE SHEETS DECEMBER 31, 1998 AND 1997
1998 1997 ------------- ------------- ASSETS Cash and due from banks............................................................ $ 6,485,000 $ 5,487,000 Federal funds sold................................................................. 13,780,000 4,800,000 Held-to-maturity securities, fair value of 1998 $15,642,000; 1997 $13,920,000 (Note 2)............................................................................... 15,585,000 13,856,000 Loans, net of allowance for loan losses of 1998 $1,118,000; 1997 $1,058,000 (Notes 3, 4 and 10)..................................................................... 41,437,000 44,202,000 Loans held for sale (Note 3)....................................................... 594,000 -- Bank premises and equipment, net (Note 5).......................................... 2,158,000 2,160,000 Other real estate owned............................................................ 1,749,000 1,711,000 Accrued interest receivable........................................................ 611,000 561,000 Cash surrender value of life insurance (Note 9).................................... 712,000 661,000 Deferred tax assets (Note 7)....................................................... 730,000 642,000 Other assets....................................................................... 868,000 486,000 ------------- ------------- TOTAL ASSETS................................................................. $ 84,709,000 $ 74,566,000 ------------- ------------- ------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits (Notes 2 and 6): Noninterest-bearing demand..................................................... $ 20,061,000 $ 17,517,000 Interest bearing: Demand....................................................................... 27,618,000 23,964,000 Savings...................................................................... 11,610,000 11,268,000 Other time................................................................... 16,450,000 13,490,000 ------------- ------------- TOTAL DEPOSITS............................................................... 75,739,000 66,239,000 Accrued interest payable and other liabilities (Note 9).......................... 238,000 456,000 ESOP bank notes payable (Note 9)................................................. 478,000 579,000 ------------- ------------- TOTAL LIABILITIES............................................................ 76,455,000 67,274,000 ------------- ------------- Commitments and Contingencies (Notes 8 and 9) Stockholders' Equity (Notes 9, 11 and 12) Common stock, $5 par value; 2,400,000 shares authorized; issued and outstanding 1,171,906 shares............................................................... 5,860,000 5,860,000 Surplus.......................................................................... 142,000 77,000 Retained earnings................................................................ 2,684,000 1,895,000 ------------- ------------- 8,686,000 7,832,000 Less unearned ESOP shares 1998 87,794; 1997 109,410.............................. 432,000 540,000 ------------- ------------- TOTAL STOCKHOLDERS' EQUITY................................................... 8,254,000 7,292,000 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................... $ 84,709,000 $ 74,566,000 ------------- ------------- ------------- -------------
See Notes to Financial Statements. F-35 VALLEY BANK STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------ ------------ ------------ Interest income on: Loans................................................................. $ 4,959,000 $ 4,784,000 $ 4,266,000 Securities, taxable................................................... 724,000 764,000 703,000 Securities, nontaxable................................................ 54,000 76,000 100,000 Federal funds sold.................................................... 444,000 354,000 269,000 ------------ ------------ ------------ TOTAL INTEREST INCOME............................................... 6,181,000 5,978,000 5,338,000 ------------ ------------ ------------ Interest expense on: Deposits.............................................................. 1,387,000 1,227,000 1,109,000 Other borrowings...................................................... 51,000 55,000 10,000 ------------ ------------ ------------ 1,438,000 1,282,000 1,119,000 ------------ ------------ ------------ Net interest income before provision for loan losses................ 4,743,000 4,696,000 4,219,000 Provision for loan losses (Note 4)...................................... 200,000 980,000 360,000 ------------ ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES................. 4,543,000 3,716,000 3,859,000 ------------ ------------ ------------ Other income: Service charges and other fees........................................ 1,714,000 1,858,000 1,657,000 Gain on sale of loans................................................. 1,057,000 772,000 375,000 Other................................................................. 144,000 89,000 103,000 ------------ ------------ ------------ 2,915,000 2,719,000 2,135,000 ------------ ------------ ------------ Other expenses: Salaries, wages and employee benefits (Note 9)........................ 3,272,000 3,019,000 2,639,000 Furniture and equipment............................................... 441,000 426,000 452,000 Occupancy and expenses (Note 8)....................................... 480,000 476,000 451,000 Other real estate..................................................... 41,000 294,000 401,000 Legal and professional services....................................... 892,000 558,000 560,000 Telephone and postage................................................. 214,000 199,000 183,000 Office supplies....................................................... 114,000 139,000 164,000 Other................................................................. 631,000 526,000 361,000 ------------ ------------ ------------ 6,085,000 5,637,000 5,211,000 ------------ ------------ ------------ Income before income taxes.......................................... 1,373,000 798,000 783,000 Income tax expense (Note 7)............................................. 584,000 242,000 329,000 ------------ ------------ ------------ NET INCOME.......................................................... $ 789,000 $ 556,000 $ 454,000 ------------ ------------ ------------ ------------ ------------ ------------ Basic earnings per share................................................ $ 0.73 $ 0.53 $ 0.41 ------------ ------------ ------------ ------------ ------------ ------------ Diluted earnings per share.............................................. $ 0.65 $ 0.51 $ 0.41 ------------ ------------ ------------ ------------ ------------ ------------
See Notes to Financial Statements F-36 VALLEY BANK STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
COMMON STOCK UNEARNED ------------------------ RETAINED ESOP SHARES SHARES PAR VALUE SURPLUS EARNINGS (NOTE 9) TOTAL ---------- ------------ ---------- ------------ ----------- ------------ Balance, December 31, 1995....... 1,108,701 $ 5,544,000 $ -- $ 1,218,000 $ -- $ 6,762,000 Net income..................... -- -- -- 454,000 -- 454,000 Issuance of ESOP notes payable...................... -- -- -- -- (327,000) (327,000) ESOP shares committed to be released..................... -- -- 3,000 -- 10,000 13,000 ---------- ------------ ---------- ------------ ----------- ------------ Balance, December 31, 1996....... 1,108,701 5,544,000 3,000 1,672,000 (317,000) 6,902,000 Net income..................... -- -- -- 556,000 -- 556,000 Stock dividend declared........ 55,333 277,000 55,000 (332,000) -- -- Cash paid in lieu of fractional shares....................... -- -- -- (1,000) -- (1,000) Issuance of ESOP notes payable...................... -- -- -- -- (278,000) (278,000) ESOP shares committed to be released..................... -- -- 16,000 -- 55,000 71,000 Stock options exercised........ 7,872 39,000 3,000 -- -- 42,000 ---------- ------------ ---------- ------------ ----------- ------------ Balance, December 31, 1997....... 1,171,906 5,860,000 77,000 1,895,000 (540,000) 7,292,000 Net income..................... -- -- -- 789,000 -- 789,000 ESOP shares committed to be released..................... -- -- 65,000 -- 108,000 173,000 ---------- ------------ ---------- ------------ ----------- ------------ Balance, December 31, 1998....... 1,171,906 $ 5,860,000 $ 142,000 $ 2,684,000 $ (432,000) $ 8,254,000 ---------- ------------ ---------- ------------ ----------- ------------ ---------- ------------ ---------- ------------ ----------- ------------
See Notes to Financial Statements. F-37 VALLEY BANK STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ----------- ----------- ---------- Cash Flows from Operating Activities Net income.............................................................. $ 789,000 $ 556,000 $ 454,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization......................................... 320,000 325,000 378,000 Provision for loan losses............................................. 200,000 980,000 360,000 Net amortization and accretion of bond premiums and discounts......... (38,000) 6,000 125,000 Amortization of deferred gain on SBA loan sales....................... (127,000) (69,000) (47,000) Write-down of other real estate owned................................. 58,000 64,000 119,000 Change in deferred taxes.............................................. (88,000) (346,000) (143,000) ESOP shares committed to be released.................................. 173,000 71,000 13,000 Proceeds from sale of loans held for sale............................. 14,626,000 12,059,000 7,725,000 Origination/transfer of loans held for sale........................... (13,851,000) (10,111,000) (7,532,000) Loss on sale of bank premises and equipment........................... 26,000 -- -- (Gain) on sale of loans held for sale................................. (1,057,000) (772,000) (375,000) (Gain) loss on sale of other real estate owned........................ 8,000 (2,000) 244,000 (Increase) in interest receivable and other assets.................... (510,000) (327,000) (193,000) Increase (decrease) in accrued interest and other liabilities......... (218,000) (98,000) 328,000 ----------- ----------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES........................... 311,000 2,336,000 1,456,000 ----------- ----------- ---------- Cash Flows from Investing Activities Purchase of securities held to maturity................................. (14,000,000) (6,500,000) (5,500,000) Proceeds from maturities of securities held to maturity................. 12,309,000 5,566,000 7,550,000 Change in loans made to customers, net.................................. 1,748,000 (4,971,000) (695,000) Purchase of residential lot loans....................................... -- -- (6,988,000) Net (increase) decrease in federal funds sold........................... (8,980,000) 524,000 (222,000) Proceeds from sale of bank premises and equipment....................... 5,000 -- 56,000 Proceeds from sale of other real estate owned........................... 555,000 277,000 156,000 Purchases of bank premises and equipment................................ (349,000) (249,000) (249,000) ----------- ----------- ---------- NET CASH (USED IN) INVESTING ACTIVITIES............................. (8,712,000) (5,353,000) (5,892,000) ----------- ----------- ---------- Cash Flows from Financing Activities Net increase in deposits................................................ 9,500,000 2,953,000 4,285,000 Dividends paid.......................................................... -- (1,000) -- Exercise of stock options............................................... -- 42,000 -- Principal payments on ESOP bank note payable............................ (101,000) (26,000) -- ----------- ----------- ---------- NET CASH PROVIDED BY FINANCING ACTIVITIES........................... 9,399,000 2,968,000 4,285,000 ----------- ----------- ---------- INCREASE (DECREASE) IN CASH AND DUE FROM BANKS...................... 998,000 (49,000) (151,000) Cash and Due from Banks Beginning............................................................... 5,487,000 5,536,000 5,687,000 ----------- ----------- ---------- Ending.................................................................. $ 6,485,000 $ 5,487,000 $5,536,000 ----------- ----------- ---------- ----------- ----------- ---------- Supplemental disclosures of cash flow information: Cash payments for: Interest.............................................................. $ 1,382,000 $ 1,222,000 $1,104,000 ----------- ----------- ---------- ----------- ----------- ---------- Income taxes paid..................................................... $ 1,037,000 $ 416,000 $ 323,000 ----------- ----------- ---------- ----------- ----------- ---------- Supplemental schedule of noncash investing and financing activities: Issuance of ESOP notes payable to purchase Bank stock................... $ -- $ 278,000 $ 327,000 ----------- ----------- ---------- ----------- ----------- ---------- Other real estate acquired in settlement of loans....................... $ 710,000 $ 906,000 $ 108,000 ----------- ----------- ---------- ----------- ----------- ---------- Loans acquired in exchange for other real estate owned.................. $ 50,000 $ -- $1,000,000 ----------- ----------- ---------- ----------- ----------- ---------- Stock dividend declared................................................. $ -- $ 332,000 $ -- ----------- ----------- ---------- ----------- ----------- ----------
See Notes to Financial Statements F-38 VALLEY BANK NOTES TO FINANCIAL STATEMENTS NOTE 1. NATURE OF BANKING ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Valley Bank (the Bank) provides a full range of banking services to its commercial and consumer customers through seven branches located in the Inland Empire and the low desert areas of Southern California and a lending office located in Portland, Oregon. The Bank grants commercial, residential and consumer loans to customers, substantially all of whom are middle-market businesses or residents. The Bank's business is concentrated in the Inland Empire, the low desert area of Southern California and Portland, Oregon. The loan portfolio includes significant credit exposure to the real estate industry (commercial and residential) of these areas. As of December 31, 1998, real estate-related loans accounted for approximately 69% of total loans. Substantially all of these loans are secured by first liens with an initial loan-to-value ratio of generally not more than 70%. Less than 10% of commercial loans are unsecured. The loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrowers. The Bank's policy requires that collateral be obtained on substantially all loans. Such collateral is primarily first trust deeds on property. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. CASH AND DUE FROM BANKS For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks. Cash flows from loans originated by the Bank, deposits and federal funds sold are reported net. The Bank maintains amounts due from banks which, at times, may exceed federally insured limits. The Bank has not experienced any losses in such accounts. The Bank is required to maintain reserve balances in cash or on deposit with Federal Reserve Banks. The total of those reserve balances was approximately $1,351,000 and $1,197,000 as of December 31, 1998 and 1997, respectively. SECURITIES HELD TO MATURITY Securities classified as held to maturity are those debt securities the Bank has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted F-39 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 1. NATURE OF BANKING ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) for amortization of premiums and accretion of discount, computed by the interest method over their contractual lives. The sale of a security within three months of its maturity date or after at least 85% of the principal outstanding has been collected is considered a maturity for purposes of classification and disclosure. LOANS Loans are stated at the amount of unpaid principal, reduced by unearned fees and an allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb estimated losses on existing loans that may become uncollectible, based on evaluation of the collectibility of loans and prior loan loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower's ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic or other conditions. In addition, the Federal Deposit Insurance Corporation (FDIC) and California Department of Financial Institutions, as an integral part of their examination process, periodically review the Bank's allowance for loan losses and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations. A loan is impaired when it is probable the creditor will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses. INTEREST AND FEES ON LOANS Interest on loans is recognized over the terms of the loans and is calculated using the simple-interest method on principal amounts outstanding. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When the accrual of interest is discontinued, all unpaid F-40 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 1. NATURE OF BANKING ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan's yield. The Bank is generally amortizing these amounts over the contractual life. SALE OF LOANS The Bank sells the guaranteed and unguaranteed portion of Small Business Administration (SBA) loans in the secondary market to provide funds for additional lending and to generate servicing income. Under such agreements, the Bank continues to service the loans and the buyer receives the principal collected together with interest. Loans held for sale are valued at the lower of cost or market value. The Bank has issued various representations and warranties associated with the sale of loans. These representations and warranties may require the Bank to repurchase loans for a period of 90 days after the date of sale as defined per the applicable sales agreement. The Bank experienced no losses during the years ended December 31, 1998 and 1996 regarding these representations and warranties. Reference should be made to Note 8 for losses incurred in 1997. The Bank serviced approximately $28,594,000 and $22,425,000 of loans for SBA as of December 31, 1998 and 1997, respectively, which are not included in the accompanying balance sheets (see Note 8). BANK PREMISES AND EQUIPMENT Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed principally by the straight-line method over the estimated useful lives of the assets. Improvements to leased property are amortized over the lesser of the term of the lease or life of the improvements. OTHER REAL ESTATE OWNED Other real estate owned (OREO) represents properties acquired through foreclosure or other proceedings. OREO is held for sale and is recorded at the lower of the carrying amounts of the related loans or the estimated fair value of the properties less estimated costs of disposal. Any write-down to estimated fair value less cost to sell at the time of transfer to OREO is charged to the allowance for loan losses. Property is evaluated regularly by management and reduction of the carrying amounts to estimated fair value less estimated costs to dispose are recorded as necessary. Revenue and expense from the operations of OREO and changes in the valuation allowance are included in expenses. F-41 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 1. NATURE OF BANKING ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INCOME TAXES Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when management determines that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. FAIR VALUE OF FINANCIAL INSTRUMENTS Management uses its best judgment in estimating the fair value of the Bank's financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Bank could have realized in a sales transaction at December 31, 1998 or 1997. The estimated fair value amounts for 1998 and 1997 have been measured as of year end, and have not been reevaluated or updated for purposes of these financial statements subsequent to that date. As such, the estimated fair values of these financial instruments subsequent to the reporting date may be different than the amounts reported at year end. The information in Note 13 should not be interpreted as an estimate of the fair value of the entire Bank since a fair value calculation is only required for a limited portion of the Bank's assets. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimate, comparisons between the Bank's disclosures and those of other banks may not be meaningful. The following methods and assumptions were used by the Bank in estimating the fair value of its financial instruments: CASH The carrying amounts reported in the balance sheets for cash and due from banks and federal funds sold approximate their fair value. SECURITIES Fair value for securities held to maturity is based on quoted market prices. F-42 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 1. NATURE OF BANKING ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) LOANS For variable rate loans that reprice frequently and that have experienced no significant change in credit risk, fair value is based on carrying value. At December 31, 1998 and 1997, variable rate loans comprised approximately 90% and 86%, respectively, of the loan portfolio. Fair value for all other loans is estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. Prepayments prior to the repricing date are not expected to be significant. Loans are expected to be held to maturity and any unrealized gains or losses are not expected to be realized. LOANS HELD FOR SALE Fair value is based on quoted market prices of similar loans sold on the secondary market. OFF-BALANCE-SHEET INSTRUMENTS Fair value for off-balance-sheet instruments (guarantees, letters of credit and lending commitments) is based on quoted fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. DEPOSIT LIABILITIES Fair value disclosed for demand deposits equals their carrying amounts, which represent the amount payable on demand. The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair value for fixed rate certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregate expected monthly maturities on time deposits. Early withdrawal of fixed rate certificates of deposit are not expected to be significant. ACCRUED INTEREST RECEIVABLE AND PAYABLE The fair value of both accrued interest receivable and payable approximates their carrying amounts. ESOP BANK NOTES PAYABLE The fair value of the ESOP bank notes payable approximates their carrying amounts. F-43 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 1. NATURE OF BANKING ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) OTHER OFF-BALANCE-SHEET INSTRUMENTS In the ordinary course of business, the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded. EARNINGS PER SHARE Components used in computing earnings per share (EPS) for the years ended December 31 are as follows:
1998 1997 1996 ----------------------------------- ----------------------------------- ---------------------- INCOME SHARES PER- INCOME SHARES PER- INCOME SHARES (NUMER- (DENOMI- SHARE (NUMER- (DENOMI- SHARE (NUMER- (DENOMI- ATOR) NATOR) AMOUNT ATOR) NATOR) AMOUNT ATOR) NATOR) --------- ----------- ----------- --------- ----------- ----------- --------- ----------- BASIC EPS Income available to common stockholders................ $ 789,000 1,084,112 $ 0.73 $ 556,000 1,055,293 $ 0.53 $ 454,000 1,094,211 EFFECT OF DILUTIVE SECURITIES Options....................... -- 129,740 -- 42,151 -- 23,543 --------- ----------- ----- --------- ----------- ----- --------- ----------- DILUTED EPS Income available to common stockholders + assumed conversions................. $ 789,000 1,213,852 $ 0.65 $ 556,000 1,097,444 $ 0.51 $ 454,000 1,117,754 --------- ----------- ----- --------- ----------- ----- --------- ----------- --------- ----------- ----- --------- ----------- ----- --------- ----------- PER- SHARE AMOUNT ----------- BASIC EPS Income available to common stockholders................ $ 0.41 EFFECT OF DILUTIVE SECURITIES Options....................... ----- DILUTED EPS Income available to common stockholders + assumed conversions................. $ 0.41 ----- -----
The average number of common shares outstanding excludes 87,794, 109,410 and 69,823 shares owned by the Employee Stock Ownership Plan (ESOP) that have not been committed to be released as of December 31, 1998, 1997 and 1996, respectively. See Note 9 for further information regarding the shares owned by the ESOP. CURRENT ACCOUNTING DEVELOPMENT In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard is effective for the year 2000 and is not expected to have a material impact on the financial statements of the Bank. RECLASSIFICATIONS Certain amounts in the prior year's financial statements and related footnote disclosures were reclassified to conform to the current year presentation, with no effect on net income or stockholders' equity. F-44 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 2. SECURITIES Carrying amounts and fair value of securities being held to maturity as of December 31 are summarized as follows:
1998 ------------------------------------------------------ AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE ------------- ----------- ----------- ------------- U.S. Treasury securities and obligations of other U.S. government corporations and agencies..................... $ 15,004,000 $ 39,000 $ (1,000) $ 15,042,000 Municipal obligations...................................... 581,000 19,000 -- 600,000 ------------- ----------- ----------- ------------- $ 15,585,000 $ 58,000 $ (1,000) $ 15,642,000 ------------- ----------- ----------- ------------- ------------- ----------- ----------- -------------
1997 ------------------------------------------------------ AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE ------------- ----------- ----------- ------------- U.S. Treasury securities and obligations of other U.S. government corporations and agencies..................... $ 11,957,000 $ 39,000 $ (4,000) $ 11,992,000 Mortgage-backed securities................................. 781,000 1,000 -- 782,000 Municipal obligations...................................... 1,118,000 37,000 (9,000) 1,146,000 ------------- ----------- ----------- ------------- $ 13,856,000 $ 77,000 $ (13,000) $ 13,920,000 ------------- ----------- ----------- ------------- ------------- ----------- ----------- -------------
The amortized cost and fair value of investment securities as of December 31, 1998 by contractual maturities are shown below.
AMORTIZED COST FAIR VALUE ------------- ------------- Due in one year or less........................................ $ 11,149,000 $ 11,170,000 Due after one year through five years.......................... 4,436,000 4,472,000 ------------- ------------- $ 15,585,000 $ 15,642,000 ------------- ------------- ------------- -------------
Securities being held to maturity with carrying amounts of $6,585,000 and $8,070,000 at December 31, 1998 and 1997, respectively, were pledged as collateral on public deposits, repurchase agreements and for other purposes as required or permitted by law. F-45 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3. LOANS The composition of the Bank's loan portfolio as of December 31 is as follows:
1998 1997 ------------- ------------- Real estate loans: Construction................................................. $ 6,733,000 $ 6,873,000 Residential.................................................. 4,848,000 7,116,000 Unimproved residential lots.................................. 4,898,000 6,369,000 Commercial................................................... 13,910,000 14,535,000 ------------- ------------- 30,389,000 34,893,000 Commercial and industrial loans................................ 2,653,000 1,746,000 Government guaranteed loans.................................... 9,173,000 8,377,000 Loans to individuals........................................... 504,000 435,000 ------------- ------------- 42,719,000 45,451,000 Deduct: Unearned net loan fees and discounts......................... 164,000 191,000 Allowance for loan losses.................................... 1,118,000 1,058,000 ------------- ------------- $ 41,437,000 $ 44,202,000 ------------- ------------- ------------- -------------
IMPAIRED LOANS Information about impaired loans as of and for the years ended December 31 is as follows:
1998 1997 ------------ ------------ Impaired loans for which there is a related allowance for loan losses.......................................................... $ 3,934,000 $ 1,763,000 ------------ ------------ ------------ ------------ Related allowance for loan losses................................. $ 502,000 $ 317,000 ------------ ------------ ------------ ------------ Average balance (based on month-end balances)..................... $ 2,644,000 $ 1,447,000 ------------ ------------ ------------ ------------ Interest income recognized........................................ $ -- $ -- ------------ ------------ ------------ ------------
The Bank is not committed to lend additional funds to debtors whose loans have been modified due to an impairment. The Bank had nonaccrual loans of $4,752,000 and $3,227,000 as of December 31, 1998 and 1997, respectively. Interest income that would have been earned on such nonaccrual loans, had such loans performed according to their loan terms, would have been $424,000, $147,000 and $307,000 in 1998, 1997 and 1996, respectively. Management estimates that certain nonaccrual loans, which are not classified as impaired, will ultimately be collected in full in accordance with the original terms. F-46 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3. LOANS (CONTINUED) LOANS HELD FOR SALE Information about loans held for sale as of and for the years ended December 31 is as follows:
1998 1997 -------------- -------------- Balance, beginning............................................ $ -- $ 670,000 Loans transferred from loan portfolio....................... 13,851,000 10,111,000 Loans sold.................................................. (13,257,000) (10,781,000) -------------- -------------- Balance, ending............................................... $ 594,000 $ -- -------------- -------------- -------------- --------------
There were no outstanding commitments to sell loans at December 31, 1997. NOTE 4. ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses for the years ended December 31 are as follows:
1998 1997 1996 ------------ ------------ ----------- Balance, beginning................................... $ 1,058,000 $ 756,000 $ 497,000 Provision charged to operating expense............. 200,000 980,000 360,000 Recoveries of amounts charged off.................. 272,000 81,000 20,000 Amounts charged off................................ (412,000) (759,000) (121,000) ------------ ------------ ----------- Balance, ending...................................... $ 1,118,000 $ 1,058,000 $ 756,000 ------------ ------------ ----------- ------------ ------------ -----------
NOTE 5. BANK PREMISES AND EQUIPMENT The major classes of bank premises and equipment and the total accumulated depreciation and amortization as of December 31 are as follows:
1998 1997 ------------ ------------ Land.............................................................. $ 579,000 $ 579,000 Buildings and leasehold improvements.............................. 2,259,000 2,309,000 Equipment and furnishings......................................... 2,322,000 2,611,000 Construction in progress.......................................... 31,000 52,000 ------------ ------------ 5,191,000 5,551,000 Less accumulated depreciation and amortization.................... 3,033,000 3,391,000 ------------ ------------ $ 2,158,000 $ 2,160,000 ------------ ------------ ------------ ------------
NOTE 6. DEPOSITS The aggregate amount of jumbo certificates of deposit, each with a minimum denomination of $100,000, was approximately $2,443,000 and $2,103,000 in 1998 and 1997, F-47 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 6. DEPOSITS (CONTINUED) respectively. Substantially all certificates of deposit mature in the year ending December 31, 1999. NOTE 7. INCOME TAXES The cumulative tax effects of temporary differences as of December 31 are shown in the following table:
1998 1997 ---------- ---------- Deferred tax assets: Credit loss allowance............................................... $ 189,000 $ 149,000 Deferred loan fees.................................................. 73,000 86,000 Other real estate owned............................................. 26,000 29,000 Nonaccrual interest................................................. 44,000 26,000 Gain recognized on sale of loans.................................... 409,000 380,000 Other............................................................... 30,000 -- ---------- ---------- Total deferred tax assets......................................... 771,000 670,000 ---------- ---------- Deferred tax liabilities: Property and equipment.............................................. 41,000 17,000 Other............................................................... -- 11,000 ---------- ---------- Total deferred tax liabilities.................................... 41,000 28,000 ---------- ---------- Net deferred tax asset............................................ $ 730,000 $ 642,000 ---------- ---------- ---------- ----------
At December 31, 1998, no valuation reserve was considered necessary as management believes it is more likely than not that the deferred tax assets will be realized due to taxes paid in prior years or future operations. The provision for income taxes charged to operations for the years ended December 31 consists of the following:
1998 1997 1996 ---------- ----------- ----------- Current tax expense.................................... $ 672,000 $ 588,000 $ 472,000 Deferred tax (benefit)................................. (88,000) (346,000) (143,000) ---------- ----------- ----------- $ 584,000 $ 242,000 $ 329,000 ---------- ----------- ----------- ---------- ----------- -----------
F-48 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 7. INCOME TAXES (CONTINUED) The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the years ended December 31 as follows:
1998 1997 1996 ---------- ----------- ---------- Computed "expected" tax expense......................... $ 481,000 $ 279,000 $ 274,000 Increase (decrease) in income taxes resulting from: State income taxes, net of federal tax benefit........ 98,000 58,000 55,000 Change in valuation allowance......................... -- (134,000) -- Other................................................. 5,000 39,000 -- ---------- ----------- ---------- $ 584,000 $ 242,000 $ 329,000 ---------- ----------- ---------- ---------- ----------- ----------
NOTE 8. COMMITMENTS AND CONTINGENCIES CONTINGENCIES In the normal course of business, the Bank is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the financial statements. In the normal course of business, the Bank makes loans which are partially guaranteed by third parties, primarily the SBA. These guarantees are conditional upon satisfactory underwriting and loan monitoring standards which are agreed upon in advance by both parties. During the year ended December 31, 1997, the Bank experienced a loss of approximately $380,000 on a loan on which the SBA did not honor its guarantee due to unsatisfactory underwriting standards. The Bank's existing loan portfolio contains approximately $28,594,000 of loans serviced for others, of which $26,794,000 are guaranteed by the governmental agencies, and excluded from the accompanying balance sheet. The Bank's management believes it is generally in compliance with the required underwriting and loan monitoring standards. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of amounts recognized on the balance sheets. The Bank's exposure to credit loss in the event of nonperformance by the other parties to the financial instruments for these commitments is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. F-49 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 8. COMMITMENTS AND CONTINGENCIES (CONTINUED) A summary of the contract amount of the Bank's exposure to off-balance-sheet risk as of December 31 is as follows:
1998 1997 ------------ ------------ Commitments to extend credit, including unsecured loan commitments of 1998 $368,000; 1997 $167,000................................. $ 2,582,000 $ 6,664,000 Standby letters of credit......................................... 178,000 212,000 ------------ ------------ $ 2,760,000 $ 6,876,000 ------------ ------------ ------------ ------------
COMMITMENTS TO EXTEND 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. The Bank evaluates each customer's creditworthiness on a case-by-case basis. If deemed necessary upon extension of credit, the amount of collateral obtained is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties. STANDBY LETTERS OF CREDIT Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Bank deems necessary. At December 31, 1998, approximately 17% of the standby letters of credit were collateralized. INTEREST RATE RISK The Bank assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are more likely to prepay in a falling rate environment and less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Bank's overall interest rate risk. F-50 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 8. COMMITMENTS AND CONTINGENCIES (CONTINUED) LEASE COMMITMENTS The Bank leases the facilities for two of its branch offices and its Data Processing Center under noncancelable operating lease agreements expiring through the year 2000. The leases contain renewal options of various five- and ten-year terms with various rental increases based on the Consumer Price Index. In addition, the Bank has the option to purchase the Perris branch property at certain agreed-upon terms. The leases require the Bank to pay property taxes, utilities, insurance and normal maintenance on the premises. The following is a schedule of future minimum rental payments under this lease:
YEARS ENDING DECEMBER 31, AMOUNT - ----------------------------------------------------------------------------------- --------- 1999............................................................................... $ 53,000 2000............................................................................... 6,000 --------- $ 59,000 --------- ---------
Total rent expense under these leases for the years ended December 31, 1998, 1997 and 1996 was $101,000, $99,000 and $80,000, respectively. FINANCIAL INSTRUMENTS WITH CONCENTRATION OF CREDIT RISK CONCENTRATION BY GEOGRAPHIC LOCATION: The Bank makes commercial, residential and consumer loans to customers primarily in the Inland Empire, the low desert areas of Southern California and in Portland, Oregon. In addition, the Bank has a concentration of residential lot loans located in Fort Mojave, Arizona. A substantial portion of the Bank's customers' abilities to honor their contracts is dependent on the business economy in the Inland Empire, low desert areas of Southern California, its surrounding areas, Portland, Oregon, and Fort Mojave, Arizona. CONCENTRATION BY INDUSTRY: The loan portfolio has a concentration of loans related to real estate, primarily loans for commercial and residential operations. These concentrations are reflected in Note 3 to these financial statements. NOTE 9. EMPLOYEE BENEFIT PLANS EMPLOYEE BONUS PLAN The Bank has an employee bonus plan for all employees. Employee bonuses are based on a percentage of beginning equity ranging from 6% to 20% depending upon the level of the Bank's profitability for the year. Total disbursements to employees were $146,000, $54,000 and $29,000 for the years ended December 31, 1998, 1997 and 1996, respectively. F-51 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9. EMPLOYEE BENEFIT PLANS (CONTINUED) PROFIT SHARING/SALARY DEFERRAL PLAN The Bank has a salary deferral 401(k) plan for all employees who have completed one year and 1,000 hours of service. Annual contributions are limited to the maximum deductible percentage of covered employee compensation. The Bank contributes matching funds at its option which amounted to $99,000, $71,000 and $76,000 in 1998, 1997 and 1996, respectively. STOCK PURCHASE PLAN The Bank offered a stock purchase plan to eligible officers and employees, which was terminated in 1998. The plan provided for a voluntary payroll deduction on the part of the eligible officer or employee up to 15% of their gross salary. The amount of funds set aside was used to purchase Bank stock as it became available on the open market. The Bank has agreed to supplement up to 25% of the payroll deduction by a contribution to this plan. Contributions for this plan amounted to $5,000, $6,000 and $5,000 in 1998, 1997 and 1996, respectively. SALARY CONTINUATION PLAN In April 1995, the Board of Directors authorized the Bank to enter an agreement with the Bank's president to provide for annual cash payments to the officer for a period not to exceed 15 years, beginning at his normal retirement age (age 65). In the event of death prior to normal retirement age, annual cash payments would be made to beneficiaries for a period of ten years following the date of death. The present value of the Bank's liability under this agreement was approximately $160,000 and $109,000 at December 31, 1998 and 1997, respectively. The Bank purchased life insurance policies in 1995 which are intended to ultimately fund all costs of this agreement. The cash surrender value related to these insurance policies was approximately $712,000 and $661,000 at December 31, 1998 and 1997, respectively. CONTINGENCY CONTRACTS Certain officers of the Bank have contingency contracts which provide for benefits upon termination or in the event the Bank experiences a merger, acquisition or other act. EMPLOYEE STOCK OWNERSHIP PLAN The Bank sponsors a leveraged ESOP covering substantially all employees. Contributions to the ESOP are at the discretion of the Board of Directors. The Bank makes annual contributions to the ESOP equal to the ESOP's debt service less dividends received by the ESOP, if any. The ESOP shares initially were pledged as collateral for the debt. As the debt is repaid, shares are released from collateral and allocated to active employees, based on the proportion of debt service paid in the year. The debt of the ESOP is recorded as debt and F-52 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9. EMPLOYEE BENEFIT PLANS (CONTINUED) the shares pledged as collateral are deducted from stockholders' equity as unearned ESOP shares in the accompanying balance sheets. The notes payable referred to in the preceding paragraph require annual principal payments plus interest at rates ranging from 1% to 1.25% over the reference rate (7.75% at December 31, 1998). Future principal payments are due as follows:
YEARS ENDING DECEMBER 31, AMOUNT - ---------------------------------------------------------------------------------- ---------- 1999.............................................................................. $ 118,000 2000.............................................................................. 120,000 2001.............................................................................. 122,000 2002.............................................................................. 93,000 2003.............................................................................. 25,000 ---------- $ 478,000 ---------- ----------
The ESOP did not purchase any shares of the Bank's common stock for the year ended of December 31, 1998 and purchased a total of 118,214 shares of the Bank's common stock through December 31, 1997. The ESOP financed a portion of the purchase price by issuing notes payable which are guaranteed by the Bank. As shares are released from collateral, the Bank reports compensation expense equal to management's estimate of the fair value price of the shares, and the shares become outstanding for EPS computations. ESOP compensation expense was $173,000, $71,000 and $13,000 for the years ended December 31, 1998, 1997 and 1996, respectively. In the event a terminated ESOP participant desires to sell his or her shares of the Bank's stock, the Bank may be required to purchase the shares from the participant at their fair market value. Shares of the Bank held by the ESOP at December 31 are as follows:
NUMBER OF SHARES -------------------- 1998 1997 --------- --------- Allocated shares..................................................... 13,842 2,280 Shares released for allocation....................................... 21,616 11,562 Unreleased (unearned) shares......................................... 87,794 109,410 --------- --------- 123,252 123,252 --------- --------- --------- ---------
At December 31, 1998, based on management's estimate, the fair value of the shares allocated and released for allocation amounted to $284,000 and the fair value of the unreleased shares amounted to $702,000. F-53 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 10. RELATED PARTY TRANSACTIONS Stockholders of the Bank, and officers and directors, including their families and companies of which they are principal owners, are considered to be related parties. These related parties were loan customers of, and had other transactions with, the Bank in the ordinary course of business. In management's opinion, these loans and transactions were on the same terms as those for comparable loans and transactions with nonrelated parties. Total loans to related parties were approximately $65,000 at December 31, 1998. None of these loans are past due, nonaccrual or restructured to provide a reduction or deferral of interest or principal because of deterioration in the financial position of borrower. There were no loans to a related party which were considered classified loans at December 31, 1998. There were no related party loans at December 31, 1997. NOTE 11. RESTRICTIONS ON RETAINED EARNINGS AND REGULATORY MATTERS In October 1998, the Bank's Board of Directors adopted a resolution with certain compliance criteria of the California Department of Financial Institutions and the FDIC which replaced the resolution dated June 1996. The Bank's Board of Directors' resolution requires the Bank to perform the following: - Develop, approve and submit a formal written testing plan to the FDIC by January 10, 1999 in full compliance with the Interagency Guidance of Testing for Year 2000 Readiness. - Complete testing of its mission-critical systems by March 31, 1999. - Maintain qualified senior management and notify the FDIC when they propose to add an individual to the Board of Directors or to the senior management of the Bank. - Provide quarterly progress reports to the FDIC. In addition, the Bank fulfilled or complied with the following resolutions as of December 31, 1998: - Corrected all data processing deficiencies identified in the April 1, 1998 Report of Examination of Information Systems. - Revised, adopted and implemented written lending and collection policies to provide effective guidance and control over the Bank's lending function. - Established asset quality improvement plans and goals for the reduction of each classified loan and parcel of OREO over $50,000. - Revised, adopted and implemented a plan to improve earnings, including a formal budget for 1999 - Adopt procedures to ensure future compliance with all applicable laws and regulations. - Maintain Tier I capital of at least 8.0% of the Bank's adjusted total assets. F-54 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 11. RESTRICTIONS ON RETAINED EARNINGS AND REGULATORY MATTERS (CONTINUED) The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve qualitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. As of December 31, 1998, the most recent notification from the FDIC categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank's category. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1998, that the Bank meets all capital adequacy requirements to which it is subject. At December 31, 1998 and 1997, the Bank's actual capital amounts and ratios are presented in the following table:
FOR CAPITAL ADEQUACY ACTUAL PURPOSES ------------------------- ------------------------- AMOUNT RATIO AMOUNT RATIO ------------ ----- ------------ ----- As of December 31, 1998: Total capital (to risk-weighted Greater than or Greater than or assets)................................ $ 8,927,000 16.7% equal to $ 4,270,000 8.0% equal to Tier I capital (to risk-weighted Greater than or Greater than or assets)................................ 8,254,000 15.5 equal to 2,135,000 4.0 equal to Greater than or Greater than or Tier I capital (to average assets)....... 8,254,000 10.2 equal to 3,250,000 4.0 equal to As of December 31, 1997: Total capital (to risk-weighted Greater than or Greater than or assets)................................ 7,981,000 14.5 equal to 4,383,000 8.0 equal to Tier I capital (to risk-weighted Greater than or Greater than or assets)................................ 7,292,000 13.5 equal to 2,164,000 4.0 equal to Greater than or Greater than or Tier I capital (to average assets)....... 7,292,000 9.8 equal to 2,977,000 4.0 equal to TO BE WELL CAPITALIZED UNDER PROMPT CORRECTIVE ACTION PROVISIONS ------------------------- AMOUNT RATIO ------------ ----- As of December 31, 1998: Total capital (to risk-weighted assets)................................ $ 5,338,000 10.0% Tier I capital (to risk-weighted assets)................................ 3,203,000 6.0 Tier I capital (to average assets)....... 4,062,000 5.0 As of December 31, 1997: Total capital (to risk-weighted assets)................................ 5,479,000 10.0 Tier I capital (to risk-weighted assets)................................ 3,264,000 6.0 Tier I capital (to average assets)....... 3,721,000 5.0
F-55 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 12. STOCK OPTION PLANS EMPLOYEES' INCENTIVE STOCK OPTION PLAN The Bank maintains a compensatory incentive stock option plan in which options to purchase shares of the Bank's common stock are granted at the Board of Directors' discretion to certain management and other key personnel. The plan was originally established for a maximum of 240,000 shares (264,600 after stock dividends) of the Bank's common stock. Additional shares were authorized and granted as a result of stock dividends in subsequent years. All options expire ten years from date of grant and vest over a five-year period with 20% in each year. Upon certain change of control events, these options will become fully vested. Other pertinent information relating to the plan follows:
1998 1997 1996 ------------------------ ------------------------ ------------------------ WEIGHTED WEIGHTED WEIGHTED NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE SHARES PRICE SHARES PRICE SHARES PRICE ----------- ----------- ----------- ----------- ----------- ----------- Outstanding, beginning of year...................... 189,834 $ 5.49 161,750 $ 5.40 141,750 $ 5.63 Granted................... -- -- 20,000 6.25 20,000 3.75 5% stock dividend......... -- -- 8,084 5.40 -- -- ----------- ----------- ----------- Outstanding, end of year.... 189,834 5.49 189,834 5.49 161,750 5.40 ----------- ----------- ----------- ----------- ----------- ----------- Exercisable, end of year.... 143,595 5.62 123,270 5.71 85,050 5.83 ----------- ----------- ----------- ----------- ----------- -----------
Additional option information for the year ended December 31, 1998 is as follows:
WEIGHTED WEIGHTED AVERAGE WEIGHTED AVERAGE CONTRACTUAL AVERAGE PRICE RANGE OUTSTANDING PRICE LIFE IN YEARS EXERCISABLE PRICE - -------------------------------- ----------- ----------- --------------- ----------- ----------- $3.75-$5.375.................... 81,634 $ 4.75 6.1 51,395 $ 4.91 $6.00-$6.25..................... 108,200 6.05 4.7 92,200 6.01 ----------- ----------- 189,834 $ 5.49 5.3 143,595 $ 5.62 ----------- ----------- ----------- -----------
DIRECTORS' STOCK OPTION PLAN In March 1994, the Bank's stockholders approved the 1993 Directors' Option Plan. This is a compensatory incentive stock option plan in which options to purchase shares of the Bank's common stock are granted at the discretion of the Board of Directors or a committee appointed by the Board of Directors. The Bank originally reserved 76,800 shares (84,672 after stock dividends) of common stock for issuance under this plan. Additional shares were authorized and granted as a result of stock dividends in subsequent years. All options expire ten years from date of grant and vest over a five-year period with 20% in each year. Upon certain change of control events, these options will become fully vested. F-56 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 12. STOCK OPTION PLANS (CONTINUED) Other pertinent information relating to the plan follows:
1998 1997 1996 ------------------------ ------------------------ ------------------------ WEIGHTED WEIGHTED WEIGHTED NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE SHARES PRICE SHARES PRICE SHARES PRICE ----------- ----------- ----------- ----------- ----------- ----------- Outstanding, beginning of year.................. 75,792 $ 4.94 79,680 $ 4.98 70,080 $ 5.38 Granted....................................... -- -- -- 19,200 3.75 Terminated and canceled....................... (2,712) 5.38 -- (9,600) 5.38 5% stock dividend............................. -- -- 3,984 4.98 -- -- Options exercised............................. -- -- (7,872) 5.38 -- -- ----------- ----------- ----------- Outstanding, end of year........................ 73,080 4.93 75,792 4.94 79,680 $ 4.98 ----------- ----------- ----------- ----------- ----------- ----------- Exercisable, end of year........................ 57,816 5.15 51,072 4.93 35,136 $ 5.38 ----------- ----------- ----------- ----------- ----------- ----------- As of December 31, 1998 Price of outstanding options...................................................................... $3.75-$5.37 Weighted average remaining contractual life of outstanding options................................ 6.0 years
The Bank applies Accounting Principles Board Opinion 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized. The Bank has elected not to adopt FASB Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. Had compensation cost for the Bank's stock option plan been determined based on the fair value at the grant dates for awards under this plan consistent with the method of Statement No. 123, the Bank's net income and net income per common share would have been reduced to the pro forma amounts indicated below:
1998 1997 1996 ---------- ---------- ---------- Net income As reported............................................ $ 789,000 $ 556,000 $ 454,000 Pro forma.............................................. 768,000 532,000 437,000 Basic earnings per share As reported............................................ 0.73 0.53 0.41 Pro forma.............................................. 0.71 0.50 0.40 Diluted earnings per share As reported............................................ 0.65 0.51 0.41 Pro forma.............................................. 0.63 0.48 0.39
The pro forma compensation cost was recognized for the fair value of the stock options granted, which was estimated using the minimum-value method, including a risk-free interest rate of 5.69% and 5.59% for 1997 and 1996, respectively, an estimated life of the options of ten years and no dividend rate or volatility on the stock. The weighted average fair value of these stock options granted in 1997 and 1996 was $2.67 and $1.58, respectively. There were no stock options granted in 1998. F-57 VALLEY BANK NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 13. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Bank's financial instruments is as follows at December 31:
1998 1997 ---------------------------- ---------------------------- CARRYING CARRYING AMOUNT FAIR VALUE AMOUNT FAIR VALUE ------------- ------------- ------------- ------------- Financial assets: Cash and federal funds sold... $ 20,265,000 $ 20,265,000 $ 10,287,000 $ 10,287,000 Securities.................... 15,585,000 15,642,000 13,856,000 13,920,000 Loans and loans held for sale, net......................... 42,031,000 42,843,000 44,202,000 44,902,000 Accrued interest receivable... 611,000 611,000 561,000 561,000 Financial liabilities: Deposits...................... 75,739,000 75,698,000 66,239,000 66,209,000 Interest payable.............. 47,000 47,000 42,000 42,000 ESOP bank note payable........ 478,000 478,000 579,000 579,000
FAIR VALUE OF COMMITMENTS The estimated fair value of fee income on letters of credit at December 31, 1998 and 1997 is insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at December 31, 1998 and 1997. NOTE 14. POTENTIAL SALE OF THE BANK The management of the Bank has entered into a definitive agreement to sell 100% of the common stock of the Bank to a bank holding company in 1999. The potential sale is pending regulatory and shareholder approval. The sale, if completed, is expected to close in May 1999. F-58 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT WHICH IS SET FORTH IN THIS PROSPECTUS. WE ARE OFFERING TO SELL SHARES OF COMMON STOCK AND SEEKING OFFERS TO BUY SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THE PROSPECTUS OR OF ANY SALE OF COMMON STOCK. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary...................................................... 1 Risk Factors............................................................ 6 Use of Proceeds......................................................... 14 Dividend Policy......................................................... 14 Capitalization.......................................................... 15 Dilution................................................................ 16 Regulatory Capital and Leverage Ratio................................... 17 The Acquisitions........................................................ 17 Unaudited Pro Forma Combined Financial Data............................. 19 Pacific Community Banking Group Selected Financial Data................. 23 Management's Discussion and Analysis............................................................ 24 Business.............................................................. 25 The Bank of Hemet Selected Financial Data............................................... 28 Management's Discussion and Analysis............................................................ 30 Business.............................................................. 45 Valley Bank Selected Financial Data............................................... 61 Management's Discussion and Analysis............................................................ 63 Business.............................................................. 77 Management.............................................................. 96 Certain Transactions.................................................... 104 Principal and Selling Shareholders...................................... 104 Supervision and Regulation.............................................. 107 Description of Capital Stock............................................ 114 Shares Eligible for Future Sale......................................... 121 Underwriting............................................................ 123 Experts................................................................. 125 Legal Matters........................................................... 125 Additional Information.................................................. 126 Index to Financial Statements........................................... F-1
UNTIL , 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. SHARES [PACIFIC COMMUNITY BANKING GROUP LOGO] COMMON STOCK --------------------- PROSPECTUS --------------------- SUTRO & CO. INCORPORATED , 1999 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following is an itemized list of the estimated expenses to be incurred in connection with this offering of the securities being offered hereunder other than underwriting discounts and commissions.
AMOUNT TO BE PAID ----------- Registration fee....................................................................................... $ NASD filing fee and expenses........................................................................... 9,000 Nasdaq National Market listing fee..................................................................... Printing and Engraving expenses........................................................................ Legal fees and expenses................................................................................ Blue Sky qualification fees and expenses............................................................... 3,500 Accounting fees and expenses........................................................................... Directors' and Officers' liability insurance........................................................... Transfer Agent and registrar fees...................................................................... Miscellaneous.......................................................................................... Total.............................................................................................. $
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Article V of the Registrant's Articles of Incorporation, as amended, provides that the liability of the directors of the corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. Article VI of the Registrant's Articles of Incorporation provides that the corporation is authorized to provide for the indemnification of agents (as defined in Section 317 of the California General Corporation Law) of the corporation in excess of that expressly permitted by such Section 317 for breach of duty to the corporation and its shareholders to the fullest extent permissible under California Law. Article III of the Registrant's Bylaws provides, in pertinent part, that each person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another foreign or domestic corporation or other entity, shall be indemnified by the Registrant to the full extent permitted by the General Corporation Law of the State of California or any other applicable laws. Article III also authorizes the registrant to enter into one or more agreements with any person which provides for indemnification greater or different than that provided for in that Article. The Registrant has entered into indemnification agreements with their respective officers and directors in the forms incorporated by reference as Exhibit 10.1 to this Registration Statement. Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended, may be permitted pursuant to the foregoing provisions to directors, officers or persons controlling the Registrant, the Registrant has been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in said Act and is therefore unenforceable. II-1 Reference is made to the following documents filed as exhibits to this Registration Statement regarding relevant indemnification provisions described above and elsewhere herein:
EXHIBIT DOCUMENT NUMBER - -------------------------------------------------------------------------------------------------------- ----------- Form of Underwriting Agreement.......................................................................... 1.1 Articles of Incorporation, as amended................................................................... 3.1 Bylaws.................................................................................................. 3.2 Form of Indemnification Agreements...................................................................... 10.1
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES In October 1997, Pacific Community Banking Group sold a total 10,000 shares in order to initially capitalize Pacific Community Banking Group. In the sale, Pacific Community Banking Group relied on the exemption from registration available under Section 4(2) of the Securities Act of 1933, as amended. Mr. E. Lynn Caswell, Chairman, Chief Executive Officer and founder, purchased 10,000 shares for the total consideration of $2,500. As of March 31, 1999, Pacific Community Banking Group had 1,085,000 shares of Series A preferred stock outstanding, held at record by 18 shareholders. In addition, as of March 31, 1999, Pacific Community Banking Group had 375,000 shares of Series B preferred stock outstanding, held at record by 16 shareholders. In the sale of these shares, Pacific Community Banking Group relied on the exemption from registration available under Section 4(2) of the Securities Act of 1933, as amended. The Series A preferred stock and the Series B preferred stock are currently the only series of preferred stock with designated terms. Each sale of Series A preferred stock is convertible into shares of Pacific Community Banking Group common stock at a conversion price equal to 80% of the price of Pacific Community Banking Group common stock in this offering of the securities being offered hereunder. Each share of Series B preferred stock is convertible into shares of Pacific Community Banking Group common stock at a conversion price equal to 85% of the price of Pacific Community Banking Group common stock in this offering of the securities being offered hereunder. The holders of Series A and Series B preferred stock do not have voting rights and are not entitled to receive dividends. On the closing of this offering of the securities being offered hereunder, all of the preferred stock will automatically convert to common stock. ITEM 16. EXHIBITS AND FINANCIAL STATEMENTS (a) Exhibits
EXHIBIT NUMBER DESCRIPTION - ------ -------------------------------------------------------------------------- 1.1* Underwriting Agreement 2.1 First Restatement of Agreement and Plan of Reorganization by and between Registrant and The Bank of Hemet dated January 5, 1999. 2.2 First Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and The Bank of Hemet dated March 24, 1999.
II-2
EXHIBIT NUMBER DESCRIPTION - ------ -------------------------------------------------------------------------- 2.3 Second Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and The Bank of Hemet dated April 2, 1999. 2.4 First Restatement of Agreement and Plan of Reorganization by and between Registrant and Valley Bank dated as of January 5, 1999. 2.5 First Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and Valley Bank dated March 4, 1999. 2.6 Second Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and Valley Bank dated April 12, 1999. 3.1 Articles of Incorporation of Registrant. 3.2 Certificate of Amendment to Articles of Incorporation of Registrant. 3.3 Restated Bylaws of Registrant. 3.4 Certificate of Determination. 4.1* Specimen Stock Certificate. 4.2 Forms of Warrant to Shareholders of The Bank of Hemet and Valley Bank. 5.1* Opinion of Morrison & Foerster LLP. 10.1 Form of Indemnification Agreement. 10.2 Employment Agreement between Registrant and E. Lynn Coswell. 10.3 Agreement between Registrant and Harold Williams. 10.4 Registrant's 1999 Stock Option Plan. 10.5 Shareholder Agreement. 10.6 Form of Warrant Purchase Agreement. 10.7 Form of Non-competition and Consulting Agreements. 10.8 Form of Continuation Agreement between The Bank of Hemet and certain executives (Jaqua, McDonough) dated March 22, 1995, as amended. 10.9 Head Office Lease, 1600 E. Florida Avenue, Hemet, California. 10.10 Form of Executive Employment Agreement dated September 26, 1996 between Valley Bank and each of Marvin Lentini, Mark Nugent, Bonnie Parrott and Dianna Williams. 10.11 Executive Employment Agreement dated September 26, 1996, as amended October 30, 1997, between Valley Bank and N. Douglas Mills. 10.12 Executive Salary Continuation Agreement, dated October 19, 1995, as amended October 30, 1997, between Valley Bank and N. Douglas Mills. 10.13 Second Amendment to Employment Agreement between Valley Bank and N. Douglas Mills.
II-3
EXHIBIT NUMBER DESCRIPTION - ------ -------------------------------------------------------------------------- 10.14 Fairness Opinion of Baxter Fentriss & Company with reference to The Bank of Hemet--Appendix C of joint proxy statement/prospectus incorporated by reference. 10.15 Fairness Opinion of Baxter Fentriss & Company with reference to Valley Bank-- Appendix D of joint proxy statement/prospectus incorporated by reference. 23.1* Consent of Morrison & Foerster LLP (included in their opinion filed as Exhibit 5.1). 23.2 Consent of Arthur Andersen LLP. 23.4 Consent of McGladrey & Pullen, LLP for Valley Bank Financial Statements. 24.1 Power of Attorney. (Please refer to p. II-4) 27.1 Financial Data Schedule for the year ended December 31, 1998. 99.1 Consent of James Jaqua 99.2 Consent of N. Douglas Mills 99.3 Consent of Marion V. Ashley 99.5 Consent of Harold Williams.
- ------------------------ * To be filed by amendment. (b) Financial Statement Schedules No schedules are included because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. II-4 ITEM 17. UNDERTAKINGS (a) The undersigned registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. (b) That insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described under Item 14 above, or otherwise, the registrants have been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of their counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes: (c) That, for purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrants pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (d) That, for the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and this offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Laguna Hills, County of Orange, State of California, on April 16, 1999. PACIFIC COMMUNITY BANKING GROUP By: /s/ E. LYNN CASWELL ----------------------------------------- Chairman of the Board, Chief Executive Officer and Chief Financial Officer
POWER OF ATTORNEY The undersigned hereby constitutes and appoints E. Lynn Caswell and Loren P. Hansen, and each of them, as his true and lawful attorneys-in-fact and agents, jointly and severally, with full power of substitution and resubstitution, for and in his stead, in any and all capacities, to sign on his behalf this Registration Statement on Form S-1 in connection with the offering of common stock by Pacific Community Banking Group and to execute any amendments thereto (including post-effective amendments), including a registration statement filed pursuant to Rule 462(b), or certificates that may be required in connection with this Registration Statement, and to file the same, with all exhibits thereto, and all other documents in connection therewith, with the Securities and Exchange Commission and granting unto said attorneys-in-fact and agents, and each of them, jointly and severally, the full power and authority to do and perform each and every act and thing necessary or advisable to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, jointly or severally, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement on Form S-1 to be signed on its behalf by the undersigned, each thereunto duly authorized, in the City of Laguna Hills, County of Orange, State of California, as of April 16, 1999.
SIGNATURE TITLE - ------------------------------ -------------------------- E. Lynn Caswell, Chairman /s/ E. LYNN CASWELL of the Board of - ------------------------------ Directors, Chief E. Lynn Caswell Executive Officer and Chief Financial Officer /s/ MITCHELL ALLEN - ------------------------------ Mitchell Allen, Director Mitchell Allen /s/ ALFRED JANNARD - ------------------------------ Alfred Jannard, Director Alfred Jannard /s/ CARLOS SAENZ - ------------------------------ Carlos Saenz, Director Carlos Saenz /s/ HENRY SCHIELEIN - ------------------------------ Henry Schielein, Director Henry Schielein
II-6 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------ -------------------------------------------------------------------------- 1.1* Underwriting Agreement 2.1 First Restatement of Agreement and Plan of Reorganization by and between Registrant and The Bank of Hemet dated January 5, 1999. 2.2 First Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and The Bank of Hemet dated March 24, 1999. 2.3 Second Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and The Bank of Hemet dated April 2, 1999. 2.4 First Restatement of Agreement and Plan of Reorganization by and between Registrant and Valley Bank dated as of January 5, 1999. 2.5 First Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and Valley Bank dated March 4, 1999. 2.6 Second Amendment to First Restatement of Agreement and Plan of Reorganization by and between Registrant and Valley Bank dated April 12, 1999. 3.1 Articles of Incorporation of Registrant. 3.2 Certificate of Amendment of Articles of Incorporation of Registrant. 3.3 Restated Bylaws of Registrant. 3.4 Certificate of Determination. 4.1* Specimen Stock Certificate. 4.2 Forms of Warrant to Shareholders of The Bank of Hemet and Valley Bank. 5.1* Opinion of Morrison & Foerster LLP. 10.1 Form of Indemnification Agreement. 10.2 Employment Agreement between Registrant and E. Lynn Coswell. 10.3 Agreement between Registrant and Harold Williams. 10.4 Registrant's 1999 Stock Option Plan. 10.5 Shareholder Agreement. 10.6 Form of Warrant Purchase Agreement. 10.7 Form of Non-competition and Consulting Agreements. 10.8 Form of Continuation Agreement between The Bank of Hemet and certain executives (Jaqua, McDonough) dated March 22, 1995, as amended. 10.9 Head Office Lease, 1600 E. Florida Avenue, Hemet, California. 10.10 Form of Executive Employment Agreement dated September 26, 1996 between Valley Bank and each of Marvin Lentini, Mark Nugent, Bonnie Parrott and Dianna Williams. 10.11 Executive Employment Agreement dated September 26, 1996, as amended October 30, 1997, between Valley Bank and N. Douglas Mills.
EXHIBIT NUMBER DESCRIPTION - ------ -------------------------------------------------------------------------- 10.12 Executive Salary Continuation Agreement, dated October 19, 1995, as amended October 30, 1997, between Valley Bank and N. Douglas Mills. 10.13 Second Amendment to Employment Agreement between Valley Bank and N. Douglas Mills. 10.14 Fairness Opinion of Baxter Fentriss & Company with reference to The Bank of Hemet--Appendix C of joint proxy statement/prospectus incorporated by reference. 10.15 Fairness Opinion of Baxter Fentriss & Company with reference to Valley Bank-- Appendix D of joint proxy statement/prospectus incorporated by reference. 23.1* Consent of Morrison & Foerster LLP (included in their opinion filed as Exhibit 5.1). 23.2 Consent of Arthur Andersen LLP. 23.4 Consent of McGladrey & Pullen, LLP for Valley Bank Financial Statements. 24.1 Power of Attorney. (Please refer to p. II-4) 27.1 Financial Data Schedule for the year ended December 31, 1998. 99.1 Consent of James Jaqua 99.2 Consent of N. Douglas Mills 99.3 Consent of Marion V. Ashley 99.5 Consent of Harold Williams.
- ------------------------ * To be filed by amendment. EX-2.1 2 EXHIBIT 2.1 EXHIBIT 2.1 First Restatement of Agreement and Plan of Reorganization by and between Pacific Community Banking Group and The Bank of Hemet dated January 5, 1999 FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION by and between PACIFIC COMMUNITY BANKING GROUP AND THE BANK OF HEMET Dated: January 5, 1999 FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION THIS FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION (hereinafter referred to as the "Agreement") is made and entered into as of January 5, 1999, by and between THE BANK OF HEMET (the "Bank"), a California banking corporation, and PACIFIC COMMUNITY BANKING GROUP (the "Company"), a California corporation. R E C I T A L S A. The Bank is a California banking corporation duly organized and existing under the laws of the State of California with its principal office in the City of Hemet, County of Riverside, State of California. The Company is a proposed bank holding company duly organized and existing under the laws of the State of California with its principal office in the City of Laguna Hills, County of Orange, State of California; B. The parties desire to provide for the acquisition by the Company of all of the outstanding shares of the common stock, no par value of the Bank ("Bank Stock") pursuant to the Merger (as defined below), subject to the terms and conditions specified herein, as follows: (a) The Company will establish PCBG Merger Corporation (as defined below) as a wholly-owned subsidiary; and (b) The Bank and PCBG Merger Corporation will enter into an Agreement of Merger (as defined below) providing for the merger of PCBG Merger Corporation and the Bank under the state charter of the Bank; C. At the Effective Time (hereinafter defined below) of the Merger, all of the issued and outstanding shares of Bank Stock, except for shares of Bank Stock held by Dissenting Shareholders (as hereinafter defined below), shall be converted into and exchanged for a combination of cash and Warrants exercisable into shares of Company Stock all upon the terms and subject to the conditions hereinafter set forth; D. As a condition and inducement to the Company's willingness to enter into this Agreement, the Bank and the Company are entering into, immediately after the execution and delivery hereof, a Warrant Purchase Agreement (the "Warrant Agreement") dated as of the date hereof and attached hereto as EXHIBIT "C", pursuant to which the Bank shall grant to the Company an option to purchase shares of the common stock, no par value, of the Bank representing 1 19.9% of Bank stock to be outstanding after giving pro forma effect to the issuance of such shares at a price of $46.50 per Bank Stock; E. The Merger requires certain shareholder and regulatory approvals and may be effected only after the necessary approvals have been obtained; F. The parties desire to make certain representations, warranties and agreements in connection with the Merger and also to prescribe certain conditions to the Merger; and G. Subject to any specific provisions of this Agreement, it is the intent of the parties that the Company by reason of this Agreement shall not (until consummation of the Merger) control, and shall not be deemed to control the Bank or any of its subsidiaries, directly or indirectly, and shall not exercise or be deemed to exercise, directly or indirectly, a controlling influence over the management or policies of the Bank or any of its subsidiaries; H. The Company and the Bank desire that this First Restatement of the Agreement and Plan of Reorganization now govern the rights and obligations of the Parties in place of that certain Agreement and Plan of Reorganization dated July 30, 1998. Accordingly, to consummate the transactions set forth above and in consideration of the mutual covenants, agreements, representations and warranties contained herein, the parties hereto agree as follows: ARTICLE I DEFINITIONS 1.1 DEFINITIONS. Capitalized terms used in this Agreement shall have the meanings set forth below unless the context otherwise requires: "Affiliate" means any Person (as defined below) that directly, or through one or more intermediaries controls, or is controlled by, or is under common control with, the Person specified. "Aggregate Option Price" shall have the meaning given such term in Section 2.8. "Aggregate Purchase Consideration" shall have the meaning given such term in Section 2.4. 2 "Agreement of Merger" shall mean the Agreement of Merger to be entered into by and between PCBG Merger Corporation and the Bank substantially in the form of EXHIBIT "A" hereto, but subject to any changes that may be necessary to conform to any requirements of any Governmental Entity having authority over the Merger. "Alternative Transaction" shall have the meaning given such term in Section 6.5. "Audited Bank Financial Statements" shall have the meaning given such term in Section 4.4. "BHC Act" shall mean the Bank Holding Company Act of 1956, as amended. "Bank" shall mean The Bank of Hemet. "Bank Corporate Governance Changes" shall have the meaning given such term in Section 2.1 (d). "Bank Dissenting Shares" means shares of Bank Stock held by "Dissenting shareholders" within the meaning of Chapter 13 of the CGCL. "Bank Employment Agreements" shall mean any employment agreement, severance agreement, "golden parachute" agreement or any other agreement which provides for payments to employees of the Bank upon termination of employment, including termination after a change in control. "Bank Filings" shall have the meaning given such term in Section 4.18. "Bank Options" shall mean options to purchase Bank Stock (as defined below) pursuant to the Bank Stock Option Plan (as defined below). "Bank Perfected Dissenting Shares" means Dissenting Shares which the holders thereof have not withdrawn or caused to lose their status as Bank Dissenting Shares. "Bank Representatives" shall have the meaning given such term in Section 7.3. "Bank Stock" shall mean the meaning given such term in Recital B. "Bank Stock Option Plan" shall mean The Bank of Hemet 1994 Stock Option Plan. 3 "Baxter" shall mean Baxter, Fentriss and Company, who shall serve as the financial advisor to the Bank. "Benefit Arrangement" means any plan or arrangement maintained or contributed to by a Party, including an "employee benefit plan" within the meaning of ERISA (as defined below), (but exclusive of base salary and base wages) which provides for any form of current or deferred compensation, bonus, stock option, profit sharing, benefit, retirement, incentive, group health or insurance, welfare or similar plan or arrangement for the benefit of any employee or class of employee, whether active or retired, of a Party. "Business Day" shall mean any day other than a Saturday, Sunday or day on which commercial banks in California are authorized or required to be closed. "Caswell" shall mean Mr. E. Lynn Caswell, Chairman of the Board and Chief Executive Officer of the Company. "CERCLA" shall have the meaning given such term in the definition of Environmental Law. "CFC" means the California Financial Code. "CGCL" means the California General Corporations Law. "Charter Documents" shall mean, with respect to any business organization, any certificate or articles of incorporation or association, any bylaws, any partnership agreement and any other similar documents that regulate the basic organization of the business organization and its internal relations. "Classified Credit" shall have the meaning given such term in Section 6.6. "Closing" shall mean the consummation of the transactions contemplated by this Agreement on the Closing Date (as defined below) at the law offices of Knecht & Hansen, 1301 Dove Street, Suite 900, Newport Beach, California 92660, or at such other place as the Parties (as defined below) may agree upon. "Closing Date" shall mean, unless the Parties (as defined below) agree on another date, the first Friday or as soon as possible following the Determination Date, and in no case more than 30 days following the receipt of the approvals and consents and expiration of the waiting periods specified in Section 9.1 have occurred and/or have been obtained, the receipt of the necessary cash capital by 4 the Company in order to complete the transaction as contemplated by this Agreement, and satisfaction of the remaining conditions to the transaction as contemplated by this Agreement. "Code" shall mean the United States Internal Revenue Code of 1986, as amended, and all regulations thereunder. "Commissioner" shall mean the California Commissioner of Financial Institutions. "Company" shall mean Pacific Community Banking Group, a California corporation. "Company Corporate Governance Changes" shall have the meaning given such term in Section 2.1(e). "Company Filings" shall have the meaning given such term in Section 5.13. "Company Representatives" shall have the meaning given such term in Section 6.3. "Company Stock Option Plan" shall mean the proposed Pacific Community Banking Group 1998 Stock Option Plan. "Company Financial Statements" shall have the meaning given such term in Section 5.4. "Company Stock" shall mean the common stock, no par value, of the Company. "Confidential Information" shall mean all information exchanged heretofore or hereafter between the Company, its affiliates and agents, on the one hand, and the Bank, its affiliates and agents, on the other hand, which is information related to the business, financial position or operations of the Person responsible for furnishing the information or an Affiliate of such Person (such information to include, by way of example only and not of limitation, client lists, pricing information, company manuals, internal memoranda, strategic plans, budgets, forecasts, projections, computer models, marketing plans, files relating to loans originated by such Person, loans and loan participation purchased by such Person from others, investments, deposits, leases, contracts, employment records, minutes of board meetings (and committees thereof) and stockholder meetings, legal proceedings, reports of examination by any Governmental Entity, and such other records or documents such Person may supply to the other Party pursuant to the terms of this Agreement or as contemplated hereby). Notwithstanding the 5 foregoing, "Confidential Information" shall not include any information that (i) at the time of disclosure or thereafter is generally available to and known by the public (other than as a result of an improper disclosure directly or indirectly by the Company or the Bank, as the case may be, or any of their officers, directors, employees or other representatives), (ii) was available to the recipients on a non-confidential basis from a source other than from the Persons responsible for furnishing the information, provided that such source learned the information independently and is not and was not bound by a confidentiality agreement with respect to the information, or (iii) has been independently acquired or developed by the recipients without violating any obligations under this Agreement. "Consents" shall mean every consent, approval, absence of disapproval, waiver or authorization from, or notice to, or registration or filing with, any Person (as defined below). "CRA" shall mean the Community Reinvestment Act. "Deposit" shall mean any deposit as defined in Section 3(I) of the Federal Deposit Insurance Act, as amended, to the date of this Agreement (12 USC Section 1813(I)). "Determination Date" shall mean the last day of the month preceding the Closing Date. "Directors' Agreement" shall mean an agreement, substantially in the form of EXHIBIT "B" hereto, pursuant to which each signatory shall agree to vote or cause to be voted all shares of Bank Stock with respect to which such Person has voting power on the date hereof or hereafter acquires to approve the Agreement and the transactions contemplated hereby and all requisite matters related thereto. "DPC Property" shall mean voting securities, other personal property and real property acquired by foreclosure or otherwise, in the ordinary course of collecting a debt previously contracted in good faith, retained with the object of sale for a period not longer than one year, or any applicable statutory holding period, and recorded in the holder's business records as such. "Effective Day" shall mean the day on which the Effective Time occurs. "Effective Time" shall mean the date and time of the filing of the Agreement of Merger with the Secretary of State (as defined below). "Employee Plan" shall have the meaning given such term in Section 4.11(c). 6 "Encumbrance" shall mean any option, pledge, security interest, lien, mechanic's lien, charge, encumbrance or restriction (whether on voting, disposition or otherwise), whether imposed by agreement, understanding, law or otherwise. "Environmental Law" shall mean any federal, state, provincial or local statute, law, ordinance, rule, regulation, order, consent, decree, judicial or administrative decision or directive of the United States or other jurisdiction whether now existing or as hereinafter promulgated, issued or enacted relating to: (A) pollution or protection of the environment, including natural resources; (B) exposure of persons, including employees, to Hazardous Substances (as defined below) or other products, materials or chemicals; (C) protection of the public health or welfare from the effects of products, by-products, wastes, emissions, discharges or releases of chemical or other substances from industrial or commercial activities; or (D) regulation of the manufacture, use or introduction into commerce of substances, including, without limitation, their manufacture, formulation, packaging, labeling, distribution, transportation, handling, storage and disposal. For the purposes of this definition the term "Environmental Law" shall include, without limiting the foregoing, the following statutes, as amended from time to time: (1) the Clean Air Act, as amended, 42 U.S.C. Section 7401 ET SEQ.; (2) the Federal Water Pollution Control Act, as amended, 33 U.S.C. Section 1251 ET SEQ.; (3) the Resource Conservation and Recovery Act of 1976, as amended, 42 U.S.C. Section 6901 ET SEQ., (4) the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (including the Superfund Amendments and Reauthorization Act of 1986), 42 U.S.C Section 9601 ET SEQ.("CERCLA"); (5) the Toxic Substances Control Act, as amended, 15 U.S.C. Section 2601 ET SEQ.; (6) the Occupational Safety and Health Act, as amended, 29 U.S.C. Section 65; (7) the Emergency Planning and Community Right-To-Know Act of 1986, 42 U.S.C. Section 11001 ET SEQ.; (8) the Mine Safety and Health Act of 1977, as amended, 30 U.S.C. Section 801 ET SEQ.; (9) the Safe Drinking Water Act, 42 U.S.C. Section 300f ET SEQ.; (10) the Federal Water Pollution Control Act, as amended (33 U.S.C. 1251, ET SEQ.; and (11) all comparable state and local laws, laws of other jurisdictions or orders and regulations including, but not limited to, the Carpenter-Presley- Tanner Hazardous Substance Account Act, Cal. Health & Safety Code Section 25300 ET SEQ., the Porter-Cologne Water Quality Control Action, 25140, 25501(j) and (k); 255501.1.25281 and 25250.1 of the California Health and Safety Code and/or Article I or Title 22 of the California Code of Regulations, Division 4, Chapter 30 (the "State Acts"); laws of other jurisdictions or orders and regulations; or the presence of which causes or threatens to cause a nuisance, trespass or other common law tort upon real property or adjacent properties or poses or threatens to pose a hazard to the health or safety of persons or without limitation, which contains gasoline, diesel fuel or other petroleum hydrocarbons; polychlorinated biphenyls (PCB's), asbestos or urea formaldehyde foam insulation. "Equity Securities" shall mean the capital stock of Bank or any options, rights, warrants or other rights to subscribe for or purchase, or any plans, 7 contracts or commitments that are exercisable in, such capital stock or that provide for the issuance of, or grant the right to acquire, or are convertible into, or exchangeable for, such capital stock. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended, and all regulations thereunder. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and all rules and regulations thereunder. "Exchange Agent" shall mean U. S. Stock Transfer Corporation, or, subject to the reasonable approval of the Bank, any other financial institution or company appointed by the Company to effect the exchange contemplated by Section 2.5. "Executive Officer'' shall mean a natural person who participates or has the authority to participate (other than in the capacity of a director) in major policy making functions, whether or not such person has a title or is serving with salary or other compensation. "Expected Net Proceeds" shall mean $52.6 million. "Expenses" shall have the meaning given such term in Section 13.1. "FDIC" shall mean the Federal Deposit Insurance Corporation. "FRB" shall mean the Board of Governors of the Federal Reserve System. "GAAP" shall mean Generally Accepted Accounting Principles, consistently applied from period to period, applicable to banks and bank holding companies, as appropriate, for the period in question. "Governmental Entity" shall mean any court or tribunal in any jurisdiction or any United States federal, state, municipal, domestic, foreign or other administrative agency, department, commission, board, bureau or other regulatory or governmental authority or instrumentality. "Hazardous Substances" shall mean (1) any "hazardous waste" as defined by CERCLA and the State Acts, as such acts are in effect on the date hereof, and any and all regulations promulgated thereunder; (2) any "hazardous substance" as such term is defined by CERCLA; (3) any "regulated substance" as defined by the State Acts; (4) asbestos requiring abatement, removal or encapsulation pursuant to the requirements of any Governmental Entity; (5) polychlorinated biphenyls; (6) petroleum products; (7) "hazardous chemicals" or 8 "extremely hazardous substances" in quantities sufficient to require reporting, registration, notification and/or optional treatment or handling under the Emergency Planning and Community Right to Know Act of 1986; (8) any "hazardous chemical" in levels that would result in exposure greater than is allowed by permissible exposure limits established pursuant to the Occupational Safety and Health Act of 1970; (9) any substance that requires reporting, registration, notification, removal, abatement and/or special treatment, storage, handling or disposal, under Section 6, 7 and 8 of the Toxic Substance Control Act (15 U.S.C. Section 2601); (10) any toxic or hazardous chemical described in 29 C.F.R. 1910.1000-1047 in levels that would result in exposure greater than those allowed by the permissible exposure limits pursuant to such regulations; and (11) any (A) "hazardous waste", (B) "solid waste" capable of causing a "release or threatened release" that present an "imminent and substantial endangerment" to the public health and safety of the environment, (C) "solid waste" that is capable of causing a "hazardous substance incident" (D) "solid waste" with respect to which special requirements are imposed by any applicable Governmental Entity upon the generation and transportation thereof as such terms are defined and used within the meaning of the State Acts, or (E) any "pollutant" or "toxic pollutant" as such term is defined in the Federal Clean Water Act, 33 U.S.C. Section 1251-1376, as amende, by Public Law 100-4, February 4, 1987, and the regulations promulgated thereunder, including 40 C.F.R. Sections 122.1 and 122.26. "Managing Underwriter" shall mean Sutro (as defined below). "Managing Underwriters" shall mean the Managing Underwriter and such other firm or firms as the Company and the Managing Underwriter shall agree. "Material Adverse Change" shall have the meaning given such term in Sections 4.17 and 5.9. "Material Contract" shall have the meaning given such term in Section 4.12. "Merger" shall mean the merger of the PCBG Merger Corporation with and into the Bank. "Offering" shall mean a public offering underwritten by the Underwriters (as defined below), as determined by the Company in its sole discretion, and based upon current market conditions and assumptions of sufficient shares of the Company Stock at a gross offering price to be determined by the Company and its underwriters, in order to fund cash portion of the acquisition of the Bank by the Company, to provide new capital for growth of the Company following the acquisition of the Bank by the Company, and the payment of any necessary expenses of the Company as provided herein, as determined by the Company in its sole discretion. 9 "Offering Price" shall mean the gross offering price per share of Company Stock in the Offering. "OREO" shall have the meaning given such term in Section 6.2(xx). "Party" shall mean either the Company or the Bank and "Parties" shall mean both the Company and Bank. "Per Share Consideration" shall have the meaning given such term in Section 2.4. "Permit" shall mean any United States federal, foreign, state, local or other license, permit, franchise, certificate of authority, order or approval necessary or appropriate under any applicable Rule (as defined below). "Person" shall mean any natural person, corporation, trust, association, unincorporated body, partnership, joint venture, Governmental Entity, statutorily or regulatory sanctioned unit or any other person or organization. "Proxy Statement" shall have the meaning given such term in Section 6.8. "RAP" shall mean regulatory accounting principles, if any, applicable to a particular person. "Real Property" shall have the meaning given such term in subsection (a) of Section 4.6. "Representatives" shall have the meaning given such term in subsection (a) of Section 6. 3. "Rule" shall mean any statute or law or any judgment, decree, injunction, order, regulation or rule of any Governmental Entity, including, without limitation, those relating to disclosure, usury, equal credit opportunity, equal employment, fair credit reporting and anticompetitive activities. "S-1" means the registration statement on Form S-1 to be filed with the SEC relating to the registration under the Securities Act of the shares of Company Stock to be issued in the Offering. "S-4" means the registration statement on Form S-4, and such amendments thereto, that is filed with the SEC to register the Warrants to be issued in the Merger under the Securities Act and to clear use of the Proxy Statement in connection with the Company Shareholders' Meeting and the Bank 10 Shareholders' Meeting pursuant to the regulations promulgated under the Exchange Act. "SEC" means the Securities and Exchange Commission. "SEC Reports" shall mean all reports filed by a Party hereto pursuant to the Exchange Act with the SEC or the FDIC. "Secretary of State" shall mean the Secretary of State of the State of California. "Section 1300" shall mean Section 1300 ET SEQ. of the California Corporations Code. "Securities Act" shall mean the Securities Act of 1933, as amended, and all rules and regulations thereunder. "State Acts" shall have the meaning given such term in the definition of "Environmental Law." "Surviving Bank" shall mean the bank surviving the Merger. "Surviving Bank Stock" shall mean the common stock, no par value, of the Surviving Bank. "Sutro" shall mean Sutro & Company who may also act as a financial advisor to the Company and as an underwriter in the Offering. "Tax Filings" shall have the meaning given such term in Section 4.8. "Third Party Consent" shall have the meaning given such term in Sections 6.17 and 7.8. "To the knowledge" and "to the best knowledge" shall have the meanings given such terms in Section 15.15. "Total Acquisition Costs" shall mean the sum of the Aggregate Purchase Consideration for the Bank and Valley Bank. "Unaudited Bank Financial Statements" shall have the meaning given such term in Section 4.4. "Understanding" shall have the meaning given such term in Section 4.11(m) or 4.12. 11 "Underwriter" shall mean a group of broker/dealers that include the Managing Underwriters as assembled by the Managing Underwriter with the consent of the Company. "Warrant" shall mean a warrant issuable by the Company at the Closing exercisable into one (1) share of the Company for each share of Bank Stock exchanged for a ten year period from the Closing Date with an exercise price equal to 122% of the Offering Price. "Warrant Agreement" shall mean the warrant agreement attached hereto as Exhibit "D." ARTICLE II THE MERGER AND RELATED MATTERS 2.1 THE MERGER. The Company agrees that it will use its best efforts, with all necessary cooperation of the Bank, to perfect the organization of PCBG Merger Corporation in accordance with the CGCL prior to the Closing Date. The directors and officers of PCBG Merger Corporation, and the Articles of Incorporation and Bylaws of PCBG Merger Corporation, shall be determined by the Company. Subject to the provisions of this Agreement, the Parties agree to request that the approval of the Merger to be issued by the Commissioner, the FDIC, the FRB and any other necessary regulatory agency on or prior to the Closing Date shall provide that the Merger shall become effective (the "Effective Time") as of the Closing Date. The Bank shall cause its officers to execute the Agreement of Merger, as well as all other necessary documents, in order to effect the Merger in accordance with the terms hereof as requested by the Company. At the Effective Time of the Merger, the following transactions will occur simultaneously: (a) MERGER OF THE BANK AND PCBG MERGER CORPORATION. The Bank and PCBG Merger Corporation shall be merged under the certificate of authority of the Bank, with the Bank being the Surviving Bank pursuant to the provisions of, and with the effect provided in, the CGCL and the CFC, and shall continue its corporate existence under the laws of the State of California. The name of the Surviving Bank shall be "The Bank of Hemet." Upon the consummation of the Merger, the separate corporate existence of PCBG Merger Corporation shall cease. (b) EFFECT ON BANK STOCK. Subject to Section 2.3, each share of Bank Stock issued and outstanding immediately prior to the Effective Time of the Merger shall, on and at the Effective Time of the Merger, pursuant to the Agreement of Merger and without any further action on the part of the Bank or the holders of Bank Stock, be automatically cancelled and cease to be an issued and outstanding share of Bank Stock, and shall be exchanged for and converted into the right to receive the Per Share Consideration. 12 (c) EFFECT ON PCBG MERGER CORPORATION STOCK. Each share of PCBG Merger Corporation Stock issued and outstanding immediately prior to the Effective Time of the Merger shall, on and at the Effective Time of the Merger, pursuant to the Agreement of Merger and without any further action on the part of the Bank or the holder of the PCBG Merger Corporation Stock be converted into, and shall for all purposes be deemed to represent, one share of Surviving Bank Stock, and one certificate representing one share of the Surviving Bank Stock will be issued to the Company. (d) BANK CORPORATE GOVERNANCE CHANGES. The Charter Document of the Bank as in effect immediately prior to the Effective Time shall continue in effect after the Merger until thereafter amended in accordance with applicable law and the operations of the Bank shall continue in effect after the Merger; except that the Bank shall have taken prior to the Effective Time all necessary steps so that at the Effective Time (i) James B. Jaqua, President, Chief Executive Officer and a director of the Bank, shall have tendered his resignation from his positions at the Bank, in form and substance satisfactory to the Company, without incurring any liability on the part of any Party; the Bank and the Company will honor Mr. Jaqua's Executive Salary Continuation Agreement dated March 22, 1995; Mr. Jaqua will continue as Chairman of Banklink for a one (1) year period, with no management authority and no additional compensation, subject to possible annual reappointment as Chairman of Banklink in the sole discretion of the Company; the Company intends to appoint Mr. Jaqua as the Bank's representative on the Company's Board of Directors as described in Section 2.1(e), and any such Bank representation on the Company's Board of Directors shall be for a minimum three (3) year period; and the Company in its sole discretion may extend such time period. Mr. Jaqua's appointments as Chairman of Banklink and as a director of the Company shall be annual appointments to be made by the Company in its sole discretion; and Mr. Jaqua and the Company will enter into a noncompetition agreement and a consulting agreement, the forms of which are attached hereto as part of Exhibit 2.1(d)(1); (ii) Caswell shall have been appointed Chairman of the Board and Chief Executive Officer of the Bank; (iii) John J. McDonough, Chairman of the Board of the Bank, shall resign as Chairman of the Board of the Bank but shall remain a member of the Board of Directors of the Bank unless and until a successor is chosen by the Company, the Bank shall honor Mr. McDonough's Executive Salary Continuation Agreement dated August 17, 1981; and the Company and Mr. McDonough will enter into a noncompetition agreement and a consulting agreement, the forms of which are attached hereto as part of Exhibit 2.1(d)(2), (iv) except for the persons set forth on Exhibit 2.1(d), which Exhibit shall be delivered by the Company to the Bank within sixty (60) days of the date of the Agreement, each of the directors of the Bank shall have tendered his resignation as a director of the Bank, in form and substance satisfactory to the Company, without incurring any liability on the part of any Party; (v) the number of authorized directors, and the specific members of the Board of Directors, of the Bank shall be changed as 13 determined in the sole discretion of the Company; and (vi) the Company shall name additional directors in its sole discretion who shall be duly elected and appointed to the Board of Directors of the Bank (or if any such persons is unable to serve, such other person designated by the Company) and shall serve until the earlier of their resignation or removal or until their respective successors are duly elected and qualified (clauses (i)-(vi) being hereinafter collectively referred to as the "Bank Corporate Governance Changes."). (e) COMPANY CORPORATE GOVERNANCE CHANGES. The Charter Documents of the Company as in effect immediately prior to the Effective Time shall continue in effect after the Merger until thereafter amended in accordance with applicable law and the members of the Board of Directors and the Executive Officers of the Company immediately prior to the Merger shall continue in their respective positions after the Merger and be the Board of Directors and the Executive Officers of the Company, except that the Company shall have taken prior to the Effective Time all necessary steps so that, (i) the Company's Charter Documents shall be amended to provide for a range of directors of between five (5) to nine (9), and at least seven (7) individuals, including one individual from the Board of Directors of the Bank, which is intended to be Mr. Jaqua, and which shall be for a maximum of (3) three years unless the Company in its sole discretion decides to extend such time period, and two (2) individuals from the Board of Directors of Valley Bank, all three of whom shall be annual appointments as selected in the sole discretion of the Company, excluding Caswell who is currently the sole director and who shall remain a director, shall be appointed to the Board of Directors of the Company in the sole discretion of the Company (clause (i) being hereinafter collectively referred to as the "Company Corporate Governance Changes"). 2.2 EFFECT OF THE MERGER. At the Effective Time of the Merger, the corporate existence of PCBG Merger Corporation and the Bank shall be merged into and continued in the Surviving Bank, and the Surviving Bank shall be deemed the same corporation as each corporation participating in the Merger. All rights, franchises, and interests of PCBG Merger Corporation and Bank in and to every type of property (real, personal and mixed) and choses in action shall be transferred to and vested in the Surviving Bank by virtue of the Merger without any deed or other transfer and the Surviving Bank shall hold and enjoy all rights of property, franchises and interests, in the same manner and to the same extent as such rights, franchises and interests were held or enjoyed by any one of the consolidating corporations at the Effective Time of the Merger. 2.3 DISSENTING SHAREHOLDERS. (a) Any Bank Perfected Dissenting Shares shall not be converted into the right to receive the Per Share Consideration, but the holders thereof shall be entitled only to such rights as are granted them by Section 1300. Each dissenting shareholder who is entitled to payment for his 14 shares of Bank Stock under Section 1300 shall receive such payment in an amount as determined pursuant to Section 1300. (b) If any shareholder of the Bank shall fail to perfect, or shall effectively withdraw or lose, his or her rights under Section 1300, the Bank Dissenting Shares of such holder shall be treated for purposes of this Article II as any other shares of outstanding Bank Stock. If any holder of Bank Stock shall fail to perfect, or shall effectively withdraw or lose, his or her right to appraisal of and payment for his or her Bank Dissenting Shares under Section 1300, each share of Bank Dissenting Shares shall be converted into the right to receive the Per Share Consideration. 2.4 THE AGGREGATE PURCHASE CONSIDERATION AND PER SHARE CONSIDERATION. The Aggregate Purchase Consideration shall be equal to the sum of (i) the product of 844,278 and the Per Share Consideration and (ii) the Aggregate Option Price. The Per Share Consideration shall be equal to $51.00 in cash. One (1) Warrant shall be added to the Per Share Consideration for each $51.00 paid in cash. The Per Share Consideration will be increased (the "Increase in Per Share Consideration"), up to a maximum of $58.50 per share, calculated as follows: the quotient of (a) the ratio of the Aggregate Purchase Consideration to the Total Acquisition Costs, multiplied by the difference between the net proceeds received in the Offering and the Expected Net Proceeds in the Offering, divided by (b) the sum of the total number of issued and outstanding shares of Bank Stock and the number of Bank Options outstanding as of the date of this Agreement. An Illustration of such calculation is attached as Exhibit 2.4(a). In the event of such increase in the Per Share Consideration, the number of Warrants shall be reduced and shall be calculated as follows: the amount of the reduction of the Warrants per share of Bank Stock shall be equal to the Increase in Per Share Consideration divided by $18.00. An illustration of such calculation is attached as Exhibit 2.4(b). 2.5 DELIVERY OF CONSIDERATION. At the Closing, the Company will deliver to the Exchange Agent an amount of cash equal to the Aggregate Purchase Consideration, and the Warrants, plus any cash payment for a fractional share of Company Stock. Delivery to such holders of the cash and Warrants to which they are entitled will subsequently be made by the Exchange Agent against delivery of share certificates formerly evidencing Bank Stock (duly executed and in proper form for transfer) to the Exchange Agent in accordance with this Section 2.5 and an agreement to be entered into between the Company and the Exchange Agent. 2.6 NAME OF SURVIVING BANK. The name of the Surviving Bank shall be "The Bank of Hemet," unless the Company proposes to change such name following the Closing Date, and the Board of Directors of the Bank agrees to support such name change. 2.7 (Reserved) 15 2.8 STOCK OPTIONS. Immediately prior to the Effective Time of the Merger, all stock options will be fully vested and each holder of a Bank Option will be given the opportunity to, in whole or in part, cancel such option and receive at the Closing an amount in cash equal to the number of shares of Bank Stock covered by such option multiplied by the number obtained by subtracting the exercise price of such option from the Per Share Consideration in effect on the Closing Date (the total of sum of such payments for all Bank Options so cancelled shall be defined as the "Aggregate Option Price"). For each $51.00 of cash paid by the Company in the previous sentence, each holder of a bank option will receive one (1) Warrant. Such cash payment may be made either by the Bank, the Company or a combination of both as determined in the sole discretion of the Company. All remaining Bank Options which are entitled to participate in the Aggregate Option Price but the holder of a Bank Option elects not to participate in the Aggregate Option Price shall be cancelled immediately prior to the Effective Time of the Merger. 2.9 DIRECTORS' AGREEMENTS. Concurrently with the execution of this Agreement, the Bank shall cause each of its directors to enter into the Directors' Agreement. 2.10 TRANSMITTAL LETTER. Immediately after the Effective Time of the Merger, the Company shall instruct the Exchange Agent to mail appropriate transmittal materials to the former stockholders of Bank Stock, and the form of such transmittal letter shall be subject to the reasonable approval of the Bank. ARTICLE III THE CLOSING 3.1 CLOSING DATE. Consummation of the transactions contemplated by this Agreement shall take place at the office of the Bank, 3715 Sunnyside Drive, Riverside, California, or such other location as may be agreed upon by the parties, on the Closing Date. The Effective Time shall occur following the last to occur of (i) the receipt of all approvals and consents specified in this Agreement and the expiration of the applicable waiting periods specified in Article IX, and (ii) satisfaction of the conditions precedent set forth in Articles IX, X and XI or written waiver of such conditions as provided herein (the "Closing Date", "Effective Time of the Merger" or "Effective Time"). 3.2 EXECUTION OF AGREEMENT OF MERGER. Prior to the Closing Date, and as soon as practicable after the organization of PCBG Merger Corporation, the Agreement of Merger (as amended, if necessary, to conform to any requirements of any Governmental Entity having authority over the Merger) shall be executed by Bank and PCBG Merger Corporation. On the Closing Date, the Merger shall become 16 effective in accordance with the approvals granted by the Commissioner, the FDIC and the FRB, and the Agreement of Merger, together with all requisite certificates, shall be duly filed with the California Secretary of State. 3.3 DOCUMENTS TO BE DELIVERED. At the Closing the Parties shall deliver, or cause to be delivered, such documents or certificates as may be necessary in the reasonable opinion of counsel for any of the parties, to effectuate the transactions called for in this Agreement. If, at any time after the Effective Time of the Merger, the Company or its successors or assigns shall determine that any further conveyance, assignment or other documents or any further action is necessary or desirable to further effectuate the transactions set forth herein or contemplated hereby, the officers and directors of the Parties hereto shall execute and deliver, or cause to be executed and delivered, all such documents as may be reasonably required to effectuate such transactions. 3.4 NO FRACTIONAL WARRANTS. Notwithstanding any other provision of this Agreement, no fractional Warrants shall be issued, and no cash or other consideration shall be paid in lieu of fractional Warrants. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF THE BANK The Bank represents and warrants to the Company as follows: 4.1 ORGANIZATION AND GOOD STANDING. The Bank is a California banking corporation duly organized and validly existing in good standing under the laws of the State of California and it has the corporate power and authority to carry on its business as presently conducted, and is authorized to transact business as a bank. The Bank is a not a member of the Federal Reserve System and its deposits are insured by the FDIC in the manner and to the extent provided by law. The Bank has all requisite corporate power and authority to own, lease and operate its properties and assets and to carry on its business as presently conducted. The nature of its operations and the business transacted by it as of the date hereof make licensing and qualification in any other state or jurisdiction unnecessary. The Bank has delivered to the Company true and correct copies of its Articles of Incorporation and Bylaws, as amended and in effect as of the date hereof, 4.2 CAPITALIZATION. The authorized capital stock of Bank consists of 20,000,000 shares of Common Stock, no par value, of which 844,278 shares are outstanding on the date hereof, all validly issued, fully paid and nonassessable, and 10,000,000 shares of Preferred Stock, none of which are outstanding. Except for stock options covering 46,968 shares of Bank Stock granted pursuant to the Bank Stock Option Plan and the Warrant Agreement, no unissued shares of Bank Stock or any other securities of the Bank are subject to any warrants, options, rights or 17 commitments of any character, kind or nature and the Bank is not obligated to issue or repurchase any shares of Bank Stock or any other security to or from any person except in accordance with the terms of the Bank Stock Option Plan and Agreements pursuant thereto, and true and correct copies, as amended and in effect as of the date hereof have been delivered to the Company. Exhibit 4.2 sets forth the name of each holder of a Bank Option, the number of shares of Bank Stock covered by each such holder's option, the date of grant of each such holder's option, the exercise price per share, the vesting schedule for each such holder's option, and the expiration date of each such holder's option. 4.3 SUBSIDIARIES. Except as indicated in Exhibit 4.3, the Bank does not own, directly or indirectly (except as pledgee pursuant to loans which are not in default), any equity position or other voting interest in any corporation, partnership, joint venture or other entity. 4.4 FINANCIAL STATEMENTS. The Bank has delivered to the Company copies of the audited Consolidated Balance Sheets of the Bank as of December 31, 1997 and 1996; Consolidated Statements of Operations, Stockholders' Equity and Cash Flows for each of the years ended December 31, 1997, 1996 and 1995, and the related notes and related opinions thereon of Arthur Andersen LLP, certified public accountants, with respect to such financial statements (the "Audited Bank Financial Statements"). The Bank has delivered to the Company copies of the unaudited Consolidated Balance Sheet of the Bank as of September 30, 1998; Consolidated Statement of Operations, Stockholders' Equity and Cash Flows for the nine month period ended September 30, 1998, and the related notes thereon (the "Unaudited Bank Financial Statements). The Bank has furnished the Company with true and correct copies of each management letter or other letter delivered to the Bank by Arthur Andersen LLP in connection with the Audited Bank Financial Statements or relating to any review of the internal controls of the Bank by Arthur Andersen LLP since January 1, 1996. The Audited Bank Financial Statements and the Unaudited Bank Financial Statements: (i) present fairly the financial condition and results of operations of the Bank as of and for the dates or periods covered thereby in accordance with GAAP and RAP consistently applied throughout the periods involved; (ii) are based on the books and records of the Bank; (iii) contain and reflect reserves for all material accrued liabilities and for all reasonably anticipated losses, and set forth adequate reserves for loan losses and other contingencies to the extent required by GAAP and RAP; and (iv) none of the Audited Bank Financial Statements or Unaudited Bank Financial Statements contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading under GAAP or RAP. The books and records of the Bank have been, and are being, maintained in all material respects in accordance with GAAP and RAP and other applicable legal and accounting requirements and reflect only actual transactions. 18 4.5 BOOKS AND RECORDS. (a) The minute books of the Bank which have been made available to the Company contain (i) true, accurate and complete records of all meetings and actions taken by the Board of Directors, Board committees and shareholders of the Bank, and (ii) true and complete copies of its Charter Documents. (b) The Bank has records which accurately and validly reflect, in all material respects, its transactions and accounting controls sufficient to insure that such transactions are (i) in all material respects, executed in accordance with management's general or specific authorization, and (ii) recorded in conformity with GAAP or RAP; such records, to the extent they contain important information pertaining to the Bank which is not easily and readily available elsewhere, have been duplicated, and such duplicates are stored safely and securely pursuant to procedures and techniques reasonably adequate for companies of the size of the Bank and in the businesses in which the Bank is engaged; and the data processing equipment and software used by the Bank in the operation of its businesses (including any disaster recovery facility) to generate and retrieve such records are reasonably adequate for companies of the size of the Bank and in the businesses in which the Bank is engaged. 4.6 PROPERTY AND ASSETS. (a) Exhibit 4.6(a) sets forth a general description (including the character of the ownership of the Bank) of all real property of the Bank, including fees, leaseholds and all other interest in real property (including real property that is DPC Property) ("Real Property"). Except as set forth on Exhibit 4.6(a), (i) the Bank has good and marketable title, free and clear of any encumbrance, lien or charge of any kind or nature (except liens for taxes not yet due) to all of the property, real, mixed or intangible, reflected on the Audited Bank Financial Statements, except as reflected therein or in the notes thereto (except property sold or transferred or Encumbrances incurred in the ordinary course of business since the date thereof except (a) Encumbrances in the aggregate which do not materially detract from the value, interfere with the use, or restrict the sale, transfer or disposition, of such properties and assets or otherwise materially and adversely affect the Bank; (b) any lien for taxes not yet due; and (c) any Encumbrances arising under the document that created the interest in the Real Property (other than Encumbrances arising as a result of any breach or default of the Bank); (ii) all leasehold interests for Real Property and any material personal property used by the Bank in its business are held pursuant to lease agreements which are valid and enforceable, except as the enforceability thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable in accordance with their terms; (iii) all such properties comply in all material respects with all applicable private agreements, zoning requirements and other governmental laws and regulations relating thereto and there are no condemnation proceedings pending or, to the knowledge of the Bank, threatened with respect to such 19 properties; (iv) the Bank has valid itle or other ownership rights under licenses to all material intangible personal or intellectual property used by the Bank in its business, free and clear of any claim, defense or right of any other person or entity which is material to such property, subject only to rights of the licensors pursuant to applicable license agreements, which rights do not materially adversely interfere with the use of such property; and (v) all material insurable properties owned or held by the Bank are adequately insured in such amounts and against such risks as is customary with banks of similar size. The Bank has furnished the Company with true and correct copies of all leases included on Exhibit 4.6(a) delivered as of the date of the Agreement. (b) CONDITION OF PROPERTIES. All tangible properties of the Bank that are material to the business, financial condition, or results of operations of the Bank are in a good state of maintenance and repair, except for ordinary wear and tear, and are adequate for the conduct of the business of the Bank as presently conducted, and comply with all applicable Rules related thereto. Except as set forth in Exhibit 4.6(a), (i) the execution of this Agreement, the performance of the obligations of the Bank hereunder and the consummation of the transactions contemplated herein, including the Merger, does not conflict with and will not result in a breach or default under any lease, agreement or contract described in Exhibit 4.6(a), or give any other party thereto a right to terminate or modify any term thereof; (ii) the Bank has no obligation to improve any Real Property; (iii) each lease and agreement under which the Bank is a lessor is in full force and effect and is a valid and legally binding obligation of the Bank, and, to the best knowledge of the Bank, each other party thereto; and (iv) the Bank, and to the best knowledge of the Bank, each other party to any such lease or agreement have performed in all material respects all the obligations required to be performed by them to date under such lease or agreement and are not in default in any material respect under any such lease or agreement and there is no pending or, to the best knowledge of the Bank, threatened proceeding, or proceeding which the Bank has reason to believe may be threatened, with respect to such property or any such lease. 4.7 LITIGATION PROCEEDINGS AND AGREEMENTS WITH GOVERNMENTAL ENTITIES. (a) The Bank is not engaged as a defendant in any legal or other proceedings before any court, administrative agency or other Governmental Entity except as is shown on Exhibit 4.7. Except as set forth on Exhibit 4.7, the Bank is not aware of any "threatened or pending litigation" (within the meaning of Paragraph 5 of the American Bar Association Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information adopted December 8, 1975) against the Bank. The Bank is not subject to any agreement, order, writ, injunction or decree of any federal, state or local court, out of a proceeding involving the Bank or any of its business or properties except as described in Exhibit 4.7. The Bank has not been served with notice of, nor, to best of Bank's knowledge is it currently under investigation with respect to, any violation of 20 federal, state or local law or administrative regulation. Except as set forth on Exhibit 4.7, there is no (i) outstanding judgment, order, writ, injunction or decree, stipulation or award of any Governmental Entity or by arbitration, against, or to the knowledge of the Bank, affecting the Bank or its assets or business that (a) has had or may have a material adverse effect on the assets, liabilities, business, financial condition or results of operations of the Bank, (b) requires any payment by, or excuses a material obligation of a third party to make any payment to, the Bank, or (c) has the effect of prohibiting any business practice of, or the acquisition, retention or disposition of property by, the Bank; or (ii) legal, administrative, arbitration, investigatory or other proceeding pending or, to the best knowledge of the Bank that has been threatened, or which the Bank has reason to believe may be threatened, against or affecting any director, officer, employee, agent or representative of the Bank, in connection with which any such person has or may have rights to be indemnified by the Bank. (b) Except as set forth in Exhibit 4.7, the Bank is not a party to, or otherwise subject to, any agreement or memorandum of understanding with or order of any Governmental Entity charged with the supervision or regulation of banks or engaged in the insurance of bank deposits, that restricts the conduct of its business, or in any manner relates to its capital adequacy, its credit or investment policies or its management. 4.8 TAXES AND ASSESSMENTS. The Bank has timely filed all federal income and state franchise tax returns and all tax reports or returns which it is required to file with applicable federal, state, county or local authorities and agencies except (a) where the failure to make any such filing would not have any materially adverse effect on the business, financial condition or results of operations of the Bank taken as a whole, and (b) where the required filing date has been lawfully extended, and the Bank has paid all taxes provided for and to be due in such returns and reports ("Tax Filings"). Except as set forth in Exhibit 4.8, the Bank's Tax Filings have not been examined by a Governmental Entity in the past five (5) years. As of December 31, 1997, to the extent required by GAAP, the Bank had paid, or set up adequate accruals for the payment of, all taxes, penalties and assessments for which it was liable as of such date, whether or not disputed, with respect to any and all United Sates federal, foreign, state, local, environmental (including under any Environmental Law) and other taxes for the periods covered by the financial statements of the Bank and for all prior and subsequent periods. Except as set forth in Exhibit 4.8 the Bank has no knowledge of any deficiency proposed to be assessed against it. The Bank has paid all assessments made by the FDIC and the Commissioner required to be paid prior the date hereof. There is currently no federal or state income tax audit or investigation in process or to the best knowledge of the Bank any other pending investigation by any authorized body of the taxes paid or to be paid by the Bank, and the Bank has not been informed that any such audit or investigation is proposed. 21 4.9 COMPLIANCE WITH LAWS AND REGULATIONS. (a) Except as set forth in Exhibit 4.9, the Bank is not in default under or in breach of any law, ordinance, rule, regulation, order, judgment or decree applicable to it promulgated by any Governmental Entity having authority over it, where such default or breach would have a material adverse effect on its financial condition, results of operations, or business. (b) The Bank has conducted in all material respects its businesses in accordance with all applicable federal, foreign, state and local laws, regulations and orders, including without limitation disclosure, usury, equal credit opportunity, equal employment, fair credit reporting, antitrust, licensing and other laws, regulations and orders, and the forms, procedures and practices used by the Bank are in compliance with such laws, regulations, and orders, except for such violations or noncompliance as will not have a material adverse effect on the financial condition, results of operations, or business of the Bank. 4.10 PERFORMANCE OF OBLIGATIONS. Except as set forth in Exhibit 4.10, the Bank has performed in all respects all of the obligations required to be performed by it to date and is not in default under or in breach of any term or provision of any covenant, contract, lease, indenture or any other agreement to which the Bank is a party or is subject or is otherwise bound, and no event has occurred which, with the giving of notice or the passage of time or both, would constitute such default or breach, where such default or breach would have a material adverse effect on the financial condition, results of operations, or business of the Bank, except for loans of the Bank in default on the date of this Agreement. No party with whom the Bank has an agreement which is material to the financial condition, results of operations or business of the Bank is in default thereunder. 4.11 EMPLOYEES. (a) Except as set forth in Exhibit 4.11(a), there are no understandings for the employment of any officer or employee of the Bank which are not terminable by the Bank without liability on not more than 30 days' notice. Except as set forth in Exhibit 4.11(a), the Bank is not a party to an oral or written consultant agreement not terminable upon 60 days' or less notice or involving the payment of more than $10,000 per annum. Except as set forth in Exhibit 4.11(a), there are no material controversies pending or threatened between the Bank and any of its employees. Except as disclosed in the Audited Bank Financial Statements, the Unaudited Bank Financial Statement or in Exhibit 4.11(a), all material sums due for employee compensation and benefits have been duly and adequately paid or provided, and all deferred compensation obligations are fully funded. The Bank is not a party to any collective bargaining agreement with respect to any of its employees or any labor organization to which its employees or 22 any of them belong. Except as set forth in Exhibit 4.11(a), no director, officer or employee of the Bank is entitled to receive any payment of any amount under any employment agreement, severance plan or other benefit plan as a result of the consummation of any transaction contemplated by this Agreement. (b) Except as disclosed in Exhibit 4.11(b), (i) the Bank is and has been in material compliance with all applicable laws respecting employment and employment practices, terms and conditions of employment and wages and hours, including, without limitation, any such laws respecting employment discrimination and occupational safety and health requirements, and in any unfair labor practice; (ii) there is no material unfair labor practice complaint against the Bank pending or, to the knowledge of the Bank, threatened before the National Labor Relations Board; (iii) there is no labor dispute, strike, slowdown or stoppage actually pending or, to the knowledge of the Bank, threatened against or directly affecting the Bank; and (iv) the Bank has not experienced any material work stoppage or other material labor difficulty during the past five years, except in each case which would not result in a Material Adverse Change. (c) Except as disclosed in Exhibit 4.11(c), the Bank does not maintain, contribute to or participate in or have any material liability under any employee benefit plans, as defined in ERISA, or any nonqualified employee benefit plans or deferred compensation, bonus, stock or incentive plans, or other employee benefit or fringe benefit programs for the benefit of former or current employees of the Bank (the "Employee Plans"). To the best knowledge of the Bank, no present or former employee of the Bank has been charged with breaching nor has breached a fiduciary duty under any of the Employee Plans. The Bank does not participate in, nor has it in the past five years participated in, nor has it any present or future obligation or liability under, any multiemployer plan (as defined at Section 3(37) of ERISA). Except as may be separately disclosed in Exhibit 4.11(c), the Bank does not maintain, contribute to, or participate in, any plan that provides health, major medical, disability or life insurance benefits to former employees of the Bank. (d) Exhibit 4.11 (d) sets forth and describes all Employee Plans in which the Bank participates, or by which it is bound, including, without limitation; (i) any profit sharing, deferred compensation, bonus, stock option, stock purchase, pension, retainer, consulting, retirement, welfare or incentive plan or agreement whether legally binding or not; (ii) any plan providing for "fringe benefits" to its employees, including but not limited to vacation, sick leave, medical, hospitalization, life insurance and other insurance plans, and related benefits; (iii) any written employment agreement and any other employment agreement not terminable at will; or (iv) any other "employee benefit plan" (within the meaning of Section 3(3) of ERISA) (collectively, the "Employee Plans"). Except as set forth in Exhibit 4.11(d), (i) there are no negotiations, demands or proposals that are pending or threatened that concern matters now covered, or that would be covered, by any employment agreements or Employee Plan other than amendments 23 to plans qualified under Section 401 of the Code that are required by the Tax Reform Act of 1986 and later legislation; (ii) the Bank is in compliance with the material reporting and disclosure requirements of Part 1 of Subtitle IB of ERISA and the corresponding provisions of the Code to the extent applicable to all such Employee Plans; (iii) the Bank has substantially performed all of its obligations under all such Employee Plans and employment agreements required to be performed heretofore; and (iv) there are no actions, suits or claims (other than routine claims for benefits) pending or, to the best knowledge of the Bank, threatened against any such Employee Plans and employment agreements or the assets of such plans, and to the best knowledge of the Bank, no facts exist which could give rise to any actions, suits or claims (other than routine claims for benefits) against such plans or the assets of such plans. (e) The "Employee Plans" (within the meaning of Section 3(2) of ERISA) described on Exhibit 4.11(d) have been duly authorized by the Board of Directors of the Bank. Except as set forth in Exhibit 4.11(d), each such plan and associated trust intended to be qualified under Section 401(a) and to be exempt from tax under Section 501(a) of the Code, respectively, has either received a favorable determination letter from the Internal Revenue Service (the "IRS"), has applied for such a determination letter or will apply for such a determination letter before the expiration of the remedial amendment period set forth in Section 401(b) of the Code, as the IRS may extend such period, and to the best knowledge of the Bank, no event has occurred that will or could give rise to disqualification of any such plan which is intended to be qualified under Section 401(a) of the Code or loss of the exemption from tax of any such trust which is intended to be exempt from tax under Section 501(a) of the Code. No event has occurred that will or could subject any such plans to tax under Section 511 of the Code. None of such plans has engaged in a merger or consolidation with any other plan or transferred assets or liabilities from any other plan. To the best of the Bank's knowledge, no prohibited transaction (within the meaning of Section 409 or 502(i) of ERISA or Section 4975 of the Code) or party-in-interest transaction (within the meaning of Section 406 of ERISA) has occurred with respect to any of such plans which could subject the Bank to an excise tax or penalty. To the best knowledge of the Bank, no employee of the Bank has engaged in any transactions which could subject the Bank to indemnify such person against liability. All costs of plans have been provided for on the basis of consistent methods in accordance with sound actuarial assumptions and practices. No Employee Plan has incurred any "accumulated funding deficiency" (as defined in Section 302(2) of ERISA), whether or not waived, taking into account contributions made within the period described in Section 412(c)(10) of the Code; nor are there any unfunded amounts under any Employee Plan which is required to be funded under Part 3 of Subtitle IB of ERISA and Section 412 of the Code); nor has the Bank failed to make any contributions or pay any amount due and owing as required by law or the terms of any Employee Plan or employment agreement. Subject to amendments that are required by the Tax Reform Act of 1986 and later legislation, since the last valuation date for each 24 Employee Plan, there has been no amendment or change to such plan that would increase the amount of benefits thereunder. (f) The Bank does not sponsor or participate in, or has not sponsored or participated in, any employee benefit pension plan to which Section 4021 of ERISA applies that would create a liability under Title IV of ERISA. (g) The Bank does not sponsor or participate in, or has not sponsored or participated in, any Employee Plan that is a "multi-employer plan" (within the meaning of Section 3(37) of ERISA) that would subject such Person to any liability with respect to any such plan. (h) All group health plans of the Bank (including any plans of Affiliates of the Bank that must be taken into account under Section 162(i) or (k) of the Code as in effect immediately prior to the Technical and Miscellaneous Revenue Act of 1988 and Section 4980B of the Code) have been operated in compliance with the group health plan continuation coverage requirements of Section 4980B of the Code to the extent such requirements are applicable. (i) There have been no acts or omissions by the Bank that have given rise to or may give rise to fines, penalties, taxes, or related charges under Sections 502(c) or (i) or 4071 of ERISA or Chapter 43 of the Code which could be imposed on the Bank. (j) Except as described in Section 4.11(j), the Bank does not maintain any Employee Plan or employment agreement pursuant to which any Employee Plan or other payment will be required to be made by the Bank or pursuant to which any other benefit will accrue or vest in any director, officer or employee the Bank, in either case as a result of the consummation of the transactions contemplated by the Agreement. (k) No "reportable event," as defined in ERISA, has occurred with respect to any of the Employee Plans. (l) All amendments required to bring each of the employee benefit plans into conformity with all of the provisions of ERISA and the Code and all other applicable laws, rules and regulations have been made, or will be made before the expiration of the remedial amendment period set forth under Section 401(b) of the Code, as such period may be extended by the IRS. (m) Exhibit 4.11(m) sets forth the name of each director, officer, employee, agent or representative of the Bank and every other person entitled to receive any benefit or any payment of any amount under any existing employment agreement, severance plan or other benefit plan or Understanding as a result of the consummation of any transaction contemplated in this Agreement, and with 25 respect to each such person, the nature of such benefit or the amount of such payment, the event triggering the benefit or payment, and the date of, and parties to, such employment agreement, severance or other benefit plan or Understanding. The Bank has furnished the Company with true and correct copies of all documents with respect to the plans and agreements referred to in Exhibit 4.11(d) delivered as of the date of the Agreement, including all amendments and supplements thereto, and all related summary plan descriptions. For each of the employee pension benefit plans of the Bank referred to in Exhibit 4.11(d) delivered as of the date of the Agreement, the Bank has furnished the Company with true and correct copies of (i) the Form 5500 which was filed in each of the three most recent plan years, including without limitation, all schedules thereto and all financial statements with attached opinions of independent accountants to the extent required; (ii) the most recent determination letter from the IRS; (iii) the statement of assets and liabilities as of the most recent valuation date; and (iv) the statement of changes in fund balance and in financial position or the statement of changes in net assets available for benefits under each of said plans for the most recently ended plan year. The documents referred to in subdivisions (iii) and (iv) fairly present the financial condition of each of said plans as of and at such dates and the results of operations of each of said plans, all in accordance with GAAP or on the cash method of accounting applied on a consistent basis. 4.12 CONTRACTS AND AGREEMENTS. Except as listed in Exhibit 4.12, the Bank is not a party to any oral or written agreement, commitment, or obligation (hereinafter referred to as an "Understanding" or "Material Contract") which individually, or with all other similar Understandings relating to the same or similar subject matter, falls within any of the following classifications: (i) any Understanding dealing with advertising, brokerage, licensing, dealership, representative or agency relationship; (ii) any Understanding with any labor or collective bargaining organization or association; (iii) any mortgage, pledge, conditional sales contract, security agreement, or any other similar Understanding with respect to any real or personal property in an amount in excess of $25,000, under which the Bank is a debtor or to which any of its property is subject; (iv) any profit sharing, group insurance, bonus, deferred compensation, stock option, severance pay, pension, retirement, or any other similar Understanding which might provide benefits to the employees, officers or directors of the Bank; (v) any Understanding for the future purchase of materials, supplies, services, merchandise or equipment, the price of which exceeds $20,000 26 and which will not be terminable without liability as to future purchases as of the Effective Time; it being understood that materials, supplies, service, merchandise or equipment shall not be deemed to include loans, repurchase or reverse repurchase agreements, securities or other financial transactions incurred by the Bank in the ordinary course of its banking business; (vi) any Understanding for the sale of any of its assets, or for the grant of any right to purchase any of its assets, properties or rights, or which requires the consent of any third party to the transfer and assignment of any of its assets, properties or rights; it being understood that the foregoing shall not be deemed to include any Understanding for the sale of mortgage loans, repurchase or reverse repurchase agreements, securities or other financial transactions incurred by the Bank in the ordinary course of its banking business; (vii) any guarantee, subordination or other similar or related types of Understanding except where the Bank is a beneficiary; (viii) any Understanding for the borrowing of any money by the Bank (other than time savings or demand deposits) or for a line of credit to it; (ix) any Understanding for any one capital expenditure or series of related capital expenditures in excess of $25,000 individually or $100,000 in the aggregate; (x) any real property lease, whether as lessor or lessee; or any personal property lease, whether as lessor or lessee, involving payments in excess of $1000 per month; (xi) any Understanding to make or participate in a loan (not yet fully disbursed or funded) to any borrower or related group of borrowers, which undisbursed or unfunded amount would exceed $500,000 unsecured or secured; (xii) any Understanding of any kind (other than contracts relating to demand or time deposits or otherwise made in the ordinary course of business) with any director or officer of the Bank or with any member of the immediate family of any such director of officer or with any partnership, corporation, associate or entity of which any such person is an Affiliate; (xiii) any Understanding for insurance other than as described in Section 4.13 below; or (xiv) any Understanding, the purpose or effect of which could encompass (a) merging with any person or bank or bank holding company other than with the Company (b) the selling of any of its assets (except in the ordinary course of business) or stock to any person, (c) recommending to any of its 27 shareholders that their Bank Stock be sold to any person or bank other than the Company, or causing any other person to make such recommendations or acquiescing in any such recommendations made by any other person, or (d) in any other way transferring, directly or indirectly, control of the Bank. Except as stated in Exhibit 4.12, true and correct copies of all documents relating to the foregoing Understandings have been delivered by the Bank prior to the date hereof. As used in this Section 4.12, "immediate family" of a person shall mean his or her spouse, parents, children, and siblings. 4.13 INSURANCE. The Bank has and at all times within three years of the date of this Agreement has had, in full force and effect policies of insurance and bonds (including without limitation Bankers' blanket bond, fidelity coverage, director and officer liability, fire, third party liability, use and occupancy) with respect to its assets and business and against such casualties and contingencies and of such amounts, types and forms which are customary in the banking industry and are adequate or appropriate to cover its assets and businesses as set forth in Exhibit 4.13. Set forth in Exhibit 4.13 is a schedule of all policies of insurance (other than title or credit insurance) carried and owned by the Bank, showing the name of the insurance or bonding company, a summary of the coverage, the amounts, the deductible features, the annual premiums and the expiration dates. If any such policy or bond is changed, terminated or modified following the date of this Agreement, such termination, change or modification shall be promptly disclosed to the Company in writing. The Bank is not in default under any such policy of insurance or bond such that it could be canceled, and all material claims thereunder have been filed in a timely fashion. The Bank has filed claims with or given notice of claim to its insurers or bonding companies with respect to all material matters and occurrences for which it believes it has coverage. 4.14 BROKERS. Except as indicated in Exhibit 4.14, no agent, broker, investment banker, person or firm acting on behalf or under authority of the Bank (except for any payments for fairness opinions as required in Section 10.9) is or will be entitled to any broker's or finder's fee or any other commission or similar fee directly or indirectly in connection with any of the transactions contemplated by this Agreement. 4.15 AUTHORIZATION. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by the Board of Directors of the Bank. Assuming due and proper execution and delivery of this Agreement by the Company, this Agreement constitutes a legal, valid and binding agreement of the Bank in accordance with its respective terms, except as the enforceability hereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general 28 application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable, and by Section 8(b) 6(D) of the Federal Deposit Insurance Act, 12 U.S.C. Section 1818(b)(6)(D). Subject to obtaining the requisite approval of this Agreement by the shareholders of the Bank, the Bank has full corporate power and authority to perform its obligations under this Agreement and the transactions contemplated hereby. 4.16 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein, including the Merger, and compliance by the Bank with any provision hereof and thereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 4.16 any material agreement, instrument or obligation to which it is a party or by which the property of the Bank is bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, Commissioner, any other required Governmental Entity and as set forth in Exhibit 4.16, require any Consents; or (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of the Bank; or (d) violate the Charter Documents or any Rules to which the Bank is subject. 