-----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, Fh3dCU3daWrKxEdiCNcJn22peUYeSr15DK0dkweP6WAwwmnE8v7DgrFY0mTlmYPl nhxG9BTkRxIpPuIoyz2bhQ== 0000702147-96-000002.txt : 19960329 0000702147-96-000002.hdr.sgml : 19960329 ACCESSION NUMBER: 0000702147-96-000002 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960328 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SDNB FINANCIAL CORP CENTRAL INDEX KEY: 0000702147 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 953725079 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-11117 FILM NUMBER: 96540124 BUSINESS ADDRESS: STREET 1: 1420 KETTNER BLVD CITY: SAN DIEGO STATE: CA ZIP: 92101 BUSINESS PHONE: 6192331234 MAIL ADDRESS: STREET 1: P O BOX 12605 CITY: SAN DIEGO STATE: CA ZIP: 92112-3605 10-K405 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1995 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-11117 SDNB FINANCIAL CORP. (Exact name of Registrant as Specified in its Charter) Incorporated in California - IRS Employer I.D. No. 95-3725079 1420 Kettner Boulevard, San Diego, California 92101 (Address of Principal Executive Office) (Zip Code) Registrant's Telephone Number including area code: 619-233-1234 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered None None Securities registered pursuant to Section 12(g) of the Act: Common Stock (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by nonaffiliates of the Registrant as of the close of business on March 4, 1996: $ 14,662,000 The number of shares of Common Stock outstanding as of the close of business on March 4, 1996: 3,073,260 DOCUMENTS INCORPORATED BY REFERENCE The Registrant's 1995 Annual Report to Shareholders is incorporated by reference into Part IV of this Form 10-K. PART I Item 1. Business. (a) General Development of Business. SDNB Financial Corp (the "Company") was organized under the laws of California on April 15, 1982, at the direction of San Diego National Bank (the "Bank") for the purpose of becoming a bank holding company by acquiring all of the outstanding capital stock of the Bank, a national banking association. The Federal Reserve Board ("Reserve Board") approved the Company's application to become a bank holding company on November 1, 1982, and continues as the Company's primary regulator. The Bank was granted its Charter by the Comptroller of the Currency ("Comptroller") on November 12, 1981, and commenced operations as a national bank on the same date. The Bank is engaged in a general commercial banking business through its head office in San Diego, California. The Comptroller is the Bank's primary regulator. Until June 30, 1993, the Company owned SDNB Development Corp ("Devco"), a California corporation, for the purpose of said entity participating as a joint venture partner in the San Diego National Bank Building Joint Venture (the "Joint Venture"), a partnership formed for the purpose of constructing and developing an office building in downtown San Diego to house the Company and the Bank. Effective July 1, 1993, the Company merged Devco into itself, thus assuming the position as Joint Venture partner. In addition, the Company owns SDNB Mortgage Bankers ("Mortgage"), a California corporation, for the purpose of said entity engaging in mortgage banking and brokerage activities pursuant to approval from the Federal Reserve Bank of San Francisco as permitted by Section 225.25(b)(1) of Regulation Y and Section 4(c)(3) of the Bank Holding Company Act of 1956. Mortgage has obtained a corporate real estate broker's license from the California Department of Real Estate. Mortgage is currently inactive. (b) Financial Information About Industry Segments. Not applicable to the Company, which presently operates in only one business area, banking. (c) Narrative Description of Business. 1. Supervision and Regulation. The banking industry is subject to extensive federal regulation and is undergoing significant change. In 1991, the Federal Deposit Insurance Corporation Improvement Act ("FDICIA") was enacted. FDICIA substantially amended the Federal Deposit Insurance Act ("FDI Act") and certain other statutes. Since FDICIA's enactment, the federal bank regulatory agencies have been in the process of adopting regulations to implement its statutory provisions. Most of these new regulatory provisions are now in effect, while others are being phased in over time. FDICIA and its implementing regulations contain a number of substantial provisions that likely will have a significant impact on the banking industry as a whole and potentially could have a material impact upon the operations and earnings of the Company. The following discussion summarizes certain aspects of the banking laws and regulations that affect the Company. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress and before the various bank regulatory agencies. The likelihood and timing of any changes and the impact such changes might have on the Company are impossible to determine with certainty. A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business of the Company. To the extent that the following information describes statutory or regulatory provisions, it is qualified entirely by reference to the particular statutory or regulatory provision. (a) Bank Holding Company Regulation. As a registered bank holding company, the Company and its nonbank subsidiaries are subject to supervision and regulation under the Bank Holding Company Act ("BHCA") by the Reserve Board. The Reserve Board requires regular reports from the Company and is authorized by the BHCA to make regular examinations of the Company and its subsidiaries. Under the BHCA, the Company may not acquire direct or indirect ownership or control of more than 5% of the voting shares of any company, including a bank, without the prior approval of the Reserve Board, except as specifically authorized under the BHCA. The Company is also subject to regulation under this banking law with respect to certain acquisitions of domestic banks. Under the BHCA, the Company, subject to the approval of the Reserve Board, may acquire shares of nonbanking corporations, the activities of which are deemed by the Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Reserve Board has enforcement powers over bank holding companies and their nonbanking subsidiaries, among other things to interdict activities that represent unsafe or unsound practices or constitute violations of law, rule, regulation, administrative orders or written agreements with a federal bank regulator. These powers may be exercised through the issuance of cease-and-desist orders, civil money penalties and other actions. Under the Reserve Board's statement of policy with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit all available resources to support such institutions in circumstances where it might not do so absent such policy. Although this "source of strength" policy has been challenged in litigation, the Reserve Board continues to take the position that it has authority to enforce it. For a discussion of circumstances under which a bank holding company may be required to guarantee the capital levels or performance of its subsidiary bank, see "Capital Adequacy" below. The Reserve Board also has the authority to terminate any activity of a bank holding company that constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution or to terminate its control of any bank or nonbank subsidiaries. Bank holding companies and their subsidiary banks are also subject to the provisions of the Community Reinvestment Act of 1977 ("CRA"). Under the terms of the CRA, the Comptroller (or other appropriate bank regulatory agency) is required in connection with its examination of a bank to assess such bank's record in meeting the credit needs of the community served by that bank, including low- and moderate-income neighborhoods. Further, such assessment is also required of any bank that has applied, among other things, to merge or consolidate with, or acquire the assets or assume the liabilities of, a federally- regulated financial institution, or to open or relocate a branch office. In the case of a bank holding company applying for approval to acquire a bank or bank holding company, the Reserve Board will assess the record of each subsidiary bank of the applicant bank holding company in considering the application. Under recently enacted revisions to the CRA regulations, the current CRA assessment is being replaced with a new evaluation system that would rate institutions based on their actual performance (rather than efforts) in meeting community credit needs. Under new regulations, each institution would be evaluated based on the degree to which it is providing loans (the leading test), branches and other services (the service test) and investments (the investment test) to low and moderate income areas in the communities it serves, based on the communities demographics, characteristics and the institution's capacity, product offerings and business strategy. Each depository institution would have to report to its federal supervisory agency and make available to the public data on the geographic distribution of its loan applications, denial, originations and purchases. Institutions would continue to receive one of four composite ratings: Outstanding, Satisfactory, Needs to Improve or Substantial Noncompliance. The new rules are going into effect in stages from July 1995 to January 1997. The Company does not believe that the new CRA regulations will