4.17 MATERIAL ADVERSE CHANGES. Except as specifically required, permitted or effected by this Agreement, and except as set forth on Exhibit 4.17, since December 31, 1997 there has not been, occurred or arisen any of the following (whether or not in the ordinary course of business unless otherwise indicated) ("Material Adverse Changes"): (a) Any materially adverse change in any of the assets, liabilities, permits, methods of accounting or accounting practice, or manner of conducting business, of the Bank or any other event or development that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, Permits, business, financial condition, or results of operations of the Bank or which should be disclosed in order to make the Audited Bank Financial Statements not misleading; (b) Any damage, destruction or other casualty loss (whether or not covered by insurance) that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Bank or that may involve a loss of more than $20,000 in excess of applicable insurance coverage; (c) Any amendment, modification or termination of any existing, or entry into any new Material Contract or Permit that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Bank; 29 (d) Any disposition by the Bank of an asset the lack of which has had or may reasonably be expected to have a material adverse effect on the business, financial condition, or results of operations of the Bank; (e) Any direct or indirect redemption, purchase or other acquisition by the Bank of any Equity Securities or any declaration, setting aside or payment of any dividend or other distribution on or in respect of Bank Stock whether consisting of money, other personal property, real property or other things of value; (f) Any changes by the Bank in accounting principles or methods or tax methods, except as required or permitted by, the Financial Accounting Standards Board or by any Governmental Entity having jurisdiction over the Bank; (g) A reduction in the Bank's CAMELS rating; (h) A reduction in the Bank's CRA rating to less than satisfactory; (i) A reduction in shareholders' equity to less than 100% of the Bank's shareholders' equity at December 31, 1998 as reduced for any cash dividends paid in 1999 or as authorized by Section 6.2(vii) and as determined in accordance with GAAP or RAP; and/or a reduction in the Bank's 1999 net income to less than 85% of the Bank's 1999 projected net income, as agreed between the Bank and Company; (j) Any event of which the Bank obtains knowledge which may materially and adversely affect the business, financial condition, results of operations or prospects of the Bank; or (k) Any event, development or circumstance that, to the best knowledge of the Bank, will or, with the passage of time or the giving of notice or both, is reasonably expected to result in the loss to the Bank of the services of any Executive Officers of the Bank. 4.18 REPORTS AND FILINGS. Since January 1, 1995, the Bank has filed all reports, returns, registrations and statements (such reports and filings referred to as "Bank Filings"), together with any amendments required to be made with respect thereto, that were required to be filed with (a) the FDIC, (b) the Commissioner and (c) any other applicable Governmental Entity, including taxing authorities, except where the failure to file such reports, returns, registrations and statements has not had and is not reasonably expected to have a material adverse effect on the business, financial condition, or results of operations of the Bank. No administrative actions have been taken or orders issued in connection with such Bank Filings. As of their respective dates, each of such Bank Filings complied in all material respects with all Rules enforced or promulgated by the Governmental 30 Entity with which it was filed (or was amended so as to be so promptly following discovery of any such noncompliance). Any financial statement contained in any of such Bank Filings that was intended to present the financial position of Bank fairly and was prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved. The Bank has made available to the Company true and correct copies of all Bank Filings filed by the Bank since January 1, 1995. 4.19 INFORMATION REGARDING LOANS. The Bank has provided the Company access to all of the information in its possession concerning its loans, and such information was true and correct in all material respects as of the date access was provided. Except as may be disclosed in Exhibit 4.19, (i) all loans and discounts shown on the Audited Bank Financial Statements at December 31, 1997 or which were entered into after December 31, 1997, but before the Closing Date, were and will be made in all material respects for good, valuable and adequate consideration in the ordinary course of the business of the Bank, in accordance in all material respects with the Bank's lending practices, and are not subject to any material known defenses, setoffs or counterclaims, including without limitation any such as are afforded by usury or truth in lending laws, except as may be provided by bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or enforcement of creditor rights and the application of equitable principles in any action, legal or equitable; (ii) the notes or other evidences of indebtedness evidencing such loans and all forms of pledges, mortgages and other collateral documents and security agreements constituting the Bank's loan portfolio, taken as a whole, are and will be, in all material respects, enforceable except as the enforceability hereof and thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles; and (iii) the Bank has complied in all material respects, and will prior to the Closing Date comply with all laws and regulations relating to such loans, or to the extent there has not been such compliance, such failure to comply will not materially interfere with the collection of any such loan. All loans and loan commitments extended by the Bank and any extensions, renewals or continuations of such loans and loan commitments that are n the Bank's books were made in accordance with customary lending standards of the Bank in the ordinary course of business. Such loans are evidenced by documentation based upon customary and ordinary past practices of the Bank. Prior to the date hereof, the Bank has provided the Company with a schedule which sets forth a description (a) by type and classification, if any, of each loan, lease or other extension of credit and commitment to extend credit; (b) by type and classification, if any, of all loans, leases, other extensions of credit and commitments to extend credit that have been classified by any Governmental Entity or auditors (external or internal) as "Watch List," "Substandard," "Doubtful," "Loss" or any comparable classification; and (c) all consumer loans as to which any payment of principal, interest or other amount is 90 days or more past due. 31 (b) As of (i) the date of this Agreement, (ii) the Determination Date and (iii) the Closing Date, the allowance for loan and lease losses for the Bank is adequate and in accordance with GAAP and RAP. 4.20 COMPLIANCE WITH CRA To the best knowledge of the Bank, the Bank's compliance under the CRA should not constitute grounds for either the denial by any Governmental Entity of any application to consummate the transactions contemplated by this Agreement or the imposition of a materially burdensome condition in connection with the approval of any such application. 4.21 CERTAIN INTERESTS. Except as described in Exhibit 4.12(xii), Exhibit 4.21 sets forth a description of each instance in which an executive officer or director of the Bank (a) has any material interest in any property, real or personal, tangible or intangible, used by or in connection with the business of the Bank; (b) is indebted to the Bank except for normal business expense advances; or (c) is a creditor (other than as a Deposit holder) of the Bank except for amounts due under normal salary and related benefits or reimbursement of ordinary business expenses. Except as set forth in Exhibit 4.21, all such arrangements are arm's length transactions pursuant to normal commercial terms and conditions. 4.22 BRANCHES. Exhibit 4.22 hereto sets forth the common name and location of each office of the Bank, an indication of whether such office is a branch, service center, or other place of business, whether such premises are owned or leased, the basic terms of such leases, the common name and location of each approved but unopened office, and a description of each application for additional offices of the Bank, and the status of each such application. The Bank has received appropriate and effective permits and governmental authority where any Permit, approval or notice was required by law or regulation prior to the establishment and operation of each such office now in operation. Except for the offices described on Exhibit 4.22, the Bank does not operate or conduct business out of any other location and the Bank does not have any current application for, and the Bank has not received permission to open, any other branch or to operate out of any other location. 4.23 UNDISCLOSED LIABILITY. The Bank has no liabilities or obligations, either accrued or contingent, which are in excess of Twenty Thousand Dollars ($20,000) individually or in the aggregate, which have not been: (i) reflected or disclosed in the Audited Bank Financial Statements or Unaudited Bank Financial Statements; (ii) incurred subsequent to December 31, 1997, in the ordinary course of business; or 32 (iii) disclosed on Exhibit 4.23 or any other exhibit to this Agreement. To the best of the Bank's knowledge and the knowledge of their executive officers and directors, after due investigation, there is no basis for the assertion against the Bank of any liability, obligation or claim that is likely to result in or cause any material adverse change in the business or financial condition of the Bank, taken as a whole, which is not fairly reflected in the Audited Bank Financial Statements, the Unaudited Bank Financial Statements or otherwise disclosed on Exhibit 4.23 hereto. 4.24 ACCURACY OF INFORMATION FURNISHED. Except as to any statements or information which shall include projections or forecasts, none of the statements or information made or contained in any of the covenants, representations or warranties of the Bank set forth in this Agreement or in any of the schedules, exhibits, lists, certificates or other documents furnished herewith taken as a whole contains any untrue statement of a material fact required to be stated herein or therein or necessary to make the statements or information contained herein or therein, in light of the circumstances in which they were made, not misleading. As to any such information or statements which include projections or forecast, such information or statements are based upon assumptions believed by the Bank to be reasonable. 4.25 ENVIRONMENTAL LAWS. Except as may be disclosed in Exhibit 4.25, to the best of the Bank's knowledge (and without conducting any site investigation or other analysis for the purpose of making this representation), neither the conduct nor operation of the Bank nor any condition of any Real Property presently or previously owned, leased or operated by the Bank violates or violated Environmental Laws in any respect material to the business of Bank taken as a whole and no condition or event has occurred with respect to the Bank or any Real Property that, with notice or the passage of time, or both, would constitute a violation material to the business of the Bank taken as a whole of Environmental Laws or obligate (or potentially obligate) the Bank to remedy, stabilize, neutralize or otherwise alter the environmental condition of any such Real Property where the aggregate cost of such actions would be material to the Bank taken as a whole. Except as may be disclosed in Exhibit 4.25, the Bank has not received any notice from any person or entity that the Bank or the operation or condition of any Real Property ever owned, leased or operated by the Bank is or was in violation of any Environmental Laws or that the Bank is responsible (or potentially responsible) for remedying, or the cleanup of, any pollutants, contaminants, or hazardous or toxic wastes, substances or materials at, on or beneath any such Real Property. 4.26 COMMISSIONER AND FDIC EXAMINATIONS. (a) The Commissioner has completed an examination of the Bank as of November 30, 1996, and (i) the Commissioner believes the Bank's allowance for loan losses is adequate and the 33 Commissioner required no material adjustments, and (ii) the Bank's CAMELS rating did not adversely change and the Bank's financial condition is deemed by the Commissioner to be satisfactory. (b) The FDIC has completed an examination of the Bank as of December 31, 1997, and (i) the FDIC believes the Bank's allowance for loan losses is adequate and the FDIC required no material adjustments, and (ii) the Bank's CAMELS rating did not adversely change and the Bank's financial condition is deemed by the FDIC to be satisfactory. (c) The FDIC has completed an examination of the Bank and Banklink Corporation, the Bank's data processing subsidiary, for compliance with Year 2000 safety and soundness issues as of February 3, 1998, and the FDIC has rated the Bank and Banklink Corporation at least satisfactory regarding the Bank's and Banklink Corporation's progress in addressing Year 2000 Safety and Soundness Progress Standards established by the FDIC. Further, Banklink Corporation has also been rated satisfactory regarding its progress in addressing Year 2000 Safety and Soundness issues. 4.27 INSIDER LOANS; OTHER TRANSACTIONS. The Bank has previously provided the Company with a listing, current as of November May 301, 1998, of all extensions of credit made to the Bank and each of its Executive Officers and directors and their related interests (all as defined under Federal Reserve Board Regulation "O"), all of which have been made in compliance with Regulation O, which listing is true, correct and complete in all material respects. The Bank does not owe any amount to, nor does it have any contract or lease with or commitment to, any of the present Executive Officers or directors of the Bank (other than for compensation for current services not yet due and payable, and reimbursement of expenses arising in the ordinary course of business). 4.28 DERIVATIVE TRANSACTIONS. The Bank is not a party to a transaction in or involving forwards, futures, options on futures, swaps or other derivative instruments. 4.29 TRUST ADMINISTRATION. The Bank presently does not exercise trust powers, including, but not limited to, trust administration, and has not exercised such trust powers for a period of at least 3 years prior to the date hereof. The term "trusts" as used in this Section 4.29 includes (i) any and all common law or other trusts between an individual, corporation or other entities and the Bank, as trustee or co-trustee, including, without limitation, pension or other qualified or nonqualified employee benefit plans, compensation, testamentary, intervivos, and charitable trust indentures; (ii) any and all decedents' estates where the Bank is serving or has served as a co-executor or sole executor, personal representative or administrator, administrator de bonis non, administrator de bonis non with will annexed, or in any similar fiduciary capacity; (iii) any and all guardianships, 34 conservatorships or similar positions where the Bank is serving or has served as a co-grantor or a sole grantor or a conservator or a co-conservator of the estate, or any similar fiduciary capacity; and (iv) any and all agency and/or custodial accounts and/or similar arrangements, including plan administrator for employee benefit accounts, under which the Bank is serving or has served as an agent or custodian for the owner or other party establishing the account with or without investment authority. 4.30 STATEMENTS TRUE AND CORRECT. None of the information supplied or to be supplied by the Bank for inclusion in the S-1, the S-4 or the Proxy Statement, or incorporated by reference therein, or any other document to be filed with any Governmental Entity in connection with the transactions contemplated hereby will, in the case of the S-1, the S-4 and the Proxy Statement, when it is first mailed to the shareholders of the Bank, contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which such statements are made, not misleading or, in the case of the S-1 and the S-4, when it becomes effective, be false or misleading with respect to any material fact, or omit to state any material fact necessary in order to make the statements therein not misleading, or, in the case of the S-1, the S-4 and Proxy Statement or any amendment thereof or supplement thereto, at the time of the meeting of shareholders of the Bank, be false or misleading with respect to any material fact or omit to state any material fact necessary to correct any statement or remedy any omission in any earlier communication with respect to the solicitation of any proxy of the Bank shareholders' meeting. 4.31 ACCURATE DISCLOSURE. The Bank agrees that through the Effective Time of the Merger, each of its reports, and other filings required to be filed with any applicable Governmental Entity will comply in all material respects with all of the applicable statutes, Rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any such report, or other filing that is intended to present the financial position of the Bank will fairly present the financial position of the Bank and will be prepared in accordance with GAAP or RAP consistently applied during the periods involved. Notwithstanding anything to the contrary set forth in this Section 4.31, the Bank makes no representation or warranty with respect to any information supplied by the Company. 4.32 YEAR 2000. The Bank and Banklink Corporation have formed a Year 2000 management committee to identify potential problems associated with the Year 2000 issues and to develop resolutions to any problems. The Bank and Banklink Corporation are making satisfactory progress for compliance with Year 35 2000 safety and soundness issues in order to ensure that the Bank's and Banklink Corporation's existing computer systems are Year 2000 compliant. ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to the Bank as follows: 5.1 ORGANIZATION AND GOOD STANDING. The Company is a California corporation duly organized and validly existing in good standing under the laws of the State of California, is proposed to be registered with the FRB to become a bank holding company and it has the corporate power and authority to carry on its business as presently conducted. The Company has all requisite corporate power and authority to own, lease and operate its properties and assets and to carry on its business as presently conducted. The nature of its operations and the business transacted by it as of the date hereof make licensing and qualification in any other state or jurisdiction unnecessary. The Company has delivered to the Bank true and correct copies of its Articles of Incorporation and Bylaws, as amended and in effect as of the date hereof. 5.2 CAPITALIZATION. The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, no par value, of which 10,000 shares are outstanding on the date hereof, all validly issued, fully paid and nonassessable, and 100,000,000 shares of Preferred Stock, none of which are outstanding. Except as provided in Exhibit 5.2, no unissued shares of Company Stock or any other securities of the Company are subject to any warrants, options, rights or commitments of any character, kind or nature and the Company is not obligated to issue or repurchase any shares of Company Stock or any other security to or from any person except in accordance with the terms of the proposed Company Stock Option Plan and Agreements pursuant thereto. Exhibit 5.2 sets forth the name of each holder of a Company stock option, the number of shares of Company Stock covered by each such holder's option, the date of grant of each such holder's option, the exercise price per share, the vesting schedule for each such holder's option and the expiration date of each such holder's option. 5.3 SUBSIDIARIES. Except for PCBG Merger Corporation, which the Company intends to own prior to the Closing Date, the Company does not own, directly or indirectly (except as pledgee pursuant to loans which are not in default), any equity position or other voting interest in any corporation, partnership, joint venture or other entity. 5.4 FINANCIAL STATEMENTS. The Company has delivered to the Bank copies of the unaudited Statements of Financial Condition of the Company as of December 31, 1997 (the "Company Financial Statements"). The Company Financial 36 Statements: (i) present fairly the financial condition and results of operations of the Company as of and for the dates or periods covered thereby in accordance with GAAP consistently applied throughout the periods involved; (ii) are based on the books and records of the Company; (iii) contain and reflect reserves for all material accrued liabilities and for all reasonably anticipated losses, and set forth adequate reserves loan losses and other contingencies to the extent required by GAAP; and (iv) none of the Company Financial Statements contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading under GAAP. The books and records of the Company have been, and are being, maintained in all material respects in accordance with GAAP and other applicable legal and accounting requirements and reflect any actual transactions. Since the Company was recently incorporated, there are no audited financial statements of the Company for December 31, 1997 or previous years. 5.5 LITIGATION PROCEEDINGS AND AGREEMENTS WITH GOVERNMENTAL ENTITIES. (a) The Company is not engaged as a defendant in any legal or other proceedings before any court, administrative agency or other Governmental Entity except as is shown on Exhibit 5.5. Except as set forth on Exhibit 5.5, the Company is not aware of any "threatened or pending litigation" (within the meaning of Paragraph 5 of the American Bar Association Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information adopted December 8, 1975) against the Company. The Company is not subject to any agreement, order, writ, injunction or decree of any federal, state or local court, out of a proceeding involving the Company or any of its business or properties except as described in Exhibit 5.5. The Company has not been served with notice of, nor, to best of the Company's knowledge is it currently under investigation with respect to, any violation of federal, state or local law or administrative regulation. Except as set forth on Exhibit 5.5, there is no (i) outstanding judgment, order, writ, injunction or decree, stipulation or award of any Governmental Entity or by arbitration, against, or to the knowledge of the Company, affecting the Company or its assets or business that (a) has had or may have a material adverse effect on the assets, liabilities, business, financial condition or results of operations of the Company, (b) requires any payment by, or excuses a material obligation of a third party to make any payment to, the Company, or (c) has the effect of prohibiting any business practice of, or the acquisition, retention or disposition of property by, the Company; or (ii) legal, administrative, arbitration, investigatory or other proceeding pending or, to the best knowledge of the Company that has been threatened, or which the Company has reason to believe may be threatened, against or affecting any director, officer, employee, agent or representative of the Company, in connection with which any such person has or may have rights to be indemnified by the Company. 37 (b) Except as set forth in Exhibit 5.5, the Company is not a party to, or otherwise subject to, any agreement or memorandum of understanding with or order of any Governmental Entity charged with the supervision or regulation of bank holding companies or banks or engaged in the insurance of bank deposits, that restricts the conduct of its business, or in any manner relates to its capital adequacy, its credit or investment policies or its management. 5.6 PERFORMANCE OF OBLIGATIONS. Except as set forth in Exhibit 5.6, the Company has performed in all respects all of obligations required to be performed by it to date and is not in default under or in breach of any term or provision of any covenant, contract, lease, indenture or any other agreement to which the Company is a party or is subject or is otherwise bound, and no event has occurred which, with the giving of notice or the passage of time or both, would constitute such default or breach, where such default or breach would have a material adverse effect on the financial condition, results of operations, or business of the Company. No party with whom the Company has an agreement which is material to the financial condition, results of operations or business of the Company is in default thereunder. 5.7 BROKERS. Except as indicated in Exhibit 5.7, no agent, broker, investment banker, person or firm acting on behalf or under authority of the Company (except for any payments for fairness opinions as required in Section 11.14) is or will be entitled to any broker's or finder's fee or any other commission or similar fee directly or indirectly in connection with any of the transactions contemplated by this Agreement. 5.8 INSURANCE. The Company has in full force and effect policies of insurance and bonds with respect to its assets and business and against such casualties and contingencies and of such amounts, types and forms which in the judgment of the Company are adequate or appropriate to cover its assets and businesses as set forth in Exhibit 5.8. Set forth in Exhibit 5.8 is a schedule of all policies of insurance (other than title or credit insurance) carried and owned by the Company, showing the name of the insurance or bonding company, a summary of the coverage, the amounts, the deductible features, the annual premiums and the expiration dates. If any such policy or bond is changed, terminated or modified following the date of this Agreement, such termination, change or modification shall be promptly disclosed to the Bank in writing. The Company is not in default under any such policy of insurance or bond such that it could be canceled, and all material claims thereunder have been filed in a timely fashion. The Company has filed claims with or given notice of claim to its insurers or bonding companies with respect to all material matters and occurrences for which it believes it has coverage. 5.9 MATERIAL ADVERSE CHANGES. Except as specifically required, permitted or effected by this Agreement, and except as set forth on Exhibit 5.9 38 since inception there has not been, occurred or arisen any of the following (whether or not in the ordinary course of business unless otherwise indicated)("Material Adverse Changes"): (a) Any materially adverse change in any of the assets, liabilities, permits, methods of accounting or accounting practice, or manner of conducting business, of the Company or any other event or development that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, Permits, business, financial condition, or results of operations of the Company or which should be disclosed in order to make the Company Financial Statements not misleading. (b) Any damage, destruction or other casualty loss (whether or not covered by insurance) that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Company or that may involve a loss of more than $10,000 in excess of applicable insurance coverage; (c) Any amendment, modification or termination of any existing, or entry into any new, Material Contract or Permit that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Company; (d) Any disposition by the Company of an asset the lack of which has had or may reasonably be expected to have a material adverse effect on the business, financial condition, or results of operations of the Company; or (e) Any direct or indirect redemption, purchase or other acquisition by the Company of any Equity Securities or any declaration, setting aside or payment of any dividend or other distribution on or in respect of the Company Stock whether consisting of money, other personal property, real property or other things of value. 5.10 COMPLIANCE WITH LAWS AND REGULATIONS. (a) Except as set forth in Exhibit 5.10, the Company is not in default under or in breach of any law, ordinance, rule, regulation, order, judgment or decree applicable to it promulgated by any Governmental Entity having authority over it, where such default or breach would have a material adverse effect on its financial condition, results of operations, or business. (b) To the best of its knowledge, the Company has conducted in all material respects its businesses in accordance with all applicable federal, foreign, state and local laws, regulations and orders, including without limitation disclosure, usury, equal credit opportunity, equal employment, fair credit reporting, antitrust, 39 licensing and other laws, regulations and orders, and the forms, procedures and practices used by the Company are in compliance with such laws, regulations, and orders, except for such violations or noncompliance as will not have a material adverse effect on the financial condition, results of operations, or business of the Company. 5.11 AUTHORIZATION. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by the Board of Directors of the Company. Assuming due and proper execution and delivery of this Agreement by the Bank, this Agreement constitutes a legal, valid and binding agreement of the Company in accordance with its respective terms, except as the enforceability hereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable. Subject to obtaining requisite approval of this Agreement by the shareholders of the Company, if required, the Company has full corporate power and authority to perform its obligations under this Agreement and the transactions contemplated hereby. 5.12 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein, including the Merger, and compliance by the Company with any provision hereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 5.12 any material agreement, instrument or obligation to which it is a party or by which the property of the Company is bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, the Commissioner and any other required Governmental Entity, and as set forth in Exhibit 5.12, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets or the Company; or (d) violate the Charter Documents or any Rules to which the Company is subject. 5.13 REPORTS AND FILINGS. Since inception, the Company has filed all reports, returns, registrations and statements (such reports and filings referred to as "the Company Filings"), together with any amendments required to be made with respect thereto, that were required to be filed with (a) the FRB, (b) the Commissioner and (c) any other applicable Governmental Entity, including taxing authorities, except where the failure to file such reports, returns, registrations and statements has not had and is not reasonably expected to have a material adverse effect on the business, financial condition, or results of operations of the Company. No administrative actions have been taken or orders issued in connection with the Company Filings. As of their respective dates, each of the Company Filings complied in all material respects with all Rules enforced or promulgated by the Governmental Entity with which it was filed (or was amended so as to be so 40 promptly following discovery of any such noncompliance). Any financial statement contained in any of the Company Filings that was intended to present the financial position of the Company fairly and was prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved. 5.14 (reserved) 5.15 UNDISCLOSED LIABILITY. The Company has no liabilities or obligations, either accrued or contingent, which are in excess of Ten Thousand Dollars ($10,000) individually or in the aggregate, which have not been: (i) reflected or disclosed in the Company Financial Statements; (ii) incurred since inception, in the ordinary course of business; or (iii) disclosed on Exhibit 5.15 or any other exhibit to this Agreement. To the best of the Company's knowledge and the knowledge of its officers and directors, after due investigation, there is no basis for the assertion against the Company of any liability, obligation or claim that is likely to result in or cause any material adverse change in the business or financial condition of the Company, taken as a whole, which is not fairly reflected in the Company Financial Statements, or otherwise disclosed on Exhibit 5.15 hereto. 5.16 ACCURACY OF INFORMATION FURNISHED. Except as to any statements or information which shall include projections or forecasts, none of the statements or information made or contained in any of the covenants, representations or warranties of the Company set forth in this Agreement or in any of the schedules, exhibits, lists, certificates or other documents furnished herewith taken as a whole contains any untrue statement of a material fact required to be stated herein or therein or necessary to make the statements or information contained herein or therein, in light of the circumstances in which they were made, not misleading. As to any such information or statements which include projections or forecast, such information or statements are based upon assumptions believed by the Company to be reasonable. 5.17 AUTHORITY OF PCBG MERGER CORPORATION. The execution and delivery by PCBG Merger Corporation of the Agreement of Merger and, subject to the requisite approval of the shareholder of PCBG Merger Corporation, the consummation of the transactions completed thereby will be duly and validly authorized by all necessary corporation action on the part of PCBG Merger Corporation, and the Agreement of Merger will be, upon execution by the parties 41 thereto, a valid and binding obligation of PCBG Merger Corporation, enforceable in accordance with its terms, except as the enforceability thereof may be limited by bankruptcy, insolvency, moratorium or other similar laws affecting the rights of creditors generally, by general equitable principles. Except as set forth in Exhibit 5.17, neither the execution and delivery by PCBG Merger Corporation of the Agreement of Merger, nor the consummation of the transaction contemplated therein, nor compliance by PCBG Merger Corporation with any of the provisions thereof will (a) conflict with or result in a breach of any provision of its Charter Documents; (b) except for approval by the shareholder of PCBG Merger Corporation and the prior approval of the Commissioner or the FRB, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of PCBG Merger Corporation; or (d) subject to obtaining the Consents referred to in subsection (b) of this Section 5.17, and the expiration of any waiting period, violate any Rules to which PCBG Merger Corporation is subject. 5.18 CAPITAL OF COMPANY, OFFERING AND COMMITMENTS. As of the date of this Agreement, the Company does not have sufficient capital to consummate the transactions contemplated by this Agreement. The Company intends to conduct the Offering in order to raise sufficient cash capital to carry out the acquisition of the Bank, provide capital for growth and operations of the Company, and the other transactions contemplated by this Agreement. 5.19 REGULATORY APPROVALS. To the best knowledge of the Company, except as described in Section 5.19 of this Agreement, the Company has no reason to believe that it would not receive all required approvals from any Governmental Entity of any application to consummate the transactions contemplated by this Agreement without the imposition of a materially burdensome condition in connection with the approval of any such application. 5.20 STATEMENTS TRUE AND CORRECT. None of the information supplied or to be supplied by the Company for inclusion in the S-1, the S-4 or the Proxy Statement, or incorporated by reference therein, or any other document to be filed with any Governmental Entity in connection with the transactions contemplated hereby will, in the case of the S-1, S-4 and the Proxy Statement (or incorporated by reference therein), contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which such statements are made, not misleading, or, in the case of the S-1 and the S-4, when it becomes effective, be false or misleading with respect to any material fact, or omit to state any material fact necessary in order to make the statements therein not misleading. 5.21 ACCURATE DISCLOSURE. The Company agrees that through the Effective Time of the Merger, each of its reports, and other filings required to be filed with any applicable Governmental Entity will comply in all material respects with all of the applicable statutes, Rules and regulations enforced or promulgated 42 by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any such report, or other filing that is intended to present the financial position of the Company will fairly present the financial position of the Company and will be prepared in accordance with GAAP or RAP consistently applied during the periods involved. Notwithstanding anything to the contrary set forth in this Section 5.21, the Company makes no representation or warranty with respect to any information supplied by the Bank. 5.22 OTHER TRANSACTIONS. The Company has informed the Bank of all other acquisition transactions that the Company is contemplating or reviewing as of the date of this Agreement. 5.23 DUE DILIGENCE. The Company and its representatives have had the opportunity to conduct a due diligence of the Bank, and such due diligence has been shared with the Managing Underwriter. As of December 15, 1998, the Company and its agents have completed a primary review of the financial condition of the Bank, and to the best knowledge of the Company and its agents, no item concerning the financial condition of the Bank has come to the attention of the Company or its agents that would preclude the consummation of the Merger as described herein. ARTICLE VI COVENANTS OF THE BANK The Bank covenants and agrees with the Company as follows: 6.1 BEST EFFORTS. The Bank shall use its best efforts to bring about the satisfaction of the conditions specified in Articles IX and XI hereof. 6.2 CONDUCT OF BUSINESS. Unless the Company shall give its prior consent, which consent will not be unreasonably withheld, or unless otherwise indicated, until the Effective Time, the Bank will: (i) conduct its affairs and business in the usual and ordinary course, generally consistent with past practice, and in accordance with safe and sound practices; (ii) refrain from (a) creating, incurring, or suffering to exist, any encumbrance or restriction of any kind against or in respect of any property or right of the Bank except for such which are not material in amount or nature to the financial condition or results of operations of the Bank, except for a pledge or 43 security interest given in connection with the acceptance of government or public deposits; it being understood that the foregoing shall not be deemed to preclude loans, repurchase or reverse repurchase agreements, securities or other financial transactions incurred in the ordinary course of the Bank's banking business, and (b) borrowing or agreeing to borrow any amount of funds except in the ordinary course of business, or directly or indirectly guaranteeing or agreeing to guarantee any obligations of others except for such which are not material in amount or nature to the financial condition or results of operations of the Bank; (iii) refrain from making or becoming a party to any Material Contract or material commitment, or renewing, extending, amending or modifying any such contract or commitment except for loan and deposit transactions, in the usual and ordinary course of business, consistent with past practice; and refrain from making any loan or other extension of credit, or entering into any commitment to make any loan or other extension of credit, to any Bank director, executive officer or employee or 5% or more shareholder, except in accordance with existing practice or policy; and refrain from extending any lease; (iv) refrain from making any capital expenditures or commitments to do so, except for ordinary repairs and replacements, exceeding $50,000 for any one item or $200,000 for all items in the aggregate; (v) refrain from paying or agreeing to pay any bonus, extra compensation, pension or severance pay, under any pension plan or otherwise, or increasing the rate of compensation paid by the Bank at June 30, 1998, to any officer, director, agent, consultant, or employee (except for raises and bonuses consistent with past practices accrued and paid prior to the Determination Date and except as contemplated by this Agreement), and any such amounts shall be accrued or paid in accordance with GAAP prior to the Determination Date; or agreeing to enter into any employment agreements or hire any officer level staff where such agreements or arrangements cannot be terminated without any liability upon not more than 90 days notice; or agreeing to hire any president of Banklink; (vi) maintain its assets and properties in good condition and repair (ordinary wear and tear excepted) and refrain from selling or otherwise disposing of any of its assets or properties, except in the usual and ordinary course, consistent with prior customary practice, and in accordance with safe and sound practices, and maintain the Bank's present branch operations unless changed by mutual agreement; (vii) refrain from declaring or paying any dividend on or making any other distribution upon, or purchasing or redeeming, any shares of the Bank Stock; 44 (viii) refrain from (a) issuing or selling or obligating itself to issue or sell any shares of the Bank Stock or any other securities or any warrants, rights or options to acquire Bank Stock or other securities, except for the exercise of the Warrant Agreement, (b) effecting a reclassification, recapitalization, split-up, exchange of shares, readjustment or other similar change in or to any capital stock or otherwise reorganize or recapitalize; (ix) refrain from directly or indirectly redeeming, purchasing or otherwise acquiring any Bank Stock or stock of any corporation or any interest in any business enterprise except as it relates to a foreclosure in the usual and ordinary course of its business; (x) refrain from amending its Charter Documents except to the extent as may be required or contemplated by this Agreement; (xi) use its best efforts to preserve its business organization intact and to retain its present officers and employees in a manner consistent with the Bank's other obligations under this Agreement; (xii) use its best efforts to preserve the goodwill of its depositors, customers and those having business relations with it, refrain from materially changing the make-up of the Bank's deposit structure, refrain from amending, modifying, terminating or failing to renew or preserve its business organization, material rights, franchises, Permits, and refrain from taking any action which would jeopardize the continuance of the goodwill of its customers where such action would have a material adverse effect, taken as a whole, on the financial condition, or results of operations of the Bank in a manner consistent with the Bank's other obligations under this Agreement; (xiii) use its best efforts to maintain insurance and bond coverage at least equal to that now in effect on all its properties and all properties for which it is responsible and on its business operations, and carry the same coverage for public liability, personal injury and property damage that is now in effect, except if such insurance and coverage (a) is not available except at extraordinary rates, or (b) is not available except under materially different terms which are inconsistent with those in effect as of the date of this Agreement, and following the receipt of the consent of the Company, renew the Bank's directors and officers liability insurance policy; (xiv) meet its material contractual obligations and not become in default in any material respect on any thereof; (xv) duly observe and conform to lawful requirements applicable to its business in all material respects; 45 (xvi) duly and timely file all reports and returns required to be filed with any federal, state or local Governmental Entity unless any extensions have been duly granted by such authorities; (xvii) refrain from commencing any proceeding to merge, consolidate or liquidate or dissolve (except as contemplated by this Agreement) or obligating itself to do so; (xviii) maintain its books of account and records in the regular manner substantially in accordance with all applicable statutory and regulatory requirements applied on a consistent basis; (xix) except for instituting actions against borrowers of the Bank to collect loans in default, refrain from instituting, settling, or agreeing to any material claim, action or proceeding before any court or Governmental Entity unless not instituting, settling or agreeing to any material claim, action or proceeding would result in a Material Adverse Change to the Bank; (xx) refrain from making its credit underwriting policies, standards or practices applicable to all loans relating to the making of loans and other extensions of credit, or commitments to make loans and other extensions of credit, less stringent than those in effect on the date hereof. The Bank shall not grant or commit to grant, without receiving the Company's Consent, (i) any loan or other extension of credit, including renewals, to an existing customer of the Bank, if such loan or other extension of credit, together with all other credit then outstanding to the same Person and all Affiliates of such Person, would exceed $1,000,000, irrespective of any plans or intentions to sell or participate all or a portion of such loans, on an unsecured basis or $1,500,000 secured by a lien on real estate, cash or readily marketable collateral, as that term is used in section 1220 ET SEQ. of the CFC, (ii) any participation loans purchased or sold, or (iii) any renewals or other extensions of credit to any borrower whose loans or other extensions of credit have been classified by any Governmental Entity. In addition, Bank shall not take any property into Other Real Estate Owned ("OREO"), or sell any OREO property, not in the ordinary course of the Bank's business or not in accordance with the Bank's policy concerning OREO without receiving the Company's Consent. Consent shall be deemed granted if within three Business Days of written notice received by the Company's designee, notice of objection in writing is not received by Bank; (xxi) refrain from making special or extraordinary material payments to any Person other than as contemplated and as disclosed in this Agreement as of the date hereof; (xxii) except for transactions in accordance with safe and sound banking practices, refrain from making any material investments, by 46 purchase of stock or securities, contributions to capital, property transfers, purchases of any property or assets or otherwise, in any other individual, corporation or other entity; (xxiii) advise the Company promptly in writing of any Material Adverse Change known to the Bank in the capital structure, financial condition, results of operations or of any event or condition which with the passage of time is reasonably likely to result in a Material Adverse Change to the Bank, or of any other materially adverse change known to the Bank respecting the business and operations of the Bank, or in the event the Bank determines that the Merger will not be consummated because of any inability to meet the conditions to the performance of the Company set forth in Article XI or of any matter which would make the representations and warranties set forth in Article IV hereof not true and correct in any material respect at the Closing; (xxiv) promptly advise the Company in writing of any event or any other transaction within the Bank's knowledge whereby any person or related group of persons acquires, directly or indirectly, record or beneficial ownership (as defined in Rule 13d3 promulgated by the Exchange Act or control of 5% or more of the outstanding shares of Bank Stock prior to the record date fixed for the Bank shareholders' meeting or any adjourned meeting thereof to approve the transactions contemplated herein; (xxv) charge-off all loans, receivables and other assets, or portions thereof, deemed uncollectible in accordance with GAAP or RAP, applicable law or regulation, or classified as "loss" or as directed by any Governmental Entity; and maintain the allowance for loan losses of the Bank at a level which in the reasonable opinion of the Bank's management is adequate to provide for all known and estimated credit losses on loans and leases outstanding and other inherent risks in the Bank's loan portfolio, but in no case less than the level which in the reasonable opinion of the Bank's management is adequate to provide for all known and reasonably expected losses on assets outstanding in accordance with GAAP and RAP; (xxvi) furnish to the Company, as soon as practicable, and in any event within ten (10) days after it is prepared (except for the reports submitted to the Board of Directors of the Bank, as described in clause (i) below, which shall be furnished to the Company within ten (10) days after the Bank's Board of Directors has reviewed the report), (i) a copy of any report submitted to the Board of Directors of the Bank and access to the working papers related thereto and copies of other operating or financial reports prepared for management of any of their businesses and access to the working papers thereto, provided, however, that the Bank need not furnish the Company communications of the Bank's legal counsel regarding the Bank's rights against and obligations to the Company or its Affiliates under this Agreement, (ii) to the extent permitted by law, copies of all 47 reports, renewals, filings, certificates, statements and other documents filed with or received from the FDIC and/or the Commissioner or any other Governmental Entity, (iii) monthly unaudited statements of condition and statements of operations for the Bank, and quarterly unaudited statements of condition and statements of operations for the Bank and statements of changes in stockholders' equity for the Bank, in each case prepared in a manner consistent with past practice, and (iv) such other reports as the Company may reasonably request relating to the Bank. Each of the financial statements delivered pursuant to this Section 6.2(xxvi), except as stated therein, shall be prepared in accordance with the Bank's normal practices; (xxvii) consistent with the standards set forth in this subsection 6.2 (xxvii), the Bank agrees that through the Effective Time of the Merger, as of their respective dates, (i) each of the Bank Filings will be true and complete in all material respects; and (ii) each of the Bank Filings will comply in all material respects with all of the statutes, rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any of such Bank Filings that is intended to present the financial position of the Bank will be prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved; (xxviii) maintain reserves for contingent liabilities in accordance with GAAP and RAP; (xxix) promptly notify the Company of the filing of any material litigation, governmental or regulatory action, or similar proceeding or notice of any claims against the Bank or any of its assets; (xxx) Except for the Donohoe litigation previously described or those matters described in Exhibit 4.11(b), conduct good faith settlement negotiations, and, with the written consent of the Company, settle when deemed prudent by the Parties, of all existing or threatened litigation as specified in Exhibits 4.7, or for any new litigation filed or threatened from the date hereof to the Closing Date; (xxxi) except in the ordinary course of business, refrain from canceling or accelerating any material indebtedness owing to the Bank or any claims which the Bank may possess or waive any material rights of substantial value; (xxxii) refrain from selling or otherwise disposing of any Real Property or any material amount of any tangible or intangible personal property 48 other than properties acquired in foreclosure or otherwise in the ordinary collection of indebtedness to the Bank; (xxxiii) refrain from foreclosing upon or otherwise taking title to or possession or control of any real property without first obtaining a phase one environmental report thereon which indicates that the property is free of pollutants, contaminants or hazardous or toxic waste materials; provided, however, that the Bank shall not be required to obtain such a report with respect to single family, non-agricultural residential property of one acre or less to be foreclosed upon unless it has reason to believe that such property might contain any such waste materials or otherwise might be contaminated; (xxxiv) refrain from committing any act or failing to do any act which will cause a breach of any agreement, contract or commitment and which will have a material adverse effect on the Bank's business, financial condition, or results of operations; and (xxxv) duly observe and conform, and Banklink Corporation shall duly observe and conform, to all compliance requirements for Year 2000 safety and soundness issues. For purposes of this Section 6.2, the Company shall be deemed to have given its consent to any action which is contrary to any specified covenant set forth in this Section if, within five (5) Business Days, or three (3) Business Days for loans, after actual receipt by the Company of written notice from the Bank of the Bank's intention to act contrary to any of the specified covenants set forth in this Section, the Company shall not have delivered to the Bank written objection to any such action. 6.3 ACCESS TO INFORMATION. (a) As long as the transaction contemplated herein has not been terminated, the Bank will afford the Company, its representatives, counsel, accountants, agents and employees including the underwriter selected to assist in the issuance of the common stock contemplated in Section 9.1(iii) and its counsel (collectively "Company Representatives"), access during normal business hours to all of its business, operations, properties, personnel books, files and records and will do everything reasonably necessary to enable the Company and the Company Representatives to make a complete examination of the financial statements, books, records, loans and leases, operating reports, audit reports, contracts and documents, and all other information with respect to assets and properties of the Bank and the condition thereof, and to update such examination at such intervals as the Company shall deem appropriate. Such access shall include reasonable access by the Company and the Company Representatives to auditors' work papers with respect to the business and properties of the Bank, other than (i) books, records and documents covered by the attorney-client privilege, or which are attorneys' work product, and (ii) books, 49 records and documents that the Bank is legally obligated to keep confidential. Such examination shall be conducted in cooperation with the officers of the Bank and in such a manner as to minimize, to the extent possible consistent with the conducting of a comprehensive examination, any disruption of, or interference with, the normal business operations of the Bank. No such examination, however, shall constitute a waiver or relinquishment on the part of the Company to rely upon the representations and warranties made by the Bank herein or pursuant hereto; provided, that the Company shall disclose any fact or circumstance it may discover which it believes renders any representation or warranty made by the Bank hereunder incorrect in any respect. The Company will hold in strict confidence all documents and information concerning the Bank so obtained (except to the extent that such documents or information are a matter of public record or require disclosure in the Proxy Statement or as may be necessary for the accomplishment of the purposes of such examination) and, if the transactions contemplated herein are not consummated, such confidence shall be maintained and all such documents including all copies shall be returned to the Bank. (b) As long as the transaction contemplated hereunder has not been terminated, (i) one Company Representative, selected by the Company in its sole discretion, shall be invited by the Bank to attend all regular and special Board of Directors' meetings of the Bank from the date hereof until the Effective Time of the Merger and (ii) one representative of Sutro shall be invited by the Bank to attend all regular and special Board of Director meetings of the Bank from the date hereof until the Effective Time of the Merger for the purpose of discussing the condition of the market for the Offering. The Bank shall inform the Company of such Board of Director meeting at least five (5) days in advance of such meeting; provided, however, that the attendance of such Company Representative shall not be permitted at any meeting, or portion thereof, for the sole purpose of discussing the transactions contemplated by this Agreement on the obligations of the Bank under this Agreement. 6.4 FINANCIAL STATEMENTS. In the event the following have not been previously delivered prior to the date hereof, within three (3) days of receipt from Arthur Andersen LLP, the Bank will deliver to the Company a copy of the audited Statements of Financial Condition of the Bank as of December 31, 1998; Statements of Earnings, Stockholders' Equity and Cash Flows for the year ended December 31, 1998, the related notes and related opinions thereon of Arthur Andersen LLP, with respect to such financial statements (the "1998 Audited Bank Financial Statements"). The Bank will furnish to the Company with a true and correct copy of the management letter or other letter delivered to the Bank by Arthur Andersen LLP in connection with the 1998 Audited Bank Financial Statements relating to any review of the internal controls of the Bank by Arthur Andersen LLP. The 1998 Audited Bank Financial Statements will: (i) present fairly the financial condition and results of operations of the Bank as of and for the dates or periods covered thereby in accordance with generally accepted accounting 50 principles consistently applied throughout the periods involved; (ii) be based on the books and records of the Bank; (iii) contain and reflect reserves for all material accrued liabilities and for all reasonably anticipated losses, and set forth adequate reserves for loan losses and other contingencies, to the extent required by GAAP; and (iv) none of the 1998 Audited Bank Financial Statements will contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading under GAAP. 6.5 NO SOLICITATION. (a) The Bank shall not, and will cause each of its officers, directors, employees, agents, legal and financial advisors and Affiliates not to, directly or indirectly, make, solicit, encourage, initiate or, except as permitted in this Section 6.5, enter into any agreement or agreement in principle, or announce any intention to do any of the foregoing, concerning the acquisition of the Bank, or substantially all of the Bank's business and properties or a majority of Bank Stock or debt securities, whether by purchase, merger (other than by the Company), purchase of assets, tender offer or otherwise (an "Alternative Transaction"). (b) The Bank shall not, and will cause each of its officers, directors, legal and financial advisors, agents and Affiliates not to, directly or indirectly, participate in any negotiations or discussions regarding, or furnish any information with respect to, or otherwise cooperate in any way in connection with, or assist or participate in, facilitate or encourage, any effort or attempt to effect or seek to effect, any Alternative Transaction with or involving any Person other than the Company, unless the Bank shall have received an unsolicited written offer from a Person other than the Company to effect an Alternative Transaction and the Board of Directors of the Bank is advised in writing by outside legal counsel that in the exercise of the fiduciary obligations of the Bank's Board of Directors such information should be provided to or such discussions or negotiations undertaken with the Person submitting such unsolicited written offer. (c) The Bank will promptly communicate to the Company the receipt of any proposal with respect to any Alternative Transaction, and will keep the Company informed as to the status of any such proposal; PROVIDED, HOWEVER, that the Bank shall not be required to disclose any matters which, in the written opinion of outside legal counsel, may not be disclosed in the exercise of the fiduciary obligations of the Bank's Board of Directors. 6.6 CERTAIN LOANS AND OTHER EXTENSIONS OF CREDIT. The Bank will promptly inform the Company of the amounts and categories of any loans, leases or other extensions of credit that have been criticized special mention or classified by any bank regulatory authority or deemed by the Bank to require special attention pursuant to its internal policies (collectively "Classified Credits"). In addition, the Bank will furnish to the Company, as soon as practicable, and in any event within 51 seven days after receipt by the Bank's Board of Directors, schedules including the following: (a) Classified Credits; (b) nonaccrual credits; (c) accrual exception credits that are delinquent 90 or more days and have not been placed on nonaccrual status; (d) participating loans and leases, stating, with respect to each, whether it is purchased or sold, the loan or lease type, and the originating unit; (e) loans or leases (including any commitments) by the Bank to any director, officer or shareholder holding 5% or more of the capital stock of such party; (f) letters of credit; (g) loans or leases charged-off during the previous month; (h) loans or leases written down during the previous month; and (i) OREO or assets owned, stating with respect to each its type. 6.7 BREACHES. The Bank shall, in event it becomes aware of the impending or threatened occurrence of any event or condition which would cause or constitute a breach (or would have caused or constituted a breach had such event occurred or been known prior to the date hereof) of any of its representations or agreements contained or referred to herein, give prompt written notice thereof to the Company and, without limiting the Company's rights under paragraph 14.1(a)(ii), the Bank shall use its best efforts to prevent or promptly remedy the same. 6.8 SHAREHOLDER APPROVAL. As soon as practicable, the Company and the Bank shall prepare the S-4 and the proxy statement ("Proxy Statement") and take all action necessary in accordance with applicable Rules and its Charter Documents to submit the Agreement and the transactions contemplated hereby to its shareholders for approval by April 1, 1999, or as soon thereafter as is reasonably possible. In connection with such submission, subject to its fiduciary obligations specified in Section 6.5(b) the Bank's Board of Directors shall recommend shareholder approval of all the matters referred to in this Section 6.8 and the Bank shall use its best efforts to obtain such shareholder approval. 6.9 COMPLIANCE WITH RULES. The Bank shall comply with the requirements of all applicable Rules, the noncompliance with which would materially and adversely affect the assets, liabilities, business, financial condition, results of operations or prospects of the Bank. 6.10 TERMINATION OF THE BANK STOCK OPTION PLAN AND AGREEMENTS. The Bank will take all steps necessary to cause the Bank Stock Option Plan to be terminated as of or prior to the Effective Time of the Merger, will grant no additional options under said plan prior to the Effective Time of the Merger, and the Bank will not permit any options to be exercised as of or prior to the Effective Time of the Merger. 6.11 OFFICERS AND EMPLOYEES. Following the Closing Date, the Company and the Bank will agree to consolidate and/or reduce certain back office and administrative functions, and other overhead, of the Bank in order to reduce 52 Bank expense. Other than officers with employment contracts, the Bank will use its best efforts to cause each officer and employee of the Bank to indicate in writing to the Company that such officers and employees will agree to the Bank's employment policies, procedures and handbook, acknowledge his or her at-will employment status while employed by the Bank, and acknowledge his or her salary or compensation and title while employed by the Bank, in the form similar to that attached as EXHIBIT 6.11(a). The Company also will honor all Bank Employment Agreements specified in EXHIBIT 4.11(a). The Bank will cancel by the Closing Date the keyman life insurance policy and the disability insurance policy for Mr. Jaqua. 6.12 TERMINATION OF CONTRACTS AND ACCRUAL OF LIABILITIES. Upon determination by the Company, the Bank shall obtain the termination of any contracts, commitments or Understanding as defined in Section 4.12(v), and pay or accrue as of the Closing Date for any termination fees, for the future purchase of materials, supplies, services, merchandise or equipment, the price of which exceeds $20,000. The Bank shall also cancel the consulting contract with Mr. Cockrum effective as of the Closing Date. Before the Determination Date, the Bank shall have paid, or set-up adequate accruals for the payment of, all expenses, including, but not limited to, professional fees as outlined in Section 11.18, and expenses as outlined in Section 13.1, but only to the extent that such fees and expenses shall be chargeable to the after tax net income of the Bank up to the Determination Date in accordance with GAAP. 6.13 EXECUTION OF AGREEMENT OF MERGER. As soon as possible after organization of PCBG Merger Corporation, subject to receipt of any and all necessary approvals and Permits by any Governmental Entity and approval by the Bank's shareholders, the Bank shall execute the Agreement of Merger and any and all related documents. 6.14 ACCOUNTANTS. Promptly upon request of the Company, the Bank will ask its accountants to permit the Company or the Company Representatives to review and examine the work papers relating to the Audited Bank Financial Statements for the years ended December 31, 1995, 1996, 1997 and 1998, and the Bank will permit such accountants to discuss with the Company any matter relating to the audits of the Bank. In addition, the Bank will make available to the Company copies of each management letter or other letter delivered to the Bank by its accountants in connection with such financial statements or relating to any review by its accountants of the internal controls of the Bank since January 1, 1995, unless previously provided to the Company and the Bank has instructed its accountants to make available for inspection by the Company or the Company Representatives all reports and working papers produced or developed by its accountants in connection with their examination of such financial statements, as well as all such reports and working papers for any periods for which any tax of the party has not been finally determined or barred by applicable statutes of limitation. 53 6.15 CORPORATE ACTION. The Bank shall take or cause to be taken all necessary corporate action required to carry out the transactions contemplated in this Agreement. 6.16 REGULATORY APPROVALS. Promptly following execution of this Agreement, the parties hereto shall prepare, submit and file, or cause to be prepared, submitted and filed, all applications for approvals and consents as may be required of any of them, respectively, by applicable law and regulations with respect to the transactions contemplated by this Agreement, including without limitation any and all applications required to be filed with the Commissioner, the FRB, the FDIC and such other Governmental Entity as the Company or the Bank may reasonably believe necessary. Each party shall cooperate with the other in the preparation of all of such applications and will furnish promptly upon request all documents, information, financial statements or other materials as may be required in order to complete such applications. Each party shall afford the other a reasonable opportunity to review all such applications (except confidential portions thereof) and all amendments and supplements thereto before filing. The Company and the Bank each covenant and agree that any and all information furnished by it to the other for inclusion in such applications will not contain any untrue statement of a material fact and will not omit to state any material fact required to be stated therein or necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. 6.17 NECESSARY CONSENTS. In addition to the regulatory approvals referred to in Section 6.16, the parties hereto shall each apply for and diligently seek to obtain all other third party consents or approvals which may be necessary for the consummation of the Merger, including, without limitation, the written consent of any lessors of real and personal property which property cannot be assigned without the written consent of the other such lessors ("Third Party Consent"). 6.18 FURTHER ASSURANCES. The parties agree that from time to time, whether prior to, at or after the Effective Time of the Merger, they will execute and deliver such further instruments of conveyance and transfer and take such other action as may reasonably be expected to consummate the transactions contemplated hereby. The Company and the Bank each agrees to take such further action as may reasonably be requested by the other in order to consummate the transactions contemplated by this Agreement and that are not inconsistent with the other provisions hereof, including compliance with all of the terms of Article II. 6.19 BANK EMPLOYEE BENEFITS. Upon the mutual agreement of the Bank and the Company, the Bank shall cause all Employee Plans of the Bank to be terminated except as otherwise provided by applicable labor laws as of the Effective Time of the Merger. 54 6.20 ENVIRONMENTAL REPORTS. Except for the Banklink leases, the 1600 Florida Avenue lease, and foreclosed OREO, and except as otherwise agreed to in writing by the Company, the Bank shall provide to the Company, as soon as reasonably practical, but not later than 45 days after the date hereof, a report of a phase one environmental investigation on all Real Property owned, leased or operated by Bank as of the date hereof (other than space in retail and similar establishments leased by the Bank for automatic teller machines) and within ten days after the acquisition or lease of any Real Property acquired or leased by the Bank after the date hereof (other than space in retail and similar establishments leased or operated by the Bank for automatic teller machines), except as otherwise provided in Section 6.2(xxxiii). If required by the phase one investigation in the Company's reasonable opinion, the Bank shall provide to the Company a report of a phase two investigation on the Real Property or Real Properties requiring such additional study. The Company shall have 15 business days from the receipt of any such phase two investigation report to notify the Bank of any objection to the contents of such report. If the cost of taking all remedial and corrective actions and measures (i) required by applicable law, or (ii) recommended or suggested by such report or reports or prudent in light of serious life, health or safety concerns, in the aggregate, is in excess of the sum of Three Hundred Thousand Dollars ($300,000) as reasonably estimated by an environmental expert retained for such purpose by the Company and reasonably acceptable to the Bank, or if the cost of such actions and measures cannot be so reasonably estimated by such expert to be, in the aggregate, $300,000 or less with any reasonable degree of certainty, the Company shall have the right to terminate the Agreement pursuant to Article IV, Section 14.1(e) hereof, for a period of 10 business days following receipt of such estimate or indication that the cost of such actions and meaures. 6.21 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of the Agreement of Merger and the consummation of the transactions contemplated therein, and compliance by the Bank with any provision thereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 6.21 any material agreement, instrument or obligation to which the Surviving Bank will become a party or by which the property of the Surviving Bank will become bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, the FDIC and the Commissioner and as set forth in Exhibit 6.21, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of the Surviving Bank; or (d) violate the Charter Documents or any Rules to which the Surviving Bank is subject. 6.22 THE OFFERING. The Bank will assist the Company in connection with the preparation of the offering materials for the issuance of the Company Stock contemplated by this Agreement, and such assistance will include, but not necessarily be limited to, the preparation or provision, as appropriate, of 55 information concerning the business, properties and personnel of the Bank needed in connection with the issuance of the Company Stock and the closing of the Offering, as well as any and all comfort letters from Arthur Andersen LLP , and any and all necessary opinions from Gary Steven Findley & Associates, with respect to the Offering as specified by the Underwriters. Such information to be supplied by the Bank will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not intentionally misleading. 6.23 S-4, PROXY STATEMENT AND THE OFFERING. The Company and the Bank will prepare the S-4 and the Proxy Statement, and the Bank will assist the Company in connection with preparation of the S-1, contemplated by this Agreement, and such preparation and assistance will include, but not necessarily be limited to, the preparation or provision, as appropriate, of information concerning the business, properties and personnel of the Bank needed in connection with the issuance of the Company Stock, the S-4 and the Proxy Statement and the closing of the Merger. Such information to be prepared by the Bank including any and all information furnished by the Bank for inclusion in all applications and statements filed with the appropriate regulatory authorities for approval of, or consent to, the Merger will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. 6.24 PUBLICITY. The initial press release announcing this Agreement shall be a joint press release and thereafter the Company and the Bank shall consult with each other in issuing any press releases or otherwise making public statements with respect to the transactions contemplated hereby and in making any filings with any Governmental Entity or with any national securities exchange with respect thereto. If any party hereto, on the advice of counsel, determines that a disclosure is required by law, it may make such disclosure without the consent of the other parties, but only after affording the other party a reasonable opportunity to review and comment upon the disclosure. The parties hereby agree that all public statements after the initial press release announcing this Agreement referring to the Bank shall be made by Mr. James B. Jaqua, and all public statements made after the initial press release announcing this Agreement referring to the Company shall be made by Mr. E. Lynn Caswell, and both parties agree that all public statements shall be made by mutual agreement with consultation with the Managing Underwriter. 6.25 AFFILIATES AND FIVE PERCENT SHAREHOLDER AGREEMENTS. Within thirty (30) days of the execution of this Agreement, (a) the Bank shall deliver to the Company a letter identifying all persons who are then "affiliates" of the Bank for purposes of Rule 145 under the Securities Act and (b) the Bank shall advise the persons identified in such letter of the resale restrictions imposed by applicable 56 securities laws and shall use reasonable efforts to obtain from each person identified in such letter a written agreement substantially in the form attached hereto as Exhibit 6.25. The Bank shall use reasonable efforts to obtain from any person who becomes an affiliate of the Bank after the Bank's delivery of the letter referred to above, and on or prior to the date of the Bank's Shareholders' Meeting to approve this Agreement, a written agreement substantially in the form attached as Exhibit 6.25 hereto as soon as practicable after obtaining such status. At least 10 Business Days prior to the filing of the S-4, the Bank shall use its best efforts to cause each person or group of persons who holds more than five percent (5%) of Bank Stock (regardless of whether such person is an "affiliate" under Rule 145) to deliver to the Company's accountants and Knecht & Hansen, a letter stating that such shareholder(s) has no present plan or intention to dispose of Bank Stock and committing that such shareholder(s) will not dispose of Bank Stock in a manner to cause a violation of the "continuity of shareholder interest" requirements of Treasury Regulation 1.368-1. ARTICLE VII COVENANTS OF THE COMPANY The Company covenants and agrees with the Bank as follows: 7.1 BEST EFFORTS. The Company shall use its best efforts to bring about the satisfaction of the conditions specified in Articles IX and X hereof. 7.2 CONDUCT OF BUSINESS. Unless the Bank shall give its prior consent, which consent will not be unreasonably withheld, or unless otherwise indicated, until the Effective Time, the Company will: (i) conduct its affairs and business in the usual and ordinary course, generally consistent with past practice, and in accordance with safe and sound practices; (ii) refrain from amending its Charter Documents except to the extent as may be required or contemplated by this Agreement; (iii) use its best efforts to preserve its business organization intact and to retain its present officers and employees in a manner consistent with the Company's other obligations under this Agreement; (iv) use its best efforts to preserve the goodwill of those having business relations with the Company, refrain from amending, modifying, terminating or failing to renew or preserve its business organization, material rights, franchises, Permits, and refrain from taking any action which would jeopardize the continuance of the goodwill of its customers where such action would have, taken 57 as a whole, a material adverse effect on the financial condition, or results of operations of the Company in a manner consistent with the Company's other obligations under this Agreement; (v) duly and timely file all reports and returns required to be filed with any federal, state or local Governmental Entity unless any extensions have been duly granted by such authorities; (vi) maintain its books of account and records in the regular manner substantially in accordance with all applicable statutory and regulatory requirements applied on a consistent basis; (vii) advise the Bank promptly in writing of any material adverse change known to the Company in the capital structure, financial condition, results of operations, or of any event or condition which with the passage of time is reasonably likely to result in a material adverse change in the capital structure, financial condition or results of operations of the Company, or in the event the Company determines that the Merger will not be consummated because of any inability to meet the conditions to the performance of the Bank set forth in Article X or of any matter which would make the representations and warranties set forth in Article V hereof not true and correct in any material respect at the Closing; (viii) the Company agrees that through the Effective Time of the Merger, as of their respective dates, (i) each of the Company Filings will be true and complete in all material respects; and (ii) each of the filings with any regulatory agency will comply in all material respects with all of the statutes, rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any of such Company Filings that is intended to present the financial position of the entities or entity to which it relates will fairly present the financial position of such entities or entity and will be prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved; For purposes of this Section 7.2, the Bank shall be deemed to have given its consent to any action which is contrary to any specified covenant set forth in this Section if, within five (5) Business Days, after actual receipt by the Bank of written notice from the Company of the Company's intention to act contrary to any of the specified covenants set forth in this Section, the Bank shall not have delivered to the Company written objection to any such action. 7.3 ACCESS TO INFORMATION. The Company will afford the Bank, its representatives, counsel, accountants, agents and employees (collectively "Bank 58 Representatives"), access during normal business hours to all of its business, operations, properties, books, files and records and will do everything reasonably necessary to enable the Bank and the Bank Representatives to make a complete examination of the financial statements, books, records, loans and leases, operating reports, audit reports, contracts and documents, and all other information with respect to assets and properties of the Company and the condition thereof, and to update such examination at such intervals as the Bank shall deem appropriate. Such access shall include reasonable access by the Bank and the Bank Representatives to auditors' work papers with respect to the business and properties of the Company, other than (i) books, records and documents covered by the attorney-client privilege, or which are attorneys' work product, and (ii) books, records and documents that the Company is legally obligated to keep confidential. Such examination shall be conducted in cooperation with the officers of the Company and in such a manner as to minimize, to the extent possible consistent with the conducting of a comprehensive examination, any disruption of, or interference with, the normal business operations of the Company. No such examination, however, shall constitute a waiver or relinquishment on the part of the Bank to rely upon the representations and warranties made by the Company herein or pursuant hereto; provided, that the Bank shall disclose any fact or circumstance it may discover which it believes renders any representation or warranty made by the Company hereunder incorrect in any respect. The Bank will hold in strict confidence all documents and information concerning the Company so obtained (except to the extent that such documents or information are a matter of public record or require disclosure in the Proxy Statement or as may be necessary for the accomplishment of the purposes of such examination) and, if the transactions contemplated herein are not consummated, such confidence shall be maintained and all such documents including all copies shall be returned to the Company. 7.4 BREACHES. The Company shall, in event it becomes aware of the impending or threatened occurrence of any event or condition which would cause or constitute a breach (or would have caused or constituted a breach had such event occurred or been known prior to the date hereof) of any of its representations or agreements contained or referred to herein, given prompt written notice thereof to the Bank and, without limiting the Bank's rights under paragraph 14.1(a)(ii), the Company shall use its best efforts to prevent or promptly remedy the same. 7.5 COMPLIANCE WITH RULES. The Company shall comply with the requirements of all applicable Rules, the noncompliance with which would materially and adversely affect the assets, liabilities, business, financial condition, or results of operations of the Company taken as a whole. The Company shall also comply with all securities statutes, rules and regulations, whether federal or state, in connection with the Offering. Except for information supplied by the Bank pursuant to Section 6.22, the information contained in the Offering disclosure documents shall not contain any untrue statement of a material fact or omit to 59 state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. 7.6 CORPORATE ACTION. The Company shall take or cause to be taken all necessary corporate action required to carry out the transactions contemplated in this Agreement and the Agreement of Merger, including without limitation, all necessary action required to organize and fund PCBG Merger Corporation. 7.7 REGULATORY APPROVALS. Promptly following execution of this Agreement, the parties hereto shall prepare, submit and file, or cause to be prepared, submitted and filed, all applications for approvals and consents as may be required of any of them, respectively, by applicable law and regulations with respect to the transactions contemplated by this Agreement, including without limitation any and all applications required to be filed with the Commissioner, the FRB, the FDIC and such other Governmental Entity as the Company or the Bank may reasonably believe necessary. Each party shall cooperate with the other in the preparation of all of such applications and will furnish promptly upon request all documents, information, financial statements or other materials as may be required in order to complete such applications. Each party shall afford the other a reasonable opportunity to review all such applications (except confidential portions thereof) and all amendments and supplements thereto before filing. The Company and the Bank each covenant and agree that any and all information furnished by it to the other for inclusion in such applications will not contain any untrue statement of a material fact and will not omit to state any material fact required to be stated therein or necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. 7.8 NECESSARY CONSENTS. In addition to the regulatory approvals referred to in Section 7.7, the parties hereto shall each apply for and diligently seek to obtain all other third party consents or approvals which may be necessary for the consummation of the Merger, including, without limitation, the written consent of any lessors of real and personal property which property cannot be assigned without the written consent of the other such lessors ("Third Party Consent"). 7.9 FURTHER ASSURANCES. The parties agree that from time to time, whether prior to, at or after the Effective Time of the Merger, they will execute and deliver such further instruments of conveyance and transfer and take such other action as may reasonably be expected to consummate the transactions contemplated hereby. The Company and the Bank each agree to take such further action as may reasonably be requested by the other in order to consummate the transactions contemplated by this Agreement and that are not inconsistent with the other provisions hereof, including compliance with the terms of Article II. 7.10 (reserved). 60 7.11 (reserved). 7.12 INDEMNIFICATION AND INSURANCE. (a) The Company will cause the Bank to maintain in effect policies of directors' and officers' liability insurance (with such coverage, terms and conditions as are no less advantageous than the insurance presently maintained by the Bank with respect to the officers and directors)with respect to all matters arising from facts or events which occurred before the Effective Time of the Merger, and for a three (3) year period thereafter, for which the Bank would have had an obligation to indemnify its directors and officers. (b) If the Company or any of its successors or assigns (i) shall consolidate with or merge into any other corporation or entity and shall not be the continuing or surviving corporation or entity of such consolidation or merger or (ii) shall transfer all or substantially all of its properties and assets to any individual, corporation or other entity, then and in each such case, the Company shall take no action to impair the rights provided in this Section 7.12. 7.13 EXECUTION OF AGREEMENT OF MERGER. As soon as practicable after the organization of PCBG Merger Corporation, the Company as the sole shareholder of PCBG Merger Corporation, shall approve the Merger and shall cause PCBG Merger Corporation to execute the Agreement of Merger. 7.14 THE OFFERING. (a) The Company intends to conduct the Offering in order to raise sufficient cash capital to complete the acquisition of the Bank, provide capital for growth and operations of the Company, and to otherwise carry out the transaction contemplated by this Agreement. (b) All Directors and officers of the Company and the Surviving Bank will undertake in writing with the Underwriters not to sell any Warrants or shares of Company Stock held by them for a period of six months following the completion of the Offering unless specifically granted permission to do so by the Underwriters. (c) Simultaneously with, and upon the condition of, the consummation of the acquisition of the Bank, the Company through the Underwriters intends to consummate the Offering at a gross public offering price to be determined by the Company and the Underwriters. Based upon current market conditions and assumptions, the Offering will consist of sufficient shares of Company Stock offered to the public at a gross offering price to be determined by the Company and the Managing Underwriter. The shares constituting the Offering 61 will be comprised of newly issued shares of Company Stock to fund the cash portion of the acquisition of the Bank and to provide the Company with new capital for growth and operations of the Company following the acquisition of the Bank and the consummation of the Offering. (d) The Managing Underwriter has not withdrawn, or materially and adversely modified, the letter expressing their degree of confidence, and the Managing Underwriter will promptly notify the parties if such withdrawal should occur. 7.15 AUTHORIZATION. The execution and delivery of the Agreement of Merger and the consummation of the transactions contemplated thereby will have been duly authorized by the Board of Directors of PCBG Merger Corporation. The Agreement of Merger will constitute a legal, valid and binding agreement of PCBG Merger Corporation in accordance with its respective terms, except as the enforceability thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable. PCBG Merger Corporation will have full corporate power and authority to perform its obligations under the Agreement of Merger and the transactions contemplated thereby. 7.16 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of the Agreement of Merger and the consummation of the transactions contemplated therein, and compliance by PCBG Merger Corporation with any provision thereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 7.16 any material agreement, instrument or obligation to which PCBG Merger Corporation will become a party or by which the property of PCBG Merger Corporation will become bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, the FDIC and the Commissioner and as set forth in Exhibit 7.16, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of PCBG Merger Corporation; or (d) violate the Charter Documents or any Rules to which PCBG Merger Corporation is subject. 7.17 ACCURACY OF INFORMATION FURNISHED. Except as to any statements or information which shall include projections or forecasts, none of the statements or information made or contained in any of the covenants, representations or warranties of the Company set forth in this Agreement or in any of the schedules, exhibits, lists, certificates or other documents furnished herewith contains any untrue statement of a material fact required to be stated herein or therein or necessary to make the statements or information contained herein or therein, in light of the circumstances in which they were made, not misleading. As 62 to any such information or statements which include projections or forecast, such information or statements are based upon assumptions believed by the Company to be reasonable. The Company shall further amend or supplement the schedules as of the Closing Date if necessary to reflect any additional changes in the status of the Company. 7.18 1999 STOCK OPTION PLAN. Prior to or following the completion of the transactions contemplated herein, the Company will use its best efforts to establish the Company's 1999 Stock Option Plan for the benefit of directors, officers and key employees of the Company and the Bank. 7.19 FURTHER ASSURANCES. The Company knows of no reason that the transaction would not consummate. Without the prior approval of the Bank, the Company will not enter into any further agreements to acquire another financial institution that would materially and adversely affect the transaction or the timing contemplated by this Agreement. ARTICLE VIII FURTHER COVENANTS OF THE COMPANY AND THE BANK The parties covenant and agree as follows: 8.1 S-4, PROXY STATEMENT AND REGISTRATION STATEMENT FOR THE OFFERING. (a) As promptly as practicable, the Company and the Bank shall use their best efforts to prepare and file the S-4, in which the Proxy Statement will be included as a prospectus, and the S-1 with the SEC and any other Governmental Entity. The Bank agrees to provide the information necessary for inclusion in the S-4, the Proxy Statement and the S-1. The Company will use its best efforts to have the S-4 and the Proxy Statement declared effective under the Securities Act as promptly as practicable after it is filed and to satisfy the requirements of the SEC and any other Governmental Entity. (b) After the date of the filing of the S-4 and the S-1 with the SEC and any other Governmental Entity, each of the Parties agrees to promptly notify the other of and to correct any information furnished by such party that shall have become false or misleading in any material respect and to cooperate with the other to take all steps necessary to file with the SEC and any other Governmental Entity and have declared effective or cleared by the SEC and any other Governmental Entity any amendment or supplement to the S-1 and the S-4 so as to correct such information and to cause the S-4 and the S-1 as so corrected to be disseminated to the shareholders of the Company and the Bank to the extent required by applicable Rules. All documents that the Company files with the SEC or any other 63 Governmental Entity in connection with this Agreement will comply as to form in all material respects with the provisions of applicable Rules. (c) The Company shall take all required action with appropriate Governmental Entities under state securities or blue sky laws in connection with the issuance of Company Stock pursuant to this Agreement. (d) The Bank and the Company, through their Board of Directors, will recommend that its shareholders approve the transactions contemplated hereby, and both parties will use their best efforts to obtain the affirmative votes of the holders of the largest possible percentage of its outstanding Common Stock, so long as it is consistent with its fiduciary obligation to do so. 8.2 FEDERAL SECURITIES LAWS. In obtaining the consent of its shareholders of the matters described in Section 8.1 hereof, the Company, the Bank and their respective officers, directors and controlling shareholders will, in all respects, comply with the Rules and regulations of the SEC and any other Governmental Entity promulgated under the Exchange Act applicable to commercial banks which are reporting companies, other applicable provisions of the United States Code, the Rules and regulations of the SEC and the securities laws of all states in which shareholders of the parties reside as applicable. Without in any way limiting the generality of the foregoing, the Company and the Bank agrees that the Notice of Meeting, Proxy Statement submitted in connection therewith, form of Proxy and other solicitation materials that will be used in soliciting the aforesaid shareholder approvals and authorizations and the S-1: (i) will be filed with, and not be used before the same are cleared for use by, the SEC, other Governmental Entities having jurisdiction over the Company and the Bank, and this transaction, and the securities administrators of all states in which their respective shareholders reside as applicable; (ii) will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, except that neither party warrants the accuracy or completeness of any information contained therein which is furnished to it by the other relating to the business, assets, properties, financial condition or management of the other or any corporation or person affiliated or contractually obligated to become affiliated therewith, whether by merger, acquisition of assets or otherwise; (iii) the Company and the Bank will use their best efforts to obtain clearance by all appropriate Governmental Entities for the use of its Notice of Meeting, Proxy Statement, form of Proxy and other solicitation materials. Each 64 party will consult and cooperate with the other in the preparation of all such proxy solicitation materials for the Bank Shareholders' Meeting and the Company's Shareholders Meeting, and the Bank and the Company agree not to transmit any proxy materials without the prior consent of the other party and its counsel; and (iv) the Company and the Bank shall each covenant and agree and each pay their own expenses in connection with the preparation and filing, including attorney fees, of the Notice of Meeting, Proxy Statement, form of Proxy and other solicitation materials. 8.3 MAILING OF PROXY STATEMENT. The Bank and the Company each covenant and agree that they will use their best efforts and shall cooperate with each other in the preparation, filing and mailing of the Proxy Statement as soon as it reasonably practicable and is permitted under applicable law; it being the intention of the Bank to include its December 31, 1998 financial statements and information, and any necessary quarterly financial statements and information, in the financial disclosures contained in the Proxy Statement. 8.4 MATERIALS TO BE FURNISHED PRIOR TO MAILING DATES. On or prior to the mailing date of the Proxy Statement ("Bank Mailing Date"), the Bank (a) shall use its best efforts to cause an appropriate firm that shall be selected by the Bank in its discretion, subject to the reasonable approval of the Company, to deliver to the Company a copy of any letter to the Board of Directors of Bank, dated as of a date not more than five days prior to such mailing date, in form and substance satisfactory to the Company to the effect set forth in Section 10.9 hereof, (b) shall have received a letter by a date not more than five days prior to the Bank Mailing Date, to the effect that the consideration to be received by the shareholders of the Bank in the Merger is fair from a financial point of view, and (c) shall have received a letter by a date not more than five days prior to the Bank Mailing Date, of the valuation of dissenters rights shares as described in Section 1300. 8.5 REGULATORY APPROVALS. The Bank and the Company each agree to use their best efforts to provide promptly such information and reasonable assistance as may be requested by the other party to this Agreement and to take promptly such other actions as shall be necessary or appropriate in order to consummate the transactions contemplated hereby. Without limiting the foregoing, the Bank and the Company will each (a) prepare, submit and file, or cause to be prepared, submitted and filed, all applications for all authorizations, consents, orders and approvals of federal, state, local and other Governmental Entities and officials necessary under applicable law for the performance of its obligations pursuant to this Agreement and the consummation of the transactions contemplated hereby, (b) use their best efforts to obtain all such authorizations, consents, orders and approvals as expeditiously as possible in accordance with the terms of this Agreement, and (c) cooperate fully with each other in promptly seeking to obtain such authorizations, consents, orders and approvals, including 65 without limitation, in each case, the approval of the FRB, the FDIC and the Commissioner. The Bank and the Company each agree to promptly provide the other with copies of all applications referred to in clause (a) above and copies of all written communications, letters, reports or other documents delivered to or received from any Governmental Entity, and copies of all memoranda relating to discussions with such Governmental Entity, if any, with respect to the Merger, except that the Company and the Bank shall not be required to provide the other with any of the foregoing documents submitted or received on a confidential basis or which incorporate confidential information relating to other financial institutions. The Parties agree that through the Effective Time of the Merger, each of its reports, registration, statements and other filings required to be filed with any applicable Governmental Entity will comply in all material respects with the applicable statues, rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. Any financial statement contained in any such report, registration statement or other filing that is intended to represent the financial position of the Party to which it relates will fairly present the financial position of such Party and will be prepared in accordance with GAAP or RAP consistently applied during the periods involved. 8.6 CORPORATE GOVERNANCE. (a) Prior to the Effective Time, the Bank shall take all necessary steps to effect the Bank Corporate Governance Changes at the Effective Time. (b) Prior to the Effective Time, the Company shall take all necessary steps to effect the Company Corporate Governance Changes at the Effective Time. 8.7 NASDAQ. The Company's Stock will be listed on the Nasdaq National Market System at the Effective Time of the Merger. ARTICLE IX CONDITIONS PRECEDENT TO THE CONTEMPLATED TRANSACTIONS The obligations of the Parties to consummate the transactions as provided for herein are subject to the fulfillment, at or prior to the Effective Time, of the following conditions: 9.1 PERMITS AND APPROVALS. Appropriate permits or approvals from the Commissioner, the FRB, the FDIC and/or any other Governmental Entities which 66 are necessary to carry out the transactions contemplated in this Agreement, shall have been received, the United States Department of Justice shall not have taken any adverse action within the period allowed under 12 U.S.C. Section 1828(c)(6), and all other statutory or regulatory requirements for the valid completion of the transactions contemplated hereby shall have been satisfied. Said permits and approvals shall include, but shall not be limited to, the following: (i) prior written approval from the Commissioner pursuant to the CFC, the FDIC pursuant to 12 U.S.C. Section 1828(c)(2) and the FRB pursuant to the Federal Reserve Act and the BHC Act; (ii) to the extent required by applicable Rule, all Consents of any Governmental Entity, including, without limitation, those of the FRB, the FDIC and the Commissioner, shall have been obtained, granted or waived for organization of PCBG Merger Corporation and the Merger, and all applicable waiting periods under all rules shall have expired; and (iii) all approvals, orders and/or permits necessary for the Offering and any other necessary regulatory approvals and the issuance of approvals or assurances from the Commissioner, the FRB, the FDIC, the SEC, any blue sky authority and any other necessary Governmental Entity having authority over the Merger that the approval of the Merger will be forthcoming that are satisfactory to the Company, that would allow the Company to commence the marketing of the Offering by the Company to complete the Merger as described in this Agreement. 9.2 ABSENCE OF LITIGATION. On the Closing Date and at the Effective Time: (i) there shall be no action pending before any court of competent jurisdiction in which any injunction is sought by any Governmental Entity against the transactions contemplated hereby; and (ii) there shall be in effect no order, writ, injunction or decree of any court or Governmental Entity prohibiting the consummation of any of the transactions contemplated hereby. 9.3 SHAREHOLDER APPROVAL. The Agreement, the Merger, and the other transactions contemplated hereby, shall have been approved by the holders of at least a majority of the issued and outstanding shares of Bank Stock entitled to vote and the requisite approval of the Company as the sole shareholder of PCBG Merger Corporation as soon as practicable. Any and all other action required by the shareholders of the Bank or the Company to authorize or effect the transactions called for herein shall have been duly and validly taken. 9.4 STOCK OFFERING. The Company shall close the Offering as soon as is reasonably possible, the Company shall have received the amount of cash necessary to complete the Merger as provided in Section 2.5, and to carry out the transactions contemplated hereby. 67 9.5 S-1, S-4 AND PROXY STATEMENT. The S-4, Proxy Statement and the S-1 shall have been declared effective by the SEC or the FDIC, as appropriate, and shall not be the subject of any stop order or proceeding seeking or threatening a stop order. The Company shall have received all state securities or "Blue Sky" permits and other authorization necessary to issue the Company Stock in the Offering and the S-4 in order to consummate the Merger. 9.6 NASDAQ. The Company's Common Stock issued in the Offering will be listed on the Nasdaq National Market System at the Effective Time. 9.7 SEVERANCE POLICY. The Bank and the Company shall continue the Bank's present severance policy. ARTICLE X CONDITIONS PRECEDENT TO THE OBLIGATIONS OF THE BANK All of the obligations of the Bank to consummate the transactions contemplated herein shall be subject to the satisfaction, at or prior to the Closing Date, of the following conditions, or their waiver by resolution of the Board of Directors of the Bank: 10.1 LEGAL OPINION. The Bank shall have received the opinion of Knecht & Hansen, acting as counsel for the Company, dated as of the Closing Date, in substantially the form of EXHIBIT 10.1. 10.2 CERTIFICATE OF NO DEFAULT. All covenants, terms and conditions of this Agreement to be complied with and performed by the Company at or before the Closing Date shall have been complied with and performed in all material respects and the representations and warranties of the Company contained in Article V hereof shall have been true and correct in all material respects as of the Effective Time, with the same effect as though such representations and warranties had been made on and as of the Effective Time, except as otherwise specified in, or permitted or contemplated by, this Agreement. The Company shall have delivered to the Bank, a certificate dated the Closing Date, signed by the President, certifying the fulfillment of this condition. 10.3 CLOSING DOCUMENTS. The Company shall have delivered to the Bank all items required by the Bank pursuant to Section 3.3, all of which documents shall be properly executed and, if required by the Bank, acknowledged before a notary. 10.4 EFFECTIVE S-4 AND PROXY STATEMENT. The S-4 and the Proxy Statement shall have been approved or otherwise become effective and no stop 68 order suspending the effectiveness thereof shall be in effect and no proceedings therefor shall be pending or threatened by any Governmental Entity at the Closing Date. 10.5 REGULATORY APPROVALS AND RELATED CONDITIONS. Any and all governmental and regulatory approvals and Consents referred to in Article IX and any other section of this Agreement shall have been granted without the imposition of conditions, or with conditions subject to the approval of the Company and the Bank, that are or would have become applicable to the Company or the Surviving Bank, and that the Company reasonably and in good faith concludes would materially adversely affect the financial condition or operations of the Company or the Surviving Bank, or otherwise would be materially burdensome; provided, however, that conditions or requirements which are imposed on purchasers or acquired institutions by Governmental Entities in comparable transactions shall not be deemed to be a basis for excuse of performance under this Agreement. All actions necessary to authorize the execution, delivery and performance of the Agreement by the Company and consummation of the Merger by the Company and PCBG Merger Corporation shall have been duly and validly taken by the Board of Directors of the Company and the PCBG Merger Corporation. 10.6 THIRD PARTY CONSENTS. The Company shall have obtained all consents of other parties to the Company's material mortgages, notes, leases, franchises, agreements, licenses and permits as may be necessary to permit the transactions contemplated herein to be consummated, without default, acceleration, breach or loss of rights or benefits thereunder. 10.7 ABSENCE OF CERTAIN CHANGES. As of the Closing Date there shall not exist any of the following: (i) any change(s) in the financial condition or results of operation of the Company since inception which individually is or in the aggregate are materially adverse to the Company; or (ii) any damage, destruction, loss or event materially and adversely affecting the properties, business or prospects of the Company on a consolidated basis. 10.8 VALIDITY OF TRANSACTIONS. The validity of all transactions herein contemplated, as well as the form and substance of all opinions, certificates, instruments of transfer and other documents to be delivered to the Bank hereunder, shall be subject to the approval, to be reasonably exercised, of counsel for the Bank. 10.9 FAIRNESS OPINION. Prior to solicitation of shareholder approval, the Bank shall have received an opinion pursuant to Section 8.4 confirming the 69 fairness of the terms of the Merger from a financial perspective, and such opinion shall not have been withdrawn prior to the mailing date of the Proxy Statement. 10.10 NASDAQ LISTING. The Company will have the shares of Company Stock issuable pursuant to this transaction duly authorized for listing, subject to notice of issuance, on the Nasdaq National Market System. ARTICLE XI CONDITIONS PRECEDENT TO THE OBLIGATIONS OF THE COMPANY All of the obligations of the Company to consummate the transactions contemplated herein shall be subject to the satisfaction, at or prior to the Closing Date, of the following conditions, or their waiver by resolution of the Board of Directors of the Company, as appropriate: 11.1 LEGAL OPINION. The Company shall have received the opinion of Gary Steven Findley & Associates acting as counsel for the Bank, dated as of the Closing Date, in substantially the form of EXHIBIT 11.1. 11.2 CERTIFICATE OF NO DEFAULT. All covenants, terms and conditions of this Agreement to be complied with and performed by the Bank at or before the Closing Date shall have been complied with and performed in all material respects and the representations and warranties of the Bank contained in Article IV hereof shall have been true and correct in all material respects as of the Effective Time, with the same effect as though such representations and warranties had been made on and as of the Effective Time, except as otherwise specified in, or permitted or contemplated by, this Agreement. The Bank shall have delivered to the Company a certificate, dated the Closing Date, signed by the President of the Bank, certifying the fulfillment of this condition. 11.3 CLOSING DOCUMENTS. The Bank shall have delivered to the Company all items required by the Company pursuant to Section 3.3, all of which documents shall be properly executed and, if required by the Company, acknowledged before a notary. 11.4 EFFECTIVE S-1, S-4 AND PROXY STATEMENT. The S-1, the S-4 and the Proxy Statement shall have become effective and no stop order suspending the effectiveness thereof shall be in effect and no proceedings therefor shall be pending or threatened by the SEC, FDIC, the Commissioner, the FRB or any blue sky authority at the Closing Date. 11.5 BANK DISSENTING SHAREHOLDERS AGAINST MERGER. The Bank's shareholders voting against the Merger or the Bank's shareholders giving notice in 70 writing to the Bank at or before the Bank's meeting that such shareholder dissents from the Merger, on a combined basis, shall hold not more than ten percent (10%) of the outstanding shares of the Bank. 11.6 REGULATORY APPROVALS AND RELATED CONDITIONS. Any and all governmental and regulatory approvals and Consents referred to in Article IX and any other section of this Agreement shall have been granted without the imposition of conditions, or with conditions subject to the approval of the Company, that are or would have become applicable to the Company or the Surviving Bank and that the Company reasonably and in good faith concludes would materially adversely affect the financial condition or operations of the Company or the Surviving Bank, or otherwise would be materially burdensome; provided, however, that conditions or requirements which are imposed on purchasers or acquired institutions by Governmental Entities in comparable transactions shall not be deemed to be a basis for excuse of performance under this Agreement. 11.7 THIRD PARTY CONSENTS. The Company shall have obtained all consents of other parties to the Company's material mortgages, notes, leases, franchises, agreements, licenses and permits as may be necessary to permit the transactions contemplated herein to be consummated, without default, acceleration, breach or loss of rights or benefits thereunder. 11.8 ABSENCE OF CERTAIN CHANGES. As of the Closing Date, there shall not exist any of the following: (i) any change(s) in the consolidated financial condition, or results of operation of the Bank since December 31, 1997, which individually is or in the aggregate are materially adverse to the Bank; (ii) any damage, destruction, loss or event materially and adversely affecting the properties, business or prospects of the Bank; or (iii) any material adverse change in the deposit structure of the Bank from the date of this Agreement to the Closing Date. 11.9 BANK STOCK OPTION PLAN; AND OFFICERS AND EMPLOYEES. The Bank shall have caused the Bank Stock Option Plan to be terminated as of or prior to the Effective Time of the Merger and shall have obtained the consents or agreements specified in, and otherwise shall have complied with the terms of, Section 6.10. Pursuant to California Law and its employment policies and practices, the Bank shall have complied with Section 6.11 of this Agreement as of the Effective Time of the Merger. 11.10 DIRECTOR AGREEMENTS. Pursuant to Section 2.9, concurrently with the execution of this Agreement, each director of the Bank shall enter into separate agreements with the Company in the form attached hereto as EXHIBIT "B". 11.11 TERMINATION OF CONTRACTS. As determined by the Company under Section 6.12, the Bank shall have obtained the terminations of any 71 contracts, commitments or Understandings as defined in Section 4.12(v), and paid or accrued as of the Closing Date for any termination fees for the future purchases of materials, supplies, services, merchandise or equipment, the price of which exceeds $20,000. 11.12 VALIDITY OF TRANSACTIONS. The validity of all transactions herein contemplated, as well as the form and substance of all opinions, certificates, instruments of transfer and other documents to be delivered to the Company hereunder, shall be subject to the approval, to be reasonably exercised, of counsel for the Company. 11.13 EMPLOYEE BENEFIT PLANS. Upon the mutual agreement of the Company and the Bank regarding whether any Employee Plan should be terminated, the Company shall have received satisfactory evidence that the Bank has caused such Employee Plan to be terminated, except as otherwise provided by applicable labor laws, as of the effective Time of the Merger, and that all benefits payable under such plans, programs and arrangements have been paid or accrued as of the Closing Date. 11.14 FAIRNESS OPINION. Prior to commencement of the marketing of the Offering described in Sections 9.1(iii) and 9.4, the Company in its discretion may receive an opinion concerning the fairness of the terms of the Merger to the shareholders of the Company from a financial point of view. 11.15 STOCK OFFERING. The Bank shall have provided such information as deemed necessary by the Company in connection with the sale of stock including but not limited to, certificates of its officers and directors attesting to, among other things, the truthfulness and correctness of the representations contained in this Agreement, opinions of legal counsel and comfort letters from the Bank's accountants. 11.16 S-4, PROXY STATEMENT AND REGULATORY APPLICATIONS. The Bank shall have provided such information as deemed necessary by the Company in connection with the S-4 and the Proxy Statement and any other regulatory applications including but not limited to, certificates of its officers and directors attesting to, among other things, the truthfulness and correctness of the representations contained in this Agreement, opinions of legal counsel and comfort letters from the Bank's accountants. 11.17 BLUE SKY MATTERS. The issuance of the Company Stock in the Offering and the S-4 shall have been qualified or registered with the appropriate Governmental Entity under state securities or Blue Sky laws, and such qualification or registrations are in effect on the Closing Date. 72 11.18 PROFESSIONAL FEES. The Bank's costs and expenses for professional expenses in connection with the transaction contemplated by this Agreement, including investment banking, accounting, attorney and any related costs and expenses, shall not exceed the amount that would be reasonable and customary for a transaction as described in this Agreement. Investment banking fees are as set forth in Exhibit 4.14. The accounting and attorney fees, and related costs and expenses thereto, of the Bank shall not exceed $175,000 in the aggregate. The Company agrees that it will promptly reimburse the Bank at the close or termination for the first $50,000 of legal and attorney fees and expenses incurred by the Bank since November 15, 1998 directly related to this transaction with the Company, and the Bank shall pay for any additional accounting and attorney fees and expenses incurred by the Bank thereafter. The Company also consents to the Bank paying at the close up to $25,000 to William Cochrum for his investment banking services to the Bank related to this transaction with the Company. 11.19 YEAR 2000. The Bank shall certify that the Bank and Banklink Corporation are making satisfactory progress toward compliance with Year 2000 safety and soundness issues with respect to their own computer systems. ARTICLE XII DISSENTING SHAREHOLDERS OF BANK Any shareholder of the Bank who lawfully dissents shall be entitled to receive cash for the fair market value of his or her shares determined in accordance with Section 1300. ARTICLE XIII EXPENSES 13.1 EXPENSES. All fees and out-of-pocket costs incurred in connection with the transactions contemplated by this Agreement, including but not limited to legal, accounting, investment banking fees and cost reimbursements, fees and cost of consultants, costs of proxy statements and shareholder action on the Merger, shall be paid by the party incurring such costs. 73 ARTICLE XIV TERMINATION 14.1 Termination of this Agreement. (a) Notwithstanding that this Agreement and the Agreement of Merger may have already been approved by shareholders of one or both of constituent corporations to the transactions contemplated by this Agreement, this Agreement may be terminated prior to the Effective Time of the Merger: (i) by mutual agreement of the parties, in writing; (ii) by (A) the Company immediately upon the expiration of 30 days from the date that the Company has given notice to the Bank of a material breach or default by the Bank in the performance of any covenant, agreement, representation, warranty, duty or obligation hereunder or (B) the Bank immediately upon the expiration of 30 days from the date that the Bank has given notice to the Company of a breach or default by the Company in the performance of any covenant, agreement, representation, warranty, duty or obligation hereunder, except for Sections 5.18 and 7.14 (iii) by the Company or the Bank if any Governmental Entity denies or refuses to grant the approvals, consents or authorizations required to be obtained, or if any Governmental Entity approves the transaction covered and contemplated by this Agreement upon conditions not reasonably acceptable to the Company, in order to consummate the transactions covered and contemplated by this Agreement. If any regulatory application filed pursuant to this Agreement hereof should be finally denied or disapproved by the respective Governmental Entity, then this Agreement thereupon shall be deemed terminated and canceled; provided, however, that a request for additional information or undertaking by the Company, as a condition for approval, shall not be deemed to be a denial or disapproval so long as the Company diligently provides the requested information or undertaking. In the event an application is denied pending an appeal, petition for review, or similar such act on the part of the Company (hereinafter referred to as the "appeal") then the application will be deemed denied unless the Company prepares and timely files such appeal and continues the appellate process for purposes of obtaining the necessary approval. (iv) by the Company or the Bank if (A) the Board of Directors of the Bank approves a transaction (or the Bank executes a letter of intent or other agreement) pursuant to which any person or entity or related group of persons or entities acquires, directly or indirectly, record or beneficial ownership (as defined in Rule 13d3 promulgated by the SEC pursuant to the Exchange Act) or control of 10% or more of the outstanding shares of Bank Stock or other securities of the 74 Bank; (B) any person or entity or related group of persons or entities seeks to acquire 10% or more of the outstanding shares of Bank Stock by tender offer or otherwise, and the Board of Directors of the Bank does not advise the Bank's shareholders that the Bank's Board of Directors does not support such tender offer or acquisition and that it supports the Merger; (C) if the Bank violates its covenant pursuant to Section 6.2 (xxiii) and (xxiv); (D) the Merger does not receive the requisite approval of the Bank's shareholders; or (E) any Person or entity commences an Alternative Transaction pursuant to the terms of Section 6.5; (v) by the Company or the Bank immediately upon the expiration of 15 days from the date that the Bank or the Company has given notice to the Company of a default by the Company in the performance of Sections 5.18 and 7.14; (vi) by the Company or the Bank by May 15, 1999, unless regulatory approvals and/or completion of the Offering is relatively imminent and is expected to be completed in the near future, in which case the date in this subsection shall be automatically extended for up to an additional 30 days. (b) Notwithstanding that this Agreement and the Agreement of Merger may have already been approved by shareholders of one or both of the constituent corporations to the Merger, this Agreement shall be terminated prior to the Effective Time of the Merger if any conditions specified in Articles IX, X or XI have not been satisfied or waived in writing by the party authorized to waive such conditions unless mutually extended by the parties hereto. (c) Regulatory Enforcement Matters. In the event that Bank or the Company or any of their respective subsidiaries shall, after the date of this Agreement, become a party or subject to any new or amended written agreement, memorandum of understanding, cease and desist order, imposition of civil money penalties or other regulatory enforcement action or proceeding with any federal or state agency charged with the supervision or regulation of banks or bank holding companies which is material to the Bank or the Company and their respective subsidiaries taken as a whole, then either the Company or the Bank may terminate this Agreement. (d) (reserved) (e) Notwithstanding anything to the contrary contained herein: (i) If this Agreement is terminated by the Bank before the Closing Date pursuant to Sections 14.1(a)(ii)(B), (not including Sections 5.18 or 7.14) hereof, the Company shall pay to the Bank, as reasonable and full liquidated damages and reasonable compensation for the loss sustained thereby and not as a penalty or forfeiture, the expenses incurred by the Bank in connection with the 75 transactions contemplated by this Agreement, including, but not limited to, those costs and expenses outlined in Section 11.18, plus 50% of such expenses, up to a maximum of $500,000, within ten (10) Business Days of such termination; (ii) If this Agreement is terminated by the Company before the Closing Date pursuant to Sections 14.1(a)(ii)(A) hereof, the Bank shall pay to the Company, as reasonable and full liquidated damages and reasonable compensation for the loss sustained thereby, and not as a penalty or forfeiture, the expenses incurred by the Company in connection with the transactions contemplated by this Agreement, plus 50% of such expenses, up to a maximum of $500,000 within ten (10) Business Days of such termination; and (iii) If this Agreement is terminated by the Company before the Closing pursuant to Section 14.1(a)(iv) hereof, and the Warrant is not exercised by the Company, the Bank will pay to the Company, as reasonable and full liquidated damages and reasonable compensation for the loss sustained thereby, and not as a penalty or forfeiture, the expenses incurred by the Company in connection with the transaction contemplated by this Agreement, plus 50% of such expenses, within ten (10) Business Days of such termination. ARTICLE XV GENERAL PROVISIONS 15.1 CONFIDENTIALITY. All Confidential Information disclosed heretofore or hereafter by either Party to this Agreement to the other Party to this Agreement shall be kept confidential by such other Party and shall not be used by such other Party otherwise than as herein contemplated, except to the extent that (a) it is necessary or appropriate to disclose to the Bank or the Company or as may otherwise be required by Rule (any disclosure of Confidential Information to a Governmental Entity shall be accompanied by a request that such Governmental Entity preserve the confidentiality of such Confidential Information); or (b) to the extent such duty as to confidentiality is waived by the other Party. Such obligation as to confidentiality and nonuse shall survive the termination of this Agreement pursuant to Article XIV. In the event of such termination and on request of the other Party, such Party shall use all reasonable efforts to (y) return to the other Party all documents (and reproductions thereof) received from such other Party that contain Confidential Information (and, in the case of reproductions, all such reproductions made by the receiving Party); and (z) destroy the originals and all copies of any analyses, computations, studies or other documents prepared for the internal use of such Party that include Confidential Information, unless otherwise advised by counsel in connection with any controversy under the Agreement. 15.2 PUBLICITY. The Parties shall coordinate all publicity relating to the transactions contemplated by this Agreement, and no Party shall issue any 76 press release, publicity statement, shareholder communication or other public notice relating to this Agreement or any of the transactions contemplated hereby without obtaining the prior consent of the other Party except to the extent that independent legal counsel to the Party, as the case may be, shall deliver a written opinion to the Party that a particular action is required by applicable Rules. The Parties hereby agree that all public statements after the initial press release announcing this Agreement referring to the Bank shall be made by Mr. James B. Jaqua, and all public statements made after the initial press release announcing this Agreement referring to the Company shall be made by Mr. E. Lynn Caswell, and both Parties agree that all public statements shall be made by mutual agreement. 15.3 INDEMNIFICATION. (a) The Bank agrees to defend, indemnify and hold harmless the Company, its officers and directors, attorneys, accountants and each person who controls the Company within the meaning of the Securities Act from and against any costs, damages, liabilities and expenses of any nature, insofar as any such costs, damages, liabilities and expenses arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Proxy Statement, the Company's Offering disclosure documents or any amendments or supplements thereto, or arise out of or are based solely upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading based upon information with respect to the Bank furnished to the Company by or on behalf of the Bank specifically for use therein; provided, however, that the Bank shall not be liable in any such case to the extent that any such cost, damage, liability or expense arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Proxy Statement, the Company's Offering disclosure documents or amendments or supplements thereto, in reliance upon and in conformity with information with respect to the Company furnished to the Bank by or on behalf of the Company specifically for use therein. (b) The Company agrees to defend indemnify and hold harmless the Bank, its officers and directors, attorneys, accountants and each person who controls the Bank within the meaning of the Securities Act from and against any costs, damages, liabilities and expenses of any nature, insofar as any such costs, damages, liabilities or expenses arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Proxy Statement, the Company's Offering disclosure documents or any amendments or supplements thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make statements therein not misleading based solely upon information with respect to the Company and its subsidiaries furnished to the Bank by or on behalf of the Company and its subsidiaries specifically for use therein; provided, however, that the Company shall not be liable in any such case to the extent that any such 77 cost, damage, liability or expense arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Proxy Statement, the Company's Offering disclosure documents or amendments or supplements thereto, in reliance upon and in conformity with information with respect to the Bank furnished to the Company by or on behalf of the Bank specifically for use therein. (c) Promptly after receipt by the Party to be indemnified pursuant to this section ("Indemnified Party") of notice of (i) any claim or (ii) the commencement of any action or proceeding, Indemnified Party will give the other Party "(Indemnifying Party") written notice of such claim or the commencement of such action or proceeding. Indemnifying Party shall have the right, at its option, to compromise or defend, by its own counsel, any such matter involving Indemnified Party's asserted liability, at the expense of the Indemnifying Party. In the event that Indemnifying Party shall undertake to compromise or defend any such asserted liability, it shall promptly notify Indemnified Party of its intention to do so, and Indemnified Party agrees to cooperate fully with Indemnifying Party and its counsel in the compromise of, or defense against, any such asserted liability. In any event, Indemnifying Party shall have the right to participate in the defense of such asserted liability. In any event Indemnifying Party shall have the right to participate in the defense of such asserted liability. 15.4 NOTICES. All notices, demands or other communications hereunder shall be in writing and be made by (a) hand delivery; (b) overnight mail; (c) United States mail, first class, certified or registered, postage prepaid; or (d) facsimile transmission, and shall be deemed to have been duly given (i) on the date of service if delivered by hand or facsimile transmission (provided that telecopied notices are also mailed by United States mail, first class, certified or registered, postage prepaid); (ii) on the next day if delivered by overnight mail or delivery service; or (iii) 72 hours after mailing if mailed by United States mail, first class, certified or registered, postage prepaid, and properly addressed as follows: (a) If to the Bank: James B. Jaqua, President and Chief Executive Officer The Bank of Hemet 3715 Sunnyside Drive Riverside, California 92506 Telecopier No.: (909) 784-5791 78 With a copy to: Gary S. Findley, Esq. Gary Steven Findley & Associates 1470 North Hundley Street Anaheim, California 92806 Telecopier No.: (714) 630-7910 (b) If to the Company: Mr. E. Lynn Caswell, Chairman and CEO Pacific Community Banking Group 23332 Mill Creek Drive, Suite 230 Laguna Hills, California 92653 Telecopier No.: (949) 458-2086 With a copy to: Loren P. Hansen, Esquire Knecht & Hansen 1301 Dove Street, Suite 900 Newport Beach, California 92660 Telecopier No.: (949) 851-1732 The persons or addresses to which mailings or deliveries shall be made may change from time to time by notice given pursuant to the provisions of this Section 15.4. 15.5 SUCCESSORS AND ASSIGNS. Subject to Section 7.12 and 15.3, all terms and provisions of this Agreement shall be binding upon and inure to the benefit of the Parties hereto and their respective transferees, successors and assigns; provided, however, that, except as otherwise contemplated herein, this Agreement and all rights, privileges, duties and obligations of the Parties hereto may not be assigned or delegated by any party hereto without the prior written consent of the other Party to this Agreement and any purported assignment in violation of this Section 15.5 shall be null and void. 15.6 THIRD PARTY BENEFICIARIES. Except as provided in Section 7.12, each party hereto intends that this Agreement shall not benefit, or create any right or cause of action in or on behalf of, any Person other than the Parties hereto. 15.7 COUNTERPARTS. This Agreement may be executed in one or more counterparts, all of which taken together shall constitute one instrument. 79 15.8 GOVERNING LAW. This Agreement is made and entered into in the State of California and the laws of the State of California shall govern the validity and interpretation hereof and the performance of the parties hereto of their respective duties and obligations hereunder. 15.9 CAPTIONS. The captions contained in this Agreement are for convenience of reference only and do not form a part of this Agreement. 15.10 WAIVER AND MODIFICATION. No waiver of any term, provision or condition of this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be or construed as a further or continuing waiver of any such term, provision or condition of this Agreement. This Agreement and the Agreement of Merger, when executed and delivered, may be modified or amended by action of the Board of Directors of the Company and the Bank without action by their respective shareholders to the extent permitted by law. This Agreement may be modified or amended only by an instrument of equal formality signed by the Parties of their duly authorized agents. 15.11 ATTORNEYS' FEES. In the event either of the Parties to this Agreement brings an action or suit against the other Party by reason of any breach of any covenant, agreement, representation, warranty or other provision hereof, or any breach of any duty or obligation created hereunder by such other Party, the prevailing Party, as determined by the court or other body having jurisdiction, shall be entitled to have and recover of and from the losing Party, as determined by the court or other body have jurisdiction, all reasonable costs and expenses incurred or sustained by such prevailing Party in connection with such suit or action, including, without limitation, legal fees and court costs (whether or not taxable as such). 15.12 ENTIRE AGREEMENT. The making, execution and delivery of this Agreement by the Parties hereto have not been induced by any representations, statements, warranties or agreements other than those herein expressed. This Agreement embodies the entire understanding of the Parties and there are no further or other agreements or understandings, written or oral, in effect between the Parties relating to the subject matter hereof, unless expressly referred to by reference herein. 15.13 SEVERABILITY. Whenever possible, each provision of this Agreement and every related document shall be interpreted in such manner as to be valid under applicable law. However, if any provision of any of the foregoing shall be invalid or prohibited under said applicable law, it shall be construed, interpreted and limited to effectuate its purpose to the maximum legally permissible extent. If it cannot be so construed and interpreted so as to be valid under such law, such provision shall be ineffective to the extent of such invalidity or prohibition without invalidating the remainder of such provision or the remaining provisions of this Agreement, and this Agreement shall be construed to the maximum extent possible 80 to carry out its terms without such invalid or unenforceable provision or portion thereof. 15.14 EFFECT OF DISCLOSURE. Any list, statement, document, writing or other information set forth in, referenced to or attached to any schedule or exhibit delivered pursuant to any provision of this Agreement shall be deemed to constitute disclosure for purposes of any other schedule or exhibit required to be delivered pursuant to any other provision of this Agreement. 15.15 KNOWLEDGE. Whenever any statement herein or in any schedule, exhibit, certificate or other documents delivered to any Party pursuant to this Agreement is made "to the knowledge" or "to the best knowledge" of any Party or other person, such Party or other person, who shall be an officer of a Party, shall make such statement only after conducting an investigation which such person determines in good faith to be reasonable under the circumstances of the subject matter thereof, and each such statement shall constitute a representation that such investigation has been conducted. 15.16 TERMINATION OF REPRESENTATION, WARRANTIES AND COVENANTS. The representations, warranties and covenants of each Party contained herein or in any certificate or other writing delivered by such Party pursuant hereto or in connection herewith shall not survive the Merger other than those provided for in Sections 7.12, 13.1, 14.1(e), 15.1, 15.3, and 15.11 which shall survive a termination. 81 IN WITNESS WHEREOF, the Parties hereto have duly executed this Agreement on the day and year first above written. PACIFIC COMMUNITY BANKING GROUP By: /s/ E. LYNN CASWELL ------------------------------------ E. Lynn Caswell, Chairman of the Board and Chief Executive Officer THE BANK OF HEMET By: /s/ John J. McDonough ------------------------------------ John J. McDonough Chairman of the Board By: /s/ James Jaqua ------------------------------------ James Jaqua, President and Chief Executive Officer By: /s/ John B. Brudin ------------------------------------ John B. Brudin, Director By: /s/ Jack E. Gosch ------------------------------------ Jack E. Gosch, Director By: /s/ E. Kenneth Hyatt ------------------------------------ E. Kenneth Hyatt, Director By: /s/ Joseph D. Pehl ------------------------------------ Joseph D. Pehl, Director By: /s/ Clayton A. Record, Jr., ------------------------------------ Clayton A. Record, Jr., Director 82 EXHIBIT A AGREEMENT OF MERGER THIS AGREEMENT OF MERGER is made and entered into as of this day of , 1999, by and between PCBG Merger Corporation ("PCBG"), a California corporation, The Bank of Hemet ("BOH"), a California corporation, and Pacific Community Banking Group (the "Company"), a California corporation, with reference to the following facts: RECITALS 1. PCBG is a California corporation duly organized, validly existing and in good standing under the laws of the State of California, with authorized capital of 1,000,000 shares of no par value common stock of which, on the date hereof, there are 100 shares issued and outstanding ("PCBG Common Stock") owned by the Company. 2. BOH is a banking corporation duly organized, validly existing and in good standing under the laws of the State of California and is authorized by the California Commissioner of Financial Institutions to conduct a general banking business, with authorized capital of 20,000,000 shares of no par value common stock, of which, on the date hereof, there are 844,278 shares issued and outstanding ("BOH Common Stock"), and 10,000,000 shares of Preferred Stock of which on the date hereof there are no shares issued and outstanding. 3. The Company is a California corporation duly organized, validly existing and in good standing under the laws of the State of California, with authorized capital of 100,000,000 shares of no par value common stock, of which, on the date hereof, there are 2,500 shares issued and outstanding ("Company Common Stock"), and 100,000,000 shares of Preferred Stock of which on the date hereof there are shares issued and outstanding. 4. The respective Boards of Directors of PCBG and BOH deem it desirable and in the best interest of their respective corporations and stockholders that PCBG be merged (the "Merger") with and into BOH as provided in this Agreement of Merger pursuant to the laws of the State of California and that BOH be the surviving corporation ("Surviving Corporation"). 5. In connection with the Merger, the Company and BOH have entered into the First Restatement of Agreement and Plan of Reorganization, dated as of January 5, 1999, as amended on 1999 and 1999 (the "Reorganization Agreement"). 1 NOW THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein set forth and for the purpose of prescribing the terms and conditions of such Merger, the parties hereto agree as follows: ARTICLE I THE MERGER Upon consummation of the Merger at the Effective Time (as defined in Article IX hereof), PCBG shall be merged with and into BOH which shall thereupon be the Surviving Corporation, and the separate corporate existence of PCBG shall cease. ARTICLE II NAME The name of the Surviving Corporation shall remain "The Bank of Hemet." ARTICLE III ARTICLES OF INCORPORATION The Articles of Incorporation of BOH as in effect immediately prior to the Effective Time shall, at and after the Effective Time, continue to be the Articles of Incorporation of the Surviving Corporation. ARTICLE IV BYLAWS The Bylaws of BOH as in effect immediately prior to the Effective Time shall, at and after the Effective Time, continue to be the Bylaws of the Surviving Corporation. ARTICLE V DIRECTORS The Board of Directors and officers of BOH at the Effective Time shall serve as the Board of Directors and officers of the Surviving Corporation until such time as their successors have been elected and qualified as provided for by the Bylaws of BOH. ARTICLE VI RIGHTS AND DUTIES OF SURVIVING CORPORATION At and after the Effective Time, all rights, privileges, powers and franchises and property and assets of every kind and description of PCBG and BOH 2 shall be vested in and be held and enjoyed by the Surviving Corporation, without further act or deed, and all the estates and interests of every kind of PCBG and BOH, including all debts due to either of them, shall be as effectively the property of the Surviving Corporation as they were of PCBG and BOH, and the title to any real estate vested by deed or otherwise in either PCBG or BOH shall not revert or be in any way impaired by reason of the Merger; and all rights of creditors and liens upon any property of PCBG and BOH shall be preserved unimpaired and all debts, liabilities and duties of PCBG and BOH shall be debts, liabilities and duties of the Surviving Corporation and may be enforced against it to the same extent as if said debts, liabilities and duties had been incurred or contracted by it. ARTICLE VII CONVERSION OF SHARES In and by virtue of the Merger and at the Effective Time, pursuant to this Agreement of Merger, the shares of PCBG Stock and BOH Stock outstanding at the Effective Time shall be converted as follows: (a) EFFECT ON PCBG STOCK. Each share of PCBG Stock issued and outstanding immediately prior to the Effective Time shall for all purposes be deemed to represent, one share of common stock of the Surviving Corporation. (b) EFFECT ON BOH STOCK. Each share of BOH Common Stock issued and outstanding immediately prior to the Effective Time, except for shares as to which dissenters' rights are perfected pursuant to Section 1300 ET SEQ. of the California Corporations Code ("Perfected Dissenting Shares") shall be automatically cancelled and cease to be an issued and outstanding share of BOH Stock and shall be converted into the right to receive 3.4 shares of Company Stock, and a Warrant exercisable into one share of Company Stock. The Company will pay or cause to be paid cash in lieu of fractional shares of BOH Stock in an amount proportionate to the fair value of a whole share as determined by the board of directors of the Company which would otherwise be issuable as provided above. ARTICLE VIII SHAREHOLDER APPROVAL This Agreement shall be approved by the affirmative vote of the holders of a least a majority of the capital stock of BOH, PCBG and the Company at meetings duly held on the call of the directors or otherwise in accordance with law, and the Merger shall become effective on the Effective Time. 3 ARTICLE IX FURTHER ACTION The parties hereto shall execute and deliver, or cause to be executed and delivered, all such deeds and other instruments, and will take or cause to be taken all further or other action as they may deem necessary or desirable, in order to vest in and confirm to the Surviving Corporation title to and possession of all of BOH's and PCBG's property, rights, privileges, powers and franchises hereunder, and otherwise to carry out the intent and purposes of this Agreement of Merger. ARTICLE X EFFECTIVE TIME The Merger will become effective upon the filing of a copy of this Agreement of Merger and all other requisite accompanying certificates in the office of the Secretary of State of the State of California. The date and time of such filing with the Secretary of State of the State of California is referred to herein as the "Effective Time". ARTICLE XI SUCCESSORS AND ASSIGNS This Agreement of Merger shall be binding upon and enforceable by the parties hereto and their respective successors, assigns and transferees, but this Agreement of Merger may not be assigned by either party without the written consent of the other. ARTICLE XII GOVERNING LAW This Agreement of Merger has been executed in the State of California, and the laws of the State of California shall govern the validity and interpretation hereof and the performance by the parties hereto. ARTICLE XIII TERMINATION This Agreement of Merger may, by the mutual consent and action of the Boards of Directors of BOH and PCBG, be abandoned at any time before or after approval thereof by the shareholders of PCBG and BOH, but not later than the filing of this Agreement of Merger with the Secretary of State of the State of California. 4 ARTICLE XIV SATISFACTION OF OBLIGATIONS AND CONDITIONS (a) The obligations of BOH to proceed with the Closing are subject to the satisfaction at or prior to the Closing of all of the conditions to the obligations of PCBG and BOH under the Reorganization Agreement, any one or more of which, to the extent it is or they are waivable, may be waived, in whole or in part, by BOH. (b) The obligations of PCBG to proceed with the Closing are subject to the satisfaction at or prior to the Closing of all of the conditions to the obligations of Pacific Community Banking Group and BOH under the Reorganization Agreement, any one or more of which, to the extent it is or they are waivable, may be waived, in whole or in party, by PCBG. 5 IN WITNESS WHEREOF, BOH and PCBG, pursuant to the approval and authority duly given by resolution of their respective Board of Directors, have caused this Agreement of Merger to be signed by their respective officers on the day and year first above written. THE BANK OF HEMET By: -------------------------------------- James B Jaqua, President By: -------------------------------------- -------------------------, Secretary PCBG MERGER CORPORATION By: -------------------------------------- E. Lynn Caswell Chairman of the Board By: -------------------------------------- Alfred Jannard, Secretary PACIFIC COMMUNITY BANKING GROUP By: -------------------------------------- E. Lynn Caswell Chairman of the Board By: -------------------------------------- Alfred Jannard, Secretary 6 EXHIBIT B DIRECTORS AGREEMENT This Agreement ("Agreement") is made and entered into this 30th day of July 1998 by and between Pacific Community Banking Group, a California corporation ("Company"), and each of the other persons executing this Agreement (each such person is referred to individually as a "Bank Director" and collectively as "Bank Directors" with reference to the following facts: A. The Bank of Hemet, a California banking corporation ("Bank"), and the Company have entered into that certain Agreement and Plan of Reorganization dated as of July 30, 1998 ("Reorganization Agreement"), pursuant to which the Bank will acquire a subsidiary of the Company by means of a Merger, and the Company will exchange cash to the shareholders of the Bank for their shares of the Bank, as those terms are defined in the Reorganization Agreement ("Acquisition"). B. In order to facilitate Company and Bank entering into the Reorganization Agreement, the Bank Directors (comprising the entire Board of Directors of Bank) desire to enter into this Agreement. The execution of this Agreement shall be a condition precedent to the execution of the Reorganization Agreement. NOW, THEREFORE, in consideration of the promises and of the respective representations, warranties and covenants, agreements and conditions contained herein and in the Reorganization Agreement, the parties hereto agree as follows: 1. AGREEMENTS OF BANK DIRECTORS. 1.1 AGREEMENT TO VOTE. At any meeting of shareholders of Bank or in connection with any solicitation of the written consent of shareholders of Bank to approve the Reorganization Agreement and the transactions contemplated thereby, each of the Bank Directors shall vote or cause to be voted all shares of Common Stock of Bank ("Bank Stock") owned by each such Bank Directors and any other shares of Bank Stock hereafter acquired by each such Bank Director in favor of, and to approve, the principal terms of the Acquisition and any other matter contemplated by the Reorganization Agreement which requires the approval of the shareholders of Bank, including but not limited to the "Merger," as those terms are defined in the Reorganization Agreement. 1.2 AGREEMENT TO RECOMMEND. Each Bank Director shall recommend to the shareholders of Bank to vote in favor of, and to approve, the principal terms of the Acquisition and any other matter contemplated by the Reorganization Agreement. 1 1.3 RESTRICTIONS ON DISPOSITIONS. Each Bank Director agrees that, except (i) with the prior written consent of Company, or (ii) pursuant to the Acquisition, such Bank Director will not pledge nor otherwise encumber, sell, assign or otherwise dispose of any shares of Bank Stock currently owned, or acquired after the date of this Agreement, by such Bank Director. 1.4 COOPERATION. Each Bank Director agrees to cooperate fully with Company in connection with the Acquisition. Each Bank Director agrees that he or she will not, directly or indirectly, solicit any inquiries or proposals from, or enter into, or continue any discussions, negotiations or agreements relating to, or vote in favor of any proposal or transaction for disposition of the business or assets of Bank or any subsidiary thereof, or the acquisition of Bank's or any subsidiary of Bank's voting securities or any business combination with, any person entity other than Company. 2. REPRESENTATIONS AND WARRANTIES OF BANK DIRECTORS. Each of the Bank Directors represents and warrants to and agrees with Company as follows: 2.1 CAPACITY. Each such Bank Director has all the requisite capacity and authority to enter into and perform such Bank Director's obligations under this Agreement. 2.2 BINDING AGREEMENT. This Agreement constitutes the valid and legally binding obligation of each such Bank Director. 2.3 NON-CONTRAVENTION. The execution and delivery of this Agreement by each such Bank Director does not, and the performance by such Bank Director of such Bank Director's obligations hereunder will not, violate or conflict with or constitute a default under any agreement, instrument, contract or other obligation or any order, arbitration award, judgment or decree to which such Bank Director is a party or by which such Bank Director is bound, or any statute, rule or regulation to which such Bank Director or any of such Bank Director's property is subject. 2.4 OWNERSHIP OF SHARES. SCHEDULE 1 hereto correctly sets forth the number of shares of Bank Stock owned by each Bank Director, or with respect to which each Bank Director has voting power or beneficial ownership, as of the date indicated on such schedule. Each Bank Director has good title to all of the shares of Bank Stock indicated as owned by such Bank Director in the capacity set forth on SCHEDULE 1 as of the date indicated on such SCHEDULE 1, and such shares of Bank Stock are so owned free and clear of any liens, security interests, charges or other encumbrances, except as set forth in such SCHEDULE 1. 2 3. TERMINATION. 3.1 TERMINATION DATE. Except for the terms of Section 1.4, this Agreement shall terminate and be of no further force and effect immediately upon the earlier of: (a) consummation of the Acquisition or (b) termination of the Reorganization Agreement in accordance with the terms thereof. 3.2 EFFECT OF TERMINATION. Upon the termination of this Agreement in accordance with Section 3.1 hereof, the respective obligations of the parties hereto shall immediately become void and have no further force or effect except that the termination of this Agreement shall not excuse or forgive any breach hereof. 4. SPECIFIC PERFORMANCE. The parties hereto recognize and agree that monetary damages will not compensate adequately the parties hereto for nonperformance. Accordingly, each party agrees that such party's obligations shall be enforceable by court order requiring specific performance. 5. MISCELLANEOUS. 5.1 EXPENSES. Each party hereto shall pay its own costs and expenses, including, without limitation, those of its attorneys and accountants, in connection with this Agreement and transactions covered and contemplated hereby. 5.2 NOTICES. All notices, demands or other communications hereunder shall be in writing and be made by (a) hand delivery; (b) overnight mail; (c) United States mail, first class, certified or registered, postage prepaid; or (d) facsimile transmission, and shall be deemed to have been duly given (i) on the date of service if delivered by hand or facsimile transmission (provided that telecopied notices are also mailed by United States mail, first class, certified or registered, postage prepaid); (ii) on the next day if delivered by overnight mail; or first-class, certified or registered, postage prepaid, and properly addressed as follows: (a) If to Company: Pacific Community Banking Group 23332 Mill Creek Drive, Suite 230 Laguna Hills, California 92653 Attention: E. Lynn Caswell, President Telecopier: (714) 460-4501 3 With copies to: Knecht & Hansen 1301 Dove Street, Suite 900 Newport Beach, CA 92660 Attention: Loren P. Hansen, Esq. Telecopier: (714) 851-1732 (b) If to a Bank Director: to the Bank Director and address noted on page 7 hereof With copies to: Gary Steven Findley & Associates 1470 North Hundley Street Anaheim, California 92806 Attention: Gary S. Findley, Esq. Telecopier: (714) 630-7910 The persons or addresses to which mailings or deliveries shall be made may change from time to time by notice given pursuant to the provisions of this SECTION 5.2. 5.3 SUCCESSORS AND ASSIGNS. Subject to Section 5.4 herein, all terms and provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective transferees, successors and assigns; provided, however, that, except as otherwise contemplated herein, this Agreement and all rights, privileges, duties and obligations of the parties hereto may not be assigned or delegated by any Bank Director without the prior written consent of Company and any purported assignment in violation of this Section 5.3 shall be null and void. 5.4 THIRD PARTY BENEFICIARIES. Each party hereto intends that this Agreement shall not benefit, or create any right or cause of action in or on behalf of, any person other than the parties hereto. As used in this Agreement, the term "party" or "parties" shall refer only to Company and the Bank Directors or any of them. 5.5 COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one instrument. 4 5.6 GOVERNING LAW. This Agreement is made and entered into in the State of California and the laws of the State of California shall govern the validity and interpretation hereof and the performance of the parties hereto of their respective duties and obligations hereunder except as specifically provided in SECTION 5.9 hereof. 5.7 CAPTIONS. The captions contained in this Agreement are for convenience of reference only and do not form a part of this Agreement. 5.8 WAIVER AND MODIFICATION. No waiver of any term, provision or condition of this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be or construed as a further or continuing waiver of any such term, provision or condition of this Agreement. This Agreement may be modified or amended only by an instrument of equal formality signed by the parties or their duly authorized agents. 5.9 ATTORNEYS' FEES. In the event a Bank Director or Company brings an action or suit against the other party by reason of any breach of any covenant, agreement, representation, warranty or other provision hereof, or any breach of any duty or obligation created hereunder by such other party, the prevailing party, as determined by the court or other body having jurisdiction, shall be entitled to have and recover of and from the losing party, as determined by the court or other body having jurisdiction, all reasonable costs and expenses incurred or sustained by such prevailing party in connection with such action or suit, including, without limitation, legal fees and court costs (whether or not taxable as such). In an action or suit brought by a Bank Director or Company to enforce any provision hereof, or for damages for the breach hereof, such action or suit shall be commenced and maintained exclusively in the state court sitting in Orange County, California. 5.10 ENTIRE AGREEMENT. The making, execution and delivery of this Agreement by the parties hereto have not been induced by any representation, statements, warranties or agreements other than those expressed herein. This Agreement, in addition to the applicable provisions of the Reorganization Agreement, embodies the entire understanding of the parties and there are no further or other agreements or understandings, written or oral, in effect between the parties relating to the subject matter hereof, unless expressly referred to by reference herein. 5.11 SEVERABILITY. Whenever possible, each provision of this Agreement and every related document shall be interpreted in such manner as to be valid under applicable law. However, if any provision of any of the foregoing shall be invalid or prohibited under said applicable law, it shall be construed, interpreted and limited to effectuate its purpose to the maximum legally permissible extent. If it cannot be so construed and interpreted so as to be valid under such law, such provision shall be ineffective to the extent of such invalidity or prohibition without invalidating the remainder of such provision or the remaining provisions of this 5 Agreement, and this Agreement shall be construed to the maximum extent possible to carry out its terms without such invalid or unenforceable provision or portion thereof. 5.12 SEVERAL OBLIGATIONS. All duties and obligations of each party to this Agreement shall be several and not joint. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written. Pacific Community Banking Group By: /s/ E. Lynn Caswell --------------------------- E. Lynn Caswell, Chairman 6 "Bank Director" and address /s/ Clayton A. Record., Jr. /s/ Jack E. Gosch - --------------------------- --------------------------- 890 N. Lyon Ave. 150 Carriage Circle San Jacinto, CA 92582 Hemet, CA 92545 /s/ John B. Brudin /s/ James Jaqua - --------------------------- --------------------------- 26680 Rio Vista Dr. 440 Emerald Bay Hemet, CA 92546 Laguna Beach, CA 92651 /s/ E. Kenneth Hyatt /s/ John J. McDonough - --------------------------- --------------------------- 38122 Stone Meadow Dr. 27265 Hemet St. Murrieta, CA 92562 Hemet, CA 92544 7 Schedule 1 as of ______________, 1998
Owned Bank Common Shares - ----- ------------------ _________________________ _________________________ _________________________ _________________________ _________________________ _________________________ _________________________ _________________________
8 Exhibit C TBOH WARRANT AGREEMENT THIS WARRANT AGREEMENT, dated as of , 1999, is made between PACIFIC COMMUNITY BANKING GROUP, a California corporation (the "Company"), and each person to whom a warrant is issued or provided herein (the "Holder"). RECITALS A. The Company proposes to issue warrants as hereinafter described (the "Warrants") to each Holder to purchase shares of its Common Stock, no par value per share (the "Common Stock"), in connection with the acquisition of The Bank of Hemet (the "Bank") by the Company in which at the Effective Time of the Merger, the Bank would become a wholly-owned subsidiary of the Company, and all of the issued and outstanding shares of The Bank of Hemet Stock ("Bank Stock"), except for shares of Bank Stock held by Dissenting Shareholders, shall be converted into and exchanged for cash and a warrant exercisable into shares of Company Stock, under the terms and conditions contained in the First Restatement of the Agreement and Plan of Reorganization dated January 5, 1999, as amended in which each warrant (the "Warrant") entitling the holder thereof to purchase shares of Common Stock of the Company (the "Warrant Shares"). B. In consideration of the foregoing and for the purpose of defining the terms and provisions of the Warrants and the respective rights and obligations thereunder of the Company and the Holder, the Company and the Holder hereby agree as follows: SECTION 1. GRANT OF WARRANT. The Company hereby grants to the Holder, as of the date hereof, Warrants to purchase all or any part of the number of shares of the Company's Common Stock set forth in the Warrant, subject to the terms, conditions and adjustment provisions as provided in this Agreement. SECTION 2. TERM OF WARRANTS; EXERCISE OF WARRANTS. 2.1 TERM OF EXERCISE OF WARRANTS. The Warrants are exercisable for a ten-year period commencing upon the date of issuance (the "Issuance Date"). Subject to the terms of this Agreement, each Holder shall have the right, which may be exercised at any time until ten years from the original date of issuance (the "Expiration Date") to purchase from the Company that number of shares of Common Stock of the Company specified in Section 1 at the warrant prices specified in Section 9. Upon such purchase, the shares of Common Stock of the Company will be fully paid and nonassessable to which the Holder may at the time be entitled to purchase upon exercise of such Warrants. 2.2 EXERCISE OF WARRANTS. A Warrant may be exercised upon surrender to the Company at its principal office of the certificate or certificates evidencing the Warrants to be exercised, together with the form of election to purchase on the reverse thereof duly 1 filled in and signed, (and upon payment to the Company for the account of the Company in accordance with the provisions of Sections 9 and 10 hereof), for the number of shares of Common Stock in respect of which such Warrants are then exercised. Payment of the aggregate Warrant Price shall be made by check, Cashier's Check, money order, or any combination thereof. Subject to Section 6 hereof, upon such surrender of Warrants and payment of the Warrant Price as aforesaid, the Company shall issue and cause to be delivered with all reasonable dispatch to or upon the written order of the Holder and in such name or names as the Holder may designate, a certificate or certificates for the number of full shares of Common Stock so purchased upon the exercise of such Warrants, together with cash, as provided in Section 11 hereof, in respect of any fractional shares of Common Stock otherwise issuable upon such surrender. Such certificate or certificates shall be deemed to have been issued and any person so designated to be named therein shall be deemed to have become a holder of record of such Common Stock as of the date of the surrender of such Warrants and payment of the Warrant Price, as aforesaid; provided, however, that if, at the date of surrender of such Warrants and payment of the Warrant Price, the transfer books for the Common Stock or other class of stock purchasable upon the exercise of such Warrants shall be closed, the certificates for the Common Stock in respect of which such Warrants are then exercised shall be issuable as of the date on which such books shall next be opened (whether before or after the Expiration Date) and until such date the Company shall be under no duty to deliver any certificate for such Common Stock; provided further, however, that the transfer books of record, unless otherwise required by law, shall not be closed at any one time for a period longer than twenty days. The rights of purchase represented by the Warrants shall be exercisable, at the election of the Holders thereof, either in full or from time to time in part and, in the event that a certificate evidencing Warrants is exercised in respect of less than all of the Common Stock purchasable on such exercise at any time prior to the date of expiration of the Warrants, a new certificate evidencing the remaining Warrant or Warrants will be issued. SECTION 3. REGISTRATION. Transferability. Issuance and Form of Warrant. 3.1 REGISTRATION. The Warrants shall be numbered and shall be registered in a Warrant Register as they are issued. The Company shall be entitled to treat the Holder of any Warrant as the owner in fact thereof for all purposes and shall not be bound to recognize any equitable or other claim to or interest in such Warrant on the part of any other person, and shall not be liable for any registration of transfer of Warrants which are registered or to be registered in the name of a fiduciary or the nominee of a fiduciary unless made with the actual knowledge that a fiduciary or nominee is committing a breach of trust in requesting such registration of transfer, or with such knowledge of such facts that its participation therein amounts to bad faith. 3.2 TRANSFER. The Common Stock and the Warrants received from the Company pursuant to the Agreement will be separately transferable from the date of 2 issuance. The Warrants shall be transferable on the books of the Company maintained at the principal office of the Company upon delivery thereof duly endorsed by the Holder or by his duly authorized attorney or representative, or accompanied by proper evidence of succession, assignment or authority to transfer, with signatures properly guaranteed. In all cases of transfer by an attorney, the original power of attorney, duly approved, or an official copy thereof, duly certified, shall be deposited and remain with the Company. In case of transfer by executors, administrators, guardians or other legal representatives, duly authenticated evidence of their authority shall be produced, and may be required to be deposited and remain with the Company in its discretion. Upon any registration of transfer, the Company shall execute and deliver a new Warrant or Warrants to the persons entitled thereto. The Warrants may be exchanged at the option of the Holder thereof, when surrendered at the principal office of the Company for another Warrant or Warrants to the persons entitled thereto. The Warrants may be exchanged at the option of the Holder thereof, when surrendered at the principal office of the Company for another Warrant, or other Warrants of different denominations, of like tenor and representing in the aggregate the right to purchase a like number of Warrant Shares. The Company shall not be required to effect any registration of transfer or exchange which will result in the issuance of a Warrant Certificate for a fraction of a Warrant. The Holder understands that the Warrants and the securities exercisable hereunder are intended to be registered pursuant to the Securities Act of 1933, as amended, upon issuance, and such securities are intended to be transferable once the registration has been completed. 3.3 ISSUANCE. Warrant certificates shall be issued and delivered by the Company as evidence of the Warrants sold by the Company as a part of the Offering (the "Warrant Certificates"). Each Warrant Certificate shall evidence the right, subject to the provisions of this Agreement and of the Warrant Certificate itself, for the registered holder thereof or his assigns to purchase the number of shares of Common Stock of the Company stated therein. 3.4 FORM OF WARRANT. The Form of Election to Purchase shares of Common Stock shall be substantially as set forth in EXHIBIT "A" attached hereto. The price per share of Common Stock and the number of shares of Common Stock issuable upon the exercise of Warrants are subject to adjustment upon the occurrence of certain events, all as hereinafter provided. The Warrants shall be executed on behalf of the Company by its Chairman of the Board or Chief Executive Officer or one of its Vice Presidents, under its corporate seal reproduced thereon attested by its Secretary or an Assistant Secretary. The signature of any of such officers on the Warrants may be manual or facsimile. Warrants bearing the manual or facsimile signatures of individuals who were at any time the proper officers of the Company shall bind the Company, notwithstanding that such individuals or any one of them shall have ceased to hold such offices prior to the delivery of such Warrants or did not hold such offices on the date of this Agreement. 3 Warrants shall be dated as of the date of signature thereof by the Company either upon initial issuance or upon division, exchange, substitution or transfer. SECTION 4. SIGNATURE OF WARRANTS. The Warrants shall be signed by the Company (or any successor to the Company) and shall not be valid for any purpose unless so signed. Warrants may be signed, however, by the Company and may be delivered by the Company, notwithstanding that the persons whose manual or facsimile signatures appear thereon as proper officers of the Company shall have ceased to be such officers at the time of such signature, issuance or delivery. SECTION 5. EXCHANGE OF WARRANT CERTIFICATES. Each Warrant certificate may be exchanged for another certificate or certificates entitling the Holder thereof to purchase a like aggregate number of shares of Common Stock as the certificate or certificates to be so exchanged. Thereupon, the Company shall execute and deliver to the person entitled thereto a new Warrant certificate or certificates, as the case may be, as so requested. SECTION 6. PAYMENT OF TAXES. The Company will pay all documentary stamp taxes, if any, attributable to the initial issuance of shares of Common Stock upon the exercise of Warrants; provided, however, that the Company shall not be required to pay any tax or taxes which may be payable in respect of any transfer involved in the issuance or delivery of any Warrants or certificate for shares of Common Stock in a name other than that of the registered Holder of Warrants in respect of which such shares of Common Stock are issued, and in such case the Company shall not be required to issue or deliver any certificate for shares of Common Stock or any Warrant until the person requesting the same has paid to the Company the amount of such tax or has established to the Company's satisfaction that such tax has been paid. SECTION 7. MUTILATED OR MISSING WARRANTS. In case of any of the certificates evidencing the Warrants shall be mutilated, lost, stolen or destroyed, the Company may, in its discretion, execute, issue and deliver in exchange and substitution for and upon cancellation of the mutilated Warrant certificate, or in lieu of and substitution for the Warrant certificate lost, stolen or destroyed, a new Warrant certificate of like tenor and representing an equivalent right or interest; but only upon receipt of evidence satisfactory to the Company of such loss, theft or destruction of such Warrant and indemnity, if requested, also satisfactory to them. An applicant for such substitute Warrant certificate shall also comply with such other reasonable regulations and pay such other reasonable charges as the Company may prescribe. SECTION 8. RESERVATION OF SHARES: PURCHASE OF WARRANTS. 8.1 RESERVATION OF WARRANT SHARES. There will be reserved, and thereafter the Company shall at all times keep reserved, out of its authorized Common Stock, a number of shares of Common Stock sufficient to provide for the exercise of the rights of purchase represented by the outstanding Warrants. The Transfer Agent for the Common Stock and 4 every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of any rights of purchase aforesaid will be irrevocably authorized and directed at all times to reserve such number of authorized shares as shall be requisite for such purposes. The Company will keep a copy of this Agreement on file with the Transfer Agent for the Common Stock and with every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrants. The Company will supply such Transfer Agent with duly executed stock certificates for such purposes and will provide or otherwise make available any cash which may be payable as provided in Section 11 hereof. All Warrants surrendered in the exercise of the rights thereby evidenced shall be canceled by the Company. 8.2 PURCHASE OF WARRANTS BY THE COMPANY. The Company shall have the right, except as limited by law, other agreement or herein, to purchase or otherwise acquire Warrants at such times, in such manner and for such consideration as it may deem appropriate. 8.3 CANCELLATION OF WARRANTS. In the event the Company shall purchase or otherwise acquire Warrants, the same shall thereupon be canceled by the Company and retired. The Company shall cancel any Warrant surrendered for exchange, substitution, transfer or exercise in whole or in part. SECTION 9. WARRANT EXERCISE PRICE. The price per share at which shares of Common Stock shall be purchasable upon exercise of Warrants (the "Warrant Price") shall be $ per share from the date of issuance to on or before the end of the tenth year after the date of issuance of the Warrant, subject to the adjustment pursuant to Section 10 hereof. SECTION 10. ADJUSTMENT OF WARRANT PRICE AND NUMBER OF SHARES. The number and kind of securities purchasable upon the exercise of each Warrant and the Warrant Price shall be subject to adjustment from time to time upon the occurrence of certain events, as hereinafter defined. 10.1 MECHANICAL ADJUSTMENTS. The number of Warrant Shares purchasable upon the exercise of each Warrant and the Warrant price shall be subject to adjustment as follows: (a) In case the Company shall (i) pay a dividend in shares of Common Stock or make a distribution in shares of Common Stock, (ii) subdivide its outstanding shares of Common Stock into a greater number of shares, (iii) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock or (iv) issue a reclassification of its shares of Common Stock or capital reorganization of other securities of the Company, the number of Warrant Shares purchasable upon exercise of each Warrant immediately prior thereto shall be adjusted so that the Holder of each Warrant shall be entitled to receive the kind and number of Warrant Shares or other securities of the Company which he would have owned or have been entitled to receive after the occurrence of any of 5 the events described above, had such Warrant been exercised immediately prior to the happening of such event or any record date with respect thereto. An adjustment made pursuant to this paragraph (a) shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. (b) In case, at any time or from time to time after issuance of the Warrant and while the Warrant remains outstanding and has not been exercised, the Company shall issue or sell any warrants or options, other than options granted under the Company's 1999 Stock Option Plan, as it may be amended from time to time, or any similar plan hereafter adopted by the Company or any of its subsidiaries, for the purchase of the Company's Common Stock with a price per share at which shares of Common Stock shall be purchasable upon exercise of such warrants or options that is less than the Warrant Price in effect immediately prior to such issue or sale, then forthwith upon such issue or sale the Warrant Price shall be immediately reduced to such price per share. No adjustment of the Warrant Price shall be made as a result of the Company's issuance or sale of Common Stock or other securities of the Company, regardless of the price at which such shares or other securities are issued, including, without limitation, the Company's issuance or sale of stock options under the Company's 1999 Stock Option Plan, as it may be amended from time to time, or any similar plan hereafter adopted by the Company or any of its subsidiaries, with an exercise price less than the Warrant Price. In addition, no adjustment of the Warrant Price shall be made if the adjustment would otherwise be for an amount less then $.25 per share, but any such nonadjustment shall be carried forward and shall be made at the time of and together with the next subsequent adjustment which, together with any adjustments so carried forward, shall amount to $.25 per share or more. Further, no adjustment shall be made in the case of an issuance or sale of warrants with respect to fewer than 10% of the then-outstanding shares of the Company's Common Stock in any 24 month period. (c) Whenever the number of Warrant Shares purchasable upon the exercise of each Warrant is adjusted, as herein provided, the Warrant Price payable upon exercise of each Warrant shall be adjusted by multiplying such Warrant Price immediately prior to such adjustment by a fraction, of which the numerator shall be the number of Warrant Shares purchasable upon the exercise of each Warrant immediately prior to such adjustment, and of which the denominator shall be the number of Warrant Shares so purchasable immediately thereafter. (d) For the purpose of this subsection 10. 1, the term "shares of Common Stock" shall mean (i) the class of stock designated as the Common Stock of the Company at the date of this Agreement, or (ii) any other class of stock resulting from successive changes or reclassifications of such shares consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. In the event that at any time, as a result of an adjustment made pursuant to paragraph (a) above, the Holders shall become entitled to purchase any shares of the Company other than shares so purchasable upon exercise of each Warrant and the Warrant Price of such shares shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as 6 practicable to the provisions with respect to the shares of Common Stock contained in paragraphs (a) and (b), inclusive, above, and the provisions of Section 5 and subsections 10.2 through 10.4, inclusive, with respect to the shares of Common Stock shall apply on like terms to any such other shares. 10.2 NOTICE OF ADJUSTMENT. Whenever the number of shares of Common Stock purchasable upon the exercise of each Warrant or the Warrant Price of such shares of Common Stock is adjusted, as herein provided, the Company, within thirty (30) days thereafter, shall cause to be mailed promptly by first class mail, postage prepaid, to each Holder notice of such adjustment or adjustments and the Warrant Price of such shares of Common Stock after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which such adjustment was made. A firm of independent public accountants selected by the Board of Directors of the Company (who may be the regular accountants employed by the Company) may make any computation required under this Section 10.2. 10.3 NO ADJUSTMENT FOR DIVIDENDS OR DISTRIBUTIONS. Except as provided in subsection 10.1, no adjustment in respect of any dividends or distributions shall be made during the term of a Warrant or upon the exercise of a Warrant. 10.4 PRESERVATION OF PURCHASE RIGHTS UPON CONSOLIDATION, MERGER. ETC. In case of any consolidation of the Company with, or merger of the Company into, another corporation, or in case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety, the Company or such successor or purchasing corporation, as the case may be, shall execute an agreement that each Holder shall have the right thereafter upon payment of the Warrant price in effect immediately prior to such action to purchase upon the exercise of each Warrant the kind and amount of shares and other securities and property (including cash) which he would have owned or have been entitled to receive after the occurrence of such consolidation, merger, sale or conveyance had such Warrant been exercised immediately prior to such action. The Company shall mail by first class mail, postage prepaid, to each Holder, notice of the execution of any such agreement. Such agreement shall provide for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 10. The provisions of this subsection 10.4 shall similarly apply to successive consolidations, mergers, sales or conveyances. 10.5 STATEMENTS ON WARRANTS. Irrespective of any adjustments in the Warrant Price or the number or kind of shares purchasable upon the exercise of the Warrants, Warrants theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in the Warrants initially issuable pursuant to this Agreement. SECTION 11. FRACTIONAL INTERESTS. The Company shall not be required to issue fractional shares of Common Stock on the exercise of Warrants. If more than one Warrant shall be presented for exercise of shares of Common Stock in full at the same time by the 7 same Holder, the number of full shares of Common Stock which shall be issuable upon the exercise thereof shall be computed on the basis of the aggregate number of shares of Common Stock purchasable upon exercise of the Warrants so presented. If any fraction of a share of Common Stock would, except for the provisions of this Section 11, be issuable on the exercise of any Warrant (or specified portion thereof), the Company shall pay an amount in cash equal to the difference between the then current book value price per share of Common Stock and the exercise price of the Warrant, multiplied by such fraction. SECTION 12. NO RIGHTS AS STOCKHOLDERS: NOTICES TO HOLDERS. Nothing contained in this Agreement or in any of the Warrants shall be construed as conferring upon the Holders or their transferees the right to vote or to receive dividends or to consent or to receive notice as stockholders in respect of any meeting of stockholders for the election of directors of the Company or any other matter, or any rights whatsoever as stockholders of the Company. If, however, at any time after 60 days before the Exercise Date, and prior to the expiration of the Warrants and prior to their exercise, any of the following events shall occur: (a) the Company shall declare any dividend or distribution payable in any securities upon its shares of Common Stock to the Holders of its shares of Common Stock; or (b) The Company shall offer to the holders of its shares of Common Stock any additional shares of Common Stock or securities convertible into shares of common stock or any right to subscribe thereto; or (c) A dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger, or sale of all or substantially all of its property, assets, and business as an entirety) shall be proposed; then in any one or more of said events, the Company shall give notice in writing of such event to the Holders as provided in Section 13 hereof, such giving of notice to be completed at least 20 days prior to the date fixed as a record date or the date of closing the transfer books for the determination of the stockholders entitled to such dividend, distribution, or subscription rights, or for the determination of stockholders entitled to vote on such proposed dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the transfer books, as the case may be. Failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of any action taken in connection with such dividend, distribution or subscription rights, or proposed dissolution, liquidation or winding up. SECTION 13. NOTICES. Any notice pursuant to this Agreement be any Holder to the Company shall be in writing and shall be mailed first class, postage prepaid, or delivered (a) to the Company, at its office at 23332 Mill Creek Drive, Suite 230, Laguna Hills, California 92653, with copies to Knecht & Hansen, 1301 Dove Street, Suite 900, Newport Beach, California 92660. Each party hereto may from time to time change the address to which 8 notices to it are to be delivered or mailed hereunder by notice in writing to the other party. Any notice mailed pursuant to this Agreement by the Company to the Holders shall be in writing and shall be mailed first class, postage prepaid, or delivered to such Holders at their respective addresses on the books of the Company. SECTION 14. SUPPLEMENTS AND AMENDMENTS. The Company may not supplement or amend this Agreement without the approval of any Holder, in order to cure any ambiguity or to correct or supplement any provision contained herein which may be defective or inconsistent with any other provision herein, or to make any other provisions in regard to matters or questions arising hereunder which the Company and the Holder may deem necessary or desirable and which shall not be inconsistent with the provisions of the Warrants. SECTION 15. SUCCESSORS. All covenants and provisions of this Agreement by or for the benefit of the Company or the Holder shall bind and inure to the benefit of their respective successors and assigns hereunder. SECTION 16. APPLICABLE LAW. This Agreement and Warrant issued hereunder shall be governed by and construed in accordance with the laws of the State of California, without giving effect to principles of conflict of laws. SECTION 17. BENEFITS OF THIS AGREEMENT. Nothing in this Agreement shall be construed to give to any person or corporation other than the Company and the Holders any legal or equitable right, remedy or claim under this Agreement; but this Agreement shall be for the sole and exclusive benefit of the Company and the Holders of the Warrants. SECTION 18. COUNTERPARTS. This Agreement may be executed in any number of counterparts and each of such counterparts shall for all purposes be deemed to be an original, and all such counterparts shall together constitute but one and the same instrument. SECTION 19. CAPTIONS. The captions of the Sections and subsections of this Agreement have been inserted for convenience only and shall have no substantive effect. 9 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed, all as of the day and year first written. PACIFIC COMMUNITY BANKING GROUP By: ------------------------------------- E. Lynn Caswell Chairman and Chief Executive Officer By: ------------------------------------- Secretary 10 EX-2.2 3 EXHIBIT 2.2 Exhibit 2.2 FIRST AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION This FIRST AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION (the "First Amendment") is dated as of February _, 1999 and entered into by and between The Bank of Hemet (the "Bank") and Pacific Community Banking Group (the "Company"). WHEREAS, the Bank and the Company entered into a First Restatement of Agreement and Plan of Reorganization dated as of January 5, 1999 (the "Agreement"); and WHEREAS, the parties hereto desire to amend the Agreement as provided in this First Amendment as provided herein. NOW, THEREFORE, in consideration of the premises and mutual promises of the parties set forth below, the parties hereto agree as follows: 1. Capitalized terms used herein and not otherwise defined shall have the same meaning as set forth in the Agreement. 2. The first sentence of Section 5.2 of the Agreement is hereby amended to read in its entirety as follows: "The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, no par value, of which 10,000 shares are outstanding on the date hereof, all validly issued, fully paid and nonassessable, and 100,000,000 shares of Preferred Stock, of which not more than 2 million shares have been issued or are to be issued before the Closing Date." 3. Section 7.2(ii) of the Agreement is hereby amended to read in its entirety as follows "(ii) refrain from amending its Charter Documents except to the extent as may be required or contemplated by this Agreement, and except as the Company proposes to amend its articles of incorporation and bylaws as attached to this Agreement as EXHIBIT 7.2(II)." 4. This First Amendment may be entered into in one or more counterparts, all of which shall be considered one in the same instrument, and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart. 1 5. Except as herein amended, the Agreement shall remain in full force and effect. 6. This First Amendment shall be governed by and construed in accordance with the laws of the State of California. 7. The execution and delivery of this First Amendment by the officers executing the First Amendment have been duly authorized by the Boards of Directors of the Bank and the Company, and this First Amendment constitutes a legal, valid and binding agreement of the parties in accordance with its respective terms. 2 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the day and year first above written. PACIFIC COMMUNITY BANKING GROUP By: -------------------------------------- E. Lynn Caswell Chairman and Chief Executive Officer THE BANK OF HEMET By: -------------------------------------- John J. McDonough Chairman of the Board By: -------------------------------------- James B. Jaqua President and Chief Executive Officer By: -------------------------------------- Secretary 3 EX-2.3 4 EXHIBIT 2.3 Exhibit 2.3 SECOND AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION This SECOND AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION (the "Second Amendment") is dated as of ________ 1999 and entered into by and between The Bank of Hemet (the "Bank") and Pacific Community Banking Group (the "Company"). WHEREAS, the Bank and the Company entered into a First Restatement of Agreement and Plan of Reorganization dated as of January 5, 1999 (the "Agreement"); and a First Amendment to the Agreement dated as of March 24, 1999. WHEREAS, the parties hereto desire to amend the Agreement and the First Amendment as provided in this Second Amendment. NOW, THEREFORE, in consideration of the premises and mutual promises of the parties set forth below, the parties hereto agree as follows: 1. Capitalized terms used herein and not otherwise defined shall have the same meaning as set forth in the Agreement. 2. Recital C of the Agreement is hereby amended to read in its entirety as follows: "C. At the Effective Time (hereinafter defined below) of the Merger, all of the issued and outstanding shares of Bank Stock, except for shares of Bank Stock held by Dissenting Shareholders (as hereinafter defined below), shall be converted into and exchanged for a combination of shares of Company Stock and Warrants exercisable into shares of Company Stock, all upon the terms and subject to the conditions hereinafter set forth;" 3. Recital I is hereby added to read in its entirety as follows: "i. For federal income tax purposes, it is intended that the Merger shall qualify as a "reorganization" within the meaning of Section 368 of the Internal Revenue Code of 1986, as amended (the "Code"), and the Bank, the Company and PCBG Merger Corporation will each be "a party to a reorganization," within the meaning of Section 368(b) of the Code, with respect to the Merger;" 4. The definition of Bank Shareholder is hereby added to read in its entirety as follow: 1 "'Bank Shareholder' shall mean any holder of Bank Stock or an option to purchase Bank Stock immediately prior to the Merger." 5. The definition of Expected Net Proceeds is hereby deleted. 6. The definition of "Offering" is hereby amended to read in its entirety as follows: "'Offering' shall mean a public offering underwritten by the Underwriters (as defined below), as determined by the Company in its sole discretion, of a certain number of shares of Company Stock as determined by the Company in its sole discretion, of shares of the Company held by shareholders of the Bank and Valley Bank and newly issued shares, at a gross offering price of not less than $15.00 per share, as described in Section 7.14." 7. The definition of "S-l" is hereby amended in its entirety as follows: "'S-1' means the registration statement on Form S-1 to be filed with the SEC relating to the registration under the Securities Act of the shares of Company Stock held by shareholders of the Bank and Valley Bank to be sold, and shares of Company Stock to be issued, in the Offering." 8. The definition of "Selling Shareholder" is hereby added to read in its entirety as follows: "'Selling Shareholder' shall mean any Bank shareholder or holder of a Bank stock option who elects to sell his or her shares of Bank Stock or to exchange his or her options and sell the Company Stock received in exchange therefore in the Offering." 9. The definition of "Total Acquisition Costs" is hereby deleted. 10. The definition of "Undesignated Shares" is hereby added to read in its entirety as follows: "'Undesignated Shares' shall have the meaning given such term in Section 2.10." 11. A second sentence is hereby added to Section 2.1(b), which will read in its entirety as follows: "Holders of Bank Stock shall have a right to sell in the Offering all the shares of Company Stock received in exchange for Bank Stock as they so elect, as 2 provided in Section 2.10, provided that if more than 88% or less than 75% of the shares of Company Stock received by the Bank Shareholders (including, for this purpose, holders of Bank stock options, as provided in Section 2.8) is elected to be sold in the Offering, the shares sold in the Offering by each Selling Shareholder shall be adjusted. If more than 88% of the shares of Company Stock received by the Bank Shareholders (including, for this purpose, holders of Bank stock options, as provided in Section 2.8) is elected to be sold in the Offering, the shares sold in the Offering by each Selling Shareholder shall be decreased ratably in proportion to the number of shares requested to be sold, so that the total number of shares retained (i.e., not sold in the Offering) by the Bank Shareholders in the aggregate is equal to at least 12% of the Company Stock received by the Bank Shareholders. If less than 75% of the shares of Company Stock received by the Bank Shareholders (including, for this purpose, holders of Bank stock options, as provided in Section 2.8) is elected to be sold in the Offering, the shares sold in the Offering by each Selling Shareholder so electing shall be increased ratably in proportion to the number of shares requested to be sold, so that the total number of shares retained (i.e., not sold in the Offering) by the Bank Shareholders in the aggregate is equal to no more than 25% of the Company Stock received by the Bank Shareholders. If, after such proration, the number of shares to be retained by all Bank Shareholders in the aggregate remains more than 25%, then each of the Directors hereby agrees to decrease the number of shares retained by them, ratably in proportion to their total shareholdings, to the extent necessary to aggregate retention of 25%. The Selling Shareholder shall receive, for each share of Company Stock sold in the Offering, the price at which shares are sold in the Offering, without reduction for expenses or commissions of the Offering, it being understood that the Company shall bear such expenses and commissions." 12. Section 2.1(e) is hereby amended to read in its entirety as follows: (e) COMPANY CORPORATE GOVERNANCE CHANGES. The Charter Documents of the Company as in effect immediately prior to the Effective Time shall continue in effect after the Merger until thereafter amended in accordance with applicable law and the members of the Board of Directors and the Executive Officers of the Company immediately prior to the Merger shall continue in their respective positions after the Merger and be the Board of Directors and the Executive Officers of the Company, except that the Company shall have taken prior to the Effective Time all necessary steps so that, (i) two (2) individuals from the Board of Directors or executive staff of the Bank, which are intended to be Mr. Jaqua and Mr. Harold Williams, shall be appointed to the Board of Directors of the Company, shall be renominated by the Board of Directors for election at the Company's yearly annual meetings for a minimum of (3) three years;(ii) two (2) individuals from the Board of Directors of Valley Bank shall be appointed to the Board of Directors of the Company; and (iii) the individuals elected to fill such four (4) directorships shall be 3 annual appointments as selected in the sole discretion of the Company; (clauses (i)-(iii) being hereinafter collectively referred to as the "Company Corporate Governance Changes")." 13. Section 2.4 is hereby amended to read in its entirety as follows: "2.4 THE AGGREGATE PURCHASE CONSIDERATION AND PER SHARE CONSIDERATION. The Aggregate Purchase Consideration shall be equal to the sum of (i) the product of 844,278 and the Per Share Consideration and (ii) the Aggregate Option Price. The Per Share Consideration shall be equal to 3.4 shares of Company Stock for each share of Bank Stock, plus one (1) Warrant." 14. Section 2.5 is hereby amended to read in its entirety as follows: "2.5 DELIVERY OF CONSIDERATION. At the Closing, the Company will deliver to the Exchange Agent an amount of Company Stock and Warrants equal to the Aggregate Purchase Consideration, plus any cash payment for a fractional share of Company Stock. In the case of shares of Company Stock to be sold in the Offering, as provided in Section 2.1(b), the Exchange Agent shall deliver such shares to, or pursuant to the direction of, the Underwriters. In the case of all other shares of Company Stock, and the cash and Warrants, the Exchange Agent shall deliver the same to the Selling Shareholders, provided that share certificates formerly evidencing Bank Stock (duly executed and in proper form for transfer, or a lost certificate affidavit acceptable to the Company) shall have been delivered to the Exchange Agent in accordance with this Section 2.5, Section 2.10 and an agreement to be entered into between the Company and the Exchange Agent." 15. Section 2.8 is hereby amended to read in its entirety as follows: "2.8 STOCK OPTIONS. Immediately prior to the Effective Time of the Merger, all stock options will be fully vested and each holder of a Bank Option will be given the opportunity to, in whole or in part, cancel such option and receive Company Stock equal to the number of shares of Bank Stock covered by such option multiplied by the number obtained by subtracting the exercise price of such option from the Per Share Consideration in effect on the Closing Date (i.e., shares subject to option times ($51.00 minus exercise price of option), all divided by $15.00) (the total of sum of such payments for all Bank Options so cancelled shall be defined as the "Aggregate Option Price"). Holders of Bank Options who elect to cancel their options in exchange for Company Stock (and Warrants, as provided in the next sentence) will have their Bank Options cancelled immediately prior to the Effective Time. For each 3.4 shares of Company Stock paid by the Company in exchange for options on Bank Stock as provided in the previous two sentences, each holder of a bank option will also receive one (1) Warrant. Such payment may be made either by the Bank, the Company or a combination of both as determined 4 in the sole discretion of the Company. Each such option holder shall be afforded an election to have the shares so received in the Offering, upon substantially identical terms as the Selling Shareholders, and subject to proration together with and on the same terms as the Selling Shareholders. All remaining Bank Options which are entitled to participate in the Aggregate Option Price but the holder of a Bank Option elects not to participate in the Aggregate Option Price shall be cancelled immediately prior to the Effective Time of the Merger." 16. Section 2.9 is hereby amended to read in its entirety as follows: "2.9 DIRECTORS' AGREEMENTS. The Directors' Agreements previously entered into by each of the Directors of the Bank continue to be in full force and effect, and shall apply to the Agreement as amended pursuant to this Second Amendment. By signing this Second Amendment, each of the Directors of the Bank so agrees." 17. Section 2.10 is hereby amended to read in its entirety as follows: "2.10 (a) TRANSMITTAL LETTER. On or about the mailing date of the Joint Proxy Statement/Prospectus, the Company, the Bank or the Company's Exchange Agent shall mail appropriate transmittal materials to the stockholders of Bank Stock, in form acceptable to the Company. The transmittal materials shall include documentation by which stockholders may indicate their election regarding the sale of shares in the Offering, subject to the possible adjustment as provided in Section 2.1(b), and shall provide that sale in the Offering will be contingent on the completion of the Offering. The transmittal letter shall also contain a power of attorney authorizing an authorized representative of the Company to exchange the Bank's shares for Company shares, and then immediately deliver the Company shares to the Underwriter for sale in the Offering. The transmittal letter shall also require a signature guarantee, from a bank or brokerage with medallion capability. The holder of Bank Stock shall be instructed to send to the Company, or to the entity designated by the Company (which may be the Bank or the Exchange Agent), the holder's Bank Stock certificates with the properly completed letter of transmittal. The transmittal letter shall contain an election box and other appropriate and customary transmittal materials (which shall specify that delivery shall be effected, and risk of loss and title to the certificates theretofore representing shares of Bank Stock shall pass, only upon proper delivery of such certificates to the Exchange Agent in such form as Company requires). The transmittal materials shall identify the Election Deadline established by the Company, which shall not be less than 30 days from the date of mailing of such transmittal letter to the holder (or such shorter time as the Bank may approve), and shall state that any share of Bank Stock (other than Dissenting Common Stock) with respect to which the holder (or the Beneficial Owner, as the case may be) 5 shall not have submitted an effective, properly completed letter of transmittal together with the Bank Stock certificates (or customary affidavits and indemnification regarding the loss or destruction of such certificates or the guaranteed delivery of such certificates) prior to the Election Deadline shall be deemed to be "Undesignated Shares" hereunder, and shall not sell Company Stock in the Offering. The Bank shall provide to the Exchange Agent all information reasonably necessary for it to perform its obligations as specified herein. (b) PROPER AND TIMELY ELECTION. Any Election shall have been properly made and effective only if the Company or its designee shall have actually received a properly completed letter of transmittal by the date and time established by the Company and specified in the transmittal materials, as such date and time may be extended by the Company in its discretion (the "Election Deadline"). A letter of transmittal shall be deemed properly completed only if an Election is indicated for each share of Bank Stock covered by such letter of transmittal and if accompanied by one or more certificates (or customary affidavits and indemnification regarding the loss or destruction of such certificates or the guaranteed delivery of such certificates) representing all shares of Bank Stock owned by the holder of Bank Stock, together with duly executed transmittal materials included in or required by the letter of transmittal. Any Election may be revoked or changed by the person submitting a revised, properly completed letter of transmittal at or prior to the Election Deadline. In the event a letter of transmittal is revoked prior to the Election Deadline, the shares of Bank Stock represented by such Election shall automatically become Undesignated Shares unless and until a new Election is properly made with respect to such shares on or before the Election Deadline, and the Company shall cause the certificates representing such shares of Bank Stock to be promptly returned without charge to the person submitting the revoked Election upon written request to that effect from the holder who submitted such Election Form. Subject to the terms of this Agreement and of the Election, the Company or the Exchange Agent shall have reasonable discretion to determine whether any election, revocation or change has been properly or timely made and to disregard immaterial defects in the letter of transmittal, and any decisions of the Company and Bank required by the Exchange Agent and made in good faith in determining such matters shall be binding and conclusive. Neither the Company nor the Exchange Agent shall be liable for the failure to notify any person of any defect in an Election or the letter of transmittal, provided that the Company uses its reasonable best efforts promptly to notify (or to cause the Exchange Agent promptly to notify) any holder of Bank Stock of any defect in an Election or the Letter of Transmittal. (c) If the aggregate number of shares of Bank Stock as to which Elections to sell shall have effectively been submitted would, absent proration, result in the sale in the Offering of more or less shares than are permitted pursuant to Section 2.1(b), then the sales in the Offering shall be increased or reduced pro 6 rata as provided in Section 2.1(b) in order to ensure that the shares sold by Selling Shareholders in the Offering do not exceed or are not less than the amounts provided in Section 2.1(b). (d) CALCULATIONS. The calculations required by this Section 2.10 shall be prepared by the Company prior to the Effective Time and shall be set forth in a certificate executed by the Chief Financial Officer or Chief Executive Officer of the Company and furnished to the Bank at least two Business Days prior to the Closing Date showing the manner of calculation in reasonable detail. Any cash payment shall be rounded to the nearest cent. (e) NO FRACTIONAL SHARES OR WARRANTS. Notwithstanding any other provisions of this Agreement, each holder of shares of Bank Stock exchanged pursuant to the Merger who would otherwise have been entitled to receive a fraction of a share of Company Stock (after taking into account all certificates delivered by such holder) shall receive, in lieu thereof, cash (without interest) in an amount equal to such fractional part of a share of Company Stock multiplied by $15.00. Notwithstanding any other provision of this Agreement, no fractional warrants shall be issued, and no cash or other consideration shall be paid in lieu of fractional warrants. No holder will be entitled to dividends, voting rights or any other rights as a shareholder in respect of any fractional share of Company Stock." 18. Section 3.4 is hereby deleted, and Sections 3.4, 3.5, 3.6 and 3.7 are hereby amended in full as follows: "3.4 EXCHANGE PROCEDURES. (a) EXCHANGE AGENT. Prior to the Effective Time, the Company shall deposit with the Exchange Agent shares of Company Stock and Warrants to be issued to selling shareholders of the Bank, such shares being the number of shares of Company Stock equal to the Aggregate Purchase Consideration issuable in the Merger. The Exchange Agent shall deliver or cause to be delivered to the Underwriter those of such shares to be sold in the Offering. Upon completion of the Offering, the Underwriter will deposit with the Exchange Agent the gross proceeds of the sale of shares by selling shareholders in the Offering. The Exchange Agent shall distribute to each selling shareholder the cash proceeds, shares of Company Stock and Warrants to which such selling shareholder is entitled, provided that the selling shareholder shall have delivered the requisite letter of transmittal and Bank share certificates (or customary affidavits and indemnification regarding the loss or destruction of such certificates or the guaranteed delivery of such certificates). The Exchange Agent shall not be entitled to vote or exercise any rights of ownership with respect to Company Stock held by it from time to time hereunder, except that it shall receive and hold all dividends or other distributions paid or distributed with respect to such shares for the account 7 of the persons entitled thereto. (b) EXCHANGE OF CERTIFICATES. Each holder of a certificate formerly representing Bank Stock (other than Dissenting Common Stock) who surrenders or has surrendered such certificate (or customary affidavits and indemnification regarding the loss or destruction of such certificate), together with duly executed transmittal materials required by Section 2.10, to the Exchange Agent shall, upon acceptance thereof, be entitled to the Per Share Consideration of a certificate representing Company Stock or the proceeds of the sale of such stock in the Offering and Warrants into which the shares of Bank Stock shall have been converted pursuant hereto, as well as cash in lieu of any fractional shares of Company Stock to which such holder would otherwise be entitled. The Exchange Agent shall accept such Bank certificate upon compliance with such reasonable and customary terms and conditions as the Exchange Agent may impose to effect an orderly exchange thereof in accordance with normal practices. Until surrendered as contemplated by this Section 3.4, each certificate representing Bank Stock shall be deemed from and after the Effective Time to evidence only the right to receive the Per Share Consideration Company Stock and a Warrant, as the case may be, upon such surrender. The Company shall not be obligated to deliver the consideration to which any former holder of Bank Stock is entitled as a result of the Merger until such holder surrenders his certificate or certificates representing shares of Bank Stock for exchange as provided in this Article III. If any certificate for shares of Company Stock, or any check representing declared but unpaid dividends, is to be issued in a name other than that in which a certificate surrendered for exchange is issued, the certificate so surrendered shall be properly endorsed and otherwise in proper form for transfer and the person requesting such exchange shall affix any requisite stock transfer tax stamps to the certificate surrendered or provide funds for their purchase or establish to the satisfaction of the Exchange Agent that such taxes are not payable. (c) PAYMENT TO HOLDERS OF A BANK OPTION. Each holder of a Bank Option who presents a demand for cancellation and payment of such Bank Option as provided in Section 2.8 of the Agreement to the Exchange Agent prior to the Closing shall, upon acceptance thereof, be entitled to the per share equivalent of the Aggregate Option Price. Upon receipt of the Aggregate Purchase Consideration and as soon as reasonably possible after the Closing, the Exchange Agent shall deliver to each former holder of a Bank Option the consideration due each such holder under Section 2.8 of the Agreement, in the form of shares of Company Stock and Warrants as provided therein, or in the form of cash, if the shares received in exchange for the cancellation of the Bank Option were submitted for sale in the Offering as provided in Section 7.14(b). The Exchange Agent shall be entitled to rely upon the records of the Bank and the information provided in such demand for cancellation documentation provided by any such holder of a Bank Option, as verified by the Company as to the method and means of payment and 8 disposition of such consideration. (d) AFFILIATES. Certificates surrendered for exchange by any person constituting an "affiliate" of Bank for purposes of Rule 144(a) under the Securities Act shall not be exchanged for certificates representing whole shares of Company Stock until the Company has received a written agreement from such person as provided in Section 6.25. 3.5 VOTING AND DIVIDENDS. Former shareholders of record of Bank shall not be entitled to vote after the Effective Time at any meeting of Company shareholders the number of whole shares of Company Stock into which their respective shares of Bank Stock are converted, until such holders have exchanged their certificates representing Bank Stock for certificates representing Company Stock in accordance with the provisions of this Agreement. Until surrendered for exchange in accordance with the provisions of Sections 2.10 and 3.4 of this Agreement, each certificate theretofore representing shares of Bank Stock (other than shares to be canceled pursuant to Section 2.1 of this Agreement) shall from and after the Effective Time represent for all purposes only the right to receive the Per Share Consideration consisting of shares of Company Stock and a Warrant, and cash in lieu of fractional shares, as set forth in this Agreement. No dividends or other distributions declared or made after the Effective Time with respect to Company Stock with a record date after the Effective Time shall be paid to the holder of any unsurrendered certificate of Bank Stock with respect to the shares of Company Stock represented thereby, until the holder of such certificate of Common Stock shall surrender such certificate. Subject to the effect of applicable laws, following surrender of any such certificates of Bank Stock for which shares of Company Stock are to be issued, there shall be paid to the holder of the certificates, without interest, (i) the amount of any cash payable with respect to a fractional share of Company Stock to which such holder is entitled pursuant to Section 2.1 and the amount of dividends or other distributions with a record date after the Effective Time theretofore paid with respect to such whole shares of Company Stock, and (ii) at the appropriate payment date, the amount of dividends or other distributions with a record date after the Effective Time but prior to surrender and a payment date subsequent to surrender payable with respect to such whole shares of Company Stock." 3.6 NO LIABILITY. Neither the Company, the Bank nor the Exchange Agent shall be liable to any holder of shares of Bank Stock for any shares of Company Stock (or dividends or distributions with respect thereto) or cash delivered to a public official pursuant to any applicable abandoned property, escheat or similar law. 3.7 WITHHOLDING RIGHTS. The Company or the Exchange Agent shall 9 be entitled to deduct and withhold from the consideration otherwise payable pursuant to this Agreement to any holder of shares of Company Stock such amounts as the Company or the Exchange Agent is required to deduct and withhold with respect to the making of such payment under the Code, or any provision of state, local or foreign tax law. To the extent that amounts are so withheld by the Company or the Exchange Agent, such withheld amounts shall be treated for all purposes of this Agreement as having been paid to the holder of the shares of Bank Stock in respect of which such deduction and withholding was made by the Company or the Exchange Agent." 19. Section 5.18 is hereby amended to read in its entirety as follows: "5.18 CAPITAL OF COMPANY, OFFERING AND COMMITMENTS. The Company intends to use its best efforts to conduct the Offering in order to permit stockholders of the Bank and Valley Bank, to sell shares of Company Stock and to provide capital for expenses, growth and operations of the Company. As of the date of this Agreement, the Company and Sutro have entered into the Engagement Agreement, a copy of which has been provided to the Bank and which has not been terminated or materially altered, except that the Company can change its relationship with Sutro, or increase or decrease the number of underwriters or co-mangers of the Offering, in the Company's sole discretion. The Company shall not impose any cost or expense of the Offering, including Underwriter costs and expenses, on any selling shareholder." 20. The first sentence of Section 6.8 is hereby amended to read in its entirety as follows: "As soon as practicable, the Company and the Bank shall prepare the S-4 and the proxy statement ("Proxy Statement") and take all action necessary in accordance with applicable Rules and its Charter Documents to submit the Agreement and the transactions contemplated hereby to its shareholders for approval by June 21, 1999, or as otherwise reasonably directed by the Company." 21. Section 7.14 is hereby amended to read in its entirety as follows: "7.14 THE OFFERING. (a) The Company intends to conduct the Offering in order to permit stockholders of the Bank and Valley Bank, to sell shares of Company Stock and to provide capital for expenses, growth and operations of the Company. All shareholders of the Bank will be given the opportunity to sell shares of the Company (whether in exchange for Bank Stock or Bank Options) in the Offering, 10 subject to proration as provided in Section 2.1(b). Shares of Company Stock sold by the selling shareholders will not incur any cost and expenses of the Offering, and that pursuant to the terms of this Section 7.14, the amount of cash from the Offering to be received by a Selling Shareholder will not be less than $15.00 per share. (b) All holders of Bank Options who exchange their options for shares Company Stock and elect to sell the shares of Company Stock so received may do so without having to first exercise such options. Such option holders wishing to sell shares of Company Stock underlying their options to be received in exchange for the Bank Options may do so by depositing with the Exchange Agent the options with respect to the shares of Bank Stock to be exchanged prior to the Offering, together with appropriate Letters of Transmittal properly completed and executed. At the time of the Merger, the Bank Options will be deemed exchanged for the number of shares of Company Stock and Warrants as provided in Section 2.8, and, upon completion of the Offering, the Exchange Agent will distribute to each former option holder (a) the proceeds of sale of those of such shares that are sold in the Offering, and (b) the shares and cash to which the former option holder is entitled. (c) All Directors and officers of the Company and the Surviving Bank have undertaken in writing with the Underwriters not to sell any Warrants or shares of Company Stock held by them for a period of six months following the completion of the Offering unless specifically granted permission to do so by the Underwriters, such undertaking is in full force and effect. It is understood that the Underwriters will (a) reduce the period from six months to ninety (90) days, and (b) exclude from the effect of these undertakings those shares sold in the Offering. (d) Simultaneously with, and upon the condition of, the consummation of the acquisition of the Bank, the Company through the Underwriters intends to consummate the Offering at a gross public offering price of at least $15.00 per share. If the Offering cannot be consummated at a gross public offering price of at least $15.00 per share, the Company will not be obligated to proceed with the Offering and the acquisition of the Bank and Valley Bank." 22. Section 9.4 is hereby amended to read in its entirety as follows: "9.4 STOCK OFFERING. An election to sell shares in the Offering shall have been made, and proper documentation submitted, with respect to not less than 75% of the shares of Company Stock received by holders of Bank Stock. The Company shall have entered into a firm commitment underwriting agreement for the Offering, and all conditions to the consummation of the Offering, other than the completion of the mergers of PCBG Merger Corporation with the Bank and of Interim Valley Bank with Valley Bank, shall have been satisfied or waived." 11 23. Section 9.8 is hereby added to read in its entirety as follows: "9.8 TAX OPINION. The Company shall have received from its accountants an opinion for the benefit of the holders of Bank Stock reasonably satisfactory to the Company and the Bank to the effect that the Merger shall not result in the recognition of gain or loss for federal income tax purposes to the Company or the Bank, the issuance of Company Stock or Warrants shall not result in the recognition of gain or loss by the holders of Bank Stock who receive Company Stock and Warrants in connection with the Merger, and shall state that the holding period for Company Stock, for purposes of capital gains taxation, shall include the period during which Bank Stock was held. This opinion shall be dated prior to the date the Proxy Statement is first mailed to the shareholders of the Company and the Bank and such opinions shall not have been withdrawn or modified in any respect." 24. Section 11.18 is hereby amended to read in its entirety as follows: 11.18 PROFESSIONAL FEES. The Bank's costs and expenses for professional expenses in connection with the transaction contemplated by this Agreement, including investment banking, accounting, attorney and any related costs and expenses, shall not exceed the amount that would be reasonable and customary for a transaction as described in this Agreement. Investment banking fees are as set forth in Exhibit 4.14. The accounting and attorney fees, and related costs and expenses thereto, of the Bank shall not exceed $200,000 in the aggregate. The Company agrees that it will promptly reimburse the Bank at the close or termination for the first $75,000 of legal and attorney fees and expenses incurred by the Bank since November 15, 1998 directly related to this transaction with the Company, and the Bank shall pay for any additional accounting and attorney fees and expenses incurred by the Bank thereafter. The Company also consents to the Bank paying at the close up to $25,000 to William Cockrum for his investment banking services to the Bank related to this transaction with the Company. 25. Section 14.1(a)(vi) is hereby amended to read in its entirety as follows: "(vi) by the Company or the Bank by June 28, 1999, unless regulatory approvals and/or completion of the Offering is relatively imminent and is expected to be completed in the near future, in which case the date in this subsection shall be automatically extended for up to an additional 30 days." 26. Section 14.1(e)(iv) is hereby added to read in its entirety as follows: "(iv) If this Agreement is terminated by the Company before the 12 Closing as a result of a default by the Company in the performance of Sections 5.18 and 7.14, no costs, expenses, fees or other liability or damages will be accrued or incurred by the Company or any of its representatives or agents." 27. This Second Amendment may be entered into in one or more counterparts, all of which shall be considered one in the same instrument, and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart. 28. Except as herein amended, the Agreement and the First Amendment shall remain in full force and effect. 29. This Second Amendment shall be governed by and construed in accordance with the laws of the State of California. 30. The execution and delivery of this Second Amendment by the directors and officers executing the Second Amendment have been duly authorized by the Boards of Directors of the Bank and the Company, and this Second Amendment constitutes a legal, valid and binding agreement of the parties in accordance with its respective terms. 13 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the day and year first above written. PACIFIC COMMUNITY BANKING GROUP By: -------------------------------------- E. Lynn Caswell Chairman and Chief Executive Officer By: -------------------------------------- Alfred Jannard Secretary THE BANK OF HEMET By: -------------------------------------- John J. McDonough By: -------------------------------------- James B. Jaqua By: -------------------------------------- John B. Brudin By: -------------------------------------- Jack E. Gosch 14 By: -------------------------------------- E. Kenneth Hyatt By: -------------------------------------- Joseph D. Pehl By: -------------------------------------- Clayton A. Record, Jr. 15 EX-2.4 5 EXHIBIT 2.4 EXHIBIT 2.4 First Restatement of Agreement and Plan of Reorganization by and between Pacific Community Banking Group and Valley Bank dated January 5, 1999 FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION by and between PACIFIC COMMUNITY BANKING GROUP AND VALLEY BANK Dated: January 5, 1999 FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION THIS FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION (hereinafter referred to as the "Agreement") is made and entered into as of January 5, 1999, by and between VALLEY BANK (the "Bank"), a California banking corporation, and PACIFIC COMMUNITY BANKING GROUP (the "Company"), a California corporation. R E C I T A L S A. The Bank is a California banking corporation duly organized and existing under the laws of the State of California with its principal office in the City of Moreno Valley, County of Riverside, State of California. The Company is a proposed bank holding company duly organized and existing under the laws of the State of California with its principal office in the City of Laguna Hills, County of Orange, State of California; B. The parties desire to provide for the acquisition by the Company of all of the outstanding shares of the common stock, $5.00 par value of the Bank ("Bank Stock") pursuant to the Merger (as defined below), subject to the terms and conditions specified herein, as follows: (a) The Company will establish PCBG Valley Corporation (as defined below) as a wholly-owned subsidiary; and (b) The Bank and PCBG Valley Corporation will enter into an Agreement of Merger (as defined below) providing for the merger of PCBG Valley Corporation and the Bank under the state charter of the Bank; C. At the Effective Time (hereinafter defined below) of the Merger, all of the issued and outstanding shares of Bank Stock, except for shares of Bank Stock held by Dissenting Shareholders (as hereinafter defined below), shall be converted into and exchanged for a combination of cash, shares of Company Stock, and Warrants exercisable into shares of Company Stock, all upon the terms and subject to the conditions hereinafter set forth; D. The Merger requires certain shareholder and regulatory approvals and may be effected only after the necessary approvals have been obtained; E. For federal income tax purposes, it is intended that the Merger shall qualify as a "reorganization" within the meaning of Section 368 of the Internal Revenue Code of 1986, as amended (the "Code"); 1 F. The parties desire to make certain representations, warranties and agreements in connection with the Merger and also to prescribe certain conditions to the Merger; and G. Subject to any specific provisions of this Agreement, it is the intent of the parties that the Company by reason of this Agreement shall not (until consummation of the Merger) control, and shall not be deemed to control the Bank or any of its subsidiaries, directly or indirectly, and shall not exercise or be deemed to exercise, directly or indirectly, a controlling influence over the management or policies of the Bank or any of its subsidiaries. H. The Company and the Bank desire that this First Restatement of the Agreement and Plan of Reorganization now govern the rights and obligations of the Parties in place of that certain Agreement and Plan of Reorganization dated July 30, 1998. Accordingly, to consummate the transactions set forth above and in consideration of the mutual covenants, agreements, representations and warranties contained herein, the parties hereto agree as follows: ARTICLE I DEFINITIONS 1.1 DEFINITIONS. Capitalized terms used in this Agreement shall have the meanings set forth below unless the context otherwise requires: "Affiliate" means any Person (as defined below) that directly, or through one or more intermediaries controls, or is controlled by, or is under common control with, the Person specified. "Aggregate Option Price" shall have the meaning given such term in Section 2.8. "Aggregate Purchase Consideration" shall have the meaning given such term in Section 2.4. "Agreement of Merger" shall mean the Agreement of Merger to be entered into by and between PCBG Valley Corporation and the Bank substantially in the form of EXHIBIT "A" hereto, but subject to any changes that may be necessary to conform to any requirements of any Governmental Entity having authority over the Merger. "Alternative Transaction" shall have the meaning given such term in Section 6.5. 2 "Audited Bank Financial Statements" shall have the meaning given such term in Section 4.4. "BHC Act" shall mean the Bank Holding Company Act of 1956, as amended. "Bank" shall mean Valley Bank. "Bank Corporate Governance Changes" shall have the meaning given such term in Section 2.1 (d). "Bank Dissenting Shares" means shares of Bank Stock held by "Dissenting Shareholders" within the meaning of Chapter 13 of the CGCL. "Bank Employment Agreements" shall mean any employment agreement, severance agreement, "golden parachute" agreement or any other agreement which provides for payments to employees of the Bank upon termination of employment, including termination after a change in control. "Bank Filings" shall have the meaning given such term in Section 4.18. "Bank Incentive Compensation Plan" shall mean the Valley Bank Employee Stock Ownership Plan, the Valley Bank 401(k) Plan and the Valley Bank Profit Sharing Plan. "Bank Options" shall mean options to purchase Bank Stock (as defined below) pursuant to the Bank Stock Option Plan (as defined below). "Bank Perfected Dissenting Shares" means Dissenting Shares which the holders thereof have not withdrawn or caused to lose their status as Bank Dissenting Shares. "Bank Representatives" shall have the meaning given such term in Section 7.3. "Bank Stock" shall mean the meaning given such term in Recital B. "Bank Stock Option Plan" shall mean Valley Bank 1992 Stock Option Plan, and the Valley Bank 1993 Directors Stock Option Plan. "Baxter" shall mean Baxter, Fentriss and Company, who shall serve as the financial advisor to the Bank. "Benefit Arrangement" means any plan or arrangement maintained or contributed to by a Party, including an "employee benefit plan" within the meaning of ERISA (as defined below), (but exclusive of base salary and base wages) which 3 provides for any form of current or deferred compensation, bonus, stock option, profit sharing, benefit, retirement, incentive, stock purchase plan, group health or insurance, welfare or similar plan or arrangement for the benefit of any employee or class of employee, whether active or retired, of a Party. "Business Day" shall mean any day other than a Saturday, Sunday or day on which commercial banks in California are authorized or required to be closed. "Cash Election" shall have the meaning given such term in Section 2.11. "Caswell" shall mean Mr. E. Lynn Caswell, Chairman of the Board and Chief Executive Officer of the Company. "CERCLA" shall have the meaning given such term in the definition of Environmental Law. "CFC" means the California Financial Code. "CGCL" means the California General Corporations Law. "Charter Documents" shall mean, with respect to any business organization, any certificate or articles of incorporation or association, any bylaws, any partnership agreement and any other similar documents that regulate the basic organization of the business organization and its internal relations. "Classified Credit" shall have the meaning given such term in Section 6.6. "Closing" shall mean the consummation of the transactions contemplated by this Agreement on the Closing Date (as defined below) at the law offices of Knecht & Hansen, 1301 Dove Street, Suite 900, Newport Beach, California 92660, or at such other place as the Parties (as defined below) may agree upon. "Closing Date" shall mean, unless the Parties (as defined below) agree on another date, the first Friday or as soon as possible following the Determination Date, and in no case more than 30 days following the receipt of the approvals and consents and expiration of the waiting periods specified in Section 9.1 have occurred and/or have been obtained, the receipt of the necessary cash capital by the Company in order to complete the transaction as contemplated by this Agreement, satisfaction of the remaining conditions to the transaction as contemplated by this Agreement, and no less than four (4) business days after the occurrence of the Election Deadline, or at such other time as may be determined in good faith by the Parties in order to assure an orderly transition process. 4 "Code" shall mean the United States Internal Revenue Code of 1986, as amended, and all regulations thereunder. "Combination Election" shall have the meaning given such term in Section 2.11. "Commissioner" shall mean the California Commissioner of Financial Institutions. "Company" shall mean Pacific Community Banking Group, a California corporation. "Company Corporate Governance Changes" shall have the meaning given such term in Section 2.1(e). "Company Filings" shall have the meaning given such term in Section 5.16. "Company Representatives" shall have the meaning given such term in Section 6.3. "Company Stock Option Plan" shall mean the proposed Pacific Community Banking Group 1998 Stock Option Plan. "Company Financial Statements" shall have the meaning given such term in Section 5.4. "Company Stock" shall mean the common stock, no par value, of the Company. "Confidential Information" shall mean all information exchanged heretofore or hereafter between the Company, its affiliates and agents, on the one hand, and the Bank, its affiliates and agents, on the other hand, which is information related to the business, financial position or operations of the Person responsible for furnishing the information or an Affiliate of such Person (such information to include, by way of example only and not of limitation, client lists, pricing information, company manuals, internal memoranda, strategic plans, budgets, forecasts, projections, computer models, marketing plans, files relating to loans originated by such Person, loans and loan participation purchased by such Person from others, investments, deposits, leases, contracts, employment records, minutes of board meetings (and committees thereof) and stockholder meetings, legal proceedings, reports of examination by any Governmental Entity, and such other records or documents such Person may supply to the other Party pursuant to the terms of this Agreement or as contemplated hereby). Notwithstanding the foregoing, "Confidential Information" shall not include any information that (i) at the time of disclosure or thereafter is generally available to and known by the public (other than as a result of 5 an improper disclosure directly or indirectly by the Company or the Bank, as the case may be, or any of their officers, directors, employees or other representatives), (ii) was available to the recipients on a non-confidential basis from a source other than from the Persons responsible for furnishing the information, provided that such source learned the information independently and is not and was not bound by a confidentiality agreement with respect to the information, or (iii) has been independently acquired or developed by the recipients without violating any obligations under this Agreement. "Consents" shall mean every consent, approval, absence of disapproval, waiver or authorization from, or notice to, or registration or filing with, any Person (as defined below). "CRA" shall mean the Community Reinvestment Act. "Deposit" shall mean any deposit as defined in Section 3(l) of the Federal Deposit Insurance Act, as amended, to July 30, 1998 (12 USC Section 1813(l)). "Determination Date" shall mean the last day of the month preceding the Closing Date. "Directors' Agreement" shall mean an agreement, substantially in the form of EXHIBIT "B" hereto, pursuant to which each signatory shall agree to vote or cause to be voted all shares of Bank Stock with respect to which such Person has voting power on the date hereof or hereafter acquires to approve the Agreement and the transactions contemplated hereby and all requisite matters related thereto. "DPC Property" shall mean voting securities, other personal property and real property acquired by foreclosure or otherwise, in the ordinary course of collecting a debt previously contracted in good faith, retained with the object of sale for a period not longer than any applicable statutory holding period, and recorded in the holder's business records as such. "Effective Day" shall mean the day on which the Effective Time occurs. "Effective Time" shall mean the date and time of the filing of the Agreement of Merger with the Secretary of State (as defined below). "Employee Plan" shall have the meaning given such term in Section 4.11(c). "Encumbrance" shall mean any option, pledge, security interest, lien, mechanic's lien, charge, encumbrance or restriction (whether on voting, disposition or otherwise), whether imposed by agreement, understanding, law or otherwise. 6 "Environmental Law" shall mean any federal, state, provincial or local statute, law, ordinance, rule, regulation, order, consent, decree, judicial or administrative decision or directive of the United States or other applicable jurisdiction whether now existing or as hereinafter promulgated, issued or enacted relating to: (A) pollution or protection of the environment, including natural resources; (B) exposure of persons, including employees, to Hazardous Substances (as defined below) or other products, materials or chemicals; (C) protection of the public health or welfare from the effects of products, by-products, wastes, emissions, discharges or releases of chemical or other substances from industrial or commercial activities; or (D) regulation of the manufacture, use or introduction into commerce of substances, including, without limitation, their manufacture, formulation, packaging, labeling, distribution, transportation, handling, storage and disposal. For the purposes of this definition the term "Environmental Law" shall include, without limiting the foregoing, the following statutes, as amended from time to time: (1) the Clean Air Act, as amended, 42 U.S.C. Section 7401 ET SEQ.; (2) the Federal Water Pollution Control Act, as amended, 33 U.S.C. Section 1251 ET SEQ.; (3) the Resource Conservation and Recovery Act of 1976, as amended, 42 U.S.C. Section 6901 ET SEQ., (4) the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (including the Superfund Amendments and Reauthorization Act of 1986), 42 U.S.C Section 9601 ET SEQ.("CERCLA"); (5) the Toxic Substances Control Act, as amended, 15 U.S.C. Section 2601 ET SEQ.; (6) the Occupational Safety and Health Act, as amended, 29 U.S.C. Section 65; (7) the Emergency Planning and Community Right-To-Know Act of 1986, 42 U.S.C. Section 11001 ET SEQ.; (8) the Mine Safety and Health Act of 1977, as amended, 30 U.S.C. Section 801 ET SEQ.; (9) the Safe Drinking Water Act, 42 U.S.C. Section 300f ET SEQ.; (10) the Federal Water Pollution Control Act, as amended (33 U.S.C. 1251, ET SEQ.; and (11) all comparable state and local laws, laws of other applicable jurisdictions or orders and regulations including, but not limited to, the Carpenter-Presley- Tanner Hazardous Substance Account Act, Cal. Health & Safety Code Section 25300 ET SEQ., the Porter-Cologne Water Quality Control Action, 25140, 25501(j) and (k); 255501.1.25281 and 25250.1 of the California Health and Safety Code and/or Article I or Title 22 of the California Code of Regulations, Division 4, Chapter 30 (the "State Acts"). "Equity Securities" shall mean the capital stock of Bank or any options, rights, warrants or other rights to subscribe for or purchase, or any plans, contracts or commitments that are exercisable in, such capital stock or that provide for the issuance of, or grant the right to acquire, or are convertible into, or exchangeable for, such capital stock. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended, and all regulations thereunder. "ESOP" shall mean the Valley Bank Employee Stock Ownership Plan. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and all rules and regulations thereunder. 7 "Exchange Agent" shall mean U. S. Stock Transfer Corporation, or, subject to the reasonable approval of the Bank, any other financial institution or company appointed by the Company to effect the exchange contemplated by Section 2.5. "Executive Officer" shall mean a natural person who participates or has the authority to participate (other than in the capacity of a director) in major policy making functions of the Company or the Bank, whether or not such person has a title or is serving with salary or other compensation. "Expected Net Proceeds" shall mean $52.6 million. "Expenses" shall have the meaning given such term in Section 13.1. "FDIC" shall mean the Federal Deposit Insurance Corporation. "FRB" shall mean the Board of Governors of the Federal Reserve System. "GAAP" shall mean Generally Accepted Accounting Principles, consistently applied from period to period, applicable to banks and bank holding companies, as appropriate, for the period in question. "Governmental Entity" shall mean any court or tribunal in any jurisdiction or any United States federal, state, municipal, domestic, foreign or other administrative agency, department, commission, board, bureau or other regulatory or governmental authority or instrumentality. "Hazardous Substances" shall mean (1) any "hazardous waste" as defined by CERCLA and the State Acts, as such acts are in effect on the date hereof, and any and all regulations promulgated thereunder; (2) any "hazardous substance" as such term is defined by CERCLA; (3) any "regulated substance" as defined by the State Acts; (4) asbestos requiring abatement, removal or encapsulation pursuant to the requirements of any Governmental Entity; (5) polychlorinated biphenyls; (6) petroleum products; (7) "hazardous chemicals" or "extremely hazardous substances" in quantities sufficient to require reporting, registration, notification and/or optional treatment or handling under the Emergency Planning and Community Right to Know Act of 1986; (8) any "hazardous chemical" in levels that would result in exposure greater than is allowed by permissible exposure limits established pursuant to the Occupational Safety and Health Act of 1970; (9) any substance that requires reporting, registration, notification, removal, abatement and/or special treatment, storage, handling or disposal, under Section 6, 7 and 8 of the Toxic Substance Control Act (15 U.S.C. Section 2601); (10) any toxic or hazardous chemical described in 29 C.F.R. 1910.1000-1047 in levels that would result in exposure greater than those allowed by the permissible exposure limits pursuant to such regulations; and 8 (11) any (A) "hazardous waste", (B) "solid waste" capable of causing a "release or threatened release" that present an "imminent and substantial endangerment" to the public health and safety of the environment, (C) "solid waste" that is capable of causing a "hazardous substance incident" (D) "solid waste" with respect to which special requirements are imposed by any applicable Governmental Entity upon the generation and transportation thereof as such terms are defined and used within the meaning of the State Acts, or (E) any "pollutant" or "toxic pollutant" as such term is defined in the Federal Clean Water Act, 33 U.S.C. Section 1251-1376, as amended, by Publc Law 100-4, February 4, 1987, and the regulations promulgated thereunder, including 40 C.F.R. Sections 122.1 and 122.26. "Managing Underwriter" shall mean Sutro (as defined below). "Managing Underwriters" shall mean the Managing Underwriter and such other firm or firms as the Company and the Managing Underwriter shall agree. "Material Adverse Change" shall have the meaning given such term in Sections 4.17 and 5.12. "Material Contract" shall have the meaning given such term in Section 4.12. "Merger" shall mean the merger of the PCBG Valley Corporation with and into the Bank. "Offering" shall mean a public offering underwritten by the Underwriters (as defined below), as determined by the Company in its sole discretion, and based upon current market conditions and assumptions, of sufficient shares of the Company Stock at a gross offering price to be determined by the Company and its underwriters, in order to fund the cash portion of the acquisition of the Bank by the Company, to provide new capital for growth of the Company following the acquisition of the Bank by the Company, and the payment of any necessary expenses of the Company as provided herein, as determined by the Company in its sole discretion. "Offering Price" shall mean the gross offering price per share of Company Stock in the Offering. "OREO" shall have the meaning given such term in Section 6.2(xx). "Party" shall mean either the Company or the Bank and "Parties" shall mean both the Company and Bank. "Per Share Cash Consideration" shall have the meaning given such term in Section 2.1. 9 "Per Share Consideration" shall have the meaning given such term in Section 2.4. "Permit" shall mean any United States federal, foreign, state, local or other license, permit, franchise, certificate of authority, order or approval necessary or appropriate under any applicable Rule (as defined below). "Person" shall mean any natural person, corporation, trust, association, unincorporated body, partnership, joint venture, Governmental Entity, statutorily or regulatory sanctioned unit or any other person or organization. "Profit Sharing Plan" shall mean the Valley Bank 401(k) Profit Sharing Plan. "Proxy Statement" shall have the meaning given such term in Section 6.8. "RAP" shall mean regulatory accounting principles, if any, applicable to a particular Person. "Real Property" shall have the meaning given such term in subsection (a) of Section 4.6. "Representatives" shall have the meaning given such term in subsection (a) of Section 6.3. "Rule" shall mean any statute or law or any judgment, decree, injunction, order, regulation or rule of any Governmental Entity with applicable jurisdiction, including, without limitation, those relating to disclosure, usury, equal credit opportunity, equal employment, fair credit reporting and anticompetitive activities. "S-1" means the registration statement on Form S-1 to be filed with the SEC relating to the registration under the Securities Act of the shares of Company Stock to be issued in the Offering. "S-4" means the registration statement on Form S-4, and such amendments thereto, that is filed with the SEC to register the shares of Company Stock to be issued in the Merger under the Securities Act and to clear use of the Proxy Statement in connection with the Company Shareholders' Meeting and the Bank Shareholders' Meeting pursuant to the regulations promulgated under the Exchange Act. "SEC" means the Securities and Exchange Commission. 10 "SEC Reports" shall mean all reports filed by a Party hereto pursuant to the Exchange Act with the SEC or the FDIC. "Secretary of State" shall mean the Secretary of State of the State of California. "Section 1300" shall mean Section 1300 ET SEQ. of the California Corporations Code. "Securities Act" shall mean the Securities Act of 1933, as amended, and all rules and regulations thereunder. "State Acts" shall have the meaning given such term in the definition of "Environmental Law." "Surviving Bank" shall mean the bank surviving the Merger. "Surviving Bank Stock" shall mean the common stock, $5.00 par value, of the Surviving Bank. "Sutro" shall mean Sutro & Company who may also act as a financial advisor to the Company and as an underwriter in the Offering. "Tax Filings" shall have the meaning given such term in Section 4.8. "Third Party Consent" shall have the meaning given such term in Sections 6.17 and 7.8. "To the knowledge" and "to the best knowledge" shall have the meanings given such terms in Section 15.15. "Total Acquisition Costs" shall mean the sum of the Aggregate Purchase Consideration for the Bank and The Bank of Hemet. "Unaudited Bank Financial Statements" shall have the meaning given such term in Section 4.4. "Understanding" shall have the meaning given such term in Section 4.12. "Undesignated Shares" shall have the meaning given such term in Section 2.11. "Underwriter" shall mean a group of broker/dealers that include the Managing Underwriters as assembled by the Managing Underwriter with the consent of the Company. 11 "Warrant" shall mean a warrant issuable by the Company at the Closing exercisable into one (1) share of the Company for a ten year period from the Closing Date with an exercise price equal to 122% of the Offering Price. "Warrant Agreement" shall mean the warrant agreement attached hereto as EXHIBIT "C." ARTICLE II THE MERGER AND RELATED MATTERS 2.1 THE MERGER. The Company agrees that it will use its best efforts, with all necessary cooperation of the Bank, to perfect the organization of PCBG Valley Corporation in accordance with the CGCL prior to the Closing Date. The directors and officers of PCBG Valley Corporation, and the Articles of Incorporation and Bylaws of PCBG Valley Corporation, shall be determined by the Company. Subject to the provisions of this Agreement, the Parties agree to request that the approval of the Merger to be issued by the Commissioner, the FDIC, the FRB and any other necessary regulatory agency on or prior to the Closing Date shall provide that the Merger shall become effective (the "Effective Time") as of the Closing Date. The Bank shall cause its officers to execute the Agreement of Merger, as well as all other necessary documents, in order to effect the Merger in accordance with the terms hereof as requested by the Company. At the Effective Time of the Merger, the following transactions will occur simultaneously: (a) MERGER OF THE BANK AND PCBG VALLEY CORPORATION. The Bank and PCBG Valley Corporation shall be merged under the certificate of authority of the Bank, with the Bank being the Surviving Bank pursuant to the provisions of, and with the effect provided in, the CGCL and the CFC, and shall continue its corporate existence under the laws of the State of California. The name of the Surviving Bank shall be "Valley Bank." Upon the consummation of the Merger, the separate corporate existence of PCBG Valley Corporation shall cease. (b) EFFECT ON BANK STOCK. Subject to Section 2.3, each share of Bank Stock issued and outstanding immediately prior to the Effective Time of the Merger shall, on and at the Effective Time of the Merger, pursuant to the Agreement of Merger and without any further action on the part of the Bank or the holders of Bank Stock, be automatically cancelled and cease to be an issued and outstanding share of Bank Stock, and shall be exchanged for and converted into the right to receive the Per Share Consideration. Subject to proration by the Company in its absolute and sole discretion to ensure that the cash portion of the Aggregate Purchase Consideration does not exceed 55% of the Aggregate Purchase Consideration, or such lesser percentage that will allow the Company's accountants to opine that the Merger will qualify as a "reorganization" within the meaning of Section 368 of the Code, holders of Bank Stock will be given the opportunity to receive, in exchange for 12 each share for the Bank, in lieu of the Per Share Consideration, at the election of the holder thereof as provided in Section 2.11, the Warrant plus either (i) Company Stock having a value of $10.00, with the number of shares to be received equal to the quotient of $10.00 and the Offering Price, or (ii) cash equal to $10.00. (c) EFFECT ON PCBG VALLEY CORPORATION STOCK. Each share of PCBG Valley Corporation Stock issued and outstanding immediately prior to the Effective Time of the Merger shall, on and at the Effective Time of the Merger, pursuant to the Agreement of Merger and without any further action on the part of the Bank or the holder of the PCBG Valley Corporation Stock be converted into, and shall for all purposes be deemed to represent, one share of Surviving Bank Stock, and one certificate representing one share of the Surviving Bank Stock will be issued to the Company. (d) BANK CORPORATE GOVERNANCE CHANGES. The Charter Document of the Bank as in effect immediately prior to the Effective Time shall continue in effect after the Merger until thereafter amended in accordance with applicable law and the operations of the Bank shall continue in effect after the Merger; except that the Bank shall have taken prior to the Effective Time all necessary steps so that at the Effective Time (i) at the request of the Company, Mr. N. Douglas Mills, President and Chief Executive Officer of the Bank, shall resign from his positions (but not as an employee of the Bank), in form and substance satisfactory to the Company, either during the pendency of this transaction or following the consummation of this transaction, without incurring any liability on the part of any Party, except that (a) the Bank and Mr. Mills will enter into the Second Amendment to Mr. Mills' Employment Agreement originally dated September 26, 1996 and amended October 30, 1997, upon the Bank's payment on the Closing Date to Mr. Mills of the compensation described in revised Section 2.3 of the Second Amendment to Mr. Mills' Employment Agreement with the Bank in the form attached hereto as Exhibit 2.1(d)(i)(a), (b) Mr. Mills will remain a director of the Bank unless and until a successor is appointed by the Company, and (c) the Board and/or the Company will not become liable for any obligations under Mr. Mills' Salary Continuation Agreement dated October 19, 1995, as amended October 30, 1997, nor, unless accelerated earlier by the Company in its sole discretion, will such Salary Continuation Agreement accelerate, until termination of Mr. Mills' employment with the Company or a subsidiary of the Company pursuant to the Second Amendment to Mr. Mills' Employment Agreement; (ii) Caswell shall have been appointed Chairman of the Board and Chief Executive Officer of the Bank; (iii) except for the persons set forth on Exhibit 2.1(d), which Exhibit shall be delivered by the Company to the Bank within sixty (60) days of the date of the Agreement, each of the directors of the Bank shall have tendered his resignation as a director of the Bank, in form and substance satisfactory to the Company, without incurring any liability on the part of any Party; (iv) the number of authorized directors, and the specific members of the Board of Directors, of the Bank shall be changed as determined in the sole discretion of the Company; (v) the Company shall name additional directors in its sole discretion who shall be duly elected and appointed to the Board of Directors of the Bank (or if any such persons is unable to serve, such 13 other person designated by the Company) and shall serve until the earlier of their resignation or removal or until their respective successors are duly elected and qualified; (vi) the remaining members of the Board of Directors of the Bank will agree to support any and all expense reductions, consolidations, mergers, transfer of headquarters, sale of assets, FRB membership, closure of branches, or any other corporate changes as requested by the Company, consistent with their fiduciary duties; and (vii) the Company will assume the obligations of the employment agreements for Bonnie Parrott, Mark A. Nugent, Marvin Lentini and Dianna Williams, and the Company will assume the obligations of Bank under that "Employment Compensation Agreement" dated March 12, 1970 by and between Bank and Walter M. Wachtel in favor of Willow Wachtel Decker (clauses (i)-(vii) being hereinafter collectively referred to as the "Bank Corporate Governance Changes."). (e) The Charter Documents of the Company as in effect immediately prior to the Effective Time shall continue in effect after the Merger until thereafter amended in accordance with applicable law and the members of the Board of Directors and the Executive Officers of the Company immediately prior to the Merger shall continue in their respective positions after the Merger and be the Board of Directors and the Executive Officers of the Company, except that the Company shall have taken prior to the Effective Time all necessary steps so that, (i) the Company's Charter Documents shall be amended to provide for a range of directors of between five (5) to nine (9), and at least four (4) individuals, excluding Caswell who is currently the sole director and who shall remain a director, shall be appointed to the Board of Directors of the Company in the sole discretion of the Company; and (ii) the Company shall appoint at the Effective Time, and the Company shall continue to propose for election at each successive Company annual shareholder meeting thereafter, the ratio of that number of directors from the Bank's Board of Directors bears to the total number of directors to be elected, compared to the ratio of the number of former Bank's shares bears to the total number of shares of the Company, with a minimum of two to be appointed or elected from the Bank's Board of Directors, subject to the approval of the Company (clauses (i) and (ii) being hereinafter collectively referred to as the "Company Corporate Governance Changes"). 2.2 EFFECT OF THE MERGER. At the Effective Time of the Merger, the corporate existence of PCBG Valley Corporation and the Bank shall be merged into and continued in the Surviving Bank, and the Surviving Bank shall be deemed the same corporation as each corporation participating in the Merger. All rights, franchises, and interests of PCBG Valley Corporation and Bank in and to every type of property (real, personal and mixed) and choses in action shall be transferred to and vested in the Surviving Bank by virtue of the Merger without any deed or other transfer and the Surviving Bank shall hold and enjoy all rights of property, franchises and interests, in the same manner and to the same extent as such rights, franchises and interests were held or enjoyed by any one of the consolidating corporations at the Effective Time of the Merger. 14 2.3 DISSENTING SHAREHOLDERS. (a) Any Bank Perfected Dissenting Shares shall not be converted into the right to receive the Per Share Consideration, but the holders thereof shall be entitled only to such rights as are granted them by Section 1300. Each dissenting shareholder who is entitled to payment for his shares of Bank Stock under Section 1300 shall receive such payment in an amount as determined pursuant to Section 1300. (b) If any shareholder of the Bank shall fail to perfect, or shall effectively withdraw or lose, his or her rights under Section 1300, the Bank Dissenting Shares of such holder shall be treated for purposes of this Article II as any other shares of outstanding Bank Stock. If any holder of Bank Stock shall fail to perfect, or shall effectively withdraw or lose, his or her right to appraisal of and payment for his or her Bank Dissenting Shares under Section 1300, each share of Bank Dissenting Shares shall be converted into the right to receive the Per Share Consideration. 2.4 THE AGGREGATE PURCHASE CONSIDERATION AND PER SHARE CONSIDERATION. The Aggregate Purchase Consideration shall be equal to the sum of (i) the product of 1,171,906 and the Per Share Consideration, and (ii) the Aggregate Option Price. The Per Share Consideration shall be equal to the sum of (i) $5.00 in cash; and (ii) a fraction of a share of Company Stock having a value equal to $5.00, with the amount of the fraction of a share of Company Stock equal to the quotient of $5.00 and the Offering Price. One third (1/3) of a Warrant shall be added to the Per Share Consideration. The cash and the Company Stock portion of the Per Share Consideration will be increased (the "Increase in Per Share Consideration"), up to a maximum value of $12.50 per share, calculated as follows: the quotient of (a) the ratio of the Aggregate Purchase Consideration to the Total Acquisition Costs, multiplied by the difference between the net proceeds received in the Offering and the Expected Net Proceeds in the Offering, and (b) the sum of the total number of issued and outstanding shares of Bank Stock and the number of Bank Options outstanding as of July 30, 1998. The Increase in Per Share Consideration shall be allocated equally between cash and the shares of Company Stock. An illustration of such calculation is attached as Exhibit 2.4(a). In the event of such increase in the Per Share Consideration, the number of Warrants per share of Bank Stock shall be reduced and shall be calculated as follows: the amount of the reduction of the Warrants per share of Bank Stock shall be equal to the Increase in Per Share Consideration divided by $18.00. An illustration of such calculation is attached as Exhibit 2.4(b). 2.5 DELIVERY OF CONSIDERATION. At the Closing, the Company will deliver to the Exchange Agent an amount of cash and shares of Company Stock equal to the Aggregate Purchase Consideration, and the aggregate number of Warrants plus cash payment for any fractional shares of Company Stock. Delivery to such holders of the cash, Company Stock and Warrants to which they are entitled will subsequently be made by the Exchange Agent against delivery of share certificates formerly evidencing Bank Stock (duly executed and in proper form for transfer) to the 15 Exchange Agent in accordance with this Section 2.5 and an agreement to be entered into between the Company and the Exchange Agent consistent with this Agreement. 2.6 NAME OF SURVIVING BANK. The name of the Surviving Bank shall be "Valley Bank," unless the Company proposes to change such name following the Closing Date, and the Board of Directors of the Bank hereby agrees to support such name changes. 2.7 (Reserved) 2.8 STOCK OPTIONS. Immediately prior to the Effective Time of the Merger, each holder of a Bank Option will be given the opportunity to, in whole or in part, cancel such option and receive at the Closing an amount in cash, shares of Company Stock and Warrants payable on, and allocated on the same basis as, the number of shares of Bank Stock covered by such option multiplied by the number obtained by subtracting the exercise price of such option from the Per Share Consideration in effect on the Closing Date (the total of sum of such payments for all Bank Options so cancelled shall be defined as the "Aggregate Option Price"). A holder of a Bank Option shall not be entitled to the election provided in Section 2.11. The cash payment portion may be made either by the Bank, the Company, or a combination of both as determined in the sole discretion of the Company. All remaining Bank Options which are entitled to participate in the Aggregate Option Price, but where the holder of such Bank Option elects not to participate in the Aggregate Option Price, shall be cancelled immediately prior to the Effective Time of the Merger. 2.9 DIRECTORS' AGREEMENTS. The Bank has caused each of its directors to enter into the Directors' Agreement attached hereto as EXHIBIT "B." 2.10 TRANSMITTAL LETTER. Immediately after the Effective Time of the Merger, the Company shall instruct the Exchange Agent to mail appropriate transmittal materials to the former holders of Bank Stock, and the form of such transmittal letter shall be subject to the reasonable approval of the Bank. 2.11 ELECTION AND PRORATION PROCEDURES. (a) ELECTION FORMS AND TYPES OF ELECTIONS. An election form and other appropriate and customary transmittal materials (which shall specify that delivery shall be effected, and risk of loss and title to the certificates theretofore representing shares of Bank Stock shall pass, only upon proper delivery of such certificates to the Exchange Agent in such form as Company and Bank shall mutually agree ("Election Form"), shall be mailed no less than thirty-five (35) days prior to the Closing Date or on such other date as the Bank and the Company shall mutually agree ("Mailing Date") to each holder of record of Bank Stock as of five (5) Business Days prior to the Mailing Date ("Election Form Record Date"). The Company shall make 16 available one or more Election Forms as may be reasonably requested by all persons who become holders (or beneficial owners) of Bank Stock after the Election Form Record Date and prior to the Election Deadline (as defined herein), and Bank shall provide to the Exchange Agent all information reasonably necessary for it to perform its obligations as specified herein. Each Election Form shall permit the holder (or the Beneficial Owner through appropriate and customary documentation and instructions) to elect (an "Election") to receive the Warrant plus either (i) 100% Company Stock (a "Stock Election") with respect to all of such holder's Bank Stock, or (ii) 100% cash (a "Cash Election") with respect to all of such holder's Bank Stock. Any share of Bank Stock (other than Dissenting Common Stock) with respect to which the holder (or the Beneficial Owner, as the case may be) shall not have submitted to the Exchange Agent, an effective, properly completed Election Form received prior to the Election Deadline shall be deemed to be "Undesignated Shares" hereunder, and shall receive the Per Share Consideration. Holders of Bank Stock selecting either (i) or (ii) shall be subject to proration as provided in Section 2.1(b). b. PROPER AND TIMELY ELECTION. Any Election shall have been properly made and effective only if the Exchange Agent shall have actually received a properly completed Election Form by 5:00 P.M. on the later of the 30th day following the Mailing Date or the 31st day following the mailing of any notice required by Section 1301 of the GCL (or such other time and date as the Company and the Bank may mutually agree) (the "Election Deadline"). An Election Form shall be deemed properly completed only if an Election is indicated for each share of Bank Stock covered by such Election Form and if accompanied by one or more certificates (or customary affidavits and indemnification regarding the loss or destruction of such certificates or the guaranteed delivery of such certificates) representing all shares of Bank Stock covered by such Election Form, together with duly executed transmittal materials included in or required by the Election Form. Any Election Form may be revoked or changed by the person submitting such Election Form at or prior to the Election Deadline. In the event an Election Form is revoked prior to the Election Deadline, the shares of Bank Stock represented by such Election Form shall automatically become Undesignated Shares unless and until a new Election is properly made with respect to such shares on or before the Election Deadline, and the Company shall cause the certificates representing such shares of Bank Stock to be promptly returned without charge to the person submitting the revoked Election Form upon written request to that effect from the holder who submitted such Election Form. Subject to the terms of this Agreement and of the Election Form, the Exchange Agent shall have reasonable discretion to determine whether any election, revocation or change has been properly or timely made and to disregard immaterial defects in the Election Forms, and any decisions of the Company and Bank required by the Exchange Agent and made in good faith in determining such matters shall be binding and conclusive. Neither the Company nor the exchange Agent shall be under any obligation to notify any person of any defect in an Election Form. (c) If the aggregate number of shares of Bank Stock as to which Stock Elections and Cash Elections shall have effectively been made results in the 17 issuance of cash pursuant to the Merger that would be more than the cash that may be paid pursuant to Section 2.1(b) of the aggregate value of the total consideration paid ("Aggregate Purchase Consideration") in exchange for shares of Bank Stock, then such all cash elections shall be reduced pro rata in order to ensure that the Aggregate Purchase Consideration will consist of maximum cash as permitted in Section 2.1(b). (d) Notwithstanding any other provision of this Agreement, if the aggregate value of cash that would be issued pursuant to the Merger is more than the cash that may be paid pursuant to Section 2.1(b) of the aggregate value of the total consideration to be paid in exchange for Bank Stock, the Company shall be authorized to reallocate, in good faith and in such a manner as it reasonably determines to be fair and equitable, shares of Company Stock and cash among the holders of Bank Stock, in a manner such that the amount of cash to be issued in the Merger shall not be more than the cash that may be paid pursuant to Section 2.1(b). (e) CALCULATIONS. The calculations required by this Section 2.1 shall be prepared by the Company prior to the Effective Time and shall be set forth in a certificate executed by the Chief Financial Officer or Chief Executive Officer of the Company and furnished to the Bank at least two Business Days prior to the Closing Date showing the manner of calculation in reasonable detail. Any calculation of a portion of a share of the Company Stock shall be rounded to the nearest ten-thousandth of a share, and any cash payment shall be rounded to the nearest cent. (f) NO FRACTIONAL SHARES. Notwithstanding any other provisions of this Agreement, each holder of shares of Bank Stock exchanged pursuant to the Merger who would otherwise have been entitled to receive a fraction of a share of Company Stock (after taking into account all certificates delivered by such holder) shall receive, in lieu thereof, cash (without interest) in an amount equal to such fractional part of a share of Company Stock multiplied by the Per Share Consideration (as defined in Section 2.1). In addition, such holder of Bank Stock exchanged pursuant to the Merger who would otherwise have been entitled to receive a fraction of a Warrant (after taking into account all Warrants delivered by such holder) shall receive, in lieu thereof, cash (without interest) in an amount equal to such fractional Warrant multiplied by the product of 0.4 and the Offering Price. No holder will be entitled to dividends, voting rights or any other rights as a shareholder in respect of any fractional share of Company Stock. ARTICLE III THE CLOSING 3.1 CLOSING DATE. Consummation of the transactions contemplated by this Agreement shall take place at the office of the Bank, 24010 Sunnymead Boulevard, Moreno Valley, California, or such other location as may be agreed upon 18 by the parties, on the Closing Date. The Effective Time shall occur following the last to occur of (i) the receipt of all approvals and consents specified in this Agreement and the expiration of the applicable waiting periods specified in Article IX, and (ii) satisfaction of the conditions precedent set forth in Articles IX, X and XI or written waiver of such conditions as provided herein (the "Closing Date", "Effective Time of the Merger" or "Effective Time"). 3.2 EXECUTION OF AGREEMENT OF MERGER. Prior to the Closing Date, and as soon as practicable after the organization of PCBG Valley Corporation, the Agreement of Merger (as amended, if necessary, to conform to any requirements of any Governmental Entity having authority over the Merger) shall be executed by Bank and PCBG Valley Corporation. On the Closing Date, the Merger shall become effective in accordance with the approvals granted by the Commissioner, the FDIC and the FRB, and the Agreement of Merger, together with all requisite certificates, shall be duly filed with the California Secretary of State. 3.3 DOCUMENTS TO BE DELIVERED. At the Closing the Parties shall deliver, or cause to be delivered, such documents or certificates as may be necessary in the reasonable opinion of counsel for any of the parties, to effectuate the transactions called for in this Agreement. If, at any time after the Effective Time of the Merger, the Company or its successors or assigns shall determine that any further conveyance, assignment or other documents or any further action is necessary or desirable to further effectuate the transactions set forth herein or contemplated hereby, the officers and directors of the Parties hereto shall execute and deliver, or cause to be executed and delivered, all such documents as may be reasonably required to effectuate such transactions. 3.4 EXCHANGE PROCEDURES. (a) EXCHANGE AGENT. Promptly following the Effective Time, the Company shall deposit with the Exchange Agent the amount of cash and number of shares of Company Stock equal to the Aggregate Purchase Consideration and the Warrants issuable in the Merger. The Exchange Agent shall not be entitled to vote or exercise any rights of ownership with respect to Company Stock held by it from time to time hereunder, except that it shall receive and hold all dividends or other distributions paid or distributed with respect to such shares for the account of the persons entitled thereto. (b) EXCHANGE OF CERTIFICATES. Each holder of a certificate formerly representing Bank Stock (other than Dissenting Common Stock) who surrenders or has surrendered such certificate (or customary affidavits and indemnification regarding the loss or destruction of such certificate), together with duly executed transmittal materials included in or required by the Election Form, to the Exchange Agent shall, upon acceptance thereof, be entitled to the Per Share Consideration of cash, a certificate representing Company Stock and a Warrant into which the shares of Bank Stock shall have been converted pursuant hereto, as well 19 as cash in lieu of any fractional shares of Company Stock to which such holder would otherwise be entitled. The Exchange Agent shall accept such Bank certificate upon compliance with such reasonable and customary terms and conditions as the Exchange Agent may impose to effect an orderly exchange thereof in accordance with normal practices. Until surrendered as contemplated by this Section 3.4, each certificate representing Bank Stock shall be deemed from and after the Effective Time to evidence only the right to receive the Per Share Consideration of cash, Company Stock and a Warrant, as the case may be, upon such surrender. The Company shall not be obligated to deliver the consideration to which any former holder of Bank Stock is entitled as a result of the Merger until such holder surrenders his certificate or certificates representing shares of Bank Stock for exchange as provided in this Article III. If any certificate for shares of Company Stock, or any check representing declared but unpaid dividends, is to be issued in a name other than that in which a certificate surrendered for exchange is issued, the certificate so surrendered shall be properly endorsed and otherwise in proper form for transfer and the person requesting such exchange shall affix any requisite stock transfer tax stamps to the certificate surrendered or provide funds for their purchase or establish to the satisfaction of the Exchange Agent that such axes are not payable. (c) PAYMENT TO HOLDERS OF A BANK OPTION. Each holder of a Bank Option who presents a demand for cancellation and payment of such Bank Option as provided in Section 2.8 of the Agreement to the Exchange Agent prior to the Closing shall, upon acceptance thereof, be entitled to the per share equivalent of the Aggregate Option Price. Upon receipt of the Aggregate Purchase Consideration and as soon as reasonably possible after the Closing, the Exchange Agent shall deliver to each holder of a Bank Option the consideration due each such holder under Section 2.8 of the Agreement, in the form of cash, shares of Company Stock and Warrants as provided therein. The Exchange Agent shall be entitled to rely upon the records of the Bank and the information provided in such demand for cancellation documentation provided by any such holder of a Bank Option, as verified by the Company as to the method and means of payment and disposition of such consideration. (d) AFFILIATES. Certificates surrendered for exchange by any person constituting an "affiliate" of Bank for purposes of Rule 144(a) under the Securities Act shall not be exchanged for certificates representing whole shares of Bank Stock until the Company has received a written agreement from such person as provided in Section 6.25. 3.5 VOTING AND DIVIDENDS. Former shareholders of record of Bank shall not be entitled to vote after the Effective Time at any meeting of Company shareholders the number of whole shares of Company Stock into which their respective shares of Bank Stock are converted, until such holders have exchanged their certificates representing Bank Stock for certificates representing Company Stock in accordance with the provisions of this Agreement. Until surrendered for exchange in accordance with the provisions of Section 3.4 of this Agreement, each certificate 20 theretofore representing shares of Bank Stock (other than shares to be canceled pursuant to Section 2.1 of this Agreement) shall from and after the Effective Time represent for all purposes only the right to receive the Per Share Consideration consisting of cash, shares of Company Stock and a Warrant, and cash in lieu of fractional shares, as set forth in this Agreement. No dividends or other distributions declared or made after the Effective Time with respect to Company Stock with a record date after the Effective Time shall be paid to the holder of any unsurrendered certificate of Bank Stock with respect to the shares of Company Stock represented thereby, until the holder of such certificate of Common Stock shall surrender such certificate. Subject to the effect of applicable laws, following surrender of any such certificates of Bank Stock for which shares of Company Stock are to be issued, there shall be paid to the holder of the certificates, without interest, (i) the amount of any cash payable with respect to a fractional share of Company Stock to which such holder is entitled pursuant to Section 2.1 and the amount of dividends or other distributions with a record date after the Effective Time theretofore paid with respect to such whole shares of Company Stock, and (ii) at the appropriate payment date, the amount of dividends or other distributions with a record date after the Effective Time but prior to surrender and a payment date subsequent to surrender payable with respect to suh whole shares of Company Stock. 3.6 NO LIABILITY. Neither the Company, the Bank nor the Exchange Agent shall be liable to any holder of shares of Bank Stock for any shares of Company Stock (or dividends or distributions with respect thereto) or cash delivered to a public official pursuant to any applicable abandoned property, escheat or similar law. 3.7 WITHHOLDING RIGHTS. The Company or the Exchange Agent shall be entitled to deduct and withhold from the consideration otherwise payable pursuant to this Agreement to any holder of shares of Company Stock such amounts as the Company or the Exchange Agent is required to deduct and withhold with respect to the making of such payment under the Code, or any provision of state, local or foreign tax law. To the extent that amounts are so withheld by the Company or the Exchange Agent, such withheld amounts shall be treated for all purposes of this Agreement as having been paid to the holder of the shares of Bank Stock in respect of which such deduction and withholding was made by the Company or the Exchange Agent. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF THE BANK The Bank represents and warrants to the Company as of July 30, 1998 as follows: 4.1 ORGANIZATION AND GOOD STANDING. The Bank is a California banking corporation duly organized and validly existing in good standing under the laws of the State of California and it has the corporate power and authority to carry on its business as presently conducted, and is authorized to transact business as a bank. 21 The Bank is a not a member of the Federal Reserve System and its deposits are insured by the FDIC in the manner and to the extent provided by law. The Bank has all requisite corporate power and authority to own, lease and operate its properties and assets and to carry on its business as presently conducted. The nature of its operations and the business transacted by it as of the date hereof make licensing and qualification in any other state or jurisdiction unnecessary. The Bank has delivered to the Company true and correct copies of its Articles of Incorporation and Bylaws, as amended and in effect as of the date hereof, 4.2 CAPITALIZATION. The authorized capital stock of Bank consists of 2,400,000 shares of Common Stock, $5.00 par value, of which 1,171,906 shares are outstanding on the date hereof, and except for 7,872 shares issued on November 26, 1997 to Kenneth Ray, are all validly issued, fully paid and nonassessable, and all 1,171,906 shares will be validly issued, fully paid and nonassessable on the Closing Date. Except for stock options covering 262,914 shares of Bank Stock granted pursuant to the Bank Stock Option Plan, and except as to preemptive rights of Valley Bank shareholders, no unissued shares of Bank Stock or any other securities of the Bank are subject to any warrants, options, rights or commitments of any character, kind or nature and the Bank is not obligated to issue or repurchase any shares of Bank Stock or any other security to or from any person except in accordance with the terms of the Bank Stock Option Plan and Agreements pursuant thereto, and true and correct copies, as amended and in effect as of the date hereof have been delivered to the Company. Exhibit 4.2 sets forth the name of each holder of a Bank Option, the number of shares of Bank Stock covered by each such holder's option, the date of grant of each such holder's option, the exercise price per share, the vesting schedule for each such holder's option, and the expiration date of each such holder's option. 4.3 SUBSIDIARIES. Except as indicated in Exhibit 4.3, the Bank does not own, directly or indirectly (except as pledgee pursuant to loans which are not in default), any equity position or other voting interest in any corporation, partnership, joint venture or other entity. 4.4 FINANCIAL STATEMENTS. The Bank has delivered to the Company copies of the audited Balance Sheets of the Bank as of December 31, 1997 and 1996; Statements of Income, Stockholders' Equity and Cash Flows for each of the years ended December 31, 1997, 1996 and 1995, and the related notes and related opinions thereon of McGladrey & Pullen, certified public accountants, with respect to such financial statements (the "Audited Bank Financial Statements"). The Bank has delivered to the Company copies of the unaudited Balance Sheet of the Bank as of September 30, 1998; Statement of Income, Stockholders' Equity and Cash Flows for each of the nine months ended September 30, 1998, and the related notes thereon (the "Unaudited Bank Financial Statements). The Bank has furnished the Company with true and correct copies of each management letter or other letter delivered to the Bank by McGladrey & Pullen in connection with the Audited Bank Financial Statements or relating to any review of the internal controls of the Bank by 22 McGladrey & Pullen since January 1, 1996. The Audited Bank Financial Statements and the Unaudited Bank Financial Statements: (i) present fairly the financial condition and results of operations of the Bank as of and for the dates or periods covered thereby in accordance with GAAP and RAP consistently applied throughout the periods involved; (ii) are based on the books and records of the Bank; (iii) contain and reflect reserves for all material accrued liabilities and for all reasonably anticipated losses, and set forth adequate reserves for loan losses and other contingencies to the extent required by GAAP and RAP; and (iv) none of the Audited Bank Financial Statements or Unaudited Bank Financial Statements contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading under GAAP or RAP. The books and records of the Bank have been, and are being, maintained in all material respects in accordance with GAAP and RAP and other applicable legal and accounting requirements and reflect only actual transactions. 4.5 BOOKS AND RECORDS. (a) The minute books of the Bank which have been made available to the Company contain (i) true, accurate and complete records of all meetings and actions taken by the Board of Directors, Board committees and shareholders of the Bank, and (ii) true and complete copies of its Charter Documents. (b) The Bank has records which accurately and validly reflect, in all material respects, its transactions and accounting controls sufficient to insure that such transactions are (i) in all material respects, executed in accordance with management's general or specific authorization, and (ii) recorded in conformity with GAAP or RAP; such records, to the extent they contain important information pertaining to the Bank which is not easily and readily available elsewhere, have been duplicated, and such duplicates are stored safely and securely pursuant to procedures and techniques reasonably adequate for companies of the size of the Bank and in the businesses in which the Bank is engaged; and the data processing equipment and software used by the Bank in the operation of its businesses (including any disaster recovery facility) to generate and retrieve such records are reasonably adequate for companies of the size of the Bank and in the businesses in which the Bank is engaged. 4.6 PROPERTY AND ASSETS. (a) Exhibit 4.6(a) sets forth a general description (including the character of the ownership of the Bank) of all real property of the Bank, including fees, leaseholds and all other interest in real property (including real property that is DPC Property) ("Real Property"). Except as set forth on Exhibit 4.6(a), (i) the Bank has good and marketable title, free and clear of any encumbrance, lien or charge of any kind or nature (except liens for taxes not yet due) to all of the property, real, mixed or intangible, reflected on the Audited Bank Financial Statements, except as reflected therein or in the notes thereto (except property sold or transferred or Encumbrances incurred in the ordinary course of business since the date thereof) and except (a) Encumbrances in the aggregate which do not materially 23 detract from the value, interfere with the use, or restrict the sale, transfer or disposition, of such properties and assets or otherwise materially and adversely affect the Bank; (b) any lien for taxes not yet due; and (c) any Encumbrances arising under the document that created the interest in the Real Property (other than Encumbrances arising as a result of any breach or default of the Bank); (ii) all leasehold interests for Real Property and any material personal property used by the Bank in its business are held pursuant to lease agreements which are valid and enforceable, except as the enforceability thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable in accordance with their terms; (iii) all such properties comply in all material respects with all applicable private agreements, zoning requirements and other governmental laws and regulations relating thereto and there are no condemnation proceedings pending or, to the knowledge of the Bank, threatened with respect to such properties; (iv) the Bank has valid title or other ownership rights under licenses to all material intangible personal or intellectual property used by the Bank in its business, free and clear of any claim, defense or right of any other person or entity which is material to such property, subject only to rights of the licensors pursuant to applicable license agreements, which rights do not materially adversely interfere with the use of such property; and (v) all material insurable properties owned or held by the Bank are adequately insured in such amounts and against such risks as is customary with banks of similar size. The Bank has furnished the Company with true and correct copies of all leases included on Exhibit 4.6(a) delivered as of the date of July 30, 1998, all title insurance policies relating to the Real Property and all documents evidencing recordation of all recordable interest in the Real Property. (b) CONDITION OF PROPERTIES. All tangible properties of the Bank that are material to the business, financial condition, or results of operations of the Bank are in a good state of maintenance and repair, except for ordinary wear and tear, and are adequate for the conduct of the business of the Bank as presently conducted, and comply with all applicable Rules related thereto. Except as set forth in Exhibit 4.6(b), (i) the execution of this Agreement, the performance of the obligations of the Bank hereunder and the consummation of the transactions contemplated herein, including the Merger, does not conflict with and will not result in a breach or default under any lease, agreement or contract described in Exhibit 4.6(b), or give any other party thereto a right to terminate or modify any term thereof; (ii) the Bank has no obligation to improve any Real Property; (iii) each lease and agreement under which the Bank is a lessor is in full force and effect and is a valid and legally binding obligation of the Bank, and, to the best knowledge of the Bank, each other party thereto; and (iv) the Bank, and to the best knowledge of the Bank, each other party to any such lease or agreement have performed in all material respects all the obligations required to be performed by them to date under such lease or agreement and are not in default in any material respect under any such lease or agreement and there is no pending or, to the best knowledge of the Bank, threatened proceeding, or proceeding which the 24 Bank has reason to believe may be threatened, with respect to such property or any such lease. 4.7 LITIGATION PROCEEDINGS AND AGREEMENTS WITH GOVERNMENTAL ENTITIES. (a) The Bank is not engaged as a defendant in any legal or other proceedings before any court, administrative agency or other Governmental Entity except as is shown on Exhibit 4.7. Except as set forth on Exhibit 4.7, the Bank is not aware of any "threatened or pending litigation" (within the meaning of Paragraph 5 of the American Bar Association Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information adopted December 8, 1975) against the Bank. The Bank is not subject to any agreement, order, writ, injunction or decree of any federal, state or local court, out of a proceeding involving the Bank or any of its business or properties except as described in Exhibit 4.7. The Bank has not been served with notice of, nor, to best of Bank's knowledge is it currently under investigation with respect to, any violation of federal, state or local law or administrative regulation. Except as set forth on Exhibit 4.7, there is no (i) outstanding judgment, order, writ, injunction or decree, stipulation or award of any Governmental Entity or by arbitration, against, or to the knowledge of the Bank, affecting the Bank or its assets or business that (a) has had or may have a material adverse effect on the assets, liabilities, business, financial condition or results of operations of the Bank, (b) requires any payment by, or excuses a material obligation of a third party to make any payment to, the Bank, or (c) has the effect of prohibiting any business practice of, or the acquisition, retention or disposition of property by, the Bank; or (ii) legal, administrative, arbitration, investigatory or other proceeding pending or, to the best knowledge of the Bank that has been threatened, or which the Bank has reason to believe may be threatened, against or affecting any director, officer, employee, agent or representative of the Bank, in connection with which any such person has or may have rights to be indemnified by the Bank. (b) Except as set forth in Exhibit 4.7, the Bank is not a party to, or otherwise subject to, any agreement or memorandum of understanding with or order of any Governmental Entity charged with the supervision or regulation of banks or engaged in the insurance of bank deposits, that restricts the conduct of its business, or in any manner relates to its capital adequacy, its credit or investment policies or its management. 4.8 TAXES AND ASSESSMENTS. The Bank has timely filed all federal income and state franchise tax returns and all tax reports or returns which it is required to file with applicable federal, state, county or local authorities and agencies except (a) where the failure to make any such filing would not have any materially adverse effect on the business, financial condition or results of operations of the Bank taken as a whole, and (b) where the required filing date has been lawfully extended, and the Bank has paid all taxes provided for and to be due in such returns and reports ("Tax Filings"). The Bank's Tax Filings have never been examined by a Governmental Entity, except for the pending audit for tax year 1997. As of December 31, 1997, 25 to the extent required by GAAP, the Bank had paid, or set up adequate accruals for the payment of, all taxes, penalties and assessments for which it was liable as of such date, whether or not disputed, with respect to any and all United Sates federal, foreign, state, local, environmental (including under any Environmental Law) and other taxes for the periods covered by the financial statements of the Bank and for all prior and subsequent periods. Except as set forth in Exhibit 4.8 the Bank has no knowledge of any deficiency proposed to be assessed against it. The Bank has paid all assessments made by the FDIC and the Commissioner required to be paid prior the date hereof. There is currently no federal or state income tax audit or investigation in process or to the best knowledge of the Bank any other pending investigation by any authorized body of the taxes paid or to be paid by the Bank, and the Bank has not been informed that any such audit or investigation is proposed, except for the pending tax audit for 1997. 4.9 COMPLIANCE WITH LAWS AND REGULATIONS. (a) Except as set forth in Exhibit 4.9, the Bank is not in default under or in breach of any law, ordinance, rule, regulation, order, judgment or decree applicable to it promulgated by any Governmental Entity having authority over it, where such default or breach would have a material adverse effect on its financial condition, results of operations, or business. (b) The Bank has conducted in all material respects its businesses in accordance with all applicable federal, foreign, state and local laws, regulations and orders, including without limitation disclosure, usury, equal credit opportunity, equal employment, fair credit reporting, antitrust, licensing and other laws, regulations and orders, and the forms, procedures and practices used by the Bank are in compliance with such laws, regulations, and orders, except for such violations or noncompliance as will not have a material adverse effect on the financial condition, results of operations, or business of the Bank. 4.10 PERFORMANCE OF OBLIGATIONS. Except as set forth in Exhibit 4.10, the Bank has performed in all respects all of the obligations required to be performed by it to date and is not in default under or in breach of any term or provision of any covenant, contract, lease, indenture or any other agreement to which the Bank is a party or is subject or is otherwise bound, and no event has occurred which, with the giving of notice or the passage of time or both, would constitute such default or breach, where such default or breach would have a material adverse effect on the financial condition, results of operations, or business of the Bank. Except for loans of the Bank in default on July 30, 1998, no party with whom the Bank has an agreement which is material to the financial condition, results of operations or business of the Bank is in default thereunder. 26 4.11 EMPLOYEES. (a) Except as set forth in Exhibit 4.11(a), there are no understandings for the employment of any officer or employee of the Bank which are not terminable by the Bank without liability on not more than 30 days' notice. Except as set forth in Exhibit 4.11(a), the Bank is not a party to an oral or written consultant agreement not terminable upon 60 days' or less notice or involving the payment of more than $10,000 per annum. Except as set forth in Exhibit 4.11(a), there are no material controversies pending or threatened between the Bank and any of its employees. Except as disclosed in the Audited Bank Financial Statements, the Unaudited Bank Financial Statement or in Exhibit 4.11(a), all material sums due for employee compensation and benefits have been duly and adequately paid or provided, and all deferred compensation obligations are fully funded. The Bank is not a party to any collective bargaining agreement with respect to any of its employees or any labor organization to which its employees or any of them belong. Except as set forth in Exhibit 4.11(a), no director, officer or employee of the Bank is entitled to receive any payment of any amount under any employment agreement, severance plan or other benefit plan as a result of the consummation of any transaction contemplated by this Agreement. (b) Except as disclosed in Exhibit 4.11(b), (i) the Bank is and has been in material compliance with all applicable laws respecting employment and employment practices, terms and conditions of employment and wages and hours, including, without limitation, any such laws respecting employment discrimination and occupational safety and health requirements, and in any unfair labor practice; (ii) there is no material unfair labor practice complaint against the Bank pending or, to the knowledge of the Bank, threatened before the National Labor Relations Board; (iii) there is no labor dispute, strike, slowdown or stoppage actually pending or, to the knowledge of the Bank, threatened against or directly affecting the Bank; and (iv) the Bank has not experienced any material work stoppage or other material labor difficulty during the past five years, except in each case which would not result in a Material Adverse Change. (c) Except as disclosed in Exhibit 4.11(c), the Bank does not maintain, contribute to or participate in or have any material liability under any employee benefit plans, as defined in ERISA, or any nonqualified employee benefit plans or deferred compensation, bonus, stock or incentive plans, or other employee benefit or fringe benefit programs for the benefit of former or current employees of the Bank (the "Employee Plans"). To the best knowledge of the Bank, no present or former employee of the Bank has been charged with breaching nor has breached a fiduciary duty under any of the Employee Plans. The Bank does not participate in, nor has it in the past five years participated in, nor has it any present or future obligation or liability under, any multiemployer plan (as defined at Section 3(37) of ERISA). Except as may be separately disclosed in Exhibit 4.11(c), the Bank does not maintain, contribute to, or participate in, any plan that provides health, major medical, disability or life insurance benefits to former employees of the Bank. 27 (d) Exhibit 4.11 (d) sets forth and describes all Employee Plans in which the Bank participates, or by which it is bound, including, without limitation; (i) any profit sharing, deferred compensation, bonus, stock option, stock purchase, pension, retainer, consulting, retirement, welfare or incentive plan or agreement whether legally binding or not; (ii) any plan providing for "fringe benefits" to its employees, including but not limited to vacation, sick leave, medical, hospitalization, life insurance and other insurance plans, and related benefits; (iii) any written employment agreement and any other employment agreement not terminable at will; or (iv) any other "employee benefit plan" (within the meaning of Section 3(3) of ERISA) (collectively, the "Employee Plans"). Except as set forth in Exhibit 4.11(d)(i), there are no negotiations, demands or proposals that are pending or threatened that concern matters now covered, or that would be covered, by any employment agreements or Employee Plan other than amendments to plans qualified under Section 401 of the Code that are required by the Tax Reform Act of 1986 and later legislation; (ii) the Bank is in compliance with the material reporting and disclosure requirements of Part 1 of Subtitle IB of ERISA and the corresponding provisions of the Code to the extent applicable to all such Employee Plans; (iii) the Bank has substantially performed all of its obligations under all such Employee Plans and employment agreements required to be performed heretofore; and (iv) there are no actions, suits or claims (other than routine claims for benefits) pending or, to the best knowledge of the Bank, threatened against any such Employee Plans and employment agreements or the assets of such plans, and to the best knowledge of the Bank, no facts exist which could give rise to any actions, suits or claims (other than routine claims for benefits) against such plans or the assets of such plans. (e) The "Employee Plans" (within the meaning of Section 3(2) of ERISA) described on Exhibit 4.11(d) have been duly authorized by the Board of Directors of the Bank. Except as set forth in Exhibit 4.11(d), each such plan and associated trust intended to be qualified under Section 401(a) and to be exempt from tax under Section 501(a) of the Code, respectively, has either received a favorable determination letter from the Internal Revenue Service (the "IRS"), has applied for such a determination letter or will apply for such a determination letter before the expiration of the remedial amendment period set forth in Section 401(b) of the Code, as the IRS may extend such period, and to the best knowledge of the Bank, no event has occurred that will or could give rise to disqualification of any such plan which is intended to be qualified under Section 401(a) of the Code or loss of the exemption from tax of any such trust which is intended to be exempt from tax under Section 501(a) of the Code. No event has occurred that will or could subject any such plans to tax under Section 511 of the Code. None of such plans has engaged in a merger or consolidation with any other plan or transferred assets or liabilities from any other plan. To the best of the Bank's knowledge, no prohibited transaction (within the meaning of Section 409 or 502(i) of ERISA or Section 4975 of the Code) or party-in-interest transaction (within the meaning of Section 406 of ERISA) has occurred with respect to any of such plans which could subject the Bank to an excise tax or penalty. To the best knowledge of the Bank, no employee of the Bank has 28 engaged in any transactions which could subject the Bank to indemnify such person against liability. All costs of plans have been provided for on the basis of consistent methods in accordance with sound actuarial assumptions and practices. No Employee Plan has incurred any "accumulated funding deficiency" (as defined in Section 302(2) of ERISA), whether or not waived, taking into account contributions made within the period described in Section 412(c)(10) of the Code; nor are there any unfunded amounts under any Employee Plan which is required to be funded under Part 3 of Subtitle IB of ERISA and Section 412 of the Code); nor has the Bank failed to make any contributions or pay any amount due and owing as required by law or the terms of any Employee Plan or employment agreement. Subject to amendments that are required by the Tax Reform Act of 1986 and later legislation, since the last valuation date for each Employee Plan, there has been no amendment or change to such plan that would increase the amount of benefits thereunder. (f) The Bank does not sponsor or participate in, or has not sponsored or participated in, any employee benefit pension plan to which Section 4021 of ERISA applies that would create a liability under Title IV of ERISA. (g) The Bank does not sponsor or participate in, or has not sponsored or participated in, any Employee Plan that is a "multi-employer plan" (within the meaning of Section 3(37) of ERISA) that would subject such Person to any liability with respect to any such plan. (h) All group health plans of the Bank (including any plans of Affiliates of the Bank that must be taken into account under Section 162(i) or (k) of the Code as in effect immediately prior to the Technical and Miscellaneous Revenue Act of 1988 and Section 4980B of the Code) have been operated in compliance with the group health plan continuation coverage requirements of Section 4980B of the Code to the extent such requirements are applicable. (i) There have been no acts or omissions by the Bank that have given rise to or may give rise to fines, penalties, taxes, or related charges under Sections 502(c) or (i) or 4071 of ERISA or Chapter 43 of the Code which could be imposed on the Bank. (j) Except as described in Section 4.11(j), the Bank does not maintain any Employee Plan or employment agreement pursuant to which any Employee Plan or other payment will be required to be made by the Bank or pursuant to which any other benefit will accrue or vest in any director, officer or employee the Bank, in either case as a result of the consummation of the transactions contemplated by the Agreement. (k) No "reportable event," as defined in ERISA, has occurred with respect to any of the Employee Plans. 