substantially change its program and policies designed to meet the needs of its communities. The primary assets of the Company consist of the ownership of the Bank, and through the Joint Venture, a 62% interest in the San Diego National Bank Building. Various legal limitations affect the extent to which the Bank may extend credit, pay dividends, or otherwise supply funds to the Company or the Bank's other affiliates. In particular, the Bank is subject to certain restrictions imposed by Federal law on any extensions of credit to the Company or, with certain exceptions, other affiliates. Such restrictions prohibit the Company or such other affiliates from borrowing from the Bank unless the loans are secured by specified collateral. Further, such secured loans and investments by the Bank are limited to 10% of the Bank's capital and surplus in the case of the Company or to any other such affiliate and 20% of the Bank's capital and surplus as to the Company and all such affiliates in the aggregate. In addition, there are certain limitations on the payment of dividends to the Company by the Bank. In general, the Bank may pay dividends out of its net profits. However, the prior approval of the Comptroller is required if the total of all dividends declared by the Bank in any calendar year will exceed the Bank's net profits for that year combined with its retained net profits for the preceding two years. At January 1, 1996, the Bank had available for dividends to the Company approximately $1,370,000 without the approval of the Comptroller. In addition, the Comptroller and the Federal Deposit Insurance Corporation ("FDIC") have authority to prohibit a bank from engaging in an unsafe or unsound practice in conducting its business. The payment of dividends, depending upon the financial condition of the bank in question, could be deemed to constitute such an unsafe or unsound practice, and the regulatory agencies have indicated their view that it generally would be an unsafe and unsound practice to pay dividends except out of current operating earnings. Finally, under FDICIA, an insured depository institution is prohibited from making any capital distribution to its owner, including any dividend, if, after making such distribution, the depository institution fails to meet the required minimum level for any relevant capital measure, including the risk-based capital adequacy and leverage standards discussed below. The Company and the Federal Reserve Bank of San Francisco ("Reserve Bank") entered into an agreement on November 20, 1992, pursuant to which the Company must obtain the approval of the Reserve Bank prior to the declaration of any cash dividends or the incurrence of debt, other than in the ordinary course of business, and the Company must give notice to the Reserve Bank prior to adding or replacing a director or a senior executive officer. Also, the Company submitted a proposed capital infusion plan. As outlined in the management discussion and analysis and the notes to the consolidated financial statements, the capital infusion was successfully completed in 1995. (b) Capital Adequacy. The Reserve Board and the Comptroller have adopted risk-based capital adequacy guidelines for bank holding companies and banks under their supervision. Under the guidelines the so-called "Tier 1 capital" and "total capital" as a percentage of risk weighted assets and certain off-balance sheet instruments must be at least 4% and 8%, respectively. The Reserve Board and the Comptroller have also imposed a leverage standard to supplement their risk based ratios. This leverage standard focuses on a banking institution's ratio of Tier 1 capital to average total assets adjusted for goodwill and certain other items. Under these guidelines, banking institutions that meet certain criteria, including excellent asset quality, high liquidity, low interest rate exposure and good earnings, and have received the highest regulatory rating must maintain a ratio of Tier 1 capital to total assets of at least 3%. Institutions not meeting these criteria, as well as institutions with supervisory, financial or operational weaknesses, along with those experiencing or anticipating significant growth are expected to maintain a Tier l capital to total assets ratio equal to at least 4% to 5%. As reflected in the following table, the risk-based capital ratios and leverage ratios of the Company and the Bank as of December 31, 1995 exceeded the fully phased-in risk-based capital adequacy guidelines and the leverage standard. Capital Components and Ratios at December 31, 1995 (dollars in thousands) Company Bank Capital Components Tier 1 capital $16,726 $13,656 Total capital 18,218 15,017 Risk-weighted assets and off-balance sheet instruments 117,967 107,310 Risk-based Capital Ratio Tier 1 capital 14.18% 12.73% Total capital 15.43% 13.98% Leverage Ratio 9.37% 8.43% FDICIA requires each federal banking agency, including the Reserve Board, to revise its risk-based capital standards, in order to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risk of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multifamily mortgages. The federal banking agencies in September 1993 issued proposed rules whereby exposures to interest rate risk would be measured as the effect that a specified change in market interest rates would have on the net economic value of a bank. This economic perspective considers the effect that changing market interest rates may have on the value of a bank's assets, liabilities, and off-balance-sheet positions. Institutions with interest rate risk exposure in excess of a threshold level would be required to hold additional capital proportionate to that risk. The Company is studying these latest proposals but cannot assess at this point the impact the proposals would have on the Company's capital requirements. The Reserve Board, the FDIC, the Comptroller and the Office of Thrift Supervision have issued a final rule amending the risk-based capital guidelines to take account of concentration of credit risk and the risk of non-traditional activities. The final rule amends each agency's risk-based capital standards by explicitly identifying concentration of credit risk and the risk arising from non-traditional activities, as well as an institution's ability to manage those risks, as important factors to be taken into account by the agency in assessing an institution's overall capital adequacy. This final rule has not materially impacted the Company's capital requirements, but there can be no assurance that the adoption of other proposals implementing FDICIA will not have an adverse impact on the Company's capital requirements. Bank regulators and legislators continue to indicate their desire to raise capital requirements applicable to banking organizations beyond current levels. However, management is unable to predict whether and when higher capital requirements would be imposed and if so, at what levels and on what schedule. FDICIA substantially revised the bank regulatory and funding provisions of the FDI Act and made revisions to several other federal banking statutes. Among other things, FDICIA required the federal banking agencies to take "prompt corrective action" in respect to depository institutions that do not meet minimum capital requirements. FDICIA established five capital tiers: "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized" and "critically undercapitalized". A depository institution's capital tier will depend upon where its capital levels are in relation to various relevant capital measures, which will include a risk-based capital measure and a leverage ratio capital measure, and certain other factors. Under the implementing regulations adopted by the federal banking agencies, a bank is considered "well capitalized" if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% of greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An "adequately capitalized" bank is defined as one that has (i) a total-risk- based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with a composite CAMEL rating of 1). A bank is considered (A) "undercapitalized" if it has (i) a total risk-based capital ratio of less than 6%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% or greater in the case of a bank with a composite CAMEL rating of 1), (B) "significantly undercapitalized" if the bank has (i) a total risk-based capital ratio of less than 6%, or (ii) a tier 1 risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and (C) "critically undercapitalized" if the bank has a ratio of tangible equity to total assets equal to or less than 2%. The Reserve Board may reclassify a "well capitalized" bank as "adequately capitalized" or subject an "adequately capitalized" or "undercapitalized" institution to the supervisory actions applicable to the next lower capital category if it determines that the bank is in an unsafe or unsound condition or deems the bank to be engaged in an unsafe or unsound practice and not to have corrected the deficiency. The Bank currently meets the definition of a "well capitalized" institution. "Undercapitalized" depository institutions, among other things, are subject to growth limitations, are prohibited, with certain exceptions, from making capital distributions, are limited in their ability to obtain funding from a Federal Reserve Bank and are required to submit a capital restoration plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan and provide appropriate assurance of