29 (l) All amendments required to bring each of the employee benefit plans into conformity with all of the provisions of ERISA and the Code and all other applicable laws, rules and regulations have been made, or will be made before the expiration of the remedial amendment period set forth under Section 401(b) of the Code, as such period may be extended by the IRS. (m) Exhibit 4.11(m) sets forth the name of each director, officer, employee, agent or representative of the Bank and every other person entitled to receive any benefit or any payment of any amount under any existing employment agreement, severance plan or other benefit plan or Understanding as defined in Section 4.12 as a result of the consummation of any transaction contemplated in this Agreement, and with respect to each such person, the nature of such benefit or the amount of such payment, the event triggering the benefit or payment, and the date of, and parties to, such employment agreement, severance or other benefit plan or Understanding. The Bank has furnished the Company with true and correct copies of all documents with respect to the plans and agreements referred to in Exhibit 4.11(d) delivered as of July 30, 1998, including all amendments and supplements thereto, and all related summary plan descriptions. For each of the employee pension benefit plans of the Bank referred to in Exhibit 4.11(d) delivered as of July 30, 1998, the Bank has furnished the Company with true and correct copies of (i) the Form 5500 which was filed in each of the three most recent plan years, including without limitation, all schedules thereto and all financial statements with attached opinions of independent accountants to the extent required; (ii) the most recent determination letter from the IRS; (iii) the statement of assets and liabilities as of the most recent valuation date; and (iv) the statement of changes in fund balance and in financial position or the statement of changes in net assets available for benefits under each of said plans for the most recently ended plan year. The documents referred to in subdivisions (iii) and (iv) fairly present the financial condition of each of said plans as of and at such dates and the results of operations of each of said plans, all in accordance with GAAP or on the cash method of accounting applied on a consistent basis. 4.12 CONTRACTS AND AGREEMENTS. Except as listed in Exhibit 4.12, the Bank is not a party to any oral or written agreement, commitment, or obligation (hereinafter referred to as an "Understanding") which individually, or with all other similar Understandings relating to the same or similar subject matter, falls within any of the following classifications (hereinafter referred to as a "Material Contract"): (i) any Understanding dealing with advertising, brokerage, licensing, dealership, representative or agency relationship; (ii) any Understanding with any labor or collective bargaining organization or association; (iii) any mortgage, pledge, conditional sales contract, security agreement, or any other similar Understanding with respect to any real or personal 30 property in an amount in excess of $25,000, under which the Bank is a debtor or to which any of its property is subject; (iv) any profit sharing, group insurance, bonus, deferred compensation, stock option, severance pay, pension, retirement, or any other similar Understanding which might provide benefits to the employees, officers or directors of the Bank; (v) any Understanding for the future purchase of materials, supplies, services, merchandise or equipment, the price of which exceeds $10,000 and which will not be terminable without liability as to future purchases as of the Effective Time; it being understood that materials, supplies, service, merchandise or equipment shall not be deemed to include loans, repurchase or reverse repurchase agreements, securities or other financial transactions incurred by the Bank in the ordinary course of its banking business; (vi) any Understanding for the sale of any of its assets, or for the grant of any right to purchase any of its assets, properties or rights, or which requires the consent of any third party to the transfer and assignment of any of its assets, properties or rights; it being understood that the foregoing shall not be deemed to include any Understanding for the sale of mortgage loans, repurchase or reverse repurchase agreements, securities or other financial transactions incurred by the Bank in the ordinary course of its banking business; (vii) any guarantee, subordination or other similar or related types of Understanding except where the Bank is a beneficiary; (viii) any Understanding for the borrowing of any money by the Bank (other than time savings or demand deposits) or for a line of credit to it; (ix) any Understanding for any one capital expenditure or series of related capital expenditures in excess of $5,000 individually or $10,000 in the aggregate; (x) any real property lease, whether as lessor or lessee; or any personal property lease, whether as lessor or lessee, involving payments in excess of $500 per month; (xi) any Understanding to make or participate in a loan (not yet fully disbursed or funded) to any borrower or related group of borrowers, which undisbursed or unfunded amount would exceed $50,000 unsecured or $100,000 secured, except government agency guaranteed loans, which are covered herein only if the unguaranteed portion would exceed $250,000; (xii) any Understanding of any kind (other than contracts relating to demand or time deposits or otherwise made in the ordinary course of 31 business) with any director or officer of the Bank or with any member of the immediate family of any such director of officer or with any partnership, corporation, associate or entity of which any such person is an Affiliate; (xiii) any Understanding for insurance of any type described in Section 4.13 below; or (xiv) any Understanding, the purpose or effect of which could encompass (a) merging with any person or bank or bank holding company other than with the Company (b) the selling of any of its assets (except in the ordinary course of business) or stock to any person, (c) recommending to any of its shareholders that their Bank Stock be sold to any person or bank other than the Company, or causing any other person to make such recommendations or acquiescing in any such recommendations made by any other person, or (d) in any other way transferring, directly or indirectly, control of the Bank. Except as stated in Exhibit 4.12, true and correct copies of all documents relating to the foregoing Understandings have been delivered by the Bank prior to July 30, 1998 . As used in this Section 4.12, "immediate family" of a person shall mean his or her spouse, parents, children, and siblings. 4.13 INSURANCE. The Bank has and at all times within three years of July 30, 1998 has had, in full force and effect policies of insurance and bonds (including without limitation Bankers' blanket bond, fidelity coverage, director and officer liability, fire, third party liability, use and occupancy) with respect to its assets and business and against such casualties and contingencies and of such amounts, types and forms which are customary in the banking industry and are adequate or appropriate to cover its assets and businesses as set forth in Exhibit 4.13. Set forth in Exhibit 4.13 is a schedule of all policies of insurance (other than employee benefit, title or credit insurance) carried and owned by the Bank, showing the name of the insurance or bonding company, a summary of the coverage, the amounts, the deductible features, the annual premiums and the expiration dates. If any such policy or bond is materially changed, terminated or modified following July 30, 1998 , such termination, change or modification shall be promptly disclosed to the Company in writing. The Bank is not in default under any such policy of insurance or bond such that it could be canceled, and all material claims thereunder have been filed in a timely fashion. The Bank has filed claims with or given notice of claim to its insurers or bonding companies with respect to all material matters and occurrences for which it believes it has coverage, in excess of the applicable deductible. 4.14 BROKERS. Except as indicated in Exhibit 4.14, no agent, broker, investment banker, person or firm acting on behalf or under authority of the Bank (except for any payments for fairness opinions as required in Section 10.9) is or will be entitled to any broker's or finder's fee or any other commission or similar fee 32 directly or indirectly in connection with any of the transactions contemplated by this Agreement. 4.15 AUTHORIZATION. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by the Board of Directors of the Bank. Assuming due and proper execution and delivery of this Agreement by the Company, this Agreement constitutes a legal, valid and binding agreement of the Bank in accordance with its respective terms, except as the enforceability hereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable, and by Section 8(b) 6(D) of the Federal Deposit Insurance Act, 12 U.S.C. Section 1818(b)(6)(D). Subject to obtaining the requisite approval of this Agreement by the shareholders of the Bank, the Bank has full corporate power and authority to perform its obligations under this Agreement and the transactions contemplated hereby. 4.16 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein, including the Merger, and compliance by the Bank with any provision hereof and thereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 4.16 any material agreement, instrument or obligation to which it is a party or by which the property of the Bank is bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, Commissioner, any other required Governmental Entity and as set forth in Exhibit 4.16, require any Consents; or (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of the Bank; or (d) violate the Charter Documents or any Rules to which the Bank is subject. 4.17 MATERIAL ADVERSE CHANGES. Except as specifically required, permitted or effected by this Agreement, and except as set forth on Exhibit 4.17, since December 31, 1997 there has not been, occurred or arisen any of the following (whether or not in the ordinary course of business unless otherwise indicated) ("Material Adverse Changes"): (a) Any materially adverse change in any of the assets, liabilities, permits, methods of accounting or accounting practice, or manner of conducting business, of the Bank or any other event or development that has had or may reasonably be expected, when taken as a whole, to have a material adverse effect on the assets, liabilities, Permits, business, financial condition, or results of operations of the Bank or which should be disclosed in order to make the Audited Bank Financial Statements not misleading; 33 (b) Any damage, destruction or other casualty loss (whether or not covered by insurance) that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Bank or that may involve a loss of more than $50,000 in excess of applicable insurance coverage; (c) Any amendment, modification or termination of any existing, or entry into any new Material Contract or Permit that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Bank; (d) Any disposition by the Bank of an asset the lack of which has had or may reasonably be expected to have a material adverse effect on the business, financial condition, or results of operations of the Bank; (e) Any direct or indirect redemption, purchase or other acquisition by the Bank of any Equity Securities or any declaration, setting aside or payment of any dividend or other distribution on or in respect of Bank Stock whether consisting of money, other personal property, real property or other things of value; (f) Any changes by the Bank in accounting principles or methods or tax methods, except as required or permitted by, the Financial Accounting Standards Board or by any Governmental Entity having jurisdiction over the Bank; (g) A reduction in the Bank's CAMELS rating; (h) A reduction in the Bank's CRA rating to less than satisfactory; (i) A reduction in shareholders' equity to less than 100% of the Bank's shareholders' equity at December 31, 1997 as determined in accordance with GAAP or RAP; and/or a material reduction in the Bank's projected earnings except as to the transaction expenses related to this Agreement, as reduced for any cash dividends as authorized by Section 6.2(vii); (j) Any event of which the Bank obtains knowledge which may materially and adversely affect the business, financial condition, results of operations or prospects of the Bank; or (k) Any event, development or circumstance that, to the best knowledge of the Bank, will or, with the passage of time or the giving of notice or both, is reasonably expected to result in the loss to the Bank of the services of any Executive Officers of the Bank. 4.18 REPORTS AND FILINGS. Since January 1, 1995, the Bank has filed all reports, returns, registrations and statements (such reports and filings referred to as "Bank Filings"), together with any amendments required to be made with respect 34 thereto, that were required to be filed with (a) the FDIC, (b) the Commissioner and (c) any other applicable Governmental Entity, including taxing authorities, except where the failure to file such reports, returns, registrations and statements has not had and is not reasonably expected to have a material adverse effect on the business, financial condition, or results of operations of the Bank. No administrative actions have been taken or orders issued in connection with such Bank Filings. As of their respective dates, each of such Bank Filings complied in all material respects with all Rules enforced or promulgated by the Governmental Entity with which it was filed (or was amended so as to be so promptly following discovery of any such noncompliance). Any financial statement contained in any of such Bank Filings that was intended to present the financial position of Bank fairly and was prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved. The Bank has furnished the Company with true and correct copies of all Bank Filings filed by the Bank since January 1, 1995. 4.19 INFORMATION REGARDING LOANS. The Bank has provided the Company access to all of the information in its possession concerning its loans, and such information was true and correct in all material respects as of the date access was provided. Except as may be disclosed in Exhibit 4.19, (i) all loans and discounts shown on the Audited Bank Financial Statements at December 31, 1997 or which were entered into after December 31, 1997, but before the Closing Date, were and will be made in all material respects for good, valuable and adequate consideration in the ordinary course of the business of the Bank, in accordance in all material respects with the Bank's lending practices, and are not subject to any material known defenses, setoffs or counterclaims, including without limitation any such as are afforded by usury or truth in lending laws, except as may be provided by bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or enforcement of creditor rights and the application of equitable principles in any action, legal or equitable; (ii) the notes or other evidences of indebtedness evidencing such loans and all forms of pledges, mortgages and other collateral documents and security agreements constituting the Bank's loan portfolio, taken as a whole, are and will be, in all material respects, enforceable except as the enforceability hereof and thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles; and (iii) the Bank has complied in all material respects, and will prior to the Closing Date comply with all laws and regulations relating to such loans, or to the extent there has not been such compliance, such failure to comply will not materially interfere with the collection of any such loan. All loans and loan commitments extended by the Bank and any extensions, renewals or continuations of such loans and loan commitments that are on the Bank's books were made in accordance with customary lending standards of the Bank in the ordinary course of business. Such loans are evidenced by documentation based upon customary and ordinary past practices of the Bank. Prior to the date hereof, the Bank has provided the Company with a schedule which sets forth a description as of June 30, 1998 (a) by type and classification, if any, of each loan, lease other extension of credit and commitment to extend credit; (b) by type 35 and classification, if any, of all loans, leases, other extensions of credit and commitments to extend credit that have been classified by any Governmental Entity or auditors (external or internal) as "Watch List," "Substandard," "Doubtful," "Loss" or any comparable classification; and (c) all consumer loans as to which any payment of principal, interest or other amount is 90 days or more past due. (b) The allowance for loan and lease losses for the Bank is adequate and substantially in accordance with GAAP and RAP. 4.20 COMPLIANCE WITH CRA To the best knowledge of the Bank, the Bank's compliance under the CRA should not constitute grounds for either the denial by any Governmental Entity of any application to consummate the transactions contemplated by this Agreement or the imposition of a materially burdensome condition in connection with the approval of any such application. 4.21 CERTAIN INTERESTS. Except as described in Exhibit 4.12(xii), Exhibit 4.21 sets forth a description of each instance in which an officer or director of the Bank (a) has any material interest in any property, real or personal, tangible or intangible, used by or in connection with the business of the Bank; (b) is indebted to the Bank except for normal business expense advances; or (c) is a creditor (other than as a Deposit holder) of the Bank except for amounts due under normal salary and related benefits or reimbursement of ordinary business expenses. Except as set forth in Exhibit 4.21, all such arrangements are arm's length transactions pursuant to normal commercial terms and conditions. 4.22 BRANCHES. Exhibit 4.22 hereto sets forth the common name and location of each office of the Bank, an indication of whether such office is a branch, service center, or other place of business, whether such premises are owned or leased, the basic terms of such leases, the common name and location of each approved but unopened office, and a description of each application for additional offices of the Bank, and the status of each such application. The Bank has received appropriate and effective permits and governmental authority where any Permit, approval or notice was required by law or regulation prior to the establishment and operation of each such office now in operation. Except for the offices described on Exhibit 4.22, the Bank does not operate or conduct business out of any other location and the Bank does not have any current application for, and the Bank has not received permission to open, any other branch or to operate out of any other location. 4.23 UNDISCLOSED LIABILITY. The Bank has no liabilities or obligations, either accrued or contingent, which are in excess of Ten Thousand Dollars ($10,000) individually or in the aggregate, which have not been: (i) reflected or disclosed in the Audited Bank Financial Statements or Unaudited Bank Financial Statements; (ii) incurred subsequent to December 31, 1997, in the ordinary 36 course of business; or (iii) disclosed on Exhibit 4.23 or any other exhibit to this Agreement. To the best of the Bank's knowledge and the knowledge of their officers and directors, after due investigation, there is no basis for the assertion against the Bank of any liability, obligation or claim that is likely to result in or cause any material adverse change in the business or financial condition of the Bank, taken as a whole, which is not fairly reflected in the Audited Bank Financial Statements, the Unaudited Bank Financial Statements or otherwise disclosed on Exhibit 4.23 hereto. 4.24 ACCURACY OF INFORMATION FURNISHED. Except as to any statements or information which shall include projections or forecasts, none of the statements or information made or contained in any of the covenants, representations or warranties of the Bank set forth in this Agreement or in any of the schedules, exhibits, lists, certificates or other documents furnished herewith taken as a whole contains any untrue statement of a material fact required to be stated herein or therein or necessary to make the statements or information contained herein or therein, in light of the circumstances in which they were made, not misleading. As to any such information or statements which include projections or forecast, such information or statements are based upon assumptions believed by the Bank to be reasonable. 4.25 ENVIRONMENTAL LAWS. Except as may be disclosed in Exhibit 4.25, to the best of the Bank's knowledge (and without conducting any site investigation or other analysis for the purpose of making this representation), neither the conduct nor operation of the Bank nor any condition of any Real Property presently or previously owned, leased or operated by the Bank violates or violated Environmental Laws in any respect material to the business of Bank taken as a whole and no condition or event has occurred with respect to the Bank or any Real Property that, with notice or the passage of time, or both, would constitute a violation material to the business of the Bank taken as a whole of Environmental Laws or obligate (or potentially obligate) the Bank to remedy, stabilize, neutralize or otherwise alter the environmental condition of any such Real Property where the aggregate cost of such actions would be material to the Bank taken as a whole. Except as may be disclosed in Exhibit 4.25, the Bank has not received any notice from any person or entity that the Bank or the operation or condition of any Real Property ever owned, leased or operated by the Bank is or was in violation of any Environmental Laws or that the Bank is responsible (or potentially responsible) for remedying, or the cleanup of, any pollutants, contaminants, or hazardous or toxic wastes, substances or materials at, on or beneath any such Real Property. 4.26 COMMISSIONER AND FDIC EXAMINATIONS. (a) The Commissioner has completed an examination of the Bank as of December 31, 1997, and (i) the Commissioner believes the Bank's allowance for loan losses is adequate and the Commissioner required no material adjustments, and (ii) the Bank's CAMELS rating 37 did not adversely change and the Bank's financial condition is deemed by the Commissioner to be less than satisfactory; however, the Bank has made all necessary adjustments and has followed the recommendations of the Commissioner. (b) The FDIC has completed an examination of the Bank as of December 31, 1997, and (i) the FDIC believes the Bank's allowance for loan losses is adequate and the FDIC required no material adjustments, and (ii) the Bank's CAMELS rating did not adversely change and the Bank's financial condition is deemed by the FDIC to be less than satisfactory; however, the Bank has made all necessary adjustments and has followed the recommendations of the FDIC. (c) The FDIC has completed an examination of the Bank for compliance with Year 2000 safety and soundness issues as of June 9, 1998, and the FDIC has rated the Bank "needs to improve" regarding the Bank's progress in addressing Year 2000 Safety and Soundness Progress Standards established by the FDIC. 4.27 INSIDER LOANS; OTHER TRANSACTIONS. The Bank has previously provided the Company with a listing, current as of November 30, 1998, of all extensions of credit made to the Bank and each of its Executive Officers and directors and their related interests (all as defined under Federal Reserve Board Regulation "O"), all of which have been made in compliance with Regulation O, which listing is true, correct and complete in all material respects. The Bank does not owe any amount to, nor does it have any contract or lease with or commitment to, any of the present Executive Officers or directors of the Bank (other than for compensation for current services not yet due and payable, and reimbursement of expenses arising in the ordinary course of business). 4.28 DERIVATIVE TRANSACTIONS. The Bank is not a party to a transaction in or involving forwards, futures, options on futures, swaps or other derivative instruments. 4.29 TRUST ADMINISTRATION. The Bank presently does not exercise trust powers, including, but not limited to, trust administration, and has not exercised such trust powers for a period of at least 3 years prior to the date hereof. The term "trusts" as used in this Section 4.29 includes (i) any and all common law or other trusts between an individual, corporation or other entities and the Bank, as trustee or co-trustee, including, without limitation, pension or other qualified or nonqualified employee benefit plans, compensation, testamentary, intervivos, and charitable trust indentures; (ii) any and all decedents' estates where the Bank is serving or has served as a co-executor or sole executor, personal representative or administrator, administrator de bonis non, administrator de bonis non with will annexed, or in any similar fiduciary capacity; (iii) any and all guardianships, conservatorships or similar positions where the Bank is serving or has served as a co-grantor or a sole grantor or a conservator or a co-conservator of the estate, or any similar fiduciary capacity; and (iv) any and all agency and/or custodial accounts and/or similar arrangements, 38 including plan administrator for employee benefit accounts, under which the Bank is serving or has served as an agent or custodian for the owner or other party establishing the account with or without investment authority. 4.30 STATEMENTS TRUE AND CORRECT. None of the information supplied or to be supplied by the Bank for inclusion in the S-1, the S-4 or the Proxy Statement, or incorporated by reference therein, or any other document to be filed with any Governmental Entity in connection with the transactions contemplated hereby will, in the case of the S-1, the S-4 and the Proxy Statement, when it is first mailed to the shareholders of the Bank, contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which such statements are made, not misleading or, in the case of the S-1 and the S-4, when it becomes effective, be false or misleading with respect to any material fact, or omit to state any material fact necessary in order to make the statements therein not misleading, or, in the case of the S-1, the S-4 and Proxy Statement or any amendment thereof or supplement thereto, at the time of the meeting of shareholders of the Bank, be false or misleading with respect to any material fact or omit to state any material fact necessary to correct any statement or remedy any omission in any earlier communication with respect to the solicitation of any proxy for the Bank shareholders' meeting. 4.31 ACCURATE DISCLOSURE. The Bank agrees that through the Effective Time of the Merger, each of its reports, and other filings required to be filed with any applicable Governmental Entity will comply in all material respects with all of the applicable statutes, Rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any such report, or other filing that is intended to present the financial position of the Bank, will fairly present the financial position of the Bank in all material respects and will be prepared in accordance with GAAP or RAP consistently applied during the periods involved. Notwithstanding anything to the contrary set forth in this Section 4.31, the Bank makes no representation or warranty with respect to any information supplied by the Company, or contained in any of the Company's Reports. 4.32 YEAR 2000. The Bank has formed a Year 2000 management committee to identify potential problems associated with the Year 2000 issues and to develop resolution to any problems. The Bank is making satisfactory progress toward compliance with Year 2000 safety and soundness issues affecting the Bank's existing computer systems, and any related vendor or customer system. 39 ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to the Bank as follows: 5.1 ORGANIZATION AND GOOD STANDING. The Company is a California corporation duly organized and validly existing in good standing under the laws of the State of California, is proposed to be registered with the FRB to become a bank holding company and it has the corporate power and authority to carry on its business as presently conducted. The Company has all requisite corporate power and authority to own, lease and operate its properties and assets and to carry on its business as presently conducted. The nature of its operations and the business transacted by it as of the date hereof make licensing and qualification in any other state or jurisdiction unnecessary. The Company has delivered to the Bank true and correct copies of its Articles of Incorporation and Bylaws, as amended and in effect as of the date hereof. 5.2 CAPITALIZATION. The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, no par value, of which 10,000 shares are outstanding on the date hereof, all validly issued, fully paid and nonassessable, and 100,000,000 shares of Preferred Stock, none of which are outstanding. Except as provided in Exhibit 5.2, no unissued shares of Company Stock or any other securities of the Company are subject to any warrants, options, rights or commitments of any character, kind or nature and the Company is not obligated to issue or repurchase any shares of Company Stock or any other security to or from any person except in accordance with the terms of the proposed Company Stock Option Plan and Agreements pursuant thereto. Exhibit 5.2 sets forth the name of each holder of a Company stock option, the number of shares of Company Stock covered by each such holder's option, the date of grant of each such holder's option, the exercise price per share, the vesting schedule for each such holder's option and the expiration date of each such holder's option. 5.3 SUBSIDIARIES. The Company does not own, directly or indirectly (except as pledgee pursuant to loans which are not in default), any equity position or other voting interest in any corporation, partnership, joint venture or other entity. 5.4 FINANCIAL STATEMENTS. The Company has delivered, or will deliver when available, to the Bank copies of the unaudited Statements of Financial Condition of the Company as of December 31, 1997 and September 30, 1998 (the "Company Financial Statements"). The Company Financial Statements: (i) present fairly the financial condition and results of operations of the Company as of and for the dates or periods covered thereby in accordance with GAAP consistently applied throughout the periods involved; (ii) are based on the books and records of the Company; (iii) contain and reflect reserves for all material accrued liabilities and for all reasonably anticipated losses, and set forth adequate reserves loan losses and other 40 contingencies to the extent required by GAAP; and (iv) none of the Company Financial Statements contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading under GAAP. The books and records of the Company have been, and are being, maintained in all material respects in accordance with GAAP and other applicable legal and accounting requirements and reflect any actual transactions. Since the Company was recently incorporated, there are no audited financial statements of the Company for December 31, 1997 or previous years. 5.5 BOOKS AND RECORDS. (a) The minute books of the Company which have been made available to the Bank contain (i) true, accurate and complete records of all meetings and actions taken by the Board of Directors, Board committees and shareholders of the Company, and (ii) true and complete copies of its Charter Documents. (b) The Company has records which accurately and validly reflect, in all material respects, its transactions and accounting controls sufficient to insure that such transactions are (i) in all material respects, executed in accordance with management's general or specific authorization, and (ii) recorded in conformity with GAAP; such records, to the extent they contain important information pertaining to the Company which is not easily and readily available elsewhere, have been duplicated, and such duplicates are stored safely and securely pursuant to procedures and techniques reasonably adequate for companies of the size of the Company and in the businesses in which the Company is engaged; and the data processing equipment and software used by the Company in the operation of its businesses (including any disaster recovery facility) to generate and retrieve such records are reasonably adequate for companies of the size of the Company and in the businesses in which the Company is engaged. 5.6 PROPERTY AND ASSETS. (a) Exhibit 5.6(a) sets forth a general description (including the character of the ownership of the Company) of all real property of the Company, including fees, leaseholds and all other interest in real property (including real property that is DPC Property) ("Real Property"). Except as set forth on Exhibit 5.6(a), (i) the Company has good and marketable title, free and clear of any encumbrance, lien or charge of any kind or nature (except liens for taxes not yet due) to all of the property, real, mixed or intangible, reflected on the Company's Financial Statements as of December 31, 1997, except as reflected therein or in the notes thereto (except property sold or transferred or Encumbrances incurred in the ordinary course of business since the date thereof except (a) Encumbrances in the aggregate which do not materially detract from the value, interfere with the use, or restrict the sale, transfer or disposition, of such properties and assets or otherwise materially and adversely affect the Company; (b) any lien for taxes not yet due; and (c) any Encumbrances arising under the document that created the interest in the real property (other than Encumbrances arising as a result of any breach or default of the Company); (ii) all leasehold interests for real property and any 41 material personal property used by the Company in its business are held pursuant to lease agreements which are valid and enforceable, except as the enforceability hereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable in accordance with their terms; (iii) all such properties comply in all material respects with all applicable private agreements, zoning requirements and other governmental laws and regulations relating thereto and there are no condemnation proceedings pending or, to the knowledge of the Company, threatened with respect to such properties; (iv) the Company has valid title or other ownership rights under licenses to all material intangible personal or intellectual property used by the Company in its business, free and clear of any claim, defense or right of any other person or entity which is material to such property, subject only to rights of the licensors pursuant to applicable license agreements, which rights do not materially adversely interfere with the use of such property; and (v) all material insurable properties owned or held by the Company are adequately insured in such amounts and against such risks as is customary with banks of similar size. The Company has furnished the Bank with true and correct copies of all leases included on Exhibit 5.6(a) delivered as of July 30, 1998, all title insurance policies relating to the Real Property and all documents evidencing recordation of all recordable interest in the Real Property. (b) CONDITION OF PROPERTIES. All tangible properties of the Company that are material to the business, financial condition, or results of operations of the Company are in a good state of maintenance and repair, except for ordinary wear and tear, and are adequate for the conduct of the business of the Company as presently conducted. Except as set forth in Exhibit 5.6(b), (i) the execution of this Agreement, the performance of the obligations of the Company hereunder and the consummation of the transactions contemplated herein, including the Merger, does not conflict with and will not result in a breach or default under any lease, agreement or contract described in Exhibit 5.6(b), or give any other party thereto a right to terminate or modify any term thereof; (ii) the Company has no obligation to improve any Real Property; (iii) each lease and agreement under which the Company is a lessor is in full force and effect and is a valid and legally binding obligation of the Company, and, to the best knowledge of the Company, each other party thereto; and (iv) the Company, and to the best knowledge of the Company, each other party to any such lease or agreement have performed in all material respects all the obligations required to be performed by them to date under such lease or agreement and are not in default in any material respect under any such lease or agreement and there is, to the best knowledge of the Company, no pending or threatened proceeding, or proceeding which the Company has reason to believe may be threatened, with respect to such property or any such lease. 42 5.7 LITIGATION PROCEEDINGS AND AGREEMENTS WITH GOVERNMENTAL ENTITIES. (a) The Company is not engaged as a defendant in any legal or other proceedings before any court, administrative agency or other Governmental Entity except as is shown on Exhibit 5.7. Except as set forth on Exhibit 5.7, the Company is not aware of any "threatened or pending litigation" (within the meaning of Paragraph 5 of the American Bar Association Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information adopted December 8, 1975) against the Company. The Company is not subject to any agreement, order, writ, injunction or decree of any federal, state or local court, out of a proceeding involving the Company or any of its business or properties except as described in Exhibit 5.7. The Company has not been served with notice of, nor, to best of the Company's knowledge is it currently under investigation with respect to, any violation of federal, state or local law or administrative regulation. Except as set forth on Exhibit 5.7, there is no (i) outstanding judgment, order, writ, injunction or decree, stipulation or award of any Governmental Entity or by arbitration, against, or to the knowledge of the Company, affecting the Company or its assets or business that (a) has had or may have a material adverse effect on the assets, liabilities, business, financial condition or results of operations of the Company, (b) requires any payment by, or excuses a material obligation of a third party to make any payment to, the Company, or (c) has the effect of prohibiting any business practice of, or the acquisition, retention or disposition of property by, the Company; or (ii) legal, administrative, arbitration, investigatory or other proceeding pending or, to the best knowledge of the Company that has been threatened, or which the Company has reason to believe may be threatened, against or affecting any director, officer, employee, agent or representative of the Company, in connection with which any such person has or may have rights to be indemnified by the Company. (b) Except as set forth in Exhibit 5.7, the Company is not a party to, or otherwise subject to, any agreement or memorandum of understanding with or order of any Governmental Entity charged with the supervision or regulation of bank holding companies or banks or engaged in the insurance of bank deposits, that restricts the conduct of its business, or in any manner relates to its capital adequacy, its credit or investment policies or its management. 5.8 PERFORMANCE OF OBLIGATIONS. Except as set forth in Exhibit 5.8, the Company has performed in all respects all of obligations required to be performed by it to date and is not in default under or in breach of any term or provision of any covenant, contract, lease, indenture or any other agreement to which the Company is a party or is subject or is otherwise bound, and no event has occurred which, with the giving of notice or the passage of time or both, would constitute such default or breach, where such default or breach would have a material adverse effect on the financial condition, results of operations, or business of the Company. No party with whom the Company has an agreement which is material to the financial condition, results of operations or business of the Company is in default thereunder. 43 5.9 BROKERS. Except as indicated in Exhibit 5.9, no agent, broker, investment banker, person or firm acting on behalf or under authority of the Company (except for any payments for fairness opinions as required in Section 11.14) is or will be entitled to any broker's or finder's fee or any other commission or similar fee directly or indirectly in connection with any of the transactions contemplated by this Agreement. 5.10 INSURANCE. The Company has in full force and effect policies of insurance and bonds with respect to its assets and business and against such casualties and contingencies and of such amounts, types and forms which in the judgment of the Company are adequate or appropriate to cover its assets and businesses as set forth in Exhibit 5.10. Set forth in Exhibit 5.10 is a schedule of all policies of insurance (other than title or credit insurance) carried and owned by the Company, showing the name of the insurance or bonding company, a summary of the coverage, the amounts, the deductible features, the annual premiums and the expiration dates. If any such policy or bond is changed, terminated or modified followingJuly 30, 1998, such termination, change or modification shall be promptly disclosed to the Bank in writing. The Company is not in default under any such policy of insurance or bond such that it could be canceled, and all material claims thereunder have been filed in a timely fashion. The Company has filed claims with or given notice of claim to its insurers or bonding companies with respect to all material matters and occurrences for which it believes it has coverage. 5.11 TAXES AND ASSESSMENTS. The Company has timely filed all federal income and state franchise tax returns and all tax reports or returns which it is required to file with applicable federal, state, county or local authorities and agencies except (a) where the failure to make any such filing would not have any materially adverse effect on the business, financial condition or results of operations of the Company taken as a whole, and (b) where the required filing date has been lawfully extended, and the Company has paid all taxes provided for and to be due in such returns and reports ("Tax Filings"). The Company's Tax Filings have never been examined by a Governmental Entity. As of December 31, 1997, to the extent required by GAAP, the Company had paid, or set up adequate accruals for the payment of, all taxes, penalties and assessments for which it was liable as of such date, whether or not disputed, with respect to any and all United Sates federal, foreign, state, local, environmental (including under any Environmental Law) and other taxes for the periods covered by the financial statements of the Company and for all prior and subsequent periods. Except as set forth in Exhibit 5.11 the Company has no knowledge of any deficiency proposed to be assessed against it. The Company has paid all assessments made by the FDIC and the Commissioner required to be paid prior the date hereof. There is currently no federal or state income tax audit or investigation in process or to the best knowledge of the Company any other pending investigation by any authorized body of the taxes paid or to be paid by the Company, and the Company has not been informed that any such audit or investigation is proposed. 44 5.12 MATERIAL ADVERSE CHANGES. Except as specifically required, permitted or effected by this Agreement, and except as set forth on Exhibit 5.12 since December 31, 1997 there has not been, occurred or arisen any of the following (whether or not in the ordinary course of business unless otherwise indicated)("Material Adverse Changes"): (a) Any materially adverse change in any of the assets, liabilities, permits, methods of accounting or accounting practice, or manner of conducting business, of the Company or any other event or development that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, Permits, business, financial condition, or results of operations of the Company or which should be disclosed in order to make the Company Financial Statements not misleading; (b) Any damage, destruction or other casualty loss (whether or not covered by insurance) that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Company or that may involve a loss of more than $10,000 in excess of applicable insurance coverage; (c) Any amendment, modification or termination of any existing, or entry into any new, Material Contract or Permit that has had or may reasonably be expected to have a material adverse effect on the assets, liabilities, business, financial condition, or results of operations of the Company; (d) Any disposition by the Company of an asset the lack of which has had or may reasonably be expected to have a material adverse effect on the business, financial condition, or results of operations of the Company; or (e) Any direct or indirect redemption, purchase or other acquisition by the Company of any Equity Securities or any declaration, setting aside or payment of any dividend or other distribution on or in respect of the Company Stock whether consisting of money, other personal property, real property or other things of value. (f) Any event of which the Company obtains knowledge which may materially and adversely affect the business, financial condition, results of operations or prospects of the Company. (g) Any event, development or circumstance that, to the best knowledge of the Company, will or, with the passage of time or the giving of notice or both, is reasonably expected to result in the loss to the Company of the services of any Executive Officer of the Company. 45 5.13 COMPLIANCE WITH LAWS AND REGULATIONS. (a) Except as set forth in Exhibit 5.13, the Company is not in default under or in breach of any law, ordinance, rule, regulation, order, judgment or decree applicable to it promulgated by any Governmental Entity having authority over it, where such default or breach would have a material adverse effect on its financial condition, results of operations, or business. (b) To the best of its knowledge, the Company has conducted in all material respects its businesses in accordance with all applicable federal, foreign, state and local laws, regulations and orders, including without limitation disclosure, usury, equal credit opportunity, equal employment, fair credit reporting, antitrust, licensing and other laws, regulations and orders, and the forms, procedures and practices used by the Company are in compliance with such laws, regulations, and orders, except for such violations or noncompliance as will not have a material adverse effect on the financial condition, results of operations, or business of the Company. 5.14 AUTHORIZATION. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by the Board of Directors of the Company. Assuming due and proper execution and delivery of this Agreement by the Bank, this Agreement constitutes a legal, valid and binding agreement of the Company in accordance with its respective terms, except as the enforceability hereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable. Subject to obtaining requisite approval of this Agreement by the shareholders of the Company, if required, the Company has full corporate power and authority to perform its obligations under this Agreement and the transactions contemplated hereby. 5.15 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated herein, including the Merger, and compliance by the Company with any provision hereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 5.15 any material agreement, instrument or obligation to which it is a party or by which the property of the Company is bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, the Commissioner and any other required Governmental Entity, and as set forth in Exhibit 5.15, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets or the Company; or (d) violate the Charter Documents or any Rules to which the Company is subject. 46 5.16 REPORTS AND FILINGS. Since inception, the Company has filed all reports, returns, registrations and statements (such reports and filings referred to as "the Company Filings"), together with any amendments required to be made with respect thereto, that were required to be filed with (a) the FRB, (b) the Commissioner and (c) any other applicable Governmental Entity, including taxing authorities, except where the failure to file such reports, returns, registrations and statements has not had and is not reasonably expected to have a material adverse effect on the business, financial condition, or results of operations of the Company. No administrative actions have been taken or orders issued in connection with the Company Filings. As of their respective dates, each of the Company Filings complied in all material respects with all Rules enforced or promulgated by the Governmental Entity with which it was filed (or was amended so as to be so promptly following discovery of any such noncompliance). Any financial statement contained in any of the Company Filings that was intended to present the financial position of the Company fairly and was prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved. 5.17 ASSETS OF THE COMPANY. The assets of the Company upon the execution of this Agreement consist of the following: (i) no material adverse change in the Company's equity capital as of December 31, 1997; (ii) the experienced bank holding company management services of Caswell; (iii) an engagement agreement with experienced investment banking firms, the Underwriters, providing for financial advisory services for the identification of possible acquisition candidates, the negotiation of acquisition agreements and the firm commitment underwriting of the Company Stock in the Offering in order to accomplish the transactions (the "Engagement Agreement"), and (iv) an agreement to employ Caswell. 5.18 UNDISCLOSED LIABILITY. The Company has no liabilities or obligations, either accrued or contingent, which are in excess of Ten Thousand Dollars ($10,000) individually or in the aggregate, which have not been: (i) reflected or disclosed in the Company Financial Statements; (ii) incurred since inception, in the ordinary course of business; or (iii) disclosed on Exhibit 5.18 or any other exhibit to this Agreement. To the best of the Company's knowledge and the knowledge of its officers and directors, after due investigation, there is no basis for the assertion against the Company of any liability, obligation or claim that is likely to result in or cause any material adverse change in the business or financial condition of the Company, taken as a whole, which is not fairly reflected in the Company Financial Statements, or otherwise disclosed on Exhibit 5.18 hereto. 47 5.19 ACCURACY OF INFORMATION FURNISHED. Except as to any statements or information which shall include projections or forecasts, none of the statements or information made or contained in any of the covenants, representations or warranties of the Company set forth in this Agreement or in any of the schedules, exhibits, lists, certificates or other documents furnished herewith taken as a whole contains any untrue statement of a material fact required to be stated herein or therein or necessary to make the statements or information contained herein or therein, in light of the circumstances in which they were made, not misleading. As to any such information or statements which include projections or forecast, such information or statements are based upon assumptions believed by the Company to be reasonable. 5.20 AUTHORITY OF PCBG VALLEY CORPORATION. The execution and delivery by PCBG Valley Corporation of the Agreement of Merger and, subject to the requisite approval of the shareholder of PCBG Valley Corporation, the consummation of the transactions completed thereby will be duly and validly authorized by all necessary corporation action on the part of PCBG Valley Corporation, and the Agreement of Merger will be, upon execution by the parties thereto, a valid and binding obligation of PCBG Valley Corporation, enforceable in accordance with its terms, except as the enforceability thereof may be limited by bankruptcy, insolvency, moratorium or other similar laws affecting the rights of creditors generally, by general equitable principles. The Company agrees to take any and all actions reasonably necessary to ensure that PCBG Valley Corporation consummates the transactions contemplated hereby. Except as set forth in Exhibit 5.20, neither the execution and delivery by PCBG Valley Corporation of the Agreement of Merger, nor the consummation of the transaction contemplated therein, nor compliance by PCBG Valley Corporation with any of the provisions thereof will (a) conflict with or result in a breach of any provision of its Charter Documents; (b) except for approval by the shareholder of PCBG Valley Corporation and the prior approval of the Commissioner or the FRB, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of PCBG Valley Corporation; or (d) subject to obtaining the Consents referred to in subsection (b) of this Section 5.20, and the expiration of any waiting period, violate any Rules to which PCBG Valley Corporation is subject. 5.21 CAPITAL OF COMPANY, OFFERING AND COMMITMENTS. As of the date of this Agreement, the Company does not have sufficient capital to consummate the transactions contemplated by this Agreement. The Company intends to conduct the Offering in order to raise sufficient cash capital to carry out the acquisition of the Bank, provide capital for growth and operations of the Company, and the other transactions contemplated by this Agreement. As of the date of this Agreement, the Company and Sutro have entered into the Engagement Agreement described in Section 5.17(iii), a copy of which has been provided to the Bank and which has not been terminated or materially altered, except that the Company can change its relationship with Sutro, or increase or decrease the number of underwriters or co-mangers of the Offering, in the Company's sole discretion. 48 5.22 REGULATORY APPROVALS. To the best knowledge of the Company, except as described in Exhibit 5.22, the Company has no reason to believe that it would not receive all required approvals from any Governmental Entity of any application to consummate the transactions contemplated by this Agreement without the imposition of a materially burdensome condition in connection with the approval of any such application. 5.23 STATEMENTS TRUE AND CORRECT. None of the information supplied or to be supplied by the Company for inclusion in the S-1, S-4 or the Proxy Statement, or incorporated by reference therein, or any other document to be filed with any Governmental Entity in connection with the transactions contemplated hereby will, in the case of the S-1, S-4 and the Proxy Statement (or incorporated by reference therein), contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which such statements are made, not misleading, or, in the case of the S-1 and S-4, when it becomes effective, be false or misleading with respect to any material fact, or omit to state any material fact necessary in order to make the statements therein not misleading. 5.24 ACCURATE DISCLOSURE. The Company agrees that through the Effective Time of the Merger, each of its reports, and other filings required to be filed with any applicable Governmental Entity will comply in all material respects with all of the applicable statutes, Rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any such report, or other filing that is intended to present the financial position of the Company will fairly present the financial position of the Company and will be prepared in accordance with GAAP or RAP consistently applied during the periods involved. Notwithstanding anything to the contrary set forth in this Section 5.24, the Company makes no representation or warranty with respect to any information supplied by the Bank. 5.25 OTHER TRANSACTIONS. The Company has informed the Bank of all other acquisition transactions that the Company is contemplating or reviewing as of the date of this Agreement. 5.26 DUE DILIGENCE. The Company and its representatives have had the opportunity to conduct a due diligence of the Bank, and such due diligence has been shared with the Managing Underwriter. 5.27 EMPLOYEES. (a) Except as set forth in Exhibit 5.27(a), there are no understandings for the employment of any officer or employee of the Company which are not 49 terminable by the Company without liability on not more than 30 days' notice. Except as set forth in Exhibit 5.27(a), the Company is not a party to an oral or written consultant agreement not terminable upon 60 days or less notice or involving the payment of more than $10,000 per annum. Except as set forth in Exhibit 5.27(a), there are no material controversies pending or threatened between the Company and any of its employees. Except as disclosed in the Company Financial Statements or in Exhibit 5.27(a), all material sums due for employee compensation and benefits have been duly and adequately paid or provided for, and all deferred compensation obligations are fully funded. The Company is not a party to any collective bargaining agreement with respect to any of its employees or any labor organization to which its employees or any of them belong. Except as set forth in Exhibit 5.27(a), no director, officer or employee of the Company is entitled to receive any payment of any amount under any Employment Agreement, severance plan or other benefit plan as a result of the consummation of any transaction contemplated by this Agreement. The Bank has been provided with a complete and accurate listing of the names and current annual salary rates of all persons employed by the Company, showing for each such person the amounts paid or payable as salary, bonus payments and any indirect compensation through September 30, 1998, the current pay rate as of September 30, 1998, the names of all of the directors and officers of the Company, and the names of all persons, if any, holding tax and other powers of attorney for the Company. (b) Except as disclosed in Exhibit 5.27(b), (i) the Company is and has been in material compliance with all applicable laws respecting employment and employment practices, terms and conditions of employment and wages and hours, including, without limitation, any such laws respecting employment discrimination and occupational safety and health requirements, and in any unfair labor practice; (ii) there is no material unfair labor practice complaint against the Company pending or, to the knowledge of the Company, threatened before the National Labor Relations Board; (iii) there is no labor dispute, strike, slowdown or stoppage actually pending or, to the knowledge of the Company, threatened against or directly affecting the Company; and (iv) the Company has not experienced any material work stoppage or other material labor difficulty during the past five years, except in each case which would not result in a Material Adverse Change. (c) Except as disclosed in Exhibit 5.27(c), the Company does not maintain, contribute to or participate in or have any material liability under any employee benefit plans, as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or any nonqualified employee benefit plans or deferred compensation, bonus, stock or incentive plans, or other employee benefit or fringe benefit programs for the benefit of former or current employees of the Company (the "Employee Plans"). No present or former employee of the Company has been charged with breaching nor has breached a fiduciary duty under any of the Employee Plans. The Company does not participate in, nor has it in the past five years participated in, nor has it any present or future obligation or liability under, any multiemployer plan (as defined at Section 3(37) of ERISA). Except as may 50 be separately disclosed in Exhibit 5.27(c), the Company does not maintain, contribute to, or participate in, any plan that provides health, major medical, disability or life insurance benefits to former employees of the Company. (d) Exhibit 5.27(d) sets forth and describes all employee benefit plans in which the Company participates, or by which it is bound, including, without limitation; (i) any profit sharing, deferred compensation, bonus, stock option, stock purchase, pension, retainer, consulting, retirement, welfare or incentive plan or agreement whether legally binding or not; (ii) any plan providing for "fringe benefits" to its employees, including but not limited to vacation, sick leave, medical, hospitalization, life insurance and other insurance plans, and related benefits; (iii) any written employment agreement and any other employment agreement not terminable at will; or (iv) any other "employee benefit plan" (within the meaning of Section 3(3) of ERISA) (collectively, the "Company Employee Plans"). Except as set forth in Exhibit 5.27(d), there are no negotiations, demands or proposals that are pending or threatened that concern matters now covered, or that would be covered, by any employment agreements or employee benefit plans other than amendments to plans qualified under Section 401 of the Code that are required by the Tax Reform Act of 1986 and later legislation; (ii) the Company is in compliance with the material reporting and disclosure requirements of Part 1 of Subtitle IB of ERISA and the corresponding provisions of the Code to the extent applicable to all such Employee Plans; (iii) the Company has substantially performed all of its obligations under all such employee benefit plans and employment agreements required to be performed heretofore; and (iv) there are no actions, suits or claims (other than routine claims for benefits) pending or, to the best knowledge of the Company, threatened against any such employee benefit plans and employment agreements or the assets of such plans, and to the best knowledge of the Company, no facts exist which could give rise to any actions, suits or claims (other than routine claims for benefits) against such plans or the assets of such plans. (e) The "employee pension benefit plans" (within the meaning of Section 3(2) of ERISA) described on Exhibit 5.27(d) have been duly authorized by the Board of Directors of the Company. Except as set forth in Exhibit 5.27(d), each such plan and associated trust intended to be qualified under Section 401(a) and to be exempt from tax under Section 501(a) of the Code, respectively, has either received a favorable determination letter from the Internal Revenue Service (the "IRS"), has applied for such a determination letter or will apply for such a determination letter before the expiration of the remedial amendment period set forth in Section 401(b) of the Code, as the IRS may extend such period, and to the best knowledge of the Company, no event has occurred that will or could give rise to disqualification of any such plan which is intended to be qualified under Section 401(a) of the Code or loss of the exemption from tax of any such trust which is intended to be exempt from tax under Section 501(a) of the Code. No event has occurred that will or could subject any such plans to tax under Section 511 of the Code. None of such plans has engaged in a merger or consolidation with any other plan or transferred assets or liabilities from any other plan. To the best of the their knowledge, no prohibited 51 transaction (within the meaning of Section 409 or 502(i) of ERISA or Section 4975 of the Code) or party-in-interest transaction (within the meaning of Section 406 of ERISA) has occurred with respect to any of such plans which could subject the Company to an excise tax or penalty. To the best knowledge of the Company, no employee of the Company has engaged in any transactions which could subject the Company to indemnify such person against liability. All costs of plans have been provided for on the basis of consistent methods in accordance with sound actuarial assumptions and practices. No employee benefit plan has incurred any "accumulated funding deficiency" (as defined in Section 302(2) of ERISA), whether or not waived, taking into account contributions made within the period described in Section 412(c)(10) of the Code; nor are there any unfunded amounts under any employee benefit plan which is required to be funded under Part 3 of Subtitle IB of ERISA and Section 412 of the Code); nor has the Company failed to make any contributions or pay any amount due and owing as required by law or the terms of any employee benefit plan or employment agreement. Subject to amendments that are required by the Tax Reform Act of 1986 and later legislation, since the last valuation date for each employee pension benefit plan, there has been no amendment or change to such plan that would increase the amount of benefits thereunder. (f) The Company does not sponsor or participate in, or has not sponsored or participated in, any employee benefit pension plan to which Section 4021 of ERISA applies that would create a liability under Title IV of ERISA. (g) The Company does not sponsor or participate in, or has not sponsored or participated in, any employee benefit plan that is a "multi-employer plan" (within the meaning of Section 3(37) of ERISA) that would subject such Person to any liability with respect to any such plan. (h) All group health plans of the Company (including any plans of Affiliates of the Company that must be taken into account under Section 162(i) or (k) of the Code as in effect immediately prior to the Technical and Miscellaneous Revenue Act of 1988 and Section 4980B of the Code) have been operated in compliance with the group health plan continuation coverage requirements of Section 4980B of the Code to the extent such requirements are applicable. (i) There have been no acts or omissions by the Company that have given rise to or may give rise to fines, penalties, taxes, or related charges under Sections 502(c) or (i) or 4071 of ERISA or Chapter 43 of the Code which could be imposed on the Company. (j) Except as described in Section 5.27(j), the Company does not maintain any employee benefit plan or employment agreement pursuant to which any Employee Plan or other payment will be required to be made by the Company or pursuant to which any other benefit will accrue or vest in any director, officer or employee the Company, in either case as a result of the consummation of the transactions contemplated by the Agreement. 52 (k) No "reportable event," as defined in ERISA, has occurred with respect to any of the employee benefit plans. (l) All amendments required to bring each of the employee benefit plans into conformity with all of the provisions of ERISA and the Code and all other applicable laws, rules and regulations have been made, or will be made before the expiration of the remedial amendment period set forth under Section 401(b) of the Code, as such period may be extended by the IRS. (m) Exhibit 5.27(d) sets forth the name of each director, officer, employee, agent or representative of the Company and every other person entitled to receive any benefit or any payment of any amount under any existing employment agreement, severance plan or other benefit plan or Understanding as a result of the consummation of any transaction contemplated in this Agreement, and with respect to each such person, the nature of such benefit or the amount of such payment, the event triggering the benefit or payment, and the date of, and parties to, such employment agreement, severance or other benefit plan or Understanding. The Company has furnished the Bank with true and correct copies of all documents with respect to the plans and agreements referred to in Exhibit 5.27(d) delivered as of the date of the Agreement, including all amendments and supplements thereto, and all related summary plan descriptions. For each of the employee pension benefit plans of the Company referred to in Exhibit 5.27(d) delivered as of the date of the Agreement, the Company has furnished the Bank with true and correct copies of (i) the Form 5500 which was filed in each of the three most recent plan years, including without limitation, all schedules thereto and all financial statements with attached opinions of independent accountants to the extent required; (ii) the most recent determination letter from the IRS; (iii) the statement of assets and liabilities as of the most recent valuation date; and (iv) the statement of changes in fund balance and in financial position or the statement of changes in net assets available for benefits under each of said plans for the most recently ended plan year. The documents referred to in subdivisions (iii) and (iv) fairly present the financial condition of each of said plans as of and at such dates and the results of operations of each of said plans, all in accordance with generally accepted accounting principles or on the cash method of accounting applied on a consistent basis. 5.28 CONTRACTS AND AGREEMENTS. Except as listed in Exhibit 5.28, the Company is not a party to any oral or written agreement, commitment, or obligation (hereinafter referred to as an "Understanding" or "Material Contract") which individually, or with all other similar Understandings relating to the same or similar subject matter, falls within any of the following classifications: (i) any Understanding dealing with advertising, brokerage, licensing, dealership, representative or agency relationship; (ii) any Understanding with any labor or collective bargaining 53 organization or association; (iii) any mortgage, pledge, conditional sales contract, security agreement, or any other similar Understanding with respect to any real or personal property in an amount in excess of $25,000, under which the Company is a debtor or to which any of its property is subject; (iv) any profit sharing, group insurance, bonus, deferred compensation, stock option, severance pay, pension, retirement, or any other similar Understanding which might provide benefits to the employees, officers or directors of the Company; (v) any Understanding for the future purchase of materials, supplies, services, merchandise or equipment, the price of which exceeds $5,000 and which will not be terminable without liability as to future purchases as of the Effective Time; it being understood that materials, supplies, service, merchandise or equipment shall not be deemed to include loans, repurchase or reverse repurchase agreements, securities or other financial transactions incurred by the Company in the ordinary course of its banking business; (vi) any Understanding for the sale of any of its assets, or for the grant of any right to purchase any of its assets, properties or rights, or which requires the consent of any third party to the transfer and assignment of any of its assets, properties or rights; it being understood that the foregoing shall not be deemed to include any Understanding for the sale of mortgage loans, repurchase or reverse repurchase agreements, securities or other financial transactions incurred by the Company in the ordinary course of its banking business; (vii) any guarantee, subordination or other similar or related types of Understanding except where the Company is a beneficiary; (viii) any Understanding for the borrowing of any money by the Company (other than time savings or demand deposits) or for a line of credit to it; (ix) any Understanding for any one capital expenditure or series of related capital expenditures in excess of $5,000 individually or $10,000 in the aggregate; (x) any real property lease, whether as lessor or lessee; or any personal property lease, whether as lessor or lessee, involving payments in excess of $500 per month; (xi) any Understanding to make or participate in a loan (not yet fully disbursed or funded) to any borrower or related group of borrowers, which undisbursed or unfunded amount would exceed $50,000 unsecured or secured; 54 (xii) any Understanding of any kind (other than contracts relating to demand or time deposits or otherwise made in the ordinary course of business) with any director or officer of the Company or with any member of the immediate family of any such director of officer or with any partnership, corporation, associate or entity of which any such person is an Affiliate; (xiii) any Understanding for insurance of any type described in Section 5.10 above; or (xiv) any Understanding, the purpose or effect of which could encompass (a) merging with any person or bank or bank holding company other than with the Company (b) the selling of any of its assets (except in the ordinary course of business) or stock to any person, (c) recommending to any of its shareholders that their Company Common Stock be sold to any person or bank other than the person, or (d) in any other way transferring, directly or indirectly, control of the Company. Except as stated in Exhibit 5.28, true and correct copies of all documents relating to the foregoing Understandings have been delivered by the Company to the Bank prior to the date hereof. As used in this Section 5.28, "immediate family" of a person shall mean his or her spouse, parents, children, and siblings. ARTICLE VI COVENANTS OF THE BANK The Bank covenants and agrees with the Company as follows: 6.1 BEST EFFORTS. The Bank shall use its best efforts to bring about the satisfaction of the conditions specified in Articles IX and XI hereof. 6.2 CONDUCT OF BUSINESS. Unless the Company shall give its prior consent, which consent will not be unreasonably withheld, or unless otherwise indicated, until the Effective Time, the Bank will: (i) conduct its affairs and business in the usual and ordinary course, generally consistent with past practice, and in accordance with safe and sound practices; (ii) refrain from (a) creating, incurring, or suffering to exist, any encumbrance or restriction of any kind against or in respect of any property or right of the Bank except for such which are not material in amount or nature to the financial condition or results of operations of the Bank, except for a pledge or security interest given in connection with the acceptance of government or public deposits; it being understood that the foregoing shall not be deemed to preclude loans, 55 repurchase or reverse repurchase agreements, securities or other financial transactions incurred in the ordinary course of the Bank's banking business, and (b) borrowing or agreeing to borrow any amount of funds except in the ordinary course of business, or directly or indirectly guaranteeing or agreeing to guarantee any obligations of others except for such which are not material in amount or nature to the financial condition or results of operations of the Bank; (iii) refrain from making or becoming a party to any Material Contract or material commitment, or renewing, extending, amending or modifying any such contract or commitment except for loan and deposit transactions, in the usual and ordinary course of business, consistent with past practice, and refrain from making any loan or other extension of credit, or entering into any commitment to make any loan or other extension of credit, to any Bank director, officer or employee or 5% or more shareholder, except in accordance with existing practice or policy; (iv) refrain from making any capital expenditures, except for ordinary repairs and replacements not exceeding $10,000 for any one item; (v) refrain from paying or agreeing to pay any bonus, extra compensation, pension or severance pay, under any pension plan or otherwise, or increasing the rate of compensation paid by the Bank at June 30, 1998, to any officer, director, agent, consultant, or employee (except for raises and bonuses consistent with past practices accrued and paid prior to the end of the month prior to the Closing Date and except as contemplated by this Agreement), and any such amounts shall be accrued and paid prior to the Determination Date; or agreeing to enter into any employment agreements or hire any officer level staff where such agreements or arrangements cannot be terminated without any liability upon not more than 90 days notice; (vi) maintain its assets and properties in good condition and repair (ordinary wear and tear excepted) and refrain from selling or otherwise disposing of any of its assets or properties, except in the usual and ordinary course, consistent with prior customary practice, and in accordance with safe and sound practices, and maintain the Bank's present branch operations unless changed by mutual agreement; (vii) refrain from declaring or paying any dividend on or making any other distribution upon, or purchasing or redeeming, any shares of the Bank Stock; (viii) refrain from (a) issuing or selling or obligating itself to issue or sell any shares of the Bank Stock or any other securities or any warrants, rights or options to acquire Bank Stock or other securities, (b) effecting a reclassification, recapitalization, split-up, exchange of shares, readjustment or other similar change in or to any capital stock or otherwise reorganize or recapitalize, except pursuant to Section 6.5; 56 (ix) refrain from directly or indirectly redeeming, purchasing or otherwise acquiring any Bank Stock or stock of any corporation or any interest in any business enterprise except as it relates to a foreclosure in the usual and ordinary course of its business, or pursuant to the Bank's ESOP; (x) refrain from amending its Charter Documents except to the extent as may be required or contemplated by this Agreement; (xi) use its best efforts to preserve its business organization intact and to retain its present officers and employees in a manner consistent with the Bank's other obligations under this Agreement; (xii) use its best efforts to preserve the goodwill of its depositors, customers and those having business relations with it, refrain from materially changing the make-up of the Bank's deposit structure, refrain from amending, modifying, terminating or failing to renew or preserve its business organization, material rights, franchises, Permits, and refrain from taking any action which would jeopardize the continuance of the goodwill of its customers where such action would have a material adverse effect on the financial condition, or results of operations of the Bank in a manner consistent with the Bank's other obligations under this Agreement; (xiii) use its best efforts to maintain insurance and bond coverage at least equal to that now in effect on all its properties and all properties for which it is responsible and on its business operations, and carry the same coverage for public liability, personal injury and property damage that is now in effect, except if such insurance and coverage (a) is not available except at extraordinary rates, or (b) is not available except under materially different terms which are inconsistent with those in effect as of July 30, 1998; (xiv) meet its material contractual obligations and not become in default in any material respect on any thereof; (xv) duly observe and conform to lawful requirements applicable to its business in all material respects; (xvi) duly and timely file all reports and returns required to be filed with any federal, state or local Governmental Entity unless any extensions have been duly granted by such authorities; (xvii) refrain from commencing, and cease any previously commenced proceeding except for such proceedings with the Company, any proceeding to merge, consolidate or liquidate or dissolve (except as contemplated by this Agreement) or obligating itself to do so, subject to Sections 6.5 and 14.1;; (xviii) maintain its books of account and records in the regular 57 manner substantially in accordance with all applicable statutory and regulatory requirements applied on a consistent basis; (xix) except for instituting actions against borrowers of the Bank to collect loans in default, refrain from instituting, settling, or agreeing to any material claim, action or proceeding before any court or Governmental Entity unless not instituting, settling or agreeing to any material claim, action or proceeding would result in a Material Adverse Change to the Bank; (xx) refrain from making its credit underwriting policies, standards or practices applicable to all loans relating to the making of loans and other extensions of credit, or commitments to make loans and other extensions of credit, less stringent than those in effect on the date hereof. The Bank shall not grant or commit to grant, without receiving the Company's Consent, (i) any loan or other extension of credit, including renewals, to an existing customer of the Bank, if such loan or other extension of credit, together with all other credit then outstanding to the same Person and all Affiliates of such Person, would exceed $50,000, irrespective of any plans or intentions to sell or participate all or a portion of such loans, on an unsecured basis, or exceed $100,000 secured by a lien on real estate, cash or readily marketable collateral, as that term is used in section 1220 ET SEQ. of the CFC, except loans guaranteed by a government agency, which are prohibited only if the unguaranteed portion of which would exceed $250,000, (ii) any participation loans purchased or sold, or (iii) any renewals or other extensions of credit to any borrower whose loans or other extensions of credit have been classified by any Governmental Entity. In addition, Bank shall not take any property into Other Real Estate Owned ("OREO"), or sell any OREO property, without receiving the Company's Consent. Consent shall be deemed granted if within three Business Days of written notice received by the Company's designee, notice of objection in writing is not received by Bank; (xxi) refrain from making special or extraordinary material payments to any Person other than as contemplated and as disclosed in this Agreement as of the date hereof; (xxii) except for transactions in accordance with safe and sound banking practices, refrain from making any material investments, by purchase of stock or securities, contributions to capital, property transfers, purchases of any property or assets or otherwise, in any other individual, corporation or other entity; (xxiii) advise the Company promptly in writing of any Material Adverse Change known to the Bank in the capital structure, financial condition, results of operations or of any event or condition which with the passage of time is reasonably likely to result in a Material Adverse Change to the Bank, or of any other materially adverse change known to the Bank respecting the business and operations of the Bank, or in the event the Bank determines that the Merger will not be consummated because of any inability to meet the conditions to the performance of 58 the Company set forth in Article XI or of any matter which would make the representations and warranties set forth in Article IV hereof not true and correct in any material respect at the Closing; (xxiv) promptly advise the Company in writing of any event or any other transaction within the Bank's knowledge whereby any person or related group of persons acquires, directly or indirectly, record or beneficial ownership (as defined in Rule 13d3 promulgated by the Exchange Act or control of 5% or more of the outstanding shares of Bank Stock prior to the record date fixed for the Bank shareholders' meeting or any adjourned meeting thereof to approve the transactions contemplated herein; (xxv) charge-off all loans, receivables and other assets, or portions thereof, deemed uncollectible in accordance with GAAP or RAP, applicable law or regulation, or classified as "loss" or as directed by any Governmental Entity; and maintain the allowance for loan losses of the Bank at a level which in the reasonable opinion of the Bank's management is adequate to provide for all known and estimated credit losses on loans and leases outstanding and other inherent risks in the Bank's loan portfolio, but in no case less than the level which is the reasonable opinion of the Bank's management is adequate to provide for all known and reasonably expected losses on assets outstanding in accordance with GAAP and RAP; (xxvi) furnish to the Company, as soon as practicable, and in any event within ten (10) days after it is prepared (except for the reports submitted to the Board of Directors of the Bank, as described in clause (i) below, which shall be furnished to the Company within ten (10) days after the Bank's Board of Directors has reviewed the report), (i) a copy of any report submitted to the Board of Directors of the Bank and access to the working papers related thereto and copies of other operating or financial reports prepared for management of any of their businesses and access to the working papers thereto, provided, however, that the Bank need not furnish the Company communications of the Bank's legal counsel regarding the Bank's rights against and obligations to the Company or its Affiliates under this Agreement, (ii) to the extent permitted by law, copies of all reports, renewals, filings, certificates, statements and other documents filed with or received from the FDIC and/or the Commissioner or any other Governmental Entity, (iii) monthly unaudited average statements of condition and statements of operations for the Bank, and quarterly unaudited statements of condition and statements of operations for the Bank and statements of changes in stockholders' equity for the Bank, in each case prepared in a manner consistent with past practice, and (iv) such other reports as the Company may reasonably request relating to the Bank. Each of the financial statements delivered pursuant to this Section 6.2(xxvi), except as stated therein, shall be prepared in accordance with the Bank's normal practices; (xxvii) consistent with the standards set forth in this subsection 6.2 (xxvii), the Bank agrees that through the Effective Time of the Merger, as of their 59 respective dates, (i) each of the Bank Filings will be true and complete in all material respects; and (ii) each of the Bank Filings will comply in all material respects with all of the statutes, rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any of such Bank Filings that is intended to present the financial position of the Bank will be prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved; (xxviii) maintain reserves for contingent liabilities in accordance with GAAP and RAP; (xxix) promptly notify the Company of the filing of any material litigation, governmental or regulatory action, or similar proceeding or notice of any claims against the Bank or any of its assets; (xxx) conduct good faith settlement negotiations, and, with the written consent of the Company, settle when deemed prudent by the Parties, of all existing or threatened litigation as specified in Exhibits 4.7, or for any new litigation filed or threatened from the date hereof to the Closing Date; (xxxi) except in the ordinary course of business, refrain from canceling or accelerating any material indebtedness owing to the Bank or any claims which the Bank may possess or waive any material rights of substantial value; (xxxii) refrain from selling or otherwise disposing of any Real Property or any material amount of any tangible or intangible personal property other than properties acquired in foreclosure or otherwise in the ordinary collection of indebtedness to the Bank; (xxxiii) refrain from foreclosing upon or otherwise taking title to or possession or control of any real property without first obtaining a phase one environmental report thereon which indicates that the property is free of pollutants, contaminants or hazardous or toxic waste materials; provided, however, that the Bank shall not be required to obtain such a report with respect to single family, non-agricultural residential property of one acre or less to be foreclosed upon unless it has reason to believe that such property might contain any such waste materials or otherwise might be contaminated; (xxxiv) refrain from committing any act or failing to do any act which will cause a breach of any agreement, contract or commitment and which will have a material adverse effect on the Bank's business, financial condition, or results of operations; and 60 (xxxv) duly observe and conform to all applicable compliance requirements for Year 2000 safety and soundness issues. For purposes of this Section 6.2, the Company shall be deemed to have given its consent to any action which is contrary to any specified covenant set forth in this Section if, within five (5) Business Days, or three (3) Business Days for loans, after actual receipt by the Company of written notice from the Bank of the Bank's intention to act contrary to any of the specified covenants set forth in this Section, the Company shall not have delivered to the Bank written objection to any such action. 6.3 ACCESS TO INFORMATION. (a) As long as the transaction contemplated herein has not been terminated, the Bank will afford the Company, its representatives, counsel, accountants, agents and employees including the underwriter selected to assist in the issuance of the common stock contemplated in Section 9.1(iii) and its counsel (collectively "Company Representatives"), access during normal business hours to all of its business, operations, properties, personnel books, files and records and will do everything reasonably necessary to enable the Company and the Company Representatives to make a complete examination of the financial statements, books, records, loans and leases, operating reports, audit reports, contracts and documents, and all other information with respect to assets and properties of the Bank and the condition thereof, and to update such examination at such intervals as the Company shall deem appropriate. Such access shall include reasonable access by the Company and the Company Representatives to auditors' work papers with respect to the business and properties of the Bank, other than (i) books, records and documents covered by the attorney-client privilege, or which are attorneys' work product, and (ii) books, records and documents that the Bank is legally obligated to keep confidential. Such examination shall be conducted in cooperation with the officers of the Bank and in such a manner as to minimize, to the extent possible consistent with the conducting of a comprehensive examination, any disruption of, or interference with, the normal business operations of the Bank. No such examination, however, shall constitute a waiver or relinquishment on the part of the Company to rely upon the representations and warranties made by the Bank herein or pursuant hereto; provided, that the Company shall promptly disclose in writing to the Bank any fact or circumstance it may discover which it believes renders any representation or warranty made by the Bank hereunder incorrect in any respect. The Company will hold in strict confidence all documents and information concerning the Bank so obtained (except to the extent that such documents or information are a matter of public record or require disclosure in the Proxy Statement or as may be necessary for the accomplishment of the purposes of such examination) and, if the transactions contemplated herein are not consummated, such confidence shall be maintained and all such documents including all copies shall be returned to the Bank. (b) As long as the transaction contemplated hereunder has not been terminated, (i) one Company Representative, selected by the Company in its sole 61 discretion, shall be invited by the Bank to attend all regular and special Board of Directors' and Loan Committee meetings of the Bank from the date hereof until the Effective Time of the Merger, and (ii) one representative of Sutro shall be invited by the Bank to attend all regular and special Board of Directors meetings of the Bank from the date hereof until the Effective Time of the Merger for the purpose of discussing the condition of the market for the Offering and any possible Increase in Per Share Consideration. The Bank shall inform the Company of such Board of Director meeting at least five (5) days in advance of such meeting; provided, however, that the attendance of such Company Representative shall not be permitted at any meeting, or portion thereof, for the sole purpose of discussing the transactions contemplated by this Agreement on the obligations of the Bank under this Agreement. 6.4 FINANCIAL STATEMENTS. In the event the following have not been previously delivered prior to the date hereof, the Bank will deliver to the Company a copy of the audited Statements of Financial Condition of the Bank as of December 31, 1998; Statements of Earnings, Stockholders' Equity and Cash Flows for the year ended December 31, 1998, the related notes and related opinions thereon of McGladrey & Pullen, certified public accountants, with respect to such financial statements (the "1998 Audited Bank Financial Statements"). The Bank will furnish the Company with a true and correct copy of the management letter or other letter delivered to the Bank by McGladrey & Pullen in connection with the 1998 Audited Bank Financial Statements relating to any review of the internal controls of the Bank by McGladrey & Pullen. The 1998 Audited Bank Financial Statements will: (i) present fairly the financial condition and results of operations of the Bank as of and for the dates or periods covered thereby in accordance with generally accepted accounting principles consistently applied throughout the periods involved; (ii) be based on the books and records of the Bank; (iii) contain and reflect reserves for all material accrued liabilities and for all reasonably anticipated losses, and set forth adequate reserves for loan losses and other contingencies, to the extent required by GAAP; and (iv) none of the 1998 Audited Bank Financial Statements will contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading under GAAP. 6.5 NO SOLICITATION. (a) The Bank shall not, and will cause each of its officers, directors, employees, agents, legal and financial advisors and Affiliates not to, directly or indirectly, make, solicit, encourage, initiate or, except as permitted in this Section 6.5, enter into any agreement or agreement in principle, or announce any intention to do any of the foregoing, concerning the acquisition of the Bank, or substantially all of the Bank's business and properties or a majority of Bank Stock or debt securities, whether by purchase, merger (other than by the Company), purchase of assets, tender offer or otherwise (an "Alternative Transaction"). (b) The Bank shall not, and will cause each of its officers, directors, legal and financial advisors, agents and Affiliates not to, directly or indirectly, 62 participate in any negotiations or discussions regarding, or furnish any information with respect to, or otherwise cooperate in any way in connection with, or assist or participate in, facilitate or encourage, any effort or attempt to effect or seek to effect, any Alternative Transaction with or involving any Person other than the Company, unless the Bank shall have received an unsolicited written offer from a Person other than the Company to effect an Alternative Transaction and the Board of Directors of the Bank is advised in writing by outside legal counsel that in the exercise of the fiduciary obligations of the Bank's Board of Directors such information should be provided to or such discussions or negotiations undertaken with the Person submitting such unsolicited written offer. (c) The Bank will promptly communicate to the Company the receipt of any proposal with respect to any Alternative Transaction, and will keep the Company informed as to the status of any such proposal; PROVIDED, HOWEVER, that the Bank shall not be required to disclose any matters which, in the written opinion of outside legal counsel, may not be disclosed in the exercise of the fiduciary obligations of the Bank's Board of Directors. 6.6 CERTAIN LOANS AND OTHER EXTENSIONS OF CREDIT. The Bank will promptly inform the Company of the amounts and categories of any loans, leases or other extensions of credit that have been criticized special mention or classified by any bank regulatory authority or deemed by the Bank to require special attention pursuant to its internal policies (collectively "Classified Credits"). In addition, the Bank will furnish to the Company, as soon as practicable, and in any event within seven days after receipt by the Bank's Board of Directors, schedules including the following: (a) Classified Credits; (b) nonaccrual credits; (c) accrual exception credits that are delinquent 90 or more days and have not been placed on nonaccrual status; (d) participating loans and leases, stating, with respect to each, whether it is purchased or sold, the loan or lease type, and the originating unit; (e) loans or leases (including any commitments) by the Bank to any director, officer or shareholder holding 5% or more of the capital stock of such party; (f) letters of credit; (g) loans or leases charged-off during the previous month; (h) loans or leases written down during the previous month; and (i) OREO or assets owned, stating with respect to each its type. 6.7 BREACHES. The Bank shall, in event it becomes aware of the impending or threatened occurrence of any material event or condition which would cause or constitute a breach (or would have caused or constituted a breach had such event occurred or been known prior to the date hereof) of any of its representations or agreements contained or referred to herein, give prompt written notice thereof to the Company and, without limiting the Company's rights under paragraph 14.1(a)(ii), the Bank shall use its best efforts to prevent or promptly remedy the same. 6.8 SHAREHOLDER APPROVAL. As soon as practicable, the Company and the Bank shall prepare the S-4 and the proxy statement ("Proxy Statement") and take all action necessary in accordance with applicable Rules and its Charter Documents 63 to submit the Agreement and the transactions contemplated hereby to its shareholders for approval by April 1, 1999, unless otherwise agreed between the Company and the Bank. In connection with such submission, subject to its fiduciary obligations specified in Section 6.5(b) the Bank's Board of Directors shall recommend shareholder approval of all the matters referred to in this Section 6.8 and the Bank shall use its best efforts to obtain such shareholder approval. 6.9 COMPLIANCE WITH RULES. The Bank shall materially comply with the requirements of all applicable Rules, the noncompliance with which would materially and adversely affect the assets, liabilities, business, financial condition, results of operations or prospects of the Bank. 6.10 TERMINATION OF THE BANK STOCK OPTION PLAN AND AGREEMENTS. The Bank will take all steps necessary to cause the Bank Stock Option Plan to be terminated as of or prior to the Effective Time of the Merger, will grant no additional options under said plan prior to the Effective Time of the Merger, and the Bank will not permit any options to be exercised as of or prior to the Effective Time of the Merger, without any liability to any Party. The Bank will also terminate all Stock Option Agreements following the payment of the Aggregate Option Price, without any liability to any Party. 6.11 OFFICERS AND EMPLOYEES. Following the Closing Date, the Company and the Bank will agree to consolidate and/or reduce certain back office and administrative functions, and other overhead, of the Bank in order to reduce Bank expense. Other than officers with employment contracts, each officer and employee of the Bank has indicated in writing to the Bank that such officers and employees agree to the Bank's Personnel Policy Manual and acknowledged his or her at-will employment status while employed by the Bank, in the form attached as EXHIBIT 6.11(a). The Company also will honor all Bank Employment Agreements specified in EXHIBIT 4.11(a). 6.12 TERMINATION OF CONTRACTS AND ACCRUAL OF LIABILITIES. Upon determination by the Company, the Bank shall obtain the termination of any contracts, commitments or Understandings as defined in Section 4.12(v), and pay any termination fees, for the future purchase of materials, supplies, services, merchandise or equipment, the price of which exceeds $10,000 prior to the Closing Date. Before the end of the month prior to the Closing Date, the Bank shall have paid, or set-up adequate accruals for the payment of, all material expenses that the Bank shall be liable for up to the Closing Date, including, but not limited to, all accounting, attorney fees and data processing costs and related costs in connection with this Agreement. 6.13 EXECUTION OF AGREEMENT OF MERGER. As soon as possible after organization of PCBG Valley Corporation, subject to receipt of any and all necessary approvals and Permits by any Governmental Entity and approval by the Bank's shareholders, the Bank shall execute the Agreement of Merger and any and all related documents. 64 6.14 ACCOUNTANTS. Promptly upon request of the Company, the Bank will ask its accountants to permit the Company or the Company Representatives to review and examine the work papers relating to the Audited Bank Financial Statements for the years ended December 31, 1995, 1996, 1997 and 1998, and the Bank will permit such accountants to discuss with the Company any matter relating to the audits of the Bank. In addition, the Bank will make available to the Company copies of each management letter or other letter delivered to the Bank by its accountants in connection with such financial statements or relating to any review by its accountants of the internal controls of the Bank since January 1, 1995, unless previously provided to the Company and the Bank has instructed its accountants to make available for inspection by the Company or the Company Representatives all reports and working papers produced or developed by its accountants in connection with their examination of such financial statements, as well as all such reports and working papers for any periods for which any tax of the party has not been finally determined or barred by applicable statutes of limitation. 6.15 CORPORATE ACTION. The Bank shall take or cause to be taken all necessary corporate action required to carry out the transactions contemplated in this Agreement. 6.16 REGULATORY APPROVALS. Promptly following execution of this Agreement, the parties hereto shall prepare, submit and file, or cause to be prepared, submitted and filed, all applications for approvals and consents as may be required of any of them, respectively, by applicable law and regulations with respect to the transactions contemplated by this Agreement, including without limitation any and all applications required to be filed with the Commissioner, the FRB, the FDIC and such other Governmental Entity as the Company or the Bank may reasonably believe necessary. Each party shall cooperate with the other in the preparation of all of such applications and will furnish promptly upon request all documents, information, financial statements or other materials as may be required in order to complete such applications. Each party shall afford the other a reasonable opportunity to review all such applications (except confidential portions thereof) and all amendments and supplements thereto before filing. The Company and the Bank each covenant and agree that any and all information furnished by it to the other for inclusion in such applications will not contain any untrue statement of a material fact and will not omit to state any material fact required to be stated therein or necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. 6.17 NECESSARY CONSENTS. In addition to the regulatory approvals referred to in Section 6.16, the parties hereto shall each apply for and diligently seek to obtain all other third party consents or approvals which may be necessary for the consummation of the Merger, including, without limitation, the written consent of any lessors of real and personal property which property cannot be assigned without the written consent of the other such lessors ("Third Party Consent"). 65 6.18 FURTHER ASSURANCES. The parties agree that from time to time, whether prior to, at or after the Effective Time of the Merger, they will execute and deliver such further instruments of conveyance and transfer and take such other action as may reasonably be expected to consummate the transactions contemplated hereby. The Company and the Bank each agrees to take such further action as may reasonably be requested by the other in order to consummate the transactions contemplated by this Agreement and that are not inconsistent with the other provisions hereof, including compliance with all of the terms of Article II. 6.19 BANK EMPLOYEE BENEFITS. Prior to or at the Effective Time of the Merger, the Bank will terminate the Bank Stock Option Plan and the ESOP. Upon the agreement of the Company and the Bank, the Bank shall cause all Employee Plans of the Bank to be terminated except as otherwise provided by applicable labor laws. 6.20 ENVIRONMENTAL REPORTS. Except as otherwise agreed to in writing by the Company, the Bank shall provide to the Company, as soon as reasonably practical, but not later than 45 days after the date hereof, a report of a phase one environmental investigation on all Real Property owned, leased or operated by Bank as of the date hereof (other than space in retail and similar establishments leased by the Bank for automatic teller machines) and within ten days after the acquisition or lease of any Real Property acquired or leased by the Bank after the date hereof (other than space in retail and similar establishments leased or operated by the Bank for automatic teller machines), except as otherwise provided in Section 6.2(xxxiii). If required by the phase one investigation in the Company's reasonable opinion, the Bank shall provide to the Company a report of a phase two investigation on the Real Property or Real Properties requiring such additional study. The Company shall have 15 business days from the receipt of any such phase two investigation report to notify the Bank of any objection to the contents of such report. Should the cost of taking all remedial and corrective actions and measures (i) required by applicable law, or (ii) recommended or suggested by such report or reports or prudent in light of serious life, health or safety concerns, in the aggregate, exceed the sum of Twenty-Five Thousand Dollars ($25,000) as reasonably estimated by an environmental expert retained for such purpose by the Company and reasonably acceptable to the Bank, or if the cost of such actions and measures cannot be so reasonably estimated by such expert to be $25,000 or less with any reasonable degree of certainty, the Company shall have the right to terminate the Agreement pursuant to Article IV, Section 14.1(e) hereof, for a period of 10 business days following receipt of such estimate or indication of the cost of such actions and measures. 6.21 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of the Agreement of Merger and the consummation of the transactions contemplated therein, and compliance by the Bank with any provision thereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 6.21 any material agreement, instrument or obligation to which the Surviving Bank will become a party or by which 66 the property of the Surviving Bank will become bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, the FDIC and the Commissioner and as set forth in Exhibit 6.21, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of the Surviving Bank; or (d) violate the Charter Documents or any Rules to which the Surviving Bank is subject. 6.22 THE OFFERING. The Bank will assist the Company in connection with the preparation of the offering materials for the issuance of the Company Stock contemplated by this Agreement, and such assistance will include, but not necessarily be limited to, the preparation or provision, as appropriate, of information concerning the business, properties and personnel of the Bank needed in connection with the issuance of the Company Stock and the closing of the Offering, as well as any and all comfort letters from McGladrey & Pullen or other legal counsel of the Bank, and any and all necessary opinions from Aldrich & Bonnefin or other legal counsel of the Bank, with respect to the Offering as reasonably required and specified by the Underwriters. Such information to be supplied by the Bank will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not intentionally misleading. 6.23 S-4, PROXY STATEMENT AND THE OFFERING. The Company and the Bank will prepare the S-4 and the Proxy Statement, and the Bank will assist the Company in connection with preparation of the Registration Statement for the Offering, contemplated by this Agreement, and such preparation and assistance will include, but not necessarily be limited to, the preparation or provision, as appropriate, of information concerning the business, properties and personnel of the Bank needed in connection with the issuance of the Company Stock, the S-4 and the Proxy Statement and the closing of the Merger. Such information to be prepared or supplied by the Bank including any and all information furnished by the Bank for inclusion in all applications and statements filed with the appropriate regulatory authorities for approval of, or consent to, the Merger will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. 6.24 PUBLICITY. The initial press release announcing this Agreement shall be a joint press release and thereafter the Company and the Bank shall consult with each other in issuing any press releases or otherwise making public statements with respect to the transactions contemplated hereby and in making any filings with any Governmental Entity or with any national securities exchange with respect thereto. If any party hereto, on the advice of counsel, determines that a disclosure is required by law, it may make such disclosure without the consent of the other parties, but only after affording the other party a reasonable opportunity to review and comment upon the disclosure. The parties hereby agree that all public 67 statements after the initial press release announcing this Agreement referring to the Bank shall be made by Mr. N. Douglas Mills, and all public statements made after the initial press release announcing this Agreement referring to the Company shall be made by Mr. E. Lynn Caswell, and both parties agree that all public statements shall be made by mutual agreement with consultation with the Managing Underwriter. 6.25 AFFILIATES AND FIVE PERCENT SHAREHOLDER AGREEMENTS. Within thirty (30) days of the execution of this Agreement, (a) the Bank shall deliver to the Company a letter identifying all persons who are then "affiliates" of the Bank for purposes of Rule 145 under the Securities Act and (b) the Bank shall advise the persons identified in such letter of the resale restrictions imposed by applicable securities laws and shall use reasonable efforts to obtain from each person identified in such letter a written agreement substantially in the form attached hereto as Exhibit 6.25. The Bank shall use reasonable efforts to obtain from any person who becomes an affiliate of the Bank after the Bank's delivery of the letter referred to above, and on or prior to the date of the Bank's Shareholders' Meeting to approve this Agreement, a written agreement substantially in the form attached as Exhibit 6.25 hereto as soon as practicable after obtaining such status. At least 10 Business Days prior to the issuance of the opinion required by Section 9.8, the Bank shall use its best efforts to cause each person or group of persons who holds more than five percent (5%) of Bank Stock (regardless of whether such person is an "affiliate" under Rule 145) to deliver to the Company's accountants and Knecht & Hansen, a letter stating that such shareholder(s) has no present plan or intention to dispose of Bank Stock and committing that such shareholder(s) will not dispose of Bank Stock in a manner to cause a violation of the "continuity of shareholder interest" requirements of Treasury Regulation 1.368-1. ARTICLE VII COVENANTS OF THE COMPANY The Company covenants and agrees with the Bank as follows: 7.1 BEST EFFORTS. The Company shall use its best efforts to bring about the satisfaction of the conditions specified in Articles IX and X hereof. 7.2 CONDUCT OF BUSINESS. Unless the Bank shall give its prior consent, which consent will not be unreasonably withheld, or unless otherwise indicated, until the Effective Time, the Company will: (i) conduct its affairs and business in the usual and ordinary course, generally consistent with past practice, and in accordance with safe and sound practices; (ii) refrain from amending its Charter Documents except to the extent as may be required or contemplated by this Agreement; 68 (iii) use its best efforts to preserve its business organization intact and to retain its present officers and employees in a manner consistent with the Company's other obligations under this Agreement; (iv) use its best efforts to preserve the goodwill of those having business relations with the Company, refrain from amending, modifying, terminating or failing to renew or preserve its business organization, material rights, franchises, Permits, and refrain from taking any action which would jeopardize the continuance of the goodwill of its customers where such action would have, taken as a whole, a material adverse effect on the financial condition, or results of operations of the Company in a manner consistent with the Company's other obligations under this Agreement; (v) duly and timely file all reports and returns required to be filed with any federal, state or local Governmental Entity unless any extensions have been duly granted by such authorities; (vi) maintain its books of account and records in the regular manner substantially in accordance with all applicable statutory and regulatory requirements applied on a consistent basis; (vii) advise the Bank promptly in writing of any material adverse change known to the Company in the capital structure, financial condition, results of operations, or of any event or condition which with the passage of time is reasonably likely to result in a material adverse change in the capital structure, financial condition or results of operations of the Company, or in the event the Company determines that the Merger will not be consummated because of any inability to meet the conditions to the performance of the Bank set forth in Article X or of any matter which would make the representations and warranties set forth in Article V hereof not true and correct in any material respect at the Closing; (viii) the Company agrees that through the Effective Time of the Merger, as of their respective dates, (i) each of the Company Filings will be true and complete in all material respects; and (ii) each of the filings with any regulatory agency will comply in all material respects with all of the statutes, rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they will be made, not misleading. Any financial statement contained in any of such Company Filings that is intended to present the financial position of the entities or entity to which it relates will fairly present the financial position of such entities or entity and will be prepared in accordance with GAAP or RAP consistently applied, except as stated therein, during the periods involved; 69 For purposes of this Section 7.2, the Bank shall be deemed to have given its consent to any action which is contrary to any specified covenant set forth in this Section if, within five (5) Business Days, after actual receipt by the Bank of written notice from the Company of the Company's intention to act contrary to any of the specified covenants set forth in this Section, the Bank shall not have delivered to the Company written objection to any such action. 7.3 ACCESS TO INFORMATION. The Company will afford the Bank, its representatives, counsel, accountants, agents and employees (collectively "Bank Representatives"), access during normal business hours to all of its business, operations, properties, books, files and records and will do everything reasonably necessary to enable the Bank and the Bank Representatives to make a complete examination of the financial statements, books, records, loans and leases, operating reports, audit reports, contracts and documents, and all other information with respect to assets and properties of the Company and the condition thereof, and to update such examination at such intervals as the Bank shall deem appropriate. Such access shall include reasonable access by the Bank and the Bank Representatives to auditors' work papers with respect to the business and properties of the Company, other than (i) books, records and documents covered by the attorney-client privilege, or which are attorneys' work product, and (ii) books, records and documents that the Company is legally obligated to keep confidential. Such examination shall be conducted in cooperation with the officers of the Company and in such a manner as to minimize, to the extent possible consistent with the conducting of a comprehensive examination, any disruption of, or interference with, the normal business operations of the Company. No such examination, however, shall constitute a waiver or relinquishment on the part of the Bank to rely upon the representations and warranties made by the Company herein or pursuant hereto; provided, that the Bank shall promptly disclose in writing to the Company any fact or circumstance it may discover which it believes renders any representation or warranty made by the Company hereunder incorrect in any respect. The Bank will hold in strict confidence all documents and information concerning the Company so obtained (except to the extent that such documents or information are a matter of public record or require disclosure in the Proxy Statement or as may be necessary for the accomplishment of the purposes of such examination) and, if the transactions contemplated herein are not consummated, such confidence shall be maintained and all such documents including all copies shall be returned to the Company. 7.4 BREACHES. The Company shall, in event it becomes aware of the impending or threatened occurrence of any event or condition which would cause or constitute a breach (or would have caused or constituted a breach had such event occurred or been known prior to the date hereof) of any of its representations or agreements contained or referred to herein, given prompt written notice thereof to the Bank and, without limiting the Bank's rights under paragraph 14.1(a)(ii), the Company shall use its best efforts to prevent or promptly remedy the same. 70 7.5 COMPLIANCE WITH RULES. The Company shall comply with the requirements of all applicable Rules, the noncompliance with which would materially and adversely affect the assets, liabilities, business, financial condition, or results of operations of the Company taken as a whole. The Company shall also comply with all securities statutes, rules and regulations, whether federal or state, in connection with the Offering. Except for information supplied by the Bank pursuant to Section 6.22, the information contained in the Offering disclosure documents shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. 7.6 CORPORATE ACTION. The Company shall take or cause to be taken all necessary corporate action required to carry out the transactions contemplated in this Agreement and the Agreement of Merger, including without limitation, all necessary action required to organize and fund PCBG Valley Corporation. 7.7 REGULATORY APPROVALS. Promptly following execution of this Agreement, the parties hereto shall prepare, submit and file, or cause to be prepared, submitted and filed, all applications for approvals and consents as may be required of any of them, respectively, by applicable law and regulations with respect to the transactions contemplated by this Agreement, including without limitation any and all applications required to be filed with the Commissioner, the FRB, the FDIC and such other Governmental Entity as the Company or the Bank may reasonably believe necessary. Each party shall cooperate with the other in the preparation of all of such applications and will furnish promptly upon request all documents, information, financial statements or other materials as may be required in order to complete such applications. Each party shall afford the other a reasonable opportunity to review all such applications (except confidential portions thereof) and all amendments and supplements thereto before filing. The Company and the Bank each covenant and agree that any and all information furnished by it to the other for inclusion in such applications will not contain any untrue statement of a material fact and will not omit to state any material fact required to be stated therein or necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. 7.8 NECESSARY CONSENTS. In addition to the regulatory approvals referred to in Section 7.7, the parties hereto shall each apply for and diligently seek to obtain all other third party consents or approvals which may be necessary for the consummation of the Merger, including, without limitation, the written consent of any lessors of real and personal property which property cannot be assigned without the written consent of the other such lessors ("Third Party Consent"). 7.9 FURTHER ASSURANCES. The parties agree that from time to time, whether prior to, at or after the Effective Time of the Merger, they will execute and deliver such further instruments of conveyance and transfer and take such other action as may reasonably be expected to consummate the transactions contemplated 71 hereby. The Company and the Bank each agree to take such further action as may reasonably be requested by the other in order to consummate the transactions contemplated by this Agreement and that are not inconsistent with the other provisions hereof, including compliance with the terms of Article II. 7.10 (reserved). 7.11 (reserved). 7.12 INDEMNIFICATION AND INSURANCE. (a) The Company will cause the Bank to maintain in effect policies of directors' and officers' liability insurance (with such coverage, terms and conditions as are no less advantageous than the insurance presently maintained by the Bank with respect to the present and former officers and directors, specifically including a "piece of mind" coverage endorsement or policy covering current Bank directors not to exceed $16,000) with respect to all matters arising from facts or events which occurred before the Effective Time of the Merger for which the Bank would have had an obligation to indemnify its directors and officers. (b) If the Company or any of its successors or assigns (i) shall consolidate with or merge into any other corporation or entity and shall not be the continuing or surviving corporation or entity of such consolidation or merger or (ii) shall transfer all or substantially all of its properties and assets to any individual, corporation or other entity, then and in each such case, the Company shall take no action to impair the rights provided in this Section 7.12. 7.13 EXECUTION OF AGREEMENT OF MERGER. As soon as practicable after the organization of PCBG Valley Corporation, the Company as the sole shareholder of PCBG Valley Corporation, shall approve the Merger and shall cause PCBG Valley Corporation to execute the Agreement of Merger and take any and all other actions reasonably necessary to consummate the transactions contemplated herein. 7.14 THE OFFERING. (a) The Company intends to conduct the Offering in order to raise sufficient cash capital to complete the acquisition of the Bank, provide capital for growth and operations of the Company, and to otherwise carry out the transaction contemplated by this Agreement. (b) All Directors and officers of the Company and the Bank will undertake in writing with the Underwriters not to sell any Warrants or shares of Company Stock held by them for a period of six months following the completion of the Offering unless specifically granted permission to do so by the Underwriters. 72 (c) Simultaneously with, and upon the condition of, the consummation of the acquisition of the Bank, the Company through the Underwriters intends to consummate the Offering at a gross public offering price to be determined by the Company and the Underwriters. Based upon current market conditions and assumptions, the Offering will consist of sufficient shares of Company Stock offered to the public at a gross offering price to be determined by the Company and the Managing Underwriter. The shares constituting the Offering will be comprised of newly issued shares of Company Stock to fund the cash portion of the acquisition of the Bank and to provide the Company with new capital for growth and operations of the Company following the acquisition of the Bank and the consummation of the Offering. (d) The Managing Underwriter has entered into an Engagement Agreement with the Company which has not terminated and has not withdrawn the letter expressing their degree of confidence, and the Managing Underwriter will promptly notify the parties if such withdrawal should occur. 7.15 AUTHORIZATION. The execution and delivery of the Agreement of Merger and the consummation of the transactions contemplated thereby will have been duly authorized by the Board of Directors of PCBG Valley Corporation. The Agreement of Merger will constitute a legal, valid and binding agreement of PCBG Valley Corporation in accordance with its respective terms, except as the enforceability thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable. PCBG Valley Corporation will have full corporate power and authority to perform its obligations under the Agreement of Merger and the transactions contemplated thereby. 7.16 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of the Agreement of Merger and the consummation of the transactions contemplated therein, and compliance by PCBG Valley Corporation with any provision thereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 7.16 any material agreement, instrument or obligation to which PCBG Valley Corporation will become a party or by which the property of PCBG Valley Corporation will become bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, the FDIC and the Commissioner and as set forth in Exhibit 7.16, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of PCBG Valley Corporation; or (d) violate the Charter Documents or any Rules to which PCBG Valley Corporation is subject. 7.17 ACCURACY OF INFORMATION FURNISHED. Except as to any statements or information which shall include projections or forecasts, none of the statements or information made or contained in any of the covenants, representations or warranties 73 of the Company set forth in this Agreement or in any of the schedules, exhibits, lists, certificates or other documents furnished herewith contains any untrue statement of a material fact required to be stated herein or therein or necessary to make the statements or information contained herein or therein, in light of the circumstances in which they were made, not misleading. As to any such information or statements which include projections or forecast, such information or statements are based upon assumptions believed by the Company to be reasonable. The Company shall further amend or supplement the schedules as of the Closing Date if necessary to reflect any additional changes in the status of the Company. 7.18 1999 STOCK OPTION PLAN. Prior to or following the completion of the transactions contemplated herein, the Company will use its best efforts to establish the Company's 1999 Stock Option Plan for the benefit of directors, officers and key employees of the Company and the Bank. 7.19 FURTHER ASSURANCES. The Company knows of no reason that the transaction would not consummate. Without the prior approval of the Bank, the Company will not enter into any further agreements to acquire another financial institution that would adversely affect the transaction consummated by this Agreement. 7.20 FINANCIAL STATEMENTS. In the event the following have not been previously delivered prior to the date hereof, the Company will deliver to the Bank a copy of the audited Statements of Financial Condition of the Company as of December 31, 1998; Statements of Earnings, Stockholders' Equity and Cash Flows for the year ended December 31, 1998, the related notes and related opinions thereon of Arthur Andersen LLP certified public accountants, with respect to such financial statements (the "1998 Audited Company Financial Statements"). The Company will furnish the Bank with a true and correct copy of the management letter or other letter delivered to the Company by Arthur Andersen LLP in connection with the 1998 Audited Company Financial Statements relating to any review of the internal controls of the Company by Arthur Andersen LLP. The 1998 Audited Company Financial Statements will: (i) present fairly the financial condition and results of operations of the Company as of and for the dates or periods covered thereby in accordance with generally accepted accounting principles consistently applied throughout the periods involved; (ii) be based on the books and records of the Company; (iii) contain and reflect reserves for all material accrued liabilities and for all reasonably anticipated losses, and set forth adequate reserves for loan losses and other contingencies, to the extent required by GAAP; and (iv) none of the 1998 Audited Company Financial Statements will contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading under GAAP. 74 ARTICLE VIII FURTHER COVENANTS OF THE COMPANY AND THE BANK The parties covenant and agree as follows: 8.1 S-4, PROXY STATEMENT AND REGISTRATION STATEMENT FOR THE OFFERING. (a) As promptly as practicable, the Company and the Bank shall use their best efforts to prepare and file the S-4 in which the Proxy Statement will be included as a prospectus, and the Registration Statement for the Offering with the SEC and any other applicable Governmental Entity. The Bank agrees to provide the information necessary for inclusion in the S-4, the Proxy Statement and the Registration Statement for the Offering. The Company will use its best effort to have the S-4 and the Proxy Statement declared effective under the Securities Act as promptly as practicable after it is filed and to satisfy the requirements of the SEC and any other Governmental Entity. (b) After the date of the filing of the S-4 and the Registration Statement for the Offering with the SEC and any other Governmental Entity, each of the Parties agrees to promptly notify the other of and to correct any information furnished by such party that shall have become false or misleading in any material respect and to cooperate with the other to take all steps necessary to file with the SEC and any other Governmental Entity and have declared effective or cleared by the Commissioner and any other Governmental Entity any amendment or supplement to the S-4 and the Registration Statement for the Offering so as to correct such information and to cause the S-4 and the Registration Statement for the Offering as so corrected to be disseminated to the shareholders of the Company and the Bank to the extent required by applicable Rules. All documents that the Company files with the SEC or any other Governmental Entity in connection with this Agreement will comply as to form in all material respects with the provisions of applicable Rules. (c) The Company shall take all required action with appropriate Governmental Entities under state securities or blue sky laws in connection with the issuance of Company Stock and Warrants pursuant to this Agreement. (d) The Bank and the Company, through their respective Board of Directors, will recommend that its shareholders approve the transactions contemplated hereby, and both parties will use their best efforts to obtain the affirmative votes of the holders of the largest possible percentage of its outstanding Common Stock, so long as it is consistent with its fiduciary obligation to do so. 8.2 SECURITIES LAWS. In obtaining the consent of its shareholders of the matters described in Section 8.1 hereof, the Company, the Bank and their respective officers, directors and controlling shareholders will, in all respects, comply with the Rules and regulations of the SEC and any other Governmental Entity 75 applicable to commercial banks, other applicable provisions of the United States Code, the Rules and regulations of the SEC and the securities laws of all states in which shareholders of the parties reside as applicable. Without in any way limiting the generality of the foregoing, the Company and the Bank agree that the Notice of Meeting, Proxy Statement submitted in connection therewith, form of Proxy and other solicitation materials that will be used in soliciting the aforesaid shareholder approvals and authorizations and the Registration Statement for the offering: (i) will be filed with, and not be used before the same are cleared for use by the SEC, other Governmental Entities having jurisdiction over the Company and the Bank, and this transaction, and the securities administrators of all states in which their respective shareholders reside as applicable; (ii) will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, except that neither party warrants the accuracy or completeness of any information contained therein which is furnished to it by the other relating to the business, assets, properties, financial condition or management of the other or any corporation or person affiliated or contractually obligated to become affiliated therewith, whether by merger, acquisition of assets or otherwise; (iii) the Company and the Bank will use their best efforts to obtain clearance by all appropriate Governmental Entities for the use of its Notice of Meeting, Proxy Statement, form of Proxy and other solicitation materials. Each party will consult and cooperate with the other in the preparation of all such proxy solicitation materials for the Bank Shareholders' Meeting and the Company's Shareholders Meeting, and the Bank and the Company agree not to transmit any proxy materials without the prior consent of the other party and its counsel; and (iv) the Company and the Bank shall each covenant and agree and each pay their own expenses in connection with the preparation and filing, including attorney fees, of the Notice of Meeting, Proxy Statement, form of Proxy and other solicitation materials. 8.3 MAILING OF PROXY STATEMENT. The Bank and the Company each covenant and agree that they will use their best efforts and shall cooperate with each other in the preparation, filing and mailing of the Proxy Statement as soon as it is reasonably practicable and is permitted under applicable law; it being the intention of the Company and the Bank to include their December 31, 1998 financial statements and information, and any necessary quarterly financial statements and information, in the financial disclosures contained in the Proxy Statement. 76 8.4 MATERIALS TO BE FURNISHED PRIOR TO MAILING DATES. On or prior to the mailing date of the Proxy Statement ("Bank Mailing Date"), the Bank (a) shall use its best efforts to cause an appropriate firm that shall be selected by the Bank in its discretion, subject to the reasonable approval of the Company, to deliver to the Company a copy of any letter to the Board of Directors of Bank, dated as of a date not more than five days prior to such mailing date, in form and substance satisfactory to the Company to the effect set forth in Section 10.4 hereof, (b) shall have received a letter by a date not more than five days prior to the Bank Mailing Date, to the effect that the consideration to be received by the shareholders of the Bank in the Merger is fair from a financial point of view, and (c) shall have received a letter by a date not more than five days prior to the Bank Mailing Date, of the valuation of dissenters rights shares as described in Section 1300. 8.5 REGULATORY APPROVALS. The Bank and the Company each agree to use their best efforts to provide promptly such information and reasonable assistance as may be requested by the other party to this Agreement and to take promptly such other actions as shall be necessary or appropriate in order to consummate the transactions contemplated hereby. Without limiting the foregoing, the Bank and the Company will each (a) prepare, submit and file, or cause to be prepared, submitted and filed, all applications for all authorizations, consents, orders and approvals of federal, state, local and other Governmental Entities and officials necessary under applicable law for the performance of its obligations pursuant to this Agreement and the consummation of the transactions contemplated hereby, (b) use their best efforts to obtain all such authorizations, consents, orders and approvals as expeditiously as possible in accordance with the terms of this Agreement, and (c) cooperate fully with each other in promptly seeking to obtain such authorizations, consents, orders and approvals, including without limitation, in each case, the approval of the FRB, the FDIC and the Commissioner. The Bank and the Company each agree to promptly provide the other with copies of all applications referred to in clause (a) above and copies of all written communications, letters, reports or other documents delivered to or received from any Governmental Entity, and copies of all memoranda relating to discussions with such Governmental Entity, if any, with respect to the Merger, except that the Company and the Bank shall not be required to provide the other with any of the foregoing documents submitted or received on a confidential or privileged basis or which incorporate confidential information relating to other financial institutions. The Parties agree that through the Effective Time of the Merger, each of its reports, registration, statements and other filings required to be filed with any applicable Governmental Entity will comply in all material respects with the aplicable statutes, rules and regulations enforced or promulgated by the Governmental Entity with which it will be filed and none will contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. Any financial statement contained in any such report, registration statement or other filing that is intended to represent the financial position of the Party to which it relates will fairly present the financial position of such Party and will 77 be prepared in accordance with GAAP or RAP consistently applied during the periods involved. 8.6 CORPORATE GOVERNANCE. (a) Prior to the Effective Time, the Bank shall take all necessary steps to effect the Bank Corporate Governance Changes at the Effective Time. (b) Prior to the Effective Time, the Company shall take all necessary steps to effect the Company Corporate Governance Changes at the Effective Time. 8.7 NASDAQ. Prior to or at the Effective Time, the Company shall take all necessary steps to list the Company's Stock on the Nasdaq National Market System at the Effective Time of the Merger. ARTICLE IX CONDITIONS PRECEDENT TO THE CONTEMPLATED TRANSACTIONS The obligations of the Parties to consummate the transactions as provided for herein are subject to the fulfillment, at or prior to the Effective Time, of the following conditions: 9.1 PERMITS AND APPROVALS. Appropriate permits or approvals from the Commissioner, the FRB, the FDIC and/or any other Governmental Entities which are necessary to carry out the transactions contemplated in this Agreement, shall have been received, the United States Department of Justice shall not have taken any adverse action within the period allowed under 12 U.S.C. Section 1828(c)(6), and all other statutory or regulatory requirements for the valid completion of the transactions contemplated hereby shall have been satisfied. Said permits and approvals shall include, but shall not be limited to, the following: (i) prior written approval from the Commissioner pursuant to the CFC, the FDIC pursuant to 12 U.S.C. Section 1828(c)(2) and the FRB pursuant to the Federal Reserve Act and the BHC Act; (ii) to the extent required by applicable Rule, all Consents of any Governmental Entity, including, without limitation, those of the FRB, the FDIC and the Commissioner, shall have been obtained, granted or waived for organization of PCBG Valley Corporation and the Merger, and all applicable waiting periods under all rules shall have expired; and (iii) all approvals, orders and/or permits necessary for the Offering and any other necessary regulatory approvals and the issuance of approvals or assurances from the Commissioner, the FRB, the FDIC, the SEC, any blue sky 78 authority and any other necessary Governmental Entity having authority over the Merger that the approval of the Merger will be forthcoming that are satisfactory to the Company, that would allow the Company to commence the marketing of the Offering by the Company to complete the Merger as described in this Agreement. 9.2 ABSENCE OF LITIGATION. On the Closing Date and at the Effective Time: (i) there shall be no action pending before any court of competent jurisdiction in which any injunction is sought by any Governmental Entity against the transactions contemplated hereby; and (ii) there shall be in effect no order, writ, injunction or decree of any court or Governmental Entity prohibiting the consummation of any of the transactions contemplated hereby. 9.3 SHAREHOLDER APPROVAL. The Agreement, the Merger, and the other transactions contemplated hereby, shall have been approved by the holders of at least two-thirds (2/3) of the issued and outstanding shares of Bank Stock entitled to vote and the requisite approval of the Company as the sole shareholder of PCBG Valley Corporation as soon as practicable. Any and all other action required by the shareholders of the Bank or the Company to authorize or effect the transactions called for herein shall have been duly and validly taken. 9.4 STOCK OFFERING. The Company shall have closed the Offering as soon as is reasonably possible, the Company shall have received the amount of cash necessary to complete the Merger as provided in Section 2.5, and to carry out the transactions contemplated hereby. 9.5 S-1, S-4 AND PROXY STATEMENT. The S-4, Proxy Statement and the S-1 shall have been declared effective by the SEC, the Commissioner, and any other Governmental Entity, as appropriate, and shall not be the subject of any stop order or proceeding seeking or threatening a stop order. The Company shall have received all state securities or "Blue Sky" permits and other authorization necessary to issue the Company Stock in the Offering and the S-4 in order to consummate the Merger. 9.6 NASDAQ. The Company's Common Stock will be listed on the Nasdaq National Market System at the Effective Time. 9.7 SEVERANCE POLICY. The Bank and the Company have agreed to a severance policy as set forth on Exhibit 9.7. 9.8 TAX OPINION. The Company shall have received from its accountants an opinion reasonably satisfactory to the Company to the effect that the Merger shall not result in the recognition of gain or loss for federal income tax purposes to the Company or the Bank, nor shall the issuance of Company Stock result in the recognition of gain or loss by the holders of Bank Stock who receive Company Stock in connection with the Merger, dated prior to the date of the Proxy Statement is first mailed to the shareholders of the Company and the Bank and such opinions shall not have been withdrawn or modified in any respect. 79 ARTICLE X CONDITIONS PRECEDENT TO THE OBLIGATIONS OF THE BANK All of the obligations of the Bank to consummate the transactions contemplated herein shall be subject to the satisfaction, at or prior to the Closing Date, of the following conditions, or their waiver by resolution of the Board of Directors of the Bank: 10.1 LEGAL OPINION. The Bank shall have received the opinion of Knecht & Hansen, acting as counsel for the Company, dated as of the Closing Date, in substantially the form of EXHIBIT 10.1. 10.2 CERTIFICATE OF NO DEFAULT. All covenants, terms and conditions of this Agreement to be complied with and performed by the Company at or before the Closing Date shall have been complied with and performed in all material respects and the representations and warranties of the Company contained in Article V hereof shall have been true and correct in all material respects as of the Effective Time, with the same effect as though such representations and warranties had been made on and as of the Effective Time, except as otherwise specified in, or permitted or contemplated by, this Agreement. The Company shall have delivered to the Bank, a certificate dated the Closing Date, signed by the President, certifying the fulfillment of this condition. 10.3 CLOSING DOCUMENTS. The Company shall have delivered to the Bank all items required by the Bank pursuant to Section 3.3, all of which documents shall be properly executed and, if required by the Bank, acknowledged before a notary. 10.4 EFFECTIVE S-4 AND PROXY STATEMENT. The S-4 and the Proxy Statement shall have been approved or otherwise become effective and no stop order suspending the effectiveness thereof shall be in effect and no proceedings therefor shall be pending or threatened by any Governmental Entity at the Closing Date. 10.5 REGULATORY APPROVALS AND RELATED CONDITIONS. Any and all governmental and regulatory approvals and Consents referred to in Article IX and any other section of this Agreement shall have been granted without the imposition of conditions, or with conditions subject to the approval of the Company and the Bank, that are or would have become applicable to the Company or the Surviving Bank, and that the Company reasonably and in good faith concludes would materially adversely affect the financial condition or operations of the Company or the Surviving Bank, or otherwise would be materially burdensome; provided, however, that conditions or requirements which are imposed on purchasers or acquired institutions by Governmental Entities in comparable transactions shall not be deemed to be a basis for excuse of performance under this Agreement. All actions necessary to authorize 80 the execution, delivery and performance of the Agreement by the Company and consummation of the Merger by the Company and PCBG Valley Corporation shall have been duly and validly taken by the Board of Directors of the Company and the PCBG Valley Corporation. 10.6 THIRD PARTY CONSENTS. The Company shall have obtained all consents of other parties to the Company's material mortgages, notes, leases, franchises, agreements, licenses and permits as may be necessary to permit the transactions contemplated herein to be consummated, without default, acceleration, breach or loss of rights or benefits thereunder. 10.7 ABSENCE OF CERTAIN CHANGES. As of the Closing Date there shall not exist any of the following: (i) any change(s) in the financial condition or results of operation of the Company since inception which individually is or in the aggregate are materially adverse to the Company; or (ii) any damage, destruction, loss or event materially and adversely affecting the properties, business or prospects of the Company on a consolidated basis. 10.8 VALIDITY OF TRANSACTIONS. The validity of all transactions herein contemplated, as well as the form and substance of all opinions, certificates, instruments of transfer and other documents to be delivered to the Bank hereunder, shall be subject to the approval, to be reasonably exercised, of counsel for the Bank. 10.9 FAIRNESS OPINION. Prior to solicitation of shareholder approval, the Bank shall have received an opinion pursuant to Section 8.4 confirming the fairness of the terms of the Merger from a financial perspective, and such opinion shall not have been withdrawn prior to the mailing date of the Proxy Statement. 10.10 NASDAQ LISTING. The shares of Company Stock issuable pursuant to this transaction shall have been duly authorized for listing, subject to notice of issuance, on the Nasdaq National Market System. ARTICLE XI CONDITIONS PRECEDENT TO THE OBLIGATIONS OF THE COMPANY All of the obligations of the Company to consummate the transactions contemplated herein shall be subject to the satisfaction, at or prior to the Closing Date, of the following conditions, or their waiver by resolution of the Board of Directors of the Company, as appropriate: 81 11.1 LEGAL OPINION. The Company shall have received the opinion of Aldrich & Bonnefin acting as counsel for the Bank, dated as of the Closing Date, in substantially the form of EXHIBIT 11.1. 11.2 CERTIFICATE OF NO DEFAULT. All covenants, terms and conditions of this Agreement to be complied with and performed by the Bank at or before the Closing Date shall have been complied with and performed in all material respects and the representations and warranties of the Bank contained in Article IV hereof shall have been true and correct in all material respects as of the Effective Time, with the same effect as though such representations and warranties had been made on and as of the Effective Time, except as otherwise specified in, or permitted or contemplated by, this Agreement. The Bank shall have delivered to the Company a certificate, dated the Closing Date, signed by the President and Chief Financial Officer of the Bank, certifying the fulfillment of this condition. 11.3 CLOSING DOCUMENTS. The Bank shall have delivered to the Company all items required by the Company pursuant to Section 3.3, all of which documents shall be properly executed and, if required by the Company, acknowledged before a notary. 11.4 EFFECTIVE S-1, S-4 AND PROXY STATEMENT. The S-1, S-4 and the Proxy Statement shall have become effective and no stop order suspending the effectiveness thereof shall be in effect and no proceedings therefor shall be pending or threatened by the SEC, FDIC, the Commissioner, the FRB or any blue sky authority at the Closing Date. 11.5 BANK DISSENTING SHAREHOLDERS AGAINST MERGER. The Bank's shareholders voting against the Merger or the Bank's shareholders giving notice in writing to the Bank at or before the Bank's meeting that such shareholder dissents from the Merger, on a combined basis, shall hold not more than ten percent (10%) of the outstanding shares of the Bank. 11.6 REGULATORY APPROVALS AND RELATED CONDITIONS. Any and all governmental and regulatory approvals and Consents referred to in Article IX and any other section of this Agreement shall have been granted without the imposition of conditions, or with conditions subject to the approval of the Company, that are or would have become applicable to the Company or the Surviving Bank and that the Company reasonably and in good faith concludes would materially adversely affect the financial condition or operations of the Company or the Surviving Bank, or otherwise would be materially burdensome; provided, however, that conditions or requirements which are imposed on purchasers or acquired institutions by Governmental Entities in comparable transactions shall not be deemed to be a basis for excuse of performance under this Agreement. 82 11.7 THIRD PARTY CONSENTS. The Company shall have obtained all consents of other parties to the Company's material mortgages, notes, leases, franchises, agreements, licenses and permits as may be necessary to permit the transactions contemplated herein to be consummated, without default, acceleration, breach or loss of rights or benefits thereunder. 11.8 ABSENCE OF CERTAIN CHANGES. As of the Closing Date, there shall not exist any of the following: (i) any Material Adverse Change as defined in Section 4.17, (ii) any damage, destruction, loss or event materially and adversely affecting the properties, business or prospects of the Bank; or (iii) any material adverse change in the deposit structure of the Bank from July 30, 1998 to the Closing Date. 11.9 BANK STOCK OPTION PLAN; AND OFFICERS AND EMPLOYEES. The Bank shall have caused the Bank Stock Option Plan to be terminated as of or prior to the Effective Time of the Merger and shall have obtained the consents or agreements specified in, and otherwise shall have complied with the terms of, Section 6.10. Pursuant to California Law and its employment policies and practices, the Bank shall have complied with Section 6.11 of this Agreement as of the Effective Time of the Merger. 11.10 DIRECTOR AGREEMENTS. Pursuant to Section 2.9, concurrently with the execution of this Agreement, each director of the Bank shall enter into separate agreements with the Company in the form attached hereto as EXHIBIT "B". 11.11 TERMINATION OF CONTRACTS. Except as otherwise directed by the Company, the Bank shall have terminated all contracts, commitments or understandings as defined in Section 4.12(v) for the future purchase of materials, supplies, services, merchandise or equipment, the price of which exceeds $10,000, and any expense incurred in connection with such terminations shall have been charged in full to the Bank prior the last day of the month preceding the Closing Date which have been designated by the Company and agreed to by the Bank. Before the Determination Date prior to the Closing Date, the Bank shall have paid, or set-up adequate accruals for the payment of all material expenses that the Bank shall be liable for up to the Closing Date, including, but not limited to, all accounting and attorney fees in connection with this Agreement. 11.12 VALIDITY OF TRANSACTIONS. The validity of all transactions herein contemplated, as well as the form and substance of all opinions, certificates, instruments of transfer and other documents to be delivered to the Company hereunder, shall be subject to the approval, to be reasonably exercised, of counsel for the Company. 11.13 EMPLOYEE BENEFIT PLANS. Upon the agreement of the Company and the Bank, the Bank's Employee Plans, programs and arrangements, have been terminated on terms and conditions satisfactory to the Parties, and all benefits 83 payable under such plans, programs and arrangements shall be accrued prior to the Closing Date. 11.14 FAIRNESS OPINION. Prior to commencement of the marketing of the Offering described in Sections 9.1(iii) and 9.4, the Company in its discretion may receive an opinion concerning the fairness of the terms of the Merger to the shareholders of the Company from a financial point of view. 11.15 STOCK OFFERING. The Bank shall have provided such information as deemed reasonably necessary by the Company in connection with the sale of stock including but not limited to, certificates of its officers and directors attesting to, among other things, the truthfulness and correctness of the representations contained in this Agreement, opinions of legal counsel and comfort letters from the Bank's accountants. 11.16 S-4, THE PROXY STATEMENT AND REGULATORY APPLICATIONS. The Bank shall have provided such information as deemed reasonably necessary by the Company in connection with the S-4 and the Proxy Statement and any other regulatory applications including but not limited to, certificates of its officers and directors attesting to, among other things, the truthfulness and correctness of the representations contained in this Agreement, opinions of legal counsel and comfort letters from the Bank's accountants. 11.17 BLUE SKY MATTERS. The issuance of the Company Stock in the Offering and the S-4 shall have been qualified or registered with the appropriate Governmental Entity under state securities or Blue Sky laws, and such qualification or registrations are in effect on the Closing Date. 11.18 PROFESSIONAL FEES. The Bank's costs and expenses in connection with the transaction contemplated by this Agreement, including investment banker, accounting, attorney and any other costs and expenses, shall not exceed the amount that would be reasonable and customary for a transaction as described in this Agreement. Of these expenses, the accounting and attorney fees and expenses, and related costs and expenses thereto incurred from May 1, 1998 through the Closing Date, of the Bank shall not exceed $175,000 in the aggregate. 11.19 YEAR 2000. The Bank shall certify that the Bank is making satisfactory progress for compliance with Year 2000 safety and soundness issues with respect to its own computer systems, and the computer systems of its vendors and customers. 84 ARTICLE XII DISSENTING SHAREHOLDERS OF BANK Any shareholder of the Bank who lawfully dissents shall be entitled to receive cash for the fair market value of his or her shares determined in accordance with Section 1300. ARTICLE XIII EXPENSES 13.1 EXPENSES. All fees and Expenses incurred in connection with the transactions contemplated by this Agreement shall be paid by the Party incurring such Expenses. For the purposes of this Agreement, "Expenses" shall include, but not be limited to, all expenses relating to such transactions including, legal, accounting, investment banking fees and cost reimbursements, fees and costs of consultants, costs of proxy statements and shareholder action on the Merger, and if accrued according to GAAP as of the Determination Date by Bank, and provided such expenses would be properly tax deductible, the net after tax effect of severance payments and employee benefits under employment contracts and employee benefit plans reflected in Exhibits 4.11(a), (c), (j) and (m), including but not limited to accrual of any and all unfunded or accelerated obligations thereunder. ARTICLE XIV TERMINATION 14.1 TERMINATION OF THIS AGREEMENT. (a) Notwithstanding that this Agreement and the Agreement of Merger may have already been approved by shareholders of one or both of constituent corporations to the transactions contemplated by this Agreement, this Agreement may be terminated prior to the Effective Time of the Merger: (i) by mutual agreement of the parties, in writing; (ii) by (A) the Company immediately upon the expiration of 30 days from the date that the Company has given notice to the Bank of a material breach or default by the Bank in the performance of any covenant, agreement, representation, warranty, duty or obligation hereunder or (B) the Bank immediately upon the expiration of 30 days from the date that the Bank has given notice to the Company of a breach or default by the Company in the performance of any covenant, agreement, representation, warranty, duty or obligation hereunder, except for Sections 5.18 and 7.14 85 (iii) by the Company or the Bank if any Governmental Entity denies or refuses to grant the approvals, consents or authorizations required to be obtained, or if any Governmental Entity approves the transaction covered and contemplated by this Agreement upon conditions not reasonably acceptable to the Company, in order to consummate the transactions covered and contemplated by this Agreement. If any regulatory application filed pursuant to this Agreement hereof should be finally denied or disapproved by the respective Governmental Entity, then this Agreement thereupon shall be deemed terminated and canceled; provided, however, that a request for additional information or undertaking by the Company, as a condition for approval, shall not be deemed to be a denial or disapproval so long as the Company diligently provides the requested information or undertaking. In the event an application is denied pending an appeal, petition for review, or similar such act on the part of the Company (hereinafter referred to as the "appeal") then the application will be deemed denied unless the Company prepares and timely files such appeal and continues the appellate process for purposes of obtaining the necessary approval within 45 days thereafter. (iv) by the Company or the Bank if (A) the Board of Directors of the Bank approves a transaction (or the Bank executes a letter of intent or other agreement) pursuant to which any person or entity or related group of persons or entities acquires, directly or indirectly, record or beneficial ownership (as defined in Rule 13d3 promulgated by the SEC pursuant to the Exchange Act) or control of 25% or more of the outstanding shares of Bank Stock or other securities of the Bank; (B) any person or entity or related group of persons or entities seeks to acquire 25% or more of the outstanding shares of Bank Stock by tender offer or otherwise, and the Board of Directors of the Bank does not advise the Bank's shareholders that the Bank's Board of Directors does not support such tender offer or acquisition and that it supports the Merger; (C) if the Bank violates its covenant pursuant to Section 6.2 (xxiii) and (xxiv); (D) the Merger does not receive the requisite approval of the Bank's shareholders; or (E) the Bank engages in an Alternative Transaction pursuant to the terms of Section 6.5; (v) by the Company or the Bank immediately upon the expiration of 15 days from the date that the Bank or the Company has given notice to the other Party of a default by the Company in the performance of Sections 5.18 and 7.14; or (vi) by the Company or the Bank if the Closing Date has not occurred by May 15, , 1999, unless regulatory approvals and/or completion of the Offering is reasonably expected to occur within 30 days of May 15, , 1999, in which case the date in this subsection shall be automatically extended for up to an additional 30 days. (b) Notwithstanding that this Agreement and the Agreement of Merger may have already been approved by shareholders of one or both of the constituent corporations to the Merger, this Agreement shall be terminated prior to 86 the Effective Time of the Merger if any conditions specified in Articles IX, X or XI have not been satisfied or waived in writing by the party authorized to waive such conditions unless mutually extended by the parties hereto. (c) REGULATORY ENFORCEMENT MATTERS. In the event that Bank or the Company or any of their respective subsidiaries shall, after July 30, 1998, become a party or subject to any new or amended written agreement, memorandum of understanding, cease and desist order, imposition of civil money penalties or other regulatory enforcement action or proceeding with any federal or state agency charged with the supervision or regulation of banks or bank holding companies which is material to the Bank or the Company and their respective subsidiaries taken as a whole, then either the Company or the Bank may terminate this Agreement. (d) (reserved) (e) Notwithstanding anything to the contrary contained herein: (i) If this Agreement is terminated by the Bank before the Closing Date pursuant to Sections 14.1(a)(ii)(B), (not including Sections 5.18 or 7.14) hereof, the Company shall pay to the Bank, as reasonable and full liquidated damages and reasonable compensation for the loss sustained thereby and not as a penalty or forfeiture, the direct expenses incurred by the Bank in connection with the transaction contemplated by this Agreement, plus 50% of such expenses, up to a maximum of $500,000, within ten (10) business days of such termination; (ii) If this Agreement is terminated by the Company before the Closing Date pursuant to Sections 14.1(a)(ii)(A) hereof, the Bank shall pay to the Company, as reasonable and full liquidated damages and reasonable compensation for the loss sustained thereby, and not as a penalty or forfeiture, the direct expenses incurred by the Company in connection with the transaction contemplated by this Agreement, plus 50% of such expenses, up to a maximum of $500,000 within ten (10) business days of such termination; and (iii) If this Agreement is terminated by the Company before the Closing pursuant to Section 14.1(a)(iv)(C) or (D) hereof, the Bank will pay to the Company, as reasonable and full liquidated damages and reasonable compensation for the loss sustained thereby, and not as a penalty or forfeiture, the direct expenses incurred by the Company in connection with the transaction contemplated by this Agreement, plus 50% of such expenses, within ten (10) business days of such termination, except that if the Agreement is terminated by the Company pursuant to Section 14.1(a)(iv)(A), (B) or (E) hereof, the Bank will pay to the Company, as reasonable and full liquidated damages and reasonable compensation for the loss sustained thereby, and not as a penalty or forfeiture, $1,750,000 within ten (10) business days of such termination. 87 ARTICLE XV GENERAL PROVISIONS 15.1 CONFIDENTIALITY. All Confidential Information disclosed heretofore or hereafter by either Party to this Agreement to the other Party to this Agreement shall be kept confidential by such other Party and shall not be used by such other Party otherwise than as herein contemplated, except to the extent that (a) it is necessary or appropriate to disclose to the Bank or the Company or as may otherwise be required by Rule (any disclosure of Confidential Information to a Governmental Entity shall be accompanied by a request that such Governmental Entity preserve the confidentiality of such Confidential Information); or (b) to the extent such duty as to confidentiality is waived by the other Party. Such obligation as to confidentiality and nonuse shall survive the termination of this Agreement pursuant to Article XIV. In the event of such termination and on request of the other Party, such Party shall use all reasonable efforts to (y) return to the other Party all documents (and reproductions thereof) received from such other Party that contain Confidential Information (and, in the case of reproductions, all such reproductions made by the receiving Party); and (z) destroy the originals and all copies of any analyses, computations, studies or other documents prepared for the internal use of such Party that include Confidential Information, unless otherwise advised by counsel in connection with any controversy under the Agreement. 15.2 PUBLICITY. The Parties shall coordinate all publicity relating to the transactions contemplated by this Agreement, and no Party shall issue any press release, publicity statement, shareholder communication or other public notice relating to this Agreement or any of the transactions contemplated hereby without obtaining the prior consent of the other Party except to the extent that independent legal counsel to the Party, as the case may be, shall deliver a written opinion to the Party that a particular action is required by applicable Rules. The Parties hereby agree that all public statements after the initial press release announcing this Agreement referring to the Bank shall be made by Mr. N. Douglas Mills, and all public statements made after the initial press release announcing this Agreement referring to the Company shall be made by Mr. E. Lynn Caswell, and both Parties agree that all public statements shall be made by mutual agreement. 15.3 INDEMNIFICATION. (a) The Bank agrees to defend, indemnify and hold harmless the Company, its officers and directors, attorneys, accountants and each person who controls the Company within the meaning of the Securities Act from and against any costs, damages, liabilities and expenses of any nature, insofar as any such costs, damages, liabilities and expenses arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Proxy Statement, the Company's Offering disclosure documents or any amendments or supplements thereto, or arise out of or are based solely upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading based upon information with respect to the Bank furnished to the Company by or on behalf of the Bank specifically for use therein; provided, however, that the Bank shall not be liable in any such case to the extent that any such cost, damage, liability or expense arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Proxy Statement, the Company's Offering disclosure documents or amendments or supplements thereto, in reliance upon and in conformity with information with respect to the Company furnished to the Bank by or on behalf of the Company specifically for use therein. (b) The Company agrees to defend indemnify and hold harmless the Bank, its officers and directors, attorneys, accountants and each person who controls the Bank within the meaning of the Securities Act from and against any costs, damages, liabilities and expenses of any nature, insofar as any such costs, damages, liabilities or expenses arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Proxy Statement, the Company's Offering disclosure documents or any amendments or supplements thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make statements therein not misleading based solely upon information with respect to the Company and its subsidiaries furnished to the Bank by or on behalf of the Company and its subsidiaries specifically for use therein; provided, however, that the Company shall not be liable in any such case to the extent that any such cost, damage, liability or expense arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Proxy Statement, the Company's Offering disclosure documents or amendments or supplements thereto, in reliance upon and in conformity with information with respect to the Bank furnished to the Company by or on behalf of the Bank specifically for use therein. (c) Promptly after receipt by the Party to be indemnified pursuant to this section ("Indemnified Party") of notice of (i) any claim or (ii) the commencement of any action or proceeding, Indemnified Party will give the other Party "(Indemnifying Party") written notice of such claim or the commencement of such action or proceeding. Indemnifying Party shall have the right, at its option, to compromise or defend, by its own counsel, any such matter involving Indemnified Party's asserted liability, at the expense of the Indemnifying Party. In the event that Indemnifying Party shall undertake to compromise or defend any such asserted liability, it shall promptly notify Indemnified Party of its intention to do so, and Indemnified Party agrees to cooperate fully with Indemnifying Party and its counsel in the compromise of, or defense against, any such asserted liability. In any event, Indemnifying Party shall have the right to participate in the defense of such asserted liability. In any event Indemnifying Party shall have the right to participate in the defense of such asserted liability. 89 15.4 NOTICES. All notices, demands or other communications hereunder shall be in writing and be made by (a) hand delivery; (b) overnight mail; (c) United States mail, first class, certified or registered, postage prepaid; or (d) facsimile transmission, and shall be deemed to have been duly given (i) on the date of service if delivered by hand or facsimile transmission (provided that facsimile notices are also mailed by United States mail, first class, certified or registered, postage prepaid); (ii) on the next day if delivered by overnight mail or delivery service; or (iii) 72 hours after mailing if mailed by United States mail, first class, certified or registered, postage prepaid, and properly addressed as follows: (a) If to the Bank: N. Douglas Mills, President and Chief Executive Officer Valley Bank 24010 Sunnymead Drive Moreno Valley, California 92555-0188 Telecopier No.: (909) 242-1903 With a copy to: Mark E. Aldrich, Esq. Aldrich & Bonnefin 18200 Von Karman Avenue, Suite 730 Irvine, California 92612-1029 Telecopier No.: (949) 474-0617 (b) If to the Company: Mr. E. Lynn Caswell, Chairman and CEO Pacific Community Banking Group 23332 Mill Creek Drive, Suite 230 Laguna Hills, California 92653 Telecopier No.: (949) 458-2086 With a copy to: Loren P. Hansen, Esquire Knecht & Hansen 1301 Dove Street, Suite 900 Newport Beach, California 92660 Telecopier No.: (949) 851-1732 The persons or addresses to which mailings or deliveries shall be made may change from time to time by notice given pursuant to the provisions of this Section 15.4. 90 15.5 SUCCESSORS AND ASSIGNS. Subject to Section 7.12 and 15.3, all terms and provisions of this Agreement shall be binding upon and inure to the benefit of the Parties hereto and their respective transferees, successors and assigns; provided, however, that, except as otherwise contemplated herein, this Agreement and all rights, privileges, duties and obligations of the Parties hereto may not be assigned or delegated by any party hereto without the prior written consent of the other Party to this Agreement and any purported assignment in violation of this Section 15.5 shall be null and void. 15.6 THIRD PARTY BENEFICIARIES. Except as provided in Section 7.12, each party hereto intends that this Agreement shall not benefit, or create any right or cause of action in or on behalf of, any Person other than the Parties hereto. 15.7 COUNTERPARTS. This Agreement may be executed in one or more counterparts, all of which taken together shall constitute one instrument. 15.8 GOVERNING LAW. This Agreement is made and entered into in the State of California and the laws of the State of California shall govern the validity and interpretation hereof and the performance of the parties hereto of their respective duties and obligations hereunder. 15.9 CAPTIONS. The captions contained in this Agreement are for convenience of reference only and do not form a part of this Agreement. 15.10 WAIVER AND MODIFICATION. No waiver of any term, provision or condition of this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be or construed as a further or continuing waiver of any such term, provision or condition of this Agreement. This Agreement and the Agreement of Merger, when executed and delivered, may be modified or amended by action of the Board of Directors of the Company and the Bank without action by their respective shareholders to the extent permitted by law. This Agreement may be modified or amended only by an instrument of equal formality signed by the Parties of their duly authorized agents. 15.11 ATTORNEYS' FEES. In the event either of the Parties to this Agreement brings an action or suit against the other Party by reason of any breach of any covenant, agreement, representation, warranty or other provision hereof, or any breach of any duty or obligation created hereunder by such other Party, the prevailing Party, as determined by the court or other body having jurisdiction, shall be entitled to have and recover of and from the losing Party, as determined by the court or other body have jurisdiction, all reasonable costs and expenses incurred or sustained by such prevailing Party in connection with such suit or action, including, without limitation, legal fees and court costs (whether or not taxable as such). 15.12 ENTIRE AGREEMENT. The making, execution and delivery of this Agreement by the Parties hereto have not been induced by any representations, 91 statements, warranties or agreements other than those herein expressed. This Agreement embodies the entire understanding of the Parties and there are no further or other agreements or understandings, written or oral, in effect between the Parties relating to the subject matter hereof, unless expressly referred to by reference herein. 15.13 SEVERABILITY. Whenever possible, each provision of this Agreement and every related document shall be interpreted in such manner as to be valid under applicable law. However, if any provision of any of the foregoing shall be invalid or prohibited under said applicable law, it shall be construed, interpreted and limited to effectuate its purpose to the maximum legally permissible extent. If it cannot be so construed and interpreted so as to be valid under such law, such provision shall be ineffective to the extent of such invalidity or prohibition without invalidating the remainder of such provision or the remaining provisions of this Agreement, and this Agreement shall be construed to the maximum extent possible to carry out its terms without such invalid or unenforceable provision or portion thereof. 15.14 EFFECT OF DISCLOSURE. Any list, statement, document, writing or other information set forth in, referenced to or attached to any schedule or exhibit delivered pursuant to any provision of this Agreement shall be deemed to constitute disclosure for purposes of any other schedule or exhibit required to be delivered pursuant to any other provision of this Agreement. 15.15 KNOWLEDGE. Whenever any statement herein or in any schedule, exhibit, certificate or other documents delivered to any Party pursuant to this Agreement is made "to the knowledge" or "to the best knowledge" of any Party or other person, such Party or other person, who shall be an officer of a Party, shall make such statement only after conducting an investigation which such person determines in good faith to be reasonable under the circumstances of the subject matter thereof, and each such statement shall constitute a representation that such investigation has been conducted. 15.16 TERMINATION OF REPRESENTATION, WARRANTIES AND COVENANTS. The representations, warranties and covenants of each Party contained herein or in any certificate or other writing delivered by such Party pursuant hereto or in connection herewith shall not survive the Merger other than those provided for in Sections 2.1(b), 2.1(c), 7.12, 13.1, 14.1(e), 15.1, 15.3, 15.11 and 15.12 which shall survive a termination. 92 IN WITNESS WHEREOF, the Parties hereto have duly executed this Agreement on the day and year first above written. PACIFIC COMMUNITY BANKING GROUP By: /s/ E. LYNN CASWELL -------------------------------- E. Lynn Caswell, Chairman of the Board and Chief Executive Officer VALLEY BANK By: /s/ Marion V. Ashley -------------------------------- Marion V. Ashley Chairman of the Board By: /s/ N. Douglas Mills -------------------------------- N. Douglas Mills President and Chief Executive Officer By: /s/ Willow I. Wachtel Decker -------------------------------- Willow I. Wachtel Decker Director By: /s/ Juan P. Renteria -------------------------------- Juan P. Renteria Director By: /s/ Jesse Washington -------------------------------- Jesse Washington Director 93 By: /s/ George E. Wilson -------------------------------- George E. Wilson Director By: /s/ Helga Wolf -------------------------------- Helga Wolf Director By: /s/ Eugene H. Wood -------------------------------- Eugene H. Wood Director 94 EXHIBIT A AGREEMENT OF MERGER THIS AGREEMENT OF MERGER is made and entered into as of this day of , 1999, by and between Interim Valley Bank (referred to herein as "Interim Bank"), a California corporation, and Valley Bank ("VB"), a California corporation, and Pacific Community Banking Group (the "Company"), a California corporation, with reference to the following facts: RECITALS 1. Interim Bank is a California corporation duly organized, validly existing and in good standing under the laws of the State of California, with authorized capital of 1,000,000 shares of no par value common stock of which, on the date hereof, there are 100 shares issued and outstanding ("Interim Bank Common Stock") owned by the Company. 2. VB is a banking corporation duly organized, validly existing and in good standing under the laws of the State of California and is authorized by the California Commissioner of Financial Institutions to conduct a general banking business, with authorized capital of 2,400,000 shares of the $5.00 par value common stock, of which, on the date hereof, there are 1,171,906 shares issued and outstanding ("VB Common Stock"). 3. The Company is a California corporation duly organized, validly existing and in good standing under the laws of the State of California, with authorized capital of 100,000,000 shares of no par value common stock, of which, on the date hereof, there are 2,500 shares issued and outstanding ("Company Common Stock"), and 100,000,000 shares of Preferred Stock of which on the date hereof there are shares issued and outstanding. 4. The respective Boards of Directors of Interim Bank and VB deem it desirable and in the best interest of their respective corporations and stockholders that VB be merged (the "Merger") with and into Interim Bank as provided in this Agreement of Merger pursuant to the laws of the State of California and that Interim Bank be the surviving corporation ("Surviving Corporation"). 5. In connection with the Merger, the Company and VB have entered into a First Restatement of Agreement and Plan of Reorganization, dated as of January 5, 1999, as amended on March 4, 1999 and March _, 1999 (the "Reorganization Agreement"). NOW THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein set forth and for the purpose of prescribing the terms and conditions of such Merger, the parties hereto agree as follows: 1 ARTICLE I THE MERGER Upon consummation of the Merger at the Effective Time (as defined in Article IX hereof), VB shall be merged with and into Interim Bank which shall thereupon be the Surviving Corporation, and the separate corporate existence of VB shall cease. ARTICLE II NAME The name of the Surviving Corporation shall be changed to "Valley Bank." ARTICLE III ARTICLES OF INCORPORATION The Articles of Incorporation of Interim Bank as in effect immediately prior to the Effective Time shall, at and after the Effective Time, continue to be the Articles of Incorporation of the Surviving Corporation. ARTICLE IV BYLAWS The Bylaws of Interim Bank as in effect immediately prior to the Effective Time shall, at and after the Effective Time, continue to be the Bylaws of the Surviving Corporation. ARTICLE V DIRECTORS The Board of Directors and officers of Interim Bank and VB at the Effective Time shall serve as the Board of Directors and officers of the Surviving Corporation until such time as their successors have been elected and qualified as provided for by the Bylaws of Interim Bank. ARTICLE VI RIGHTS AND DUTIES OF SURVIVING CORPORATION At and after the Effective Time, all rights, privileges, powers and franchises and property and assets of every kind and description of Interim Bank and VB shall be vested in and be held and enjoyed by the Surviving Corporation, without further act or deed, and all the estates and interests of every kind of Interim Bank and VB, including all debts due to either of them, shall be as effectively the property of the 2 Surviving Corporation as they were of Interim Bank and VB, and the title to any real estate vested by deed or otherwise in either Interim Bank or VB shall not revert or be in any way impaired by reason of the Merger; and all rights of creditors and liens upon any property of Interim Bank and VB shall be preserved unimpaired and all debts, liabilities and duties of Interim Bank and VB shall be debts, liabilities and duties of the Surviving Corporation and may be enforced against it to the same extent as if said debts, liabilities and duties had been incurred or contracted by it. ARTICLE VII CONVERSION OF SHARES In and by virtue of the Merger and at the Effective Time, pursuant to this Agreement of Merger, the shares of Interim Bank Stock and VB Stock outstanding at the Effective Time shall be converted as follows: (a) EFFECT ON INTERIM BANK STOCK. Each share of Interim Bank Stock issued and outstanding immediately prior to the Effective Time shall for all purposes be deemed to represent, one share of common stock of the Surviving Corporation. (b) EFFECT ON VB STOCK. Each share of VB Common Stock issued and outstanding immediately prior to the Effective Time, except for shares as to which dissenters' rights are perfected pursuant to Section 1300 ET SEQ. of the California Corporations Code ("Perfected Dissenting Shares") shall be automatically cancelled and cease to be an issued and outstanding share of VB Stock and shall be converted into the right to receive two-thirds (2/3) share of Company Stock, and a Warrant exercisable into one-third share of Company Stock. The Company will pay or cause to be paid cash in lieu of fractional shares of VB Stock in an amount proportionate to the fair value of a whole share as determined by the board of directors of The Company which would otherwise be issuable as provided above. ARTICLE VIII SHAREHOLDER APPROVAL This Agreement shall be APPROVED by the affirmative vote of the holders of a least a majority of the capital stock of PCBG and the Company, and by the affirmative vote of the holders of at least two-thirds of the capital stock of VB, at meetings duly held on the call of the directors or otherwise in accordance with law, and the Merger shall become effective on the Effective Time. ARTICLE IX FURTHER ACTION The parties hereto shall execute and deliver, or cause to be executed and delivered, all such deeds and other instruments, and will take or cause to be taken all 3 further or other action as they may deem necessary or desirable, in order to vest in and confirm to the Surviving Corporation title to and possession of all of VB's and Interim Bank's property, rights, privileges, powers and franchises hereunder, and otherwise to carry out the intent and purposes of this Agreement of Merger. ARTICLE X EFFECTIVE TIME The Merger will become effective upon the ENDORSEMENT of a copy of this Agreement of Merger (bearing the certification of the Secretary of State of the State of California) and all other requisite accompanying certificates BY THE California Commissioner of Financial Institutions PURSUANT TO SECTION 4887(B) of THE CALIFORNIA FINANCIAL CODE. The date and time of such ENDORSEMENT with the California Commissioner of Financial Institutions is referred to herein as the "Effective Time". ARTICLE XI SUCCESSORS AND ASSIGNS This Agreement of Merger shall be binding upon and enforceable by the parties hereto and their respective successors, assigns and transferees, but this Agreement of Merger may not be assigned by either party without the written consent of the other. ARTICLE XII GOVERNING LAW This Agreement of Merger has been executed in the State of California, and the laws of the State of California shall govern the validity and interpretation hereof and the performance by the parties hereto. ARTICLE XIII TERMINATION This Agreement of Merger may, by the mutual consent and action of the Boards of Directors of VB and Interim Bank, be abandoned at any time before or after approval thereof by the shareholders of Interim Bank and VB, but not later than the filing of this Agreement of Merger with the Secretary of State of the State of California. ARTICLE XIV SATISFACTION OF OBLIGATIONS AND CONDITIONS (a) The obligations of VB to proceed with the Closing are subject to the satisfaction at or prior to the Closing of all of the conditions to the obligations 4 of Interim Bank under the Reorganization Agreement, any one or more of which, to the extent it is or they are waivable, may be waived, in whole or in part, by VB. (b) The obligations of Interim Bank to proceed with the Closing are subject to the satisfaction at or prior to the Closing of all of the conditions to the obligations of Pacific Community Banking Group and VB under the Reorganization Agreement, any one or more of which, to the extent it is or they are waivable, may be waived, in whole or in party, by Interim Bank. 5 IN WITNESS WHEREOF, VB and Interim Bank, pursuant to the approval and authority duly given by resolution of their respective Board of Directors, have caused this Agreement of Merger to be signed by their respective officers on the day and year first above written. VALLEY BANK By: ------------------------------------- N. Douglas Mills, President By: ------------------------------------- ----------------------, Secretary INTERIM VALLEY BANK By: ------------------------------------- E. Lynn Caswell Chairman of the Board By: ------------------------------------- Alfred Jannard, Secretary PACIFIC COMMUNITY BANKING GROUP By: ------------------------------------- E. Lynn Caswell Chairman of the Board By: ------------------------------------- Alfred Jannard, Secretary 6 EXHIBIT B DIRECTORS AGREEMENT This Agreement ("Agreement") is made and entered into this 30th day of July, 1998 by and between Pacific Community Banking Group, a California corporation ("Company"), and each of the other persons executing this Agreement (each such person is referred to individually as a "Bank Director" and collectively as "Bank Directors" with reference to the following facts: A. Valley Bank, a California banking corporation ("Bank"), and the Company have entered into that certain Agreement and Plan of Reorganization dated as of July 30, 1998 ("Reorganization Agreement"), pursuant to which the Bank will acquire a subsidiary of the Company by means of a Merger, and the Company will exchange cash to the shareholders of the Bank for their shares of the Bank, as those terms are defined in the Reorganization Agreement ("Acquisition"). B. In order to facilitate Company and Bank entering into the Reorganization Agreement, the Bank Directors (comprising the entire Board of Directors of Bank) desire to enter into this Agreement. The execution of this Agreement shall be a condition precedent to the execution of the Reorganization Agreement. NOW, THEREFORE, in consideration of the promises and of the respective representations, warranties and covenants, agreements and conditions contained herein and in the Reorganization Agreement, the parties hereto agree as follows: 1. AGREEMENTS OF BANK DIRECTORS. 1.1 AGREEMENT TO VOTE. Except in the case of an Alternative Transaction permitted by Section 6.5(b) of the Reorganization Agreement, at any meeting of shareholders of Bank or in connection with any solicitation of the written consent of shareholders of Bank to approve the Reorganization Agreement and the transactions contemplated thereby, each of the Bank Directors shall vote or cause to be voted all shares of Common Stock of Bank ("Bank Stock") owned by each such Bank Directors and any other shares of Bank Stock hereafter acquired by each such Bank Director in favor of, and to approve, the principal terms of the Acquisition and any other matter contemplated by the Reorganization Agreement which requires the approval of the shareholders of Bank, including but not limited to the "Merger," as those terms are defined in the Reorganization Agreement. 1.2 AGREEMENT TO RECOMMEND. Except in the case of an Alternative Transaction permitted by Section 6.5(b) of the Reorganization Agreement, each Bank Director shall recommend to the shareholders of Bank to vote in favor of, and to approve, the principal terms of the Acquisition and any other matter contemplated by the Reorganization Agreement. 1 1.3 RESTRICTIONS ON DISPOSITIONS. Except (i) in the case of an Alternative Transaction permitted by Section 6.5(b) of the Reorganization Agreement, (ii) with the prior written consent of Company, or (iii) pursuant to the Acquisition, each Bank Director agrees that such Bank Director will not pledge nor otherwise encumber, sell, assign or otherwise dispose of any shares of Bank Stock currently owned, or acquired after the date of this Agreement, by such Bank Director. 1.4 COOPERATION. Each Bank Director agrees to cooperate fully with Company in connection with the Acquisition, except as otherwise permitted by the Reorganization Agreement. Except in the case of an Alternative Transaction permitted by Section 6.5(b) of the Reorganization Agreement, each Bank Director agrees that he or she will not, directly or indirectly, solicit any inquiries or proposals from, or enter into, or continue any discussions, negotiations or agreements relating to, or vote in favor of any proposal or transaction for disposition of the business or assets of Bank or any subsidiary thereof, or the acquisition of Bank's or any subsidiary of Bank's voting securities or any business combination with, any person entity other than Company. 2. REPRESENTATIONS AND WARRANTIES OF BANK DIRECTORS. Each of the Bank Directors represents and warrants to and agrees with Company as follows: 2.1 CAPACITY. Each such Bank Director has all the requisite capacity and authority to enter into and perform such Bank Director's obligations under this Agreement. 2.2 BINDING AGREEMENT. This Agreement constitutes the valid and legally binding obligation of each such Bank Director. 2.3 NON-CONTRAVENTION. The execution and delivery of this Agreement by each such Bank Director does not, and the performance by such Bank Director of such Bank Director's obligations hereunder will not, violate or conflict with or constitute a default under any agreement, instrument, contract or other obligation or any order, arbitration award, judgment or decree to which such Bank Director is a party or by which such Bank Director is bound, or any statute, rule or regulation to which such Bank Director or any of such Bank Director's property is subject. 2.4 OWNERSHIP OF SHARES. SCHEDULE 1 hereto correctly sets forth the number of shares of Bank Stock owned by each Bank Director, or with respect to which each Bank Director has voting power or beneficial ownership, as of the date indicated on such schedule. Each Bank Director has good title to all of the shares of Bank Stock indicated as owned by such Bank Director in the capacity set forth on SCHEDULE 1 as of the date indicated on such SCHEDULE 1, and such shares of 2 Bank Stock are so owned free and clear of any liens, security interests, charges or other encumbrances, except as set forth in such SCHEDULE 1. 3. TERMINATION. 3.1 TERMINATION DATE. This Agreement shall terminate and be of no further force and effect immediately upon the earlier of: (a) consummation of the Acquisition or (b) termination of the Reorganization Agreement in accordance with the terms thereof. 3.2 EFFECT OF TERMINATION. Upon the termination of this Agreement in accordance with Section 3.1 hereof, the respective obligations of the parties hereto shall immediately become void and have no further force or effect except that the termination of this Agreement shall not excuse or forgive any breach hereof. 4. SPECIFIC PERFORMANCE. The parties hereto recognize and agree that monetary damages will not compensate adequately the parties hereto for nonperformance. Accordingly, each party agrees that such party's obligations shall be enforceable by court order requiring specific performance. 5. MISCELLANEOUS. 5.1 EXPENSES. Each party hereto shall pay its own costs and expenses, including, without limitation, those of its attorneys and accountants, in connection with this Agreement and transactions covered and contemplated hereby. 5.2 NOTICES. All notices, demands or other communications hereunder shall be in writing and be made by (a) hand delivery; (b) overnight mail; (c) United States mail, first class, certified or registered, postage prepaid; or (d) facsimile transmission, and shall be deemed to have been duly given (i) on the date of service if delivered by hand or facsimile transmission (provided that telecopied notices are also mailed by United States mail, first class, certified or registered, postage prepaid); (ii) on the next day if delivered by overnight mail; or first-class, certified or registered, postage prepaid, and properly addressed as follows: (a) If to Company: Pacific Community Banking Group 23332 Mill Creek Drive, Suite 230 Laguna Hills, California 92653 Attention: E. Lynn Caswell, President Telecopier: (949) 460-4501 3 With copies to: Knecht & Hansen 1301 Dove Street, Suite 900 Newport Beach, CA 92660 Attention: Loren P. Hansen, Esq. Telecopier: (949) 851-1732 (b) If to a Bank Director: to the Bank Director and address noted on page 7 hereof With copies to: Aldrich & Bonnefin 18200 Von Karman Avenue, Suite 730 Irvine, California 92612-1029 Attention: Mark E. Aldrich, Esq. Telecopier: (949) 474-0617 The persons or addresses to which mailings or deliveries shall be made may change from time to time by notice given pursuant to the provisions of this SECTION 5.2. 5.3 SUCCESSORS AND ASSIGNS. Subject to Section 5.4 herein, all terms and provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective transferees, successors and assigns; provided, however, that, except as otherwise contemplated herein, this Agreement and all rights, privileges, duties and obligations of the parties hereto may not be assigned or delegated by any Bank Director without the prior written consent of Company and any purported assignment in violation of this Section 5.3 shall be null and void. 5.4 THIRD PARTY BENEFICIARIES. Each party hereto intends that this Agreement shall not benefit, or create any right or cause of action in or on behalf of, any person other than the parties hereto. As used in this Agreement, the term "party" or "parties" shall refer only to Company and the Bank Directors or any of them. 5.5 COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one instrument. 5.6 GOVERNING LAW. This Agreement is made and entered into in the State of California and the laws of the State of California shall govern the 4 validity and interpretation hereof and the performance of the parties hereto of their respective duties and obligations hereunder. 5.7 CAPTIONS. The captions contained in this Agreement are for convenience of reference only and do not form a part of this Agreement. 5.8 WAIVER AND MODIFICATION. No waiver of any term, provision or condition of this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be or construed as a further or continuing waiver of any such term, provision or condition of this Agreement. This Agreement may be modified or amended only by an instrument of equal formality signed by the parties or their duly authorized agents. 5.9 ATTORNEYS' FEES. In the event a Bank Director or Company brings an action or suit against the other party by reason of any breach of any covenant, agreement, representation, warranty or other provision hereof, or any breach of any duty or obligation created hereunder by such other party, the prevailing party, as determined by the court or other body having jurisdiction, shall be entitled to have and recover of and from the losing party, as determined by the court or other body having jurisdiction, all reasonable costs and expenses incurred or sustained by such prevailing party in connection with such action or suit, including, without limitation, legal fees and court costs (whether or not taxable as such). In an action or suit brought by a Bank Director or Company to enforce any provision hereof, or for damages for the breach hereof, such action or suit shall be commenced and maintained exclusively in the state court sitting in Orange County, California. 5.10 ENTIRE AGREEMENT. The making, execution and delivery of this Agreement by the parties hereto have not been induced by any representation, statements, warranties or agreements other than those expressed herein. This Agreement, in addition to the applicable provisions of the Reorganization Agreement, embodies the entire understanding of the parties and there are no further or other agreements or understandings, written or oral, in effect between the parties relating to the subject matter hereof, unless expressly referred to by reference herein. 5.11 SEVERABILITY. Whenever possible, each provision of this Agreement and every related document shall be interpreted in such manner as to be valid under applicable law. However, if any provision of any of the foregoing shall be invalid or prohibited under said applicable law, it shall be construed, interpreted and limited to effectuate its purpose to the maximum legally permissible extent. If it cannot be so construed and interpreted so as to be valid under such law, such provision shall be ineffective to the extent of such invalidity or prohibition without invalidating the remainder of such provision or the remaining provisions of this Agreement, and this Agreement shall be construed to the maximum extent possible to carry out its terms without such invalid or unenforceable provision or portion thereof. 5 5.12 SEVERAL OBLIGATIONS. All duties and obligations of each party to this Agreement shall be several and not joint. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written. Pacific Community Banking Group By: /s/ E. Lynn Caswell --------------------------- E. Lynn Caswell, Chairman 6 "Bank Director" and address /s/ Marion V. Ashley /s/ Doug Mills - --------------------------- --------------------------- Marion V. Ashley Doug Mills 170 Wilkerson Ave., S#B 11650 Steeplechase Drive Perris, CA 92570 Moreno Valley, CA 92555 /s/ Juan Renteria /s/ Willow I. Decker - --------------------------- --------------------------- Juan Renteria Willow I. Decker 1530 Nandina Ave. 8218 Wheeler Ave. Perris, CA 92571 Fontana, CA 92355 /s/ Jesse Washington /s/ George E. Wilson - --------------------------- --------------------------- Jesse Washington George E. Wilson 30506 Cinnamon Teak Dr. 27263 Pleasant Hill Drive Canyon Lake, CA 92587 Highland, CA 92346 /s/ Helga Wolf /s/ Gene Wood - --------------------------- --------------------------- Helga Wolf Gene Wood 11640 Dalehurst Rd. 2349 Newpat Ave. Moreno Valley, CA 92555 San Bernardino, CA 92404 7 Schedule 1 as of July 17, 1998
Owned Bank Common Shares - ----- ------------------ Marion V. Ashley 122 Doug Mills 5,002 Willow I Decker 116,424 Juan Renteria 551 Jesse Washington 2,625 George E. Wilson 6,291 Helga Wolf 4,400 Gene Wood
8 Exhibit C WB WARRANT AGREEMENT THIS WARRANT AGREEMENT, dated as of 1999, is made between PACIFIC COMMUNITY BANKING GROUP, a California corporation (the "Company"), and each person to whom a warrant is issued or provided herein (the "Holder"). RECITALS A. The Company proposes to issue warrants as hereinafter described (the "Warrants") to each Holder to purchase shares of its Common Stock, no par value per share (the "Common Stock"), in connection with the acquisition of Valley Bank (the "Bank") by the Company in which at the Effective Time of the Merger, the Bank would become a wholly-owned subsidiary of the Company, and all of the issued and outstanding shares of Valley Bank Stock ("Bank Stock"), except for shares of Bank Stock held by Dissenting Shareholders, shall be converted into and exchanged for cash, shares of Company Stock, and a warrant exercisable into shares of Company Stock, under the terms and conditions contained in the First Restatement of the Agreement and Plan of Reorganization dated January 5, 1999, as amended in which each warrant (the "Warrant") entitling the holder thereof to purchase shares of Common Stock of the Company (the "Warrant Shares"). B. In consideration of the foregoing and for the purpose of defining the terms and provisions of the Warrants and the respective rights and obligations thereunder of the Company and the Holder, the Company and the Holder hereby agree as follows: SECTION 1. GRANT OF WARRANT. The Company hereby grants to the Holder, as of the date hereof, Warrants to purchase all or any part of the number of shares of the Company's Common Stock set forth in the Warrant, subject to the terms, conditions and adjustment provisions as provided in this Agreement. SECTION 2. TERM OF WARRANTS; EXERCISE OF WARRANTS. 2.1 TERM OF EXERCISE OF WARRANTS. The Warrants are exercisable for a ten-year period commencing upon the date of issuance (the "Issuance Date"). Subject to the terms of this Agreement, each Holder shall have the right, which may be exercised at any time until ten years from the original date of issuance (the "Expiration Date") to purchase from the Company that number of shares of Common Stock of the Company specified in Section 1 at the warrant prices specified in Section 9. Upon such purchase, the shares of Common Stock of the Company will be fully paid and nonassessable to which the Holder may at the time be entitled to purchase upon exercise of such Warrants. 1 Exhibit C 2.2 EXERCISE OF WARRANTS. A Warrant may be exercised upon surrender to the Company at its principal office of the certificate or certificates evidencing the Warrants to be exercised, together with the form of election to purchase on the reverse thereof duly filled in and signed, (and upon payment to the Company for the account of the Company in accordance with the provisions of Sections 9 and 10 hereof), for the number of shares of Common Stock in respect of which such Warrants are then exercised. Payment of the aggregate Warrant Price shall be made by check, Cashier's Check, money order, or any combination thereof. Subject to Section 6 hereof, upon such surrender of Warrants and payment of the Warrant Price as aforesaid, the Company shall issue and cause to be delivered with all reasonable dispatch to or upon the written order of the Holder and in such name or names as the Holder may designate, a certificate or certificates for the number of full shares of Common Stock so purchased upon the exercise of such Warrants, together with cash, as provided in Section 11 hereof, in respect of any fractional shares of Common Stock otherwise issuable upon such surrender. Such certificate or certificates shall be deemed to have been issued and any person so designated to be named therein shall be deemed to have become a holder of record of such Common Stock as of the date of the surrender of such Warrants and payment of the Warrant Price, as aforesaid; provided, however, that if, at the date of surrender of such Warrants and payment of the Warrant Price, the transfer books for the Common Stock or other class of stock purchasable upon the exercise of such Warrants shall be closed, the certificates for the Common Stock in respect of which such Warrants are then exercised shall be issuable as of the date on which such books shall next be opened (whether before or after the Expiration Date) and until such date the Company shall be under no duty to deliver any certificate for such Common Stock; provided further, however, that the transfer books of record, unless otherwise required by law, shall not be closed at any one time for a period longer than twenty days. The rights of purchase represented by the Warrants shall be exercisable, at the election of the Holders thereof, either in full or from time to time in part and, in the event that a certificate evidencing Warrants is exercised in respect of less than all of the Common Stock purchasable on such exercise at any time prior to the date of expiration of the Warrants, a new certificate evidencing the remaining Warrant or Warrants will be issued. SECTION 3. REGISTRATION. Transferability. Issuance and Form of Warrant. 3.1 REGISTRATION. The Warrants shall be numbered and shall be registered in a Warrant Register as they are issued. The Company shall be entitled to treat the Holder of any Warrant as the owner in fact thereof for all purposes and shall not be bound to recognize any equitable or other claim to or interest in such Warrant on the part of any other person, and shall not be liable for any registration of transfer of Warrants which are registered or to be registered in the name of a 2 fiduciary or the nominee of a fiduciary unless made with the actual knowledge that a fiduciary or nominee is committing a breach of trust in requesting such registration of transfer, or with such knowledge of such facts that its participation therein amounts to bad faith. 3.2 TRANSFER. The Common Stock and the Warrants received from the Company pursuant to the Agreement will be separately transferable from the date of issuance. The Warrants shall be transferable on the books of the Company maintained at the principal office of the Company upon delivery thereof duly endorsed by the Holder or by his duly authorized attorney or representative, or accompanied by proper evidence of succession, assignment or authority to transfer, with signatures properly guaranteed. In all cases of transfer by an attorney, the original power of attorney, duly approved, or an official copy thereof, duly certified, shall be deposited and remain with the Company. In case of transfer by executors, administrators, guardians or other legal representatives, duly authenticated evidence of their authority shall be produced, and may be required to be deposited and remain with the Company in its discretion. Upon any registration of transfer, the Company shall execute and deliver a new Warrant or Warrants to the persons entitled thereto. The Warrants may be exchanged at the option of the Holder thereof, when surrendered at the principal office of the Company for another Warrant or Warrants to the persons entitled thereto. The Warrants may be exchanged at the option of the Holder thereof, when surrendered at the principal office of the Company for another Warrant, or other Warrants of different denominations, of like tenor and representing in the aggregate the right to purchase a like number of Warrant Shares. The Company shall not be required to effect any registration of transfer or exchange which will result in the issuance of a Warrant Certificate for a fraction of a Warrant. The Holder understands that the Warrants and the securities exercisable hereunder are intended to be registered pursuant to the Securities Act of 1933, as amended, and such securities are intended to be transferable once the registration has been completed. 3.3 ISSUANCE. Warrant certificates shall be issued and delivered by the Company as evidence of the Warrants sold by the Company as a part of the Offering (the "Warrant Certificates"). Each Warrant Certificate shall evidence the right, subject to the provisions of this Agreement and of the Warrant Certificate itself, for the registered holder thereof or his assigns to purchase the number of shares of Common Stock of the Company stated therein. 3.4 FORM OF WARRANT. The Form of Warrant shall be substantially as set forth in EXHIBIT "A" attached hereto. The price per share of Common Stock and the number of shares of Common Stock issuable upon the exercise of Warrants are subject to adjustment upon the occurrence of certain events, all as hereinafter provided. The Warrants shall be executed on behalf of the Company by its Chairman of the Board or Chief Executive Officer or one of its Vice Presidents, 3 under its corporate seal reproduced thereon attested by its Secretary or an Assistant Secretary. The signature of any of such officers on the Warrants may be manual or facsimile. Warrants bearing the manual or facsimile signatures of individuals who were at any time the proper officers of the Company shall bind the Company, notwithstanding that such individuals or any one of them shall have ceased to hold such offices prior to the delivery of such Warrants or did not hold such offices on the date of this Agreement. Warrants shall be dated as of the date of signature thereof by the Company either upon initial issuance or upon division, exchange, substitution or transfer. SECTION 4. SIGNATURE OF WARRANTS. The Warrants shall be signed by the Company (or any successor to the Company) and shall not be valid for any purpose unless so signed. Warrants may be signed, however, by the Company and may be delivered by the Company, notwithstanding that the persons whose manual or facsimile signatures appear thereon as proper officers of the Company shall have ceased to be such officers at the time of such signature, issuance or delivery. SECTION 5. EXCHANGE OF WARRANT CERTIFICATES. Each Warrant certificate may be exchanged for another certificate or certificates entitling the Holder thereof to purchase a like aggregate number of shares of Common Stock as the certificate or certificates to be so exchanged. Thereupon, the Company shall execute and deliver to the person entitled thereto a new Warrant certificate or certificates, as the case may be, as so requested. SECTION 6. PAYMENT OF TAXES. The Company will pay all documentary stamp taxes, if any, attributable to the initial issuance of shares of Common Stock upon the exercise of Warrants; provided, however, that the Company shall not be required to pay any tax or taxes which may be payable in respect of any transfer involved in the issuance or delivery of any Warrants or certificate for shares of Common Stock in a name other than that of the registered Holder of Warrants in respect of which such shares of Common Stock are issued, and in such case the Company shall not be required to issue or deliver any certificate for shares of Common Stock or any Warrant until the person requesting the same has paid to the Company the amount of such tax or has established to the Company's satisfaction that such tax has been paid. SECTION 7. MUTILATED OR MISSING WARRANTS. In case of any of the certificates evidencing the Warrants shall be mutilated, lost, stolen or destroyed, the Company may, in its discretion, execute, issue and deliver in exchange and substitution for and upon cancellation of the mutilated Warrant certificate, or in lieu 4 of and substitution for the Warrant certificate lost, stolen or destroyed, a new Warrant certificate of like tenor and representing an equivalent right or interest; but only upon receipt of evidence satisfactory to the Company of such loss, theft or destruction of such Warrant and indemnity, if requested, also satisfactory to them. An applicant for such substitute Warrant certificate shall also comply with such other reasonable regulations and pay such other reasonable charges as the Company may prescribe. SECTION 8. RESERVATION OF SHARES: PURCHASE OF WARRANTS. 8.1 RESERVATION OF WARRANT SHARES. There will be reserved, and thereafter the Company shall at all times keep reserved, out of its authorized Common Stock, a number of shares of Common Stock sufficient to provide for the exercise of the rights of purchase represented by the outstanding Warrants. The Transfer Agent for the Common Stock and every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of any rights of purchase aforesaid will be irrevocably authorized and directed at all times to reserve such number of authorized shares as shall be requisite for such purposes. The Company will keep a copy of this Agreement on file with the Transfer Agent for the Common Stock and with every subsequent transfer agent for any shares of the Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrants. The Company will supply such Transfer Agent with duly executed stock certificates for such purposes and will provide or otherwise make available any cash which may be payable as provided in Section 11 hereof. All Warrants surrendered in the exercise of the rights thereby evidenced shall be canceled by the Company. 8.2 PURCHASE OF WARRANTS BY THE COMPANY. The Company shall have the right, except as limited by law, other agreement or herein, to purchase or otherwise acquire Warrants at such times, in such manner and for such consideration as it may deem appropriate, but the Holder of such warrant shall be under no obligation to sell. 8.3 CANCELLATION OF WARRANTS. In the event the Company shall purchase or otherwise acquire Warrants, the same shall thereupon be canceled by the Company and retired. The Company shall cancel any Warrant surrendered for exchange, substitution, transfer or exercise in whole or in part. SECTION 9. WARRANT EXERCISE PRICE. The price per share at which shares of Common Stock shall be purchasable upon exercise of Warrants (the "Warrant Price") shall be $ per share from the date of issuance to on or before the end of the tenth year after the date of issuance of the Warrant, subject to the adjustment pursuant to Section 10 hereof. 5 SECTION 10. ADJUSTMENT OF WARRANT PRICE AND NUMBER OF SHARES. The number and kind of securities purchasable upon the exercise of each Warrant and the Warrant Price shall be subject to adjustment from time to time upon the occurrence of certain events, as hereinafter defined. 10.1 MECHANICAL ADJUSTMENTS. The number of Warrant Shares purchasable upon the exercise of each Warrant and the Warrant price shall be subject to adjustment as follows: (a) In case the Company shall (i) pay a dividend in shares of Common Stock or make a distribution in shares of Common Stock, (ii) subdivide its outstanding shares of Common Stock into a greater number of shares, (iii) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock or (iv) issue a reclassification of its shares of Common Stock or capital reorganization of other securities of the Company, the number of Warrant Shares purchasable upon exercise of each Warrant immediately prior thereto shall be adjusted so that the Holder of each Warrant shall be entitled to receive the kind and number of Warrant Shares or other securities of the Company which he would have owned or have been entitled to receive after the occurrence of any of the events described above, had such Warrant been exercised immediately prior to the happening of such event or any record date with respect thereto. An adjustment made pursuant to this paragraph (a) shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. (b) In case, at any time or from time to time after issuance of the Warrant and while the Warrant remains outstanding and has not been exercised, the Company shall issue or sell any warrants or options, other than options granted under the Company's 1999 Stock Option Plan, as it may be amended from time to time, or any similar plan hereafter adopted by the Company or any of its subsidiaries, for the purchase of the Company's Common Stock with a price per share at which shares of Common Stock shall be purchasable upon exercise of such warrants or options that is less than the Warrant Price in effect immediately prior to such issue or sale, then forthwith upon such issue or sale the Warrant Price shall be immediately reduced to such price per share. No adjustment of the Warrant Price shall be made as a result of the Company's issuance or sale of Common Stock or other securities of the Company, regardless of the price at which such shares or other securities are issued, including, without limitation, the Company's issuance or sale of stock options under the Company's 1999 Stock Option Plan, as it may be amended from time to time, or any similar plan hereafter adopted by the Company or any of its subsidiaries, with an exercise price less than the Warrant Price. In addition, no adjustment of the Warrant Price shall be made if the adjustment would otherwise be for an amount less then $.25 per share, but any such nonadjustment shall be carried forward and shall be made at the time of and together with the next subsequent adjustment which, together with any 6 adjustments so carried forward, shall amount to $..25 per share or more. Further, no adjustment shall be made in the case of an issuance or sale of warrants with respect to fewer than 10% of the then-outstanding shares of the Company's Common Stock in any 24 month period. (c) Whenever the number of Warrant Shares purchasable upon the exercise of each Warrant is adjusted, as herein provided, the Warrant Price payable upon exercise of each Warrant shall be adjusted by multiplying such Warrant Price immediately prior to such adjustment by a fraction, of which the numerator shall be the number of Warrant Shares purchasable upon the exercise of each Warrant immediately prior to such adjustment, and of which the denominator shall be the number of Warrant Shares so purchasable immediately thereafter. (d) For the purpose of this subsection 10. 1, the term "shares of Common Stock" shall mean (i) the class of stock designated as the Common Stock of the Company at the date of this Agreement, or (ii) any other class of stock resulting from successive changes or reclassifications of such shares consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. In the event that at any time, as a result of an adjustment made pursuant to paragraph (a) above, the Holders shall become entitled to purchase any shares of the Company other than shares so purchasable upon exercise of each Warrant and the Warrant Price of such shares shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the shares of Common Stock contained in paragraphs (a) and (b), inclusive, above, and the provisions of Section 5 and subsections 10.2 through 10.4, inclusive, with respect to the shares of Common Stock shall apply on like terms to any such other shares. 10.2 NOTICE OF ADJUSTMENT. Whenever the number of shares of Common Stock purchasable upon the exercise of each Warrant or the Warrant Price of such shares of Common Stock is adjusted, as herein provided, the Company, within thirty (30) days thereafter, shall cause to be mailed promptly by first class mail, postage prepaid, to each Holder notice of such adjustment or adjustments and the Warrant Price of such shares of Common Stock after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which such adjustment was made. A firm of independent public accountants selected by the Board of Directors of the Company (who may be the regular accountants employed by the Company) may make any computation required under this Section 10.2. 10.3 NO ADJUSTMENT FOR DIVIDENDS OR DISTRIBUTIONS. Except as provided in subsection 10.1, no adjustment in respect of any dividends or distributions shall be made during the term of a Warrant or upon the exercise of a Warrant. 7 10.4 PRESERVATION OF PURCHASE RIGHTS UPON CONSOLIDATION, MERGER. ETC. In case of any consolidation of the Company with, or merger of the Company into, another corporation, or in case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety, the Company or such successor or purchasing corporation, as the case may be, shall execute an agreement that each Holder shall have the right thereafter upon payment of the Warrant price in effect immediately prior to such action to purchase upon the exercise of each Warrant the kind and amount of shares and other securities and property (including cash) which he would have owned or have been entitled to receive after the occurrence of such consolidation, merger, sale or conveyance had such Warrant been exercised immediately prior to such action. The Company shall mail by first class mail, postage prepaid, to each Holder, notice of the execution of any such agreement. Such agreement shall provide for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 10. The provisions of this subsection 10.4 shall similarly apply to successive consolidations, mergers, sales or conveyances. 10.5 STATEMENTS ON WARRANTS. Irrespective of any adjustments in the Warrant Price or the number or kind of shares purchasable upon the exercise of the Warrants, Warrants theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in the Warrants initially issuable pursuant to this Agreement. SECTION 11. FRACTIONAL INTERESTS. The Company shall not be required to issue fractional shares of Common Stock on the exercise of Warrants. If more than one Warrant shall be presented for exercise of shares of Common Stock in full at the same time by the same Holder, the number of full shares of Common Stock which shall be issuable upon the exercise thereof shall be computed on the basis of the aggregate number of shares of Common Stock purchasable upon exercise of the Warrants so presented. If any fraction of a share of Common Stock would, except for the provisions of this Section 11, be issuable on the exercise of any Warrant (or specified portion thereof), the Company shall pay an amount in cash equal to the difference between the then current book value price per share of Common Stock and the exercise price of the Warrant, multiplied by such fraction. SECTION 12. NO RIGHTS AS STOCKHOLDERS: NOTICES TO HOLDERS. Nothing contained in this Agreement or in any of the Warrants shall be construed as conferring upon the Holders or their transferees the right to vote or to receive dividends or to consent or to receive notice as stockholders in respect of any meeting of stockholders for the election of directors of the Company or any other matter, or any rights whatsoever as stockholders of the Company. If, however, at any time after 60 days before the Exercise Date, and prior to the expiration of the Warrants and prior to their exercise, any of the following events shall occur: 8 (a) the Company shall declare any dividend or distribution payable in any securities upon its shares of Common Stock to the Holders of its shares of Common Stock; or (b) The Company shall offer to the holders of its shares of Common Stock any additional shares of Common Stock or securities convertible into shares of common stock or any right to subscribe thereto; or (c) A dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger, or sale of all or substantially all of its property, assets, and business as an entirety) shall be proposed; then in any one or more of said events, the Company shall give notice in writing of such event to the Holders as provided in Section 13 hereof, such giving of notice to be completed at least 20 days prior to the date fixed as a record date or the date of closing the transfer books for the determination of the stockholders entitled to such dividend, distribution, or subscription rights, or for the determination of stockholders entitled to vote on such proposed dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the transfer books, as the case may be. Failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of any action taken in connection with such dividend, distribution or subscription rights, or proposed dissolution, liquidation or winding up. SECTION 13. NOTICES. Any notice pursuant to this Agreement be any Holder to the Company shall be in writing and shall be mailed first class, postage prepaid, or delivered (a) to the Company, at its office at 23332 Mill Creek Drive, Suite 230, Laguna Hills, California 92653, with copies to Knecht & Hansen, 1301 Dove Street, Suite 900, Newport Beach, California 92660. Each party hereto may from time to time change the address to which notices to it are to be delivered or mailed hereunder by notice in writing to the other party. Any notice mailed pursuant to this Agreement by the Company to the Holders shall be in writing and shall be mailed first class, postage prepaid, or delivered to such Holders at their respective addresses on the books of the Company. SECTION 14. SUPPLEMENTS AND AMENDMENTS. The Company may not supplement or amend this Agreement without the approval of any Holder, in order to cure any ambiguity or to correct or supplement any provision contained herein which may be defective or inconsistent with any other provision herein, or to make any other provisions in regard to matters or questions arising hereunder which the Company and the Holder may deem necessary or desirable and which shall not be inconsistent with the provisions of the Warrants. 9 SECTION 15. SUCCESSORS. All covenants and provisions of this Agreement by or for the benefit of the Company or the Holder shall bind and inure to the benefit of their respective successors and assigns hereunder. SECTION 16. APPLICABLE LAW. This Agreement and Warrant issued hereunder shall be governed by and construed in accordance with the laws of the State of California, without giving effect to principles of conflict of laws. SECTION 17. BENEFITS OF THIS AGREEMENT. Nothing in this Agreement shall be construed to give to any person or corporation other than the Company and the Holders any legal or equitable right, remedy or claim under this Agreement; but this Agreement shall be for the sole and exclusive benefit of the Company and the Holders of the Warrants. SECTION 18. COUNTERPARTS. This Agreement may be executed in any number of counterparts and each of such counterparts shall for all purposes be deemed to be an original, and all such counterparts shall together constitute but one and the same instrument. SECTION 19. CAPTIONS. The captions of the Sections and subsections of this Agreement have been inserted for convenience only and shall have no substantive effect. 10 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed, all as of the day and year first written. PACIFIC COMMUNITY BANKING GROUP By: ------------------------------------- E. Lynn Caswell Chairman and Chief Executive Officer By: ------------------------------------- ------------------------------------- Secretary 11 EX-2.5 6 EXHIBIT 2.5 Exhibit 2.5 FIRST AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION This FIRST AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION (the "First Amendment") is dated as of March 4, 1999 and entered into by and between Valley Bank (the "Bank"), and Pacific Community Banking Group (the "Company"). WHEREAS, the Bank and the Company entered into a First Restatement of Agreement and Plan of Reorganization dated as of January 5, 1999 (the "Agreement"); and WHEREAS, the parties hereto desire to amend the Agreement as provided in this First Amendment as provided herein. NOW, THEREFORE, in consideration of the premises and mutual promises of the parties set forth below, the parties hereto agree as follows: 1. Capitalized terms used herein and not otherwise defined shall have the same meaning as set forth in the Agreement. 2. Recital B.(a) and B.(b) of the Agreement is hereby amended to read in its entirety as follows: "(a) The Company will establish Interim Bank (as defined below) as a wholly-owned subsidiary; (b) Bank and Interim Bank will enter into an Agreement of Merger (as defined below) providing for the merger of Interim Bank and Bank under the state charter of the Interim Bank;" 3. The definition of "Agreement of Merger" in the Agreement is hereby amended to read in its entirety as follows: "'Agreement of Merger' shall mean the Agreement of Merger to be entered into by and between Interim Bank (as defined below) and the Bank substantially in the form of EXHIBIT "A" hereto, but subject to any changes that may be necessary to conform to any requirements of any Governmental Entity having authority over the Merger." 4. The definition of "Per Share Cash Consideration" in the Agreement is hereby deleted. 1 5. The following definitions are hereby added to the Agreement as follows: "'Interim Bank' shall mean the interim California banking corporation established by Company solely for the purpose of effecting the Merger. 'Interim Bank Stock' shall mean the common stock, no par value, of Interim Bank." 6. The definition of "Merger" in the Agreement is hereby amended to read in its entirety as follows: "'Merger' shall mean the merger of the Bank with and into Interim Bank." 7. The first and second sentences of Section 2.1 of the Agreement are hereby amended to read in their entirety as follows: "The Company agrees that it will use its best efforts, with all necessary cooperation of the Bank, to perfect the organization of Interim Bank in accordance with the CFC and the regulations promulgated thereunder prior to the Closing Date. The directors and officers of Interim Bank, and the Articles of Incorporation and Bylaws of Interim Bank, shall be determined by the Company." 8. Section 2.1(a) of the Agreement is hereby amended to read in its entirety as follows: "(a) MERGER OF THE BANK AND INTERIM BANK. The Bank and Interim Bank shall be merged under the certificate of authority of the Interim Bank, with the Interim Bank being the Surviving Bank pursuant to the provisions of, and with the effect provided in, the CGCL and the CFC, and shall continue its corporate existence under the laws of the State of California. The name of the Surviving Bank shall be "Valley Bank." Upon the consummation of the Merger, the separate corporate existence of the Bank shall cease." 9. Section 2.1(c) of the Agreement is hereby amended to read in its entirety as follows: "(c) EFFECT ON INTERIM BANK STOCK. All shares of Interim Bank Stock outstanding shall remain outstanding and shall be held by the Company." 10. Section 2.1(d) of the Agreement is hereby amended to read in its entirety as follows: 2 "(d) BANK CORPORATE GOVERNANCE CHANGES. The Charter Documents of the Interim Bank as in effect immediately prior to the Effective Time shall continue in effect after the Merger until thereafter amended in accordance with applicable law. At the Effective Time of the Merger, the directors of Interim Bank and the Bank shall be the directors of the Surviving Bank until their successors have been chosen and qualified in accordance with the Articles of Incorporation and Bylaws of the Surviving Bank. The officers of Interim Bank and the Bank at the Effective Time of the Merger shall be the officers of the Surviving Bank until they resign or are replaced or terminated by the Board of Directors of the Surviving Bank or otherwise in accordance with the Surviving Bank's Charter Documents. The obligations of the Bank shall be assumed by the Surviving Bank, and operations including the policies and procedures of the Bank, shall continue in effect at the Surviving Bank after the Merger; except that the Bank and the Interim Bank shall have taken prior to the Effective Time all necessary steps so that at the Effective Time (i) at the request of the Company, Mr. N. Douglas Mills, President and Chief Executive Officer of the Bank, shall resign from his positions (but not as an employee of the Bank), in form and substance satisfactory to the Company, either during the pendency of this transaction or following the consummation of this transaction, without incurring any liability on the part of any Party, except that (a) the Surviving Bank and Mr. Mills will enter into the Second Amendment to Mr. Mills' Employment Agreement originally dated September 26, 1996 and amended October 30, 1997, upon the Bank's payment on the Closing Date to Mr. Mills of the compensation described in revised Section 2.3 of the Second Amendment to Mr. Mills' Employment Agreement with the Bank in the form attached hereto as Exhibit 2.1(d)(i)(a), (b) Mr. Mills will remain a director of the Surviving Bank unless and until a successor is appointed by the Company, and (c) the Board and/or the Company will not become liable for any obligations under Mr. Mills' Salary Continuation Agreement dated October 19, 1995, as amended October 30, 1997, nor, unless accelerated earlier by the Company in its sole discretion, will such Salary Continuation Agreement accelerate, until termination of Mr. Mills' employment with the Company or a subsidiary of the Company pursuant to the Second Amendment to Mr. Mills' Employment Agreement; (ii) Caswell shall have been appointed Chairman of the Board and Chief Executive Officer of the Surviving Bank; xiii) except for the persons set forth on Exhibit 2.1(d), which Exhibit shall be delivered by the Company to the Bank within sixty (60) days of the date of the Agreement, each of the directors of the Bank shall have tendered his resignation as a director of the Bank and Surviving Bank, in form and substance satisfactory to the Company, without incurring any liability on the part of any Party; (iv) the number of authorized directors, and the specific members of the Board of Directors, of the Surviving Bank shall be changed as determined in the sole discretion of the Company; (v) the Company shall name additional directors in its sole discretion who shall be duly elected and appointed to the Board of Directors of the Surviving Bank (or if any such persons is unable to serve, such other person designated by the Company) and shall serve until the earlier of their resignation or removal or until their respective successors are duly elected and qualified; (vi) the remaining 3 members of the Board of Directors of the Bank will agree to support any and all expense reductions, consolidations, mergers, transfer of headquarters, sale of assets, FRB membership, closure of branches, or any other corporate changes as requested by the Company, consistent with their fiduciary duties; and (vii) the Surviving Bank will assume the obligations of the employment agreements for Bonnie Parrott, Mark A. Nugent, Marvin Lentini and Dianna Williams, and the Surviving Bank will assume the obligations of Bank under that "Employment Compensation Agreement" dated March 12, 1970 by and between Bank and Walter M. Wachtel in favor of Willow Wachtel Decker (clauses (i)-(vii) being hereinafter collectively referred to as the Bank Corporate Governance Changes.")." 11. Section 2.2 of the Agreement is hereby amended to read in its entirety as follows: "2.2 EFFECT OF THE MERGER. At the Effective Time of the Merger, the corporate existence of Interim Bank and the Bank shall be merged into and continued in the Surviving Bank, and the Surviving Bank shall be deemed the same corporation as each corporation participating in the Merger. All rights, franchises, and interests of Interim Bank and Bank in and to every type of property (real, personal and mixed) and choses in action shall be transferred to and vested in the Surviving Bank by virtue of the Merger without any deed or other transfer and the Surviving Bank shall hold and enjoy all rights of property, franchises and interests, in the same manner and to the same extent as such rights, franchises and interests were held or enjoyed by any one of the consolidating corporations at the Effective Time of the Merger." 12. The second sentence of Section 2.4 of the Agreement is hereby amended to read in its entirety as follows: "The Per Share Consideration shall be equal to the sum of (i) $5.00 in cash; and (ii) a fraction of a share of Company Stock having a value equal to $5.00, with the amount of the fraction of a share of Company Stock equal to the quotient of $5.00 and the Offering Price, except that the Company may, in its sole discretion, increase or decrease the amount of Company Stock and increase or decrease the amount of cash in the Per Share Consideration in order to attempt to accommodate the elections of the holders of Bank Stock as provided in Sections 2.1(b) and 2.11." 13. The first sentence of Section 3.1 of the Agreement is hereby amended to read in its entirety as follows: "Consummation of the transactions contemplated by this Agreement shall take place at the offices of Knecht & Hansen, 1301 Dove Street, Suite 900, Newport Beach, California, or such other location as may be agreed upon by the parties, on the Closing Date." 4 14. Section 3.2 of the Agreement is hereby amended to read in its entirety as follows: "3.2 EXECUTION OF AGREEMENT OF MERGER. Prior to the Closing Date, and as soon as practicable after approval by the Commissioner to organize Interim Bank, the Agreement of Merger (as amended, if necessary, to conform to any requirements of any Governmental Entity having authority over the Merger) shall be executed by Bank and Interim Bank. On the Closing Date, the Agreement of Merger, bearing the certification of the Secretary of State, together with all requisite certificates shall be duly filed in the office of the Commissioner after being filed with the California Secretary of State with the approval of the Commissioner endorsed thereon, in accordance with the CGCL and Section 4880 et SEQ. of the CFC." 15. The first sentence of Section 5.2 of the Agreement is hereby amended to read in its entirety as follows: "The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, no par value, of which 10,000 shares are outstanding on the date hereof, all validly issued, fully paid and nonassessable, and 100,000,000 shares of Preferred Stock, of which not more than 2 million shares have been issued or are to be issued before the Closing Date." 16. Section 5.20 of the Agreement is hereby amended to read in its entirety as follows: "5.20 AUTHORITY OF INTERIM BANK. The execution and delivery by Interim Bank of the Agreement of Merger and, subject to the requisite approval of the shareholder of Interim Bank, the consummation of the transactions completed thereby will be duly and validly authorized by all necessary corporation action on the part of Interim Bank, and the Agreement of Merger will be upon execution by the parties thereto a valid and binding obligation of Interim Bank, enforceable in accordance with its terms, except as the enforceability thereof may be limited by bankruptcy, insolvency, moratorium or other similar laws affecting the rights of creditors generally, by general equitable principles and by the provisions of Section 8(b)(6)(D) of the Federal Deposit Insurance Act, 12 U.S.C. Section 1818(b)(6)(D). The Company agrees to take any and all actions reasonably necessary to ensure that Interim Bank consummates the transactions contemplated hereby. Except as set forth in Exhibit 5.20, neither the execution and delivery by Interim Bank of the Agreement of Merger, nor the consummation of the transaction contemplated therein, nor compliance by Interim Bank with any of the provisions thereof will (a) conflict with or result in a breach of any provision of its Charter Documents, (b) except for approval by the shareholder of Interim Bank and the prior approval of the FRB, the Commissioner or the FDIC, require any Consents; (c) result in the creation 5 or imposition of any Encumbrance on any of the properties or assets of Interim Bank; or (d) subject to obtaining the Consents referred to in subsection (b) of this Section 5.20, and the expiration of any waiting period, violate any Rules to which Interim Bank is subject." 17. Section 6.13 of the Agreement is hereby amended to read in its entirety as follows: "6.13 EXECUTION OF AGREEMENT OF MERGER. As soon as possible after receipt of approval of the Commissioner to organize Interim Bank, subject to receipt of any and all necessary approvals and Permits by any Governmental Entity and approval by the Bank's shareholders, the Bank shall execute the Agreement of Merger and any and all related documents." 18. Section 6.19 of the Agreement is hereby amended to read in its entirety as follows: "6.19 BANK EMPLOYEE BENEFITS. Prior to or at the Effective Time of the Merger, the Bank will terminate the Bank Stock Option Plan. Upon the agreement of the Company and the Bank, the Bank shall cause all Employee Plans of the Bank to be terminated except as otherwise provided by applicable labor laws, or as agreed between the Bank and the Company.@ 19. Section 7.2(ii) of the Agreement is hereby amended to read in its entirety as follows "(ii) refrain from amending its Charter Documents except to the extent as may be required or contemplated by this Agreement, and except as the Company proposes to amend its articles of incorporation and bylaws as attached to this Agreement as EXHIBIT 7.2(II)." 20. Section 7.6 of the Agreement is hereby amended to read in its entirety as follows: "7.6 CORPORATE ACTION. The Company shall take or cause to be taken all necessary corporate action required to carry out the transactions contemplated in this Agreement and the Agreement of Merger, including without limitation, all necessary action required to organize and fund Interim Bank." 21. Section 7.13 of the Agreement is hereby amended to read in its entirety as follows: A7.13 EXECUTION OF AGREEMENT OF MERGER. As soon as practicable after receipt of approval of the Commissioner to organize Interim Bank, the Company as the sole shareholder of Interim Bank, shall approve the Merger and 6 shall cause Interim Bank to execute the Agreement of Merger and take any and all other actions reasonably necessary to consummate the transactions contemplated herein." 22. Section 7.15 of the Agreement is hereby amended to read in its entirety as follows: "7.15 AUTHORIZATION. The execution and delivery of the Agreement of Merger and the consummation of the transactions contemplated thereby will have been duly authorized by the Board of Directors of Interim Bank. The Agreement of Merger will constitute a legal, valid and binding agreement of Interim Bank in accordance with its respective terms, except as the enforceability thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, or other laws of general application relating to or affecting enforcement of creditors rights and the application of equitable principles in any action, legal or equitable. Interim Bank will have full corporate power and authority to perform its obligations under the Agreement of Merger and the transactions contemplated thereby." 23. Section 7.16 of the Agreement is hereby amended to read in its entirety as follows: "7.16 NO CONFLICTS; DEFAULTS. The execution, delivery and performance of the Agreement of Merger and the consummation of the transactions contemplated therein, and compliance by Interim Bank with any provision thereof will not (a) conflict with or result in a breach of, or default or loss of any benefit under, any provision of its Charter Documents or, except as set forth in Exhibit 7.16 any material agreement, instrument or obligation to which Interim Bank will become a party or by which the property of Interim Bank will become bound or give any other party to any such agreement, instrument or obligation the right to terminate or modify any term thereof; (b) except for the prior approval of the FRB, the FDIC and the Commissioner and as set forth in Exhibit 7.16, require any Consents; (c) result in the creation or imposition of any Encumbrance on any of the properties or assets of Interim Bank; or (d) violate the Charter Documents or any Rules to which Interim Bank is subject." 24. Section 9.1(ii) of the Agreement is hereby amended to read in its entirety as follows: "(ii) to the extent required by applicable Rule, all Consents of any Governmental Entity, including, without limitation, those of the FRB, the FDIC and the Commissioner, shall have been obtained, granted or waived for organization of Interim Bank and the Merger, and all applicable waiting periods under all rules shall have expired; and" 7 25. Section 9.3 of the Agreement is hereby amended to read in its entirety as follows: "9.3 SHAREHOLDER APPROVAL. The Agreement, the Merger, and the other transactions contemplated hereby, shall have been approved by the holders of at least two-thirds (2/3) of the issued and outstanding shares of Bank Stock entitled to vote and the requisite approval of the Company as the sole shareholder of Interim Bank as soon as practicable. Any and all other action required by the shareholders of the Bank or the Company to authorize or effect the transactions called for herein shall have been duly and validly taken." 26. The last sentence of Section 10.5 of the Agreement is hereby amended to read in its entirety as follows: "All actions necessary to authorize the execution, delivery and performance of the Agreement by the Company and consummation of the Merger by the Company and Interim Bank shall have been duly and validly taken by the Board of Directors of the Company and Interim Bank." 27. This First Amendment may be entered into in one or more counterparts, all of which shall be considered one in the same instrument, and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart. 28. Except as herein amended, the Agreement shall remain in full force and effect. 29. This First Amendment shall be governed by and construed in accordance with the laws of the State of California. 30. The execution and delivery of this First Amendment by the officers executing the First Amendment have been duly authorized by the Boards of Directors of the Bank and the Company, and this First Amendment constitutes a legal, valid and binding agreement of the parties in accordance with its respective terms. 31. Exhibit A (Agreement of Merger), Exhibit C (VB Warrant Agreement and its attached Exhibit A), and Exhibit 10.1 of the Agreement are hereby amended to read in their entirety substantially in the forms attached hereto as Exhibit A, Exhibit C (and its attached Exhibit A) and Exhibit 10.1, respectively. 8 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the day and year first above written. PACIFIC COMMUNITY BANKING GROUP By: -------------------------------------- E. Lynn Caswell Chairman and Chief Executive Officer VALLEY BANK By: -------------------------------------- Marion V. Ashley Chairman of the Board By: -------------------------------------- N. Douglas Mills President and Chief Executive Officer By: -------------------------------------- Secretary 9 EX-2.6 7 EXHIBIT 2.6 Exhibit 2.6 SECOND AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION This SECOND AMENDMENT TO FIRST RESTATEMENT OF AGREEMENT AND PLAN OF REORGANIZATION (the "Second Amendment") is dated as of April 12, 1999 and entered into by and between Valley Bank (the "Bank") and Pacific Community Banking Group (the "Company"). WHEREAS, the Bank and the Company entered into a First Restatement of Agreement and Plan of Reorganization dated as of January 5, 1999 (the "Agreement"); and a First Amendment to the Agreement dated as of March 4, 1999. WHEREAS, the parties hereto desire to amend the Agreement and the First Amendment as provided in this Second Amendment. NOW, THEREFORE, in consideration of the premises and mutual promises of the parties set forth below, the parties hereto agree as follows: 1. Capitalized terms used herein and not otherwise defined shall have the same meaning as set forth in the Agreement. 2. Recital C of the Agreement is hereby amended to read in its entirety as follows: "C. At the Effective Time (hereinafter defined below) of the Merger, all of the issued and outstanding shares of Bank Stock, except for shares of Bank Stock held by Dissenting Shareholders (as hereinafter defined below), shall be converted into and exchanged for a combination of shares of Company Stock and Warrants exercisable into shares of Company Stock, all upon the terms and subject to the conditions hereinafter set forth;" 3. Recital E of the Agreement is hereby amended by the addition, at the end thereof, of the following clause: "and the Bank, the Company and Interim Valley Bank will each be "a party to a reorganization," within the meaning of Section 368(b) of the Code, with respect to the Merger;" 4. The definition of Bank Shareholder is hereby added to read in its entirety as follow: 1 "'Bank Shareholder' shall mean any holder of Bank Stock or an option to purchase Bank Stock immediately prior to the Merger." 5. The definition of "Cash Election" is hereby deleted. 6. The definition of "Combination Election" is hereby deleted. 7. The definition of Expected Net Proceeds" is hereby deleted. 8. The definition of "Offering" is hereby amended to read in its entirety as follows: "'Offering' shall mean a public offering underwritten by the Underwriters (as defined below), as determined by the Company in its sole discretion, of a certain number of shares of Company Stock as determined by the Company in its sole discretion, of shares of the Company held by shareholders of the Bank and The Bank of Hemet, and newly issued shares, at a gross offering price of not less than $15.00 per share, as described in Section 7.14." 9. The definition of "S-1" is hereby amended in its entirety as follows: "'S-1' means the registration statement on Form S-1 to be filed with the SEC relating to the registration under the Securities Act of the shares of Company Stock held by shareholders of the Bank and The Bank of Hemet to be sold, and shares of Company Stock to be issued, in the Offering." 10. The definition of "Selling Shareholder" is hereby added to read in its entirety as follows: "'Selling Shareholder" shall mean any Bank shareholder or holder of a Bank stock option who elects to sell his or her shares of Bank Stock or to exchange his or her options and sell the Company Stock received in exchange therefore in the Offering." 11. The definition of "Total Acquisition Costs" is hereby deleted. 12. The definition of "Undesignated Shares" is hereby amended to read in its entirety as follows: "'Undesignated Shares' shall have the meaning given such term in Section 2.10." 2 13. The second sentence of Section 2.1(b) is hereby amended to read in its entirety as follows: "Subject to proration by the Company in its absolute and sole discretion to ensure that the number of shares of Company Stock sold by the Bank Shareholders of the Bank in the Offering is equal to 60% of the aggregate number of shares of Company Stock received by the Bank Shareholders of the Bank, holders of Bank Stock shall be provided the opportunity to sell in the Offering all the shares of Company Stock received in exchange for Bank Stock, as provided in Section 2.10. If more or less than 60% of the shares of Company Stock received by the Bank Shareholders (including, for this purpose, holders of Bank stock options, as provided in Section 2.8) of the Bank is elected to be sold in the Offering, then the shares of Company Stock sold in the Offering by each Selling Shareholder so electing shall be increased or decreased, ratably in proportion to the number of shares requested to be sold, so that the total number of shares sold in the Offering by the Bank Shareholders in the aggregate is equal to 60% of the shares of Company Stock received by the Bank Shareholders. The Selling Shareholders shall receive, for each share of Company Stock sold in the Offering, the price at which shares are sold in the Offering, without reduction for expenses or commissions of the Offering, it being understood that the Company shall bear such expenses and commissions." 14. Section 2.1(e) is hereby amended to read in its entirety as follows: (e) The Charter Documents of the Company as in effect immediately prior to the Effective Time shall continue in effect after the Merger until thereafter amended in accordance with applicable law and the members of the Board of Directors and the Executive Officers of the Company immediately prior to the Merger shall continue in their respective positions after the Merger and be the Board of Directors and the Executive Officers of the Company, except that the Company shall have taken prior to the Effective Time all necessary steps so that, (i) two (2) individuals from the Board of Directors of the Bank, which are intended to be Mr. Marion Ashley and Mr. N. Douglas Mills, shall be appointed to the Board of Directors of the Company, (ii) two (2) individuals from the Board of Directors or executive staff of The Bank of Hemet shall be appointed to the Board of Directors of the Company, and (iii) the individuals elected to fill such four (4) directorships shall be annual appointments as selected in the sole discretion of the Company, and (iv) the Company shall appoint at the Effective Time, and the Company shall continue to propose for election at each successive Company annual shareholder meeting thereafter, the ratio of that number of directors from the Bank's Board of Directors bears to the total number of directors to be elected, compared to the ratio of the number of former Bank's shares bears to the total number of shares of the Company, with a minimum of two to be appointed or elected from the Bank's 3 Board of Directors, subject to the approval of the Company (clauses (i) - (iv) being hereinafter collectively referred to as the "Company Corporate Governance Changes"). 15. Section 2.4 is hereby amended to read in its entirety as follows: "2.4 THE AGGREGATE PURCHASE CONSIDERATION AND PER SHARE CONSIDERATION. The Aggregate Purchase Consideration shall be equal to the sum of (i) the product of 1,171,906 and the Per Share Consideration and (ii) the Aggregate Option Price. The Per Share Consideration shall be equal to 2/3 share of Company Stock for each share of Bank Stock, plus one-third (1/3) Warrant." 16. Section 2.5 is hereby amended to read in its entirety as follows: "2.5 DELIVERY OF CONSIDERATION. At the Closing, the Company will deliver to the Exchange Agent an amount of Company Stock and Warrants equal to the Aggregate Purchase Consideration, plus any cash payment for a fractional share of Company Stock. In the case of shares of Company Stock to be sold in the Offering, as provided in Section 2.1(b), the Exchange Agent shall deliver such shares to, or pursuant to the direction of, the Underwriters. In the case of all other shares of Company Stock, and the cash and Warrants, the Exchange Agent shall deliver the same to the Selling Shareholders, provided that share certificates formerly evidencing Bank Stock (duly executed and in proper form for transfer), or a lost certificate affidavit acceptable to the Company) shall have been delivered to the Exchange Agent in accordance with this Section 2.5, Section 2.10 and an agreement to be entered into between the Company and the Exchange Agent." 17. Section 2.8 is hereby amended to read in its entirety as follows: "2.8 STOCK OPTIONS. Immediately prior to the Effective Time of the Merger, all stock options will be fully vested and each holder of a Bank Option will be given the opportunity to, in whole or in part, cancel such option and receive Company Stock equal to the number of shares of Bank Stock covered by such option multiplied by the number obtained by subtracting the exercise price of such option from the Per Share Consideration in effect on the Closing Date (i.e., shares subject to option times ($10.00 minus exercise price of option), all divided by $15.00) (the total of sum of such payments for all Bank Options so cancelled shall be defined as the "Aggregate Option Price"). For each 2/3 share of Company Stock paid by the Company in exchange for options on Bank Stock as provided in the previous sentence, each holder of a bank option will also receive one-third (1/3) Warrant. Each such option holder shall be afforded an election to have the shares so received sold in the Offering, upon substantially identical terms as the Selling Shareholders, and subject to proration together with and on the same terms as the Selling Shareholders. All remaining Bank Options which are entitled to participate 4 in the Aggregate Option Price but the holder of a Bank Option elects not to participate in the Aggregate Option Price shall be cancelled immediately prior to the Effective Time of the Merger." 18. Section 2.9 is hereby amended to read in its entirety as follows: "2.9 SHAREHOLDERS' AGREEMENTS. The Shareholders' Agreements previously entered into by each of the Directors of the Bank continue to be in full force and effect, and shall apply to the Agreement as amended pursuant to this Second Amendment. By signing this Second Amendment, each of the Directors of the Bank so agrees." 19. Section 2.10 is hereby amended to read in its entirety as follows: "2.10 (a) TRANSMITTAL LETTER. On or about the mailing date of the Joint Proxy Statement/Prospectus, the Company, the Bank or the Company's Exchange Agent shall mail appropriate transmittal materials to the stockholders of Bank Stock, in form acceptable to the Company. The transmittal materials shall include documentation by which stockholders may indicate their election regarding the sale of shares in the Offering, subject to the possible adjustment as provided in Section 2.1(b), and shall provide that sale in the Offering will be contingent on the completion of the Offering. The transmittal letter shall also contain a power of attorney authorizing an authorized representative of the Company to exchange the Bank's shares for Company shares, and then immediately deliver the Company shares to the Underwriter for sale in the Offering. The transmittal letter shall also require a signature guarantee, from a bank or brokerage with medallion capability. The holder of Bank Stock shall be instructed to send to the Company, or to the entity designated by the Company (which may be the Bank or the Exchange Agent), the holder's Bank Stock certificates with the properly completed letter of transmittal. The transmittal letter shall contain an election box which permits the holder to elect to sell all of his or her shares of PCBG for cash or 60% of such shares (subject to adjustment as elsewhere herein provided), and other appropriate and customary transmittal materials (which shall specify that delivery shall be effected, and risk of loss and title to the certificates theretofore representing shares of Bank Stock shall pass, only upon proper delivery of such certificates to the Exchange Agent in such form as Company requires. The transmittal materials shall identify the Election Deadline established by the Company, which shall not be less than 30 days from the date of mailing of such transmittal letter to the holder (or such shorter time as the Bank may approve), and shall state that any share of Bank Stock (other than Dissenting Common Stock) with respect to which the holder (or the Beneficial Owner, as the case may be) shall not have submitted an effective, properly completed letter of transmittal together with the Bank Stock certificates (or customary affidavits and indemnification regarding the loss or destruction of 5 such certificates or the guaranteed delivery of such certificates) prior to the Election Deadline shall be deemed to be "Undesignated Shares" hereunder, and shall not sell Company Stock in the Offering. The Bank shall provide to the Exchange Agent all information reasonably necessary for it to perform its obligations as specified herein. (b) PROPER AND TIMELY ELECTION. Any Election shall have been properly made and effective only if the Company or its designee shall have actually received a properly completed letter of transmittal by the date and time established by the Company and specified in the transmittal materials, as such date and time may be extended by the Company in its discretion (the "Election Deadline"). A letter of transmittal shall be deemed properly completed only if an Election is indicated for each share of Bank Stock covered by such letter of transmittal and if accompanied by one or more certificates (or customary affidavits and indemnification regarding the loss or destruction of such certificates or the guaranteed delivery of such certificates) representing all shares of Bank Stock owned by the holder of Bank Stock, together with duly executed transmittal materials included in or required by the letter of transmittal. Any Election may be revoked or changed by the person submitting a revised, properly completed letter of transmittal at or prior to the Election Deadline. In the event a letter of transmittal is revoked prior to the Election Deadline, the shares of Bank Stock represented by such Election shall automatically become Undesignated Shares unless and until a new Election is properly made with respect to such shares on or before the Election Deadline, and the Company shall cause the certificates representing such shares of Bank Stock to be promptly returned without charge to the person submitting the revoked Election upon written request to that effect from the holder who submitted such Election Form. Subject to the terms of this Agreement and of the Election, the Company or the Exchange Agent shall have reasonable discretion to determine whether any election, revocation or change has been properly or timely made and to disregard immaterial defects in the letter of transmittal, and any decisions of the Company and Bank required by the Exchange Agent and made in good faith in determining such matters shall be binding and conclusive. Neither the Company nor the Exchange Agent shall be liable for the failure to notify any person of any defect in an Election or the letter of transmittal, provided that the Company uses its reasonable best efforts promptly to notify (or cause the Exchange Agent promptly to notify) any holder of Bank Stock of any defect in an Election or the Letter of Transmittal. (c) If the aggregate number of shares of Bank Stock as to which Elections to sell shall have effectively been made would, absent proration, result in the sale in the Offering of fewer or more shares than are permitted pursuant to Section 2.1(b), then the sales in the Offering shall be increased or decreased pro rata as provided in Section 2.1(b) in order to ensure that the shares sold by Selling 6 Shareholders in the Offering equal 60% of all shares received by Selling Shareholders (including, for this purpose, option holders). (d) CALCULATIONS. The calculations required by this Section 2.1 shall be prepared by the Company prior to the Effective Time and shall be set forth in a certificate executed by the Chief Financial Officer or Chief Executive Officer of the Company and furnished to the Bank at least two Business Days prior to the Closing Date showing the manner of calculation in reasonable detail. Any cash payment shall be rounded to the nearest cent. (e) NO FRACTIONAL SHARES OR WARRANTS. Notwithstanding any other provisions of this Agreement, each holder of shares of Bank Stock exchanged pursuant to the Merger who would otherwise have been entitled to receive a fraction of a share of Company Stock (after taking into account all certificates delivered by such holder) shall receive, in lieu thereof, cash (without interest) in an amount equal to such fractional part of a share of Company Stock multiplied by $15.00. Notwithstanding any other provision of this Agreement, no fractional Warrants shall be issued, and no cash or other consideration shall be paid in lieu of fractional Warrants. No holder will be entitled to dividends, voting rights or any other rights as a shareholder in respect of any fractional share of Company Stock." 20. Section 2.11 is hereby deleted, and Sections 3.4 and 3.5 are hereby amended in full as follows: "3.4 EXCHANGE PROCEDURES. (a) EXCHANGE AGENT. Prior to the Effective Time, the Company shall deposit with the Exchange Agent shares of Company Stock and Warrants to be issued to selling shareholders of the Bank, such shares being the number of shares of Company Stock equal to the Aggregate Purchase Consideration issuable in the Merger. The Exchange Agent shall deliver or cause to be delivered to the Underwriter those of such shares to be sold in the Offering. Upon completion of the Offering, the Underwriter will deposit with the Exchange Agent the proceeds of the sale of shares by selling shareholders in the Offering. The Exchange Agent shall distribute to each selling shareholder the cash proceeds, shares of Company Stock and Warrants to which such selling shareholder is entitled, provided that the selling shareholder shall have delivered the requisite letter of transmittal and Bank share certificates (or customary affidavits and indemnification regarding the loss or destruction of such certificates or the guaranteed delivery of such certificates). The Exchange Agent shall not be entitled to vote or exercise any rights of ownership with respect to Company Stock held by it from time to time hereunder, except that it shall receive and hold all dividends or other distributions paid or distributed with respect to such shares for the account of the persons entitled thereto. 7 (b) EXCHANGE OF CERTIFICATES. Each holder of a certificate formerly representing Bank Stock (other than Dissenting Common Stock) who surrenders or has surrendered such certificate (or customary affidavits and indemnification regarding the loss or destruction of such certificate), together with duly executed transmittal materials required by Section 2.10, to the Exchange Agent shall, upon acceptance thereof, be entitled to the Per Share Consideration of a certificate representing Company Stock or the proceeds of the sale of such stock in the Offering and Warrants into which the shares of Bank Stock shall have been converted pursuant hereto, as well as cash in lieu of any fractional shares of Company Stock to which such holder would otherwise be entitled. The Exchange Agent shall accept such Bank certificate upon compliance with such reasonable and customary terms and conditions as the Exchange Agent may impose to effect an orderly exchange thereof in accordance with normal practices. Until surrendered as contemplated by this Section 3.4, each certificate representing Bank Stock shall be deemed from and after the Effective Time to evidence only the right to receive the Per Share Consideration Company Stock and a Warrant, as the case may be, upon such surrender. The Company shall not be obligated to deliver the consideration to which any former holder of Bank Stock is entitled as a result of the Merger until such holder surrenders his certificate or certificates representing shares of Bank Stock for exchange as provided in this Article III. If any certificate for shares of Company Stock, or any check representing declared but unpaid dividends, is to be issued in a name other than that in which a certificate surrendered for exchange is issued, the certificate so surrendered shall be properly endorsed and otherwise in proper form for transfer and the person requesting such exchange shall affix any requisite stock transfer tax stamps to the certificate surrendered or provide funds for their purchase or establish to the satisfaction of the Exchange Agent that such taxes are not payable. (c) PAYMENT TO HOLDERS OF A BANK OPTION. Each holder of a Bank Option who presents a demand for cancellation and payment of such Bank Option as provided in Section 2.8 of the Agreement to the Exchange Agent prior to the Closing shall, upon acceptance thereof, be entitled to the per share equivalent of the Aggregate Option Price. Upon receipt of the Aggregate Purchase Consideration and as soon as reasonably possible after the Closing, the Exchange Agent shall deliver to each holder of a Bank Option the consideration due each such holder under Section 2.8, or if applicable, Section 2.10, of the Agreement, in the form of shares of Company Stock, Cash and Warrants as provided therein. The Exchange Agent shall be entitled to rely upon the records of the Bank and the information provided in such demand for cancellation documentation provided by any such holder of a Bank Option, as verified by the Company as to the method and means of payment and disposition of such consideration. (d) AFFILIATES. Certificates surrendered for exchange by any 8 person constituting an "affiliate" of Bank for purposes of Rule 144(a) under the Securities Act shall not be exchanged for certificates representing whole shares of Company Stock until the Company has received a written agreement from such person as provided in Section 6.25. 3.5 VOTING AND DIVIDENDS. Former shareholders of record of Bank shall not be entitled to vote after the Effective Time at any meeting of Company shareholders the number of whole shares of Company Stock into which their respective shares of Bank Stock are converted, until such holders have exchanged their certificates representing Bank Stock for certificates representing Company Stock in accordance with the provisions of this Agreement. Until surrendered for exchange in accordance with the provisions of Sections 2.10 and 3.4 of this Agreement, each certificate theretofore representing shares of Bank Stock shall from and after the Effective Time represent for all purposes only the right to receive the Per Share Consideration consisting of shares of Company Stock and a Warrant, and cash in lieu of fractional shares, as set forth in this Agreement. No dividends or other distributions declared or made after the Effective Time with respect to Company Stock with a record date after the Effective Time shall be paid to the holder of any unsurrendered certificate of Bank Stock with respect to the shares of Company Stock represented thereby, until the holder of such certificate of Common Stock shall surrender such certificate. Subject to the effect of applicable laws, following surrender of any such certificates of Bank Stock for which shares of Company Stock are to be issued, there shall be paid to the holder of the certificates, without interest, (i) the amount of any cash payable with respect to a fractional share of Company Stock to which such holder is entitled pursuant to Section 2.1 and the amount of dividends or other distributions with a record date after the Effective Time theretofore paid with respect to such whole shares of Company Stock, and (ii) at the appropriate payment date, the amount of dividends or other distributions with a record date after the Effective Time but prior to surrender and a payment date subsequent to the Effective Time payable with respect to such whole shares of Company Stock." 21. Section 5.21 is hereby amended to read in its entirety as follows: "5.21 CAPITAL OF COMPANY, OFFERING AND COMMITMENTS. The Company intends to use its best efforts to conduct the Offering in order to permit stockholders of the Bank and The Bank of Hemet to sell shares of Company Stock and to provide capital for expenses, growth and operations of the Company. As of the date of this Agreement, the Company and Sutro have entered into the Engagement Agreement, a copy of which has been provided to the Bank and which has not been terminated or materially altered, except that the Company can change its relationship with Sutro, or increase or decrease the number of underwriters or co-mangers of the Offering, in the Company's sole discretion. The Company shall 9 not impose any cost or expense of the Offering, including Underwriter costs and expenses, on any selling shareholder." 22. The first sentence of Section 6.8 is hereby amended to read in its entirety as follows: "As soon as practicable, the Company and the Bank shall prepare the S-4 and the proxy statement ("Proxy Statement") and take all action necessary in accordance with applicable Rules and its Charter Documents to submit the Agreement and the transactions contemplated hereby to its shareholders for approval by June 21, 1999, or as otherwise reasonably directed by the Company." 23. Section 7.14 is hereby amended to read in its entirety as follows: "7.14 THE OFFERING. (a) The Company intends to conduct the Offering in order to permit stockholders of the Bank and The Bank of Hemet, to sell shares of Company Stock and to provide capital for expenses, growth and operations of the Company. All shareholders of the Bank will be given the opportunity to sell shares of the Company (whether in exchange for Bank Stock or Bank Options) in the Offering, subject to proration as provided in Section 2.1(b). Shares of Company Stock sold by the selling shareholders will not incur any cost and expenses of the Offering, and pursuant to the terms of this Section 7.14, the net proceeds from the Offering will not be less than $15.00 per share. (b) All holders of Bank Options who exchange their options for shares Company Stock and elect to sell the shares of Company Stock so received may do so without having to first exercise such options. Such option holders wishing to sell shares of Company Stock underlying their options to be received in exchange for the Bank Options may do so by depositing with the Exchange Agent the options with respect to the shares of Bank Stock to be exchanged prior to the Offering, together with appropriate Letters of Transmittal properly completed and executed. At the time of the Merger, the Bank Options will be deemed exchanged for the number of shares of Company Stock and Warrants as provided in Section 2.8, and upon completion of the Offering, the Exchange Agent will distribute to each former option holder (a) the proceeds of sale of those of such shares that are sold in the Offering, and (b) the shares and cash to which the former option holder is entitled. (c) All Directors and executive officers of the Company and the Surviving Bank, except Willow Decker and Mark Nugent, have undertaken in writing with the Underwriters not to sell any Warrants or shares of Company Stock held by 10 them for a period of six months following the completion of the Offering unless specifically granted permission to do so by the Underwriters, such undertaking is in full force and effect. It is understood that the Underwriters will (a) reduce the period from six months to ninety (90) days and (b) exclude from the effect of these undertakings those shares sold in the Offering. Mark Nugent will execute similar undertakings within 15 days of the day of the Second Amendment. The Bank will use its best efforts to have Willow Decker execute similar undertakings. (d) Simultaneously with, and upon the condition of, the consummation of the acquisition of the Bank, the Company through the Underwriters intends to consummate the Offering at a gross public offering price of at least $15.00 per share. If the Offering cannot be consummated at a gross public offering price of at least $15.00 per share, the Company will not be obligated to proceed with the Offering and the acquisition of the Bank , and the Bank shall not be obligated to consummate the Merger." 24. Section 9.4 is hereby amended to read in its entirety as follows: "9.4 STOCK OFFERING. An election to sell shares in the Offering shall have been made, and proper documentation submitted, so that, after application of the proration provisions of Section 2.1(b), if necessary, 60% of Company Stock received by holders of Bank Stock are available for sale in the Offering. The Company shall have entered into a firm commitment underwriting agreement for the Offering (at an offering price of at least $15.00 per share by Selling Shareholders of 60% of the Bank Stock), and all conditions to the consummation of the Offering contained in the Underwriting Agreement, other than the completion of the mergers of Interim Valley Bank with the Bank and of PCBG Merger Corporation with The Bank of Hemet, shall have been satisfied or waived, and the Company and the Bank shall have received evidence thereof reasonably satisfactory to them." 25. Section 9.8 is hereby amended to read in its entirety as follows: "9.8 TAX OPINION. The Company shall have received from its accountants an opinion for the benefit of the holders of Bank Stock reasonably satisfactory to the Company and the Bank to the effect that the Merger shall not result in the recognition of gain or loss for federal income tax purposes to the Company or the Bank, the issuance of Company Stock or Warrants, and the subsequent sale thereof in the Offering, shall not result in the recognition of gain or loss by the holders of Bank Stock who receive Company Stock and Warrants in connection with the Merger and which are not sold in the Offering, and shall state that the holding period for Company Stock, for purposes of capital gains taxation, shall include the period during which Bank Stock was held. This opinion shall be dated prior to the date the Proxy Statement is first mailed to the shareholders of 11 the Company and the Bank and such opinions shall not have been withdrawn or modified in any respect." 26. Section 14.1(a)(vi) is hereby amended to read in its entirety as follows: "(vi) by the Company or the Bank by June 28, 1999, unless regulatory approvals and/or completion of the Offering is relatively imminent and is expected to be completed within 30 days of July 2, 1999, in which case the date in this subsection shall be automatically extended for up to an additional 30 days." 27. Section 14.1(e)(iv) is hereby added to read in its entirety as follows: "(iv) If this Agreement is terminated by the Company before the Closing as a result of a default by the Company in the performance of Sections 5.18 and 7.14, no costs, expenses, fees or other liability or damages will be accrued or incurred by the Company." 28. This Second Amendment may be entered into in one or more counterparts, all of which shall be considered one in the same instrument, and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart. 29. Except as herein amended, the Agreement and the First Amendment shall remain in full force and effect. 30. This Second Amendment shall be governed by and construed in accordance with the laws of the State of California. 31. The execution and delivery of this Second Amendment by the directors and officers executing the Second Amendment have been duly authorized by the Boards of Directors of the Bank and the Company, and this Second Amendment constitutes a legal, valid and binding agreement of the parties in accordance with its respective terms. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the day and year first above written. PACIFIC COMMUNITY BANKING GROUP 12 By: -------------------------------------- E. Lynn Caswell Chairman and Chief Executive Officer By: -------------------------------------- Alfred Jannard Secretary VALLEY BANK By: -------------------------------------- Marion V. Ashley By: -------------------------------------- N. Douglas Mills By: -------------------------------------- Juan P. Renteria By: -------------------------------------- Jesse Washington 13 By: -------------------------------------- George E. Wilson By: -------------------------------------- Helga Wolf By: -------------------------------------- Eugene H. Wood EX-3.1 8 EXHIBIT 3.1 EXHIBIT 3.1 Articles of Incorporation of Pacific Community Banking Group ARTICLES OF INCORPORATION OF PACIFIC COMMUNITY BANKING GROUP ARTICLE I - NAME The name of this corporation is PACIFIC COMMUNITY BANKING GROUP. ARTICLE II - PURPOSE The purpose of the corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code. ARTICLE III - AGENT FOR SERVICE OF PROCESS The name and address in the State of California of this corporation's initial agent for service of process is: Loren P. Hansen, Esquire 1301 Dove Street, Suite 900 Newport Beach, California 92660 ARTICLE IV - AUTHORIZED STOCK (a) The Corporation is authorized to issue two classes of shares designated "Preferred Stock" and "Common Stock", respectively. The number of shares of Preferred Stock authorized to be issued is 100,000,000 and the number of shares of Common Stock authorized to be issued is 100,000,000. (b) The Preferred Stock may be divided into such number of series as the board of directors may determine. The board of directors is authorized to determine and alter the rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued series of Preferred Stock, and to fix the number of shares of any series of Preferred Stock and the designation of any such series of Preferred Stock. The board of directors, within the limits and restrictions stated in any resolution or resolutions of the board of directors originally fixing the number of shares constituting any series, may increase or decrease (but not below the number of shares of such series then outstanding) the number of shares of such series subsequent to the issue of shares of that series. - 1 - ARTICLE V - DIRECTOR LIABILITY The liability of the directors of the corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. ARTICLE VI - INDEMNIFICATION The corporation is authorized to provide indemnification of agents (as defined in Section 317 of the Corporations Code) for breach of duty to the corporation and its stockholders through bylaw provisions or through agreements with agents, or both, in excess of the indemnification otherwise permitted by Section 317 of the Corporations Code, subject to the limits on such excess indemnification set forth in Section 204 of the Corporations Code. Dated: September 24, 1997 /s/ Loren P. Hansen -------------------------------- Loren P. Hansen Incorporator I hereby declare that I am the person who executed the foregoing Articles of Incorporation, which execution is my act and deed. /s/ Loren P. Hansen -------------------------------- Loren P. Hansen - 2 - EX-3.2 9 EXHIBIT 3.2 Exhibit 3.2 CERTIFICATE OF AMENDMENT OF ARTICLES OF INCORPORATION OF PACIFIC COMMUNITY BANKING GROUP E. Lynn Caswell and Alfred Jannard certify that: 1. They are the Chairman of the Board and Secretary, respectively, of Pacific Community Banking Group, a California corporation. 2. Article VII is hereby added to the Articles of Incorporation of this Corporation, to read as follows: "ARTICLE VII MEETINGS OF SHAREHOLDERS Meetings of shareholders may be held at such place as the Bylaws may provide." 3. Article VIII is hereby added to the Articles of Incorporation of this Corporation, to read as follows: "ARTICLE VIII DIRECTORS A. NUMBER; VACANCIES. The number of directors of the Corporation shall be such number, as shall be provided from time to time in the Bylaws; provided, however, that no decrease in the number of directors shall have the effect of shortening the term of any incumbent director, and provided further, that no action shall be taken to decrease or increase the number of directors within the range stated in the Bylaws unless at least two-thirds of the directors then in office shall approve said action. Vacancies in the board of directors of the Corporation, however caused, and newly created directorships shall be filled by a vote of two-thirds of the directors then in office, whether or not a quorum, and any director so chosen shall hold office for a term expiring at the annual meeting of shareholders at which the term of the class to which the director has been chosen expires and when the director's successor is elected and qualified. B. LISTING OF CORPORATE SHARES. The remaining provisions of this article shall become effective only when the Corporation becomes a listed corporation within 1 the meaning of Section 301.5 of the Corporations Code, which provision refers to a corporation whose shares are traded on the New York Stock Exchange, American Stock Exchange, or National Market System-NASDAQ. C. CLASSIFIED BOARD. The Board of Directors of the Corporation shall be divided into two classes of directors which shall be designated Class I and Class II. The numbers of each class shall be elected for a term of two years and until their successors are elected and qualified. Each class shall contain the number of directors which cause the classes to be as nearly equal in number as possible, and the terms of all directors in a class shall expire simultaneously. At the 2000 annual meeting of shareholders, directors of Class I shall be elected to hold office for a term expiring at the second succeeding meeting thereafter. At the next annual meeting of shareholders, directors of Class II shall be elected to hold office for a term expiring at the second succeeding meeting thereafter. Notwithstanding the foregoing, the director whose term shall expire at any annual meeting shall continue to serve until such time as his successor shall have been duly elected and shall have qualified unless his position on the Board of Directors shall have been abolished by action taken to reduce the size of the Board of Directors prior to said meeting. Should the number of directors of the Corporation be reduced, the directorship(s) eliminated shall be allocated among classes as appropriate so that the number of directors in each class is as nearly as equal as possible. The Board of Directors shall designate, by the name of the incumbent(s), the position(s) to be abolished. Notwithstanding the foregoing, no decrease in the number of directors shall have the effect of shortening the term of any incumbent director. Should the number of directors of the Corporation be increased, the additional directorships shall be allocated among classes as appropriate so that the number of directors in each class is as nearly as equal as possible. At subsequent annual meetings of shareholders, a number of directors shall be elected equal to the number of directors with terms expiring at that annual meeting. Directors elected at each such annual meeting shall be elected for a term expiring with the annual meeting of shareholders two years thereafter. D. CUMULATIVE VOTING. The election of directors shall not be by cumulative voting. At each election of directors, each shareholder entitled to vote may vote all the shares held by that shareholder for each of several nominees for director up to the number of directors to be elected. The shareholder may not cast more votes for any single nominee than the number of shares held by that shareholder." 2 4. Article IX is hereby added to the Articles of Incorporation of this Corporation, to read as follows: "IX APPROVAL OF CERTAIN BUSINESS COMBINATIONS The shareholder vote required to approve Business Combinations (as hereinafter defined) shall be as set forth in this section. A.1. Except as otherwise expressly provided in this Article IX, the affirmative vote of the holders of at least 66 2/3% of the outstanding shares entitled to vote thereon (and, if any class or series of shares is entitled to vote thereon separately, the affirmative vote of the holders of at least 66 2/3% of the outstanding shares of each such class or series), shall be required in order to authorize any of the following: (a) any merger or consolidation of the Corporation with or into a Related Person (as hereinafter defined); (b) any sale, lease, exchange, transfer or other disposition, including without limitation, a mortgage, or any other security device, of all or any Substantial Part (as hereinafter defined) of the assets of the Corporation (including without limitation any voting securities of a subsidiary) or of a subsidiary, to a Related Person; (c) any merger or consolidation of a Related Person with or into the Corporation or a subsidiary of the Corporation; (d) any sale, lease, exchange, transfer or other disposition of all or any Substantial Part of the assets of a Related Person to the Corporation or a subsidiary of the Corporation; (e) the issuance of any securities of the Corporation or a subsidiary of the Corporation to a Related Person; (f) the acquisition by the Corporation or a subsidiary of the Corporation of any securities of a Related Person; (g) any reclassification of the common stock of the Corporation, or any recapitalization involving the common stock of the Corporation; and 3 (h) any agreement, contract or other arrangement providing for any of the transactions described in this Article. 2. Such affirmative vote shall be required notwithstanding any other provision of these Articles, any provision of law, or any agreement with any regulatory agency or national securities exchange which might otherwise permit a lesser vote or no vote. 3. The term "Business Combination" as used in this Article IX shall mean any transaction which is referred to in any one or more of subparagraphs A(1)(a) through (h) above. B. The provisions of paragraph A shall not be applicable to any particular Business Combination, and such Business Combination shall require only such affirmative vote as is required by any other provision of these Articles, any provision of law, or any agreement with any regulatory agency or national securities exchange, if the Business Combination shall have been approved by a majority vote of the Continuing Directors (as hereinafter defined); provided, however, that such approval shall only be effective if obtained at a meeting at which a Continuing Director Quorum (as hereinafter defined) is present. C. For the purposes of this Article IX the following definitions apply: 1. The term "Related Person" shall mean and include (a) any individual, corporation, partnership or other person or entity which together with its "affiliates" (as that term is defined in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended), "beneficially owns" (as that term is defined in Rule 13d-3 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended) in the aggregate 10% or more of the outstanding shares of the common stock of the Corporation; and (b) any "affiliate" (as that term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) of any such individual, corporation, partnership or other person or entity. Without limitation, any shares of the common stock of the Corporation which any Related Person has the right to acquire pursuant to any agreement, or upon exercise or conversion rights, warrants or options, or otherwise, shall be deemed "beneficially owned" by such Related Person. 2. The term "Substantial Part" shall mean more than 25% of the total assets of the Corporation, as of the end of its most recent fiscal year ending prior to the time the determination is made. 3. The term "Continuing Director" shall mean any member of the Board of Directors of the Corporation who is unaffiliated with the Related Person and was a member of the board prior to the time that the Related Person became a Related 4 Person, and any successor of a Continuing Director who is unaffiliated with the Related Person and is recommended to succeed a Continuing Director by a majority of Continuing Directors then on the board. 4. The term "Continuing Director Quorum" shall mean a majority of the Continuing Directors capable of exercising the powers conferred on them." 5. Article X is hereby added to the Articles of Incorporation of this Corporation, to read as follows: "X AMENDMENT OF BYLAWS In furtherance and not in limitation of the powers conferred by statute, the Board of Directors of the Corporation is expressly authorized to make, repeal, alter, amend and rescind the Bylaws of the Corporation by a majority vote of the board. Notwithstanding any other provision of these Articles (and notwithstanding the fact that some lesser percentage may be specified by law), the Bylaws shall not be adopted, repealed, altered, amended or rescinded by the shareholders of the Corporation except by the vote of the holders of not less than 66 2/3% of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (considered for this purpose as one class) cast at a meeting of the shareholders called for that purpose (provided that notice of such proposed adoption, repeal, alteration, amendment or rescission is included in the notice of such meeting), or, as set forth above, by the Board of Directors." 6. Article XI is hereby added to the Articles of Incorporation of this Corporation, to read as follows: "XI AMENDMENT OF ARTICLES OF INCORPORATION The Corporation reserves the right to repeal, alter, amend or rescind any provision contained in these Articles in the manner now or hereafter prescribed by law, and all rights conferred on shareholders herein are granted subject to this reservation. Notwithstanding the foregoing, the provisions set forth in Articles VII, VIII, IX, X, and this Article XI may not be repealed, altered, amended or rescinded in any respect unless the same is approved by the affirmative vote of the holders of not less than 66 2/3% of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (considered for this purpose as a single class) cast at a meeting of the shareholders called for that purpose (provided that notice of such 5 proposed adoption, repeal, alteration, amendment or rescission is included in the notice of such meeting)." 7. The foregoing amendments to the Articles of Incorporation have been duly approved by the Board of Directors. 8. The foregoing amendments to the Articles of Incorporation have been duly approved by the required vote of shareholders of Common Stock in accordance with Section 902 of the Corporations Code. The corporation has 10,000 shares of Common Stock issued and outstanding and no shares of Preferred Stock issued and outstanding. The number of shares of Common Stock entitled to vote and voting in favor of each of the foregoing Amendments equaled or exceeded the vote required. The percentage vote of Common Stock required for the approval of the Amendments was more than 50% of the outstanding shares. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of our own knowledge. Date: February 25, 1999 /s/ E. Lynn Caswell ---------------------------------- E.Lynn Caswell, Chairman /s/ Alfred Jannard ---------------------------------- Alfred Jannard, Secretary 6 EX-3.3 10 EXHIBIT 3.3 Exhibit 3.3 AMENDED AND RESTATED BYLAWS FOR THE REGULATION OF PACIFIC COMMUNITY BANKING GROUP (a California corporation) ARTICLE I OFFICES Section 1.1. PRINCIPAL EXECUTIVE OFFICE. The principal executive office of the corporation is hereby fixed and located at 23332 Mill Creek Drive, Suite 230, Laguna Hills, California 92653. The board of directors is hereby granted full power and authority to change said principal executive office from one location to another, subject to all regulatory approvals. Any such change shall be noted on the Bylaws by the Secretary, opposite this section, or this section may be amended to state the new location. Section 1.2. OTHER OFFICE. Other business offices may at any time be established by the board of directors at any place or places where the corporation is qualified to do business, subject to all regulatory approvals. ARTICLE II MEETINGS OF SHAREHOLDERS Section 2.1. PLACE OF MEETINGS. All annual or other meetings of shareholders shall be held at the principal executive office of the corporation, or at any other place within the State of California which may be designated either by the board of directors or by the written consent of all persons entitled to vote thereat and not present at the meeting, given either before or after the meeting and filed with the Secretary of the corporation. Section 2.2. ANNUAL MEETINGS. The annual meetings of shareholders shall be held on the 3rd Wednesday of each May at 7:00 p.m., local time, provided, however, that should said day fall upon a legal holiday, then any such annual meeting of shareholders shall be held at the same time and place on the next day thereafter ensuing which is a full business day; provided further, that the board of directors may, by resolution adopted prior to the date fixed herein for an annual meeting, change the time and date for any annual meeting of the shareholders to any day which is not a legal holiday and is not more than 15 months after the date of the preceding annual meeting of shareholders. At such meetings, directors shall be elected, reports of the affairs of the corporation shall be considered, and any other business may be transacted which is within the powers of the shareholders. 1 Written notice of each annual meeting shall be given to each shareholder entitled to vote, either personally or by first class mail or other means of written communication, charges prepaid, addressed to such shareholder at his address appearing on the books of the corporation or given by him to the corporation for the purpose of notice. If any notice or report addressed to the shareholder at the address of such shareholder appearing on the books of the corporation is returned to the corporation by the United States Postal Service marked to indicate that the United States Postal Service is unable to deliver the notice or report to the shareholder at such address, all future notices or reports shall be deemed to have been duly given without further mailing if the same shall be available for the shareholder upon written demand of the shareholder at the principal executive office of the corporation for a period of one year from the date of the giving of the notice or report to all other shareholders. If a shareholder gives no address, notice shall be deemed to have been given him if sent by mail or other means of written communication addressed to the place where the principal executive office of the corporation is situated, or if published at least once in some newspaper of general circulation in the county in which said principal executive office is located. All such notices shall be given to each shareholder entitled thereto not less than ten (10) days nor more than sixty (60) days before each annual meeting. Any such notice shall be deemed to have been given at the time when delivered personally or deposited in the mail or sent by other means of written communication. An affidavit of mailing of any such notice in accordance with the foregoing provisions, executed by the Secretary, Assistant Secretary or any transfer agent of the corporation shall be prima facie evidence of the giving of the notice. Such notices shall specify: (a) the place, the date, and the hour of such meeting; (b) those matters which the board, at the time of the mailing of the notice, intends to present for action by the shareholders; (c) if directors are to be elected, the names of nominees intended at the time of the notice to be presented by management for election and a copy of Section 2.11 of these Bylaws; (d) the general nature of a proposal, if any, to take action with respect to approval of, (i) a contract or other transaction with an interested director, (ii) amendment of the articles of incorporation, (iii) a reorganization of the corporation as defined in Section 181 of the General Corporation Law, (iv) voluntary dissolution of the corporation, or (v) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares, if any; and 2 (e) such other matters, if any, as may be expressly required by statute. Any information contained in a proxy statement sent with such notice or other soliciting material sent with the notice shall be deemed to be a part of the notice. Section 2.3. SPECIAL MEETINGS. Special meetings of the shareholders, for the purpose of taking any action permitted by the shareholders under the General Corporation Law and the articles of incorporation of this corporation, may be called at any time by the chairman of the board or the president, or by the board of directors, or by one or more shareholders holding not less than ten percent (10%) of the votes at the meeting. Upon request in writing that a special meeting of shareholders be called for any proper purpose, directed to the chairman of the board, president, vice-president or secretary by any person (other than the board) entitled to call a special meeting of shareholders, the officer forthwith shall cause notice to be given to shareholders entitled to vote that a meeting will be held at a time requested by the person or persons calling the meeting, not less than thirty-five (35) nor more than sixty (60) days after receipt of the request. Except in special cases where other express provision is made by statute, notice of such special meetings shall be given in the same manner as for annual meetings of shareholders. In addition to the matters required by items (a); (b) if applicable, and (c) of the preceding Section, notice of any special meeting shall specify the general nature of the business to be transacted, and no other business may be transacted at such meeting except such business as properly relates to the procedural conduct of such meeting and is within the powers of the shareholders. Section 2.4. QUORUM. The presence in person or by proxy of the persons entitled to vote a majority of the voting shares at any meeting shall constitute a quorum for the transaction of business. The shareholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. Section 2.5. ADJOURNED MEETING AND NOTICE THEREOF. Any shareholders' meeting, annual or special, whether or not a quorum is present, may be adjourned from time to time by the vote of a majority of the shares, the holders of which are either present in person or represented by proxy thereat, but in the absence of a quorum no other business may be transacted at such meeting, except as provided in Section 2.4 above. When any shareholders' meeting, either annual or special, is adjourned for forty-five days or more, or if after adjournment a new record date is fixed for the adjourned meeting, notice of the adjourned meeting shall be given as in the case of an 3 original meeting. Except as provided above, it shall not be necessary to give any notice of the time and place of the adjourned meeting or of the business to be transacted thereat, other than by announcement of the time and place thereof at the meeting at which such adjournment is taken. Section 2.6. VOTING. Unless a record date for voting purposes be fixed as provided in Section 5.1 of Article V of these Bylaws, then, subject to the provisions of Sections 702 through 704 of the Corporations Code of California (relating to voting of shares held by a fiduciary, in the name of a corporation, or in joint ownership), only persons in whose names shares entitled to vote stand on the stock records of the corporation at the close of business on the business day next preceding the day on which notice of the meeting is given or if such notice is waived, at the close of business on the business day next preceding the day on which the meeting of shareholders is held, shall be entitled to vote at such meeting, and such day shall be the record date for such meeting. Such vote may be oral or by ballot; provided, however, that all elections for directors must be by ballot upon demand made by a shareholder at any election and before the voting begins. If a quorum is present, except with respect to election of directors, the affirmative vote of the majority of the shares represented at the meeting and entitled to vote on any matter shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required by the General Corporation Law, the articles of incorporation or the Banking Law. Subject to the requirements of the remaining sentences of this section, and except as provided in the Articles of Incorporation, by Statute, or these Bylaws, every shareholder entitled to vote at any election for directors shall have the right to cumulate his votes and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which his shares are entitled, or to distribute his votes on the same principal among as many candidates as he shall think fit. No shareholder shall be entitled to cumulate votes unless the name of the candidate or candidates for whom such votes would be cast has been placed in nomination prior to the voting and at least one shareholder has given notice at the meeting prior to the voting, of such shareholder's intention to cumulate his votes. The remaining provisions of this section shall become effective only when the Corporation becomes a listed corporation within the meaning of Section 310.5 of the Corporations Code, which provision refers to a corporation whose shares are traded on the New York Stock Exchange, American Stock Exchange, or National Market System-NASDAQ. CLASSIFIED BOARD. The board of directors shall be classified into two classes, the members of each class to serve for a term of two years. Notwithstanding the foregoing, the director whose term shall expire at any annual meeting shall continue to serve until such time as his successor shall have been duly elected and shall have qualified unless his position on the board of directors shall have been abolished by action taken to reduce the size of the board of directors prior to said meeting. 