performance. If a depository institution fails to submit an appropriate plan, including if the holding company refuses or is unable to make the guarantee described in the previous sentence, it is treated as if it is "significantly undercapitalized". Failure to submit or implement an acceptable capital plan also is grounds for the appointment of a conservator or a receiver. "Significantly undercapitalized" depository institutions may be subject to a number of additional requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Moreover, the parent holding company of a significantly undercapitalized depository institution may be ordered to divest itself of the institution or of nonbank subsidiaries of the holding company. "Critically undercapitalized" institutions, among other things, are prohibited from making any payments of principal and interest on subordinated debt, and are subject to the appointment of a receiver or conservator. FDICIA directed, among other things, that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares and other standards as they deem appropriate. The Reserve Board adopted such standards in 1993. FDICIA also contains a variety of other provisions that may affect the operations of the Company, including new reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions, limitations on the amount of purchased mortgage servicing rights and purchased credit card relationships includable in Tier 1 capital, and the requirement that a depository institution give 90 days' prior notice to customers and regulatory authorities before closing any branch. FDICIA also contains a prohibition on the acceptance or removal of brokered deposits by depository institutions that are not "well capitalized" or are "adequately capitalized" and have not received a waiver from the FDIC. (c) FDIC Deposit Insurance Assessments. As an institution insured by the Bank Insurance Fund ("BIF"), the Bank is subject to FDIC deposit insurance assessments. Under current law, as amended by FDICIA, the insurance assessment to be paid by BIF-insured institutions shall be specified in a schedule required to be issued by the FDIC that specifies, at semi-annual intervals, target reserve ratios designed to increase the reserve ratio to 1.25% of estimated insured deposits (or such higher ratio as the FDIC may determine in accordance with the statute) in 15 years. FDICIA also authorizes the FDIC to impose one or more special assessments in any amounts deemed necessary to enable repayment of amounts borrowed by the FDIC from the Treasury Department. The FDIC set an assessment rate for the BIF of 0.195% for periods prior to June 30, 1992, and an assessment rate of 0.23% effective on June 30, 1992. Consistent with FDICIA, on September 15, 1992, the FDIC approved the implementation of a risk-based deposit premium assessment system under which each depository institution is placed in one of nine assessment categories based on the institution's capital classification under the prompt corrective action provisions described above and whether such institution is considered by its supervisory agency to be financially sound or to have supervisory concerns. The assessment rates, when the new system became effective on January 1, 1993, ranged from 0.23% to 0.31% depending upon the assessment category into which the insured institution was placed. The Bank's assessment rate increased significantly under the new system which resulted in an increase in deposit insurance assessment expense. The rates were reduced effective July 1, 1995 to a range of .04% to .31% and effective January 1, 1996 to a range of 0 (with a minimum of $1,000 per semi-annual period) to .27%. A significant increase in the assessment rate or a special additional assessment with respect to insured deposits, however, could have an adverse impact on the results of operations and capital of the Bank. (d) Governmental Policies. The earnings of the Company are significantly affected by the monetary and fiscal policies of governmental authorities, including the Reserve Board. Among the instruments of monetary policy used by the Reserve Board to implement these objectives are open-market operations in U.S. Government securities and Federal funds, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments and deposits, and the interest rates charged on loans and paid for deposits. The Reserve Board frequently uses these instruments of monetary policy, especially its open-market operations and the discount rate, to influence the level of interest rates and to affect the strength of the economy, the level of inflation or the price of the dollar in foreign exchange markets. The monetary policies of the Reserve Board have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect which they may have on the Company's business and results of operations. (e) Other Legislative Initiatives. From time to time, various proposals are introduced in the United States Congress and before various bank regulatory authorities which would alter the powers of, and restrictions on, different types of banking organizations and which would restructure part or all of the existing regulatory framework for banks, bank holding companies and other financial institutions. Moreover, a number of other bills have been introduced in Congress which would further regulate, deregulate or restructure the financial services industry. It is not possible to predict whether these or any other proposals will be enacted into law or, even if enacted, the effect which they may have on the Company's business and results of operations. 2. Business of the Bank. The Bank focuses primarily upon wholesale commercial banking operations, emphasizing the needs of small and medium size business firms and corporations and the personal banking needs of business executives and professional persons located in the Bank's immediate service area. The Bank's marketing strategy stresses its local ownership and commitment to service community business needs. Because the Bank's primary service area is comprised largely of commercial and professional businesses, the Bank places particular emphasis on banking services appropriate to serve the financial requirements of these business sectors. The Bank concentrates on business with commercial, industrial and professional customers in connection with both loans and deposits. In addition, the Bank seeks business from manufacturing and industrial corporations in San Diego County for whom it can provide financing and other banking needs. The Bank believes that the attraction of such businesses or large personal accounts enables it to provide professional, efficient and personalized banking services on an effective basis. The Bank also offers courier services, collection services, notary public services, money market certificates of deposit, letters of credit and other customary bank services to its business customers. On September 13, 1988, the Bank was granted trust powers by the Comptroller. The trust department, specializing in self- directed employee benefit plans, began active operations in 1989. In 1992, the Bank, citing failure of the department to achieve profitable operations, discontinued operations and transferred the Bank's fiduciary responsibilities to another institution. In 1994, the Bank entered into an agreement with Danielson Trust Company ("Danielson") under which Danielson will provide trust and related services to Bank customers. In addition to offering a comprehensive array of general banking services, the Bank offers specialized services to certain businesses that have been identified by the Bank's management as key sources of deposits and loans. In 1995, the Bank established its International Department and now offers a full array of such services, including letters of credit and documentary collections. Other services, which are offered directly or through the Bank's correspondent banks, include cash management consulting and money market investments. As a corollary and supplement to its wholesale banking operations, the Bank provides a full range of retail commercial banking services, including checking and savings accounts, safe deposit boxes, traveler's checks, and cashier's checks. The Bank issues credit cards through third parties and is a merchant depository for cardholder drafts. The Bank engages in a full range of lending activities. The types of credit made available are: Business Loans and Lines of Credit Business acquisition and expansion Equipment and vehicle financing Working capital Accounts receivable and inventory financing Standby letters of credit SBA and CSSBDC guaranteed loans Consumer Loans and Lines of Credit Personal loans (secured and unsecured) Personal property loans (automobiles, boats, airplanes, recreational vehicles, mobile homes) Home equity loans (secured by 1-4 family dwellings) Home improvement loans (secured and unsecured) Home equity lines of credit (secured by deed of trust on 1- 4 family dwellings) Personal lines of credit (Ready Money-unsecured lines attached to a checking account) Real Estate Financing Mini-perm loans for commercial and multi-family property Residential and commercial land loans Development, interim construction and rehabilitation loans for commercial, 1-4 family and multi-family property HUD guaranteed loans The commercial lending (business loans and lines of credit) is directed primarily at businesses whose demands for funds fall within the Bank's unsecured lending limit (approximately $2,300,000 at December 31, 1995), and who are depositors with the Bank. The Bank has no foreign loans or highly leveraged transactions. At December 31, 1995, approximately fifty-nine percent (59%) of the Bank's total loans were commercial, a majority of which are written with an original maturity of 90 to 180 days. Real estate loans, including interim construction and mini-perm, comprised approximately thirty-eight percent (38%) of the portfolio, with an average maturity of nine to eighteen months for interim construction loans and five years for the mini- perm loans. The balance of the loans are installment and consumer loans. Most of the loans bear adjustable interest rates, which change with the Bank's base rate. The Bank's loan loss reserve was approximately $2,002,000, or two and two-tenths percent (2.2%) of gross loans at December 31, 1995. The Bank intends to maintain the loan loss reserve at a level sufficient to absorb charge-offs from unexpected and adverse economic developments. The Bank's investment portfolio includes United States government and agency investments, state and municipal bonds, bankers acceptances, certificates of deposit and other miscellaneous investments. A majority of the Bank's deposits are derived from customers who have other account relationships with the Bank. The Bank has never used money brokers to secure deposits. The Bank's deposits are comprised of time certificates of deposit, demand accounts (including interest bearing demand accounts) and savings deposits (including money market savings). During the years 1993 through 1995, the Company and the Bank have been adversely affected by a number of factors emanating primarily from the condition of the economy in San Diego. These factors, more fully described in management's discussion and analysis and in the statistical information which follows, include: a)Reduction in the level of the loan portfolio resulting from continuing low demand. b)Higher than normal loan loss provisions in 1994 and 1993. c)OREO losses and expenses from higher than normal levels of OREO properties in 1994 and 1993. Additionally, the Bank has incurred substantial expense in connection with legal fees and provision for settlement costs involving the Pioneer Mortgage Company litigation, which was settled late in 1995. Competition. The Bank competes with other commercial banks, savings and loan associations, finance companies, money market funds, credit unions, insurance companies and brokerage firms. Many of the regulations and limitations imposed upon account balances and interest rates were eliminated by the Depository Institutions Deregulation and Monetary Control Act of 1980. Savings and loan associations, credit unions and other business concerns were allowed to offer traditional banking services as a result of the Garn-St. Germain Depository Institutions Act of 1982 (the "Garn Act"). Among other provisions, the Garn Act enabled federally insured institutions to offer a new account similar to and directly competitive with money market accounts. Over the years following passage of the Garn Act, these changes have impacted the Bank's competition for deposits and the corresponding cost of deposits and have also resulted in a greater portion of the Bank's deposits being subject to rate changes. The Bank also competes for deposits with other institutions, such as brokerage firms and credit card companies, which offer alternative investment vehicles, such as money market funds, as well as traditional banking services, such as check access to money market funds and check advances on credit card accounts. In 1989, the Bank initiated the Executive Money Market account, designed to be competitive with accounts offered by securities firms. Other entities (both public and private) seeking to raise capital through the issuance and sale of debt or equity securities also compete with the Bank in the acquisition of deposits. As stated previously, nationwide reciprocal interstate banking became effective in California on January 1, 1991 (after having been allowed on a regional basis since 1987). In 1992, Bank of America merged with Security Pacific National Bank and in 1994 First Interstate Bank acquired San Diego Trust & Savings Bank. In 1996, Wells Fargo Bank successfully bid for First Interstate Bank (completion of the acquisition is scheduled in 1996). Management and the Board of Directors believe that the reduction in the number of the independent banks represents a business development opportunity for the Bank to obtain customers who would prefer to do business with a locally-based bank rather than one headquartered elsewhere. The Company has formed a Strategic Planning Committee which is studying the Bank's position in the marketplace as affected by the developments cited above. The Committee reports periodically to the Board. 3. Employees. As of March 4, 1996, the Company and/or the Bank had one hundred fourteen (114) full-time employees, of whom ten (10) were executive officers. Four (4) of the executive officers have entered into employment contracts with the Company. None of the Company's or the Bank's employees is covered by a collective bargaining agreement and the Company believes that its relationship with its employees is satisfactory. 4. Statistical Disclosure. Following is the statistical disclosure required for bank holding companies.
SELECTED STATISTICAL INFORMATION DISTRIBUTION OF ASSETS, LIABILITIES, AND STOCKHOLDERS' EQUITY INTEREST RATES AND INTEREST DIFFERENTIAL (IN THOUSANDS) 1995 1994 1993 Average Revenue/ Yield Average Revenue/ Yield Average Revenue/ Yield Balance Expense Rate Balance Expense Rate Balance Expense Rate Interest-earning assets Loans Commerical 54,290 5,900 10.87% 63,180 5,597 8.86% 78,229 6,601 8.44% Real estate 36,370 3,903 10.73% 37,082 3,623 9.77% 40,137 3,446 8.59% Installment 2,932 287 9.79% 3,146 280 8.90% 3,392 357 10.52% Total loans (including fees) 93,592 10,090 10.78% 103,408 9,500 9.19% 121,758 10,404 8.54% Investment securities U.S. Treasury securities 5,770 298 5.16% 4,184 165 3.94% 3,700 129 3.49% Securities of government agencies 18,803 1,044 5.55% 20,917 1,021 4.88% 14,416 642 4.45% State and political obligations 2,610 216 8.28% 4,617 397 8.60% 3,332 406 12.18% Other securities 1,691 103 6.09% 682 39 5.72% 903 55 6.09% Total investment securities 28,874 1,661 5.75% 30,400 1,622 5.34% 22,351 1,232 5.51% Certificates of deposit in other banks 2,271 137 6.03% 1,469 63 4.29% 1,494 67 4.48% Federal Funds Sold 15,547 904 5.81% 18,407 732 3.98% 13,235 364 2.75% Total interest-earning assets 140,284 12,792 9.12% 153,684 11,917 7.75% 158,838 12,067 7.60% Noninterest-earning assets Cash and due from banks 12,864 12,415 12,315 Premises and equipment 10,918 11,408 11,742 Other, less allowance for loan losses 168 143 3,472 Total noninterest-earning assets 23,950 23,966 27,529 TOTAL ASSETS 164,234 177,650 186,367 SELECTED STATISTICAL INFORMATION DISTRIBUTION OF ASSETS, LIABILITIES, AND STOCKHOLDERS' EQUITY INTEREST RATES AND INTEREST DIFFERENTIAL (IN THOUSANDS) 1995 1994 1993 Average Revenue/ Yield Average Revenue/ Yield Average Revenue/ Yield Balance Expense Rate Balance Expense Rate Balance Expense Rate Interest-bearing liabilities Deposits Savings, NOW accounts, and money markets 69,160 1,965 2.84% 71,173 1,700 2.39% 64,430 1,452 2.25% Time deposits 18,542 963 5.19% 22,831 797 3.49% 45,391 1,694 3.73% Total interest-bearing deposits 87,702 2,928 3.34% 94,004 2,497 2.66% 109,821 3,146 2.86% Securities sold under repurchase agreements and federal funds purchased 9,668 255 2.64% 14,603 367 2.51% 7,762 185 2.38% Short-term debt 1,777 177 9.96% 2,456 209 8.51% 2,393 174 7.27% Long-term debt 9,963 797 8.00% 10,251 621 6.06% 10,486 673 6.42% Total interest-bearing liabilities 109,110 4,157 3.81% 121,314 3,694 3.04% 130,462 4,178 3.20% Noninterest-bearing liabilities Demand deposits 42,244 46,354 44,265 Other liabilities 969 364 282 Total liabilities 152,323 168,032 175,009 Minority interest in subsidiary 0 0 0 Stockholders' equity 11,911 9,618 11,358 TOTAL LIABILITIES AND STOCKHOLDERS'EQUITY 164,234 177,650 186,367 Net interest income 8,635 8,223 7,889 Margin analysis Interest income/earning assets 9.12% 7.75% 7.60% Interest expense/earning assets 2.96% 2.40% 2.63% Net interest income/earning assets 6.16% 5.35% 4.97% 1) All loans are stated net of unearned income. 2) Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 34%. 3) These averages reflect the consolidated assets and liabilities of SDNB Financial Corp and subsidiaries. The averages for San Diego National Bank are calculated on a daily basis. The average for SDNB Financial Corp. and other subsidiaries are calculated on a quarterly basis. 4) Non-accrual loans - Loans are placed on non-accrual status when a reasonable doubt exists as to the collectibility of interest or principal. As of December 31, 1995, 1994, and 1993, the Bank had loans on non-accrual status totaling $6,969, $6,046, and $5,343, respectively. Average balances for loans include these amounts; however, revenue is recognized on a cash basis for these loans. 5) Revenue for loans includes portions of fees recognized as current income of $540, $453, and $532 in 1995, 1994, and 1993, respectively. 6) Expense for short-term debt totaling $144 in 1995, $167 in 1994, and $147 in 1993, and the expense for long-term debt of $797 in 1995, $621 in 1994, and $673 in 1993, are classified as building operating expense on the consolidated financial statements.
VOLUME/RATE VARIANCE ANALYSIS 1995 COMPARED TO 1994 1994 COMPARED TO 1993 1993 COMPARED TO 1992 Volume Rate Total Volume Rate Total Volume Rate Total INCREASE (DECREASE) IN INTEREST ON EARNING ASSETS: Loans Commercial loans (856) 1,159 303 (1,320) 316 (1,004) (466) 36 (430) Real estate loans (71) 351 280 (275) 452 177 258 (269) (11) Installment loans (20) 27 7 (25) (52) (77) (51) 71 20 Total loans (947) 1,537 590 (1,620) 716 (904) (259) (162) (421) Investment securities U.S. Treasury securities 73 60 133 18 18 36 (5) (58) (63) Securities of government agencies (109) 132 23 312 67 379 376 (82) 294 State and political obligations (167) (14) (181) 130 (139) (9) (25) (5) (30) Other securities 61 3 64 (13) (3) (16) (65) 19 (46) Total investment securities (142) 181 39 447 (57) 390 281 (126) 155 Certificates of deposit in other bank 42 32 74 (1) (3) (4) (78) (27) (105) Federal funds sold (127) 299 172 172 196 368 19 (63) (44) Total interest income change (1,174) 2,049 875 (1,002) 852 (150) (37) (378) (415) INCREASE (DECREASE) IN INTEREST PAID ON LIABILITIES: Interest on deposits Savings, NOW accounts, and money markets (49) 314 265 158 90 248 (194) (279) (473) Other domestic time deposits (170) 336 166 (794) (103) (897) 76 (326) (250) Total interest on deposits (219) 650 431 (636) (13) (649) (118) (605) (723) Securities sold under agreement to repurchase and federal funds purchased (129) 17 (112) 171 11 182 101 (60) 41 Short-term debt (64) 32 (32) 5 30 35 29 (10) 19 Long-term debt (18) 194 176 (15) (37) (52) (20) (140) (160) Total interest expense change (430) 893 463 (475) (9) (484) (8) (815) (823) Net change in net interest income (744) 1,156 412 (527) 861 334 (29) 437 408 Note: Change in interest income or expense can be attributed to (a) changes in volume (change in volume times old rate), (b) changes in rate (change in rate times old volume),and (c) changes in rate/volume (change in rate times the change in volume). The rate/volume variances are allocated proportionally between the rate and the volume variances based on their absolute values.
INVESTMENT SECURITIES 1995 1994 (Book Value) (Book Value) December 31, 1995 and 1994: Available-For-Sale: U.S. Treasuries 13,515 0 Average maturity (in years) 0.12 0 U.S. Government agencies 12,773 9,637 Average maturity (in years) 1.62 2.11 Other securities 472 0 Average maturity (in years) 0.00 0 FRB Stock 273 273 27,033 9,910 Held-To-Maturity: U.S. Treasuries 1,000 1,998 Average maturity (in years) 0.08 0.83 U.S. Government agencies 4,021 11,397 Average maturity (in years) 2.39 2.74 States and municipalities 1,637 3,176 Average maturity (in years) 1.36 3.43 Other bonds and notes 750 750 Average maturity (in years) 3.58 4.58 7,408 17,321 1993 (Book Value) December 31, 1993: Held-For-Investment: U.S. Treasuries 6,004 Average maturity (in years) 0.47 U.S. Government agencies 19,588 Average maturity (in years) 3.72 States and municipalities 4,362 Average maturity (in years) 2.69 FRB Stock 273 30,227
INVESTMENT SECURITIES MATURITY IN YEARS Under 1 1 to 5 5 to 10 Over 10 Total Available-For-Sale: U.S. Treasuries 13,515 0 0 0 13,515 Weighted average interest rate 5.44% 0.00% 0.00% 0.00% 5.44% U.S. Government agencies 1,799 10,974 0 0 12,773 Weighted average interest rate 5.51% 5.61% 0.00% 0.00% 5.60% Other securities 472 0 0 0 472 Weighted average interest rate 5.52% 0.00% 0.00% 0.00% 5.52% FRB Stock 0 0 0 273 273 Weighted average interest rate 0.00% 0.00% 0.00% 6.00% 6.00% 15,786 10,974 0 273 27,033 Held-To-Maturity: U.S. Treasuries 1,000 0 0 0 1,000 Weighted average interest rate 4.37% 0.00% 0.00% 0.00% 4.37% U.S. Government agencies 1,000 2,000 1,021 0 4,021 Weighted average interest rate 6.87% 5.15% 7.07% 0.00% 6.07% States and municipalities * 1,000 637 0 0 1,637 Weighted average interest rate 4.66% 5.70% 0.00% 0.00% 5.06% Other bonds and notes 0 500 250 0 750 Weighted average interest rate 0.00% 7.30% 8.50% 0.00% 7.70% 3,000 3,137 1,271 0 7,408 * Taxable equivalent yield based upon 34% Federal Income Tax rate.
LOAN PORTFOLIO LOAN TYPE Real Estate Real Estate Installment Lease Commercial Construction Mortgage and Consumer Financing Total Totals at year-end: 1995 54,372 5,618 29,332 2,873 136 92,331 1994 57,613 5,750 31,461 2,234 0 97,058 1993 67,087 8,995 32,099 2,852 0 111,033 1992 85,377 12,717 30,721 3,306 0 132,121 1991 81,120 12,682 23,751 4,275 0 121,828 Maturities at the end of 1995: 1 year or less 43,330 5,245 2,679 2,065 33 53,352 1 - 5 years 10,333 24 23,984 801 103 35,245 after 5 years 709 349 2,669 7 0 3,734 Outstanding loans at the end of 1995 which are due after one year earn interest as follows: Fixed rate 1,120 0 3,527 520 103 5,270 Adjustable rate 9,922 373 23,126 288 0 33,709 RISK ELEMENTS Nonperforming assets consist of non-accrual loans, restructured loans, past due loans and other real estate owned. Non-accrual loans are loans on which interest recognition has been suspended until realized because of doubts as to the borrower's ability to repay principal or interest. Restructured loans are loans where the terms have been altered to provide a reduction or deferral of interest or principal because of a deterioration in the borrower's financial position. Past due loans are accruing loans that are contractually past due 90 days or more as to interest or principal payments. The following summarizes the nonperforming assets at December 31: 1995 1994 1993 1992 1991 Non-accrual loans 6,969 6,046 5,343 1,918 2,442 Restructured loans (still accruing) 1,364 2,316 3,162 0 0 Loans 90 days past due 93 20 481 248 2,238 8,426 8,382 8,986 2,166 4,680 Other real estate owned 181 268 1,050 2,091 4,987 Total 8,607 8,650 10,036 4,257 9,667 1) Non-accrual loans are placed on non-accrual when a reasonable doubt exists as to the collectibility of interest or principal. Gross interest income that would have been recorded for the year ended December 31, 1995, if non-accrual loans had been current and in accordance with their original terms, is approximately $819. Interest actually recognized for those loans was $589. Non-accrual loans totaling $5,561 in 1995, $1,144 in 1994, $1,196 in 1993, $521 in 1992 and $326 in 1991 were also classified as restructured loans.