4 Should the number of directors of the Corporation be reduced, the directorship(s) eliminated shall be allocated among classes as appropriate so that the number of directors in each class is as nearly as equal as possible. The Board of Directors shall designate, by the name of the incumbent(s), the position(s) to be abolished. Notwithstanding the foregoing, no decrease in the number of directors shall have the effect of shortening the term of any incumbent director. Should the number of directors of the Corporation be increased, the additional directorships shall be allocated among classes as appropriate so that the number of directors in each class is as nearly as equal as possible. CUMULATIVE VOTING. The election of directors by the shareholders shall not be by cumulative voting. At each election of directors, each shareholder entitled to vote may vote all the shares held by that shareholder for each of several nominees for director up to the number of directors to be elected. The shareholder may not cast more votes for any single nominee than the number of shares held by that shareholder. At the first annual meeting of shareholders held after the corporation qualifies as a listed corporation within the meaning of Section 301.5 of the Corporations Code, one-half of the directors shall be elected for a term of two years, and one-half of the directors shall be elected for a term of one year. If the number of directors is not divisible by two, the first extra director shall be elected for a term of two years and a second extra director, if any, shall be elected for a term of one year. At subsequent annual meetings of shareholders, a number of directors shall be elected equal to the number of directors with terms expiring at that annual meeting. Directors elected at each such annual meeting shall be elected for a term expiring with the annual meeting of shareholders two years thereafter. The candidates receiving the highest number of votes of shares entitled to be voted for them, up to the number of directors to be elected, shall be elected. Section 2.7. VALIDATION OF DEFECTIVELY CALLED OR NOTICED MEETINGS. The transactions of any meeting of shareholders, either annual or special, however called and noticed, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum be present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by proxy, or who, though present, has, at the beginning of the meeting, properly objected to the transaction of any business because the meeting was not lawfully called or convened, or to particular matters of business legally required to be included in the notice, but not so included, signs a waiver of notice, or a consent to the holding of such meeting, or an approval of the minutes thereof. The waiver of notice or consent need not specify either the business to be transacted or the purpose of any annual or special meeting of shareholders, except that if action is taken or proposed to be taken 5 for approval of any of those matters specified in Section 2.2(d) of Article II, the waiver of notice or consent shall state the general nature of the proposal. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance by a person at a meeting shall also constitute a waiver of notice of that meeting, except when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened, and except that attendance at a meeting is not a waiver of any right to object to the consideration of matters not included in the notice of the meeting if that objection is expressly made at the meeting. Section 2.8. ACTION WITHOUT MEETING. Directors may be elected without a meeting by a consent in writing, setting forth the action so taken, signed by all of the persons who would be entitled to vote for the election of directors; provided that, without notice, a director may be elected at any time to fill a vacancy (other than one created by removal) not filled by the directors, by the written consent of persons holding a majority of the outstanding shares entitled to vote for the election of directors. Any other action which, under any provision of the California General Corporation Law, may be taken at a meeting of the shareholders, may be taken without a meeting, and without notice except as hereinafter set forth, if a consent in writing, setting forth the action so taken, is signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Unless the consents of all shareholders entitled to vote have been solicited in writing: (a) Notice of any proposed shareholder approval of, (i) a contract or other transaction with an interested director, (ii) indemnification of an agent of the corporation as authorized by Section 3.15, of Article III, of these Bylaws, (iii) a reorganization of the corporation as defined in Section 181 of the General Corporation Law, or (iv) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares, if any, without a meeting by less than unanimous written consent, shall be given at least ten (10) days before the consummation of the action authorized by such approval; and (b) Prompt notice shall be given of the taking of any other corporate action approved by shareholders without a meeting by less than unanimous written consent, to those shareholders entitled to vote who have not consented in writing. Such notices shall be given in the manner and shall be deemed to have been given as provided in Section 2.2 of Article II of these Bylaws. 6 Unless, as provided in Section 5.1 of Article V of these Bylaws, the board of directors has fixed a record date for the determination of shareholders entitled to notice of and to give such written consent, the record date for such determination shall be the day on which the first written consent is given. All such written consents shall be filed with the Secretary of the corporation. Any shareholder giving a written consent, or the shareholder's proxyholders, or a transferee of the shares, or a personal representative of the shareholder, or their respective proxyholders, may revoke the consent by a writing received by the corporation prior to the time that written consents by the number of shares required to authorize the proposed action have been filed with the Secretary of the corporation, but may not do so thereafter. Such revocation is effective upon its receipt by the Secretary of the corporation. Section 2.9. PROXIES. Every person entitled to vote shall have the right to do so either in person or by one or more agents authorized by a written proxy executed by such person or his duly authorized agent and filed with the Secretary of the corporation. Any proxy duly executed is not revoked and continues in full force and effect until, (i) an instrument revoking it or a duly executed proxy bearing a later date is filed with the Secretary of the corporation prior to the vote pursuant thereto, (ii) the person executing the proxy attends the meeting and votes in person, or (iii) written notice of the death or incapacity of the maker of such proxy is received by the corporation before the vote pursuant thereto is counted; provided, that no such proxy shall be valid after the expiration of eleven (11) months from the date of its execution, unless the person executing it specifies therein the length of time for which such proxy is to continue in force; provided further, that an irrevocable proxy satisfying the requirements of Section 705(e) of the General Corporations Law shall not be revoked except in accordance with its terms or if it becomes revocable under the provisions of Section 705(e) and (f) of said General Corporations Law. Section 2.10. INSPECTORS OF ELECTION. In advance of any meeting of shareholders, the board of directors may appoint any persons as inspectors of election to act at such meeting or any adjournment thereof. If inspectors of election be not so appointed, the chairman of any such meeting may, and on the request of any shareholder or his proxy shall, make such appointment at the meeting. The number of inspectors shall be either one (1) or three (3). If appointed at a meeting on the request of one or more shareholders or proxies, the majority of shares represented in person or by proxy shall determine whether one (1) or three (3) inspectors are to be appointed. In case any person appointed as inspector fails to appear or fails or refuses to act, the vacancy may, and on the request of any shareholder or a shareholder's proxy shall, be filled by appointment by the board of directors in advance of the meeting, or at the meeting by the chairman of the meeting. The duties of such inspectors shall be as prescribed in Section 707 of the General Corporation Law and shall include: determining the number of shares 7 outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the authenticity, validity and effect of proxies; receiving votes, ballots or consents; hearing and determining all challenges and questions in any way arising in connection with the right to vote; counting and tabulating all votes or consents; determining when the polls shall close; determining the result; and such acts as may be proper to conduct the election or vote with fairness to all shareholders. In the determination of the validity and effect of proxies, the dates contained on the forms of proxy shall presumptively determine the order of execution of the proxies, regardless of the postmark dates on the envelopes in which they are mailed. In making their determinations, the inspectors may consider whether proxies were solicited in accordance with applicable provisions of law. The inspectors of election shall perform their duties impartially, in good faith, to the best of their ability and as expeditiously as is practical. If there are three inspectors of election, the decision, act or certificate of a majority is effective in all respects as the decision, act or certificate of all. Any report or certificate made by the inspectors of election is prima facie evidence of the facts stated therein. Section 2.11. NOMINATION OF DIRECTORS. Nominations for election of members of the board of directors may be made by the board of directors or by any shareholder of any outstanding class of capital stock of the corporation entitled to vote for the election of directors. Notice of intention to make any nominations (other than for persons named in the notice of the meeting at which such nomination is to be made) shall be made in writing and shall be delivered or mailed to the president of the corporation by the later of the close of business 21 days prior to any meeting of shareholders called for the election of directors or 10 days after the date of mailing of notice of the meeting to shareholders. Such notification shall contain the following information to the extent known to the notifying shareholder: (a) the name and address of each proposed nominee; (b) the principal occupation of each proposed nominee; (c) the number of shares of capital stock of the corporation owned by each proposed nominee; (d) the name and residence address of the notifying shareholder; (e) the number of shares of capital stock of the corporation owned by the notifying shareholder; (f) with the written consent of the proposed nominee, a copy of which shall be furnished with the notification, whether the proposed nominee has ever been convicted of or pleaded nolo contendere to any criminal offense involving dishonesty or breach of trust, filed a petition in bankruptcy, or been adjudged bankrupt. The notice shall be signed by the nominating shareholder and by the nominee. Nominations not made in accordance herewith shall be disregarded by the chairman of the meeting, and upon his instructions, the inspectors of election shall disregard all votes cast for each such nominee. The restrictions set forth in this paragraph shall not apply to nomination of a person to replace a proposed nominee who has died or otherwise become incapacitated to serve as a director between the last day for giving notice hereunder and the date of election of directors if the procedure called for in this paragraph was followed with respect to the nomination of the proposed nominee. 8 ARTICLE III DIRECTORS Section 3.1. POWERS. Subject to limitations of the articles of incorporation and of the California General Corporation Law as to action to be authorized or approved by the shareholders, and subject to the duties of directors as prescribed by the Bylaws, all corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation shall be controlled by, the board of directors. Without prejudice to such general powers, but subject to the same limitations, it is hereby expressly declared that the directors shall have the following powers, to wit: First - To select and remove all the officers, agents and employees of the corporation, prescribe such powers and duties for them as may not be inconsistent with law, with the articles of incorporation or the Bylaws, fix their compensation and require from them security for faithful service. Second - To conduct, manage and control the affairs and business of the corporation, and to make such rules and regulations therefor not inconsistent with law, or with the articles of incorporation or the Bylaws, as they may deem best. Third - To change the principal executive office and principal office for the transaction of the business of the corporation from one location to another as provided in Article I, Section 1.1, hereof; to fix and locate from time to time one or more subsidiary offices of the corporation within or without the State of California, as provided in Article I, Section 1.2, hereof; to designate anyplace within the State of California for the holding of any shareholders' meeting or meetings; and to adopt, make and use a corporate seal, and to prescribe the forms of certificates of stock, and to alter the form of such seal and of such certificates from time to time, as in their judgment they may deem best, provided such seal and such certificates shall at all times comply with the provisions of law. Fourth - To authorize the issuance of shares of stock of the corporation from time to time, upon such terms as may be lawful. Fifth - To borrow money and incur indebtedness for the purposes of the corporation, and to cause to be executed and delivered therefor, in the corporate name, promissory notes, bonds, debentures, deeds of trust, mortgages, pledges, hypothecations or other evidences of debt and securities therefor. Sixth - By resolution adopted by a majority of the authorized number of directors, to designate executive and other committees, each consisting of two or more directors, to serve at the pleasure of the board, and to prescribe the manner in which proceedings of such committees shall be conducted. Unless the board of 9 directors shall otherwise prescribe the manner of proceedings of any such committees, meetings of such committees may be regularly scheduled in advance and may be called at any time by the chairman or any two members thereof; unless the board of directors otherwise prescribes, the other provisions of these Bylaws with respect to notice and conduct of meetings of the board shall govern. Any such committee, to the extent provided in a resolution of the board, shall have all of the authority of the board, except with respect to: (i) the approval of any action for which the General Corporation Law or the articles of incorporation also require shareholder approval; (ii) the filling of vacancies on the board or in any committee; (iii) the fixing of compensation of the directors for serving on the board or on any committee; (iv) the adoption, amendment or repeal of the board; (v) the amendment or repeal of any resolution of Bylaws; (vi) any distribution to the shareholders, except at a rate or in a periodic amount or within a price range determined by the board; (vii) the appointment of other committees of the board or the members thereof; and (viii) taking any action which requires approval of a specified number or portion of the directors under any provision of law or regulation applicable specifically to banks. Section 3.2. NUMBER AND QUALIFICATION OF DIRECTORS. The number of directors of the corporation shall not be less than five (5) nor more than nine (9), except that effective immediately before the effective time of the Company's initial public offering, the number of directors shall not be less than eight (8) nor more than fifteen (15), until changed by amendment of the articles of incorporation or by a bylaw amending this Section 3.2 duly adopted by the vote of the holders of a majority of the outstanding shares entitled to vote or written consent of the holders of a majority of the outstanding shares entitled to vote, provided that a proposal to reduce the authorized number or the minimum number of directors below five cannot be adopted. The exact number of directors shall be fixed from time to time, within the limits specified in the articles of incorporation or in this Section 3.2 (i) by resolution duly adopted by the board of directors; or (ii) by a bylaw or amendment thereof duly adopted by the vote of a majority of the shares entitled to vote represented at a duly held meeting at which a quorum is present, or by a written consent of the holders of a majority of the outstanding shares entitled to vote, or by the board of directors; or (iii) by approval of the shareholders (as defined in Section 153 of the General Corporation Law). 10 Subject to the foregoing provisions, for changing the number of directors, the number of directors of this corporation has been fixed at five (5). Section 3.3. ELECTION AND TERM OF OFFICE. Subject to the Articles of Incorporation, Statute or these Bylaws, and subject to Section 2.6 regarding Classified Board, the directors shall be elected at each annual meeting of shareholders but, if any such annual meeting is not held or the directors are not elected thereat, the directors may be elected at any special meeting of shareholders held for that purpose or by written consent in accordance with Section 2.8 of Article II of these Bylaws. All directors shall hold office until their respective successors are elected, subject to the General Corporation Law and the provisions of these Bylaws with respect to vacancies on the board. Section 3.4. VACANCIES. A vacancy in the board of directors shall be deemed to exist (i) in case of the death, resignation or removal of any director, (ii) if a director has been declared of unsound mind by order of court or convicted of a felony, (iii) if the authorized number of directors be increased, or (iv) if the shareholders fail, at any annual or special meeting of shareholders at which any director or directors are elected, to elect the full authorized number of directors to be voted for at that meeting. The number of directors of the Corporation shall be such number, as shall be provided from time to time in the Bylaws; provided, however, that no decrease in the number of directors shall have the effect of shortening the term of any incumbent director, and provided further, that no action shall be taken to decrease or increase the number of directors within the range stated in the Bylaws unless at least two-thirds of the directors then in office shall concur in said action. Vacancies in the board of directors of the Corporation, however caused, and newly created directorships shall be filled by a vote of two-thirds of the directors then in office, whether or not a quorum, and any director so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of the class to which the director has been chosen expires and when the director's successor is elected and qualified. Any director may resign effective upon giving written notice to the chairman of the board, the president, the Secretary or the board of directors of the corporation, unless the notice specifies a later time for the effectiveness of such resignation. If the board of directors accepts the resignation of a director tendered to take effect at a future time, the board or the shareholders shall have power to elect a successor to take office when the resignation is to become effective, as provided in the previous paragraph. No reduction of the authorized number of directors shall have the effect of removing any director prior to the expiration of his term of office. 11 Section 3.5. PLACE OF MEETING. Regular meetings of the board of directors shall be held at any place within the State of California which has been designated from time to time by resolution of the board or by written consent of all members of the board. In the absence of such designation regular meetings shall be held at the principal executive office of the corporation. Special meetings of the board may be held either at a place so designated, within or without the State of California, or at the principal executive office. Section 3.6. ORGANIZATION MEETING. Immediately following each annual meeting of shareholders, the board of directors shall hold a regular meeting at the place of said annual meeting or at such other place as shall be fixed by the board of directors, for the purpose of organization, election of officers, and the transaction of other business. Call and notice of such meetings are hereby dispensed with. Section 3.7. OTHER REGULAR MEETINGS. Other regular meetings of the board of directors shall be held without call on the 3rd Wednesday of January, April, July and October of each year, at 9:00 a.m. (unless another date and time is fixed by the board); provided, however, should said day fall upon a legal holiday, then said meeting shall be held at the same time on the next day thereafter ensuing which is a full business day. Notice of all such regular meetings of the board of directors is hereby dispensed with. Section 3.8. SPECIAL MEETINGS. Special meetings of the board of directors for any purpose or purposes shall be called at any time by the chairman of the board, the president, or by any two directors. Written notice of the time and place of special meetings shall be delivered personally to each director or communicated to each director orally, by telephone, or by telegraph or mail, charges prepaid, addressed to him at his address as it is shown upon the records of the corporation or, if it is not so shown on such records or is not readily ascertainable, at the place at which the meetings of the directors are regularly held. In case such notice is mailed or telegraphed, it shall be deposited in the United States mail or delivered to the telegraph company in the place in which the principal executive office of the corporation is located at least forty-eight hours prior to the time of the holding of the meeting. In case such notice is delivered personally or by telephone, as above provided, it shall be so delivered at least twenty-four hours prior to the time of the holding of the meeting. Such mailing, telegraphing or delivery, personally, orally or by telephone, as above provided, shall be due, legal and personal notice to such director. Any notice shall state the date, place and hour of the meeting and may state the general nature of the business to be transacted, and other business may be transacted at the meeting. 12 Section 3.9. ACTION WITHOUT MEETING. Any action by the board of directors may be taken without a meeting if all members of the board shall individually or collectively consent in writing to such action. Such written consent or consents shall be filed with the minutes of the proceedings of the board and shall have the same force and effect as a unanimous vote of such directors. Section 3.10. ACTION AT A MEETING: QUORUM AND REQUIRED VOTE. Presence of a majority of the authorized number directors at a meeting of the board of directors constitutes a quorum for the transaction of business, except as hereinafter provided., or as provided in the Articles of Incorporation or Statute. Members of the board may participate in a meeting through use of conference telephone or similar communications equipment, so long as all members participating in such meeting can hear one another. Participation in a meeting as permitted in the preceding sentence constitutes presence in person at such meeting. Except as provided in the Articles of Incorporation, Statute or Bylaws, every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the board of directors, unless a greater number, or the same number after disqualifying one or more directors from voting, is required by law, by the articles of incorporation, or by these Bylaws. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of director, provided that any action taken is approved by at least a majority of the required quorum for such meeting. Section 3.11. VALIDATION OF DEFECTIVELY CALLED OR NOTICED MEETINGS. The transactions of any meeting of the board of directors, however called and noticed or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum is present and if, either before or after the meeting, each of the directors not present or who, though present, has prior to the meeting or at its commencement, protested the lack of proper notice to him, (i) signs a written waiver of notice or a consent to holding such meeting or an approval of the minutes thereof, or (ii) waives notice and withdraws his objection. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance of a director at any meeting shall constitute a waiver of notice of such meeting, unless a director attends for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called, noticed, or convened; provided, however, if after stating his objection, the objecting director continues to attend and by his attendance participates in any matters other than those to which he objected, he shall be deemed to have waived notice of such meeting and withdrawn his objections. Section 3.12. ADJOURNMENT. A majority of the directors present at any director's meeting, either regular or special, may adjourn from time to time until the time fixed for the next regular meeting of the board. 13 Section 3.13. NOTICE OF ADJOURNMENT. If the meeting is adjourned for more than 24 hours, notice of any adjournment to another time or place must be given prior to the time of the adjourned meeting to the directors who were not present at the time of adjournment. Otherwise notice of the time and place of holding an adjourned meeting need not be given to absent directors if the time and place be fixed at the meeting adjourned. Section 3.14. FEES AND COMPENSATION. Directors and members of committees may receive such compensation, if any, for their services, and such reimbursement for expenses, as may be fixed or determined by resolution of the board. Section 3.15. INDEMNIFICATION OF AGENTS OF THE CORPORATION; PURCHASE OF LIABILITY INSURANCE. (a) The corporation shall, to the maximum extent and in the manner permitted by the California Corporations Code (the "Code"), indemnify each of its directors against expenses (as defined in Section 317(a) of the Code), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was an agent of the corporation. For purposes of this Section 3.15 a "director" of the corporation includes any person (i) who is or was serving at the request of the corporation (ii) as a director of another corporation, partnership, joint venture, trust or other enterprise, or (iii) who was a director of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. (b) The corporation shall have the power, to the extent and in the manner permitted by the Code, to indemnify each of its officers, employees and agents against expenses (as defined in Section 317(a) of the Code), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was an officer, employee or agent of the corporation. For purposes of this Section 3.15, an "officer", "employee" or "agent" of the corporation includes any person (i) who is or was an officers, employee, or agent of the corporation, (ii) who is or was serving at the request of the corporation as an officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or (iii) who was an officer, employee or agent of the corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. (c) Expenses incurred in defending any civil or criminal action or proceeding for which indemnification is required pursuant to Section 3.15 shall be paid by the corporation in advance of the final disposition of such action or proceeding upon receipt of an undertaking by or on behalf of the indemnified party to repay such 14 amount if it shall ultimately be determined that the indemnification party is not entitled to be indemnified as authorized in this Section 3.15. Expenses incurred in defending any civil or criminal action or proceeding for which indemnification s permitted pursuant to Section 3.15 may be paid by the corporation in advance of the final disposition of such action or proceeding upon receipt of an undertaking by or on behalf of the indemnified party to repay such amount if it shall ultimately be determined that the indemnified party is not entitled to be indemnified as authorized in this Section 3.15. (d) The indemnification provided by this Section 3.15 shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any bylaw, agreement, vote of shareholders or disinterested directors or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office, to the extent that such additional rights to indemnification are authorized in the Articles of Incorporation. (e) The corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was an agent of the corporation against any liability asserted against or incurred by such person in such capacity or arising out of such person's status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of this Section 3.15. (f) No indemnification or advance shall be made under this Section 3.15, except where such indemnification or advance is mandated by law or the order, judgment or decree of any court of competent jurisdiction, in any circumstance where it appears: (1) That it would be inconsistent with a provision of the Articles of Incorporation, these Bylaws, a resolution of the shareholders or an agreement in effect at the time of the accrual of the alleged cause of the action asserted in the proceeding in which the expenses were incurred or other amounts were paid, which prohibits or otherwise limits indemnification; or (2) That it would be inconsistent with any condition expressly imposed by a court in approving a settlement. 15 ARTICLE IV OFFICERS Section 4.1. OFFICERS. The officers of the corporation shall be a chief executive officer, a vice-president, a secretary and a chief financial officer. The corporation may also have, at the discretion of the board of directors, a chairman of the board, one or more additional vice-presidents, one or more assistant secretaries, and such other officers as may be appointed in accordance with the provisions of Section 3 of this Article. One person may hold two or more offices, except that the offices of president and Secretary shall not be held by the same person. Section 4.2. ELECTION. The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 4.3 or Section 4.5 of this Article, shall be chosen annually by the board of directors, and each shall hold his office until he shall resign or shall be removed or otherwise disqualified to serve, or his successor shall be elected and qualified. Section 4.3. SUBORDINATE OFFICERS, ETC. The board of directors may appoint, and may empower the president to appoint, such other officers as the business of the corporation may require, each of whom shall hold office, for such period, have such authority and perform such duties as are provided in the Bylaws or as the board of directors may from time to time determine. Section 4.4. REMOVAL AND RESIGNATION. Any officer may be removed, either with or without cause, by the board of directors, at any regular or special meeting thereof, or, except in case of an officer chosen by the board of directors, by any officer upon whom such power of removal may be conferred by the board of directors (subject, in each case, to the rights, if any, of an officer under any contract of employment). Any officer may resign at any time by giving written notice to the board of directors or to the president, or to the Secretary of the corporation, without prejudice however, to the rights, if any, of the corporation under any contract to which such officer is a party. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein; and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Section 4.5. VACANCIES. A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in the Bylaws for regular appointments to such office. 16 Section 4.6. CHAIRMAN OF THE BOARD. The chairman of the board, if there shall be such a person, shall be an officer of the board only and not of the corporation, and shall, if present, preside at all meetings of the board of directors. He may exercise and perform such other powers and duties as may be from time to time assigned to him by the board of directors or prescribed by the Bylaws, in which case he may be deemed to be an officer of the corporation. Section 4.7. PRESIDENT. Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board, if there be such an officer, the president shall be the chief executive officer of the corporation and shall, subject to the control of the board of directors, have general supervision, direction and control of the business and officers of the corporation. He shall preside at all meetings of the shareholders and, in the absence of the chairman of the board, or if there be none, at all meetings of the board of directors. He shall be ex-officio a member of all the standing committees (except the audit committee), including the executive committee, if any, and shall have the general powers, and duties of management usually vested in the office of president of a corporation, and shall have such other powers and duties as may be prescribed by the board of directors or the Bylaws. Section 4.8. VICE-PRESIDENT. In the absence or disability of the president, the vice-presidents in order of their rank as fixed by the board of directors or, if not ranked, the vice-president designated by the board of directors, shall perform all the duties of the president, and when so acting shall have all the powers of, and be subject to all the restrictions upon the president. The vice-presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the board of directors or the Bylaws. Section 4.9. SECRETARY. The Secretary shall record or cause to be recorded, and shall keep or cause to be kept, at the principal executive office and such other place as the board of directors may order, a book of minutes of actions taken at all meetings of directors and shareholders, with the time and place of holding, whether regular or special, and, if special, how authorized, the notice thereof given, the names of those present at director's meetings, the number of shares present or represented at shareholder's meetings, and the proceedings thereof. The Secretary shall keep, or cause to be kept, at the principal executive office or at the office of the corporation's transfer agent, a share register, or a duplicate share register, showing the names of the shareholders and their addresses, the number and classes of shares held by each, the number and date of certificates issued for the same, and the number and date of cancellation of every certificate surrendered for cancellation. The Secretary shall give, or cause to be given, notice of all the meetings of the shareholders and of the board of directors required by the Bylaws or by law to 17 be given, and he shall keep the seal of the corporation in safe custody, and shall have such other powers and perform such other duties as may be prescribed by the board of directors or by the Bylaws. Section 4.10. CASHIER. The cashier shall be the chief financial officer of the corporation and shall keep and maintain, or cause to be kept and maintained, adequate and correct accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, surplus and shares. The books of account shall at all reasonable times be open to inspection by any director. The cashier shall deposit all moneys and other valuables in the name and to the credit of the corporation with such depositories as may be designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the board of directors, shall render to the president and directors, whenever they request it, an account of all of his transactions as cashier and of the financial condition of the corporation, and shall have such other powers and perform such other duties as may be prescribed by the board of directors or the Bylaws. ARTICLE V MISCELLANEOUS Section 5.1. RECORD DATE. The board of directors may fix a time in the future as a record date for the determination of the shareholders entitled to notice of and to vote at any meeting of shareholders or entitled to give consent to corporate action in writing without a meeting, to receive any report, to receive any dividend or distribution, or any allotment of rights, or to exercise rights in respect to any change, conversion, or exchange of shares. The record date so fixed shall be not more than sixty (60) days nor less than ten (10) days prior to the date of any meeting, nor more than sixty (60) days prior to any meeting or any other event for the purpose of which it is fixed. When a record date is so fixed, only shareholders of record on that date are entitled to notice of and to vote at any such meeting, to give consent without a meeting, to receive any report, to receive a dividend, distribution, or allotment of rights, or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date, except as otherwise provided in the articles of incorporation or Bylaws. Section 5.2. INSPECTION OF CORPORATE RECORDS. The accounting books and records, the record of shareholders, and minutes of proceedings of the shareholders and the board and committees of the board of this corporation and any subsidiary of this corporation shall be open to inspection upon the written demand on the corporation of any shareholder or holder of a voting trust certificate at any reasonable time during usual business hours, for a purpose reasonably related to such holder's interests as a shareholder or as the holder of such voting trust certificate. 18 Such inspection by a shareholder or holder of a voting trust certificate may be made in person or by agent or attorney, and the right of inspection includes the right to copy and make extracts. Section 5.3. CHECKS, DRAFTS, ETC. All checks, drafts or other orders for payment of money, notes or other evidences of indebtedness, issued in the name of or payable to the corporation, shall be signed or endorsed by such person or persons and in such manner as, from time to time, shall be determined by resolution of the board of directors. Section 5.4. ANNUAL AND OTHER REPORTS. The board of directors of the corporation shall cause an annual report to be sent to the shareholders not later than 120 days after the close of the fiscal or calendar year. The requirement for such annual report is dispensed with so long as this corporation has less than 100 shareholders of record. Such report shall contain a balance sheet as of the end of such fiscal year and an income statement and statement of changes in financial position for such fiscal year, accompanied by any report thereon of independent accountants or, if there is no such report, the certificate of an authorized officer of the corporation that such statements were prepared without audit from the books and records of the corporation. A shareholder or shareholders holding at least five percent of the outstanding shares of any class of the corporation may make a written request to the corporation for an income statement of the corporation for the three-month, six-month or nine-month period of the current fiscal year ended more than 30 days prior to the date of the request and a balance sheet of the corporation as of the end of such period and, in addition, if no annual report for the last fiscal year has been sent to shareholders, the annual report for the last fiscal year. The corporation shall use its best efforts to deliver the statement to the person making the request within 30 days thereafter. A copy of any such statements shall be kept on file in the principal executive office of the corporation for 12 months and they shall be exhibited at all reasonable times to any shareholder demanding an examination of them or a copy shall be mailed to such shareholder. The corporation shall, upon the written request of any shareholder, mail to the shareholder a copy of the last annual income statement which it has prepared and a balance sheet as of the end of the period. The quarterly income statements and balance sheets referred to in this section shall be accompanied by the report thereon, if any, of any independent accountants engaged by the corporation or the certificate of an authorized officer of the corporation that such financial statements were prepared without audit from the books and records of the corporation. Section 5.5. CONTRACTS, ETC., HOW EXECUTED. The board of directors, except as in the Bylaws otherwise provided, may authorize any officer or officers, agent or agents, to enter into any contract or execute any instrument in the name of 19 and on behalf of the corporation, and such authority may be general or confined to specific instances; and, unless so authorized by the board of directors, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or to any amount. Section 5.6. CERTIFICATE FOR SHARES. Every holder of shares in the corporation shall be entitled to have a certificate signed in the name of the corporation by the chairman or vice-chairman of the board or the president or a vice-president and by the chief financial officer or the Secretary or any Assistant Secretary, certifying the number of shares and the class or series of shares owned by the shareholder. Any of the signatures on the certificate may be facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if such person were an officer, transfer agent or registrar at the date of issue. Any such certificate shall also contain such legend or other statement as may be required by Section 418 of the General Corporation Law, the Corporate Securities Law of 1968, the federal securities laws, and any agreement between the corporation and the issuee thereof. No new certificate for shares shall be issued in lieu of an old certificate unless the latter is surrendered and cancelled at the same time; provided, however, that a new certificate will be issued without the surrender and cancellation of the old certificate if (1) the old certificate is lost, apparently destroyed or wrongfully taken; (2) the request for the issuance of the new certificate is made within a reasonable time after the owner of the old certificate has notice of its loss, destruction, or theft; (3) the request for the issuance of a new certificate is made prior to the receipt of notice by the corporation that the old certificate has been acquired by a bona fide purchaser; (4) the owner of the old certificate files a sufficient indemnity bond with or provides other adequate security to the corporation; and (5) the owner satisfies any other reasonable requirements imposed by the corporation. In the event of the issuance of a new certificate, the rights and liabilities of the corporation, and of the holders of the old and new certificates, shall be governed by the provisions of Section 8104 and 8405 of the California Commercial Code. Section 5.7. REPRESENTATION OF SHARES OF OTHER CORPORATIONS. The president or vice-president and the Secretary or any Assistant Secretary of this corporation are authorized to vote, represent and exercise on behalf of this corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority herein granted to said officers to vote or represent on behalf of this corporation any and all shares held by this corporation in any other corporation or corporations may be exercised either by such 20 officers in person or by any other person authorized so to do by proxy or power of attorney duly executed by said officers. Section 5.8. INSPECTION OF BYLAWS. The corporation shall keep in its principal executive office in California, the original or a copy of the Bylaws as amended or otherwise altered to date, certified by the Secretary, which shall be open to inspection by the Shareholders at all reasonable times during office hours. Section 5.9. CONSTRUCTION AND DEFINITIONS. Unless the context otherwise requires, the general provisions, rules of construction and definitions contained in the California General Corporation Law shall govern the construction of these Bylaws. Without limiting the generality of the foregoing, the masculine gender includes the feminine and neuter, the singular number includes the plural and the plural number includes the singular, and the term "person" includes a corporation as well as a natural person. ARTICLE VI AMENDMENTS Section 6.1. POWER OF SHAREHOLDERS. Except as provided in the Articles of incorporation, Statute, or thee bylaws, new Bylaws may be adopted or these Bylaws may be amended or repealed by the affirmative vote of a majority of the outstanding shares entitled to vote, or by the written assent of shareholders entitled to vote such shares, except as otherwise provided by law or by the articles of incorporation. Section 6.2. POWER OF DIRECTORS. Subject to the right of shareholders as provided in Section 6.1 of this Article VI to adopt, amend or repeal Bylaws, Bylaws may be adopted, amended or repealed by the board of directors provided, however, that the board of directors may adopt a bylaw or amendment thereof changing the authorized number of directors only for the purpose of fixing the exact number of directors within the limits specified in the articles of incorporation or in Section 3.2 of Article III of these Bylaws. 21 CERTIFICATE OF SECRETARY I, the undersigned, do hereby certify: 1. That I am duly elected, qualified, and acting Secretary of the PACIFIC COMMUNITY BANKING GROUP, a California corporation; and 2. That the forgoing Bylaws, comprising 21 pages, constitute the Bylaws of the said Corporation as duly adopted by action of the Board of Directors of the Corporation duly taken on February 23, 1999. IN WITNESS HEREOF, I have hereunto subscribed my name and affix the seal of said Corporation this 25 day of February, 1999. /s/ Alfred Jannard ------------------------------------ Alfred Jannard, Secretary 22 EX-3.4 11 EXHIBIT 3.4 Exhibit 3.4 CERTIFICATE OF DETERMINATION FOR PACIFIC COMMUNITY BANKING GROUP E. Lynn Caswell and Alfred Jannard certify that: 1. They are the Chairman of the Board of Directors and Secretary, respectively, of Pacific Community Banking Group (the "Company"), a California corporation. 2. The number of authorized shares of Preferred Stock of the Company is 100,000,000 shares, none of which have been issued. 3. The Board of Directors of the Company has duly adopted the following resolutions: WHEREAS, the Articles of Incorporation of the Company authorize the Preferred Stock of the Company to be issued in series and authorize the Board of Directors to determine the rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued series of Preferred Stock and to fix the number of shares and designation of any such series. NOW THEREFORE, BE IT RESOLVED, that the Board of Directors does hereby establish a Series A Preferred Stock and a Series B Preferred Stock (collectively the "Preferred Stock") as follows: (a) The rights, preferences privileges and restrictions granted to and imposed upon the first such series, designated Series A Preferred Stock, of which the Company is hereby authorized to issue 1,085,000 shares, and the second such series, designated Series B Preferred Stock, of which the Company is hereby authorized to issue 375,000 shares, are set forth herein. The Board of Directors is authorized to decrease the number of shares of any series subsequent to the issuance of shares of that series, but not below the number of shares of that series then outstanding. In case the number of shares of any series shall be so decreased, the shares constituting such decrease shall resume the status they had prior to the adoption of the resolution originally fixing the number of shares of such series. The relative rights, preferences, privileges and restrictions granted to or imposed upon the Series A Preferred Stock, and the Series B Preferred Stock or the holders thereof are as follows: (b) The holders of Preferred Stock are not entitled to receive dividends. (c) Upon the voluntary or involuntary liquidation, winding up or dissolution of the Company, out of the assets available for distribution to shareholders the Preferred Stock shall be entitled to receive, in preference to any payment on the Common Stock, an amount equal to $1.00 per share. After the full preferential liquidation amount has been paid to, or determined and set apart for, the Preferred Stock, the remaining assets shall be paid to Common Stock. In the event the assets of the corporation are insufficient to pay the full preferential liquidation amount required to be paid to the Preferred Stock, the entire remaining assets shall be paid to the Preferred Stock and the Common Stock shall receive nothing. A reorganization shall not be considered to be a liquidation, winding up or dissolution within the meaning of this subdivision (c) and the Preferred Stock shall 2 be entitled only to the rights provided in the plan of reorganization, Division 1, Chapter 17, Article 5 of the Financial Code of the State of California, and Chapters 12 and 13 of the California General Corporations Law. (d)(1) Without the approval of at least two-thirds of the outstanding shares of Preferred Stock, and any required regulatory agency, the Company shall not: (i) amend the articles of incorporation to alter or change any rights, preferences or privileges of the Preferred Stock; (ii) increase the authorized number of shares of Preferred Stock; (iii) authorize another class of shares senior to the Preferred Stock with respect to distribution of assets on liquidation; (iv) enter into a reorganization with any other corporation or sell all or substantially all of its assets to any other Company or corporation, even though the transaction is not a reorganization, except a reorganization not requiring approval of the Common Stock; (v) restrict the transfer or hypothecation of shares of Preferred Stock other than as required by federal or state securities laws or regulations; (d)(2) Except as otherwise expressly provided by law or by this Certificate of Determination, the Common Stock of the Company has exclusive voting rights on all matters requiring a vote of shareholders, including election of directors, and the Preferred Stock has no voting rights. If the Company violates 3 any of the covenants in subdivision (d)(1) of this Certificate of Determination, which violation is not cured within 30 days after written notice by 10% or more of the outstanding shares of Preferred Stock, the Preferred Stock shall have the right to elect one (1) director and the Common Stock shall have the right to elect the remaining directors. Such right in the Preferred Stock shall continue until such covenant violation shall have been cured, and until the Company shall have made any and all such redemptions then required whether or not funds are legally available therefore, as the case or cases may be, after which the exclusive right to elect directors shall revert to the Common Stock, subject to renewal of the voting right of the Preferred Stock from time to time. At any time after the right to elect directors is vested in the Preferred Stock, and at any time after the exclusive right to elect directors shall revert to the Common Stock, the holders of 10% or more of the outstanding shares of Preferred Stock or Common Stock, as the case may be, have a right to call a special meeting of shareholders for the purpose of electing all of the members of the Board of Directors, such right to be exercisable by delivering a request in writing for the calling of the special meeting to the president or secretary, or to the chairman of the board or vice-president if there be such. The officer receiving the request shall forthwith cause notice to be given to the shareholders entitled to vote that a meeting will be held at a time requested by the person or persons calling the meeting, not less than 35 nor more than 60 days after the receipt of the request. If the notice is not given within 20 days after receipt of the request, the shareholders calling the meeting shall have the rights accorded to them pursuant to subdivision (c) of Section 601 of the California 4 Corporations Code. Upon the election of directors by the Preferred Stock at a special meeting, the terms of all persons who were directors immediately prior thereto shall terminate and the directors elected by the Preferred Stock together with those elected at the special meeting by the Common Stock shall constitute the directors of the Company until the next annual meeting. Upon the election of directors by the Common Stock at a special meeting after the exclusive right to elect directors has reverted to the Common Stock, the terms of all persons who were directors immediately prior thereto shall terminate and the directors elected by the Common Stock at the special meeting shall constitute the directors of the Company until the next annual meeting. (e)(1) The Preferred Stock is subject to redemption, out of funds legally available therefor, in whole, or from time to time in part, at the option of the Board of Directors of the Company, subject to any necessary regulatory approvals. If only a part of the Preferred Stock is to be redeemed, the redemption shall be effected on a prorata basis. The redemption price shall be $1.00 per share (herein called the "redemption price"). (2) The Company shall mail a notice of redemption to each holder of record of shares to be redeemed addressed to the holder at the address of such holder appearing on the books of the Company or given by the holder to the Company for the purpose of notice, or if no such address appears or is given at the place where the principal executive office of the Company is located, not earlier than 60 nor later than 20 days before the date fixed for redemption. The notice of redemption shall include (i) the class of shares or the part of a class of shares to be 5 redeemed, (ii) the date fixed for redemption, (iii) the redemption price, (iv) the place at which the shareholders may obtain payment of the redemption price upon surrender of their share certificates and (v) the last date prior to the date of redemption that the right of conversion may be exercised. If funds are available on the date fixed for the redemption, then whether or not the share certificates are surrendered for payment of the redemption price, the shares shall no longer be outstanding and the holders thereof shall cease to be shareholders after the date fixed for redemption and shall be entitled only to receive the redemption price without interest upon surrender of the share certificate. If less than all the shares represented by one share certificate are to be redeemed, the Company shall issue a new share certificate for the shares not redeemed. (3) The Company shall also cause a copy of the notice of redemption to be published in a newspaper of general circulation in the county in which the principal executive office of the Company is located at least once a week for two successive weeks, in each instance on any day of the week, commencing not earlier than 60 nor later than 20 days before the date fixed for redemption as provided in this paragraph (3). The failure of the Company to comply with the provision for mailing of notice of redemption in paragraph (2) does not invalidate the redemption of the shares. If, on or prior to any date fixed for redemption, the Company deposits with any Company or trust company in this state as a trust fund a sum sufficient to redeem, on the date fixed for redemption thereof, the shares called for redemption, with irrevocable instructions and authority to the Company or trust 6 company to publish the notice of redemption thereof (or to complete such publication if theretofore commenced) and to pay, on and after the date fixed for redemption or prior thereto, the redemption price of the shares to their respective holders upon the surrender of their share certificates, then from and after the date of the deposit (although prior to the date fixed for redemption) shares so called and tendered shall be redeemed and dividends on those shares shall cease to accrue after the date fixed for redemption. The deposit shall constitute full payment of the shares to their holders and from and after the date of the deposit the shares shall no longer be outstanding and the holders thereof shall cease to be shareholders with respect to such shares and shall have no rights with respect thereto except the right to receive from the Company or trust company payment of the redemption price of the shares without interest, upon surrender of their certificates therefor, and the right to convert the shares in accordance with subdivision (f) of this Certificate of Determination. The Company or trust company forthwith shall return to the Company funds deposited for shares converted. After 120 days, the Company or trust company shall return to the Company funds deposited and not claimed and thereafter the holder of a share certificate for shares redeemed shall look to the Company for payment. (f)(1) The Preferred Stock will be automatically converted into Common Stock only at the closing date of the Company's initial public offering of Common Stock, subject to such regulatory approvals which may be required. For the purpose of any such conversion, each share of Preferred Stock shall be treated as equivalent to its liquidation preference. The number of shares of Common Stock 7 issuable with respect to any shares of Preferred Stock upon conversion shall be determined by dividing the aggregate dollar equivalent of such shares of Preferred Stock by the "conversion price" in effect at the date of conversion. The "conversion price" per share for the Series A Preferred Stock shall be equal to 80% of the Company's initial public offering price per share of Common Stock. The "conversion price" per share for the Series B Preferred Stock shall be equal to 85% of the Company's initial public offering price per share of Common Stock. Upon conversion, no fractional shares shall be issued and the Company shall in lieu thereof pay in cash the fair value of the fraction. The Company shall reserve and keep reserved out of its authorized but unissued shares of Common Stock sufficient shares to effect the conversion of all shares of Preferred Stock outstanding from time to time. (2) Upon conversion, the Series A Preferred Stock share certificate, and the Series B Preferred share certificate, shall be delivered to the Company's Transfer Agent, if it has one, otherwise to the Company at its principal executive office. The endorsement of the share certificate shall be in form satisfactory to the Transfer Agent or the Company. The holder shall also provide evidence of compliance with regulatory requirements or an opinion of counsel that none is required, satisfactory to Company's counsel. Upon the date of the completion of the Company's initial offering of Common Stock, the conversion shall be deemed to have occurred, and the person entitled to receive share certificates for Common Stock shall be regarded for all corporate purposes from and after such date as the holder of the number of shares of Common Stock to which he is 8 entitled upon the conversion. (g) The holders of Preferred Stock shall have no right to vote upon any matter except as otherwise required by law. ------------------------------- E. LYNN CASWELL ------------------------------- ALFRED JANNARD 9 VERIFICATION E. Lynn Caswell and Alfred Jannard declare under penalty of perjury under the laws of the State of California that they have read the foregoing Certificate of Determination and know the contents thereof and that the same is true of their own knowledge. Dated: February 25, 1999 ------------------------------- E. LYNN CASWELL ------------------------------- ALFRED JANNARD 10 EX-4.2 12 EXHIBIT 4.2 Exhibit 4.2 NO. --- FORM OF WARRANT TO PURCHASE STOCK OF PACIFIC COMMUNITY BANKING GROUP Incorporated Under the Laws of the State of California. THIS CERTIFIES THAT, for value received, , the registered holder hereof or registered assigns (the "Holder"), is entitled to purchase from Pacific Community Banking Group, a California Corporation (the "Company), commencing , 1999 until 5:00 P.M., Pacific Time, , 2009, at the purchase price of $ per share from the date of issuance to on or before the end of the tenth year after the date of the issuance (the "Warrant Price"), the number of shares of Common Stock of the Company ("Common Stock"), which is equal to the number of Warrants set forth above. The number of shares purchasable upon exercise of this Warrant and the Warrant Price per share shall be subject to adjustment from time to time as set forth in the Warrant Agreement referred to below. This Warrant may be exercised in whole or in part by presentation of this Warrant with the Purchase Form duly executed and simultaneous payment for the Warrant Price (subject to adjustment) at the principal office of the Company, 23332 Mill Creek Drive, Suite 230, Laguna Hills, California 92653. Payment of such price shall be made at the option of the Holder hereof in cash, by check or any combination thereof. This Warrant is one of a duly authorized issue of Warrants evidencing the right to purchase an aggregate of up to shares of Company Common Stock and is issued under and in accordance with a Warrant Agreement dated as of 1999, between the Company and the Holder and is subject to the terms and provisions contained in the Warrant Agreement to all of which the Holder of this Warrant by acceptance hereof consents. Upon any partial exercise of this Warrant, there shall be signed and issued to the Holder hereof a new Warrant in respect of the shares of Common Stock as to which this Warrant shall not have been exercised. This Warrant may be exchanged at the office of the Company by surrender of this Warrant properly endorsed either separately or in combination with one or more other Warrants for one or more new Warrants entitling the Holder thereof to purchase the same aggregate number of shares as were evidenced by the Warrant or Warrants exchanged. No fractional shares will be issued upon the exercise of this Warrant, but the Company shall pay the cash value of any fraction upon the exercise of one or more Warrants. This Warrant is transferable at the office of the Company, in the manner and subject to the limitations set forth in the Warrant Agreement. This Warrant shall be separately transferable upon the date of issuance and for the ten-year period from the date of issuance. 1 The Holder hereof may be treated by the Company and all other persons dealing with this Warrant as the absolute owner for any purpose and as the person entitled to exercise the rights represented hereby, or to the transfer hereof on the books of the Company, any notice to the contrary notwithstanding, and until such transfer on such books, the Company may treat the Holder hereof as the owner for all purposes. This Warrant does not entitle any Holder hereof to any of the rights of a stockholder of the Company. This Warrant shall not be valid or obligatory for any purpose until it shall have been executed by the Company. Dated: , 1999 ------------- PACIFIC COMMUNITY BANKING GROUP By: ----------------------------------- 2 EX-10.1 13 EXHIBIT 10.1 EXHIBIT 10.1 Indemnity Agreement INDEMNITY AGREEMENT THIS AGREEMENT is made as of the date of October 31, 1997 by and between PACIFIC COMMUNITY BANKING GROUP, a California corporation (the "Company"), and E. LYNN CASWELL ("Indemnitee"), a director and/or officer of the Company, with reference to the following facts: A. The Company and the Indemnitee recognize the importance of providing the Company's directors and executive officers ("officers") with advance information and guidance with respect to the legal risks and potential liabilities to which they may become personally exposed as a result of performing their duties for the Company; B. The Company and the Indemnitee are aware of the substantial growth in the number of lawsuits filed against corporate officers and directors in connection with their activities in such capacities and by reason of their status as such; C. The Company and the Indemnitee recognize that the cost of defending against such lawsuits, whether or not meritorious, could be beyond the financial resources of most directors and officers of the Company; D. The Company and the Indemnitee recognize that the legal risks and potential liabilities, and the threat thereof, and the resultant substantial time and expense endured in defending against such lawsuits, bear no reasonable or logical relationship to the amount of compensation received by the Company's directors and officers. These factors pose a significant deterrent to, and induce increased reluctance on the part of, experienced and capable individuals to serve as directors and officers of the Company; E. The Company has investigated the availability and deficiency of liability insurance to provide its directors and officers with adequate protection against the foregoing legal risks and potential liabilities It has concluded that such insurance does not provide adequate protection to its directors and officers, is unreasonably expensive, or both. Thus, it would be in the best interests of the Company and its shareholders to contract with its directors and certain officers, including the Indemnitee, to indemnify them to the fullest extent permitted by law (as in effect on the date hereof, or, to the extent any amendment may expand such permitted indemnification, as hereinafter in effect) against personal liability for actions taken in the performance of their duties to the Company; F. The Board of Directors of the Company has concluded that it is not only reasonable and prudent but necessary for the Company to contractually obligate itself to indemnify in a reasonable and adequate manner its directors and officers and - 1 - to assume for itself maximum liability for expenses and damages in connection with claims lodged against such directors and officers for their line of duty decisions and actions; G. The General Corporation Law of the State of California (the "Code") empowers the Company to indemnify certain persons serving as a director, officer, employee or agent of the Company or a person who serves at the request of the Company as a director, officers, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, and further specifies in Code Section 317(g) that the indemnification provisions set forth in the Code "shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any bylaw, agreement, vote of shareholders or disinterested directors or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office, to the extent such additional rights to indemnification are authorized in the articles of the corporation"; thus, Section 317 does not by itself limit the extent to which the Company may indemnify persons serving as its officers and directors; H. In order to give proper effect to the indemnification provisions provided under the Code, the Articles of Incorporation which permit the Company to indemnify its directors and officers to the fullest extent permissible under the Code, subject to the limitations set forth in Section 204(a)(11) of the Code; I. The Board of Directors of the Company has determined, after due consideration and investigation of this Agreement and various other options available in lieu hereof, that this Agreement is reasonable, prudent and necessary to promote and ensure the best interests of the Company and its shareholders. This Agreement is intended to: (1) induce and encourage highly experienced and capable persons such as the Indemnitee to serve as officers and/or directors of the Company; (2) encourage such persons to resist what they consider unjustifiable suits and claims made against them in connection with the good faith performance of their duties to the Company, secure in knowledge that certain expenses, costs and liabilities incurred by them in their defense of such litigation will be borne by the Company and that they will receive the maximum protection against such risks and liabilities legally may be made available to them; and (3) encourage directors to exercise their best business judgment regarding matters which come before the Board of Directors without undue concern for the risk that claims may be made against them on account thereof. J. The Company desires to have the Indemnitee continue to serve as an officer and/or director of the Company free from concern for unpredictable, inappropriate or unreasonable legal risk and personal liabilities by reason of his acting in good faith in the performance of his duty to the Company. The Indemnitee desires to continue to serve as an officer and/or director of the Company, provided, and on the express condition, that he is furnished with the indemnity set forth herein. - 2 - NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth below and based on the premises set forth above, the Company and Indemnitee do hereby agree as follows: 1. DEFINITIONS. For the purposes of this Agreement, the following definitions shall apply: (a) The term "Proceeding" shall include, for the purposes of this Agreement, any threatened, pending or completed action, suit or proceeding, whether brought in the name of the Company or otherwise and whether of a civil, criminal or administrative or investigative nature, including, but not limited to, actions, suits or proceedings brought under and/or predicated upon the Securities Act of 1933, as amended, and/or the Securities Exchange Act of 1934, as amended, and/or their respective state counterparts and/or any rule or regulation promulgated thereunder, in which Indemnitee may be or may have been involved as party or otherwise (other than plaintiff against the Company), by reason of the fact that Indemnitee is or was an Agent of the Company by reason any action taken by him or of any inaction on his part while acting as such Agent. (b) The term "Expenses", includes, without limitation, all direct and indirect costs of any type or nature whatsoever, including, without limitation, expenses of investigations, judicial or administrative proceedings or appeals, court costs, attorneys' fees and disbursements and any expenses of establishing a right to indemnification under law or Paragraph 8 of this Agreement, actually and reasonably incurred by the Indemnitee in connection with the investigation, preparation, defense or appeal of a except that "Expenses" shall not include the amount of any judgment, fine or penalty actually levied against Indemnitee or amounts paid in settlement of a Proceeding. (c) References to "other enterprise" shall include employee benefit plans; reference to "fines" shall include any excise tax assessed with respect to any employee benefit plan; references to "serving at the request of the Company" shall include any service as a director of the Company which imposes duties on, or involves services by, such director with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acts in good faith and in a manner he reasonably believes to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner in the best interests of the Company as referred to in this Agreement. (d) For the purposes of this Agreement, Indemnitee shall be deemed to have been acting as an "Agent" if he was acting in his capacity as an officer of the Company, director of the Company, member of a committee of the Board of Directors of this Company, or agent of the Company, or was serving as a director or officer of another foreign or domestic corporation, partnership, joint venture, trust or any other - 3 - enterprise at the request of the Company, or was a director and/or officer of the foreign or domestic corporation which was a predecessor corporation to the Company or of another enterprise at the request of such predecessor corporation, whether or not he is serving in such capacity at the time any liability or expense is incurred for which indemnification or reimbursement can be provided under this Agreement. (e) The term "Applicable Standard" means that a person acted in good faith and in a manner such person believed to be in the best interests of the Company; except that in a criminal proceeding, such person must also have had no reasonable cause to believe that such person's conduct was unlawful. The termination of any Proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create any presumption, or establish, that the person did not meet the "Applicable Standard." (f) "Independent Legal Counsel" shall include any firm of attorneys selected by the Board of Directors or by the regular corporate counsel for the Company from a list of firms which meet minimum size criteria and other reasonable criteria established by the Board of Directors of the Company, so long as such firm has not represented the Company, Indemnitee or any entity controlled by Indemnity within the proceeding 24 calendar months. 2. AGREEMENT TO SERVE. Indemnitee agrees to serve or continue to serve as a Director and/or officer of the Company to the best of his abilities at the will of the Company or under separate contract, as the case may be, for so long as Indemnitee is duly elected or appointed and qualified until such time as he tenders his resignation in writing. Nothing contained in this Agreement is intended to create in Indemnitee any right to continued employment. 3. INDEMNIFICATION IN THIRD PARTY PROCEEDINGS. Subject to the "Limitations on Indemnification" provided in Paragraph 10 herein, or any other such limitations provided under the Code or any amendment thereto, the Company shall indemnify Indemnitee if Indemnitee is made a party to or threatened to be made a party to, or otherwise involved in, any Proceeding (other than a Proceeding which is an action by or in the right of the Company to procure a judgment in its favor), by reason of the fact that Indemnitee is or was an Agent of the Company. This indemnification shall apply, and be limited, to and against all Expenses, judgments, fines, settlements (if the settlement is approved in advance by the Company) and other amounts actually and reasonably incurred by Indemnitee in connection with the defense or settlement of the Proceeding, so long as it is determined pursuant to Paragraph 8 of this Agreement or by the court before which such action was brought, that Indemnitee met the Applicable Standard. 4. INDEMNIFICATION IN PROCEEDINGS BY OR IN THE NAME OF THE COMPANY. Subject to the "Limitations on Indemnification" provided in Paragraph 10 herein, or any - 4 - other such limitations provided under the Code or any amendment thereto, the Company shall indemnify Indemnitee if Indemnitee is made a party to, or threatened to be made a party to, or otherwise involved in, any Proceeding which is an action by or in the right of the Company to procure a judgment in its favor by reason of the fact that Indemnitee is or was an Agent of the Company. This indemnity shall apply, and be limited, to and against all Expenses actually and reasonably incurred by Indemnitee in connection with the defense or settlement of such Proceeding, but only if: (a) Indemnitee met the Applicable Standard (except that the Indemnitee's belief regarding the best interests of the Company need not have been reasonable); and (b) the action is not settled or otherwise disposed of without court approval. No indemnification shall be made under this Section 4 in respect of any claim, issue or matter as to which Indemnitee shall have been adjudged to be liable to the Company in the performance of such person's duty to the Company, unless, and only to the extent that, the court in which such Proceeding is or was pending shall determine upon application that, in view of all the circumstances of the case, Indemnitee is fairly and reasonably entitled to indemnification for the Expenses which such court shall determine. 5. EXPENSE OF SUCCESSFUL INDEMNITEE. Notwithstanding any other provision of this Agreement, to the extent that Indemnitee has been successful on the merits in defense of any Proceeding or in defense of any claim, issue or matter therein, including the dismissal of an action or portion thereof without prejudice, Indemnitee shall be indemnified against all Expenses actually and reasonably incurred in connection therewith. 6. SCOPE. Notwithstanding any other provision of this Agreement but subject to Section 9, the Company shall indemnify the Indemnitee to the fullest extent permitted by law, notwithstanding that such indemnification is not specifically authorized by other provisions of this Agreement, the Company's amended Articles of Incorporation, the Company's Bylaws or by statute. 7. ADVANCEMENT AND REPAYMENT OF EXPENSES. The Expenses incurred by Indemnitee in defending and investigating any Proceeding shall be advanced by the Company prior to the final disposition of such Proceeding after receiving from Indemnitee the copies of invoices presented to Indemnitee for such Expenses, but only if Indemnitee shall undertake in the form attached as Exhibit "A" to repay such advances to the extent that it is ultimately determined that the Indemnitee is not entitled to indemnification. Any advance required hereunder shall be deemed to have been approved by the Board of Directors of the Company to the extent this Agreement was so approved. In determining whether or not to make an advance hereunder, the ability of Indemnitee to repay shall not be a factor. However, in a proceeding brought by the Company directly, in its own right (as distinguished from an action brought derivatively or by any receiver or trustee), the Company shall have discretion whether or not to make the advances called for hereby if independent legal counsel advises in writing that the Company has probable cause to believe, and the Company does - 5 - believe, that Indemnitee did not act in good faith with regard to the subject matter of the Proceeding or a material portion thereof. In the event that the Company shall be obligated under this Section 7 to pay the Expenses of any Proceeding against Indemnitee, the Company, if appropriate, shall be entitled to assume the defense of such Proceeding, with counsel approved by Indemnitee, which approval shall not be unreasonably withheld, upon the delivery to Indemnitee of written notice of its election to do so. After delivery of such notice, approval of such counsel by Indemnitee and the retention of such counsel by the Company, the Company will not be liable to Indemnitee under this Agreement for any fees of counsel subsequently incurred by Indemnitee with respect to the same Proceeding, provided that (i) Indemnitee shall have the right to employ his counsel in any such Proceeding at Indemnitee's expense; and (ii) if (A) the employment of counsel by Indemnitee has been previously authorized by the Company, or (B) Indemnitee shall have reasonably concluded that there may be a conflict of interest between the Company and the Indemnitee in the conduct of such defense or (C) the Company shall not, in fact, have employed counsel to assume the defense of such Proceeding, then the fees and expenses of Indemnitee's counsel shall be at the expense of the Company. 8. RIGHT OF INDEMNITEE TO INDEMNIFICATION UPON APPLICATION; PROCEDURE UPON APPLICATION. Any and/or 7 hereof shall be made no later than 45 days after receipt of a written request of Indemnitee in accordance with Paragraph 12 hereof. In all other cases, indemnification shall be made by the Company only if authorized in the specific case, upon a determination that indemnification of the Agent is proper under the circumstances and the terms of this Agreement by: (a) a majority vote of a quorum of the Board of Directors (or a duly constituted committee thereof), consisting of directors who are not parties to such proceeding; (b) if such a quorum of directors is not obtainable, by independent legal counsel in a written opinion, (c) approval of the shareholders (as defined in Section 153 of the California Corporations Code), with the Indemnitee shares not being entitled to vote thereon; or (d) the court in which such proceeding is or was pending upon application made by the Company, the Indemnitee or any person rendering services in connection with Indemnitee's defense, whether or not the Company opposes such application. The right to indemnification or advances as provided by this Agreement shall be enforceable by Indemnitee in any court of competent jurisdiction. The burden of proving that indemnification or advances are not appropriate shall be on the Company. Neither the failure of the Company (including its Board of Directors or independent legal counsel) to have made a determination prior to the commencement of such action that indemnification or advances are proper in the circumstances because Indemnitee has met the applicable standard of conduct, nor an actual determination by the Company (including its Board of Directors or independent legal counsel) that Indemnitee has not met such applicable standard of conduct, shall be a - 6 - defense to the action or create a presumption that Indemnitee has not met the applicable standard of conduct. Indemnitee's Expenses incurred in connection with successfully establishing his right to indemnification or advances, in whole or in part, in any such Proceeding shall also be indemnified by the Company; provided, however, that if Indemnitee is only partially successful, only an equitably allocated portion of such Expenses shall be indemnified. If Indemnitee is deceased and is entitled to indemnification under any provision of this Agreement, the Company shall indemnify Indemnitee's estate and his or her spouse, heirs, administrators and executors against and shall assume all of the Expenses, judgments, penalties and fines actually and reasonably incurred by or for Indemnitee or his estate, in connection with the investigation, defense, settlement or appeal of any such action, suit or proceeding; provided, however, that when requested in writing by the spouse of Indemnitee, and/or the heirs, executors or administrators of Indemnitee's estate, the Company shall provide appropriate evidence of the Agreement set our herein to indemnify Agent against and to itself assume such costs, liabilities and Expenses. If Indemnitee is entitled under any provision of this Agreement or indemnification by the Company for some or a portion of the Expenses, judgments, fines or penalties actually and reasonably incurred by him in the investigation, defense, appeal or settlement of any Proceeding but not, however, for the total amount thereof, the Company shall nevertheless indemnify Indemnitee for the portion (determined on an equitable basis) of such Expenses, judgments, fines or penalties to which Indemnitee is entitled. Company's obligations to advance or indemnify hereunder shall be deemed satisfied to the extent of any payments made by an insurer on behalf of Company or Indemnitee. 9. INDEMNIFICATION HEREUNDER NOT EXCLUSIVE. (a) The indemnification provided by this Agreement shall not be deemed exclusive of any other rights to which Indemnitee may be entitled under the Articles of Incorporation, the Bylaws, any agreement, any vote of shareholders or disinterested directors, the General Corporation Law of the State of California, or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office. The indemnification under this Agreement shall continue as to Indemnitee even though he may have ceased to be a director or officer and shall inure to the benefit of the heirs and personal representatives of Indemnitee. (b) In the event of any changes, after the date of this Agreement, in any applicable law, statute, or rule which expand the right of a California corporation to indemnify its officers and directors, the Indemnitee's rights and the Company's obligations under this Agreement shall be expanded to the full extent permitted by - 7 - such changes. In the event of any changes in any applicable law, statute or rule, which narrow the right of a California corporation to indemnify a director or officer, such changes, to the extent not otherwise required by such law, statute or rule to be applied to this Agreement, shall have no effect on this Agreement or the parties' rights and obligations hereunder. 10. LIMITATIONS ON INDEMNIFICATION. The Company shall not be liable under this Agreement to make any payment in connection with any claim made against the Indemnitee: (a) for which payment is actually made to the Indemnitee under a valid and collectible insurance policy, except in respect of any excess beyond the amount of payment under such insurance; (b) for which the Indemnitee is indemnified by the Company otherwise than pursuant to this Agreement; (c) for an accounting of profits made from the purchase or sale by the Agent of securities for the Company within the meaning of Section 16(b) of the Securities Exchange Act of 1934 and amendments thereto or similar provisions of any state statutory law or common law; (d) brought about or contributed to by the active and deliberate dishonesty of the Indemnitee; however, notwithstanding the proceeding clause, the Indemnitee shall be protected to the extent otherwise provided under this Agreement as to any claims upon which suit may be brought against him by reason of any alleged dishonesty on his part, unless a judgment or other final adjudication thereof adverse to the Indemnitee shall establish that he committed (i) acts of active and deliberate dishonesty (ii) with actual dishonest purpose and intent, which acts were material to the cause of action so adjudicated; (e) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law; (f) for acts or omissions that the Indemnitee believes to be contrary to the best interests of the Company or its shareholders that involve the absence of good faith on the part of the Indemnitee; (g) for any transaction from which the Indemnitee derived an improper personal benefit; (h) for acts or omissions that show a reckless disregard for the Indemnitee's duty to the Company or its shareholders in circumstances in which the Indemnitee was aware, or should have been aware, in the ordinary course of - 8 - performing Indemnitee's duties, of a risk of serious injury to the Company or its shareholders; (i) for acts or omissions that constitute unexcused matter of inattention that amounts to abdication of the Indemnitee's duty to the Company or shareholders; (j) under Section 310 of the Code [i.e., for any transaction between the Company and (a) a director, or (b) a corporation, firm, or association in which the director has a material financial interest]; (k) under Section 316 of the Code [i.e., for any distribution to shareholders, and for any loan or guaranty to officers or directors, that violate specified provisions of the Code]; or (l) for any such further acts or omissions delineated under Code Section 204(a)(10) or any successor statute thereto. 11. SAVINGS CLAUSE. If this Agreement or any portion hereof is invalidated on any ground by any court of competent jurisdiction, then the Company shall nevertheless indemnify Indemnitee as to Expenses, judgments, fines and penalties with respect to any Proceeding to the full extent permitted by any applicable portion of this Agreement by any other applicable law. 12. NOTICES. Indemnitee shall, as a condition precedent to his right to be indemnified under this Agreement, give to the Company notice in writing within 30 days after he becomes aware of any claim made against him for which he believes, or should reasonably believe, indemnification will or could be sought under this Agreement. Notice to the Company shall be directed to the Company's main office, Attention: President (or such other address the Company shall designate in writing to Indemnitee). Failure to 80 notify Company shall not relieve Company of any liability which it may have to Indemnitee otherwise than under this Agreement. All notices, requests, demands and other communications (collectively "notices") provided for under this Agreement shall be in writing (including communications by telephone, telex or telecommunication facilities providing facsimile transmission) and mailed (postage prepaid and return receipt requested), telegraphed, telexed, transmitted or personally served to each party at the address set forth at the end of this Agreement or at such other address as any party affected may designate in a written notice to the other parties in compliance with this section. All such notices shall be effective when received; provided, however, receipt shall be deemed to be effective within three (3) business days of any properly addressed notice having been deposited in the mail, within twenty-four (24) hours from the time electronic - 9 - transmission was made, or upon actual receipt of electronic delivery, whichever occurs first. No costs, charges or expenses for which indemnity shall be sought hereunder shall be incurred without the Company's consent, which consent shall not be unreasonably withheld. 13. MAINTENANCE OF LIABILITY INSURANCE. (a) The Company hereby agrees that so long as Indemnitee shall continue to serve as a director and/or officer of the Company and thereafter so long as Indemnitee shall be subject to any possible Proceeding, the Company, subject to Section 13(b), shall use its best efforts to obtain and maintain in full force and effect directors' and officers' liability insurance ("D&O Insurance") which provides Indemnitee the same rights and benefits as are accorded to the most favorably insured of the Company's directors, if Indemnitee is a director; or of the Company's officers, if Indemnitee is not a director of the Company but is an officer. (b) Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain D&O Insurance if the Company determines in good faith that such insurance is not reasonably available, the premium costs for such insurance are disproportionate to the amount of coverage provided, the coverage provided by such insurance is limited by exclusions 80 as to provide an insufficient benefit or the Indemnitee is covered by similar insurance maintained by a subsidiary or parent of the Company. (c) If, at the time of the receipt of a notice of a claim pursuant to Section 12 hereof, the Company has D&O Insurance in effect, the Company shall give prompt notice of the commencement of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnitee, all amounts payable as a result of such Proceeding in accordance with the terms of such policies. 14. CHOICE OF LAW. This Agreement should be interpreted and enforced in accordance with the laws of the State of California, including applicable statutes of limitation and other procedural statutes. 15. AMENDMENTS. Provisions of this Agreement may be waived, altered, amended or repealed in whole or in part only by the written consent of all parties. 16. PARTIES IN INTEREST. Nothing in this Agreement, whether express or implied, is intended to confer any right or remedies under or by reason of this Agreement to any persons other than the parties to it and their respective successors - 10 - and assigns (including an estate of Indemnitee), nor is anything in this Agreement intended to relieve or discharge the obligation or liability of any third persons to any party hereto. Furthermore, no provision of this Agreement shall give any third persons any right of subrogation or action against any party hereto. 17. SEVERABILITY. Nothing in this Agreement is intended to require or shall be construed as requiring the Company to do or fail to do any act in violation of applicable law. The Company's inability, pursuant to court order, to perform its obligations under this Agreement shall not constitute a breach of this Agreement. If any portion of this Agreement shall be deemed by a court of competent jurisdiction to be unenforceable, the remaining portions shall be valid and enforceable only if, after excluding the portion deemed to be unenforceable, the remaining terms shall provide for the consummation of the transaction contemplated herein in substantially the same manner as originally set forth at the date this Agreement was executed. 18. SUCCESSOR AND ASSIGNS. All terms and conditions of this Agreement shall be binding upon and shall inure to the benefit of the parties and their respective transferees, successors and assigns; provided, however, that this Agreement and all rights, privileges, duties and obligations of the parties, may not be assigned or delegated by any party without the prior written consent of the other parties. 19. COUNTERPARTS. This Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed an original, but all of which together shall be deemed an original, but all of which together shall constitute one and the same instrument. 20. ENTIRE AGREEMENT. Except as provided in Section 9 hereof, this Agreement represents and contains the entire agreement and understanding between and among the parties, and all previous statements or understandings, whether express or implied, oral or written, relating to the subject matter hereof are fully and completely extinguished and superseded by this Agreement. This Agreement shall not be altered or varied except by a writing duly signed by all of the parties. 21. MUTUAL ACKNOWLEDGMENT. Both the Company and Indemnitee acknowledge that in certain instances, federal law or applicable public policy may prohibit the Company from indemnifying its directors and officers under this Agreement or otherwise. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company's right under public policy to indemnify Indemnitee. - 11 - IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date first above written. PACIFIC COMMUNITY BANKING GROUP By: /s/ E. Lynn Caswell ---------------------------- E. Lynn Caswell Chairman of the Board By: /s/ E. Lynn Caswell ---------------------------- E. Lynn Caswell Secretary "Company" ---------------------------- Address: ------------------- ------------------- "Indemnitee" - 12 - EXHIBIT A UNDERTAKING THIS UNDERTAKING is made as of the date of _____________, 19__ by ___________________ ("Indemnitee") with reference to the following facts: A. Indemnitee and PACIFIC COMMUNITY BANKING GROUP (the "Company") have executed an Indemnity Agreement dated _____________, 19__ permitting Indemnitee indemnification of all direct and indirect costs of Proceedings (as defined in the Indemnity Agreement) by reason of the fact that Indemnitee is an Agent (as defined in the Indemnity Agreement) of the Company and has met the Applicable Standard (as defined in the Indemnity Agreement). B. Paragraph 7 of the Indemnity Agreement allows for the Company to advance Expenses incurred by the Indemnitee in defending and investigating any Proceeding prior to the final disposition of such Proceeding after receiving from Indemnitee copies of invoices presented to Indemnitee for such Expenses, but only if Indemnitee shall undertake to repay such advances to the extent that it is ultimately determined that the Indemnitee is not entitled to indemnification, as well as other requirements contained in the Indemnity Agreement. NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth below and based on the premises set forth above, the Indemnitee does hereby undertake to the Company as follows: 1. The Expenses incurred by Indemnitee in defending and investigating any Proceeding shall be advanced by the Company prior to the final disposition of such Proceeding after receiving from Indemnitee copies of invoices presented to Indemnitee for such Expenses. 2. Indemnitee hereby undertakes to repay such advances to the extent that it is ultimately determined that the Indemnitee is not entitled to indemnification, 3. Any advance required hereunder shall be deemed to have been approved by the Board of Directors of the Company to the extent the Indemnity Agreement was approved. 4. In determining whether or not to make an advance hereunder, the ability of Indemnitee to repay shall not be a factor. 5. In a proceeding brought by the Company directly, in its own right (as distinguished from an action brought derivatively or by any receiver or trustee), the - 13 - Company shall have discretion whether or not to make the advances called for in the Indemnification Agreement if independent legal counsel advises in writing that the Company has probable cause to believe, and the Company does believe, that Indemnitee did not act in good faith with regard to the subject matter of the Proceeding or a material portion thereof. 6. The remainder of the terms and conditions of the Indemnity Agreement and Paragraph 7 regarding assumption of the defense by the Company shall also remain applicable. IN WITNESS WHEREOF, the undersigned has executed this Undertaking as of the date first above written. ---------------------------- Address: ---------------------------- ---------------------------- "Indemnitee" - 14 - EX-10.2 14 EXHIBIT 10.2 EXHIBIT 10.2 EMPLOYMENT AGREEMENT DATED OCTOBER 31, 1997 BETWEEN PACIFIC COMMUNITY BANKING GROUP AND MR. E. LYNN CASWELL EMPLOYMENT AGREEMENT AND CONTRACT THIS EMPLOYMENT AGREEMENT ("Agreement") is approved as of October 31, 1997, with an effective date of September 1, 1997 (the effective date of employment), by and between PACIFIC COMMUNITY BANKING GROUP ("PCBG" or "the Company"), with headquarters located at 23332 Mill Creek Drive, Suite 230, Laguna Hills, California 92653, and E. LYNN CASWELL, residing at 28551 Breckenridge Drive, Laguna Niguel, California 92677 (the "Employee"). A. PCBG is a corporation organized for the purpose of carrying on the business of a multi-bank holding and financial services company. B. PCBG desires to avail itself of the skill, knowledge and experience of Employee/Founder in order to insure the successful management of its business; C. The parties hereto desire to specify the terms of Employee's employment by PCBG as its Chairman of the Board (as an Officer as well as Director position) and Chief Executive Officer in this written agreement which supersedes all prior agreements, whether written or oral; and D. The employment, the duration thereof, the compensation to be paid to Employee, termination and other terms and conditions of employment provided in this Agreement were duly fixed, stated, approved and authorized for and on behalf of PCBG by action of its Board of Directors at a meeting held on October 31, 1997. NOW, THEREFORE, on the basis of the foregoing facts and in consideration of the mutual covenants and agreements contained herein, the parties hereto agree as follows: 1. TERM (a) Subject to the provisions below, PCBG agrees to employ Employee, and Employee agrees to be employed by PCBG, subject to the terms and conditions of this Agreement, for a five-year, four-month period commencing on September 1, 1997 and ending on December 31, 2002. The term for which Employee is employed hereunder is hereinafter referred to as the "Employment Period." The Term hereof shall be automatically renewed for a five-year period, unless written notice is given and received six months prior to the end of the contract term of the intention of either party not to renew the same. 1 2. DUTIES AND AUTHORITIES (a) During the Employment Period, Employee shall devote all his productive time, ability and attention to the business and affairs of the Company. Employee shall not directly render service of a business, commercial or professional nature to any other person or organization without the consent of the Board of Directors of PCBG, provided, however, that nothing contained herein shall prohibit Employee from serving as an advisor or director of any corporation which does not compete with the business of the Company, or any charitable or non-profit organization. Employee agrees during the Employment Period to use his best efforts, skill and abilities to promote the Company's interests and to serve as the Chairman of the Board (as an Executive Officer as well as Director position) and Chief Executive Officer of the Company. Employee's duties shall include all responsibilities normally assigned to the Chairman and Chief Executive Officer. The Company shall also cause Employee to be nominated, and management proxies will be voted to elect Employee as a director of PCBG during the entire term of this Agreement, and as a director of any company that acquires PCBG during the term hereof. Employee shall receive any and all Director's fees paid to the Company's Directors during the term of this Agreement. 3. COMPENSATION (a). From the Commencement Date and continuing through the Term, the Company agrees to pay Employee a base annual salary in the amount of $135,000, payable in installments on the normal payroll dates of the Company, except as amended by Section 3(m) of this Agreement. Base salary, total cash compensation and total compensation of Employee shall in no event be less than that of any other Company officer or that of any officer of any subsidiary or affiliate, adjusted annually. The Board of Directors may elect to adjust upward the base annual salary and other compensation of Employee from time to time, at its sole discretion. (b). During the term of this Agreement, Employee shall also receive annual increases to the compensation described in Section 3.(a) equal to the cumulative annual increase to the Orange County Consumer Price Index as shown in the Los Angeles Times from time to time, but not less than 3% per annum. (c) During the term of this Agreement, the Company agrees within sixty days after the end of the fiscal year to pay to Employee a bonus of not less than 10% of Employee's base salary at the end of the Company's fiscal year. The amount may be increased at the discretion of the Board of Directors, or reduced or eliminated at its discretion if the Company's net pretax 2 profits are less than 0.80% of Average Assets of the Company for the fiscal year. (d) During the term of this Agreement, the Company agrees to pay to Employee an automobile expense allowance in the amount of $900.00 per month, and necessary insurance costs, such amount to be adjusted by 3% per annum. It is deemed in the Company's best interests to provide commercial insurance to afford greater protection to the Company from liability. (e) During the Employment Period, Employee shall be eligible to participate in any pension or profit-sharing plan, or similar benefit plan or retirement program of the Company now or hereafter existing, to the extent that he is eligible under the provisions thereof and commensurate with his position in relationship to other participants. (f) Employee will be entitled to vacation of four (4) weeks per annum during the term of this agreement, at the convenience of the Company. Employee will also be granted appropriate and reasonable time to attend industry meetings, seminars and conventions which are important to the Company's business, or of which the employee is an officer, Director or committee member. Employee shall also be granted appropriate and reasonable time to serve as a Director of the Federal Reserve Bank of San Francisco. (g) The Company will provide Employee and his dependents with group medical, accident, and health insurance coverage, without cost to Employee, and the Company will provide Employee income continuation disability insurance coverage consistent with Employee's executive employment, and life insurance coverage in an amount equal to four (4) times annual salary. Such insurance coverages shall take effect at the earliest possible date after the commencement date of this agreement. Company shall reimburse Employee for the uninsured or deductible portions of Employee's annual physical and Employee shall complete such physical each year during the employment term. (h) During the term of this Agreement, and effective as soon as practicable one year after the effective date of this contract, and subject to the successful completion of the first acquisition or merger transaction, PCBG shall purchase an income continuation policy or plan for the benefit of Employee to be effective at Employee's normal retirement date or full disability in an amount payable at $60,000 per annum for a period of fifteen (15) years after retirement. As a retirement and/or pension plan, the policy as funded shall be the property of Employee if Employee completes the term of this Agreement, or upon his death ownership shall pass to his spouse or to his estate should no spouse be living or existent 3 upon his death. The conditions contained in Section 9(a) herein shall also apply, but shall not change the provisions of this section. (i) In order for the Employee to carry out the Company's business interests, including entertainment, business development, and community responsibilities, the Company agrees within one (1) year of the effective date of this Agreement to purchase as owner for Employee's benefit and in Employee's name, an equity membership in an area country club of the Employee's choosing, at a reasonable cost as applicable to such area clubs. Upon Employee's termination or resignation for any reason, Employee may purchase said membership from the Company at its unamortized remaining balance, if any. (j) Upon timely presentation to the Company of necessary and proper documentation in accordance with the regulations of the Internal Revenue Service, the Company will reimburse Employee for any necessary, usual, customary and reasonable business expenses incurred by Employee in connection with his position or for the Company's benefit, including the costs of cellular phone service related to Company business. The company will also pay for the business related charges associated with the Employee's memberships at the Center Club, Costa Mesa, and the Balboa Bay Club, Newport Beach, as being advantageous to the Company's business and business development interests. Any expenses of Employee for his activities in industry association groups, the Federal Reserve Bank of San Francisco, or other business, industry, civic, or charitable organizations which are not reimbursed by those groups will be reimbursed by the Company to the Employee upon presentation of proper documentation. All of Employee's documented expenses paid for the benefit of the Company's organization from inception, for start-up costs, travel expense, and ongoing operations which have not been reimbursed will be repaid to Employee or credited to Employee's stock purchase commitment as a founding investor of the Company. Documentation to be provided to Company's outside auditors and accountants prior to stock distribution. (k) The Company agrees to grant to the Employee, as both Chief Executive Officer and as the Company Founder assuming the associated risks of such an enterprise, the greater of two hundred fifty thousand (250,000) ten year incentive stock option shares, or options equal to 5% of the Company's outstanding common stock after the option grant, at the earliest possible date after the effective date of this Agreement. The options will have an exercise price equal to the then fair market value of the Company's common stock on the date of grant of said option shares. Should regulations or the amount of outstanding Company stock not allow for the full grant contained in this Agreement, the remainder will be 4 automatically granted as available under the Company's Stock Option Plan. The options shall be vested immediately, but be exercisable after one (1) year, in an amount not to exceed 33 1/3 % per year for the first three years after exercise date, subject to Section 10 herein. The amount of the options granted to Employee shall remain at the greater of two hundred thousand (200,000) ten year incentive stock option shares, or options equal to 5% of the Company's outstanding common stock after the option grant during the term of this Agreement, or as soon as thereafter available under the terms of the Plan. (l) During the organization and initiation of PCBG's business affairs and operations Employee's salary and auto allowance will be prorated as follows: - One-half of the contract amount for the period from September 1, 1997 to the last day of the month following the first agreement on the principle terms of the Company's first proposed acquisition or merger transaction. - Full amount of the contract amount from the first of the month thereafter. - Benefits to be fully compensated or reimbursed from September 1, 1997. - Unpaid amounts, if any, from the above may be reimbursed or credited to Employee's stock purchase commitment as a founding investor of PCBG. 4. CONFIDENTIAL INFORMATION. Without the prior written permission of the Company in each case, Employee shall not publish, disclose or make available to any other person, firm or corporation, either during or after the termination of this Agreement, any confidential information which Employee may obtain during the Employment Period, or which Employee may create prior to the end of the Employment Period relating to the business of the Company, or to the business of any customer or supplier of any of them; provided, however, Employee may use such information during the Employment Period for the benefit of the Company. At the termination or expiration of this Agreement, Employee shall return all documents, files, notes, writings and other tangible evidence of such confidential information to the Company. 5. COVENANT NOT TO SOLICIT CUSTOMERS OR FELLOW EMPLOYEES. Employee agrees that for a period of six (6) months following the termination of his employment, assuming that such termination was voluntary, he will not solicit 5 the business of any customer with whom the Company or a subsidiary bank has done business during the preceding one year period. If that termination is by action of the Board of Directors he shall be under no constraints regarding a covenant not to solicit customers or fellow employees. Employee further agrees not to solicit the services of any officer or employee of the Company during such 6-month period. 6. REMEDY. Employee understands that, because of the unique character of the services to be rendered by Employee hereunder, the Company would not have any adequate remedy at law for the material breach by Employee of any one or more of the covenants set forth in this Agreement and agrees that in the event of any such material breach, the Company may in addition to the other remedies which may be available to it: (a) Declare forfeited any moneys representing salary, contingent payments or other fringe benefits due and payable to Employee, and, or alternatively, (b) File a suit in equity to enjoin Employee from the breach of such covenants. 7. TERMINATION OF EMPLOYEE WITHOUT CAUSE. The Board of Directors may not terminate Employee's employment hereunder without Cause. Employee shall not have the right to resign without cause. In the event that the Board of Directors and Employee shall mutually agree that irreconcilable differences unrelated to cause or any material breach of this agreement have arisen, they may mutually agree to the separation of Employee. In such case, Employee will be entitled to the remainder of all salary, benefits, options, and allowances due under this contract, but in no event less than the equivalent of two (2) years of said salary, benefits and allowances, adjusted for all applicable state and federal taxes. 8. Termination of Employee for Cause. (a) Notwithstanding anything herein contained, on or after the date hereof and prior to the end of the Employment Period, the Company shall have the right to terminate Employee's employment hereunder for Cause (as defined in Subsection 10(b) below) by giving to Employee written notice of such termination as of a date (not earlier than thirty (30) days after such notice) to be specified in such notice, and the Employment Period shall terminate on the date so specified, whereupon Employee shall be entitled to receive six (6) months salary at the rate provided in Section 3, plus his accrued vacation pay; provided, however, that if termination is due to physical or mental disability of Employee, such termination shall not affect any rights which Employee may have at the time of termination 6 pursuant to any insurance or other death benefit, bonus, retirement, or arrangements of the Company; or any stock option plan or any options thereunder, which rights shall continue to be governed by the provisions of such plans and arrangements, and Sections 7, 8, and 9 of this Agreement. (b) For purposes of this Agreement, "Cause" shall mean the determination by the Board of Directors, acting in good faith and by two-thirds vote in a duly constituted meeting, that Employee has (i) willfully failed to perform or habitually neglected the appropriate duties which he is required to perform hereunder; or (ii) willfully failed to follow any significant policy of the Company which materially or adversely affects the condition of the Company; or (iii) engaged in any activity in contravention of any significant company policy, statute, regulation or governmental policy which materially or adversely affects the Company's condition; or (iv) willfully refused to follow any lawful and appropriate instruction from the Board of Directors unless Employee asserts that compliance with such instruction would cause the Company or Employee to violate any statute, regulation, governmental or Company policy; or (v) subject to Subsection (c) below, become physically or mentally disabled and evidences his inability to discharge his duties as Chief Executive Officer of the Company; or (vi) been convicted of or pleaded guilty or nolo contendere to any felony; or (vii) committed any act which would cause termination of coverage under the Company's Bond as to Employee, as distinguished from termination of coverage as to the Company as a whole. For purposes of this Agreement, "Cause" shall also mean the Company is required to remove or replace Employee by formal order or instruction, including a consent order or agreement, from the California State Banking Department, the Federal Reserve Bank, or any other supervisory authority having jurisdiction. (c) If Employee becomes disabled and such disability continues for a period of three hundred and sixty-five (365) consecutive days, then upon expiration of such 365-day period, if the term of this Agreement has not already expired, the Company may, in its discretion, terminate the Agreement and all benefits due hereunder, but Employee shall be entitled upon such termination to receive disability payments in accordance with such disability plan as may be established for the payment of disability benefits; provided, however, that if such disability is job related, as determined by an arbitrator mutually acceptable to the Company and Employee or Employee's representative, then the compensation due hereunder shall continue for the entire remaining term of this Agreement, but not less than three (3) years, and all options shall be handled as described in Section 9 under the "consulting" provisions therein. The provisions of Sections 3(g) and 3(h) shall also apply if Employee is disabled, in addition to the terms of this section. 7 9. (a) Should the Company determine to sell to or merge with another company, corporation, firm, or individual(s); or engage in a consolidation, dissolution or transfer of the assets of the Company, internally or externally in such a manner as to fundamentally change its existing structure, or transfer or sell effective (20% or more) or actual (50% or more) controlling ownership of the Company, the Company will, at the conclusion of such activity, and as a condition thereof, pay all remaining salary, benefits, and allowances due the Employee under this contract, but in no event, not less than the equivalent of three (3) years of said salary, benefits and allowances with the gross amount increased and adjusted for all applicable state and federal taxes. All other rights or benefits granted to Employee under the terms of this Agreement shall be immediately vested. (b) Such payment shall terminate this Agreement in all respects, but shall not prohibit Employee from continuing as an Employee under a new agreement with the Company or a successor company. Upon such events as described in Sections 7 and 8 herein, Employee will become a consultant of the Company or a successor company, without employment restriction, at a payment of $1.00 per year for a period equal to the remaining grant period of any unexercised stock options, and such options or replacement options shall remain in force for the full term of their original grant. Employee, at his sole discretion only, may waive the provisions of this Section. 10. With respect to any stock options issued to the Employee that were outstanding on the date of the termination of his employment under Sections 8 and 9, any options which would become exercisable had the Employee remained in the employ of the Company through the end of the Employment Period but which are not exercisable on the effective date of the Employee's termination of employment under this Section 10 shall automatically become exercisable upon any such termination, and shall remain exercisable in full, as described in Sections 8 and 9 herein. 11. The parties to this Employment Agreement and Contract agree that the compensation provisions are in all respects consistent with the experience, knowledge and skills of Employee, the risks to him associated with his position as Company founder, as well as the current general market conditions for financial industry executives with similar experience, knowledge, skills, and industry standing to that of the Employee. Nevertheless, Employee, as the Company's organizer, founder and initial shareholder, may at his sole discretion during the Employment Period, elect to postpone, waive, or otherwise modify (reduce to the Company's benefit) the terms and provisions of Sections Three (3) and Nine (9) of this Agreement if he deems such actions to be in the best interests of the Company. Notwithstanding the foregoing, the lack of any such postponement, waiver, or other such modification shall not be construed as a failure to consider the Company's best interests. Nor shall any such postponement, waiver, or other 8 such modification as to one or more provisions imply or be construed to imply a modification of any other provision contained herein, or that this Agreement in whole or in part is not in the best interests of PCBG. 12 TERMINATION UPON EMPLOYEE'S DEATH; EFFECT OF TERMINATION ON OTHER PLANS. (a) Notwithstanding anything herein contained, if Employee shall die this Agreement shall terminate on the date of Employee's death, whereupon Employee's estate shall be entitled to receive his salary, accrued vacation, and any bonus earned up through the date of termination. Such termination shall not affect any rights which Employee may have at the time of his death pursuant to any other death benefit, bonus, or retirement benefit. Additionally, health insurance benefits for the Employee's spouse will be continued for a period of one year. (b) Notwithstanding anything herein contained, any termination of employment under this Section 11 shall not affect any accrued rights which Employee may have at the time of such termination, including, but not limited to, any of the Company's plans for arrangements for insurance, vacation, retirement, and stock options, which then accrued rights shall continue to be governed by the provisions of such plans and arrangements to the extent they are not inconsistent with the terms of this Agreement. 13. MODIFICATION. This Agreement sets forth the entire understanding of the parties with respect to the subject matter hereof, supersedes all existing agreements between them concerning such subject matter, and may be modified only by written instrument duly executed by each party. 14. NOTICES. Any notice or other communication required or permitted to be given hereunder shall be in writing and shall be mailed by certified mail, return receipt requested or delivered against receipt to the party set forth in the preamble to this Agreement (or to such other address as the party shall have furnished in writing in accordance with the provisions of this Section 13). Notice to the estate of Employee shall be sufficient if addressed to Employee as provided in this Section 13. Any notice or other communication given by certified mail shall be deemed given at the time of receipted certification thereof. 15. DISPUTE RESOLUTION PROCEDURES. Any controversy or claim arising out of this Agreement or the breach thereof, or the interpretation thereof, except for assertions of fraud or illegalities, shall be settled by binding arbitration in accordance with the Rules of the American 9 Arbitration Association; and judgment upon the award rendered in such arbitration shall be final and may be entered in any court having jurisdiction thereof. Notice of the demand for arbitration shall be filed in writing with the other party to this Agreement and with the American Arbitration Association. In no event shall the demand for arbitration be made after the date when institution or legal or equitable proceedings based on such claim, dispute or other matters in question would be barred by the applicable statute of limitations. This agreement to arbitrate shall be specifically enforceable under the prevailing arbitration law. Any party desiring to initiate arbitration procedures hereunder shall serve written notice on the other party. The parties agree that an arbitrator shall be selected pursuant to these provisions within thirty (30) days of the notice of arbitration. In the event of any arbitration pursuant to these provisions, the parties shall retain the rights of all discovery provided pursuant to the California Code of Civil Procedure and the Rules thereunder, except that all time periods contained in said Code and Rules shall be shortened by fifty percent (50%) for purposes of arbitration proceedings hereunder. Any arbitration initiated pursuant to these provisions shall be on an expedited basis and the dispute shall be heard within one hundred twenty (120) days following the serving of the notice of arbitration and a written decision shall be rendered within sixty (60) days thereafter. All rights, causes of action, remedies and defenses available under California law and equity are available to the parties hereto and shall be applicable as though in a court of law. The parties shall share equally all costs of any such arbitration. 16. INDEMNIFICATION. The Company shall use its most diligent and best efforts to obtain and maintain a Directors and Officers Liability Insurance Policy in the largest amount available or reasonably affordable. In addition, to the fullest extent allowed by law, the Company shall indemnify Employee for any and all of his actions, or forbearance of any action, as an employee and Director of the Company, carried out or undertaken in good faith in the course of his duties, even if such is held to be negligent. The Company will indemnify Employee, defend, and bear the cost of defense with regard to any action or threatened action brought by a third party against the Employee (whether or not the Company is joined or included as a party defendant) and/or the Company. This indemnification shall include not only the costs of defense, but also any other expenses, judgements, fines, settlements, or other amounts actually and reasonably incurred. This indemnification does not and will not include illegal acts knowingly and willfully carried out by the Employee, but will include all actions carried out by the Employee acting in good faith and in a manner the Employee reasonably believed to be in the best interest of the Company, so long as the alleged actions by Employee arose out of and was within the course and full scope of his employment as an Officer and Director of the Company. Such indemnification shall also apply to any and all subsidiaries of the Company as regards the actions of Employee and his involvement and actions within or regarding those subsidiaries. 17. MISCELLANEOUS. 10 (a) This Agreement is drawn to be effective in the State of California and shall be construed in accordance with California laws, except to the extent superseded by any other federal law. No amendment or variation of the terms of this Agreement shall be valid unless made in writing and signed by Employee and a duly authorized representative of the Company. (b) Any waiver by either party of a breach of any provision of this Agreement shall not operate as to be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Agreement. The failure of a party to insist upon strict adherence to any term of this Agreement on one or more occasions shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. Any waiver must be in writing. (c) Employee's rights and obligations under this Agreement shall not be transferable by assignment or otherwise, such rights shall not be subject to commutation, encumbrance or the claims of Employee's creditors, and any attempt to do any of the foregoing shall be void. The provisions of this Agreement shall be binding upon and inure to the benefit of the Company, their successors and those who are its assigns under Section 8. (d) This Agreement does not create, and shall not be construed as creating, any rights enforceable by a person not a party to this Agreement (except as provided in Subsection (c) above. (e) The headings in this Agreement are solely for the convenience of reference and shall be given no effect on the construction or interpretation of this Agreement. (f) This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. It shall be governed by and construed in accordance with the laws of the State of California, without giving effect to conflict of laws, except where federal law governs. 18. RESIGNATION AS DIRECTOR UPON TERMINATION Upon termination of this Agreement, Employee, if he is then serving as a director of the Company, agrees to immediately resign his position as a director, unless otherwise agreed, by giving written notice of his resignation to the Secretary of the Board of Directors of the Company. 11 IN WITNESS WHEREOF, the Company has caused this Agreement to be signed by its duly authorized officer or representative and Employee has executed this Agreement to be effective as of the day and year written above on Page 1 herein. PACIFIC COMMUNITY BANKING GROUP By: /s/ E. Lynn Caswell ----------------------------- E. Lynn Caswell Chairman and Chief Executive Officer EMPLOYEE: By: /s/ E. Lynn Caswell ----------------------------- E. Lynn Caswell 12 EX-10.3 15 EXHIBIT 10.3 AGREEMENT This AGREEMENT is entered into this 24th day of March, 1999, by and between THE BANK OF HEMET, a California corporation (hereinafter referred to as the "Bank"), PACIFIC COMMUNITY BANKING GROUP, a California corporation (hereinafter referred to as the "Company"), and HAROLD R. WILLIAMS, JR. (hereinafter referred to as the "Executive"). This Agreement will become effective upon the completion of the acquisition of the Bank by the Company pursuant to the First Restatement of Agreement and Plan of Reorganization dated January 5, 1999, as amended. RECITALS WHEREAS, Executive has been an Executive Officer of the Bank since 1994 and will become Executive Vice President and Chief Financial Officer of the Company upon the completion of the acquisition of the Bank by the Company; WHEREAS, the Bank and the Company desire to continue to avail itself of the skill, knowledge and experience of Executive in order to ensure the successful operation of the Bank and the Company without distraction; and WHEREAS, to induce Executive to remain in the employ of the Bank and the Company, and to continue as an Executive Officer of the Bank and to become Executive Vice President and Chief Financial Officer of the Company, the Bank and the Company are willing to provide benefits to Executive in the event his employment is terminated or adversely affected as provided herein. NOW, THEREFORE, in consideration of the mutual covenants and conditions hereinafter set forth, the parties hereto covenant and agree as follows: A. TERM OF AGREEMENT This Agreement shall terminate upon the first to occur of (i) the termination of Executive's employment with Bank and/or the Company for Cause, Disability (both as defined below), death of Executive, or voluntarily by Executive other than for Good Reason, and shall have occurred between the effective date of this Agreement and December 31, 2002 (the "Term of this Agreement"), or (ii) December 31, 2002. B. EFFECT ON EMPLOYMENT This Agreement is not intended to alter or otherwise change the current employment relationship between Executive and the Bank and/or the Company - 1 - except as described in the following Paragraphs, and Executive further acknowledges his employment at-will status with the Bank and the Company as described under the Bank's Personnel Policy. C. TERMINATION OF EMPLOYMENT If Executive's employment is terminated by the Bank and the Company, or Executive terminates employment with the Bank and/or the Company pursuant to Paragraph C.3. below, and unless such termination is (a) because of his death, (b) for Cause or Disability (both as defined below) or (c) by Executive other than for Good Reason (as defined below), he shall be entitled to the benefits provided in Paragraph D.2(a). or D.2(b). below. 1. DISABILITY. If, as a result of Executive's incapacity due to physical or mental illness, he shall have been absent from or unable to perform his duties with the Bank and/or the Company for a period of three consecutive months, and if within 30 days after written notice of termination is given (which notice may not be given prior to the expiration of the three-month period) he shall not have recommenced the full-time performance of his duties, the Bank and/or the Company may terminate his employment for "Disability." 2. CAUSE. Termination of Executive's employment for "Cause" shall mean the determination by the Bank and/or the Company that the Executive has (i) willfully failed to perform or habitually neglected the appropriate duties which he is required to perform hereunder; or (ii) willfully failed to follow any significant policy of the Company which materially or adversely affects the condition of the Company; or (iii) engaged in any activity in contravention of any significant company policy, statute, regulation or governmental policy which materially or adversely affects the Company's condition; or (iv) willfully refused to follow any lawful and appropriate instruction from the Board of Directors unless Executive asserts that compliance with such instruction would cause the Company or Executive to violate any statute, regulation, governmental or Company policy; or (v) subject to Section C.1 above, become physically or mentally disabled and evidences his inability to discharge his duties as Chief Financial Officer of the Company; or (vi) been convicted of or pleaded guilty or nolo contendere to any felony; or (vii) committed any act which would cause termination of coverage under the Company's Bond as to Executive, as distinguished from termination of coverage as to the Company as a whole. For purposes of this Agreement, "Cause" shall also mean the Company is required to remove or replace Executive by formal order or instruction, including a consent order or agreement, from the California Department of Financial Institutions, the Federal Reserve Bank, or any other supervisory authority having jurisdiction. - 2 - 3. GOOD REASON. Termination by Executive of his employment for "Good Reason" shall mean termination by him after any of the following events occur without his express written consent: (i) A reduction in Executive's then current annual salary or benefits; (ii) A material diminution in Executive's title, authority or responsibilities; 4. NOTICE OF TERMINATION. Any purported termination by the Bank and/or the Company, or by Executive for Good Reason, shall be communicated by written "Notice of Termination" to the other party hereto. A Notice of Termination shall mean a notice which indicates the specific termination provision in this Agreement relied upon and sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated. 5. DATE OF TERMINATION. The "Date of Termination" shall mean (i) if Executive's employment is terminated by death, the date of death, (ii) if Executive's employment is terminated for Disability, 30 days after Notice of Termination is given (provided that Executive shall not have recommenced the full-time performance of his duties during such 30-day period), (iii) if Executive's employment is terminated pursuant to subparagraph 2 or 3 above, the date specified in the Notice of Termination, which shall be not less than 30 days after the date such Notice of Termination is given, and (iv) if Executive voluntarily terminates employment for other than for Good Reason, the date specified in the Notice of Termination, which shall be not less than 30 days after the Notice of Termination is given. D. BENEFITS 1. REGULAR COMPENSATION. If Executive's employment shall be terminated by the Bank and/or the Company for Disability, Cause, or his death, or by Executive other than for Good Reason, the Bank and/or the Company shall pay Executive the full accrued base salary and accrued incentive bonus through the Date of Termination, less withholding required by law, at the rate in effect at the time Notice of Termination is given or death occurs, and the Bank and the Company shall have no further obligation to him under this Agreement. 2. SEVERANCE BENEFITS. (a) If Executive's employment shall be terminated by the Bank and/or the Company other than for Disability, Cause or his death, or by Executive for Good Reason, within twelve (12) months of the effective date of this Agreement, Executive shall be entitled to receive an amount equal to - 3 - Executive's base salary paid by the Bank and/or the Company to Executive for the previous eighteen (18) months. Such amount shall be payable to Executive in a lump sum payment within three (3) business days following the Date of Termination, less withholding as required by law. In addition, the Bank and/or the Company shall continue payment of all of Executive's benefits in effect on the date of Executive's termination including health and other medical benefits for a period of eighteen (18) months from the Date of Termination. Payment of the foregoing amounts shall discharge the Bank and the Company from any further obligation and liability to Executive under this Agreement. (b) If Executive's employment shall be terminated by the Bank and/or the Company other than for Disability, Cause or his death, or by Executive for Good Reason, after twelve (12) months from the effective date of this Agreement until December 31, 2002, Executive shall be entitled to receive an amount equal to Executive's base salary paid by the Bank and/or the Company to Executive for the previous twelve (12) months. Such amount shall be payable to Executive in a lump sum payment within three (3) business days following the Date of Termination, less withholding as required by law. In addition, the Bank and/or the Company shall continue payment of all of Executive's benefits in effect on the date of Executive's termination including health and other medical benefits for a period of twelve (12) months from the Date of Termination. Payment of the foregoing amounts shall discharge the Bank and the Company from any further obligation and liability to Executive under this Agreement. Notwithstanding the foregoing, in the event that any payment or benefit received or to be received by Executive in connection with the termination of employment pursuant to the terms of this Agreement would not be deductible (in whole or in part) by the Bank and/or the Company as a result of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), the amount of the payment shall be reduced until no portion is not deductible as a result of Section 280G of the Code. 3. BONUS. Executive shall be entitled to a bonus in the minimum amount of $60,000 which shall be payable no later than February 29, 2000. In addition, during the term of this Agreement, Executive may receive such bonuses, if any, as the Board of Directors in its sole discretion shall determine. 4. STOCK OPTIONS. Upon the completion of the acquisition of the Bank by the Company, Executive shall be granted a ten-year incentive stock option of 50,000 option shares under the Company's 1999 Stock Option Plan at an exercise price equal to the Company's initial public offering price. Such stock options shall be vested at 33 1/3 percent each year starting December 31, 1999. - 4 - E. GENERAL PROVISIONS 1. RETURN OF DOCUMENTS. Executive expressly agrees that all manuals, documents, files, reports, studies, instruments or other materials used and/or developed by Executive related to banking or of a banking nature during the term of his employment are solely the property of the Bank and/or the Company, and that Executive has no right, title or interest therein. Upon termination of Executive's employment, Executive shall promptly deliver possession of all of said property to the Bank and/or the Company in good condition. 2. NOTICES. Any notice, request, demand or other communication required or permitted hereunder shall be in writing and shall be deemed to be properly given when personally served or forty-eight hours after deposit in the United States mail, postage prepaid, in each case addressed to the Bank and/or the Company as its head office location or to Executive at his last residence address on the Bank or the Company's records. Either party may change its address by written notice in accordance with this subparagraph. 3. BINDING EFFECT; SUCCESSORS. Except to the extent otherwise provided herein, this Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective executors, administrators, successors and assigns. The Bank and/or the Company will require any successor to all or substantially all of its assets to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Bank and/or the Company would be required to perform it if no such succession had taken place. Failure of the Bank and/or the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall entitle Executive to the benefits from the Bank and/or the Company in the same amount and on the same terms as he would be entitled to hereunder if he terminated his employment for Good Reason, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. 4. APPLICABLE LAW. Except to the extent governed by the laws of the United States, this Agreement is to be governed by and construed under the laws of the State of California. 5. CAPTIONS AND PARAGRAPH HEADINGS. Captions and paragraph headings used herein are for convenience only and are not part of this Agreement and shall not be used in construing it. 6. SEVERABILITY. Should any provision of this Agreement for any reason be declared invalid, void or unenforceable by a court of competent jurisdiction, the validly and binding effect of any remaining portion shall not be - 5 - affected, and the remaining portions of this Agreement shall remain in full force and effect as if this Agreement had been executed with said provision eliminated. 7. ENTIRE AGREEMENT. This Agreement contains the entire agreement of the parties relating to termination of employment as provided herein. It supersedes any and all other agreements, either oral or in writing, between the parties hereto with respect to such subject matter, and does not otherwise modify, alter or change the employment relationship of Executive with the Bank and/or the Company. Each party to this Agreement acknowledges that no representations, inducements, promises or agreements, oral or otherwise, have been made by any party, or anyone acting on behalf of any party, which are not embodied herein, and that no other agreement, statement or promise not contained in this Agreement concerning its subject matter shall be valid or binding. 8. MODIFICATION; WAIVER. No provision of this Agreement may be modified, waived or discharged unless such modification, waiver or discharge is agreed to in writing and signed by Executive and such officer of the Bank and/or the Company as may be specifically designated or authorized by the Board of Directors or by the Chief Executive Officer. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 9. ARBITRATION. In the event that any dispute shall arise between the parties concerning the provisions of this Agreement or the performance of any part of their obligations hereunder, or in the event of an alleged breach of this Agreement by either of the parties hereto, and the parties are unable to mutually adjust and settle same, such dispute or disputes shall be submitted to binding arbitration pursuant to the applicable rules of the American Arbitration Association, and the decision and determination of the arbitrators shall be final and conclusive. - 6 - IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. THE BANK OF HEMET By: /s/ James B. Jaqua --------------------------------------------- James B. Jaqua, President and Chief Executive Officer By: /s/ Leslie Besic --------------------------------------------- Leslie Besic, Assistant Secretary PACIFIC COMMUNITY BANKING GROUP By: /s/ E. Lynn Caswell --------------------------------------------- E. Lynn Caswell, Chairman of the Board By: /s/ Alfred Jannard --------------------------------------------- Alfred Jannard, Secretary EXECUTIVE /s/ Harold R. Williams, Jr. --------------------------------------------- Harold R. Williams, Jr. - 7 - EX-10.4 16 EXHIBIT 10.4 PACIFIC COMMUNITY BANKING GROUP 1999 STOCK OPTION PLAN Adopted February 23, 1999 1. PURPOSE The purpose of the Pacific Community Banking Group 1999 Stock Option Plan (the "Plan") is to strengthen Pacific Community Banking Group (the "Corporation") and those corporations which are or hereafter become subsidiary corporations by providing additional means of attracting and retaining competent managerial personnel and by providing to participating directors, officers, key employees, consultants and others with significant and material business relationships added incentives for high levels of performance and for unusual efforts to increase the earnings of the Corporation and any Subsidiary corporations; and to allow such individuals the opportunity to participate in the ownership of the Corporation and thereby have an interest in the success and increased value of the Corporation. The Plan seeks to accomplish these purposes and achieve these results by providing a means whereby such directors, officers, key employees, consultants and others with significant and material business relationships may purchase shares of Common Stock of the Corporation pursuant to Stock Options granted in accordance with this Plan. Stock Options granted pursuant to this Plan are intended to be Incentive Stock Options or Non-Qualified Stock Options, as shall be determined and designated by the Stock Option Committee upon the grant of each Stock Option hereunder. 1 2. DEFINITIONS For the purposes of this Plan, the following terms shall have the following meanings: (a) "COMMON STOCK." This term shall mean shares of the Corporation's no par value common stock, subject to adjustment pursuant to Paragraph 14 (Adjustment Upon Changes in Capitalization) hereunder. (b) "CORPORATION." This term shall mean Pacific Community Banking Group, a California corporation. (c) "ELIGIBLE PARTICIPANT." This term shall mean: (i) all directors of the Corporation or any Subsidiary; (ii) all full time officers (whether or not they are also directors) of the Corporation or any Subsidiary; (iii) all full time key employees (as such persons may be determined by the Stock Option Committee from time to time) of the Corporation or any Subsidiary; and (iv) consultants and others with significant and material business relationships with the Corporation. (d) "EMPLOYER." This term shall mean the Corporation, as defined herein, or any other subsidiary of the Corporation, as appropriate, depending upon which company Optionee is employed. (e) "FAIR MARKET VALUE." This term shall mean the fair market value of the Corporation's Common Stock as determined by any reasonable valuation method in accordance with the Commissioner of Corporations Regulation Section 260.140.50, which generally provides that in determining whether the price is fair, predominant weight will be given to the following: (a) if securities of the same class are publicly traded on an active market of substantial depth, the recent market price 2 of such securities; (b) if the securities of the same class have not been so publicly traded, the price at which securities of reasonable comparable corporations (if any) in the same industry are being traded, subject to appropriate adjustments for the dissimilarities between the corporations being compared; or (c) in the absence of any reliable indicator under subsection (a) or (b), the earnings history, book value and prospects of the issuer in light of market conditions generally. (f) "INCENTIVE STOCK OPTION." This term shall mean a Stock Option which is an "Incentive Stock Option" within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended. (g) "NON-QUALIFIED STOCK OPTION." This term shall mean a Stock Option which is not an Incentive Stock Option. (h) "OPTION SHARES." This term shall mean shares of Common Stock which are covered by and subject to any outstanding unexercised Stock Option granted pursuant to this Plan. (i) "OPTIONEE." This term shall mean any Eligible Participant to whom a stock option has been granted pursuant to this Plan, provided that at least part of the Stock Option is outstanding and unexercised. (j) "PLAN." This term shall mean the Pacific Community Banking Group 1999 Stock Option Plan as embodied herein and as may be amended from time to time in accordance with the terms hereof and applicable law. (k) "STOCK OPTION." This term shall mean the right to purchase from the Corporation a specified number of shares of Common Stock under the Plan at a price and upon terms and conditions determined by the Stock Option Committee. 3 (l) "STOCK OPTION COMMITTEE." The Board of Directors of the Corporation may select and designate a stock option committee consisting of at least three and not more than five persons, at least two of whom are directors, having full authority to act in the matters. Regardless of whether a Stock Option Committee is selected, the Board of Directors may act as the Stock Option Committee and any action taken by the Board of Directors as such shall be deemed to be action taken by the Stock Option Committee. All references in the Plan to the "Stock Option Committee" shall be deemed references to the Board of Directors acting as a stock option committee and to a duly appointed Stock Option Committee, if there be one. In the event of any conflict between any action taken by the Board of Directors acting as a Stock Option Committee and any action taken by a duly appointed Stock Option Committee, the action taken by the Board of Directors shall be controlling and the action taken by the duly appointed Stock Option Committee shall be disregarded. (m) "SUBSIDIARY." This term shall mean any subsidiary corporation of the Corporation as such term is defined in Section 425(f) of the Internal Revenue Code of 1986, as amended. 3. ADMINISTRATION (a) STOCK OPTION COMMITTEE. This Plan shall be administered by the Stock Option Committee. The Board of Directors of the Corporation shall have the right, in its sole and absolute discretion, to remove or replace any person from or on the Stock Option Committee at any time for any reason whatsoever. (b) ADMINISTRATION OF THE PLAN. Any action of the Stock Option Committee with respect to the administration of the Plan shall be taken pursuant to 4 a majority vote, or pursuant to the unanimous written consent, of its members. Any such action taken by the Stock Option Committee in the administration of this Plan shall be valid and binding, so long as the same is in conformity with the terms and conditions of this Plan. Subject to compliance with each of the terms, conditions and restrictions set forth in this Plan, including, but not limited to, those set forth in Section 6(a)(ii) hereof, the Stock Option Committee shall have the exclusive right, in its sole and absolute discretion, to establish the terms and conditions of any Stock Options granted under the Plan, including, without limitation, the power to: (i) establish the number of Stock Options, if any, to be granted hereunder, in the aggregate and with regard to any individual Eligible Participant; (ii) determine the time or times when such Stock Options, or any parts thereof, may be exercised; (iii) determine and designate which Stock Options granted under the Plan shall be Incentive Stock Options and which shall be Non-Qualified Stock Options; (iv) determine the Eligible Participants, if any, to whom Stock Options are granted; (v) determine the duration and purposes, if any, of leaves of absence which may be permitted to holders of unexercised, unexpired Stock Options without such constituting a termination of employment under the Plan; (vi) prescribe and amend the terms, provisions and form of any instrument or agreement setting forth the terms and conditions of every Stock Option granted hereunder; and (vii) make loans to or guarantee any obligations of any Optionees, except directors, in connection with the exercise of Stock Options as specified in Section 8(d) hereof, whenever the Stock Option Committee determines that such loan or guarantee may reasonably be expected to benefit the corporation, subject to the provisions of Section 315(b) of the 5 California General Corporations Law of 1977, as amended and subject to Regulations G, U and T promulgated by the Board of Governors of the Federal Reserve System pursuant to Section 7 of the Securities Exchange Act of 1934, if the Option Shares are listed on a stock exchange or are contained in the list of over-the-counter margin securities published by the Federal Reserve Board. (c) DECISIONS AND DETERMINATIONS. Subject to the express provisions of the Plan, the Stock Option Committee shall have the authority to construe and interpret the Plan, to define the terms used therein, to prescribe, amend, and rescind rules and regulations relating to the administration of the Plan, and to make all other determinations necessary or advisable for administration of the Plan. Determinations of the Stock Option Committee on matters referred to in this Section 3 shall be final and conclusive so long as the same are in conformity with the terms of this Plan. 4. SHARES SUBJECT TO THE PLAN Subject to adjustments as provided in Section 14 hereof, the maximum number of shares of Common Stock which may be issued upon exercise of Stock Options granted under this Plan is limited to 30% of the issued and outstanding shares of the Corporation up to a maximum of 1,350,000 shares in the aggregate. If any Stock Option shall be canceled, surrendered, or expire for any reason without having been exercised in full, the unpurchased Option Shares represented thereby shall again be available for grants of Stock Options under this Plan. 5. ELIGIBILITY Only Eligible Participants shall be eligible to receive grants of Stock Options under this Plan. 6 6. GRANTS OF STOCK OPTIONS (a) GRANT. Subject to the express provisions and limitations of the Plan, the Stock Option Committee, in its sole and absolute discretion, may grant Stock Options to Eligible Participants of the Corporation, for a number of Option Shares, at the price(s) and time(s), on the terms and conditions and to such Eligible Participants as it deems advisable and specifies in the respective grants. Subject to the limitations and restrictions set forth in the Plan, an Eligible Participant who has been granted a Stock Option may, if otherwise eligible, be granted additional Stock Options if the Stock Option Committee shall so determine. The Stock Option Committee shall designate in each grant of a Stock Option whether the Stock Option is an Incentive Stock Option or a Non-Qualified Stock Option. An eligible director, officer or employee shall not participate in the granting of his or her own options. (b) DATE OF GRANT AND RIGHTS OF OPTIONEE. The determination of the Stock Option Committee to grant a Stock Option shall not in any way constitute or be deemed to constitute an obligation of the Corporation, or a right of the Eligible Participant who is the proposed subject of the grant, and shall not constitute or be deemed to constitute the grant of a Stock Option hereunder unless and until both the Corporation and the Eligible Participant have executed and delivered the form of stock option agreement then required by the Stock Option Committee as evidencing the grant of the Stock Option, together with such other instruments as may be required by the Stock Option Committee pursuant to this Plan; provided, however, that the Stock Option Committee may fix the date of grant as any date on or after the date 7 of its final determination to grant the Stock Option (or if no such date is fixed, then the date of grant shall be the date on which the determination was finally made by the Stock Option Committee to grant the Stock Option), and such date shall be set forth in the stock option agreement. The date of grant as so determined shall be deemed the date of grant of the Stock Option for purposes of this Plan. (c) SHAREHOLDER-EMPLOYEES. Notwithstanding anything to the contrary contained elsewhere herein, a Stock Option shall not be granted hereunder to an Eligible Participant who owns, directly or indirectly, at the date of the grant of the Stock Option, more than ten percent (10%) of the total combined voting power of all classes of capital stock of the Corporation or a Subsidiary corporation, unless the purchase price of the Option Shares subject to said Stock Option is at least 110% of the Fair Market Value of the Option Shares, determined as of the date said Stock Option is granted. (d) MAXIMUM VALUE OF STOCK OPTIONS. Except as provided in paragraph (e) of this Section 6, the maximum aggregate Fair Market Value of Option Shares (determined as of the respective Stock Option grant dates) for which an Eligible Participant may be granted Incentive Stock Options in any calendar year shall not exceed $100,000, plus any "unused carryover amount." The unused carryover amount, determined on a yearly basis, shall be equal to one-half (1/2) of the difference between $100,000 and the aggregate Fair Market Value (determined as of the respective Stock Option grant dates) of all of the Option Shares subject to Incentive Stock Options granted to the Optionee during the calendar year under the Plan. The provisions of Section 422A(c)(4) of the Internal Revenue Code of 1986, 8 as amended, are incorporated herein by this reference for the purpose of the determination and application of the unused carryover amount. The aggregate fair market value (determined at the time the option is granted) of the stock with respect to which incentive stock options are exercisable for the first time by such individual under the terms of the Plan during any calendar year is limited to $100,000, but the value of stock for which options may be granted to an employee in a given year may exceed $100,000, but such options in excess of $100,000 shall be treated as non-qualified options. (e) SUBSTITUTED STOCK OPTIONS. If all of the outstanding shares of common stock of another corporation are changed into or exchanged solely for common stock in a transaction to which Section 425(a) of the Internal Revenue Code of 1986, as amended, applies, then, subject to the approval of the Board of Directors of the Bank, Stock Options under the Plan may be substituted ("Substituted Options") in exchange for valid, unexercised and unexpired stock options of such other corporation. Substituted options shall qualify as Incentive Stock Options under the Plan, provided that (and to the extent) the stock options exchanged for the Substituted-Options were "Incentive Stock Options" within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended. (f) NON-QUALIFIED STOCK OPTIONS. All Stock Options granted by the Stock Option Committee which: (i) are designated at the time of grant as Incentive Stock Options but do not so qualify under the provisions of Section 422A of the Code or any regulations or rulings issued by the Internal Revenue Service for any reason; (ii) are in excess of the fair market value limitations set forth in Section 6(d); or (iii) 9 are designated at the time of grant as Non-Qualified Stock Options, shall be deemed Non-Qualified Stock Options under this Plan. Non-Qualified Stock Options granted or substituted hereunder shall be so designated in the stock option agreement entered into between the Corporation and the Optionee. 7. STOCK OPTION EXERCISE PRICE (a) MINIMUM PRICE. The exercise price of any Option Shares shall be determined by the Stock Option Committee, in its sole and absolute discretion, upon the grant of a Stock Option. Except as provided elsewhere herein, said exercise price shall not be less than one hundred percent (100%) of the Fair Market Value of the Common Stock represented by the Option Share on the date of grant of the related Stock Option. (b) EXCHANGED STOCK OPTIONS. Where the outstanding shares of stock of another corporation are changed into or exchanged for shares of Common Stock of the Corporation without monetary consideration to that other corporation, then, subject to the approval of the Board of Directors of the Corporation, Stock Options may be granted in exchange for unexercised, unexpired stock options of the other corporation, and the exercise price of the Option Shares subject to each Stock Option so granted may be fixed at a price less than one hundred percent (100%) of the Fair Market Value of the Common Stock at the time such Stock Option is granted if said exercise price has been computed to be not less than the exercise price set forth in the stock option of the other corporation, with appropriate adjustment to reflect the exchange ratio of the shares of stock of the other corporation into the shares of Common Stock of the Corporation. 10 (c) SUBSTITUTED OPTIONS. The exercise price of the Option Shares subject to each Substituted Option may be fixed at a price less than one hundred percent (100%) of the Fair Market Value of the Common Stock at the time such Substituted option is granted if said exercise price has been computed to be not less than the exercise price set forth in the stock option of the other corporation for which it was exchanged, with appropriate adjustment to reflect the exchange ratio of the shares of stock of the other corporation into the shares of Common Stock. 8. EXERCISE OF STOCK OPTIONS. (a) EXERCISE. Except as otherwise provided elsewhere herein, each Stock Option shall be exercisable in such increments, which need not be equal, and upon such contingencies as the Stock Option Committee shall determine at the time of grant of the Stock Option; provided, however, (i) that if an Optionee shall not in any given period exercise any part of a Stock Option which has become exercisable during that period, the Optionee's right to exercise such part of the Stock Option shall continue until expiration of the Stock Option or any part thereof as may be provided in the related Stock Option Agreement, and (ii) in the case of options that are not granted to officers, directors, consultants of, or others with significant and material business relationships with, the Company, a minimum of 20% of the stock options shall be exercisable in each year over a five year period from the date the option is granted. No Stock Option or part thereof shall be exercisable except with respect to whole shares of Common Stock, and fractional share interests shall be disregarded except that they may be accumulated. 11 (b) PRIOR OUTSTANDING INCENTIVE STOCK OPTIONS. Incentive Stock Options granted to an Optionee may be exercisable while such Optionee has outstanding and unexercised any Incentive Stock Option previously granted (or substituted) to him or her pursuant to this Plan. The Stock Option Committee shall determine if such options shall be exercisable if there are any Incentive Stock Options previously granted (or substituted) to him or her pursuant to this Plan, and such determination shall be evidenced in the Agreement executed by the Optionee and Company, subject to the requirements of Rule 260.141.41(f) of the California Commissioner of Corporations. An Incentive Stock Option shall be treated as outstanding until it is exercised in full or expires by reason of lapse of time. (c) NOTICE AND PAYMENT. Stock Options granted hereunder shall be exercised by written notice delivered to the Corporation specifying the number of Option Shares with respect to which the Stock Option is being exercised, together with concurrent payment in full of the exercise price as hereinafter provided in Section 8(d) hereof. If the Stock Option is being exercised by any person or persons other than the Optionee, said notice shall be accompanied by proof, satisfactory to counsel for the Corporation, of the right to such person or persons to exercise the Stock Option. The Corporation's receipt of a notice of exercise without concurrent receipt of the full amount of the exercise price shall not be deemed an exercise of a Stock Option by an Optionee, and the Corporation shall have no obligation to an Optionee for any Option Shares unless and until full payment of the exercise price is received by the Corporation in accordance with Section 8(d) hereof, and all of the 12 terms and provisions of the Plan and the related stock option agreement have been complied with. (d) PAYMENT OF EXERCISE PRICE. The exercise price of any Option Shares purchased upon the proper exercise of a Stock Option shall be paid in full at the time of each exercise of a Stock Option in cash and/or, with the prior written approval of the Stock Option Committee, in Common Stock of the Corporation which, when added to the cash payment, if any, has an aggregate Fair Market Value equal to the full amount of the exercise price of the Stock Option, or part thereof, then being exercised and/or, with the prior written approval of the Stock Option Committee and if legally permitted, on a deferred basis evidenced by a promissory note, containing such terms and subject to such security as the Stock Option Committee shall determine to be fair and reasonable from time to time, for the total option price for the number of shares so purchased. No Director may purchase any Stock Option on a deferred basis evidenced by a promissory note. Unless payment is on a deferred basis, payment by an Optionee as provided herein shall be made in full concurrently with the Optionee's notification to the Corporation of his intention to exercise all or part of a Stock Option. If all or part of payment is made in shares of Common Stock as heretofore provided, such payment shall be deemed to have been made only upon receipt by the Corporation of all required share certificates, and all stock powers and other required transfer documents necessary to transfer the shares of Common Stock to the Corporation. (e) REORGANIZATION. Notwithstanding any provision in any stock option agreement pertaining to the time of exercise of a Stock Option, or part thereof, 13 upon adoption by the requisite holders of the Corporation's outstanding shares of Common Stock of any plan of dissolution, liquidation, reorganization, merger, consolidation or sale of all or substantially all of the assets of the Corporation to another corporation, or the acquisition of stock representing more than 50% of the voting power of the Corporation then outstanding, by another corporation or person, which would, upon consummation, result in termination of a Stock Option in accordance with Section 16 hereof, the Stock Option shall become immediately exercisable as to all Option Shares, whether or not vested, for such period of time as may be determined by the Stock Option Committee, but in any event not less than 30 days prior to the adoption of the plan of dissolution, liquidation, reorganization, merger, consolidation, sale, or acquisition on the condition that the terminating event described in Section 16 hereof is consummated. Any Option Shares not exercised will be terminated. If such Terminating Event is not consummated, Stock Options granted pursuant to the Plan shall be exercisable in accordance with their respective terms. (f) MINIMUM EXERCISE. Not less than ten (10) Option Shares may be purchased at any one time upon exercise of a Stock Option unless the number of shares purchased is the total number which remains to be purchased under the Stock Option. (g) COMPLIANCE WITH LAW. No shares of Common Stock shall be issued by the Corporation upon exercise of any Stock Option, and an Optionee shall have no rights or claim to such shares, unless and until: (a) payment in full as provided in Section 8(d) hereof has been received by the Corporation; (b) in the 14 opinion of the counsel for the Corporation, all applicable registration requirements of the Securities Act of 1933, all applicable listing requirements of securities exchanges or associations on which the Corporation's Common Stock is then listed or traded, and all other requirements of law and of regulatory bodies having jurisdiction over such issuance and delivery, have been fully complied with; and (c) if required by federal or state law or regulation, the Optionee shall have paid to the Corporation the amount, if any, required to be withheld on the amount deemed to be compensation to the Optionee as a result of the exercise of his or her Stock Option, or made other arrangements satisfactory to the Corporation, in its sole discretion, to satisfy applicable income tax withholding requirements. 9. NONTRANSFERABILITY OF STOCK OPTIONS. Each Stock Option shall, by its terms, be nontransferable by the Optionee other than by will or the laws of descent and distribution, and shall be exercisable during the Optionee's lifetime only by the Optionee or his or her guardian or legal representative. 10. CONTINUATION OF EMPLOYMENT. Except for Optionees with a written contract for any definite term, this Agreement shall not obligate the Corporation or a Subsidiary to employ Optionee. 11. CESSATION OF EMPLOYMENT. Except as provided in Sections 8(e), 12, 13, 14, 15 or 16 hereof, if, for any reason, an Optionee's status as an Eligible Participant is terminated, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their initial grant, or three (3) months after the 15 Optionee's status as an Eligible Participant is terminated, whichever is earlier. Thereafter, Options shall be exercisable only as to those increments, if any, which had become exercisable as of such expiration date, and any Stock Options or increments which had not become exercisable as of such date shall expire and terminate automatically on such expiration date. 12. TERMINATION FOR VIOLATION OF STANDARDS OF CONDUCT AS REFERENCED IN OPTIONEE'S EMPLOYEE HANDBOOK. If Optionee's status as an Eligible Participant is terminated for violation of the Employer's Standards of Conduct, the vested portion of Stock Options granted to such Optionee shall be exercisable for a thirty (30) day period following such termination, and thereafter such Stock Options shall automatically expire and terminate in their entirety; provided, however, that the Stock Option Committee may, in its sole discretion, within thirty (30) days of such termination, reinstate such Stock Options to the status of options terminated for reasons other than violations of the Employer's Standards of Conduct, death or disability by giving written notice of such reinstatement to the Optionee. In the event of such reinstatement, the Optionee may exercise the Stock Options as provided in Section 11 herein. Reasons for termination for violation of the Employer's Standards of Conduct shall include, but not be limited to, termination for malfeasance or gross misfeasance in the performance of duties or conviction of illegal activity in connection therewith, and, in any event, the determination of the Stock Option Committee with respect thereto shall be final and conclusive. 16 13. DEATH OF OPTIONEE If an Optionee loses his status as an Eligible Participant by reason of death, or if an Optionee dies during the three-month period referred to in Section 12 hereof, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their initial grant, or one (1) year after the date of such death, whichever is earlier. After such death but before such expiration, subject to the terms and provisions of the Plan and the related stock option agreements, the person or persons to whom such Optionee's rights under the Stock Options shall have passed by will or by the applicable laws of descent and distribution, or the executor or administrator of the Optionee's estate, shall have the right to exercise such Stock Options to the extent that increments, if any, had become exercisable as of the date on which the Optionee's status as an Eligible Participant had been lost. 14. DISABILITY OF OPTIONEE If an Optionee is disabled while employed by or while serving as a director of the Corporation or a Subsidiary or during the three-month period referred to in Section 12 hereof, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their initial grant, or one (1) year after the date of such disability, whichever is earlier. After such disability but before such expiration, the Optionee or a guardian or conservator of the Optionee's estate, as duly appointed by a court of competent jurisdiction, shall have the right to exercise such Stock Options to the extent that increments, if any, had become exercisable as of the date on which the Optionee became disabled or ceased to be employed by the 17 Corporation or a Subsidiary as a result of the disability. For the purpose of this Section 14, an Optionee shall be deemed to have become "disabled" if it shall appear to the Stock Option Committee, upon written certification delivered to the Corporation by a qualified licensed physician, that the Optionee has become permanently and totally unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death, or which has lasted or can be expected to last for a continuous period of not less than 12 months. 15. ADJUSTMENT UPON CHANGES IN CAPITALIZATION If the outstanding shares of Common Stock of the Corporation are increased, decreased, or changed into or exchanged for a different number or kind of shares or securities of the Corporation, through a reorganization, merger, recapitalization, reclassification, stock split, stock dividend, stock consolidation, or otherwise, without consideration to the Corporation, an appropriate and proportionate adjustment shall be made in the number and kind of shares as to which Stock Options may be granted. A corresponding adjustment changing the number or kind of Option Shares and the exercise prices per share allocated to unexercised Stock Options, or portions thereof, which shall have been granted prior to any such change, shall likewise be made. Any such adjustment, however, in an outstanding Stock Option shall be made without change in the total price applicable to the unexercised portion of the Stock Option, but with a corresponding adjustment in the price for each Option Share subject to the Stock Option. Any adjustment under this Section shall be made by the Stock Option Committee, whose determination as to what adjustments shall be made, and the 18 extent thereof, shall be final and conclusive. No fractional shares of stock shall be issued or made available under the Plan on account of any such adjustment, and fractional share interests shall be disregarded and the fractional share interest shall be rounded down to the nearest whole number. 16. TERMINATING EVENTS Not less than thirty (30) days prior to consummation of a plan of dissolution or liquidation of the Corporation, or consummation of a plan of reorganization, merger or consolidation of the Corporation with one or more corporations, as a result of which the Corporation is not the surviving corporation and the outstanding securities of the class then subject to options hereunder are changed or exchanged for cash or property or securities not of the Corporation's issue, or upon the sale of all or substantially all the assets of the Corporation to another corporation, or the acquisition of stock representing more than fifty percent (50%) of the voting power of the Corporation then outstanding by another corporation or person (the "Terminating Event"), the Stock Option Committee or the Board of Directors shall notify each Optionee of the pendency of the Terminating Event. Upon the effective date of the Terminating Event, the Plan shall automatically terminate and all Stock Options theretofore granted shall terminate, unless provision is made in connection with such transaction for the continuance of the Plan and/or assumption of Stock Options theretofore granted, or substitution for such Stock Options with new stock options, covering stock of a successor employer corporation, or a parent or subsidiary corporation thereof, solely at the discretion of such successor corporation, or parent or subsidiary corporation, with appropriate adjustments as to number and kind of 19 shares and prices, in which event the Plan and options theretofore granted shall continue in the manner and under the terms so provided. If the Plan and unexercised options shall terminate pursuant to the foregoing sentence, all persons shall have the right to exercise any unexercised portions of options outstanding and not exercised, shall have the right, at such time prior to the consummation of the transaction causing such termination as the Corporation shall designate and for a period of not less than 30 days, to exercise all unexercised portions of their options, including the portions which would, but for this paragraph entitled "Terminating Events," not yet be exercisable. 17. AMENDMENT AND TERMINATION The Board of Directors of the Corporation may at any time and from time-to-time suspend, amend, or terminate the Plan and may, with the consent of Optionee, make such modifications of the terms and conditions of a Stock Option as it shall deem advisable; provided that, except as permitted under the provisions of Section 16 hereof, no amendment or modification may be adopted without the Corporation having first obtained all necessary regulatory approvals and approval of the holders of a majority of the Corporation's shares of Common Stock present, or represented, and entitled to vote at a duly held meeting of shareholders of the Corporation if the amendment or modification would; (a) materially increase the benefits accruing to participants under the Plan; (b) materially increase the number of securities which may be issued under the Plan; 20 (c) materially modify the requirements as to eligibility for participation in the Plan; (d) increase or decrease the exercise price of any Stock Options granted under the Plan; (e) increase the maximum term of Stock Options provided for herein; (f) permit Stock Options to be granted to any person who is not an Eligible Participant; or (g) change any provision of the Plan which would affect the qualification as an incentive Stock Option under the Plan. No Stock Option may be granted during any suspension of the Plan or after termination of the Plan. Amendment, suspension, or termination of the Plan shall not (except as otherwise provided in Section 17 hereof), without the consent of the Optionees, alter or impair any rights or obligations under any Stock Option theretofore granted. 18. RIGHTS OF ELIGIBLE PARTICIPANTS AND OPTIONEES Neither any Eligible Participant, any Optionee or any other person shall have any claim or right to be granted any Stock Option under this Plan, and neither this Plan nor any action taken hereunder shall be deemed or construed as giving any Eligible Participant, Optionee or any other person any right to be retained in the employ of the Corporation or any subsidiary of the Corporation. Without limiting the generality of the foregoing, there is no vesting of any right in the classification of any person as an Eligible Participant or Optionee, such classification being used solely to 21 define and limit those persons who are eligible for consideration of the grant of Stock Options under the Plan; 19. PRIVILEGES OF STOCK OWNERSHIP; SECURITIES LAW COMPLIANCE; NOTICE OF SALE No Optionee shall be entitled to the privileges of stock ownership as to any Option Shares not actually issued and delivered. No Option Shares may be purchased upon the exercise of a Stock Option unless and until all then applicable requirements of all regulatory agencies having jurisdiction and all applicable requirements of securities exchanges upon which the stock of the Corporation is listed (if any) shall have been fully complied with. The Corporation will diligently endeavor to comply with all applicable securities laws before any options are granted under the Plan and before any stock is issued pursuant to options. The Optionee shall, not more than five (5) days after each sale or other disposition of shares of Common Stock acquired pursuant to the exercise of Stock Options, give the Corporation notice in writing of such sale of other disposition. The Corporation will provide to each Optionee its Annual Report as required by Section 260.140.46 of the regulations of the California Commissioner of Corporations. 20. EFFECTIVE DATE OF THE PLAN The Plan shall be deemed adopted as of February 23, 1999, and shall be effective immediately, subject to approval of the Plan by the holders of at least a majority of the Corporation's outstanding shares of Common Stock and approval of the Plan by the California Commissioner of Corporations. 22 21. TERMINATION Unless previously terminated as aforesaid, the Plan shall terminate ten (10) years from the earliest date of (i) adoption of the Plan by the Board of Directors; or (ii) approval of the Plan by holders of at least a majority of the Corporation's outstanding shares of Common Stock. No Stock Options shall be granted under the Plan thereafter, but such termination shall not affect any Stock Option theretofore granted. 22. OPTION AGREEMENT Each Stock Option granted under the Plan shall be evidenced by a written stock option agreement executed by the Corporation and the Optionee, and shall contain each of the provisions and agreements herein specifically required to be contained therein, and such other terms and conditions as are deemed desirable by the Stock Option Committee and are not inconsistent with the Plan. 23. STOCK OPTION PERIOD Each Stock Option and all rights and obligations thereunder shall expire on such date as the Stock Option Committee may determine, but not later than ten (10) years from the date such Stock Option is granted, and shall be subject to earlier termination as provided elsewhere in the Plan. 24. EXCULPATION AND INDEMNIFICATION OF STOCK OPTION COMMITTEE In addition to such other rights of indemnification which they may have as directors of the Corporation or as members of the Stock Option Committee, the present and former members of the Stock Option Committee, and each of them, shall be indemnified by the Corporation for and against all costs, judgments, penalties and 23 reasonable expenses, including reasonable attorney's fees, actually and necessarily incurred by them in connection with any action, suit or proceeding, or in connection with any appeal thereof, to which they or any of them may be a party by reason of any act or omission of any member of the Stock Option Committee under or in connection with the Plan or any Stock Option granted thereunder; provided, however, that a member of the Stock Option Committee shall not be entitled to any indemnification whatsoever pursuant to this Section for as a result of any act or omission of such member which was not taken in good faith and which constituted willful misconduct or gross negligence by such member; provided further, that any amounts paid by any member of the Stock Option Committee in settlement of any action, suit or proceeding for which indemnification may be sought pursuant to this Section shall be first approved in writing by independent legal counsel selected by the Corporation; and, provided further, that within thirty (30) days after institution of any action, suit or proceeding against any member with respect to which such member is entitled to indemnification hereunder, such member shall, in writing, offer the Corporation the opportunity, as its own expense, to handle (including settle) and conduct the defense thereof. The provisions of this Section shall apply to the estate, executor and administrator of each member of the Stock Option Committee. 25. (Reserved) 26. NOTICES All notices and demands of any kind which the Stock Option Committee, any Optionee, Eligible Participant, or any other person may be required or desires to serve under the terms of this Plan shall be in writing and shall be served by personal service 24 upon the respective person or by leaving a copy of such notice or demand at the address of such person as may be reflected in the records of the Corporation, or in the case of the Stock Option Committee, with the Secretary of the Corporation, or by mailing a copy thereof by certified or registered mail, postage prepaid, with return receipt requested. In the case of service by mail, it shall be deemed complete at the expiration of the third day after the day of mailing, except for notice of the exercise of any Stock Option and payment of the Stock Option exercise price, both of which must be actually received by the Corporation. 27. (Reserved) 28. LIMITATION OF RIGHTS The Stock Option Committee, in its sole and absolute discretion, is entitled to determine who, if anyone, is an Eligible Participant under this Plan, and which, if any, Eligible Participant shall receive any grant of a Stock Option. No oral or written agreement by any person on behalf of the Corporation relating to this Plan or any Stock Option granted hereunder is authorized, and such agreement may not bind the Corporation or the Stock Option Committee to grant any Stock Option to any person. 29. SEVERABILITY If any provision of this Plan as applied to any person or to any circumstances shall be adjudged by a court of competent jurisdiction to be void, invalid, or unenforceable, the same shall in no way effect any other provision hereof, the application of any such provision in any other circumstances, or the validity of enforceability hereof. 25 30. CONSTRUCTION Where the context or construction requires, all words applied in the plural shall be deemed to have been used in the singular and vice versa, and the masculine gender shall include the feminine and the neuter. 31. HEADINGS The headings of the several paragraphs of this Plan are inserted solely for convenience of reference and are not intended to form a part of and are not intended to govern, limit or aid in the construction of any term or provision hereof. 32. SUCCESSORS This Plan shall be binding upon the respective successors, assigns, heirs, executors, administrators, guardians and personal representatives of the Corporation and any Optionee. 33. GOVERNING LAW This Plan shall be governed by and construed in accordance with the laws of the State of California. 34. CONFLICT In the event of any conflict between the terms and provisions of this Plan, and any other document, agreement or instrument, including, without limitation, any stock option agreement, the terms and provisions of this Plan shall control. 26 SECRETARY'S CERTIFICATE OF ADOPTION I, the undersigned, do hereby certify: 1. That I am the duly elected and acting Assistant Secretary of Pacific Community Banking Group; and 2. That the foregoing Pacific Community Banking Group 1999 Stock Option Plan was duly adopted by the Board of Directors of Pacific Community Banking Group as the Stock Option Plan for the Corporation at a meeting duly called as required by law and convened on the 23rd day of February, 1999. IN WITNESS WHEREOF, I have hereunto subscribed my name and affixed the seal of the Corporation this 23rd day of February, 1999. /s/ MARGARAT HOWE -------------------------------------- Margarat Howe, Assistant Secretary [SEAL] 27 OPTIONEES TO WHOM INCENTIVE STOCK OPTIONS ARE GRANTED MUST MEET CERTAIN HOLDING PERIOD AND EMPLOYMENT REQUIREMENTS FOR FAVORABLE TAX TREATMENT. UNLESS OTHERWISE STATED, ALL DEFINED TERMS IN THE PLAN SHALL HAVE THE SAME MEANING HEREIN AS SET FORTH IN THE PLAN. IT IS UNLAWFUL TO CONSUMMATE A SALE OR TRANSFER OF THIS SECURITY, OR ANY INTEREST THEREIN, OR TO RECEIVE ANY CONSIDERATION THEREFOR, WITHOUT THE PRIOR WRITTEN CONSENT OF THE COMMISSIONER OF CORPORATIONS OF THE STATE OF CALIFORNIA, EXCEPT AS PERMITTED IN THE COMMISSIONER'S RULES. PACIFIC COMMUNITY BANKING GROUP STOCK OPTION AGREEMENT ---------------------- / / Incentive Stock Option / / Non-Qualified Stock Option THIS AGREEMENT, dated the ___ day of ________, 19__, by and between Pacific Community Banking Group, a California corporation (the "Corporation"), and ________________ (the "Optionee"); WHEREAS, pursuant to the Corporation's 1999 Stock Option Plan (the "Plan"), the Stock Option Committee has authorized the grant to Optionee of a Stock Option to purchase all or any part of ______________ (______) authorized but unissued shares of the Corporation's Common Stock at the price of ________________ Dollars ($______) per share, such Stock Option to be for the term and upon the terms and conditions hereinafter stated; NOW, THEREFORE, it is hereby agreed: 1. GRANT OF STOCK OPTION. Pursuant to said action of the Stock Option Committee and pursuant to authorizations granted by all appropriate regulatory 1 and governmental agencies, the Corporation hereby grants to Optionee a Stock Option to purchase, upon and subject to the terms and conditions of the Plan, which is incorporated in full herein by this Reference, all or any part of ______________ (____) Option Shares of the Corporation's Common Stock, at the price of _____________ Dollars ($______) per share. For purposes of this Agreement and the Plan, the date of grant shall be ________________, 19__. At the date of grant, Optionee [DOES] [DOES NOT OWN] stock possessing more than 10% of the total combined voting power of all classes of capital stock of the Corporation or any Subsidiary. The Stock Option granted hereunder [IS] [IS NOT] intended to qualify as an Incentive Stock Option within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended. 2. EXERCISABILITY. This Stock Option shall be exercisable as to _____________ Option Shares on _____________, 19__, as to ________________ Option Shares on _____________, 19__, as to _______________ Option Shares on _____________, 19__, as to ________________ Option Shares on _____________, 19__, and as to _______________ Option Shares on ______________, 19__. This Stock Option shall remain exercisable as to all of such Option Shares until _____________, 19__ (but not later than ten (10) years from the date hereof), at which time it shall expire in its entirety, unless this Stock Option has expired or terminated earlier in accordance with the provisions hereof. Option shares as to which this Stock Option becomes exercisable may be purchased at any time prior to expiration of this Stock Option. 2 3. EXERCISE OF STOCK OPTION. Subject to the provision of Paragraph 4 hereof, this Stock Option may be exercised by written notice delivered to the Corporation stating the number of Option Shares with respect to which this Stock Option is being exercised, together with cash and/or, if permitted at the time of exercise by the Stock Option Committee, shares of Common Stock of the Corporation which, when added to the cash payment, if any, have an aggregate Fair Market Value equal to the full amount of the purchase price of such Option Shares, and/or, if permitted at the time of exercise by the Stock Option Committee and if legally permitted, and if Optionee is not also a director, consultant or business advisor of the Corporation or any of its subsidiaries, on a deferred basis evidenced by a promissory note. Not less than ten (10) Option shares may be purchased at any one time unless the number purchased is the total number which remains to be purchased under this Stock Option and in no event may the Stock Option be exercised with respect to fractional shares. Upon exercise, Optionee shall make appropriate arrangements and shall be responsible for the withholding of any federal and state income taxes then due. 4. PRIOR OUTSTANDING STOCK OPTIONS. Incentive Stock Options granted to an Optionee may be exercisable while such Optionee has outstanding and unexercised any Incentive Stock Option previously granted to him or her pursuant to this Plan. The Stock Option Committee shall determine if such options shall be exercisable if there are any Incentive Stock Options previously granted (or substituted) to him or her pursuant to this Plan, and such determination shall be evidenced in the Agreement executed by the Optionee and the Corporation, subject 3 to the requirements of Rule 260.141.41(f) of the California Commissioner of Corporations. An Incentive Stock Option shall be treated as outstanding until it is exercised in full or expires by reason of lapse of time. 5. CESSATION OF EMPLOYMENT. Except as provided in paragraphs 7, 9, or 11 hereof, if Optionee's status as an Eligible Participant under the Plan is terminated, this Stock Option shall expire three (3) months thereafter or on the date specified in Paragraph 2 hereof, whichever is earlier. During such period after termination of status as an Eligible Participant, this Stock Option shall be exercisable only as to those increments, if any, which had become exercisable as of the date on which the Optionee's status as Eligible Participant was terminated, and any Stock Options or increments which had not become exercisable as of such date shall expire and terminate automatically on such date. 6. TERMINATION FOR VIOLATION OF STANDARDS OF CONDUCT AS REFERENCED IN OPTIONEE'S EMPLOYEE HANDBOOK. If Optionee's status as an Eligible Participant under the Plan is terminated for violation of the Employer's Standard of Conduct, the vested portion of this Stock Option shall be exercisable for a thirty (30) day period following such termination, and thereafter this Stock Option shall automatically expire and terminate in their entirety; provided, however, that the Stock Option Committee may, in its sole discretion, within thirty (30) days of such termination, reinstate such Stock Options to the status of options terminated for reasons other than violations of the Employer's Standards of Conduct, death or disability by giving written notice of such reinstatements to the Optionee. In the event of such reinstatement, the Optionee may exercise the Stock Options as provided in Section 11 herein. 4 Termination for violation of the Employer's Standard of Conduct shall include, but not be limited to, or termination for malfeasance or gross misfeasance in the performance of duties or conviction of illegal activity in connection therewith, and, in any event, the determination of the Stock Option Committee with respect thereto shall be final and conclusive. 7. DISABILITY OR DEATH OF OPTIONEE. If Optionee loses his or her status as an Eligible Participant under the Plan by reason of death or if Optionee is disabled while employed by the Corporation or a Subsidiary, or if Optionee dies or becomes so disabled during the three-month period referred to in Paragraph 5 hereof, this Stock Option shall automatically expire and terminate one (1) year after the date of Optionee's disability or death or on the day specified in Paragraph 2 hereof, whichever is earlier. After Optionee's disability or death but before such expiration, the person or persons to whom Optionee's rights under this Stock Option shall have passed by order of a court of competent jurisdiction or by will or the applicable laws of descent and distribution, or the executor, administrator or conservator of Optionee's estate, shall have the right to exercise this Stock Option to the extent that increments, if any, had become exercisable as of the date on which Optionee's status as an Eligible Participant under the Plan had been terminated. For purposes hereof, "disability" shall have the same meaning as set forth in Section 14 of the Plan. 8. NONTRANSFERABILITY. This Stock Option shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable during Optionee's lifetime only by Optionee or his or her guardian or legal representative. 5 9. EMPLOYMENT. Except for optionees with a written contract for any definite term, this Agreement shall not obligate the Corporation or a Subsidiary to employ Optionee. 10. PRIVILEGES OF STOCK OWNERSHIP. Optionee shall have no rights as a stockholder with respect to the Option Shares unless and until said Option Shares are issued to Optionee as provided in the Plan. Except as provided in Section 15 of the Plan, no adjustment will be made for dividends or other rights in respect of which the record date is prior to the date such stock certificates are issued. 11. MODIFICATION AND TERMINATION BY BOARD OF DIRECTORS. The rights of Optionee are subject to modification and termination upon the occurrence of certain events as provided in Sections 12, 13, 14, 15 and 16 of the Plan. Upon adoption by the requisite holders of the Corporation's outstanding shares of Common Stock of any plan of dissolution, liquidation, reorganization, merger, consolidation or sale of all or substantially all of the assets of the Corporation to, or the acquisition of stock representing more than fifty percent (50%) of the voting power of the Corporation then outstanding by another corporation or person which would, upon consummation, result in termination of this Stock Option in accordance with Section 16 of the Plan, this Stock Option shall become immediately exercisable as to all unexercised Option Shares notwithstanding the incremental exercise provisions of paragraph 2 of this Agreement for a period then specified by the Stock Option Committee, but in any event not less than 30 days, in accordance with Section 8(e) of the Plan, on the condition that the terminating event described in Section 16 of the Plan is consummated. If such terminating event is not consummated, this Stock Option shall 6 be exercisable in accordance with the terms of the Agreement, excepting this Paragraph 11. 12. NOTIFICATION OF SALE. Optionee agrees that Optionee, or any person acquiring Option Shares upon exercise of this Stock Option, will notify the Corporation in writing not more than five (5) days after any sale or other disposition of such Shares. 13. (Reserved) 14. NOTICES. All notices to the Corporation provided for in this Agreement shall be addressed to it in care of its President or Chief Financial Officer at its principal office and all notices to Optionee shall be addressed to Optionee's address on file with the Corporation or a subsidiary corporation, or to such other address as either may designate to the other in writing, all in compliance with the notice provisions set forth in Section 26 of the Plan. 15. INCORPORATION OF PLAN. All of the provisions of the Plan are incorporated herein by reference as if set forth in full hereat. In the event of any conflict between the terms of the Plan and any provision contained herein, the terms of the Plan shall be controlling and the conflicting provisions herein shall be disregarded. 7 IN WITNESS WHEREOF, the parties hereto have executed this Agreement. PACIFIC COMMUNITY BANKING GROUP By: ----------------------------------- By: ----------------------------------- OPTIONEE --------------------------------------- 8 EX-10.5 17 EXHIBIT 10.5 EXHIBIT 10.5 STOCKHOLDER AGREEMENT STOCKHOLDER AGREEMENT THIS AGREEMENT is entered into this 31st day of October, 1997 by and between E. Lynn Caswell ("Shareholder") and PACIFIC COMMUNITY BANKING GROUP ("Corporation"), a California corporation with its principal executive office at 23332 Mill Creek Drive, Suite 230, Laguna Hills, California 92653. A. WHEREAS, the Articles of Incorporation of the Corporation currently authorize the issuance of up to 100,000,000 of its no par value Common Stock ("Common Stock") and 100,000,000 of its no par value Preferred Stock. B. WHEREAS, the Board of Directors of the Corporation have authorized the sale and issuance of 10,000 shares of the Corporation's Common Stock at the purchase price of $.25 per share to Shareholder pursuant to the terms of Corporation Code Section 25102(f); C. WHEREAS, Shareholder desires to purchase 10,000 shares of the Corporation's Common Stock for the purchase price of $.25 per share pursuant to the terms and conditions herein set forth; IT IS MUTUALLY AGREED by and between the parties hereto as follows: 1. PURCHASE. The Corporation agrees to sell and Shareholder agrees to purchase 10,000 shares of the Corporation's Common Stock at the price of $.25 per share for an aggregate purchase price of $2,500.00 2. TRANSFER OF SHARES. The Shareholder agrees not to sell, assign, transfer, encumber, hypothecate, or make any other disposition of any of the shares of the Common Stock to be purchased except with the prior written consent of and at the direction of the Corporation and except in accordance with the terms of this Stockholder Agreement. This Stockholder Agreement shall be binding upon and shall operate for the benefit of the Corporation and the Shareholder and the respective executors or administrators and any transferees or assignees of the Shareholder, whether such transfers or assignments are in accordance with or in violation of the provisions of this Stockholder Agreement. 3. TERMINATION. This Stockholder Agreement shall terminate upon the occurrence of any of the following events: (a) The bankruptcy, receivership, or dissolution of the Corporation; or (b) Mutual agreement of the Corporation and Shareholder; 4. LEGEND. Upon execution of this Stockholder Agreement, the certificate representing the number of shares of Stock to be issued shall be endorsed as follows: - 1 - "It is unlawful to consummate a sale or transfer of this security, or any interest therein, or to receive any consideration therefor, without the prior written consent of the Commissioner of Corporations of the State of California, except as permitted by the Commissioner's rules. Additionally, this certificate is transferable only upon compliance with provisions of a Stockholder Agreement dated October 31, 1997." 5. GOVERNING LAW. This Stockholder Agreement shall be construed and governed by the laws of the State of California. The offer and sale of this stock will not be accompanied by the publication of any advertisement, that no selling expenses will be given, paid or incurred in connection therewith, that no promotional considerations will be given, paid or incurred in connection therewith, that a notice in the form prescribed by the rules of Commissioner of Corporations ("Commissioner") shall be filed with the Commissioner, and that a copy of Section 260.141.11 of the Corporate Securities Rules is attached hereto and is hereby acknowledged as received by shareholder. 6. ENTIRE AGREEMENT. This Stockholder Agreement constitutes the sole and only agreement of the parties hereto respecting the sale and purchase of the shares of the Corporation and the resale and repurchase of the shares of the Corporation's Common Stock and correctly sets forth the rights, duties, and obligations of each party to the other in relation thereto as of this date. Any prior agreements, promises, negotiations or representations concerning the subject matter of this Stockholder Agreement not expressly set forth in this Stockholder Agreement are of no force or effect. IN WITNESS WHEREOF, the parties hereto have executed this Stockholder Agreement in Laguna Hills, California on the date first above written. PACIFIC COMMUNITY BANKING GROUP By /s/ E. Lynn Caswell -------------------------------------- E. Lynn Caswell Chairman of the Board By /s/ E. Lynn Caswell -------------------------------------- E. Lynn Caswell, Chief Financial Officer By /s/ E. Lynn Caswell -------------------------------------- E. Lynn Caswell "Shareholder" - 2 - EX-10.6 18 EXHIBIT 10.6 EXHIBIT 10.6 Warrant Purchase Agreement between PCBG and TBOH dated July 30, 1998 EXHIBIT C WARRANT PURCHASE AGREEMENT This WARRANT PURCHASE AGREEMENT (the "Agreement"), dated as of July 30, 1998, between Pacific Community Banking Group, a California corporation ("PCBG"), and Bank of Hemet, a California corporation ("BOH") is made with reference to the following: RECITALS A. PCBG and BOH have entered into an Agreement and Plan of Reorganization dated July 30, 1998 (the "Merger Agreement") whereby BOH would be merged with PCBG Merger Corporation, a proposed subsidiary of PCBG, and BOH would become a wholly-owned subsidiary of PCBG (collectively, the "Merger"). B. As partial consideration to PCBG for entering into the Merger Agreement, BOH has agreed to issue to PCBG a warrant entitling the holder thereof to purchase up to 19.9% (or 210,800 shares) of the outstanding common stock of BOH ("Common Stock"), assuming the exercise of this Warrant, subject to such restrictions and conditions as may be imposed by bank regulatory authorities having jurisdiction over PCBG and BOH, respectively. C. Terms used herein and not otherwise defined shall have the meanings ascribed to them in Article VI hereof. In consideration of these premises and of the representations, covenants and agreements hereinafter set forth, BOH and PCBG hereby agree as follows: ARTICLE I ISSUANCE AND SALE OF WARRANT Section 1.1 ISSUANCE AND SALE OF THE WARRANT. Subject to the terms and conditions of this Agreement, and in reliance upon the representations and warranties hereinafter set forth, and in consideration for the execution and delivery of the Merger Agreement, BOH hereby issues to PCBG one or more warrants (such warrants, together with any warrants issued pursuant to Section 1.4, the "Warrants") entitling the holder thereof to purchase in the aggregate 210,800 duly authorized and newly issued shares of Common Stock, subject to adjustment as provided below. The Warrants being issued at the time of the execution of this Agreement will be evidenced by a single certificate in the form of Exhibit A hereto. All Warrants issued pursuant to Section 1.4 will be evidenced by one or, at PCBG's request, more certificates in the form of Exhibit A hereto, dated the date of their issuance, exercisable at the adjusted exercise price at the time in effect for the Warrants issued pursuant to this Section 1.1. 1 Section 1.2 WARRANT PRICE. The initial exercise price at which shares of Common Stock may be acquired pursuant to exercise of the Warrants shall be $46.50 per share (the "Warrant Price"), subject to adjustment as provided in Section 1.4. Section 1.3 EXERCISE OF WARRANTS. (a) The Warrants may be exercised in whole or in part only after the occurrence of an Acquisition Event. (b) As used herein, an "Acquisition Event" means any of the following events: (i) any person (other than PCBG or an Affiliate of PCBG) shall have commenced (as such term is defined in Rule 14d-2 under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), or shall have filed a registration statement under the Securities Act of 1933, as amended (the "Securities Act"), with respect to, a tender offer or exchange offer to purchase any shares of Common Stock such that, upon consummation of such offer, such person would own or control 25% or more of the then outstanding Common Stock, and such person shall have consummated such tender offer or exchange offer; (ii) BOH, without having received PCBG's prior written consent or except as permitted by the Merger Agreement, shall have authorized, recommended, proposed or publicly announced an intention to authorize, recommend or propose, or entered into, an agreement with any person (other than PCBG or any Affiliate of PCBG to (A) effect a merger, consolidation or similar transaction involving BOH, (B) sell, lease or otherwise dispose of assets of BOH representing 10% or more of the consolidated assets of BOH, or (C) issue, sell or otherwise dispose of (including by way of merger, consolidation, share exchange or any similar transaction) securities representing 10% or more of the voting power of BOH (any of the foregoing an "Acquisition Transaction"). (iii) any person (other than BOH or PCBG in a fiduciary capacity) shall have acquired beneficial ownership (as such term is defined in Rule 13d-3 under the Exchange Act) or the right to acquire beneficial ownership of, or any "group" (as such term is defined in the Exchange Act) shall have been formed which beneficially owns or has the right to acquire beneficial ownership of, 25% or more of the then outstanding Common Stock; or (iv) the holders of Common Stock shall not have approved the Merger Agreement at the meeting of such stockholders held for the purpose of voting on the Merger Agreement, such meeting shall not have been held or shall have been canceled prior to termination of the Merger Agreement and BOH's Board of Directors shall have withdrawn or modified in a manner adverse to PCBG the recommendation of BOH's Board of Directors with respect to the Merger Agreement, in each case after any person (other than PCBG) shall have (A) publicly announced a proposal, or publicly disclosed an intention to make a proposal, to engage in an Acquisition Transaction or (B) filed an 2 application (or given a notice), whether in draft or final form, under the BHC Act or the Change in Bank Control Act for approval to engage in an Acquisition Transaction. As used in this Agreement, "person" shall have the meaning specified in Sections 3(a)(9) and 13(d)(3) of the Exchange Act. (c) In the event PCBG is entitled to and wishes to exercise the Warrants, it shall send to BOH a written notice (the date of which being herein referred to as the "Notice Date") specifying (i) the total number of shares it will purchase pursuant to such exercise and (ii) a place and date not earlier than three Business Days nor later than 60 Business Days from the Notice Date for the closing of such purchase (the "Closing Date"); provided that if prior notification to or approval of the Federal Reserve Board or any other regulatory agency is required in connection with such purchase, PCBG shall promptly file the required notice or application for approval, shall promptly notify BOH of such filing, and shall expeditiously process the same and the period of time that otherwise would run pursuant to this sentence shall run instead from the date on which any required notification periods have expired or been terminated or such approvals have been obtained and any requisite waiting period or periods shall have passed. (d) At the closing referred to in subsection (c), PCBG shall pay to BOH the aggregate purchase price for the shares of Common Stock purchased pursuant to the exercise of the Warrants in immediately available funds by wire transfer to a bank account designated by BOH, provided that failure or refusal of BOH to designate such a bank account shall not preclude PCBG from exercising the Warrants. (e) At such closing, simultaneously with the delivery of immediately available funds as provided in subsection (d), BOH shall deliver to PCBG a certificate or certificates representing the number of shares of Common Stock purchased by PCBG. (f) Upon the giving by PCBG to BOH of the written notice of exercise of the Warrants provided for under subsection (c) and the tender of the applicable purchase price in immediately available funds, PCBG shall be deemed to be the holder of record of the shares of Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of BOH shall then be closed or that certificates representing such shares of Common Stock shall not then be actually delivered to PCBG. BOH shall pay all expenses, and any and all federal, state and local taxes or other charges that may be payable in connection with the preparation, issue and delivery of stock certificates hereunder in the name of PCBG. Section 1.4 ADDITIONAL WARRANTS; ADJUSTMENTS TO WARRANT PRICE AND NUMBER OF SHARES. The number of shares to which the Warrants may be exercised and the Warrant Price shall be subject to adjustment as provided below: (a) ADDITIONAL WARRANTS. If BOH shall, on one or more occasions after the date hereof, issue additional shares of Common Stock, and if, as a result of any such 3 issuance the shares of Common Stock issued or issuable upon the exercise of Warrants issued pursuant to Section 1.1 hereof shall represent less than 19.9% of the outstanding Common Stock, assuming the exercise of all Warrants and all other options, warrants or other securities convertible into Common Stock, BOH shall issue to PCBG, promptly upon PCBG's demand, without further consideration, Warrants to purchase a number of authorized but unissued shares of Common Stock which, when added to the shares issued or issuable upon the exercise of such previously issued Warrants, would represent 19.9% as the case may be of the outstanding Common Stock. (b) ADJUSTMENT FOR STOCK SPLITS AND COMBINATIONS. If BOH at any time or from time to time after the date of this Agreement effects a subdivision of the Common Stock, the Warrant Price then in effect immediately before that subdivision shall be proportionately decreased, and conversely, if BOH at any time or from time to time after the date of this Agreement combines the outstanding shares of Common Stock, the Warrant Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this subsection (b) shall become effective at the close of business on the date the subdivision or combination becomes effective. (c) ADJUSTMENT FOR CERTAIN DIVIDENDS AND DISTRIBUTIONS. In the event BOH at any time or from time to time after the date of this Agreement makes, or fixes a record date for the determination of holders of Common Stock entitled to receive a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Warrant Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date is fixed, as of the close of business on such record date, by multiplying the Warrant Price then in effect by a fraction (i) the numerator of which is the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, and (ii) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, that if such record date is fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Warrant Price shall be recomputed accordingly as of the close of business on such record date and thereafter the Warrant Price shall be adjusted pursuant to this subsection (c) as of the time of actual payment of such dividends or distributions. (d) ADJUSTMENTS FOR OTHER DIVIDENDS AND DISTRIBUTIONS. In the event BOH at any time or from time to time after the date of this Agreement makes, or fixes a record date for the determination of holders of Common Stock entitled to receive a dividend or other distribution payable in securities of BOH other than shares of Common Stock, then in each such event provision shall be made so that the holders of Warrants shall receive upon exercise thereof, in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of BOH which they would have received had their Warrants been converted into Common Stock on the date of such event and had they thereafter, during the period from the date of such event to and including the date of 4 exercise of the Warrants, retained such securities receivable by them as aforesaid during such period, subject to all other adjustments called for during such period under this Section 1.4. (e) ADJUSTMENT FOR RECLASSIFICATION, EXCHANGE AND SUBSTITUTION. If the Common Stock issuable upon the exercise of the Warrants is changed into the same or a different number of shares of any class or classes of stock, whether by recapitalization, reclassification or otherwise (other than a subdivision or combination of shares or stock dividend or a reorganization, merger, consolidation or sale of assets provided for elsewhere in this Section 1.4), then and in any such event each holder of Warrants shall have the right thereafter to receive upon exercise of the Warrants the kind and amount of stock and other securities and property receivable upon such reorganization, reclassification or other change by holders of the number of shares of Common Stock into which such Warrants might have been exercised immediately prior to such reorganization, reclassification or change, all subject to further adjustment as provided in this Section 1.4. (f) REORGANIZATION, MERGERS, CONSOLIDATIONS AND SALES OF ASSETS. If at any time or from time to time there is a capital reorganization of the Common Stock (other than a recapitalization, subdivision, combination, reclassification or exchange of shares provided for elsewhere in this Section 1.4), or a merger or consolidation of BOH with or into another corporation, or the sale of all or substantially all of BOH's properties and assets to any other person, then, as a part of such reorganization, merger, consolidation or sale, provision shall be made so that the holders of the Warrants shall thereafter be entitled to receive upon exercise of the Warrants the number of shares of stock or other securities or property of BOH, or of the successor corporation resulting from such merger or consolidation or sale, to which a holder of Common Stock deliverable upon exercise of the Warrants would have been entitled in such capital reorganization, merger, consolidation or sale. In any such case, appropriate adjustment shall be made in the application of the provisions of this Section 1.4 and the other terms and conditions with respect to the rights of the holders of the Warrants after the reorganization, merger, consolidation or sale to the end that the provisions of this Agreement, including this Section 1.4 (including adjustment of the Warrant Price then in effect and number of shares purchasable upon exercise of the Warrants) shall be applicable after that event and be as nearly equivalent to the provisions hereof as may be practicable. (g) SALE OF SHARES BELOW WARRANT PRICE. (i) If at any time or from time to time after the date of this Agreement, BOH issues or sells, or is deemed by the express provisions of this subsection (g) to have issued or sold, Additional Shares of Common Stock (as hereinafter defined), other than as a dividend or other distribution on any class of stock as provided in subsection (c) above and other than upon a subdivision or combination of shares of Common Stock as provided in subsection (b) above, for an Effective Price (as hereinafter defined) less 5 than the Warrant Price (or, if an adjusted Warrant Price shall be in effect by reason of a previous adjustment, then less than such adjusted Warrant Price) then and in each such case the then existing Warrant Price shall be reduced, as of the opening of business on the date of such issuance or sale, to a price determined by multiplying that Warrant Price by a fraction (i) the numerator of which shall be (A) the number of shares of Common Stock Deemed Outstanding at the close of business on the day next preceding the date of such issue or sale plus (B) the number of shares of Common Stock which the aggregate consideration received (or by express provision hereof deemed to have been received) by BOH for the total number of Additional Shares of Common Stock so issued would purchase at such Warrant Price, and (ii) the denominator of which shall be the number of shares of Common Stock Deemed Outstanding at the close of business on the date of such issuance after giving effect to such issuance of Additional Shares of Common Stock. For purposes of this paragraph (i), "Common Stock Deemed Outstanding" at any given time shall mean the sum of (1) the number of shares of Common Stock actually outstanding at that time, (2) the number of Additional Shares of Common Stock then deemed to have been issued under paragraphs (iii) or (iv) of this subsection (g) and (3) the number of shares of Common Stock then issuable upon exercise of stock options to the extent not already deemed to have been issued under paragraphs (iii) or (iv) of this subsection (g). (ii) For the purpose of making any adjustment required under this subsection (g), the consideration received by BOH for any issuance or sale of securities shall (i) to the extent it consists of cash be computed at the net amount of cash received by BOH after deduction of any expenses payable by BOH and any underwriting or similar commissions, compensation or concessions paid or allowed by BOH in connection with such issue or sale, (ii) to the extent it consists of property other than cash, be computed at the fair value of that property as determined in good faith by the Board and (iii) if Additional Shares of Common Stock, Convertible Securities (as hereinafter defined) or rights or options to purchase either Additional Shares of Common Stock or Convertible Securities are issued or sold together with other stock or securities or other assets of BOH for a consideration which covers both, be computed as the portion of the consideration so received that may be reasonably determined in good faith by the Board to be allocable to such Additional Shares of Common Stock, Convertible Securities or rights or options. (iii) For the purpose of the adjustment required under this subsection (g), if at any time or from time to time after the date of this Agreement BOH issues or sells any rights or options for the purchase of, or stock or other securities convertible into, Additional Shares of Common Stock (such convertible stock or securities being hereinafter referred to as "Convertible Securities"), then in each case BOH shall be deemed to have issued at the time of the issuance of such rights or options or Convertible Securities the maximum number of Additional Shares of Common Stock issuable upon exercise or conversion thereof and to have received as consideration for the issuance of such shares an amount equal to the total amount of the consideration, if any, received by BOH for the issuance of such rights or options or Convertible 6 Securities plus, in the case of such options or rights, the amounts of consideration, if any, payable to BOH upon the exercise of such options or rights and, in the case of Convertible Securities, the amounts of consideration, if any, payable to BOH upon conversion (other than by cancellation of liabilities or obligations evidenced by such Convertible Securities). No further adjustment of the Warrant Price, adjusted upon the issuance of such rights, options or Convertible Securities, shall be made as a result of the actual issuance of Additional Shares of Common Stock on the exercise of any such rights or options or the conversion of any such Convertible Securities. If any such rights or options or the conversion privilege represented by any such Convertible Securities shall expire or be canceled without having been exercised, the Warrant Price adjusted upon the issuance of such options, rights or Convertible Securities shall be readjusted to the Warrant Price which would have been in effect had an adjustment been made on the basis that the only Additional Shares of Common Stock so issued were the Additional Shares of Common Stock, if any, actually issued or sold on the exercise of such rights or optionsor rights of conversion of such Convertible Securities, and such Additional Shares of Common Stock, if any, were issued or sold for the consideration actually received by BOH upon such exercise, plus the consideration, if any, actually received by BOH for the granting of all such rights or options, whether or not exercised, plus the consideration received for issuing or selling the Convertible Securities actually converted plus the consideration, if any, actually received by BOH (other than by cancellation of liabilities or obligations evidenced by such Convertible Securities) on the conversion of such Convertible Securities. (iv) For the purpose of the adjustment required under this subsection (g), if at any time or from time to time after the date of this Agreement BOH issues or sells any rights or options for the purchase of Convertible Securities, then in each such case BOH shall be deemed to have issued at the time of the issuance of such rights or options the maximum number of Additional Shares of Common Stock issuable upon conversion of the total amount of Convertible Securities covered by such rights or options and to have received as consideration for the issuance of such Additional Shares of Common Stock an amount equal to the amount of consideration, if any, received by BOH for the issuance of such rights or options, plus the minimum amounts of consideration, if any, payable to BOH upon the exercise of such rights or options and plus the minimum amount of consideration, if any, payable to BOH (other than by cancellation of liabilities or obligations evidenced by such Convertible Securities) upon the conversion of such Convertible Securities. No further adjustment of the Warrant Price, adjusted upon the issuance of such rights or options, shall be made as a result of the actual issuance of the Convertible Securities upon the exercise of such rights or options or upon the actual issuance of Additional Shares of Common Stock upon the conversion of such Convertible Securities. The provisions of paragraph (iii) above for the readjustment of the Warrant Price upon the expiration of rights or options or the rights of conversion of Convertible Securities shall apply in like manner to the rights, options and Convertible Securities referred to in this paragraph (iv). 7 (v) "Additional Shares of Common Stock" shall mean all shares of Common Stock issued by BOH after the date of this Agreement whether or not subsequently reacquired or retired by BOH, other than (i) shares of Common Stock issued upon exercise of the Warrants and (ii) shares issued by way of dividend or other distribution on shares of Common Stock excluded from the definition of Additional Shares of Common Stock by the foregoing clause or shares of Common Stock resulting from any subdivision or combination of shares of Common Stock so excluded, or shares issued by way of dividend or other distribution on, or resulting from any subdivision or combination of, shares of Common stock excluded from the definition of "Additional Shares of Common Stock" by the foregoing provision. The "Effective Price" of Additional Shares of Common Stock shall mean the quotient determined by dividing the total number of Additional Shares of Common Stock issued or sold, or deemed to have been issued or sold by BOH under this subsection (g), into the aggregate consideration received or deemed to have been received by BOH for such issue under this subsection (i). ARTICLE II REPURCHASE OF WARRANTS AND LIMITATIONS ON SALE Section 2.1 REPURCHASE OF WARRANTS. (a) Prior to the occurrence of an Acquisition Event, BOH shall have no right to repurchase the Warrants and PCBG shall have no right to require BOH to repurchase the Warrants. (b) At any time after the occurrence of an Acquisition Event, BOH shall have the right to purchase (or to cause a person designated by BOH to purchase), and PCBG shall have the right to require that BOH repurchase (or, if BOH shall so elect, cause a person designated by BOH to purchase), (i) all (but not fewer than all) the Warrants at the time beneficially owned by PCBG and its Affiliates at the Warrant Call Price in effect for such Warrants on the date of closing (as provided below) and (ii) all (but not fewer than all) of the shares of Common Stock purchased by PCBG and its Affiliates pursuant to this Agreement with respect to which PCBG has beneficial ownership at a price equal to the aggregate Market Value for such shares as of the date of closing (as provided below). Any purchase pursuant hereto shall take place on a Business Day specified in a notice given by BOH to PCBG or by PCBG to BOH, as the case may be (but in no event prior to the 30th day following the date of any such notice to PCBG or later than the 30th day following the date of any such notice to BOH). (c) The closing of any repurchase of Warrants pursuant to this Section 2.1 shall take place at 10:00 a.m. Laguna Hills Time, on the date set forth in the applicable notice given by BOH or PCBG, as the case may be, at the office of PCBG at the address set forth in Section 8.1. The amount payable to PCBG and its Affiliates upon any repurchase of Warrants shall be paid in lawful money of the United States by a federal funds check or a wire transfer of immediately available funds to an account designated 8 by PCBG. Upon receipt of such payment, PCBG shall deliver or cause to be delivered to BOH the certificates representing all the Warrants being repurchased free and clear of any liens, security interests, charges or encumbrances. Section 2.2 CERTAIN DETERMINATIONS OF MARKET VALUE. The calculation of the Market Value, as required herein, shall be calculated in accordance with this Section 2.2. In the event that Market Value is to be determined pursuant to the terms hereof and there is not an established trading market for shares of Common Stock, or more than 50% of the outstanding shares of Common Stock are held beneficially or of record by persons, each of whom owns (individually or together with members of any group of which such persons are members) 5% or more of the outstanding shares of Common Stock, then PCBG may elect to have an investment banking firm mutually agreeable to BOH and PCBG determine (i) whether, in the opinion of such investment banking firm, as a result of the absence of an established trading market or the concentration of stock holdings, Market Value (determined in accordance with the provisions of the definition of Market Value in Article VI) does not accurately reflect the fair market value of a block of 1,000 shares of Common Stock on the date as of which Market Value is to be determined, and (ii) if such investment banking firm determines that Market Value (as so determined) does not accurately reflect such fair market value, such investment banking firm shall make determination of the fair market value of a share of Common Stock on the date as of which Market Value is to be determined, based on whatever factors it deems relevant, as soon as possible and shall promptly give written notice to PCBG and BOH of its determination. The fees of such investment banking firm in connection with such determination shall be paid by PCBG. Such determination shall be final and binding on the parties hereto and the fair market value so determined shall, if higher than the Market Value that would otherwise apply, be the Market Value of a share of Common Stock. In the event such determination is not transmitted to PCBG and BOH prior to the scheduled closing date with respect to any repurchase of Warrants or Common Stock, the scheduled closing of such transaction shall not be postponed, and BOH shall make such payments on the closing date as are required based on the Market Value of a share of Common Stock determined as if PCBG had not made an election under this Section 2.4. Within three Business Days after such investment banking firm's determination is made and conveyed to PCBG and BOH in writing, BOH shall make a payment to PCBG, or PCBG shall make a payment to BOH, as the case may be, equal to the difference between the amount paid on the closing date and the amount that would have been so payable had such amount been determined on the basis of such investment banking firm's determination of the Market Value of a share of Common Stock. ARTICLE III RESTRICTIONS ON TRANSFERABILITY OF STOCK; COMPLIANCE WITH SECURITIES ACT OF 1933 Section 3.1 RESTRICTIONS ON TRANSFERABILITY. The Warrants acquired by PCBG or any Affiliate of PCBG pursuant to this Agreement and the Common Stock issuable upon 9 exercise of such Warrants and any shares of capital stock received or issued in respect thereof, including, without limitation, securities issued upon any stock split, stock dividend, recapitalization, merger, consolidation or similar event (such Warrants and all such shares of Common Stock and securities being collectively called the "Restricted Stock") shall not be hypothecated, nor shall any claim or liability exist, nor shall any agreement, written or oral, be entered into by PCBG or any Affiliate of PCBG which would cause any claim or liability to exist with respect to the Restricted Stock, and the Restricted Stock shall not be transferred except upon the conditions, to the extent applicable, specified in this Article III. PCBG will cause any proposed transferee of Restricted Stock held by PCBG or any other Affiliate of PCBG to agree to take ownership of such Restricted Stock subject to the provisions, to the extent applicable, of this Article III; provided, however, that the provisions of this Article shall cease to apply to any Restricted Stock which shall have been sold in a registered public offering in accordance with the provisions of this Article III. PCBG represents that it is purchasing the Restricted Stock for its own account and not with a view to or for sale in connection with any distribution of such Restricted Stock. Section 3.2 RESTRICTIVE LEGEND; NOTICE OF PROPOSED TRANSFERS. (a) Each certificate representing Restricted Stock shall (unless otherwise permitted by the provisions of paragraph (b) of this Section) be stamped or otherwise imprinted with a legend in substantially the following form: THESE SHARES/WARRANTS HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THESE SHARES/WARRANTS MAY NOT BE SOLD OR TRANSFERRED EXCEPT PURSUANT TO (i) A REGISTRATION STATEMENT WITH RESPECT TO SUCH SECURITIES WHICH IS EFFECTIVE UNDER SAID ACT OR (ii) AN OPINION OF COUNSEL THAT AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT IS AVAILABLE. THE TRANSFERABILITY OF THESE SHARES/ WARRANTS IS FURTHER SUBJECT TO THE PROVISIONS OF A WARRANT PURCHASE AGREEMENT DATED AS OF JULY 30, 1998, A COPY OF WHICH IS AVAILABLE FOR INSPECTION AT THE OFFICE OF THE SECRETARY OF THE BANK OF HEMET. (b) Each holder of a certificate representing Restricted Stock by acceptance thereof agrees to comply in all respects with the provisions of this Section 3.2(b). Prior to any proposed transfer of any Restricted Stock other than pursuant to a registration under the Securities Act, the holder thereof shall give written notice to BOH of such holder's intention to effect such transfer. Each such notice shall describe the manner and circumstances of the proposed transfer of the Restricted Stock to be transferred and shall be accompanied by an unqualified written opinion of counsel reasonably satisfactory to BOH to the effect that such proposed transfer may be effected without registration under the Securities Act. Subject to Section 3.11 hereof, upon delivery to BOH of such notice and such opinion of counsel, the holder of such Restricted Stock 10 shall be entitled to transfer such Restricted Stock in accordance with the terms of such notice delivered by the holder to BOH. Each certificate evidencing Restricted Stock transferred as above provided shall bear the appropriate restrictive legend set forth in paragraph (a) above, except that such certificate shall not bear such restrictive legend if the opinion of counsel referred to above shall be to the further effect that such legend is not required in order to establish compliance with any provisions of the Securities Act. Section 3.3 NO TRANSFERS PRIOR TO ACQUISITION EVENT. Notwithstanding anything to the contrary set forth in this Agreement or the Restricted Stock, neither PCBG nor any Affiliate of PCBG shall sell, transfer or otherwise dispose of all or any portion of the Warrants owned by it, other than to an Affiliate of PCBG, except after the occurrence of an Acquisition Event; provided, however, that following an Acquisition Event, if BOH or PCBG shall give notice of its election to exercise its rights under Section 2.1, then such right of PCBG and its Affiliates to sell, transfer or otherwise dispose of the Restricted Stock shall no longer be exercised unless BOH shall have defaulted in its obligation to repurchase such Restricted Stock on the date specified in any notice. Section 3.4 LIMITATIONS ON TRANSFEREES AND MANNER OF TRANSFER. (a) In the event that PCBG and its Affiliates become entitled pursuant to the provisions of Section 3.3 to sell, transfer or otherwise dispose of Restricted Stock, such Restricted Stock may be sold or transferred (subject to Section 3.11 hereof) only (i) to a third party (or a third party and its Affiliates) in a transaction which complies with the provisions of paragraph (b) of this Section or (ii) to one or more underwriters or dealers in connection with a broad public distribution complying with the provisions of paragraph (c) of this Section of the shares of Common Stock issuable pursuant to the exercise of the transferred Warrants (such shares being hereinafter referred to as the "Underlying Shares"). The provisions of this Section shall only apply to sales, transfers or dispositions by PCBG and its Affiliates, and shall not apply to sales, transfers or dispositions by transferees of PCBG or its Affiliates (except that any sale or disposition by dealers or underwriters shall be conducted in accordance with the applicable provisions of this Section and further except that all resales shall be made in accordance with the Securities Act). (b) PCBG and its Affiliates shall be entitled, subject to the other applicable provisions of this Article III (including Section 3.11) and Section 2.1, to sell or transfer Restricted Stock in one or more transactions exempt from the registration requirements of Section 5 of the Securities Act. For purposes of the immediately preceding sentence, it shall be assumed that all Warrants, if any, that already have been sold or transferred by PCBG and its Affiliates are still outstanding and have not been exercised in whole or in part to purchase shares of Common Stock. (c) Warrants owned by PCBG and its Affiliates, unless sold to BOH or an Affiliate of BOH or in compliance with paragraph (b) of this Section, may only be sold or transferred to one or more underwriters or dealers in accordance with the provisions 11 of this paragraph. PCBG and its Affiliates may, subject to the terms and conditions set forth in this paragraph (c), sell or transfer Warrants in whole or in part to one or more underwriters or dealers who agree in writing with PCBG, prior to the effective time of any such sale or transfer, to exercise such Warrants and offer and sell the Underlying Shares either (i) to the public in a public offering registered under the Securities Act (or any successor federal securities laws) pursuant to a distribution, or (ii) in other transactions complying with the requirements of paragraph (b) above. Notwithstanding any other provision of this Agreement to the contrary, the exercise of any Warrants transferred to underwriters or dealers in accordance with this Section and the acquisition by such underwriters or dealers of shares of Common Stock pursuant to such exercise may be made simultaneously on the date of the closing of the sale or transfer by PCBG or its Affiliates of the relevant Warrants to such underwriters or dealers, provided BOH is given written notice of the date of such closing at least five Business Days prior thereto. At any such closing, against payment of the exercise price for shares of Common Stock to be acquired pursuant to the exercise of Warrants, BOH will deliver or cause to be delivered certificates representing the Underlying Shares to such underwriters or dealers, in such names and denominations as it or they shall designate not fewer than two Business Days prior to such closing. Section 3.5 "DEMAND" REGISTRATION. From and after such date as PCBG and its Affiliates become entitled pursuant to Section 3.4 to sell or transfer any Restricted Stock, BOH shall, if requested by PCBG, as expeditiously as possible, use its best efforts to effect the registration of the Restricted Stock (which BOH has been requested to register on a form in general use under the Securities Act (or any successor federal securities law) selected by BOH, in order to permit the sale or other disposition of such Restricted Stock in accordance with the intended method of sale or other disposition set forth in the request (subject to the provisions of Section 3.4(c)). The right to require registration of the Restricted Stock under this Section 3.5 may only be exercised once unless PCBG is advised in writing by its investment banking firm (a copy of which advice shall be supplied to BOH) that, in the opinion of such firm, an additional or two additional registrations are appropriate to maximize the benefits to PCBG of the proposed distribution of Restricted Stock, in which event PCBG may exercise once or twice more, as applicable, its rights under this Section 3.5. Upon the issuance of a stop order or injunction, BOH may withdraw any such registration statement and abandon the proposed offering which PCBG shall have demanded, in which case PCBG's right shall be reinstated. Section 3.6 "PIGGYBACK" REGISTRATION. From and after such date as PCBG and its Affiliates become entitled pursuant to Section 3.4 to sell or transfer any Restricted Stock, if at any time BOH proposes to register any of its securities under the Securities Act (or any successor federal securities law), whether or not for sale for its own account (except with respect to registration statements filed with respect to the issuance of securities under employee benefit plans), it will give written notice to PCBG of its intention to do so. Upon the written request of PCBG, given within 15 calendar days after receipt of BOH's notice, BOH will use its best efforts to cause to be included in the 12 shares to be covered by the registration statement proposed to be filed by BOH, in accordance with the request of PCBG, the Restricted Stock to be sold by dealers or underwriters in accordance with the provisions of Section 3.4; provided, however, that BOH need not include such Restricted Stock in such registration statement if BOH is advised in writing by its investment banking firm (a copy of which advise shall be supplied to PCBG) that the inclusion of such securities shall, in the opinion of such firm, materially interfere with the orderly sale and distribution of the BOH securities being sold by it. BOH may, in its sole discretion and without the consent of PCBG, withdraw any such registration statement and abandon the proposed offering in which PCBG shall have requested to participate pursuant to this Section. Section 3.7 REGISTRATION PROCEDURES AND EXPENSES. (a) If and whenever BOH is required by the provisions of this Article III to use its best efforts to effect the registration of any of the Restricted Stock under the Securities Act (or any successor federal securities law), PCBG and its Affiliates (including the underwriters in the case of a registration of Underlying Shares) (individually referred to as a "selling holder" or "holder" and collectively referred to as "selling holders" or "holders") will furnish in writing such information as is reasonably requested by BOH for inclusion in the registration statement relating to such offering and such other information and documentation as BOH shall reasonably request, and BOH will, as expeditiously as possible: (i) prepare and file with the SEC or any other federal agency at the time administering the Securities Act (or a successor federal securities law) a registration statement with respect to such securities and use its best efforts to cause such registration statement to become and remain effective for such period as may be necessary to permit the successful marketing of such securities, but not exceeding 90 days; (ii) prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective and to comply with the provisions of the Securities Act; (iii) furnish to each selling holder of Restricted Stock being registered such number of copies of a prospectus and preliminary prospectus in conformity with the requirements of the Securities Act (or any successor federal securities law), and such other documents as such seller may reasonably request in order to facilitate the public sale or other disposition of the Restricted Stock being registered owned by such seller; (iv) furnish, at the request of any holder or holders of securities being registered pursuant to this Article III, on the date that such securities are delivered to the underwriters for sale pursuant to such registration or if such securities are not being 13 sold through underwriters, on the date the registration statement with respect to such securities becomes effective (A) an opinion dated such date of independent counsel representing BOH for the purposes of such registration, addressed to the underwriters, if any, and to the holder or holders making such request, stating that such registration statement has become effective under the Securities Act (or such successor law) and that (a) to the best of the knowledge of such counsel, no stop order suspending the effectiveness thereof has been issued and no proceedings for that purpose have been instituted or are pending or contemplated under the Securities Act (or such successor federal securities law); (b) the registration statement, the related prospectus and each amendment or supplement thereto comply as to form in all material respects with the requirements of the Securities Act (or such successor law) and the applicable rules and regulations of the SEC thereunder, except that such counsel need express no opinion as to financial information or information provided by selling holders contained therein; (c) such counsel (subject to such customary limitation on the scope of their investigation as shall be set forth in such opinion) has no reason to believe that either the registration statement or the prospectus, or any amendment or supplement thereto, contains any untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading except that such counsel need express no opinion as to financial information or information provided by selling holders contained therein; (d) the descriptions in the registration statement and in the prospectus, or any amendment or supplement thereto, of all legal and governmental matters and all contracts and other legal documents or instruments are accurate and fairly present the information required to be shown; and (e) such counsel does not know of any legal or governmental proceedings, pending or contemplated, required to be described in the registration statement or prospectus, or any amendment or supplement thereto, or to be filed as exhibits to the registration statement which are not described and filed as required; and (B) a letter dated such date, from the independent certified public accountants of BOH, addressed to the underwriters, if any, and to the holder or holders by or on behalf of whom a request is made, stating that they are independent certified public accountants within the meaning of the Securities Act (or such successor law) and that in the opinion of such accountants the financial statements and other financial data of BOH included in the registration statement or the prospectus, or any amendment or supplement thereto, comply as to form in all material respects with the applicable accounting requirements of the Securities Act (or such successor law). Such letter from the independent certified public accountants shall additionally cover such other financial matters (including information as to the period ending not more than five business days prior to the date of such letter) with respect to the registration in respect of which such letter is being given as the holder of Restricted Stock being registered may reasonably request; (v) use its best efforts to register or qualify the Restricted Stock covered by such registration statement under such other securities or blue sky laws of such jurisdictions as each such selling holder of such Restricted Stock shall reasonably request and do any and all other acts and things which may be necessary or reasonably desirable to enable such seller to consummate the public sale or other disposition in such 14 jurisdictions as may be requested by such seller; provided, however, that BOH shall have no obligation to qualify to do business in any jurisdiction or to file a general consent to service of process in any jurisdiction; (vi) notify each selling holder of Restricted Stock covered by such registration statement, at any time when a prospectus relating thereto is required to be delivered under the Securities Act (or any successor Federal securities law), of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing; (vii) otherwise use its best efforts to comply with all applicable rules and regulations of the SEC, and make available to its security holders, as soon as reasonably practicable, an earnings statement covering the period of at least twelve months, but not more than eighteen months, beginning with the first full calendar month after the effective date of such registration statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act; (viii) provide a transfer agent and registrar for all Restricted Stock covered by such registration statement not later than the effective date of such registration statement; (ix) use its best efforts to list all Common Stock covered by such registration statement on each securities exchange, if any, on which any of the Common Stock is then listed (unless such Common Stock is already so listed) if such listing is then permitted under the rules of such exchange or with the NASDAQ, National Market System; and (x) undertake to take such further actions as may be reasonably requested by the underwriters. (b) If any registration statement pursuant to Section 3.5 or 3.6 shall have been declared effective and, in the judgment of BOH, (A) any event shall occur or state of facts exist (other than as described in clause (B)) which requires a notice to the selling holders of Restricted Stock pursuant to clause (vi) of paragraph (a) of this Section 3.7 or (B) the offering at the time of Restricted Stock pursuant to such registration statement would adversely affect, or would be improper in view of, a public offering, financing, reorganization, recapitalization, merger, consolidation, acquisition, or other similar transaction, or negotiations, discussions or pending proposals with respect thereto, immediately upon receipt of notice to such effect from BOH, PCBG shall cease to offer or sell any Restricted Stock registered thereunder and cease to deliver or use the prospectus in use thereunder. In the case of any matter described in clause (A), BOH shall, as promptly as practicable, furnish to each selling holder a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary 15 so that, as thereafter delivered to the purchaser of such securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. In the case of any matter described in clause (B), BOH shall promptly notify PCBG at such times as, in BOH's judgment, such offering may be recommended (which shall be no later than 90 days following such suspension); provided that PCBG may, in its sole discretion, discontinue such offering with respect to the Restricted Stock covered thereby, in which event PCBG shall be entitled to "demand" registration rights hereunder to the full extent as if such offering had not been requested. All expenses incurred by BOH in complying with Sections 3.5 and 3.6 hereof, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel for BOH, the expense of any special audits incident to or required by such registration, and blue sky fees and expenses are herein called "Registration Expenses," except for all underwriting discounts and selling commissions applicable to the sales, all fees and disbursements of counsel for any selling holder or holders (including counsel designated by any seller for a "due diligence" investigation of BOH), all of which are herein called "Selling Expenses." BOH shall pay all Registration Expenses and the selling holder or holders of Restricted Stock being registered shall pay all Selling Expenses. Section 3.8 INDEMNIFICATION. In the event of a registration of any of the Restricted Stock under the Securities Act (or any successor Federal securities law) pursuant to this Article III, BOH will indemnify and hold harmless each underwriter of such Restricted Stock, PCBG and its Affiliates as the transferors of the Restricted Stock or any portion thereof to underwriters, and each other person, if any, who controls such seller, assignor or underwriter within the meaning of Section 15 of the Securities Act, against any losses, claims, damages or liabilities, joint or several, to which such seller, underwriter, assignor or controlling person may become subject under the Securities Act (or such successor law) or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of any material fact contained in any registration statement under which such Restricted Stock shall have been registered under the Securities Act (or such successor law), any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; and will reimburse such seller, transferor and underwriter and each such controlling person for any legal or any other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that BOH will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in such registration statement, said preliminary prospectus or said prospectus or said amendment or supplement in 16 reliance upon and in conformity with written information furnished to BOH through an instrument execute by such seller, transferor or underwriter specifically for use in the preparation thereof; and provided further that if any losses, claims, damages or liabilities arise out of or are based upon an untrue statement, alleged untrue statement, omission or alleged omission contained in any preliminary prospectus which did not appear in the final prospectus, BOH shall not have any such liability with respect thereto to such seller, transferor or underwriter or any person who controls such seller, transferor or underwriter within the meaning of Section 15 of the Securities Act if such seller, transferor or underwriter or any person on their behalf delivered a copy of the preliminary prospectus to the person alleging such losses, claims, damages or liabilities and failed to deliver a copy of the final prospectus, as amended or supplemented if it has been amended or supplemented, to such person at or prior to the written confirmation of the sale to such person. In the event of any registration of any Restricted Stock under the Securities Act (or a successor Federal securities law) pursuant to this Article III, each seller of such Restricted Stock (other than any underwriter or dealer purchasing Underlying Shares), and PCBG and its Affiliates, as transferors of Restricted Stock, severally and not jointly, will indemnify and hold harmless BOH, each person, if any who controls BOH within the meaning of Section 15 of the Securities Act, each officer of BOH who signs the registration statement and each director of BOH against any and all such losses, claims, damages, or liabilities arising out of or based upon any untrue statement or alleged untrue statement in or omission or alleged omission from any such registration statement, prospectus, amendment or supplement, if the untrue statement or omission or alleged untrue statement or omission in respect of which such loss, claim, damage or liability is asserted was made in reliance upon and in conformity with information furnished in writing to BOH by or on behalf of such seller or transferor specifically for use in connection with the preparation of such registration statement, preliminary prospectus, prospectus, amendment or supplement; provided, however, that, if any losses, claims, damages or liabilities arise out of or are based upon an untrue statement, alleged untrue statement, omission or alleged omission contained in any preliminary prospectus which did not appear in the final prospectus, such seller or transferor shall not have any such liability with respect thereto to BOH, any person who controls BOH within the meaning of Section 15 of the Securities Act, any officer of BOH who signed the registration statement or any director of BOH if BOH or any person on their behalf delivered a copy of the preliminary prospectus to the person alleging such losses, claims, damages or liabilities and failed to deliver a copy of the final prospectus, as amended or supplemented if it has been amended or supplemented, to such person at or prior to the written confirmation of the sale to such person; and provided further that the liability of any such seller or transferor so to indemnify shall be limited to an amount equal to the net profit received by such seller upon the sale of such Restricted Stock, or if the Warrant is sold, the profit on the sale of the Warrant, pursuant to such registration statement, or by such transferor from the seller, as the case may be. 17 Payments in respect of indemnifications required by this Section 3.8 shall be made by periodic payments during the course of the investigation or defense, as and when bills are received or expenses incurred. Any party which proposes to assert the right to be indemnified under this Section 3.8 will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against an indemnifying party under this Section 3.8, notify each such indemnifying party of the commencement of such action, suit or proceeding, enclosing a copy of all papers served, but the omission so to notify such indemnifying party of any such action, suit or proceeding shall not relieve it from any liability which it may have to any indemnified party otherwise than under this Section 3.8. In case any such action, suit or proceeding shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate in, and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party, and after notice from such indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party for any legal or other expenses, other than reasonable costs of investigation, subsequently incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its own counsel in any such action, but the fees and expenses of such counsel shall be at the expense of such indemnified party, when and as incurred, unless (i) the employment of counsel by such indemnified party has been authorized in writing by the indemnifying party, (ii) the indemnified party shall have reasonably concluded that there may be a conflict of interest beteen the indemnifying party and the indemnified party in the conduct of the defense of such action (in which case the indemnifying party shall not have the right to direct the defense of such action on behalf of the indemnified party) or (iii) the indemnifying party shall not in fact have employed counsel to assume the defense of such action. An indemnifying party shall not be liable for employed counsel to assume the defense of such action. An indemnifying party shall not be liable for any settlement of any action or claim effected without its consent. In no event shall an indemnifying party be required to pay for more than one counsel for an indemnified party, exclusive of local counsel. Section 3.9 OBLIGATIONS OF BOH WITH RESPECT TO UNDERWRITTEN OFFERING. In the event that Restricted Stock shall be sold pursuant to a registration statement in an underwritten offering pursuant to Section 3.5, BOH agrees to enter into an underwriting agreement containing customary representations and warranties with respect to the business and operations of an issuer of the securities being registered and customary covenants and agreements to be performed by such issuer, including, without limiting the generality of the foregoing, customary provisions with respect to indemnification by BOH of the underwriters of such offering. BOH shall have the right to approve the managing underwriters for such offering (which in no event shall include an affiliate of PCBG); provided, however, that such approval shall not be unreasonably withheld. 18 Section 3.10 RULE 144 REQUIREMENTS. BOH shall undertake to make publicly available and available to the holders of Restricted Stock, pursuant to Rule 144 of the SEC under the Securities Act, such information as shall be necessary, and to take such further action as any such holder may reasonably request, to enable the holders of Restricted Stock to make sales of Restricted Stock pursuant to the Rule. BOH shall furnish to any holder of Restricted Stock upon request (after the preceding sentences shall have become applicable), a written statement executed by BOH as to the steps it has taken to comply with the current public information requirements of Rule 144. Section 3.11 RIGHTS OF FIRST REFUSAL. a) In the event PCBG or its Affiliates intend, at any time after the occurrence of an Acquisition Event to sell, transfer or dispose of any Restricted Stock (other than to an Affiliate of PCBG in a transaction not intended to circumvent the transfer restrictions contained in this Agreement) other than (i) pursuant to a sale or transfer of Warrants to one or more underwriters or dealers in accordance with Section 3.4(c) (in which case Section 3.11(b) shall govern) or (ii) at any time after BOH has failed for any reason to repurchase such Restricted Stock pursuant to Article II hereof on the closing date scheduled for such repurchase, then: (i) PCBG shall notify BOH in writing of its or its Affiliate's intention to sell, transfer or dispose of such Restricted Stock specifying the number of shares or amount of Warrants, as the case may be, proposed to be disposed of, the identity or identities of the prospective purchaser or purchasers thereof, the proposed purchase price therefor and the material terms of any agreement relating thereto (the "Sale Notice"); and (ii) BOH shall have the right, by written notice of its exercise of its right of first refusal given to PCBG within 15 calendar days after BOH's receipt of such notice of intention from PCBG, to purchase (or to cause a Person designated by BOH to purchase) all, but not less than all of, the Restricted Stock specified in such notice of intention for cash at the gross price set forth therein (including broker's commissions and other transaction costs of PCBG or its Affiliate to be paid or absorbed by the prospective purchaser) if the terms set forth in such notice of intention provide for a cash sale. If the purchase price specified in such notice of intention include any property other than cash, the purchase price at which BOH shall be entitled to purchase shall be (x) the amount of cash included in the purchase price specified in such notice of intention plus (y) property, to the extent feasible, substantially similar to the property described in such notice of intention and in any case of equivalent value to such property (as agreed to by BOH and PCBG, or as determined by a nationally recognized investment banking firm selected by PCBG and BOH). If BOH shall have exercised its right of first refusal under this paragraph (a) (including the designation of another purchaser as referred to in the next subparagraph), the closing of the purchase of the Restricted Stock as to which such right BOH shall 19 have been exercised shall take place as promptly as practicable, but in no event more than 10 Business Days after BOH gives notice of such exercise, and if such closing does not occur within such 10 days, such right of first refusal provided for herein (including any assignment thereof) shall be null and void and of no further force and effect with respect to such Restricted Stock and this Section 3.11 shall no longer apply to any sale or disposition or proposed sale or disposition of such Restricted Stock; provided that if prior notification to or approval of the Federal Reserve Board or any other regulatory authority is required in connection with such purchase, BOH shall promptly file the required notice or application for approval and shall expeditiously process the same and the period of time that otherwise would run pursuant to this sentence shall run instead from the date on which, as the case may be, (i) any required notification period has expired or been terminated, or (ii) such approval has been obtained and, in either event, any requisite waiting period shall have passed. If BOH elects not to exercise, or fails to exercise or cause to be exercised, its right of first refusal provided in this paragraph (a) within the time specified for such exercise or if the Federal Reserve Board or any other regulatory authority disapproves of BOH's proposed purchase, PCBG and its Affiliates shall be free thereafter for a period of 90 days to consummate the sale, transfer or other disposition with any purchaser or purchasers of the Restricted Stock who shall have been specified in the sale notice at the price (or at any price in excess of such price) and on substantially the terms specified therein. The right of first refusal provided for in this paragraph (a) may only be exercised with respect to the initial sale, transfer or other disposition of the Restricted Stock by PCBG or an Affiliate (whether in blocks or as a whole) to a person that is not an Affiliate of PCBG and not to subsequent sales, transfers or other dispositions by purchasers of Restricted Stock. (b) If PCBG or its Affiliates at any time propose to transfer any Warrants to any underwriters or dealers pursuant to the provisions of Section 3.4, other than at any time after BOH has failed for any reason to repurchase such Warrants pursuant to Article II hereof on the closing date scheduled for such repurchase, then PCBG shall first notify BOH in writing of such intention, specifying the Warrants which it proposes to sell or transfer and the name or names of the proposed dealers or of the proposed managing underwriters in the underwriting syndicate to which the sale or transfer is proposed to be made. BOH shall have the right, exercisable by written notice given to PCBG 15 calendar days after BOH's receipt of notice from PCBG pursuant to the immediately preceding sentence, to repurchase, or to cause a third party designated by BOH to purchase, all, but not fewer than all, the Warrants proposed to be sold or transferred on the terms and conditions hereinafter set forth. Any notice given by BOH of exercise of its repurchase rights under this paragraph (b) shall specify a place in Orange or Riverside Counties and a Business Day not earlier than 10 days and not later than 15 days after the date of such notice for the closing of the repurchase of the Warrants being repurchased. The purchase price payable to BOH or its designee for the repurchase of 20 Warrants pursuant to this paragraph (b) shall be a cash price equal to the product of (x) the number of Underlying Shares covered by the relevant Warrants (calculated as of the date of the closing of the repurchase) and (y) the Share Price on such date. At the closing of a sale of Warrants pursuant to the foregoing provisions, BOH or its designee will make payment to PCBG of the aggregate price for the Warrants to be repurchased in one of the manners set forth in Section 2.1(c). At such closing, PCBG shall deliver to BOH or its designee the certificates representing the Warrants to be repurchased and BOH shall deliver to PCBG replacement certificates representing the Warrans (if any) which are not to be repurchased but were covered by the certificate or certificates surrendered by PCBG. Any election by BOH pursuant to this paragraph to exercise its repurchase rights in respect of Warrants shall be irrevocable. In the event BOH fails timely to exercise its repurchase rights in respect of Warrants within the period specified above during which it must do so or notifies PCBG in writing prior to the expiration of such period that it does not intend to exercise such rights or its designee fails to repurchase Warrants on the date set for the closing of such a purchase, PCBG and its Affiliates shall be free thereafter to consummate the sale and transfer of the Warrants specified in this notice to BOH under this paragraph to any underwriters or dealers who agree to exercise the Warrants and sell the Underlying Shares in accordance with the provisions of Section 3.4(c), and this Section 3.11 shall no longer apply to such sale or transfer of such Warrants. (c) PCBG shall have the right to withdraw any notice given by it pursuant to this Section 3.11 at any time before BOH shall have given notice of its intention to exercise its right of first refusal hereunder (including by designation of another purchaser). ARTICLE IV REPRESENTATIONS AND WARRANTIES OF BOH BOH represents and warrants to PCBG that: Section 4.1 AUTHORIZATION OF AGREEMENT; NO CONFLICTS. (a) The execution and delivery of this Agreement by BOH and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of BOH. This Agreement has been duly executed and delivered by BOH and constitutes a valid and binding obligation of BOH, enforceable in accordance with its terms. (b) The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result in any violation of or default or loss of a material benefit under any provision of the articles of incorporation, articles or association or bylaws of BOH or, except for the necessity of obtaining Requisite Regulatory Approvals, any material mortgage, indenture, lease agreement or other material instrument or any permit, concession, grant, franchise, license, judgment, 21 order, decree, statute, law, ordinance, rule or regulation applicable to BOH or their respective properties, other than any such conflict, violation, default or loss which will not have a material adverse effect on BOH. No material consent, approval, order or authorization of, or registration, declaration or filing with, any governmental authority is required in connection with the execution and delivery of this Agreement by BOH or the consummation by BOH of the transactions contemplated hereby except for any approvals required to be obtained pursuant to the BHC Act or the Policy Statement of the Board of Governors of the Federal Reserve System on Nonvoting Equity Investments by Bank Holding Companies, 12 C.F.R. Section 225.143 (the "FRB Guidelines"), or any other applicable laws, for the execution and delivery of this Agreement and the issuance of the Warrants by BOH. Section 4.2 AUTHORIZED STOCK. BOH has taken all necessary corporate and other action to authorize and reserve and, subject to obtaining the governmental and other approvals and consents referred to herein, to permit it to issue, and, at all times from the date hereof until the obligation to deliver Common Stock upon the exercise of the Warrants terminates, will have reserved for issuance, upon exercise of the Warrants, shares of Common Stock necessary for PCBG to exercise the Warrants, and BOH will take all necessary corporate action to authorize and reserve for issuance all additional shares of Common Stock or other securities which may be issued pursuant to this Agreement. The shares of Common Stock to be issued upon due exercise of the Warrants, including all additional shares of Common Stock or other securities which may be issuable pursuant to this Agreement, upon issuance pursuant hereto, shall be duly and validly issued, fully paid and nonassessable, and shall be delivered free and clear of all liens, claims, charges and encumbrances of any kind or nature whatsoever, including any preemptive rights of any stockholder of BOH. ARTICLE V REPRESENTATIONS AND WARRANTIES OF PCBG PCBG represents and warrants to BOH that: Section 5.1 DUE EXECUTION OF AGREEMENT; NO CONFLICTS. (a) This Agreement has been duly executed and delivered by PCBG and constitutes a valid and binding obligation of PCBG, enforceable in accordance with its terms. (b) The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result in any violation of or default or loss of a material benefit under, any provision of the certificate of incorporation or By-laws of PCBG or, except for the necessity of obtaining Requisite Regulatory Approvals, any material mortgage, indenture, lease, agreement or other material instrument, or any permit, concession, grant, franchise, license, judgment, order 22 decree, statute, law, ordinance, rule or regulation applicable to PCBG or its respective properties, other than any such conflict, violation, default or loss which (i) will not have a material adverse effect on PCBG and its Subsidiaries taken as a whole. No material consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity is required in connection with the execution and delivery of this Agreement by PCBG or the consummation by PCBG of the transactions contemplated hereby, except for (a) filings required in order to obtain Requisite Regulatory Approvals, and (b) any approvals required to be obtained pursuant to the BHC Act, or the FRB Guidelines or any other applicable law for the execution and delivery of this Agreement by BOH, PCBG and the issuance of the Warrants. ARTICLE VI DEFINITIONS Except as otherwise provided herein, the capitalized terms set forth below (in their singular and plural forms as applicable) shall have the meanings set forth below. "Affiliate" or "affiliate" shall mean, with respect to any corporation, any person that, directly or indirectly, controls or is controlled by or is under common control with such corporation. "BHC Act" means the Bank Holding Company Act of 1956, as amended. "Business Day" shall mean any day, other than a Saturday, Sunday or legal holiday in the State of California, on which banks are open for substantially all their banking business in Laguna Hills, California.. "Change in Bank Control Act" means the Change in Bank Control Act of 1978, as amended. "Covered Shares" shall mean on any date, with respect to any Warrants, the maximum number of shares of Common Stock that would be purchasable upon the exercise on such date of such Warrants, assuming that such Warrants may be exercised on such date to purchase the maximum number of shares of Common Stock purchasable pursuant to the terms thereof (including the limitations contained in the second paragraph of the certificate evidencing each such Warrant) without regard to any provision therein (other than such limitations) or in this Agreement or in any law limiting the right of any holder of such Warrants to acquire shares otherwise purchasable thereunder. "Federal Reserve Board" means the Board of Governors of the Federal Reserve System. "Governmental Entity" shall mean any court, administrative agency or commission or other governmental authority or instrumentality. 23 "Market Value" shall mean, on any date, the average of the closing sale prices of a share of Common Stock on the principal securities exchange on which the Common Stock is traded, or, if the Common Stock is not at the time listed on any national securities exchange, as reported by the National Association of Securities Dealers Automated Quotation System ("NASDAQ"), on the 20 trading days immediately preceding the three trading days immediately preceding such date, (or such fewer number of trading days immediately preceding such date for which shares of Common Stock have been listed for trading on such exchange or quoted on NASDAQ); provided, however, that if PCBG seeks a determination of the fair market value of a share of Common Stock pursuant to the provisions of Section 2.2, Market Value shall, if required pursuant to the terms of such Section, mean the fair market value of a share of Common Stock on such date determined pursuant to such Section. "Person" or "person" shall mean an individual, corporation, partnership, joint venture, trust or unincorporated organization, or a government or any agency or political subdivision thereof. "Regulatory Authority" shall mean any United States federal or state government or governmental authority the approval of which is legally required for consummation of the Merger. "Requisite Regulatory Approvals" shall mean all material permits, approvals and consents required to be obtained, and all waiting periods required to expire, prior to the consummation of the issuance of the Covered Shares under applicable federal laws of the United States or applicable laws of any state having jurisdiction over PCBG or BOH. "SEC" shall mean the Securities and Exchange Commission. "Securities Act" shall mean the Securities Act of 1933, as amended. "Share Price" shall mean, with respect to any Warrants, the amount by which, on the date of the Acquisition Event triggering the exercisability of the Warrants(i) the Warrant Price on such date is less than (ii) the greatest of: (i) the Market Value of a share of Common Stock on such date; and (ii) the highest price paid on or prior to such date for a share of Common Stock (including in any merger or consolidation) by a purchaser or group of purchasers acting in concert of 50% or more of the outstanding shares of Common Stock, or, in the case of a purchaser of 50% or more of the consolidated assets of BOH (as shown on the books of BOH), the Market Value of a share of Common Stock on the date of consummation of such asset acquisition. 24 "Subsidiary" shall mean, with respect to any corporation (the "parent"), any other corporation, association or other business entity of which more than 50% of the shares of the Voting Stock are owned or controlled, directly or indirectly, by the parent or by one or more Subsidiaries of the parent, or by the parent and one or more of its Subsidiaries. "Voting Stock" shall mean the stock entitling the holders thereof to vote in the election of the directors or trustees of the corporation, association, or other business entity in question, except that it shall not include any stock so entitling the holders thereof to vote only upon the happening of a contingency, whether or not such contingency has occurred. "Warrant Call Price" shall mean, when used with respect to any Warrant, the product of (i) the number of Covered Shares on such date and (ii) the Share Price on such date; provided that the Warrant Call Price with respect to any Warrant shall in no event exceed (x) the quotient obtained by dividing $5,000,000 by the number of Covered Shares subject to all the outstanding Warrants multiplied by (y) the number of Covered Shares subject to such Warrant. ARTICLE VII TERMINATION Section 7.1 TERMINATION. Subject to Section 7.2, this Agreement may be terminated in the following circumstances: (a) at the Effective Time of the Merger, as set forth in the Merger Agreement; (b) at the termination of the Merger Agreement prior to the occurrence of an Acquisition Event; or (c) two years after the occurrence of an Acquisition Event. Section 7.2 EFFECT OF TERMINATION. In the event of termination of this Agreement pursuant to Section 7.1(c), the rights of the parties hereto shall forthwith become void; provided that, if this Agreement shall terminate pursuant to Section 7.1(c) and any party has filed an application to purchase securities with any regulatory authority, this Agreement shall not terminate as provided in Section 7.1(c), but shall remain in full force and effect until the day which is 30 Business Days (plus any applicable waiting periods) after the receipt or denial of regulatory approval or consent, at which time the Agreement shall then terminate. Section 7.3 INDEMNIFICATION FOR BREACH. Each party to this Agreement agrees to indemnify and hold harmless the other party against any loss, claim, damage or liability arising out of or based upon a Default of this Agreement by such defaulting party 25 in accordance with the procedures set forth in the last paragraph of Section 3.8 of this Agreement. ARTICLE VIII GENERAL PROVISIONS Section 8.1 NOTICES. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or mailed by registered or certified mail (return receipt requested) to the parties at the following addresses (or any such other address for a party as shall be specified by like notice): (a) If to BOH: Mr. James B. Jaqua President and Chief Executive Officer The Bank of Hemet 3715 Sunnyside Drive Riverside, California 92506 Telecopier No.: (909) 784-5791 With copies to: Gary S. Findley, Esq. Gary Steven Findley & Associates 1470 Hundley Anaheim, California 92806 Telecopier No.: (714) 630-7910 (b) If to PCBG: Mr. E. Lynn Caswell Chairman and CEO Pacific Community Banking Group 23332 Mill Creek Drive, Suite 230 Laguna Hills, California 92653 Telecopier No.: (949) 458-2086 With copies to: Loren P. Hansen, Esquire Knecht & Hansen 1301 Dove Street, Suite 900 Newport Beach, California 92660 Telecopier No.: (949) 851-1732 26 Section 8.2 COUNTERPARTS. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement, and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other parties, it being understood that all parties need not sign the same counterpart. Section 8.3 AMENDMENT. This Agreement may be amended by the parties hereto, by action taken by their respective Boards of Directors or the duly authorized committees thereof. This Agreement may not be amended except by an instrument in writing signed on behalf of each of the parties hereto. The parties hereto agree to make such amendments as may be necessary to respond to the request of any Regulatory Authority with respect to this Agreement. Section 8.4 WAIVER. Any term or provision of this Agreement may be waived in writing at any time by the party which is, or whose shareholders are, entitled to the benefits thereof. Section 8.5 MISCELLANEOUS. This Agreement (including the documents and instruments referred to herein) (a) constitutes the entire agreement and supersedes all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof; (b) except as contemplated in this Agreement, is not intended to confer upon any person other than the parties hereto any rights or remedies hereunder; and (c) except as contemplated in this Agreement, shall not be assigned by operation of law or otherwise. BOH and PCBG agree that, except as required by law, it shall not issue any press release with respect to the transactions contemplated by this Agreement without consulting with each other party hereto. Section 8.6 GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 27 IN WITNESS WHEREOF, BOH and PCBG have caused this Agreement to be signed by their respective officers thereunto duly authorized, all as of the date first above written. PACIFIC COMMUNITY BANKING GROUP By: /s/ E. Lynn Caswell --------------------------- E. Lynn Caswell Chairman and CEO THE BANK OF HEMET By: /s/ James B. Jaqua --------------------------- James B. Jaqua President By: /s/ Harold R. Williams, Jr. --------------------------- Secretary 28 EXHIBIT A WARRANT No. 1 July 30, 1998 210,800 Shares THE BANK OF HEMET This is to certify that, for value received and subject to the terms and conditions provided for in a Warrant Purchase Agreement dated as of July 30, 1998 (the "Agreement") by and between The Bank of Hemet, a California corporation ("BOH"), and Pacific Community Banking Group, a California corporation ("PCBG"), pursuant to which PCBG and its assigns are entitled to purchase from BOH, on the terms and conditions set forth therein, 210,800 fully paid and nonassessable shares of common stock of BOH ("Common Stock"), subject to adjustment as provided in the Agreement. Terms not otherwise defined herein shall have the meanings ascribed to them in the Agreement. This Warrant may be exercised by the holder (except any holder which shall not be permitted by the Bank Holding Company Act of 1956, as amended ("BHC Act"), or other applicable law to own, or shall not have obtained all regulatory approvals required by such Act or other applicable law as a precondition to its ownership of, the shares of Common Stock covered hereby) as to the whole or any part of the shares of Common Stock covered hereby at any time when such exercise shall be permitted under the terms of this Warrant, by surrender of this Warrant at the principal office of BOH or at the office of any transfer agent for the Warrant and upon payment to BOH of the Warrant Price for shares so purchased by wire transfer to a bank account designated by BOH. Thereupon, this Warrant shall be deemed to have been exercised and the person exercising the same to have become a holder of record of shares of Common Stock (or of the other securities or property to which it is entitled upon such exercise) purchased hereunder for all purposes, and certificates for shares so purchased shall be delivered to the purchaser. If this Warrant shall be exercised in respect of a part of the shares of Common Stock covered hereby, the holder shall be entitled to receive a new Warrant covering the number of shares in respect of which this Warrant shall not have been exercised, but otherwise identical hereto. 1 This Warrant is exchangeable, upon the surrender hereof by the holder hereof at such office or agency of BOH, for new Warrants of this tenor representing in the aggregate the right to subscribe for and purchase the number of shares which may be subscribed for and purchased hereunder, each of such new Warrants to represent the right to subscribe for and purchase not less than 1,000 shares of Common Stock (except to the extent necessary to round out the balance of the number of shares purchasable hereunder). BOH covenants and agrees that all shares which may be issued upon the exercise of the rights represented by this Warrant will, upon issuance, be fully paid and non-assessable and free from all taxes, liens and charges with respect to the issue thereof (other than taxes in respect of any transfer occurring contemporaneously with such issue). BOH further covenants and agrees that during the period within which the rights represented by this Warrant may be exercised, BOH will at all times have authorized, and reserved, a sufficient number of shares of Common Stock to provide for the exercise of the rights represented by this Warrant, and will at its expense expeditiously upon each such reservation of shares use its best efforts to procure the listing thereof (subject to issuance or notice of issuance) on all stock exchanges on which the shares of Common Stock are then listed, or if BOH Shares are not then listed on a stock exchange on NASDAQ National Market System. The rights of the holder of this Warrant shall be subject to the following further terms and conditions: Section 1.1 BOH shall at all times reserve and keep available, free from preemptive rights, out of its authorized and unissued Common Stock or shares of Common Stock held in treasury, for the purpose of effecting the exercise of this Warrant, the full number of shares of Common Stock then issuable upon the exercise of this and all other outstanding Warrants, computed on the assumption that the adjustments required by the Agreement have become effective, in the event such is not then the case. Section 1.2 BOH will pay any and all taxes that may be payable in respect of the issue or delivery of shares of Common Stock upon exercise of this Warrant. BOH shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issue and delivery of shares of Common Stock in a name other than that of the holder of the Warrant or Warrants to be exercised, and no such issue or delivery shall be made unless and until the person requesting such issue has paid to BOH the amount of any such tax, or has established, to the satisfaction of BOH, that such tax has been paid. 2 Section 1.3 This Warrant shall not entitle the holder of any rights of a shareholder of BOH, either at law or in equity, or to any notice of meetings of shareholders or of any other proceedings of BOH. Section 1.4 Subject to Section 1.5 and the terms and conditions set forth in the Agreement, this Warrant and all rights hereunder are transferable (in whole or in part), on the books of BOH by the registered holder thereof in person or by duly authorized attorney, upon surrender of this Warrant, properly endorsed, to BOH (or if BOH shall have notified the registered holder hereof of the appointment of an independent transfer agent for Warrants, then to such transfer agent). As used herein the term "this Warrant" shall mean and include any Warrant or Warrants hereafter issued in consequence of transfers of this Warrant in whole or in part. Section 1.5 THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"). THIS WARRANT MAY NOT BE SOLD OR TRANSFERRED EXCEPT PURSUANT TO (i) A REGISTRATION STATEMENT WITH RESPECT TO THIS WARRANT WHICH IS EFFECTIVE UNDER THE SECURITIES ACT, OR (ii) AN OPINION OF COUNSEL THAT AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT IS AVAILABLE. THE TRANSFERABILITY OF THIS WARRANT IS FURTHER SUBJECT TO THE PROVISIONS OF A WARRANT PURCHASE AGREEMENT DATED AS OF JULY 30, 1998, A COPY OF WHICH IS AVAILABLE FOR INSPECTION AT THE OFFICE OF THE SECRETARY OF THE BANK OF HEMET. Section 1.6 The holder of this Warrant, by the acceptance hereof, agrees that prior to the exercise of any Warrants, at a time when said Warrants have not been registered under the Securities Act or any similar Federal statute, it will, if it has not requested or is then not entitled to such registration pursuant to the provisions of Article III of the Agreement, deliver to BOH a written representation that it is acquiring the shares of Common Stock issuable upon the exercise of such Warrants for its own account for investment, and not with a view to, or for sale in connection with, any distribution thereof, and not with any present intention of distributing or selling the same. Section 1.7 (a) This Warrant shall terminate and be of no further force or effect as provided in Article VII of the Agreement. (b) Notwithstanding any other provision contained herein, this Warrant and the rights conferred hereby shall terminate, and the full consideration paid by PCBG for this Warrant shall be immediately due and payable to PCBG, if BOH or PCBG receives written notice from the Federal Reserve Board to the effect that the 3 execution and delivery of the Agreement or the issuance of the Warrants is not consistent with Section 3 of the BHC Act. Section 1.8 This Warrant shall be governed by and construed in accordance with the laws of the State of California. Section 1.9 This Warrant incorporates by reference all of the terms and conditions of the Agreement. This Warrant is subject to termination upon the occurrence of any of the events specified in Section 7.1 of the Agreement. THE BANK OF HEMET By: /s/ James B. Jaqua -------------------- James B. Jaqua President By: /s/ Harold R. Williams ----------------------- Secretary 4 EX-10.7 19 EXHIBIT 10.7 EXHIBIT 10.7 Form of Noncompetition and Consulting Agreements (Jaqua and McDonough) for ---------------------- NONCOMPETITION AGREEMENT THIS NONCOMPETITION AGREEMENT ("Agreement"), dated as of ___ __, 1999, is entered into by and between The Bank of Hemet, a state chartered banking institution ("Bank"), and ___________________ ("Consultant"). RECITALS A. Bank and Pacific Community Banking Group, a California corporation ("PCBG") entered into that certain First Restatement of Agreement and Plan of Reorganization dated as of December 31, 1998 (the "Reorganization Agreement") whereby Bank will be acquired and become a wholly owned subsidiary of PCBG. B. Consultant is a current shareholder of Bank and President, Chief Executive Officer and a Director of Bank and Chairman of the Board of Directors of Banklink, a subsidiary of Bank. C. Bank will continue its business and operations following the reorganization and pursuant to the Reorganization Agreement, Consultant will receive substantial consideration from Bank for his common shares and vested options. D. The parties recognize and acknowledge the interest of Bank in protecting its business and goodwill following the reorganization and that Section 16601 of the California Business and Professions Code authorizes this Agreement for such purpose. E. Consultant will perform consulting services and not compete with Bank's business in order to protect said business and goodwill following the reorganization, provided Bank agrees to pay Consultant fees in accordance with the terms and conditions hereinafter set forth. F. Unless otherwise provided in this Agreement, capitalized terms shall have the meanings given to them in the Reorganization Agreement. NOW THEREFORE, in consideration of the premises and of the respective representations, warranties and covenants, agreements and conditions contained herein and in the Reorganization Agreement, and intending to be legally bound hereby, Bank and Consultant agree as follows: ARTICLE I NON-COMPETITION AGREEMENT 1.1 NONDISCLOSURE. Consultant shall not at any time disclose, use, transfer or sell any confidential information or proprietary data of Bank, Banklink, PCBG or its shareholders so long as such information or proprietary data remains confidential and has not been disclosed or is not otherwise in the public domain, except as required by law or pursuant to the legal process. 1.2 CONSIDERATION. In consideration of the covenants contained herein, Bank shall pay Consultant the amount of $____ per month in cash for the first eight months of the term and $_____ per month in cash for the remaining of the term hereof, within five (5) days following each month's end. 1.3 TERM. The term of this Agreement shall begin as of the Effective Time and shall end upon the expiration of _______________________ after the Effective Time (the "Term"). 1.4 NONCOMPETITION AGREEMENT. 1.4.1 Consultant hereby agrees that during the Term and for a period of one year thereafter, Consultant will not (i) engage in the Banking Business (which term shall include the business of banks, savings and loan institutions, credit unions and other financial institutions) other than on behalf of Bank and/or PCBG or their affiliates within the Designated Area (as hereinafter defined), (ii) directly or indirectly own, manage, operate, control, be employed by, or provide management or consulting services in any capacity to any firm, corporation or other entity (other than Bank and/or PCBG or their affiliates) engaged in the Banking Business in the Designated Area, or (iii) directly or indirectly solicit or otherwise intentionally cause any employee, officer, or member of the respective Boards of Directors of Bank and/or PCBG or any other of their affiliates to engage in any action prohibited under (i) or (ii) of this Section 1.4.1 or solicit any customers of Bank that have been customers of the Bank in the last three years. 1.4.2 Consultant acknowledges and agrees that irreparable injury will result to Bank and/or PCBG in the event of a breach of any of the provisions of this Section 1.4 (the "Designated Provisions") and that Bank and/or PCBG will have no adequate remedy at law with respect thereto. Accordingly, in the event of a material breach of any Designated Provision, and in addition to any other legal or equitable remedy Bank and/or PCBG may have, Bank and/or PCBG shall be entitled to the entry of a preliminary and permanent injunction (including, without limitation, specific performance) by a court of competent jurisdiction in Riverside County, California, to restrain the violation or breach thereof by Consultant or any affiliates, agents or any other persons acting for or with Consultant in any capacity whatsoever, and Consultant submits to the jurisdiction of such court in any such action. 1.4.3 It is the desire and intent of the parties that the provisions of this Section 1.4 shall be enforced to the fullest extent permissible under the laws and public policies applied in each jurisdiction in which enforcement is sought. Accordingly, if any particular provision of this Section 1.4 shall be adjudicated to be invalid or unenforceable, such provision shall be deemed amended to delete therefrom the portion thus adjudicated to be invalid or unenforceable, such deletion to apply only with respect to the operation of such provision in the particular jurisdiction in which such adjudication is made. In addition, should any court determine that the provisions of this Section 1.4 shall be unenforceable with respect to scope, duration or geographic area, such court shall be empowered to substitute, to the extent enforceable, provisions similar hereto or other provisions so as to provide to Bank and/or PCBG, to the fullest extent permitted by applicable law, the benefits intended by this Section 1.4. 1.3.4 As used herein, "Designated Area" shall mean the area contained within Riverside, San Bernardino and Orange Counties. 2 ARTICLE II REPRESENTATIONS AND WARRANTIES OF CONSULTANT 2.1 PERFORMANCE OF OBLIGATIONS. Consultant represents and warrants to Bank and/or PCBG that his execution, delivery and performance of this Agreement will not result in or constitute a breach of or conflict with any term, covenant, condition or provision of any commitment, contract or other agreement or instrument, including, without limitation, any other employment agreement, to which Consultant is or has been a party. 2.2 RESIGNATION. At the Effective Time Consultant shall resign as President and Chief Executive Officer and Director but continue as an employee of Bank until the end of such month. Consultant agrees and acknowledges as of the end of such month, his employment with Bank shall automatically cease and he shall not continue as an employee of Bank. Consultant agrees and acknowledges that he will not be entitled to any warrants for existing stock options pursuant to the Reorganization Agreement and waives all rights to receive such warrants for stock options upon the Effective Time. 2.3 INDEMNIFICATION. Consultant shall indemnify, defend, and hold harmless Bank and PCBG, its directors, officers, representatives and agents, for, from and against any and all losses, claims, suits, damages, expenses or liabilities, including court costs and counsel fees, which Bank and/or PCBG has incurred or to which Bank and/or PCBG may become subject, insofar as such losses, claims, suits, damages, expenses, liabilities, costs or fees arise out of or are based upon any failure of any representation or warranty of Consultant in Section 2.1 hereof to be true and correct when made or any breach of the provisions of Section 1.4. ARTICLE III GENERAL 3.1 GOVERNING LAW. This Agreement is governed by and is to be construed and enforced in accordance with the laws of the State of California. If under such law, any portion of this Agreement is at any time deemed to be in conflict with any applicable statute, rule, regulation or ordinance, such portion shall be deemed to be modified or altered to conform thereto or, if that is not possible, to be omitted from this Agreement; the invalidity of any such portion shall not affect the force, effect and validity of the remaining portion hereof. 3.2 NOTICES. All notices under this Agreement shall be in writing and shall be deemed effective when delivered in person, or forty-eight (48) hours after deposit thereof in the U.S. mails, postage prepaid, for delivery as requested or certified mail, addressed, in the case of: 3 Consultant, to: ------------------ ------------------- -------------------- Bank, to: The Bank of Hemet 3715 Sunnyside Drive Riverside, California 92506 Attention: Mr. E. Lynn Caswell, Chairman With a copy to: Pacific Community Banking Group 23332 Mill Creek Drive, Suite 230 Laguna Niguel, California 92653 Attention: Mr. E. Lynn Caswell, Chairman 3.3 ENTIRE AGREEMENT. This Agreement constitutes the entire understanding among Bank, PCBG and Consultant with respect to the subject matter hereof and supersedes and cancels all prior written and oral agreements and understandings with respect to the subject matter of this Agreement, which shall be interpreted consistently herewith; provided that prior to the Effective Time, any agreement between Bank and Consultant shall remain in effect and shall not be superseded by this Agreement. This Agreement may be amended but only by a subsequent written agreement of the parties. This Agreement shall be binding upon and shall inure to the benefit of Consultant, Consultant's heirs, executors, administrators and beneficiaries, Bank and/or PCBG and each of their respective successors. 3.4 WITHHOLDING TAXES. All amounts payable to Consultant under this Agreement shall be subject to applicable income, wage and other taxes, which shall be the responsibility of Consultant. Bank and/or PCBG will not be responsible for the withholding of any deductions. 3.5 EFFECT OF AGREEMENT. This Agreement shall have no effect until the Effective Time. In the event that the Reorganization Agreement is terminated, this Agreement shall automatically terminate. 3.6 DISPUTE RESOLUTION. Any dispute regarding this Agreement shall only be heard and resolved in a court of competent jurisdiction located in the County of Riverside, California. 3.7 LEGAL COSTS. If either party commences an action against the other party arising or in connection with this Agreement, the prevailing party shall be entitled to have and recover from the losing party reasonable attorney's fees and costs of suit. 4 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the year and day first above written. THE BANK OF HEMET By ______________________________________ Its _____________________________________ _________________________________________ __________________ ACKNOWLEDGED: PACIFIC COMMUNITY BANKING GROUP _______________________________ 5 CONSULTING AGREEMENT THIS CONSULTING AGREEMENT ("Agreement"), dated as of ___ __, 1999, is entered into by and between The Bank of Hemet, a state chartered banking institution ("Bank"), and ___________________ ("Consultant"). RECITALS A. Bank and Pacific Community Banking Group, a California corporation ("PCBG") entered into that certain First Restatement of Agreement and Plan of Reorganization dated as of December 31, 1998 (the "Reorganization Agreement") whereby Bank will be acquired and become a wholly owned subsidiary of PCBG. B. Consultant is a current shareholder of Bank and President, Chief Executive Officer and a Director of Bank and Chairman of the Board of Directors of Banklink, a subsidiary of Bank. C. Following the consummation of the acquisition of Bank by PCBG, Consultant wishes to be retained by Banklink in a consulting capacity, as Chairman of Banklink and as a Director of PCBG. D. Unless otherwise provided in this Agreement, capitalized terms shall have the meanings given to them in the Reorganization Agreement. NOW THEREFORE, in consideration of the premises and of the respective representations, warranties and covenants, agreements and conditions contained herein and in the Reorganization Agreement, and intending to be legally bound hereby, Bank and Consultant agree as follows: ARTICLE I CONSULTING SERVICES 1.1 CONSULTING SERVICES. From the Effective Time until the second anniversary of the Effective Time Consultant will serve as a business development and strategic business consultant for Banklink. Such services shall be provided by Consultant on a schedule solely determined by Consultant. 1.2 DIRECTOR RESPONSIBILITIES. On the Effective Time Consultant will become a Director of PCBG and shall continue as Chairman of Banklink. Consultant will be entitled to receive monthly Board and Committee fees or other forms of consideration for outside Directors, payable to either Consultant or his designee, at Consultant's sole discretion. In the event that Consultant resigns as a member of the Board of Directors of PCBG, such Director fees or other forms of consideration shall terminate at such time. In the event that PCBG requests the resignation of Consultant as a member of the Board of Directors of PCBG or removes Consultant as a Director Exhibit 2.1(d)(1) before the third anniversary of the Effective Date, PCBG shall pay Consultant an amount equal to the monthly Director and Committee fees or other forms of compensation times thirty-six, minus the number of payments previously paid. Such payment will be made immediately upon notification that Consultant shall no longer be a Director of PCBG. 1.3 HEALTH/MEDICAL BENEFITS. From the Effective Time until the third anniversary of the Effective Time, Consultant shall be entitled to participate in the health/medical benefit program of Bank provided to outside Directors which is in place at the Effective Time. 1.4 INCENTIVE COMPENSATION. From the Effective Time to the third anniversary of the Effective Time Consultant shall be entitled to additional incentive compensation for each new data service customer which executes a data service contract with Bank, Banklink or their affiliates. Such incentive compensation shall be $______ for each financial institution signing a contract with total assets of up to $50 million, $______ for each financial institution signing a contract with total assets between $50 million and $100 million and $______ for each financial institution signing a contract with total assets over $100 million. Such incentive compensation shall be paid by Bank and/or PCBG and/or Banklink within five days of the execution of such new data service contract, the form and contents of which shall be determined by and approved by PCBG and/or the Board of Directors of Banklink. 1.5 OTHER BENEFITS. As part of Consultant's consulting services, Consultant shall be entitled to reimbursement for all reasonable entertainment expenses incurred by Consultant in connection with business development activities for PCBG or Banklink subject to satisfactory evidence of such expenses, not to excess $____ per month unless previously authorized by the Chairman of PCBG or the Board of Directors of Banklink, as appropriate. Furthermore, Consultant will be able to utilize office space of Bank and/or PCBG or Banklink during the term of this consulting agreement. 1.6 NONDISCLOSURE. Consultant shall not at any time disclose, use, transfer or sell any confidential information or proprietary data of Bank, Banklink, PCBG or its shareholders so long as such information or proprietary data remains confidential and has not been disclosed or is not otherwise in the public domain, except as required by law or pursuant to the legal process. ARTICLE II REPRESENTATIONS AND WARRANTIES OF CONSULTANT 2.1 PERFORMANCE OF OBLIGATIONS. Consultant represents and warrants to Bank and/or PCBG that his execution, delivery and performance of this Agreement will not result in or constitute a breach of or conflict with any term, covenant, condition or provision of any commitment, contract or other agreement or instrument, including, without limitation, any other employment agreement, to which Consultant is or has been a party. 2.2 RESIGNATION. At the Effective Time Consultant shall resign as President and Chief Executive Officer and Director but continue as an employee of Bank until the end of such month, and be paid at each normal pay period as per existing bank payroll policy. Consultant agrees and 2 acknowledges that as of the end of such month, his employment with Bank shall automatically cease and he shall not continue as an employee of Bank. 2.3 INDEMNIFICATION. Consultant shall indemnify, defend, and hold harmless Bank and PCBG, its directors, officers, representatives and agents, for, from and against any and all losses, claims, suits, damages, expenses or liabilities, including court costs and counsel fees, which Bank and/or PCBG has incurred or to which Bank and/or PCBG may become subject, insofar as such losses, claims, suits, damages, expenses, liabilities, costs or fees arise out of or are based upon any failure of any representation or warranty of Consultant in Section 2.1 hereof to be true and correct when made. ARTICLE III GENERAL 3.1 GOVERNING LAW. This Agreement is governed by and is to be construed and enforced in accordance with the laws of the State of California. If under such law, any portion of this Agreement is at any time deemed to be in conflict with any applicable statute, rule, regulation or ordinance, such portion shall be deemed to be modified or altered to conform thereto or, if that is not possible, to be omitted from this Agreement; the invalidity of any such portion shall not affect the force, effect and validity of the remaining portion hereof. 