SUMMARY OF LOAN LOSS EXPERIENCE 1995 1994 1993 1992 1991 Allowance for loan losses (as of Jan. 1) 2,148 2,522 2,111 2,011 1,499 Losses charged-off Commerical 619 2,211 2,277 1,294 722 Real estate construction 0 0 20 120 0 Real estate mortgage 0 0 264 101 56 Installment 36 151 155 60 70 Lease financing 0 0 0 0 0 Total loans charged-off 655 2,362 2,716 1,575 848 Recoveries of losses previously charged-off Commerical 276 121 144 299 81 Real estate construction 0 0 0 0 0 Real estate mortgage 0 10 4 50 0 Installment 33 7 29 6 9 Lease financing 0 0 0 0 0 Total recoveries 309 138 177 355 90 Net loans charged-off 346 2,224 2,539 1,220 758 Additions charged to operating expense 200 1,850 2,950 1,320 1,270 Allowance for loan losses (as of Dec. 31) 2,002 2,148 2,522 2,111 2,011 Average loans outstanding 92,376 103,897 121,758 124,945 123,490 Ratio of net charge-offs to average loans outstanding 0.37% 2.14% 2.09% 0.98% 0.61%
ALLOWANCE FOR LOAN LOSSES BY CATEGORY 1995 1994 1993 1992 1991 Percent Percent Percent Percent Percent of loans of loans of loans of loans of loans in each in each in each in each in each category category category category category to total to total to total to total to total Amount loans Amount loans Amount loans Amount loans Amount loans Commerical 933 57.6% 1,635 59.4% 1,862 60.4% 1,304 64.5% 1,417 66.6% Real estate construction 25 6.1% 49 5.9% 57 8.1% 101 9.6% 96 10.4% Real estate mortgage 293 33.1% 80 32.4% 206 28.9% 222 23.4% 196 19.5% Installment 12 3.1% 62 2.3% 93 2.6% 25 2.5% 30 3.5% Lease financing 1 0.1% 0 0.0% 0 0.0% 0 0.0% 0 0.0% Unallocated 738 NA 322 NA 304 NA 459 NA 272 NA Total 2,002 100.0% 2,148 100.0% 2,522 100.0% 2,111 1 00.0% 2,011 100.0% 1) Beginning in 1993, the Bank evaluates the adequacy of its allowance for loan losses using a "migration analysis" of net charge-offs to classified loans. Certain loans are segregated by management and reserved specifically based on potential loss exposure. The remainder of the loans in the portfolio are segregated into significant pools. Potential loss exposure is determined by creating a loss experience percentage for loans with similar characteristics and quality. These percentages are applied to the Bank's current portfolio to estimate the amount of future losses. The Bank also makes a provision for undrawn commitments and letters of credit. This quantitative analysis is supplemented with a provision based on qualitative factors including but not limited to trends in volume and severity of past due and classified loans and trends in the volume of nonaccural loans troubled debt- restructurings and other loan modifications, trends in the nature and volume of the portfolio, experience ability and depth of lending management and staff, trends in lending policies and procedures including underwriting standards and collection charge-off and recovery practices, national and local economic and business conditions and developments including the condition of various market segments, existence and effect of any concentrations of credit and changes in the level of such concentrations, quality of the institution's loan review system and the degree of oversight by the institution's board of directors, 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. The reserve balance represents the aggregate of these allocations. Prior to 1993, the Bank evaluated the adequacy of its allowance for loan losses on an individual loan basis. In determining the adequacy of the allowance, management evaluated each loan with regard to creditworthiness of the borrower, sources of repayment, general and industry specific economic conditions, and collateral. The bank reserved non-classified loans on a percentage basis related to past loss experience. Loans determined to be of higher than normal risk were assigned a higher reserve amount based upon possible loss exposure. The reserve balance for the years 1990 - 1992 were the aggregate of those allocations.
DEPOSITS 1995 1994 1993 Average Average Average Outstanding Yield Outstanding Yield Outstanding Yield Demand 42,244 0.00% 46,354 0.00% 44,265 0.00% Interest-bearing demand 14,166 1.52% 14,496 1.48% 14,280 1.47% Savings 54,994 3.18% 56,677 2.63% 50,150 2.48% Time deposits 18,542 5.19% 22,831 3.49% 45,391 3.73% At December 31, 1995, time deposits in amounts of $100,000 or more had a maturity breakdown as follows (in thousands): Time All Certificates Other of Deposit Time 3 months or less 6,167 201 Over 3 through 6 months 3,360 200 Over 6 through 12 months 2,498 0 Over 12 months 0 322 12,025 723
RETURN ON EQUITY AND ASSETS 1995 1994 1993 Return on assets 0.13% (0.09)% (1.37)% (Net income divided by average total assets) Return on equity 1.68% (1.65)% (22.56)% (Net income divided by average equity) Equity to assets 7.69% 5.41% 6.09% (Average equity divided by average total assets) Dividend payout ratio 0.00% 0.00% 0.00% (Dividends per share divided by net income per share) SHORT-TERM BORROWINGS 1995 1994 1993 Securities sold under repurchase agreements and federal funds sold a) Outstanding at end of period 12,934 12,285 9,273 b) Average interest rate, end of period 2.66% 2.78% 2.16% c) Maximum outstanding during period 14,333 18,614 12,393 d) Approximate average amount outstanding during period 9,668 14,603 7,762 e) Weighted average interest rate 2.64% 2.51% 2.38% Short-term debt a) Outstanding at end of period 0 2,544 2,384 b) Average interest rate, end of period 0.00% 9.19% 7.36% c) Maximum outstanding during period 2,544 2,554 2,448 d) Approximate average amount outstanding during period 1,777 2,456 2,393 e) Weighted average interest rate 9.96% 8.51% 7.27%
Item 2. Properties. The Company owned no properties directly at December 31, 1995. The Company's executive offices and the Bank's executive offices and banking facilities are located at 1420 Kettner Boulevard, San Diego, California 92101 (the "Bank Building"), which is owned by the Joint Venture. In January 1982, the Bank executed a 99-year ground lease, which was subsequently assumed by the Joint Venture, for approximately 27,000 square feet of undeveloped real property located at the site. The Company's wholly-owned subsidiary, Devco, was the 50% joint venturer with a limited partnership, Kettner Building Associates, Ltd. ("KBA"), in the ownership and operation of the Bank Building. As previously stated, effective July 1, 1993, Devco was merged into the Company and the Company assumed the partnership ownership. Commencing in 1985 and continuing into 1987, the Company (through Devco) acquired the 10% general partnership interest and a 14% limited partnership interest in KBA. The only activity of KBA is its 50% interest in the Joint Venture. Therefore, the acquisition of the partnership interests increased the Company's combined interest in the Bank Building to approximately 62% at December 31, 1987. On March 3, 1987, the Joint Venture obtained long-term financing from Home Fed Bank in the original amount of $11,250,000 (the "Loan"). During 1993, Resolution Trust Corporation, as successor to Home Fed, sold the Loan to an investment group as a part of a package. In November 1994, the Loan was purchased by the two limited partnerships managed by WHR Management Corp. ("WHR") which subsequently purchased some of the Company's stock (see management discussion and analysis and notes to the consolidated financial statements). In January 1995, the Joint Venture and WHR entered into a modification agreement which, inter alia, allowed for prepayment of the Loan at a discount. On November 30, 1995 the Loan was paid off at a discount from face value of $1,579,000 resulting in a net gain, after expenses and taxes, of $1,457,000. Because the Loan was held by a related party, the gain has been credited directly to shareholders' equity. The Bank Building was refinanced with a new loan from PKH Kettner Investors, LLC ("PKH") in the initial principal of $8 million, collateralized by a first deed of trust. The loan is payable in monthly installments of $76,145 which include interest at 9.8% per annum and is all due and payable December 1, 2005. As additional consideration for the loan, the Company issued to PKH a warrant to purchase 150,000 shares of the Company's common stock at a price of $5.44 per share (the average of the bid and ask prices on the day prior to the closing of the loan) until November 30, 1999. A member of PKH, Mr. Sol Price, is a principal shareholder of Price Enterprises, Inc. Murray L. Galinson, President, Chief Executive Officer and a Director of the Company and Vice Chairman, Chief Executive Officer and a Director of the Bank, serves as a Director of Price Enterprises, Inc. On January 4, 1988, the Joint Venture obtained a $2 million loan from PVCC, Inc. ("PVCC") a corporation controlled by Charles I. Feurzeig, Chairman of the Board of the Company. The proceeds of the loan were used to retire existing debt of the Joint Venture and to provide reserves for tenant improvements and negative cash flows. The loan was fully paid November 29, 1995. The Bank has leased the ground floor and the mezzanine of the Bank Building, which constitutes approximately 26,000 square feet, and the Company has leased a portion of the seventh floor, which constitutes approximately 12,000 square feet. The ground floor and mezzanine lease term is for 20 years, commencing May 1985, with an option for the Bank to renew on the same terms for two consecutive seven-year periods following the expiration of the initial term. The base rent paid by the Bank is currently $2.30 per square foot per month, subject to annual upward cost-of- living adjustments limited to an increase of 5% of the base rent for each year and 15% of the base rent for each five year period. The base rent includes all taxes, utilities, insurance, maintenance and operational common area expenses (the "pass- through expenses"). If the pass-through expenses exceed in any year the sum of $5.00 per square foot, the Bank pays such excess. The lease also provides for a right of first refusal in favor of the Bank on not less than one full leasable floor (approximately 17,000 square feet) as the same shall become available for lease within the Bank Building. The seventh floor lease term is five years and seven months commencing September 1990, with an option to renew for two consecutive five year terms. The base rate is currently $2.00 per square foot per month, subject to annual upward cost-of- living adjustments and pass-through expense similar to the Bank lease. The Bank is also renting additional space in the building on a month-to-month basis. The Company and the Bank believe the space at 1420 Kettner Boulevard (including the right of first refusal space) will be adequate for their needs for the foreseeable future. The Bank has leased property for its South Bay office at 398 H Street, Chula Vista, California. The lease term is seven years from November 1, 1995 with three options to extend of seven years each. Monthly rental is $6,900 for the first year and escalates 4% each year thereafter. The Bank is responsible for all operating expenses except for major repairs. At December 31, 1995, the Bank Building was approximately 98% leased, although concessions to some tenants who are not utilizing all of their leased premises would reduce the effective occupancy to approximately 93%. Item 3. Legal Proceedings. In January 1993, the Bank was named as a defendant in an adversary proceeding filed by Pioneer Liquidating Corporation ("PLC"), successor to six bankrupt Pioneer Mortgage Company entities (collectively, "Pioneer") in the Bankruptcy Court for the Southern District of California. Investors in Pioneer had previously filed suit against the Bank, which litigation was settled in 1992. The PLC case was settled with the final settlement agreement approved by the Federal District Court for the Southern District of California on November 29, 1995. A preliminary agreement between the Bank and PLC contemplated that the Bank would make payment to PLC on execution of the settlement agreement and assign to PLC certain charged-off loans, without recourse. The preliminary agreement further provided that after being given credit for the payment by the Bank and the collections on the assigned charged-off loans, payment of the remaining balance of the total settlement amount was to be guaranteed by Charles I. Feurzeig, Chairman of the Board of the Company, and PVCC, Inc., a corporation controlled by Mr. Feurzeig (collectively, the "Feurzeig Entities"). Such guarantee was being given by the Feurzeig Entities for consideration independent of Mr. Feurzeig's investment in the Company. Subsequent negotiations led to the settlement agreement approved by the Court whereby the Bank paid $600,000 to PLC and the Feurzeig Entities paid $1,050,000 to PLC upon execution of the settlement agreement and the Feurzeig Entities took the place of PLC with respect to assignment of the charged-off loans. In consideration of the modification of the original list of charged- off loans to eliminate certain loans which had been only partially charged-off, the Bank agreed to assign additional newly charged-off loans (90 days after charge-off) to the Feurzeig Entities, until the first to occur of: a) Five years after the date of the settlement agreement; or b) Such time as the Feurzeig Entities have collected on such loans $1,050,000 plus a return equal to the rate of 9.5% per year on the unpaid portion of such $1,050,000. Pursuant to the settlement agreement the Feurzeig Entities do not have recourse or a claim against the Bank should the collections on the assigned charged-off loans amount to less than $1,050,000. Should collections exceed $1,050,000 plus the return referred to above, the Feurzeig Entities have agreed to pay to the Bank 50% of such excess collections. Item 4. Submission of Matters to a Vote of Security Holders. No matter was submitted to a vote of security holders, through solicitation of proxies or otherwise, during the fourth quarter of 1995. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. (a) Market Information. Since October 6, 1987, the Company's Common Stock has been listed on the National Association of Securities Dealers ("NASDAQ") National Market System. There is only a limited market for the Company's Common Stock. Stock Price Information Period 1995 1994 First Quarter Low $3.25 $ 2.50 High 4.25 3.25 Second Quarter Low 3.625 2.50 High 4.25 3.25 Third Quarter Low 3.50 2.50 High 4.50 4.75 Fourth Quarter Low 4.50 3.00 High 6.25 4.75 (b) Holders. As of March 4, 1996, the Company's outstanding shares of Common Stock were held by approximately 1,000 shareholders of record (including those through broker/nominees). (c) Dividends. There were no stock or cash dividends declared in 1995 or 1994. Item 6. Selected Financial Data. Consolidated Financial Highlights Incorporated by reference - see inside front cover of the 1995 Annual Report to Shareholders. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Incorporated by reference - see pages 7 to 12 of the 1995 Annual Report to Shareholders. Item 8. Financial Statements and Supplementary Data. Incorporated by reference - see pages 13 to 23 of the 1995 Annual Report to Shareholders. Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosures. None. PART III The information required under PART III, Items 10, 11, 12 and 13, has been omitted from this Report because the Company intends to file with the Securities and Exchange Commission, not later than 120 days after the close of its fiscal year, a definitive proxy statement prepared pursuant to Regulation 14A, which will contain such information and which information is hereby incorporated by reference. PART IV Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 1. Financial statements Page* Consolidated Balance Sheets at December 31, 1995 and 1994. 13 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1995. 14 Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1995. 15 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995. 16 Notes to Consolidated Financial Statements. 17-23 Report of Independent Accountants. 24 *Refers to respective page numbers of Annual Report to Shareholders for the year ended December 31, 1995 which is incorporated by reference. 2. Financial statement schedules. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 3. Exhibits (listed by numbers corresponding to the Exhibit Table of Item 601 of Regulation S-K). (a) 3 (a) Restated Articles of Incorporation of the Company and amendment -incorporated by reference from 1988 Form 10-K. (b) Bylaws of the Company as amended through May 18, 1988 - incorporated by reference from 1988 Form 10-K. 10. (a)(1) Company's 1984 Stock Option Plan, as amended - incorporated by reference from 1992 Form 10-K. (2) The Company's 1994 Stock Option Plan - incorporated by reference from 1995 Form 10-K. (b) Employment contracts of certain executive officers. (c) Sample indemnification agreements with directors and officers - incorporated by reference from 1988 Form 10-K. 13. Annual Report to Shareholders. 22. Subsidiaries of the Registrant. 23. (a). Consent of Independent Accountants. (b) Reports on Form 8-K A report on Form 8-K was filed on December 5, 1995 reporting settlement of litigation against the Bank. (c) Exhibits required by Item 601 of Regulation S-K and not incorporated by reference are attached. (d) Not applicable. 