3.2 NOTICES. All notices under this Agreement shall be in writing and shall be deemed effective when delivered in person, or forty-eight (48) hours after deposit thereof in the U.S. mails, postage prepaid, for delivery as requested or certified mail, addressed, in the case of: Consultant, to: ---------------- ------------------ ---------------------------- Bank, to: The Bank of Hemet 3715 Sunnyside Drive Riverside, California 92506 Attention: Mr. E. Lynn Caswell, Chairman With a copy to: Mr. E. Lynn Caswell 23332 Mill Creek Drive, Suite 230 Laguna Niguel, California 92653 3 3.3 ENTIRE AGREEMENT. This Agreement constitutes the entire understanding among Bank, PCBG and Consultant with respect to the subject matter hereof and supersedes and cancels all prior written and oral agreements and understandings with respect to the subject matter of this Agreement, which shall be interpreted consistently herewith; provided that prior to the Effective Time, any agreement between Bank and Consultant shall remain in effect and shall not be superseded by this Agreement. This Agreement may be amended but only by a subsequent written agreement of the parties. This Agreement shall be binding upon and shall inure to the benefit of Consultant, Consultant's heirs, executors, administrators and beneficiaries, Bank and/or PCBG and each of their respective successors. 3.4 WITHHOLDING TAXES. All amounts payable to Consultant under this Agreement shall be subject to applicable income, wage and other taxes, which shall be the responsibility of Consultant. Bank and/or PCBG will not be responsible for the withholding of any deductions. 3.5 EFFECT OF AGREEMENT. This Agreement shall have no effect until the Effective Time. In the event that the Reorganization Agreement is terminated, this Agreement shall automatically terminate. 3.6 DISPUTE RESOLUTION. In the event of a dispute between Bank and Consultant as to the amount due Consultant under section 1.4 of this Agreement, the Bank and Consultant shall each provide the other with an accounting of the amounts each asserts are due. The parties shall then identify any disputes they have with the other's accounting. Upon identification of any disputed items, the parties shall attempt to agree upon the amount due to Consultant within seven days. If no mutual agreement is reached within said period, the parties shall have their respective accounting firms attempt to agree upon the correct amount due Consultant, within seven days thereafter. If the accounting firms are unable to reach a mutual agreement, within said period, the parties shall agree to an independent "Big Six" accounting firm to resolve any remaining items that have not been agreed upon, and the opinion of such accounting firm shall be binding upon the parties for the purposes of this Agreement. The parties shall cooperate fully with each other and the accounting firms. The cost of the expert shall be paid by the Bank. Any dispute regarding this Agreement shall only be heard and resolved in a court of competent jurisdiction located in the County of Riverside, California. 3.7 LEGAL COSTS. If either party commences an action against the other party arising or in connection with this Agreement, the prevailing party shall be entitled to have and recover from the losing party reasonable attorney's fees and costs of suit. 4 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the year and day first above written. THE BANK OF HEMET By ______________________________________ Its _____________________________________ _________________________________________ _______________ ACKNOWLEDGED: PACIFIC COMMUNITY BANKING GROUP _______________________________ 5 EXHIBIT A 6 EX-10.8 20 EXHIBIT 10.8 EXHIBIT 10.8 Form of Executive Salary Continuation Agreement (Jaqua) between TBOH and ________ dated March 22, 1995, as amended EXECUTIVE SALARY CONTINUATION AGREEMENT This Agreement is made and entered into this 22nd day of March, 1995, by and between The Bank of Hemet, a banking corporation organized under the laws of the State of California (the "Employer"), and __________________, an individual residing in the State of California (hereinafter referred to as the "Executive"). RECITALS WHEREAS, the Executive is an employee of the Employer and is serving as its President and Chief Executive Officer; WHEREAS, the Executive's experience and knowledge of the affairs of the Employer and the banking industry are extensive and valuable; WHEREAS, it is deemed to be in the best interests of the Employer to provide the Executive with certain salary continuation benefits, on the terms and conditions set forth herein, in order to reasonably induce the Executive to remain in the Employer's employment; and WHEREAS, the Executive and the Employer wish to specify in writing the terms and conditions upon which this additional compensatory incentive will be provided to the Executive, or to the Executive's spouse or the Executive's designated beneficiaries, as the case may be; NOW, THEREFORE, in consideration of the services to be performed in the future, as well as the mutual promises and covenants contained herein, the Executive and the Employer agree as follows: AGREEMENT 1. TERMS AND DEFINITIONS. 1.1. ADMINISTRATOR. The Employer shall be the "Administrator" and, solely for the purposes of ERISA, the "fiduciary" of this Agreement where a fiduciary is required by ERISA. 1.2. ANNUAL BENEFIT. The term "Annual Benefit" shall mean an annual sum of __________________ ($_______) multiplied by the Applicable Percentage (defined below) and then reduced to the extent required: (i) under the other provisions of this Agreement; (ii) by reason of the lawful order of any regulatory agency or body having jurisdiction over the Employer; and (iii) in order for the Employer to properly comply with any and all applicable state and federal laws, including, but not limited to, income, employment and disability income tax laws (e.g., FICA, FUTA, SDI). 1.3. APPLICABLE PERCENTAGE. The term "Applicable Percentage" shall mean that percentage listed on Schedule "A" attached hereto which is adjacent to the number of complete years (with a "year" being the performance of personal services for or on behalf of the Employer as an employee for a period of 365 days) which have elapsed starting from the Effective Date of this Agreement and ending on the date the Executive's employment with the Employer terminates for purposes of this Agreement. In the event the Executive's employment with the Employer is terminated other than by reason of death, disability, termination for cause or Retirement on the part of the Executive, the Executive shall be deemed for purposes of determining the number of complete years to have completed a year of service in its entirety for any partial year of service after the last anniversary date of the Effective Date during which the Executive's employment is terminated, provided that in no event shall the Executive be deemed to have completed a year of service for any partial year if the partial year occurs prior to the anniversary date of this Agreement. 1.4. BENEFICIARY. The term "beneficiary" or "designated beneficiary" shall mean the person or persons whom the Executive shall designate in a valid Beneficiary Designation, a copy of which is attached hereto as Exhibit "B", to receive the benefits provided hereunder. A Beneficiary Designation shall be valid only if it is in the form attached hereto and made a part hereof and is received by the Administrator prior to the Executive's death. 1.5. THE CODE. The "Code" shall mean the Internal Revenue Code of 1986, as amended (the "Code"). 1.6. DISABILITY/DISABLED. The term "Disability" or "Disabled" shall have the same meaning given such term in the principal disability insurance policy covering the Executive, which is incorporated herein by reference. In the event the Executive is not covered by a disability policy containing a definition of "Disability" or "Disabled," these terms shall mean an illness or incapacity which, having continued for a period of one hundred and eighty (180) consecutive days, prevents the Executive from adequately performing the Executive's regular employment duties. The determination of whether the Executive is Disabled shall be made by an independent physician selected by mutual agreement of the parties. 1.7. EFFECTIVE DATE. The term "Effective Date" shall mean the date upon which this Agreement was entered into by the parties, as first written above. 1.8. ERISA. The term "ERISA" shall mean the Employee. Retirement Income Security Act of 1974, as amended. 1.9. PLAN YEAR. The term "Plan Year" shall mean the Employer's calendar year. 1.10. RETIREMENT. The term "Retirement" or "Retires" shall refer to the date which Executive attains the age of at least 65 and which the Executive acknowledges in writing to the Employer to be the last day he will provide any significant personal services, whether as an employee, director or independent consultant or contractor, to the Employer. For purposes of this Agreement, the phrase "significant personal services" shall mean more than ten (10) hours of personal services rendered to one or more individuals or entities in any thirty (30) day period. 1.11 SALE OF BUSINESS. The term "Sale of Business" shall mean any (i) merger, consolidation or reorganization of the Employer in which (A) the Employer does not survive or (B) the Employer survives with a resulting change in beneficial ownership of the Employer of more than 50% of the voting shares of the Employer, (ii) sale of more than 50% of the beneficial ownership of the voting shares of the Employer to any person or group of persons acting in concert, or (iii) transfer or sale of more than 50% of the total market value of the assets of Employer as reflected in the most recent published balance sheet of the Employer. 1.12. SURVIVING SPOUSE. The term "Surviving Spouse" shall mean the person, if any, who shall be legally married to the Executive on the date of the Executive's death. 2. SCOPE, PURPOSE AND EFFECT. 2.1. CONTRACT OF EMPLOYMENT. Although this Agreement is intended to provide the Executive with an additional incentive to remain in the employ of the Employer, this Agreement shall not be deemed to constitute a contract of employment between the Executive and the Employer nor shall any provision of this Agreement restrict or expand the right of the Employer to terminate the Executive's employment. This Agreement shall have no impact or effect upon any separate written employment agreement which the Executive may have with the Employer, it being the parties' intention and agreement that unless this Agreement is specifically referenced in said employment agreement (or any modification thereto), this Agreement (and the Employer's obligations hereunder) shall stand separate and apart and shall have no effect upon, nor be affected by, the terms and provisions of said employment agreement. 2.2. FRINGE BENEFIT. The benefits provided by this Agreement are granted by the Employer as a fringe benefit to the Executive and are not a part of any salary reduction plan or any arrangement deferring a bonus or a salary increase. The Executive has no option to take any current payments or bonus in lieu of the benefits provided by this Agreement. 3. PAYMENTS UPON OR AFTER RETIREMENT. 3.1. PAYMENTS UPON RETIREMENT. If the Executive shall remain in the continuous employment of the Employer until Retirement, the Executive shall be entitled to be paid the Annual Benefit with the Applicable Percentage at 100%, for a period of fifteen (15) years, in One Hundred Eighty (180) equal monthly installments, with each installment to be paid on the first day of each month, beginning with the month following the month in which the Executive Retires or upon such later date as may be mutually agreed upon by the Executive and the Employer in advance of said Retirement date. At the Employer's sole and absolute discretion, the Employer may increase the Annual Benefit as and when the Employer determines the same to be appropriate in order to reflect a substantial change in the cost of living. Notwithstanding anything contained herein to the contrary, the Employer shall have no obligation hereunder to make any such cost-of-living adjustment. 3.2. PAYMENTS IN THE EVENT OF DEATH AFTER RETIREMENT. The Employer agrees that if the Executive Retires, but shall die before receiving all of the One Hundred Eighty (180) monthly payments described in paragraph 3.1 above, the Employer will make the remaining monthly payments, undiminished and on the same schedule as if the Executive had not died, to the Executive's designated beneficiary. If a valid Beneficiary Designation is not in effect, then the remaining amounts due to the Executive under the term of this Agreement shall be paid to the Executive's Surviving Spouse. If the Executive leaves no Surviving Spouse, the remaining amounts due to the Executive under the terms of this Agreement shall be paid to the duly qualified personal representative, executor or administrator of the Executive's estate. 4. PAYMENTS IN THE EVENT DEATH OR DISABILITY OCCURS PRIOR TO RETIREMENT. 4.1. PAYMENTS IN THE EVENT OF DEATH PRIOR TO RETIREMENT. In the event the Executive should die while actively employed by the Employer at any time after the Effective Date of this Agreement, the Employer agrees to pay the Annual Benefit with the Applicable Percentage at 100% for a period of fifteen (15) years in One Hundred Eighty (180) equal monthly installments, with each installment to be paid on the first of each month beginning with the month following the Executive's death, to the Executive's designated beneficiary. If a valid Beneficiary Designation is not in effect, then the amounts due to the Executive under the terms of this Agreement shall be paid to the Executive's Surviving Spouse. If the Executive leaves no Surviving Spouse, the amounts due to the Executive under the terms of this Agreement shall be paid to the duly qualified personal representative, executor or administrator of the Executive's estate. 4.2. PAYMENTS IN THE EVENT OF DISABILITY PRIOR TO RETIREMENT. In the event the Executive becomes Disabled while actively employed by the Employer at any time after the date of this Agreement but prior to Retirement, the Executive shall: (i) continue to be treated during such period of Disability as being gainfully employed by the Employer but shall not add applicable years of service for the purpose of determining the Annual Benefit; and (ii) be entitled to be paid the Annual Benefit, as set forth on Schedule "A", for fifteen (15) years, as determined by the applicable years of service at the time of disability, as defined above, in One Hundred Eighty (180) equal monthly installments, with each installment to be paid on the first day of each month, beginning with the month following the earlier of (1) the month in which the Executive attains sixty-five (65) years of age; or (2) the date upon which the Executive is no longer entitled to receive Disability benefits under the Executive's principal Disability insurance policy and does not, at such time, return to and thereafter fulfill the responsibilities associated with the employment position held with the Employer prior to becoming Disabled by reason of such Disability continuing. Notwithstanding the foregoing, in the event the Executive should die while actively or gainfully employed by the Employer at any time after the Effective Date of this Agreement and prior to attaining the age of sixty-five (65) years of age, the payments provided in Paragraph 4.1 shall be paid in lieu of the payments provided in this Paragraph 4.2, provided that the Executive or his legal representative shall have not elected to take the benefits provided by Paragraph 5 and payments provided for in this Paragraph 4.2 have not commenced. 5. PAYMENTS IN THE EVENT EMPLOYMENT IS TERMINATED FOR CAUSE OR EXECUTIVE VOLUNTARILY TERMINATES EMPLOYMENT. As indicated in Paragraph 2 above, the Employer reserves the right to terminate the Executive's employment, with or without cause but subject to any written employment agreement which may then exist, at any time prior to the Executive's Retirement. In the event that the employment of the Executive shall be terminated prior to Executive attaining age 65 and either (i) for cause as defined in Executive's current employment agreement (or most current employment agreement if there is no current employment agreement), but in no event shall cause include death or disability or (ii) voluntarily on the part of Executive, Executive shall not be entitled to any benefits pursuant to this agreement. 5.1 TERMINATION OF EXECUTIVE WITHOUT CAUSE. In the event the employment of Executive with Employer is (i) terminated without cause, (ii) terminated for cause after Executive attains age 65, or (iii) terminated voluntarily by Executive after Executive attains age 65, the Executive or his legal representative shall be entitled to be paid the Annual Benefit, as set forth in Schedule "A" for a period of fifteen (15) years, as determined by the applicable years of service at the time of the Executive's termination of employment with the Employer, in One Hundred Eighty (180) equal monthly installments, with each installment to be paid on the first day of each month, beginning with the month following the month in which the Executive terminates employment and attains sixty-five (65) years of age or the month following the Executive's death, whichever occurs first. 5.2 TERMINATION IN A SALE OF BUSINESS. In the event there is a Sale of Business, the Executive shall be entitled to be paid in a lump sum the present value (using the annual discount rate equal to the annual interest rate of a ten year treasury bond) of the Annual Benefit for a period of fifteen (15) years with the Applicable Percentage being 100% to be paid on the first day of each month, beginning with the month following the month in which the Executive for any reason terminates employment with Employer or a successor of Employer after a Sale of Business. 6. RIGHT OF THE EMPLOYER TO PAY A LUMP SUM. The Employer shall at its sole and absolute discretion have the right to pay in a lump sum the then present value using a discount rate that is to be mutually agreed upon between the Employer and the Executive or the Executive's beneficiary of all payments vested and due the Executive or the Executive's beneficiary pursuant to this Agreement. 7. NO OWNERSHIP RIGHTS TO THE EMPLOYER'S ASSETS. The Employer reserves the right to determine, in its sole and absolute discretion, whether, to what extent and by what method, if any, to provide for the payment of the amounts which may be payable to the Executive, the Executive's spouse or the Executive's beneficiaries under the terms of this Agreement ("Benefits"). The rights of the Executive or any beneficiary of the Executive under this Agreement shall be solely those of an unsecured creditor of the Employer. In the event that the Employer, in its sole and absolute discretion, elects to acquire an insurance policy, an annuity or any other asset to recoup the costs or any portion thereof of the Benefits, then such insurance policy, annuity or other asset shall not be deemed to be held under any trust for the benefit of the Executive or his beneficiaries or to be security for the performance of the obligations of the Employer under this Agreement, but shall be, and remain, a general unpledged, unrestricted asset of the Employer. The Executive and his beneficiaries shall have no rights whatsoever with respect to, or any claim against, any such insurance policy, annuity or other asset. In connection with the Employer electing to acquire any such insurance policy or annuity, the Executive agrees to cooperate to facilitate such acquisition, and pursuant thereto shall execute such documents and undergo such medical examinations or tests as the Employer may reasonably request. 8. CLAIMS PROCEDURE. The Employer shall, but only to the extent necessary to comply with ERISA, be designated as the named fiduciary under this Agreement and shall have authority to control and manage the operation and administration of this Agreement. Consistent therewith, the Employer shall make all determinations as to the rights to benefits under this Agreement. Any decision by the Employer denying a claim by the Executive, the Executive's spouse, or the Executive's beneficiary for Benefits under this Agreement shall be stated in writing and delivered or mailed, via registered or certified mail, to the Executive, the Executive's spouse or the Executive's beneficiary, as the case may be. Such decision shall set forth the specific reasons for the denial of a claim. In addition, the Employer shall provide the Executive, the Executive's spouse or the Executive's beneficiary with a reasonable opportunity for a full and fair review of the decision denying such claim. 9. STATUS OF AN UNSECURED GENERAL CREDITOR. Notwithstanding anything contained herein to the contrary: (i) neither the Executive, the Executive's spouse or the Executive's beneficiary shall have any legal or equitable rights, interests or claims in or to any specific property or assets of the Employer; (ii) none of the Employer's assets shall be held in or under any trust for the benefit of the Executive, the Executive's spouse or the Executive's beneficiary or held in any way as security for the fulfillment of the obligations of the Employer under this Agreement; (iii) all of the Employer's assets shall be and remain the general unpledged and unrestricted assets of the Employer; (iv) the Employer's obligation under this Agreement shall be that of an unfunded and unsecured promise by the Employer to pay money in the future; and (v) the Executive, the Executive's spouse and the Executive's beneficiary shall be unsecured general creditors with respect to any benefits which may be payable under the terms of this Agreement. 10. COVENANT NOT TO INTERFERE. The Executive agrees not to take any action which prevents the Employer from collecting the proceeds of any life insurance policy which the Employer may happen to own at the time of the Executive's death and of which the Employer is the designated beneficiary. 11. MISCELLANEOUS. 11.1. OPPORTUNITY TO CONSULT WITH INDEPENDENT COUNSEL. The Executive acknowledges that he has been afforded the opportunity to consult with independent counsel of his choosing regarding both the benefits granted to him under the terms of this Agreement and the terms and conditions which may affect the Executive's right to these benefits. The Executive further acknowledges that he has read, understands and consents to all of the terms and conditions of this Agreement, and that he enters into this Agreement with a full understanding of its terms and conditions. 11.2. ARBITRATION OF DISPUTES. All claims, disputes and other matters in question arising out of or relating to this Agreement or the breach or interpretation thereof, other than those matters which are to be determined by the Employer in its sole and absolute discretion, shall be resolved by binding arbitration before a representative member, selected by the mutual agreement of the parties, of the Judicial Arbitration and Mediation Services, Inc. ("JAMS"), presently located at 500 North State College Boulevard, in Orange, California. In the event JAMS is unable or unwilling to conduct the arbitration provided for under the terms of this Paragraph, or has discontinued its business, the parties agree that a representative member, selected by the mutual agreement of the parties, of the American Arbitration Association ("AAA"), presently located at 2601 Main Street, in Irvine, California, shall conduct the binding arbitration referred to in this Paragraph. Notice of the demand for arbitration shall be filed in writing with the other party to this Agreement and with JAMS (or AAA, if necessary). In no event shall the demand for arbitration be made after the date when institution of legal or equitable proceedings based on such claim, dispute or other matter in question would be barred by the applicable statute of limitations. The arbitration shall be subject to such rules of procedure used or established by JAMS, or if there are none, the rules of procedure used or established by AAA. Any award rendered by JAMS or AAA shall be final and binding upon the parties, and as applicable, their respective heirs, beneficiaries, legal representatives, agents, successors and assigns, and may be entered in any court having jurisdiction thereof. The obligation of the parties to arbitrate pursuant to this clause shall be specifically enforceable in accordance with, and shall be conducted consistently with, the provisions of Title 9 of Part 3 of the California Code of Civil Procedure. Any arbitration hereunder shall be conducted in Hemet, California, unless otherwise agreed to by the parties. 11.3. ATTORNEYS' FEES. In the event of any arbitration or litigation concerning any controversy, claim or dispute between the parties hereto, arising out of or relating to this Agreement or the breach hereof, or the interpretation hereof, the prevailing party shall be entitled to recover from the losing party reasonable expenses, attorneys' fees and costs incurred in connection therewith or in the enforcement or collection of any judgment or award rendered therein. The "prevailing party" means the party determined by the arbitrator(s) or court, as the case may be, to have most nearly prevailed, even if such party did not prevail in all matters, not necessarily the one in whose favor a judgment is rendered. 11.4. NOTICE. Any notice required or permitted of either the Executive or the Employer under this Agreement shall be deemed to have been duly given, if by personal delivery, upon the date received by the party or its authorized representative; if by facsimile, upon transmission to a telephone number previously provided by the party to whom the facsimile is transmitted as reflected in the records of the party transmitting the facsimile and upon reasonable confirmation of such transmission; and if by mail, on the third day after mailing via U.S. first class mail, registered or certified, postage prepaid and return receipt requested, and addressed to the party at the address given below for the receipt of notices, or such changed address as may be requested in writing by a party. IF TO THE EMPLOYER: THE BANK OF HEMET 1600 EAST FLORIDA AVENUE HEMET, CALIFORNIA 92544 ATTENTION: JOHN J. McDONOUGH CHAIRMAN OF THE BOARD IF TO THE EXECUTIVE: ---------------------- ---------------------- ---------------------- 11.5. ASSIGNMENT. Neither the Executive, the Executive's spouse, nor any other beneficiary under this Agreement shall have any power or right to transfer, assign, hypothecate, modify or otherwise encumber any part or all of the amounts payable hereunder, nor, prior to payment in accordance with the terms of this Agreement, shall any portion of such amounts be: (i) subject to seizure by any creditor of any such beneficiary, by a proceeding at law or in equity, for the payment of any debts, judgments, alimony or separate maintenance obligations which may be owed by the Executive, the Executive's spouse, or any designated beneficiary; or (ii) transferable by operation of law in the event of bankruptcy, insolvency or otherwise. Any such attempted assignment or transfer shall be void and shall terminate this Agreement, and the Employer shall thereupon have no further liability hereunder. 11.6. BINDING EFFECT/MERGER OR REORGANIZATION. This Agreement shall be binding upon and inure to the benefit of the Executive and the Employer and, as applicable, their respective heirs, beneficiaries, legal representatives, agents, successors and assigns. Accordingly, the Employer shall not merge or consolidate into or with another corporation, or reorganize or sell substantially all of its assets to another corporation, firm or person, unless and until such succeeding or continuing corporation, firm or person agrees to assume and discharge the obligations of the Employer under this Agreement. Upon the occurrence of such event, the term "Employer" as used in this Agreement shall be deemed to refer to such surviving or successor firm, person, entity or corporation. 11.7. NONWAIVER. The failure of either party to enforce at any time or for any period of time any one or more of the terms or conditions of this Agreement shall not be a waiver of such term(s) or condition(s) or of that party's right thereafter to enforce each and every term and condition of this Agreement. 11.8. PARTIAL INVALIDITY. If any term, provision, covenant or condition of this Agreement is determined by an arbitrator or a court, as the case may be, to be invalid, void or unenforceable, such determination shall not render any other term, provision, covenant or condition invalid, void or unenforceable, and the Agreement shall remain in full force and effect notwithstanding such partial invalidity. 11.9. ENTIRE AGREEMENT. This Agreement supersedes any and all other agreements, either oral or in writing, between the parties with respect to the subject matter of this Agreement and contains all of the covenants and agreements between the parties with respect thereto. Each party to this Agreement acknowledges that no other representations, inducements, promises or agreements, oral or otherwise, have been made by any party, or anyone acting on behalf of any party, which are not set forth herein, and that no other agreement, statement or promise not contained in this Agreement shall be valid or binding on either party. 11.10. MODIFICATIONS. Any modification of this Agreement shall be effective only if it is in writing and signed by each party or such party's authorized representative. 11.11. PARAGRAPH HEADINGS. The paragraph headings used in this Agreement are included solely for the convenience of the parties and shall not affect or be used in connection with the interpretation of this Agreement. 11.12. NO STRICT CONSTRUCTION. The language used in this Agreement shall be deemed to be the language chosen by the parties hereto to express their mutual intent, and no rule of strict construction will be applied against any person. 11.13. GOVERNING LAW. The laws of the State of California, other than those laws denominated choice of law rules, and, where applicable, the rules and regulations of: (i) the California Superintendent of Banks; (ii) the Federal Deposit Insurance Corporation; (iii) the Board of Governors of Federal Reserve System; or (iv) any other regulatory agency or governmental authority having jurisdiction over the Employer, shall govern the validity, interpretation, construction and effect of this Agreement. 12. ADDITIONAL LIMITATIONS ON THE AMOUNT OF THE ANNUAL BENEFIT. The Executive acknowledges and agrees that the parties have entered into this Agreement based upon certain financial and tax accounting assumptions. Accordingly, with full knowledge of the potential consequences, the Executive agrees that, notwithstanding anything contained herein to the contrary: (i) the amount of the Annual Benefit shall be limited to that amount of the Annual Benefit (as determined without regard to this Paragraph) which will be deductible by the Employer under the Code in the year in which payment is to be made to the Executive; (ii) the Annual Benefit amount shall be deemed to be the last payment made to the Executive and the first for which an income tax deduction, if any, has been disallowed; and (iii) any compensatory amounts for which a deduction is denied to the Employer shall, at the Employer's election, serve to first reduce the Employer's obligation to make the Annual Benefit payments otherwise due and payable to the Executive under the terms of this Agreement. The Executive recognizes that, in this regard, limitations on deductibility may be imposed under, but not limited to, Code Section 280G. Consistent with the foregoing, and in the event that any payment or benefit received or to be received by the Executive, whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Employer (together with the Annual Benefit, the "Total Payments"), will not be deductible (in whole or in part) as a result of Code Section 280G, the Annual Benefit shall be reduced until no portion of the Total Payments is nondeductible as a result of Section 28OG of the Code (or the Annual Benefit is reduced to zero (0)). For purposes of this limitation: (a) No portion of the Total payments, the receipt or enjoyment of which the Executive shall have effectively waived in writing prior to the date of payment of any future Annual Benefit payments, shall be taken into account; (b) No portion of the Total Payments shall be taken into account, which in the opinion of the tax counsel selected by the Employer and acceptable to the Executive, does not constitute a "parachute payment" with the meaning of Section 28OG of the Code; (c) Future Annual Benefit payments shall be reduced only to the extent necessary so that the Total Payments (other than those referred to in clauses (a) or (b) above in their entirety) constitute reasonable compensation for services actually rendered within the meaning of Section 280G of the Code, in the opinion of tax counsel referred to in clause (b) above; and (d) The value of any non-cash benefit or any deferred payment or benefit included in the Total Payments shall be determined by the Employer's independent auditors in accordance with the principles of Section 280G of the Code. IN WITNESS WHEREOF, the Employer and the Executive have executed this Agreement on the date first above-written in the City of Hemet, Riverside County, California. THE BANK OF HEMET __________________________ "Employer" "Executive" - -------------------------- -------------------------- John J. McDonough Chairman of the Board SCHEDULE A
NUMBER OF COMPLETE YEARS OF SERVICE APPLICABLE WHICH HAVE ELAPSED PERCENTAGE - ------------------- ----------- 1 or more years 100%
SCHEDULE B BENEFICIARY DESIGNATION TO: THE ADMINISTRATOR OF THE BANK OF HEMET EXECUTIVE SALARY CONTINUATION AGREEMENT Pursuant to the provisions of my Executive Salary Continuation Agreement with The Bank of Hemet permitting the designation of a beneficiary or beneficiaries by a participant, I hereby designate the following persons and entities as primary and secondary beneficiaries of any benefit under said Agreement payable by reason of my death: NOTE: TO NAME A TRUST AS BENEFICIARY, PLEASE PROVIDE THE NAME OF THE TRUSTEE AND THE EXACT DATE OF THE TRUST AGREEMENT. IN THE EVENT THE PRIMARY BENEFICIARY IS NOT THE SPOUSE OF THE EXECUTIVE, THE SPOUSE OF THE EXECUTIVE WILL NEED TO SIGN THE SPOUSAL CONSENT BELOW AND SUCH SIGNATURE MUST BE NOTARIZED. PRIMARY BENEFICIARY: - ------------------- ---------------- -------------- Name Address Relationship SECONDARY (CONTINGENT) BENEFICIARY: - -------------------------------------------- - ------------------- ---------------- -------------- Name Address Relationship THE RIGHT TO REVOKE OR CHANGE ANY BENEFICIARY DESIGNATION IS HEREBY RESERVED. ANY PRIOR DESIGNATION OF PRIMARY BENEFICIARIES AND SECONDARY BENEFICIARIES IS HEREBY REVOKED. The Administrator shall pay all sums payable under the Agreement by reason of my death to the Primary Beneficiary, if he or she survives me, and if no Primary Beneficiary shall survive me, then to the Secondary Beneficiary, and if no named beneficiary survives me, then the Administrator shall pay all amounts in accordance with the terms of my Executive Salary Continuation Agreement. In the event that a named beneficiary survives me and dies prior to receiving the entire benefit payable under said Agreement then and in that event, the remaining unpaid benefit payable according to the terms of my Executive Salary Continuation Agreement shall be payable to the personal representatives of the estate of said beneficiary who survived me but died prior to receiving the total benefit provided by my Executive Salary Continuation Agreement. ________________ "Executive" Dated: 3/22/95 ------------- ------------------------- SCHEDULE B BENEFICIARY DESIGNATION TO: THE ADMINISTRATOR OF THE BANK OF HEMET EXECUTIVE SALARY CONTINUATION AGREEMENT Pursuant to the provisions of my Executive Salary Continuation Agreement with The Bank of Hemet permitting the designation of a beneficiary or beneficiaries by a participant, I hereby designate the following persons and entities as primary and secondary beneficiaries of any benefit under said Agreement payable by reason of my death: NOTE: TO NAME A TRUST AS BENEFICIARY, PLEASE PROVIDE THE NAME OF THE TRUSTEE AND THE EXACT DATE OF THE TRUST AGREEMENT. IN THE EVENT THE PRIMARY BENEFICIARY IS NOT THE SPOUSE OF THE EXECUTIVE, THE SPOUSE OF THE EXECUTIVE WILL NEED TO SIGN THE SPOUSAL CONSENT BELOW AND SUCH SIGNATURE MUST BE NOTARIZED. PRIMARY BENEFICIARY: - ------------------- ---------------- -------------- Name Address Relationship SECONDARY (CONTINGENT) BENEFICIARY: - ----------------------------------- - ------------------- ---------------- -------------- Name Address Relationship THE RIGHT TO REVOKE OR CHANGE ANY BENEFICIARY DESIGNATION IS HEREBY RESERVED. ANY PRIOR DESIGNATION OF PRIMARY BENEFICIARIES AND SECONDARY BENEFICIARIES IS HEREBY REVOKED. The Administrator shall pay all sums payable under the Agreement by reason of my death to the Primary Beneficiary, if he or she survives me, and if no Primary Beneficiary shall survive me, then to the Secondary Beneficiary, and if no named beneficiary survives me, then the Administrator shall pay all amounts in accordance with the terms of my Executive Salary Continuation Agreement. In the event that a named beneficiary survives me and dies prior to receiving the entire benefit payable under said Agreement then and in that event, the remaining unpaid benefit payable according to the terms of my Executive Salary Continuation Agreement shall be payable to the personal representatives of the estate of said beneficiary who survived me but died prior to receiving the total benefit provided by my Executive Salary Continuation Agreement. _______________ "EXECUTIVE" Dated: 3/22/95 -------------- ------------------------- FORM OF AMENDMENT NO. 1 TO EXECUTIVE SALARY CONTINUATION AGREEMENT (JAQUA) This Amendment No. 1 to the Executive Salary Continuation Agreement ("Amended Agreement") is made and entered into as of this 16th day of July, 1998 by and between The Bank of Hemet, a California banking corporation (the "Employer") and ______________, an individual residing in the State of California (hereinafter referred to as "Executive"). RECITALS AND UNDERTAKINGS A. WHEREAS, the Executive is an employee of the Employer and is serving as its President and Chief Executive Officer; B. WHEREAS, the Executive's experience and knowledge of the affairs of the Employer and the banking industry are extensive and valuable; C. WHEREAS, the Employer has provided Executive with certain salary continuation benefits as set forth in the Salary Continuation Agreement ("Original Agreement") between Employer and Executive dated March 21, 1998; and D. WHEREAS, Executive has further shown his value to the Employer since the date of the Original Agreement, it is deemed to be in the best interests of the Employer to amend this agreement to provide that no "golden parachute" payments will be made. NOW, THEREFORE, the parties hereto agree to amend the Original Agreement as follows: 1. A new Section 12A is added to the Original Agreement and shall read in the entirety as follows: 12A. NO PAYMENT OF BENEFITS RESULTING IN GOLDEN PARACHUTE TAXES UNDER SECTION 280G OF THE CODE. No payment shall be made to Executive pursuant to this Agreement to the extent that such payment when aggregated with all other payments considered for purposes of calculating a parachute payment results in an excess parachute payment as defined under Section 280G of the Code. Furthermore to the extent that the Internal Revenue Service or other applicable governmental taxing authority determines that there has been an "excess parachute payment" and a notice of deficiency or similar notice has been issued, then the Employer or its successor agrees to pay all expenses associated with professional fees (legal and tax accounting) in connection with the protest, challenge, and defense of any such notice and the appeal of any decision on such matter. The Employer or its successor agrees not to settle the matter short of the appellate level without the written consent of the Executive. In the event that the Internal Revenue Service or other applicable governmental taxing authority ultimately determines that, in fact, there has been an "excess parachute payment" by the Employer, then the amount necessary to reduce the total payments such that there would be no "excess parachute payment" would be immediately and retroactively characterized as a loan from the Employer or its successor to Executive with interest at a rate equal to the ten year Treasury Bond (or if the Employer or its successor is a bank subject to Regulation O then the loan shall be at substantially the same terms as credit underwriting procedures that are not less stringent than, those prevailing at the time the loan would have been made for comparable transactions of the Employer or its successor and shall be subject to the other conditions of Regulation O). The loan shall be subject to repayment at the demand of the Employer or its successor. 2. Except as amended hereby, the provisions of the Original Agreement remain in full force and effect and the enforceability thereof is not affected by this Amended Agreement. IN WITNESS WHEREOF, the parties to this Amended Agreement have duly executed this Amended Agreement as of the day and year first above written. THE BANK OF HEMET By: --------------------------------- John J. McDonough, Chairman ---------------------------- By: --------------------------------- FORM OF AMENDMENT NO. 2 TO EXECUTIVE SALARY CONTINUATION AGREEMENT (JAQUA) This Amendment No. 2 to the Executive Salary Continuation Agreement ("Amended Agreement") is made and entered into as of this 29th day of July, 1998 by and between The Bank of Hemet, a California banking corporation (the "Employer") and _______________, an individual residing in the State of California (hereinafter referred to as "Executive"). RECITALS AND UNDERTAKINGS A. WHEREAS, the Executive is an employee of the Employer and is serving as its President and Chief Executive Officer; B. WHEREAS, the Executive's experience and knowledge of the affairs of the Employer and the banking industry are extensive and valuable; C. WHEREAS, the Employer has provided Executive with certain salary continuation benefits as set forth in the Salary Continuation Agreement ("Original Agreement") between Employer and Executive dated March 21, 1995; and amended on July 16, 1998; and D. WHEREAS, Employer and Executive desire to adopt a specific procedure to determine the present value of the Annual Benefit for a fifteen (15) year period in the event Executive terminates employment with Employer after a sale of Business. NOW, THEREFORE, the parties hereto agree to amend the Original Agreement as follows: 1. Section 5-2 is amended to the Original Agreement and shall read in the entirety as follows: 5.2 TERMINATION IN A SALE OF BUSINESS. In the event there is a Sale of Business, the Executive shall be entitled to be paid in a lump sum the present value (using the annual discount rate equal to the annual interest rate of a ten year treasury bond) of the Annual Benefit for a period of fifteen (15) years with the Applicable Percentage being 100% to be paid on the first day of each month, beginning with the month following the month in which the Executive for any reason terminates employment with Employer or a successor of Employer after a Sale of Business. The annual interest rate of a ten year treasury bond will be the yield on the 10 Year Treasury Note as shown in the "Morning Economic Notes" provided daily to Employer by Paine Webber on the date of the Sale of Business. In the event this source is no longer available on the date of the Sale of Business, then the source of the rate will be selected by mutual agreement of the Employer and Executive. The payment of the lump sum will be made to the Executive by the Employer via wire transfer to the Executive's choice of bank account as soon as practicable after the earlier of a) the Sale of Business (assuming the Executive's termination date has been contractually or officially established by the Employer), or b) the effective date of the Executive's termination by Employer or a successor of Employer after a Sale of Business. 2. Except as amended hereby, the provisions of the Original Agreement remain in full force and effect and the enforceability thereof is not affected by this Amended Agreement. IN WITNESS WHEREOF, the parties to this Amended Agreement have duly executed this Amended Agreement as of the day and year first above written. THE BANK OF HEMET By: /s/ John J. McDonough -------------------------------- John J. McDonough, Chairman -------------------------- -------------------------------- 2 EX-10.9 21 EXHIBIT 10.9 EXHIBIT 10.9 TBOH Head Office Lease OFFICE LEASE ARTICLE I IDENTIFICATION OF PARTIES AND PROPERTY 1.1. PARTIES. This lease ("Lease") is entered into between TDE INCORPORATED, a California corporation, as landlord (called "Landlord" in this Lease), and THE BANK OF HEMET, a California corporation as tenant (called "Tenant" in this Lease), and the parties agree to the terms specified below. 1.2. PROPERTY. The property which is the subject of this lease (called "the Property" in this Lease) is located in the County of Riverside, State of California, and is commonly known as Units 111 through 120 of The Bank of Hemet Professional Building, 1600 E. Florida Avenue, Hemet, California 92344. The Property is approximately 7,210 square foot bank office together with remote drive-through teller islands located generally northwest of The Property, the roof over the islands and structural supports and all machinery and equipment either above or underground which operates or is part of the remote teller locations, all of which are outlined in red on Exhibit A, attached to and made a part of this Lease by this reference together with all easements appurtenant thereto. The Property is part of The Bank of Hemet Professional Building (called "The Building" in this Lease). 1.3. USE OF ADDITIONAL AREAS. Landlord gives to Tenant and its authorized representatives and invitees the non-exclusive right to use The Building common areas, with others who are entitled to use the common areas, subject to Landlord's rights set forth in this Lease. Landlord further gives to Tenant and its authorized representatives and invitees the full and unimpaired access to The Property, including access through the Florida Avenue entrance and the Girard Street entrance, at all times except as provided in Article VII of this Lease. The term "common areas" means all areas, space, equipment, and special services provided to the Landlord by The 1600 Professional Building Owners Association, a non-profit corporation (called "the owners association" in this Lease) pursuant to Declaration of Restrictions, amended as of August 14, 1978 and recorded August 15, 1978 as Instrument No. 171582 in Official Records of Riverside County, California (called "the declaration" in this Lease) for parking and ingress and egress, and/or for the common and joint use and benefit of the occupants, tenants and their respective authorized representatives and invitees, of The Building as the owners association may in the future designate, and may change, except as limited by the terms of the Lease or the declaration, at any time during the terms hereof, including, without limitation, parking area, access roads, driveways, retaining walls, landscaped areas, truck serviceways or tunnels, loading docks, pedestrian malls, courts, stairs, ramps, and sidewalks, comfort and first aid stations, washrooms and parcel pick up stations. The Property was originally owned by Tenant and has been sold by Tenant to Landlord and that Tenant is aware of all 2 provisions of the condominium plan including, without limitation, all provisions of the declaration, the recorded condominium plan, the owners association documentation, etc. ARTICLE II TERM OF LEASE 2.1. TERM OF LEASE. Landlord leases The Property to Tenant for a term of fifteen (15) years, beginning on 12:01 A.M. March 17, 1988, and ending on 12:01 A.M. March 17, 2003. ARTICLE III RENT 3.1. RENT. During the term of this Lease, Tenant agrees to pay Landlord a minimum monthly rent of $7,210.00 (7,210 square feet x. $1.00 per sq. ft. - $7,210.00), called "the Rent" in this Lease), subject to adjustment as specified below, for the use and occupancy of the Property. 3.2. ADJUSTMENT FOR COST OF LIVING INCREASE. 3.2.1. SCHEDULED ADJUSTMENTS. The rent provided for in paragraph 3.1 shall be subject to adjustment at the commencement of the second year of the term and each year thereafter ("the adjustment date") as follows: The basis for computing the adjustment is the revised Consumer Price Index for All Urban Consumers for Los Angeles - Long Beach - Anaheim, California for All Items (1967 = 100), published by the United States Department of Labor, Bureau of Labor Statistics ("Index"), which is in effect on the date of the commencement of the term ("Beginning Index"). The Index most immediately preceding the adjustment date in question ("Extension 3 Index") is to be used in determining the amount of the adjustment. If the Extension Index has increased over the Beginning Index, the rent for the following year (until the next rent adjustment) shall be set by multiplying the rent set forth in paragraph 3.1 by a fraction, the numerator of which is the Extension Index and the denominator of which is the Beginning Index. In no event shall the rent be less than the rent set forth in paragraph 3.1. On adjustment of the rent as provided in this Lease, the parties shall immediately execute an amendment to this Lease, stating the new rent. In the event the Index is either unavailable, is no longer published, or is calculated on a significantly different basis following the date of this Lease, the most comprehensive official index published which most closely approximates the rate of inflation shall be substituted in place of the Index. 3.3. ADJUSTMENT FOR COMMON AREA COSTS. Tenant shall pay to Landlord, in addition to the rental heretofore specified, as further and additional rent, The Property's proportionate share of the common area operating costs as billed to the Landlord by the owners association. Operating costs mean the real property taxes and assessments and other taxes and assessments, including but not limited to liens or bonds, of any nature levied and assessed against the common areas, or assessed against the owners association as a result of the common areas; all sums expended by the owners association for the maintenance, repair, replacements, and operation of the common areas; and an allowance to the owners association for the owners association supervision, maintenance 4 and operation of the common areas. Costs for maintenance and operation of the common areas shall include, without limitation, cost of resurfacing, repainting and restriping, cleaning, sweeping, and other janitorial services, policing, purchase, construction, and maintenance of refuse receptacles, painting and relandscaping, directional signs and other markers, car stops, lighting and other utilities, reasonable depreciation allowance on improvements, machinery, and equipment used in connection with the common areas, premiums on public liability and property damage insurance, fire and earthquake insurance, if any, and other costs necessary in the owners association's judgment for the maintenance and operation of the common areas. Landlord will designate its agent for the sole purpose of obtaining information and other data from the owners association on all matters relating to the common areas, including operating costs of the common areas and asserting all rights which Landlord may have under the declaration to object to or modify the expense of the operating costs. 3.4. MANNER OF PAYMENT. The Rent is due and payable in advance in monthly installments commencing on the date the term of this Lease begins. In the event that any installment of the Rent is not paid within ten (10) days of a due date, a late penalty shall be added to such installment in the amount of five percent (5%) of such installment. In the event the Lease term shall commence on a date other than the first day of the month, the Rent shall be prorated to the end of such month in order that 5 the Rent thereafter becomes due on the first day of each month of the term of the Lease. The Rent and all other amounts due under this Lease shall be paid, without prior notice or demand, to Landlord at the address specified for notices to Landlord in this Lease, or at such other address as Landlord may from time to time specify by written notice to Tenant. 3.5. PERSONAL PROPERTY TAXES. Tenant agrees to pay all taxes, assessments, or other charges imposed by any government entity on personal property placed on The Property by Tenant, whether or not the personal property may, or will be, removed at the termination of this Lease. 3.6. REAL PROPERTY TAXES. Tenant agrees to pay to Landlord, prior to delinquency, all "taxes applicable to the Property," which shall include taxes, assessments, bonds and other charges imposed by any government entity on The Property, any special assessments imposed on The Property for the construction or improvement of public works for the benefit of The Property, and any tax, fee, or excise levied, assessed, and/or based on rent, on the square footage of The Property, on the act of entering into this Lease, or on Tenant's occupancy, or any other tax, fee, or excise, however described, in substitution or in addition to taxes applicable to The Property, including, without limitation, a so-called value added tax; provided, however, that Tenant shall not be required to pay any municipal, county, state, or federal income or franchise taxes of Landlord or transfer taxes of Landlord. 6 With respect to any assessments which may be levied against or on The Property and which under the laws then in force may be evidenced by improvement or other bonds or may be paid in annual installments, there shall be included within the definition of "taxes applicable to The Property," with respect to any tax fiscal year, only the current annual installment for such tax fiscal year. In the event The Property is not separately assessed, then the taxes, assessments and other charges shall be apportioned upon the ratio of total number of square feet in The Property to the total number of square feet in all offices in The Building. Within a reasonable time after the date Landlord receives each tax bill covering The Property, Landlord shall notify Tenant in writing of the following: (1) the total taxes applicable to The Property for the tax fiscal year in question; and (2) the basis for calculating the taxes applicable to The Property. Tenant's liability to pay taxes applicable to The Property shall be prorated on the basis of a 365-day year to account for any fractional portion of a tax fiscal year included in the term at its commencement and expiration. After expiration or termination of the term, Tenant shall pay to Landlord, immediately on demand, the amount remaining unpaid toward Tenant's obligation to pay taxes applicable to The Property for the partial tax fiscal year included in the term at its end, or Landlord shall pay to Tenant any excess amounts Tenant shall have paid to Landlord for such last tax fiscal year included in the term at its end, provided Tenant is not in default. 7 3.7. UTILITIES AND SERVICES. Tenant agrees to pay all charges whatsoever for the furnishing of utilities, including, but not necessarily limited to, gas, electricity, water, and telephone service to The Property and for removal of garbage from The Property. ARTICLE IV PREPARATION AND MAINTENANCE 4.1. CONDITION OF PROPERTY. Tenant accepts The Property, including the appurtenant facilities and improvements, in their present condition. Tenant has inspected The Property and stipulates that The Property and appurtenant facilities and improvements are in good, clean, safe, and tenantable condition as of the date of signing this Lease. 4.2. TRADE FIXTURES. Tenant may, at Tenant's expense, install trade fixtures on The Property for use in Tenant's business to be conducted on The Property. All trade fixtures, goods, effects, personal property, machinery, and equipment owned by Tenant, or installed at Tenant's expense, on The Property shall remain the personal property of Tenant and may be removed by Tenant at any time, and from time to time, during the term of this Lease; provided, that Tenant shall, in removing any such property, repair all damage to The Property caused by such removal and shall restore The Property to its original condition at the commencement of the term, reasonable wear and tear excepted. 4.3. ALTERATIONS TO PROPERTY. Tenant shall not make any alterations or additions on the demised premises nor make any 8 contract therefore without first procuring Landlord's written consent, except for nonstructural interior alterations and/or improvements made by Tenant to or upon the demised premises. All work with respect to alterations, additions, and changes must be done in a good and workmanlike manner and diligently prosecuted to completion to the end that the improvements on the demised premises shall at all times be a complete unit except during the period of work. Any changes, alterations, and improvements shall be performed and done strictly in accordance with the laws and ordinances relating thereto, and with the requirements of all carriers of insurance on the demised premises and the Board of Underwriters, Fire Rating Bureau, or similar organization. In performing the work of any such alterations, additions or changes, Tenant shall have the work performed in such a manner so as not to obstruct the access to The Building of any other tenant in The Building. Before commencing any such work or construction in or about the demised premises, Tenant shall notify Landlord in writing of the expected date of commencement thereof. Landlord shall have the right at any time and from time to time to post and maintain on the demised premises such notices as Landlord deems necessary to protect the demised premises and Landlord from the liens of mechanics, laborers, materialmen, suppliers or vendors. 4.4. SIGNS. Tenant may not install, or permit any other person to install, any sign, awning, canopy, marquee, or other advertising on any exterior wall, door, or window of The Property 9 or The Building without Landlord's prior written consent, which shall not be unreasonably withheld or delayed. The parties acknowledge that Tenant from time to time may engage in promotional advertising which includes the use of signs or other advertising affixed to the interior side of exterior windows. In such instances, Tenant shall not be required to obtain the Landlord's prior written consent before installing such signs. On the expiration or sooner termination of this Lease, Tenant shall remove any items which were permitted to be installed according to the terms of this paragraph. 4.5. LANDLORD'S MAINTENANCE DUTY. Landlord shall participate with the owners association as required by all the CC&R's and amendments in keeping in good order, condition and repair, including replacement if required, the roof, the foundations, bearing and exterior walls (excluding the interior of all walls, and any exterior or interior of any windows, doors, plateglass, display windows, and interior ceiling of The Property), subflooring, unexposed electrical, plumbing and sewage systems, including, without limitation, those portions of the system lying outside The Property, except for (a) any damage thereto caused by any act, negligence or omission of Tenant or its agents, contractors, servants, or employees, (b) reasonable wear and tear and (c) for any structural alterations or improvements required by a governmental agency by reason of Tenant's use and occupancy of The Property. Tenant shall reimburse Landlord for the costs which Landlord incurs in performing its obligations as aforesaid, with respect to the 10 building of which The Property are a part, and which is identified as 1600 E. Florida Avenue, Hemet, California. Said costs and expenses shall be paid to Landlord within ten (10) days of receipt of an invoice for the costs of same from Landlord. Landlord, where permitted by law and the CC&R's and amendments, shall have fifteen (15) days after written notice from Tenant to commence performance of Landlord's obligation under this paragraph, except that Landlord, where permitted by law and the CC&R's and amendments, shall perform its obligations immediately, if the nature of the problem presents a hazard or emergency. Tenant waives the provisions of any law permitting Tenant to make repairs at Landlord's expense. Tenant expressly agrees that the use of roof area shall be limited to ingress for maintenance purposes only, and that said roof areas shall not be used for storage, inventory and other similar uses. 4.6. TENANT'S MAINTENANCE DUTY. (1) Except as provided in paragraph 4.5, Tenant shall, during the term of this Lease, keep the demised premises in good order, condition and repair, including the improvements constructed by Tenant therein, and including the interior surface of exterior walls, ceiling, all windows, doors, door frames and door closures, plateglass, storefronts, and showcases, all heating and electrical equipment, air conditioning equipment and plumbing systems, if any, installed therein, and shall as necessary, or when required by governmental authority, make modifications or replacements thereof. Furthermore, Tenant shall keep in good order, condition and repair, including replacement as 11 required, the remote drive-through teller building and all its related areas. Upon Tenant's request, Landlord shall assign to Tenant all warranties applicable to the equipment, machinery and portions of The Property which Tenant is obligated to maintain or replace pursuant to this paragraph 4.6. (2) If Tenant refuses or neglects to make repairs and/or maintain the demised premises, or any part thereof, in a manner reasonably satisfactory to Landlord, Landlord shall have the right but shall not be obligated to make such repairs or perform such maintenance on behalf of and for the account of Tenant without liability to Tenant for any loss or damage that may accrue to Tenant's business by reason thereof. In such event, such work shall be paid for by Tenant as additional rent promptly upon demand. (3) Tenant shall contract with a service company for the maintenance of the heating and air conditioning equipment. 4.7. ENTRY BY LANDLORD. Landlord, and Landlord's agents and representatives, shall have the right to enter and inspect The Property at any reasonable time, for the purpose of ascertaining the condition of The Property, of exercising any right or performing any obligation of Landlord under this Lease, or of exhibiting The Property to prospective tenants, purchasers, mortgagees, or insurers of Landlord's interest in The Property. In case of emergency, Landlord shall have the right to enter The Property at any time; and, if Tenant is not present to permit such entry, Landlord may forcibly enter The Property and any such 12 entry shall not in any circumstances be construed or deemed to be a forcible or unlawful entry onto or a detainer of The Property or any portion of The Property. No entry by Landlord, permitted under this paragraph, shall be deemed a re-entry nor shall Tenant be entitled to compensation or abatement of rent for any inconvenience, nuisance, or discomfort occasioned by such entry. ARTICLE V USE OF PROPERTY 5.1. PERMITTED USE. Tenant agrees to use The Property for the sole purpose of operating a full-service bank branch and offering related financial services, during normal and customary business hours within the financial community of Hemet during the term of this Lease. Tenant may not use The Property for any other purpose than the primary purpose, or uses normally incident to the primary purpose, without Landlord's prior written consent, which shall not be unreasonably withheld. Tenant shall, at Tenant's own cost and expense, obtain any and all licenses and permits necessary for such use of The Property. 5.2. PROHIBITED USE. Tenant agrees not to do or permit to be done on or about The Property, nor to bring or keep or permit to be brought or kept on or about The Property, anything which is prohibited by or will in any way conflict with any law, statute, or government regulation now or hereafter in effect, which is prohibited by the standard form of fire insurance, or which will in any way increase the existing rate of, cause the cancellation of, or otherwise affect fire or any other insurance on The Property or any of its contents. Tenant agrees not to use or 13 allow The Property to be used for residential purposes or for any improper, immoral, unlawful, or objectionable purpose. Tenant agrees not to cause, maintain, or permit any nuisance on or about The Property and further agrees not to commit or suffer to be committed any waste on The Property. 5.3. COMPLIANCE WITH GOVERNMENT REGULATIONS. Tenant agrees to comply with all statutes, ordinances, regulations, and requirements, whether now in force or enacted during the term of this Lease, of all government entities having jurisdiction over Tenant's use and occupancy of The Property. Landlord may terminate this Lease immediately if Tenant is found to be in violation of any statute, ordinance, regulation, or requirement of any government entity and does not cure such violation within ninety (90) days of such violation. The judgment of any court, or the Tenant's admission of violation in any proceeding brought by a government entity, shall be conclusive proof between Landlord and Tenant of Tenant's violation. Such termination shall not relieve Tenant from any and all obligations under this Lease. ARTICLE VI INDEMNITY AND INSURANCE 6.1. INDEMNITY. Landlord shall not be liable to Tenant for any loss or damage to person or property caused by theft, fire, act of God, acts of the public enemy, riot, strike, insurrection, war, court order, requisition or order of governmental body or authority, or other causes beyond Landlord's reasonable control. Tenant shall indemnify Landlord and hold Landlord harmless of and from any and all loss, cost, damage, injury, or expense arising 14 out of or related to claims of injury to or death of persons or to claims of damage to property occurring or resulting directly or indirectly from Tenant's use or occupancy of The Property or from Tenant's activities on or about The Property, such indemnity to include, but without limitation, the obligation to provide all costs of defense against any such claims; provided, that such indemnity shall not extend to any such loss arising from Landlord's negligence. In addition, Tenant shall hold and save Landlord harmless and indemnify Landlord of and from any and all loss, cost, damage, injury, or expense arising out of or in any way related to claims for work or labor performed or to claims for materials or supplies furnished to or at the request of Tenant or in connection with performance of any work done for the account of Tenant on The Property. 6.2. LIABILITY INSURANCE. Tenant agrees to secure and maintain a broad form comprehensive coverage policy of public liability and property damage insurance, with a limit of not less than $3,000,000 combined single limit bodily injury and property damage coverage, issued by an insurance company acceptable to Landlord, insuring against loss or liability resulting from Tenant's use or occupancy of The Property or from Tenant's activities on or about The Property. Tenant agrees to name Landlord as an additional insured under the policy for the purpose of assuring Tenant's performance of the indemnity provisions set forth in paragraph 6.1 of this Lease, but Tenant's duty to indemnify Landlord is not limited to the amount of insurance procured pursuant to the terms of this paragraph 6.2. 15 6.3. ALL RISK INSURANCE. Tenant agrees to secure and maintain an all risk replacement cost insurance policy with agreed amount endorsement, issued by an insurance company acceptable to Landlord, covering any improvements, and Tenant's trade fixtures, equipment, and personal property of every description located on The Property, in an amount equal to the full replacement value thereof. 6.4. WAIVER OF SUBROGATION. The parties agree to release each other, and their respective authorized representatives, from any claims for damage to any person, The Property or any improvements on The Property, or Tenant's trade fixtures, equipment, or personal property located on The Property, caused by or resulting from risks insured against under any insurance policies carried by the parties pursuant to this Lease that are in force at the time of any such damage to the extent of the available insurance proceeds. Each party shall cause each insurance policy carried pursuant to this Lease by that party to be written to provide that the insurance company waives all right of recovery by way of subrogation against either party in connection with any damage covered by the policy. 6.5. EVIDENCE OF INSURANCE. Tenant agrees to deliver to Landlord a certificate of insurance, evidencing all insurance required to be maintained by Tenant under this Lease, prior to Tenant's occupancy of The Property. Notwithstanding any other provision of this Lease to the contrary, Landlord shall have no obligation to deliver possession of The Property to Tenant until Landlord has received the certificate of insurance. Upon request 16 of Tenant, Landlord shall provide to tenant a certificate of insurance evidencing all insurance required to be maintained by the Landlord under this Lease. ARTICLE VII DESTRUCTION OR CONDEMNATION 7.1. LANDLORD'S OBLIGATION TO RESTORE THE PROPERTY. Subject to the provisions of paragraphs 7.2, 7.3, and 7.4 of this Article, in case of damage to The Property by fire or other casualty against which Landlord is insured pursuant to paragraph 6.3 of this Lease or through the owners association, Tenant shall give immediate notice in writing of the damage to Landlord, who shall, on receipt of the notice, rebuild and restore The Property to its former condition or cause the owners association to do so, with reasonable speed, at Landlord's expense, subject to delays which may arise by reason of adjustment of loss under insurance policies and for delays beyond Landlord's reasonable control. To the extent that any part of The Property is rendered untenantable as a result of the damage, the rent shall abate proportionately from the date of the damage until the restoration of The Property is completed. Untenantable as used in this section shall be interpreted to mean that Tenant cannot use that portion of The Property in Tenant's normal business operation or is precluded from using it by operation of law. 7.2. LANDLORD'S OPTION TO TERMINATE THE LEASE. If The Property is damaged or destroyed by any cause whatsoever, and if, in Landlord's reasonable opinion, The Property cannot be rebuilt or made fit for Tenant's purposes within 180 days after the 17 damage or destruction, instead of rebuilding and restoring The Property Landlord may terminate this Lease by giving notice of termination to Tenant within 30 days after such damage or destruction. On giving such notice, the rent shall be apportioned and paid to the date of the damage, and Tenant shall immediately deliver up possession of The Property to Landlord. 7.3. DAMAGE DURING LAST YEAR OF TERM. If The Property is substantially destroyed by fire or other causes at any time during the last year of the term of this Lease, either Landlord or Tenant may terminate this Lease on written notice to the other party given within 60 days of the date of such destruction. Termination shall be effective within 30 days after the notice is given, the rent shall abate proportionately from the date of the destruction until the date of termination, and Tenant shall deliver up possession of The Property to Landlord on the date of termination. 7.4. NO CLAIMS. Any insurance proceeds received by Landlord because of damage to or destruction of all or a portion of The Property shall be the Landlord's sole property, and Tenant agrees to make no claim against the proceeds. No damages, compensation, or claim in excess of any insurance proceeds shall be payable by Landlord to Tenant for inconvenience, loss of business, or annoyance arising from any repair or restoration of any portion of The Property pursuant to paragraph 7.1 of this Lease. Landlord shall use best efforts to effect such repairs or restoration promptly and in such manner as not to interfere unreasonably with Tenant's occupancy. 18 7.5. TOTAL TAKING. In the event that the whole or substantially the whole of The Property is lawfully condemned or taken in any manner for public or quasi-public use, this Lease, and the term and estate granted by this Lease, shall cease forthwith and terminate as of the date of taking of possession of The Property for such public or quasi-public use. 7.6. PARTIAL TAKING. If more than 50 percent of The Property is condemned or taken, either party may elect at any time within 30 days of the date of the condemnation or taking to cancel this Lease on written notice to the other, and this Lease shall terminate on the date specified in the notice, which date shall be no earlier than the date of the condemnation or taking. If this Lease continues in force as to any part of The Property following any such condemnation or taking, the rent shall be diminished by an amount representing the part of the rent that is properly applicable to the portion of The Property which is condemned or taken. If less than fifty percent (50%) of The Property is condemned or taken and if the condemnation or taking renders the remaining portion of The Property unsuitable for Tenant's continued use of The Property, either party may, on 30 days written notice to the other, terminate this Lease as of the date of the condemnation or taking. 7.7. TERMINATION OF THE LEASE ON TAKING. In the event of the termination of this Lease pursuant to the provisions of paragraph 7.5 or 7.6, this Lease, and the term and estate granted by this Lease, shall expire as of the date of such termination in the same manner and with the same effect as if that were the date 19 set for the normal expiration of the term of this Lease, and the rent shall be apportioned as of that date. 7.8. CONDEMNATION AWARD. Except as otherwise provided in paragraph 7.9 of this Lease, Landlord shall be entitled to receive the entire award in any condemnation proceeding without deduction therefrom for any estate vested in Tenant by this Lease, and Tenant shall receive no part of such award. Tenant expressly assigns to Landlord any and all of Tenant's right, title, and interest in or to such award or any part of such award. Notwithstanding the foregoing, Tenant shall be entitled to appear, claim, prove, and receive in the condemnation proceeding such award as may be made that represents the loss or damage to Tenant's trade fixtures and removable personal property located on The Property, removal or relocation costs, and the unamortized balance of any improvements or alterations installed on The Property at Tenant's expense. 7.9. TEMPORARY TAKING. If the temporary use or occupancy of all or any part of The Property is condemned or taken for any public or quasi-public use during the term of this Lease, this Lease shall remain unaffected by such condemnation or taking, and Tenant shall continue to pay in full all sums payable by Tenant under this Lease. In the event of any such condemnation or taking, Tenant shall be entitled to appear, claim, prove, and receive in the condemnation proceeding such award as may be made that represents compensation for the use and occupancy of The Property during the term of this Lease and Landlord shall be entitled to appear, claim, prove, and receive such award as may 20 be made that represents compensation for the use and occupancy of The Property after the end of the term of this Lease. 7.10. RESTORATION OF THE PROPERTY. In the event of any condemnation or taking of less than the whole of The Property, and this Lease shall continue in effect, in whole or in part, or in the event of a condemnation or taking for a temporary use or occupancy of all or any part of The Property, Landlord, to the extent that the condemnation award shall be sufficient for the purpose, shall restore the remaining part of The Property to substantially its former condition to the extent that this is feasible. ARTICLE VIII ASSIGNMENT AND SUBLEASING 8.1. LIMITATION ON ASSIGNMENT OR SUBLEASING. Tenant may not assign, encumber, or otherwise transfer all or any part of Tenant's interest in The Property, sublease all or any part of The Property, or allow any person except Tenant's authorized agents or employees, to occupy or otherwise use all or any part of The Property, without Landlord's prior written consent. The occupancy of The Property by any successor firm of the Tenant, or any firm into which the Tenant may become merged, and any entity controlling, under common control with, or controlled by, Tenant shall not be deemed an assignment of this Lease. Any assignment, transfer, encumbrance, or sublease without Landlord's prior written consent is voidable by Landlord. This Lease shall continue in effect for so long as Landlord does not terminate Tenant's right to possession, and Landlord may enforce all rights 21 and remedies under this Lease, including the right to recover the rent as it becomes due. 8.2. CONSENT NOT TO BE UNREASONABLY WITHHELD. Landlord's consent to any assignment, transfer, encumbrance, or sublease may not be unreasonably withheld, provided that any transferee (assignee or sublessee, as appropriate) shall execute Landlord's form of lease, assuming all terms, covenants, and conditions of this Lease. A consent given to a particular assignment, transfer encumbrance, or sublease shall not constitute a consent to any subsequent assignment, transfer, encumbrance, or sublease, or a waiver of the provisions of this Article. 8.3. ASSIGNMENT OF RENTS ON SUBLEASING. If Landlord's consent to a sublease is obtained as provided above, Tenant shall immediately and irrevocably assign to Landlord all rent from the sublease. However, so long as Tenant is not in default with regard to the payment of rent under this Lease, Tenant may collect the rents from any subtenants. If at any time after the assignment is made, Tenant defaults in the payment of rent, Landlord may collect the rent due from any subtenants and apply it toward Tenant's obligations under this Lease. However, Landlord's acceptance of rent from any transferee of Tenant shall not constitute a consent to the transfer or a waiver of Tenant's breach of the covenants contained in this Article. 8.4. TRANSFER OF RIGHTS NOT DEEMED AN ASSIGNMENT. If Tenant, or any permitted assignee or subtenant of Tenant, is a corporation, and if at any time during the term of this Lease any part or all of the corporate shares or voting rights of 22 shareholders shall be transferred by sale, assignment, bequest, inheritance, trust, operation of law, or other disposition, or treasury shares be issued so as to result in a change in the control of the corporation by reason of ownership of greater than 50 percent of the voting shares of the corporation or otherwise, then such transfer or issue shall not be deemed an assignment for the purposes of this Article. Tenant shall, however, notify Landlord in writing of any such changes and, on Landlord's request, shall make available to Landlord for inspection appropriate books and records of Tenant which, alone or with other data, provide Landlord with adequate information concerning the change of control. 8.5. EFFECT OF TERMINATION OF LEASE ON SUBTENANTS. In the event of a termination of this Lease, at Landlord's option, each subtenant of space on The Property shall attorn to Landlord and shall be deemed to have agreed to the provisions of this paragraph. ARTICLE IX TERMINATION OF LEASE 9.1. TERMINATION ON TENANT'S DEFAULT. In the event that (i) Tenant defaults in the payment of rent and such default continues for a period of 10 consecutive days, or (ii) Tenant vacates or abandons The Property for a continuous period in excess of 10 days, or (iii) Tenant defaults in the performance of any obligation required to be performed by Tenant under this Lease (other than abandonment or the payment of rent) and fails for a period of 20 days after written notice from Landlord 23 specifying such default to cure the default (unless the default cannot be cured within this 20-day period, in which case Tenant shall commence to cure the default within the 20-day period and shall cure the default with all reasonable dispatch), or (iv) Tenant is adjudicated bankrupt, or a petition by or against Tenant for reorganization or adjustment of Tenant's obligations under the Bankruptcy Act or any other existing or future insolvency or bankruptcy statute is approved, or Tenant makes a general assignment of Tenant's property for the benefit of creditors, or a receiver or trustee is appointed to take control of Tenant's business or assets, then, and in each such case, Landlord may, at Landlord's option, terminate Tenant's right to possession and thereby terminate this Lease, or without terminating this Lease, Landlord may re-enter The Property and for the account of Tenant re-let The Property, or any portion or portions of The Property, for all or any part of the unexpired term of this Lease on such terms and conditions as Landlord may elect. 9.2. DAMAGES RECOVERABLE ON TERMINATION. In the event of a termination of this Lease by Landlord pursuant to paragraph 9.1, Landlord shall be entitled to recover from Tenant (i) the worth at the time of award of the unpaid rent which had been earned at the time of termination, (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided, (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time 24 of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided, and (iv) any other amount necessary to compensate Landlord for all detriment proximately caused by Tenant's failure to perform Tenant's obligations under this Lease, or, which in the ordinary course of things, would be likely to result from Tenant's failure to perform. Efforts by Landlord to mitigate the damages caused by Tenant's breach of this Lease shall not constitute a waiver by Landlord of Landlord's right to recover damages under this Lease. 9.3. "WORTH AT THE TIME OF AWARD". The "worth at the time of award" of the amounts referred to in subsections (i) and (ii) of paragraph 9.2 shall be computed with interest at the lesser rate of 18 percent per year or the maximum rate allowed by law. The "worth at the time of award" of the amount referred to in subsection (iii) of paragraph 9.2 shall be computed by reference to competent appraisal evidence or the formula prescribed by and using the lowest discount rate permitted under applicable law. 9.4. LANDLORD'S RIGHT TO RE-LET THE PROPERTY ON TENANT'S DEFAULT. In the event that Landlord re-lets The Property, without terminating this Lease, pursuant to paragraph 9.1, Landlord shall be entitled to recover monthly from Tenant the difference between the monthly installments of Basic Rent and such other amounts as may be payable by Tenant to Landlord pursuant to the provisions of this Lease over the total monthly rental received by Landlord on such re-letting, after first deducting therefrom all expenses reasonably incurred by Landlord in such re-letting and in repairing, renovating, remodeling, and 25 altering The Property for the purpose of such re-letting. Landlord shall not be deemed to have elected to terminate this Lease, the liability of Tenant to pay rent, or the liability of Tenant for damages under any of the provisions of this Lease by any such re-letting or by any action in unlawful detainer or otherwise to obtain possession of The Property, unless Landlord shall have notified tenant in writing that Landlord has so elected to terminate this Lease. For purposes of this Article, the following shall not constitute termination of Tenant's right to possession: (1) acts of maintenance or preservation or efforts to re-let The Property; or, (2) the appointment of a receiver on Landlord's initiative to protect Landlord's interest under this Lease. Nothing contained in this Article shall be construed as obligating Landlord to re-let the whole or any part of The Property. In the event of any re-letting of The Property, Landlord shall have the right, but not the obligation, to remove from The Property all or any part of the personal property located on The Property and may place such personal property in storage at a public warehouse selected by Landlord, at the expense and risk of the owner or owners of such personal property. 9.5. ADDITIONAL REMEDIES. The remedies provided to Landlord by this Article shall be cumulative and shall be in addition and supplemental to all other rights or remedies which Landlord may lawfully pursue in the event of any breach or threatened breach by Tenant of any of the provisions of this Lease. 26 ARTICLE X MISCELLANEOUS PROVISIONS 10.1. NOTICES AND RENT PAYMENTS. Except as otherwise expressly required by law, all rent payments are deemed tendered, and all notices required to be given by this Lease are deemed duly served, either when personally delivered to the party to whom it is addressed, or when mailed by registered or certified mail addressed as follows: Landlord: TDE, INCORPORATED 5602 East Second Street Long Beach, California 90803 Tenant: THE BANK OF HEMET 1600 E. Florida Avenue, Suite 211 Hemet, California 92344 Landlord and Tenant may change their respective addresses by giving written notice to the other in the manner specified in this paragraph. Any notice mailed, as provided in this paragraph, shall be effective at the expiration of 72 hours after deposit of the notice, with postage prepaid, in the United States mail at any place within the State of California. 10.2. INTERPRETATION. This Lease is to be construed and interpreted in accordance with the laws of the State of California. If any provision of this Lease is held either invalid, void, or unenforceable by a court of competent jurisdiction, the remaining provisions of this Lease remain in full force and effect. This instrument constitutes the entire agreement between Landlord and Tenant, and correctly sets forth the obligations and rights of Landlord and Tenant with respect to each other and The Property as of the date of signing this Lease. Any 27 agreements or representations not expressly set forth in this Lease are null and void. This Lease has been drafted on the basis of the parties' mutual contributions of language and it is not to be construed against any party as being the drafter (or causing the drafting) of this Lease. 10.3. HEADINGS. The headings of the articles and paragraphs of this Lease are inserted for convenience only and do not constitute part of this Lease and may not be used in its construction. 10.4. ATTORNEYS' FEES. If either Landlord or Tenant commences any legal action or proceeding against the other party to enforce the provisions of this Lease, the prevailing party is entitled to recover reasonable attorneys' fees and costs of suit, including attorneys' fees and costs on appeal. 10.5. COUNTERPARTS. For the convenience of the parties, this Lease may be executed in one or more counterparts, which must each be considered an original. All of the counterparts constitute one and the same instrument. 10.6. QUIET ENJOYMENT. So long as Tenant is not in default under any of the covenants and agreements of this Lease, Tenant's quiet and peaceful enjoyment of The Property shall not be disturbed or interfered with by Landlord or by any person claiming by, through, or under Landlord. 10.7. HOLDING OVER. In the event Tenant shall hold The Property after the expiration of the term of this Lease with the express or implied consent of Landlord, such holding over shall be deemed to have created a tenancy from month to month, 28 terminable on 30 days notice by either party to the other, at a monthly Rent equal to the monthly rent then in effect. 10.8. TRANSFERS BY LANDLORD. Landlord shall have the right to transfer and assign, in whole or in part, all of Landlord's rights and obligations under this Lease and in The Property, and in such event and on assumption by Landlord's transferee of Landlord's obligations under this Lease, no further liability or obligations shall accrue against Landlord under this Lease, and Landlord shall be entirely relieved of all agreements and conditions of this Lease to be performed by Landlord. Tenant agrees to attorn to any such transferee or assignee. 10.9. ESTOPPEL CERTIFICATES. Tenant agrees, from time to time, within 20 days after Landlord's request, to deliver to Landlord, or Landlord's designee, an estoppel certificate stating that this Lease is unmodified and in full force and effect (or if there have been modifications, that the Lease is in full force and effect as modified and stating the modifications), the date to which rent and other charges have been paid, the unexpired term of this Lease, whether there are any defaults or rent abatements or offsets claimed by Tenant, and such other matters pertaining to this Lease as may be reasonably requested by Landlord or Landlord's mortgagee, assignee, or transferee, it being intended that any such statement delivered pursuant to this paragraph may be relied on by any prospective purchaser of all or any part of Landlord's interest in The Property or by any mortgagee or assignee of any mortgage on all or any part of Landlord's interest in The 29 Property and their respective successors and assigns. 10.10. MODIFICATION. This Lease may not be altered, changed, or amended except by an instrument in writing signed by Landlord and Tenant. 10.11. TIME IS OF THE ESSENCE. Time is of the essence of this Lease, and all provisions of this Lease relating thereto shall be strictly construed. 10.12. RELATIONSHIP OF PARTIES. Nothing contained in this Lease shall be deemed or construed by Landlord and Tenant, nor by any third party, as creating the relationship of principal and agent, of partnership, or of joint venture by Landlord and Tenant, it being understood and agreed that no provision contained in this Lease, nor any acts of Landlord and Tenant, shall be deemed to create any relationship other than the relationship of landlord and tenant. 10.13. COVENANTS AND CONDITIONS. All of the obligations of Landlord and Tenant under this Lease shall be deemed and construed to be conditions as well as covenants, as though the words specifically expressing or importing covenants and conditions were used in each separate instance. 10.14. SALE OF PROPERTY. Notwithstanding any of the provisions of this Lease, Landlord may: (1) assign in whole or in part Landlord's interest in this Lease; and (2) sell all or any part of The Building or the leased premises. 30 10.15. BINDING ON SUCCESSORS. The covenants and agreements herein contained shall bind and inure to the benefit of Landlord and Tenant's successors and assigns, and Tenant, and each of its partners, their heirs, personal representatives, successors and assigns, subject to the provisions of this Lease. 10.16. AUTHORITY OF TENANT CORPORATION. A certified copy of the resolution of the board of directors of Tenant which authorizes the signatories to this Lease on Tenant's behalf to enter into and execute this Lease and to take all further actions necessary to implement the provisions of this Lease is contained in Exhibit B which is attached to and made a part of this Lease by this reference. 10.17. USE OF TENANT'S NAME. So long as Tenant remains as tenant in The Bank of Hemet Professional Building, the Landlord covenants and agrees, if Landlord hereafter acquires fee ownership of The Building or ownership interest of a majority of the condominium units in The Building, The Building shall be known as The Bank of Hemet Professional Building and so designated in all advertising for The Building. In any event, Landlord further covenants and agrees that it shall use its best efforts to preserve use of the name The Bank of Hemet Professional Building for The Building so long as Tenant remains a tenant in said building. In addition, so long as Tenant remains a tenant in The Bank of Hemet Professional Building, the Landlord may, upon written consent of the Tenant, incorporate in its signs Tenant's logo, a 31 copy of which is attached hereto as Exhibit B and incorporated herein by reference. Landlord shall submit to Tenant for review and approval, before fabrication, a detailed drawing covering the location, size, layout, design and color, including all lettering and graphics, of any proposed sign which incorporates the words, "The Bank of Hemet," or The Bank of Hemet logo. Tenant's approval shall not be unreasonably withheld. In the event Tenant is acquired by, merges or consolidates with another business entity and, as a result, changes its name but remains a tenant under its new name, then Landlord covenants and agrees, if Landlord hereafter acquires fee ownership of The Building, that the name of The Building shall be changed to Tenant's new name for so long as Tenant remains a tenant in The Building. Tenant shall pay all costs of modifying signage and other identifying features of The Building to reflect The Building's new name. This covenant shall survive assignment of this Lease by Landlord or Tenant and shall be binding upon the successors and assigns of Landlord. 10.18. PARKING AND TRAFFIC CIRCULATION. In addition to the parking rights conferred on Tenant pursuant to the common area provisions of the lease, the Tenant shall be entitled to the exclusive use of the parking spaces subject to approval of owners association and entrance and exit traffic lanes to the drive-through remote tellers, all of which are highlighted in charcoal grey on Exhibit A, attached. 32 The traffic circulation in the parking areas, as it exists as of the date of execution of this Lease, is an integral part of the efficient functioning of customer access to Tenant and use of the drive-through remote teller islands. In the event Landlord hereafter acquires fee ownership of The Building or ownership interest of a majority of the condominium units in The Building, Landlord shall not rearrange or redesignate the existing traffic circulation, as of the date of this Lease, without the prior written consent of Tenant, which shall not be unreasonably withheld. In any event, Landlord further covenants and agrees that it shall use its best efforts to preserve the existing traffic circulation, as of the date of this Lease, without the prior written consent of Tenant, which shall not be unreasonably withheld. 10.19. TENANT TO ABIDE BY RULES. Tenant agrees to observe, abide by and conform to the rules and regulations pertaining to the use and occupancy of The Property and The Building, and acknowledges receipt of a copy of the rules and regulations and amendments thereto. Tenant understands that the property is part of a project which is subject to the provisions of a Declaration, Articles of Incorporation, and Bylaws ("project documents"). In addition, the project is subject to the rules and regulations as adopted by the board of directors of the owners association. In the event of any conflict between project documents and this Lease, the project documents shall control. Tenant hereby acknowledges receipt of a copy of each of said documents, represents that is 33 has read the same and agrees to abide by all of the terms, provisions and conditions of said documents, and further agrees to abide by any and all rules and regulations not now in effect but hereafter adopted by the board of directors of the owners association or by the association itself. Breach of this covenant by Tenant shall be grounds for termination of the Lease. Executed on March 15, 1988, at Hemet, California. LANDLORD: TDE, INCORPORATED. A California Corporation By: /s/ Norene E. Scott ------------------------------------- NORENE E. SCOTT, President TENANT: THE BANK OF HEMET By: /s/ James B. Jaqua ------------------------------------- JAMES B. JAQUA, President 34 Exhibit A [FLOOR PLAN] [FLOOR PLAN] BANK OF HEMET PROFESSIONAL BUILDING ----------------------------------- BASEMENT PARKING SPACE ALLOCATION ASSIGNMENTS ADDENDUM TO LEASE Pursuant to that Lease dated March 15, 1988 between THE BANK OF HEMET, a California Corporation as tenant ("Tenant in said Lease), and TDE INCORPORATED, a California Corporation, as Landlord ("Landlord" in said Lease), both parties here agree to modifications to the Lease as follows: ARTICLE III Section 3.4 MANNER OF PAYMENT Paragraph one, line five, strike out the word "Penalty" and substitute "Charge". Section 3.6 REAL PROPERTY TAXES In the last sentence of the first paragraph, strike out "transfer taxes of Landlord" and substitute "any taxes imposed on income from the sale of the property by Landlord". ARTICLE IV Section 4.4 SIGNS Paragraph one, line ten, to the sentence ending "before installing such signs," add ", Provided tenant obtains prior approval from the Condominium Association". Section 4.6.(1) TENANT'S MAINTENANCE DUTY Second paragraph, second line, strike "all warranties applicable to" and substitute "any warranties, held by Landlord applicable to". Article 4.6.(3) TENANT'S MAINTENANCE DUTY Delete existing sentence and substitute the following sentence: Tenant shall contract for and pay the costs of maintenance of all heating and air conditioning equipment not maintained by the owners association. ARTICLE V Section 5.1 PERMITTED USE In the first sentence after the word "bank" add "or savings and loan". Strike the second sentence and substitute the following sentence: Tenant may not use the Property for any other purpose than the sole purpose set forth above, or uses incident thereto, without the prior written consent of Landlord, which shall not be unreasonably withheld. ARTICLE VIII Section 8.1 LIMITATION ON ASSIGNMENT OR SUBLETTING In the third sentence strike "is voidable by Landlord" and substitute "shall be void". Section 8.2 CONSENT NOT TO BE UNREASONABLY WITHHELD At the point in the first sentence after the word "appropriate" add "provided that any transferee shall operate a full service Bank branch or savings and loan branch office offering related financial services and". At the end of Paragraph one add the sentence "Landlord's consent to any assignment, transfer, encumbrance, or sublease, however, shall not release Tenant from its obligation under this Lease". ARTICLE X Section 10.19 TENANT TO ABIDE BY RULES Paragraph two, last sentence reads "Breach of this covenant by Tenant shall be grounds for termination of the Lease" which shall be modified as follows; "Breach of this covenant by Tenant shall be considered an event of default pursuant to Article IX, Section 9.1 of this Lease". Section 10.20 NON WAIVER (to be added to ARTICLE X) No covenant, term or condition, or breach thereof, shall be deemed waived except if expressly waived in a written instrument executed by Landlord, and any such waiver of such breach shall not be deemed to be a waiver of any preceding or succeeding breach. Acceptance of all or any portion of rent at any time shall not be deemed to be a waiver of any covenant, term or condition, except as to the rent payment accepted. Executed on March 17, 1988 Tenant: THE BANK OF HEMET By: /s/ James B. Jaqua ----------------------------------- James B. Jaqua, President Landlord: TDE, INCORPORATED a California Corporation By: /s/ Norene E. Scott ----------------------------------- NORENE E. SCOTT, PRESIDENT EX-10.10 22 EXHIBIT 10.10 EXHIBIT 10.10 Form of Executive Employment Agreement (M. Lentini dated September 26, 1996 N. Douglas Mills between B. Parrott and Certain executives and Valley Bank M. Nugent) EXECUTIVE EMPLOYMENT AGREEMENT This Executive Employment Agreement is made and entered into this 26 day of Sept. 1996, by and between VALLEY BANK, a corporation organized and existing under the laws of the State of California (hereinafter called the "Corporation"), and ____________________ (hereinafter called the "Executive"). RECITALS A. Executive has been in the employ of the Corporation serving as its ________________________________, since ____________________; B. The Corporation wishes to continue to retain Executives services on the terms and conditions set forth in this Agreement: and C. Executive wishes to continue in the employ of the Corporation on the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the services to be performed in the future as well as the mutual promises and covenants herein contained, it is agreed as follows: AGREEMENT ARTICLE I 1.1 EMPLOYMENT - Corporation agrees to employ the Executive as its _______ ________________________, and Executive agrees to serve in that capacity. Corporation shall employ Executive in such capacity and with such duties and responsibilities as may be assigned to Executive from time-to-time by the Corporation. Executive will be compensated at a salary commensurate to peer industry standards. Said salary shall not be less than $______. per annum and may be increased periodically to maintain parity with peer industry standards, as determined in the discretion of the Corporation's Board of Directors. 1.2 FULL EFFORTS - The Executive agrees to devote Executive's full time and attention exclusively to the business and affairs of Corporation, except during vacation periods, and to use Executive's best efforts to furnish faithful and satisfactory services to the Corporation. 1.3 TERM OF AGREEMENT - Unless renewed or extended by the mutual, written consent of the parties, this Agreement shall automatically expire five (5) years from the date above, unless terminated earlier pursuant to Article 2. In the event Corporation elects to extend, renew, or renegotiate this Agreement with Executive, in no instance may its term be extended beyond Executive's ________________ birthday, which is _________________. ARTICLE 2 2.1 TERMINATION OF EMPLOYMENT BY EXECUTIVE - If the Executive terminates Executive's employment prior to the expiration of the employment term specified in Article 1, Executive shall give Corporation 15 days advance notice of such termination. The obligations of Corporation under this Agreement shall end upon termination of Executive's employment. 2.2 TERMINATION OF EMPLOYMENT BY CORPORATION FOR CAUSE - Corporation may terminate this Agreement, and Executive's employment, for "cause", which for purposes of this Article shall include willful material breach by Executive of any material provision of this Agreement, willfully engaging in any business activities that materially conflict with Executive's duties to Corporation, willful failure to perform Executive's duties under this Agreement, or any criminal, unlawful, fraudulent or dishonest act. In the event this Agreement, and Executive's employment, are terminated for cause, Executive shall not be entitled to receive any compensation hereunder, except such base salary as shall have been earned prior to the date of such termination. 2.3 TERMINATION OF EMPLOYMENT BY CORPORATION OTHER THAN CAUSE - Corporation reserves the right to terminate the employment of Executive at any time, without cause, upon notice to Executive. Such termination shall be effective upon Corporation giving notice to Executive. In the event the employment of Executive shall be terminated by Corporation other than for cause or disability, Corporation shall pay Executive an amount equal to one (1) year of Executive's then current annual salary, multiplied by a factor of 140%, plus such base salary as shall have been earned prior to the date of such termination. 2.4 REMEDIES OF EXECUTIVE FOR EMPLOYMENT TERMINATION - Executive acknowledges and agrees that the provisions of this Article 2 and of Article 4 state Executive's entire and exclusive rights, entitlements and remedies against Corporation, its employees and representatives for termination of employment and/or termination of this Agreement. ARTICLE 3 3.1 BENEFIT PLANS AND OTHER BENEFITS - During Executive's employment under this Agreement, Executive shall be eligible to participate in all retirement, profit sharing, group insurance, bonus, ESOP, 401-K, vacation or similar employee benefit plans which Corporation may now have or hereafter make generally available to its executive staff, subject to the terms and conditions of such plans and programs. ARTICLE 4 4.1 REORGANIZATION - The Corporation shall not sell, merge, consolidate into or with another corporation, firm, or person, or transfer controlling ownership of the Corporation, unless and until such succeeding entity agrees to assume and discharge the obligations of the Corporation under this agreement Upon the occurrence of such event, the term "Corporation" as used in this agreement shall be deemed to refer to such successor or survivor corporation. In the event the succeeding entity refuses to assume and discharge the obligations of Corporation under this Agreement, Corporation may terminate this Agreement, and all obligations to Executive, by paying to Executive an amount equal to _________ years of Executive's then current annual salary, multiplied by a factor of 140%, before consummating such sale, merger, consolidation or transfer. ARTICLE 5 5.1 ENTIRE AGREEMENT - This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and supersedes all other written or oral agreements, understandings or negotiations on the subject matter addressed herein. IN WITNESS WHEREOF, Corporation has caused this agreement to be duly executed by its Chairman of the Board and Executive has hereunder set his hand at Moreno Valley, CA., the day and year first above written. EXECUTIVE VALLEY BANK By: /s/ Marion V. Ashley - ---------------------------------- --------------------------------------- Marion V. Ashley, Chairman of the Board EX-10.11 23 EXHIBIT 10.11 EXECUTIVE EMPLOYMENT AGREEMENT This Executive Employment Agreement is made and entered into this 26 day of Sept., 1996, by and between VALLEY BANK, a corporation organized and existing under the laws of the State of California (hereinafter called the "Corporation"), and N. Douglas Mills (hereinafter called the "Executive"). RECITALS A. Executive has been in the employ of the Corporation serving as its President & Chief Executive Officer, since July 6, 1992; B. The Corporation wishes to continue to retain Executives services on the terms and conditions set forth in this Agreement; and C. Executive wishes to continue in the employ of the Corporation on the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the services to be performed in the future as well as the mutual promises and covenants herein contained, it is agreed as follows: AGREEMENT ARTICLE I 1.1 EMPLOYMENT - Corporation agrees to employ the Executive as its President & Chief Executive Officer, and Executive agrees to serve in that capacity. Corporation shall employ Executive in such capacity and with such duties and responsibilities as may be assigned to Executive from time-to-time by the Corporation. Executive will be compensated at a salary commensurate to peer industry standards. Said salary shall not be less than $140,000. per annum and may be increased periodically to maintain parity with peer industry standards, as determined in the discretion of the Corporation's Board of Directors. 1.2 FULL EFFORTS - The Executive agrees to devote Executive's full time and attention exclusively to the business and affairs of Corporation, except during vacation periods, and to use Executive's best efforts to furnish faithful and satisfactory services to the Corporation. 1.3 TERM OF AGREEMENT - Unless renewed or extended by the mutual, written consent of the parties, this Agreement shall automatically expire five (5) years from the date above, unless terminated earlier pursuant to Article 2. In the event Corporation elects to extend, renew, or renegotiate this Agreement with Executive, in no instance may its term be extended beyond Executive's sixty-fifth (65th) birthday, which is July 28, 2004. ARTICLE 2 2.1 TERMINATION OF EMPLOYMENT BY EXECUTIVE - If the Executive terminates Executive's employment prior to the expiration of the employment term specified in Article I, Executive shall give Corporation 15 days advance notice of such termination. The obligations of Corporation under this Agreement shall end upon termination of Executive's employment. 2.2 TERMINATION OF EMPLOYMENT BY CORPORATION FOR CAUSE - Corporation may terminate this Agreement, and Executive's employment, for "cause", which for purposes of this Article shall include willful material breach by Executive of any material provision of this Agreement, willfully engaging in any business activities that materially conflict with Executive's duties to Corporation, willful failure to perform Executive's duties under this Agreement, or any criminal, unlawful, fraudulent or dishonest act. In the event this Agreement, and Executive's employment, are terminated for cause, Executive shall not be entitled to receive any compensation hereunder, except such base salary as shall have been earned prior to the date of such termination. 2.3 TERMINATION OF EMPLOYMENT BY CORPORATION OTHER THAN CAUSE - Corporation reserves the right to terminate the employment of Executive at any time, without cause, upon notice to Executive. Such termination shall be effective upon Corporation giving notice to Executive. In the event the employment of Executive shall be terminated by Corporation other than for cause or disability, Corporation shall pay Executive an amount equal to two (2) years of Executive's then current annual salary, multiplied by a factor of 140%, plus such base salary as shall have been earned prior to the date of such termination. 2.4 REMEDIES OF EXECUTIVE FOR EMPLOYMENT TERMINATION - Executive acknowledges and agrees that the provisions of this Article 2 and of Article 4 state Executive's entire and exclusive rights, entitlements and remedies against Corporation, its employees and representatives for termination of employment and/or termination of this Agreement. ARTICLE 3 3.1 BENEFIT PLANS AND OTHER BENEFITS - During Executive's employment under this Agreement, Executive shall be eligible to participate in all retirement, profit sharing, group insurance, bonus, ESOP, 401-K, vacation or similar employee benefit plans which Corporation may now have or hereafter make generally available to its executive staff, subject to the terms and conditions of such plans and programs. ARTICLE 4 4.1 REORGANIZATION - The Corporation shall not sell, merge, consolidate into or with another corporation, firm, or person, or transfer controlling ownership of the Corporation, unless and until such succeeding entity agrees to assume and discharge the obligations of the Corporation under this agreement. Upon the occurrence of such event, the term "Corporation" as used in this agreement shall be deemed to refer to such successor or survivor corporation. In the event the succeeding entity refuses to assume and discharge the obligations of Corporation under this Agreement, Corporation may terminate this Agreement, and all obligations to Executive, by paying to Executive an amount equal to three (3) years of Executive's then current annual salary, multiplied by a factor of 140%, before consummating such sale, merger, consolidation or transfer. ARTICLE 5 5.1 ENTIRE AGREEMENT - This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and supersedes all other written or oral agreements, understandings or negotiations on the subject matter addressed herein. IN WITNESS WHEREOF, Corporation has caused this agreement to be duly executed by its Chairman of the Board and Executive has hereunder set his hand at Moreno Valley, CA., the day and year first above written. EXECUTIVE VALLEY BANK /s/ N. Douglas Mills By: /s/ Marion V. Ashley - --------------------------------- ---------------------------------------- N. Douglas Mills (###-##-####) Marion V. Ashley, Chairman of the Board EXECUTIVE EMPLOYMENT AGREEMENT - Amendment The Executive Employment Agreement made and entered into the 26th day of September, 1996, by and between VALLEY BANK, a corporation organized and existing under the laws of the State of California (hereinafter called the "Corporation"), and Doug Mills (hereinafter called the "Executive"), is hereby amended pursuant to action taken by the Corporation's Board of Directors on October 27, 1997, to wit: BE IT RESOLVED THAT ARTICLE 4 is amended to read as follows: 4.1 - REORGANIZATION - THE CORPORATION MAY ELECT TO SELL, MERGE, CONSOLIDATE INTO OR WITH ANOTHER CORPORATION, FIRM, OR PERSON, OR TRANSFER CONTROLLING OWNERSHIP OF THE CORPORATION. IN THE EVENT OF A SALE, MERGER, CONSOLIDATION INTO OR WITH ANOTHER CORPORATION, FIRM, OR PERSON, OR TRANSFER OF CONTROLLING OWNERSHIP OF THE CORPORATION, THE CORPORATION WILL, AT THE CONSUMMATION OF SUCH REORGANIZATION EVENT, TERMINATE THIS AGREEMENT, AND ALL OBLIGATIONS TO EXECUTIVE, BY PAYING TO EXECUTIVE AN AMOUNT EQUAL TO THREE (3) YEARS EXECUTIVE'S THEN CURRENT ANNUAL SALARY, MULTIPLIED BY A FACTOR OF 140%. This amendment is the first, and only, amendment of the Agreement referenced above. IN WITNESS WHEREFOR, Corporation has caused this amendment to be duly executed by its Chairman of the Board. The Chairman of the Board and Executive have hereunder set their hand at Moreno Valley, CA this 30th day of October, 1997. EXECUTIVE VALLEY BANK /s/ Doug Mills By: /s/ Marion V. Ashley - --------------------------------- ---------------------------------------- Doug Mills (###-##-####) Marion V. Ashley, Chairman of the Board EX-10.12 24 EXHIBIT 10.12 EXHIBIT 10.12 Executive Salary Continuation Agreement dated October 19, 1995, amended October 30, 1997 between N. Douglas Mills and VB EXECUTIVE SALARY CONTINUATION AGREEMENT AGREEMENT, made and entered into this ____ day of __________, by and between VALLEY BANK, a corporation organized and existing under the laws of the State of California hereinafter called the "Corporation"), and ________________ (hereinafter called the "Executive"). WITNESSETH: WHEREAS, the Executive is in the employ of the Corporation serving as its ________________________________; and WHEREAS, the experience of the Executive, his knowledge of the affairs of the Corporation, his reputation and contacts in the industry are so valuable that assurance of his continued service is essential for the future growth and profits of the Corporation and it is in the best interests of the Corporation to arrange terms of continued employment for the Executive so as to reasonably assure his remaining in the Corporation's employment during his lifetime or until the age of retirement; and WHEREAS, it is the desire of the Corporation that his services be retained as herein provided; and WHEREAS the Executive is willing to continue in the employ of the Corporation provided the Corporation agrees to pay to him or his beneficiaries certain benefits in accordance with the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the services to be performed in the future as well as the mutual promises and covenants herein contained, it is agreed as follows: ARTICLE I 1.1) Employment - The Corporation agrees to employ the Executive in such capacity as the Corporation may from time to time determine. The Executive will continue in the employ of the Corporation in such capacity and with such duties and responsibilities as may be assigned to him, and such compensation as may be determined from time to time by the Board of Directors of the Corporation. 1.2) Full Efforts - The Executive agrees to devote his full time and attention exclusively to the business and affairs of the Corporation, except during vacation periods, and to use his best efforts to furnish faithful and satisfactory services to the Corporation. 1.3) Fringe Benefit - The salary continuation benefits provided by this Agreement are granted by the Corporation as a fringe benefit to the Executive and are not part of any salary reduction plan or any arrangement deferring a bonus or salary increase. The Executive has no option to take any current payment or bonus in lieu of these salary continuation benefits. ARTICLE 2 2.1) Retirement - If the Executive shall continue in the employment of the Corporation until he attains the age of sixty-five (65), he may retire from active daily employment as of the first day of the month next following attainment of age sixty-five (65) or upon such later date as may be mutually agreed upon by the Executive and the Corporation. 2.2) Payment - The Corporation agrees that upon such retirement it will pay to the Executive the annual sum of seventy thousand dollars ($70,000.00), payable monthly on the first day of each month following such retirement until he attains the age of eighty (80); subject to the conditions and limitations hereinafter set forth. The seventy thousand dollars ($70,000.00) annual payment amount will be adjusted as of the first year in which it is to be paid to reflect changes in the federally determined cost-of-living index and will be adjusted annually for each payment year thereafter to reflect further changes in said federally, determined cost-of-living index. 2.3) Death Benefit - The Corporation agrees that if the Executive shall so retire, but shall die before receiving the full amount of monthly payments to which he is entitled hereunder, it will continue to make such monthly payments to the Executive's surviving spouse for the remaining period as defined in Section 2.2 above. If the Executive is not survived by any spouse, said payments shall be made to the duly qualified personal representative, executor or administrator of his estate. ARTICLE 3 3.1) Consulting - It is mutually agreed that during the fifteen (15) year period following retirement from active daily employment upon attainment of age sixty-five (65), or such later date as may be mutually agreed upon, the Executive shall, at the request of the Corporation, be available at reasonable times and places as may be mutually agreed upon, to render services to the senior executives of the Corporation at its offices in an advisory or consulting capacity. 3.2) Informed - The Executive will keep himself informed concerning the affairs of the Corporation through reports which the Corporation will supply, and such other means as may be agreed upon. The Executive shall not be required to travel from whatever place he may be then living or staying for the purposes of such consultation unless all expenses incurred by him shall be paid by the Corporation. 3.3) Disability - Breach of this condition shall not be considered to have occurred if the Executive is unable to consult because of his mental or physical disability. 3.4) Not Employee - In furnishing such consultative services, the Executive shall not be an employee of the Corporation, but shall act in the capacity of an independent contractor, 3.5) No Competition - During the said fifteen (15) year period following retirement from active daily employment, the Executive shall not become the owner of, nor engage, directly or indirectly, in any business which is substantially similar to or competes with the business of the Corporation, either as proprietor, partner, stockholder, officer, director, or employee within the County of Riverside, unless the Corporation has first consented in writing thereto. 3.6) Forfeiture - The payments provided under Article 2 are conditioned upon the Executive fulfilling the foregoing requirements of this Article 3 and, in the event the Executive shall at any time materially breach the foregoing requirements, the Board of Directors of the Corporation may, by a Resolution, at any regular or special meeting, suspend or eliminate payment during the period of such breach. What constitutes a material breach shall be within the sole determination of the Board of Directors. 3.7) Termination of Payments - In the event the Board of Directors by such Resolution terminates further payments to the Executive as provided in this Article 3, all amounts then remaining unpaid under this Agreement shall be forfeited and the Corporation shall have no further liability to the Executive or any other persons hereunder. ARTICLE 4 4.1) Death Prior to Retirement - In the event the Executive should die while actively employed by the Corporation at any time after the date of this Agreement but prior to his attaining the age of sixty-five (65) years, the Corporation will pay the annual sum of Seventy Thousand Dollars ($70,000.00) per year, to the Executive's surviving spouse in equal monthly installments for a period of one hundred eighty (180) months. If the Executive is not survived by any spouse, said payment shall be made to the duly qualified personal representative, executor or administrator of his estate. The said monthly payments shall begin the first day of the month following the month of the decease of the Executive. Notwithstanding any other provisions of this Agreement, no benefits shall be payable hereunder to Executive, or his Spouse, or estate, if his death occurs as a result of a suicide, while sane or insane, within two years after (i) the date of this agreement and/or (ii) the date of any Subsequent change in the benefits for said executive. 4.2) Disability Prior to Retirement - In the event the Executive should become disabled while actively employed by the Corporation at any time after the date of this Agreement but prior to his attaining the age of sixty-five (65) years, the Corporation will pay the annual sum of Seventy Thousand Dollars ($70,000.00) per year to the Executive, his spouse, or if no spouse, said payment shall be made to the duly qualified representative. The said monthly payments shall begin the first day of the month following the month of disability of the Executive. For purposes of this paragraph, the definition of the term "disability" shall be the same as required for eligibility or disability payments under the Social Security Act. ARTICLE 5 5.1) Voluntary Termination of Service or Discharge - In the event that the employment of the Executive shall be terminated, either voluntarily or involuntarily, as a result of any criminal, unlawful, fraudulent, or dishonest action or any action determined to be detrimental to the interests of the Corporation, which determination shall be made in the sole discretion of its Board of Directors, prior to his attaining the age of sixty-five (65) years, this Agreement shall terminate upon the date of such termination of employment and no benefits or payments of any kind shall be made hereunder. 5.2) Other Termination of Service- The Corporation reserves the right to terminate the employment of the Executive at any time prior to retirement. In the event that the employment of the Executive shall terminate prior to his attaining the age sixty-five (65), other than for reasons stated in Section 5.1 hereof, or by reason of his disability or his death, then this Agreement shall terminate upon the date of such termination of employment. Provided, however, that the Executive shall be entitled to the following benefits under the following circumstances: (a) If the Executive has been employed by the Corporation for a period of three (3) years Subsequent to July 1, 1992, the executive will be considered vested in sixty percent (60%) of the annual benefit amount and shall become vested in an additional percent (20%) of said amount for each succeeding year thereafter until he becomes one hundred percent (100%) vested. If the Executive's employment is terminated under the provisions of this Section 5.2, the Corporation will pay the Executive's vested amount upon such terms and conditions and commencing within three (3) months after the date of termination. (b) Anything hereinabove to the contrary notwithstanding, if the Executive is not fully vested in the amount to which he is entitled under this plan, he will become fully vested in the event of a transfer of the controlling ownership or sale of the Corporation and shall be entitled to the full amount, upon the terms and conditions hereof, if termination of employment thereafter occurs under this Section 5.2. ARTICLE 6 6.1) Termination of Agreement by Reason of Changes in Law - The Corporation is entering into this Agreement upon the assumption that certain existing tax laws will continue in effect in substantially their current form. In the event of any changes in federal law relating to and allowing the tax-free accumulation of earnings within a life insurance policy, the income tax-free payment of proceeds from life insurance policies or the deduction from income of interest payments on certificates of deposit issued by banking institutions, or other change which in the sole discretion of the Board of Directors has a material adverse tax impact on the Corporation, the Corporation shall have an option to terminate or modify this Agreement. Provided, however, that the Executive shall be entitled to the same amount and under the same terms as he would have been entitled to under Sections 2.2, 4.1, 4.2 and 5.2. The payment of said amount shall be made under the same terms and conditions set forth in Sections 2.2, 4.1, 4.2, and 5.2. ARTICLE 7 7.1) Alienability - Neither the Executive, his spouse, nor any other beneficiary under this Agreement shall have any power or right to transfer, assign, anticipate, hypothecate, mortgage, commute, modify, or otherwise encumber in advance any of said benefits payable hereunder, nor shall any of said benefits be subject to seizure for the payment of any debts, judgments, alimony or separate maintenance, owed by the Executive or his beneficiary or any of them, or be transferable by operation of law in the event of bankruptcy, insolvency or otherwise. In the event the Executive or any beneficiary attempts assignment, commutation, hypothecation, transfer, or disposal of the benefits hereunder, the Corporation's obligations hereunder shall forthwith cease and terminate. ARTICLE 8 8.1) Participation in Other Plans - Nothing contained in this Agreement shall be construed to alter, abridge, or in any manner affect the rights and privileges of the Executive to participate in and be covered by any pension, profit sharing, group insurance, bonus or similar employee plans which the Corporation may now have or hereafter adopt. ARTICLE 9 9.1) Funding - The Corporation reserves the absolute right, at its sole and exclusive discretion, either to fund the obligations of the Corporation undertaken by this Agreement or to refrain from funding the same, and to determine the extent, nature, and method of such funding. Should the Corporation elect to fund this Agreement, in whole or in part, through the medium of life insurance or annuities, or both, the corporation shall be the owner and beneficiary of the policy. The Corporation reserves the absolute right, in its sole discretion, to terminate such life insurance or annuities, as well as any other funding program, at any time, in whole or in part. At no time shall the Executive be deemed to have any right, title, or interest in or to any specified asset or assets of the Corporation, including but not by way of restriction, any insurance or annuity contract or contracts or the proceeds therefrom. 9.2) Unsecured - Any such policy shall not in any way be considered to be security for the performance of the obligations of this Agreement. It shall be, and remain, a general, unpledged, unrestricted asset of the Corporation. 9.3) Cooperation - If the Corporation purchases a life insurance or annuity policy on the life of the Executive, he agrees to sign any documents that may be required for that purpose and to undergo any medical examination or tests which may be necessary. 9.4) Right as Creditor - This Agreement shall not be construed as giving the Executive or his beneficiary any greater rights than those of any other unsecured creditor of the Corporation. ARTICLE 10 10.1) Reorganization - The Corporation shall not merge or consolidate into or with another corporation, or reorganize, or sell substantially all of its assets to another corporation, firm, or person unless and until such succeeding or continuing corporation, firm, or person agrees to assume and discharge the obligations of the Corporation under this Agreement. Upon the occurrence of such event, the term "Corporation" as used in this Agreement shall be deemed to refer to such successor or survivor corporation. ARTICLE 11 11.1) Benefits and Burdens - This Agreement shall be binding upon and inure to the benefit of the Executive and his personal representatives, and the Corporation and any, successor organization which shall succeed to substantially all of its assets and business. ARTICLE 12 12.1) Not a Contract of Employment - This Agreement shall not be deemed to constitute a contract of employment between the parties hereto, nor shall any provision hereof restrict the right of the Corporation to discharge the Executive, or restrict the right of the Executive to terminate his employment. ARTICLE 13 13.1) The Fiduciary of the Plan and for purpose of the claims procedure under the Agreement is the Chief Financial Officer of the Corporation. The business address of the Fiduciary is 24010 Sunnymead Blvd., Moreno Valley, CA 92553. The Corporation shall have the right to change the Fiduciary of the Plan created under this Agreement. The Corporation shall give the Executive written notice of a change of the Fiduciary, or any change in the address or telephone number of the Fiduciary. 13.2) Claims Procedure - Benefits shall be paid in accordance with the provisions of this Agreement. The Executive, or a designated recipient or any other person claiming through the Executive shall make a written request for benefits under this Agreement, This written claim shall be mailed or delivered to the Fiduciary. Such claim shall be reviewed by the Fiduciary. If the claim is denied, in full or in part, the Fiduciary shall provide a written notice within ninety (90) days setting forth the specific reasons for denial, specific reference to the provisions of this Agreement upon which the denial is based, and any additional material or information necessary to perfect the claim, and an explanation of why such material or information is necessary, and appropriate information and explanation of the steps to be taken if a review of the denial is desired. If the claim is denied and a review is desired, the Executive (or beneficiary) shall notify the Fiduciary in writing within sixty (60) days [a claim shall be deemed denied if the Fiduciary does not take any action within the aforesaid ninety (90) day period] after receipt of the written notice of denial. In requesting a review, the Executive or his beneficiary may request a review of the Plan Document or other pertinent documents with regard to the employee benefit plan created under this Agreement, may submit any written issues and comments, may request an extension of time for such written submission of issues and comments, and may request that a hearing be held, but the decision to hold a hearing shall be within the sole discretion of the Fiduciary. The decision on the review of the denial claim shall be rendered by the Fiduciary within sixty (60) days after the receipt of the request for review (if a hearing is held) or within sixty (60) days after the hearing if one is held. The decision shall be written stating the specific reasons for the decision and shall include reference to specific provisions of this Agreement on which the decision is based. IN WITNESS WHEREOF, the Corporation has caused this Agreement to be duly executed by its Chairman of the Board of Directors and its Corporate Secretary, and the Executive has hereunder set his hand at Moreno Valley, CA, the day and year first above written. EXECUTIVE: VALLEY BANK, by /s/ N. Douglas Mills /s/ Marion V. Ashley - ----------------------------------- ------------------------------------ N. Douglas Mills (###-##-####) Marion V. Ashley, Chairman /s/ Dianna Williams ------------------------------------ Dianna Williams, Corporate Secretary EXECUTIVE SALARY CONTINUATION AGREEMENT - Amendment The Executive Salary Continuation Agreement made and entered into the 19th day of October, 1995, by and between VALLEY BANK, a corporation organized and existing under the laws of the State of California (hereinafter called the "Corporation"), and N. Douglas Mills (hereinafter called the "Executive"), is hereby amended pursuant to action taken by the Corporation's Board of Directors on October 27, 1997, to wit: BE IT RESOLVED THAT ARTICLE 10 is amended to read as follows: 10.1 REORGANIZATION - THE CORPORATION MAY ELECT TO MERGE, CONSOLIDATE INTO OR WITH ANOTHER CORPORATION, REORGANIZE, OR SELL SUBSTANTIALLY ALL OF ITS ASSETS TO ANOTHER CORPORATION, FIRM, OR PERSON. UPON THE OCCURRENCE, AND CONSUMMATION OF SUCH REORGANIZATION EVENT, THE CORPORATION WILL TERMINATE THIS AGREEMENT, AND THE EXECUTIVE SHALL BE ENTITLED TO THE FULL AMOUNT OF BENEFITS AS DESCRIBED IN SECTION 2.2 AND SECTION 5.2 OF THIS AGREEMENT. This amendment is the first, and only, amendment of the Agreement referenced above. IN WITNESS WHEREFOR, Corporation has caused this amendment to be duly executed by its Chairman of the Board. The Chairman of the Board and Executive have hereunder set their hand at Moreno Valley, CA this 30th day of October, 1997. EXECUTIVE VALLEY BANK /s/ N. Douglas Mills /s/ Marion V. Ashley - ----------------------------------- --------------------------------------- N. Douglas Mills (###-##-####) Marion V. Ashley, Chairman of the Board EX-10.13 25 EXHIBIT 10.13 EXHIBIT 10.13 Second Amendment to Executive Employment Agreement between N. Douglas Mills and Valley Bank SECOND AMENDMENT TO EXECUTIVE EMPLOYMENT AGREEMENT This Second Amendment to Executive Employment Agreement is made this ____ day of ______ 199_, between Valley Bank, (hereinafter the "Corporation") and N. Douglas Mills (hereinafter the "Executive"). RECITALS WHEREAS, the Corporation has entered into an Executive Employment Agreement with Executive dated September 26, 1996, amended October 30, 1997; and WHEREAS, the Corporation and Pacific Community Banking Group, a California corporation ("PCBG") entered into that certain First Restatement of Agreement and Plan of Reorganization dated as of _______________, 1999 (the "Reorganization Agreement") whereby the Corporation will be acquired and become a wholly-owned subsidiary of PCBG; and WHEREAS, Executive is currently a shareholder of the Corporation, and President, Chief Executive Officer and a Director of the Corporation; and WHEREAS, following the consummation of the acquisition of the Corporation by PCBG, Executive desires to be retained by the Corporation in accordance with this amended Executive Employment Agreement; and WHEREAS, unless otherwise provided in this Agreement, capitalized terms shall have the meanings given to them in the Reorganization Agreement. NOW THEREFORE, in consideration of the mutual representations, warranties and covenants, agreements and conditions contained herein and in the Reorganization Agreement, and intending to be legally bound hereby, the Corporation and Executive agree as follows: 1. Paragraph 1.1 is deleted in its entirety, and the following is substituted, which shall read as follows: "EMPLOYMENT - The Corporation shall employ the Executive in an executive position with the Corporation as determined by the Corporation with such duties and responsibilities as may be assigned to Executive from time to time by the Corporation. Executive agrees to serve in such capacity. Executive shall be compensated at the annual rate of $160,000, payable in amounts 1 EXHIBIT 2.1(d)(i)(a) consistent with regular payroll periods of Corporation. This Executive Employment Agreement shall not generally be assignable or transferable without the consent of Executive; provided, however, that Executive hereby consents to the assignment and assumption of this Executive Employment Agreement by The Bank of Hemet, Pacific Community Banking Group or their successors or assigns, so long as such successor or assignee has sufficient financial resources and capabilities to honor the terms and conditions of this Executive Employment Agreement." 2. Paragraph 1.3 is deleted in its entirety, and a new paragraph 1.3 is substituted, which shall read as follows: "TERM OF AGREEMENT - The term of this Agreement shall be for not less than one year from the date of consummation of the Reorganization Date, but shall automatically renew for successive one year periods thereafter unless terminated as provided herein. If this Executive Employment Agreement is terminated by the Corporation, the Consulting Agreement attached hereto as EXHIBIT "A," and which is hereby executed and agreed to by the Corporation and Executive (the "Consulting Agreement"), shall become effective as of such date of termination. If this Executive Employment Agreement is terminated by Executive, the Consulting Agreement shall become effective as of the date of such termination by Executive or one year from the date of consummation of the Reorganization Agreement, whichever is later." 3. Paragraph 2.3 is deleted in its entirety, and a new paragraph 2.3 is substituted, which shall read as follows: "CONSUMMATION OF REORGANIZATION AGREEMENT - Upon consummation of the Reorganization Agreement, the Corporation shall pay Executive the sum of $393,992." 4. Paragraph 2.5 is added, which shall read as follows: "TERMINATION OF EMPLOYMENT BY CORPORATION OTHER THAN CAUSE - The Corporation reserves the right to terminate the employment of Executive at any time, without cause, upon notice to Executive, prior to the expiration of the Term of the Agreement in Section 1.3. Such termination 2 shall be effective upon the Corporation giving notice to Executive. In the event the employment of Executive shall be terminated by the Corporation other than for cause or disability, the Corporation and Executive shall then enter into the Consulting Agreement attached hereto as EXHIBIT "A." In the event the employment of Executive shall be terminated by the Corporation other than for cause or disability, the Consulting Agreement shall become effective as of the date of such termination as provided in paragraph 1.3 above." 5. Paragraph 3.2 is added, which shall read as follows: "SALARY CONTINUATION AGREEMENT - Executive and Corporation agree that Pacific Community Banking Group will not become liable for any obligations under Executive's Salary Continuation Agreement dated October 19, 1995, as amended October 30, 1997, ("Salary Continuation Agreement") unless Pacific Community Banking Group becomes assignee or transferee of the Salary Continuation Agreement. Executive and Corporation hereby further agree that, notwithstanding the consummation of the Reorganization Agreement, Section 10.1 of the Salary Continuation Agreement will not require the Corporation to accelerate payments due to Executive thereunder until expiration or termination of this Executive Employment Agreement, at which time such payments shall then accelerate and the Consulting Agreement will become effective." 6. Paragraph 4.1, as amended, is hereby deleted in its entirety. Except as amended hereby, Executive Employment Agreement between Mr. N. Douglas Mills and the Corporation dated September 20, 1996, amended October 30, 1997, shall remain in full force and effect. 3 IN WITNESS WHEREOF, this Second Amendment has been executed as of the date first hereinabove written. EXECUTIVE _____________________________________ N. Douglas Mills VALLEY BANK BY: __________________________________ Marion V. Ashley Chairman of the Board 4 CONSULTING AGREEMENT I. PARTIES The parties to this Consulting Agreement (the "Agreement") are VALLEY BANK, a California banking corporation (the "Bank"), and N. Douglas Mills, an individual ("Consultant"). II. RECITALS Consultant is possessed of experience and talents in the management field which will be useful to the Bank in the conduct of its commercial banking enterprise (the "Business"). III. HIRING Upon the terms and conditions set forth herein, the Bank hereby hires Consultant as an independent contractor of the Bank, not as an employee, and Consultant agrees to provide services to Bank as described herein. IV. DUTIES OF CONSULTANT Consultant agrees to provide business development, customer retention, customer development, and management consulting services as requested by the Chairman and Chief Executive Officer of the Bank. Consultant agrees to devote such time as is reasonably required for the performance of these services, including but not limited to attendance at Board meetings and such committee meetings as requested by the Board of Directors or the Chairman and Chief Executive Officer, review of such credit files as may be requested by the Chairman and Chief Executive Officer, develop collection strategies for such loans as may be requested by the Chairman and Chief Executive Officer, work with the officers of the Bank to develop and implement customer retention and business development strategies as requested by the Chairman and Chief Executive Officer, participate in individual consultations with the officers of the Bank as required by the Chairman and Chief Executive Officer, join any advisory board of the Bank, attend all meetings of such advisory board, and assist the Bank in increasing the size of the advisory board with qualified individuals, and provide other services as requested from time to time by the Chairman of the Board of the Bank from time to time. Consultant agrees that, to the best of his ability and experience, he will at all times loyally and conscientiously perform all of the duties and obligations either expressly or implicitly required of him by the terms of this Agreement. 1 EXHIBIT A V. TERM AND COMMENCEMENT DATE Subject to "IX. TERMINATION" below, the term of this Agreement shall commence on _________, ____ ("Commencement Date") as provided in the Executive Employment Agreement and will terminate on ___________, ____ (the "Term"), a term of five (5) years, subject to renewal upon such terms and conditions as shall be agreed upon by the Board and Consultant. VI. DEATH If Consultant shall die during the Term, Bank will continue to make such monthly payments to the Consultant's surviving spouse for the remaining Term as provided in Paragraph V above. If the Executive is not survived by any spouse, said payments shall be made to the duly qualified personal representative, executor or administer of his estate. VII. COMPENSATION Bank agrees to pay Consultant and Consultant agrees to accept as payment for his services to be performed in accordance with this Agreement a consulting fee in the amount of Four Thousand Six Hundred Fifty Dollars ($4,650) per month, or $55,800 per year ("Base Annual Compensation") commencing on the Commencement Date. Bank agrees to pay Consultant and Consultant agrees to accept the consulting fee under this consulting arrangement with the Bank as payment for his services to be performed in accordance with this Agreement. VIII. TIME Consultant shall be required to devote such time as is necessary to the performance of his duties as Consultant of Bank. Consultant may, without the prior written consent of Bank, render services directly or indirectly, of a business or commercial nature, to any other person or organization, provided such other person or organization does not compete, directly or indirectly with the Business of the Bank. IX. TERMINATION AUTOMATIC TERMINATION. This Agreement automatically terminates if Bank is closed by or taken over by the California Commissioner of Financial Institutions, the Federal Deposit Insurance Corporation or any other supervisory authority; but in no event shall Consultant's obligations under this Agreement terminate as a result of a sale of assets, acquisition, merger or other like transaction involving Bank, whether or not Bank is the surviving or resulting bank following such a transaction. 2 X. OWNERSHIP OF CUSTOMER RECORDS All records of the accounts of customers, and any other records and books relating in any manner whatsoever to the customers of the Bank, whether prepared by Consultant or otherwise coming into his possession, shall be the exclusive property of Bank regardless of who actually purchased the original book or record. All such books and records shall be immediately returned to the Bank by Consultant upon the termination of this Agreement. XI. CONFIDENTIAL INFORMATION Without the prior written permission of the Bank in each case, Consultant shall not publish, disclose or make available to any other person, firm or corporation, either during or after the termination of this Agreement, any confidential information which Consultant may obtain during the Employment Period, or which Consultant may create prior to the end of the Term relating to the business of the Bank, or to the business of any customer or supplier of any of them; provided, however, Consultant may use such information during the Term for the benefit of the Bank. Prior to or at the termination of this Agreement, Consultant shall return all documents, files, notes, writings and other tangible evidence of such confidential information to the Bank. XII. COVENANT NOT TO SOLICIT CUSTOMERS OR EMPLOYEES Consultant agrees that for a period of twelve (12) months following the termination of this consulting agreement hereunder, consultant will not solicit the banking business of any customer with whom the Bank had done business during the preceding one year period. Consultant further agrees not to solicit the services of any officer or employee of the Bank during such twelve (12) month period. XIII. MISCELLANEOUS A. ASSIGNMENT AND MODIFICATION. This Agreement and the rights and duties hereunder may not be assigned by any party hereto without the prior written consent of the other and the parties expressly agree that any attempt to assign the rights of any party hereunder without such consent will be null and void. B. FURTHER ASSURANCE. From time to time each party will execute and deliver such further instruments and will take such other action as any other party reasonably may request in order to discharge and perform their obligations and agreements hereunder. 3 C. FORM OF DOCUMENTS. All instruments, certificates, and other documents to be executed and delivered under this Agreement by any party to the other party shall be in a form satisfactory to the other party. D. SUCCESSORS. This Agreement shall be binding upon, and shall inure to the benefit of, the successors and assigns of the parties. E. ENTIRE AGREEMENT. Except as provided herein, this Agreement is the entire agreement between the parties, and all prior negotiations, representations, or agreements between the parties are merged into this Agreement. F. GOVERNING LAW. This Agreement shall be construed in accordance with California law. G. EXECUTED COUNTERPARTS. This Agreement may be executed in one or more counterparts, all of which together shall constitute a single agreement and each of which shall be an original for all purposes. H. SECTION HEADINGS. The various section headings are inserted for convenience of reference only, and shall not affect the meaning or interpretation of this Agreement or any section thereof. I. CALENDAR DAYS; CLOSE OF BUSINESS. Unless the context otherwise requires, all periods terminating on a given day, period of days, or date shall terminate on the close of business on that day or date and references to "days" shall refer to calendar days. J. SEVERABILITY. In the event that any of the provisions, or portions thereof, of this Agreement are held to be unenforceable or invalid by any court of competent jurisdiction, the validity and enforceability of the remaining provisions or portions thereof, shall not be affected thereby. K. ATTORNEYS' FEES. In the event that any party shall bring an action in connection with the performance, breach, or interpretation hereof, then the prevailing party in such action as determined by the court having jurisdiction, shall be entitled to recover from the losing party in such action, as determined by the courts having jurisdiction, all reasonable attorney's fees, court costs, costs of investigation and other costs reasonably related to such litigation, in such amounts as may be determined in the discretion of the court having jurisdiction. 4 XIV. EXECUTION This Agreement is executed at Moreno Valley, California, to be effective as of the Commencement Date. BANK: VALLEY BANK a California banking corporation BY: _________________________________ E. Lynn Caswell Chairman of the Board CONSULTANT: ________________________________ N. Douglas Mills 5 EX-23.2 26 EXHIBIT 23.2 Exhibit 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our reports (and all references to our Firm) included in or made a part of this registration statement. ARTHUR ANDERSEN LLP Orange County, California April 15, 1999 EX-23.4 27 EXHIBIT 23.4 McGladrey & Pullen LLP CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in this Registration Statement on Form S-1 filed on or about April 14, 1999 of our report, dated January 15, 1999, relating to the financial statements of Valley Bank. We also consent to the reference to our Firm under the caption "Experts" in the Prospectus. McGladrey & Pullen LLP Pasedena, California April 13, 1999 EX-27.1 28 EXHIBIT 27.1
9 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 395,948 0 0 0 0 0 0 0 0 601,046 0 0 94,429 0 0 0 2,500 504,117 601,046 0 0 11,326 11,326 0 0 0 0 0 525,568 514,242 0 0 0 513,442 51.34 51.34 0 0 0 0 0 0 0 0 0 0 0 0
EX-99.1 29 EXHIBIT 99.1 Exhibit 99.1 CONSENT The undersigned hereby consents to his nomination to serve as a Director of Pacific Community Banking Group, a California corporation, and to all references to him and to his professional history, including but not limited to his biography in the prospectus that is included or made a part of this Registration Statement on Form S-1 filed with the Securities and Exchange Commission, and any amendment thereto. Dated as of ___________, 1999 /s/ --------------------------- By: James B. Jacqua EX-99.2 30 EXHIBIT 99.2 Exhibit 99.2 CONSENT The undersigned hereby consents to his nomination to serve as a Director of Pacific Community Banking Group, a California corporation, and to all references to him and to his professional history, including but not limited to his biography in the prospectus that is included or made a part of this Registration Statement on Form S-1 filed with the Securities and Exchange Commission, and any amendment thereto. Dated as of ______________, 1999 /s/ -------------------------- By: N. Douglas Mills EX-99.3 31 EXHIBIT 99.3 Exhibit 99.3 CONSENT The undersigned hereby consents to his nomination to serve as a Director of Pacific Community Banking Group, a California corporation, and to all references to him and to his professional history, including but not limited to his biography in the prospectus that is included or made a part of this Registration Statement on Form S-1 filed with the Securities and Exchange Commission, and any amendment thereto. Dated as of _________________, 1999 /s/ ------------------------ By: Marion V. Ashley EX-99.5 32 EXHIBIT 99.5 Exhibit 99.5 CONSENT The undersigned hereby consents to his nomination to serve as a Director of Pacific Community Banking Group, a California corporation, and to all references to him and to his professional history, including but not limited to his biography in the prospectus that is included or made a part of this Registration Statement on Form S-1 filed with the Securities and Exchange Commission, and any amendment thereto. Dated as of ________________, 1999. /s/ Harold R. Williams, Jr. -------------------------------- By: Harold R. Williams, Jr. -----END PRIVACY-ENHANCED MESSAGE-----