27. Financial Data Schedule (submitted only in electronic format and omitted from paper copies pursuant to Paragraph (c)(v) of Regulation S-K (17 CFR 220.601(c)(v)) and Note 2 to Paragraph (c)(1)(vi) of Regulation S-K (17 CFR 229.601(c)(1)(vi))). SIGNATURES Pursuant to the Requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SDNB FINANCIAL CORP. Dated: March 27, 1996 By: /s/Murray L. Galinson Murray L. Galinson President and Chief Executive Officer By: /s/Howard W. Brotman Howard W. Brotman Senior Vice President, Secretary and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signatures Title Date Chairman of the Board March , 1996 CHARLES I. FEURZEIG and Director /s/Murray L. Galinson President, Chief March 27, 1996 MURRAY L. GALINSON Executive Officer and Director /s/ Douglas E. Barnhart Director March 27, 1996 DOUGLAS E. BARNHART /s/Margaret Costanza Director March 27, 1996 MARGARET COSTANZA /s/Karla J. Hertzog Director March 27, 1996 KARLA J. HERTZOG /s/Robert B. Horsman Director March 27, 1996 ROBERT B. HORSMAN /s/Mark P. Mandell Director March 27, 1996 MARK P. MANDELL /s/ Patricia L. Roscoe Director March 27, 1996 PATRICIA L. ROSCOE /s/Julius H. Zolezzi Director March 27, 1996 JULIUS H. ZOLEZZI /s/Howard W. Brotman Director, Senior Vice March 27, 1996 HOWARD W. BROTMAN President, Secretary and Chief Financial Officer INDEX OF EXHIBITS Exhibit Number 10 (b) Employment contracts of certain executive officers. 13 Annual Report to Shareholders. 22 Subsidiaries of Registrant. 23 (a) Consent of Independent Accountants. 27 Financial Data Schedule (submitted only in electronic format and omitted from paper copies pursuant to Paragraph (c)(v) of Regulation S-K (17 CFR 220.601(c)(v)) and Note 2 to Paragraph (c)(1)(vi) of Regulation S-K (17 CFR 229.601(c)(1)(vi))). EX-10.B 2 EXHIBIT "10 (b)" EMPLOYMENT CONTRACTS OF CERTAIN EXECUTIVE OFFICERS EXECUTIVE EMPLOYMENT AGREEMENT This is an Employment Agreement (hereinafter referred to as this ("Agreement") made effective as of this 27th day of March , 1996 by and between SDNB Financial Corp., a California corporation("Employer") sometimes referred to hereafter as ("Financial") and Murray L. Galinson (hereinafter referred to as "Employee"). RECITAL This Agreement is made with reference to the following facts: A. Employee is currently employed as President and Chief Executive Officer of Financial and CEO of Employer's wholly owned subsidiary, San Diego National Bank, a national association (hereinafter referred to as the "Bank"). B. Employer believes it to be in its best interest to have Employee continue his/her employment with the Bank in such capacities and in order to induce Employee to accept such continued employment as President and Chief Executive Officer, Employer is willing to enter into this Agreement. AGREEMENTS NOW, THEREFORE, in consideration of the mutual covenants contained herein, and for other good and valuable consideration, Employer and Employee covenant and agree as follows: 1. Term of Employment. Employer hereby agrees to cause the Bank and Financial to employ Employee and Employee hereby accepts employment with the Bank & Financial for a period beginning on the effective date of this Agreement as set forth hereinabove and continuing through and until December 31, 1998 (hereinafter referred to as the "Initial Employment Term"). In the event of any extension of this Agreement for one or more consecutive one (1) year terms upon the agreement of the parties hereto, or pursuant to the provisions of Section 9 hereof, the terms of this Agreement shall be deemed to continue in effect for the term of such extension (hereinafter referred to as the "Extended Employment Term") (the Initial Employment Term and the Extended Employment Term hereinafter collectively referred to as the "Employment Term"). 2. Duties of Employee. Employee shall serve as President and Chief Executive Officer throughout the Employment Term. Employee shall have such duties and responsibilities as are presently set forth in the Bylaws of the Bank and as are commensurate with such position, as may be from time to time more particularly set fourth by the Board of Directors of the Bank and Financial. Employee shall devote such portion of his productive time and attention to the business of the Bank as shall be reasonably necessary to carry out his duties during the Employment Term. Employee shall also serve as director of the Bank and Financial and shall be required to serve as an officer and director of all other corporations which are wholly-owned subsidiaries of Financial which exist now or may exist during the Employment Term. Subject to the provision of Section 12 hereof, this Agreement shall not be interpreted to prohibit Employee from making passive personal investments or conducting private business affairs if such activities do not materially interfere with the services required under this Agreement. 3. Indemnification. Employer shall indemnify and hold Employee harmless from all losses, costs, damages, liability, therefor, charges, claims, demands, attorneys' fees and/or expenses, actions and causes of action of any nature or sort, liquidated or unliquidated, past, present and future, of whatsoever kind or character which shall or may at any time incurred, suffered or sustained by Employee arising from the discharge of his duties on behalf of the Bank and/or Financial and/or other subsidiaries of Financial for which Employee provides services. 4. Compensation. As full compensation for the services to be performed hereunder, Employee shall receive the following: a. Basic Salary Subject to approved annual increases as hereinafter provided, basic salary at the rate of One Hundred Eighty Five Thousand One Hundred Twenty Dollars ($185,120) per year to be paid in accordance with the payroll schedule established by the Bank's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph may be adjusted on January 1 or each year of the Employment Term at the discretion of the Employer's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph shall be adjusted on January 1 of each year of the Employment Term at the discretion of the Employer's Board of Directors, but in no event shall the adjusted amount less than the amount of Employee's basic annual salary for the preceding year. b. Bonuses and Deferred Savings Plan. Employee shall be entitled to receive such other compensation as may be determined by the Employer's Board of Directors to be appropriate, in its sole discretion, including without limitation any amounts payable to Employee by participation in the Bank's Bonus Program and Deferred Savings Plan in accordance with the terms and conditions of said plans as in effect during the Employment Term. Employer shall not reduce during the Employment Term the proportionate annual share of the total amount of said Bonus Program and Deferred Savings Plan which Employee is eligible to receive based upon said Program and Plan as presently in effect as of the date of this Agreement. Further, if said Program and/or Plan are eliminated by Employer or Bank, Employee shall nevertheless continue to receive during the Employment Term an annual share of the Bank's profits which Employee last received pursuant to said program and/or Plan. 5. Tax Withholding. Employer shall have the right to deduct or withhold from the compensation due to Employee hereunder any and all sums required for any and all federal, social security, state and local taxes now applicable or that may be enacted and become applicable in the future. 6. Employee Benefits. a. Vacation Time. Employee shall be entitled to vacation time as set forth in the Bank's policies each calendar year during the Employment Term without loss of compensation. One increment of such annual vacation time shall be taken by Employee for a period of not less than two (2) consecutive weeks. In the event that Employee does not for any reason take the total amount of vacation time authorized herein during any year, the amount of time not taken in said year shall accumulate, and be available as additional vacation time in subsequent years; however, Employee shall not be permitted at any time to accumulate vacation time in excess of the amount of vacation time authorized for Employee during a two-year period. b. Use of Automobile. Employer shall provide Employee with the use of an "executive class" automobile throughout the Employment Term, or alternatively, at the discretion of Employer, an automobile allowance of Six Hundred ($600) Dollars per month. In addition, whether Employer provides Employee with an automobile or with an automobile allowance, Employer shall pay or reimburse for all operating expense of the automobile used by Employee, including a reasonable gasoline allowance and shall further provide and maintain liability insurance on such automobile, with coverage in amounts to be determined by the Employer's Board of Directors, but in any event not less than the minimum liability coverage required by California law. Employee shall be required to maintain adequate records of all business mileage incurred an all automobile operating expenses, such records to be maintained in compliance with IRS record-keeping guidelines then in effect. c. Seminars. Employer shall reimburse Employee for all costs and expenses, including without limitation registration fees, transportation costs, meals and lodging, incurred by Employee in connection with Employee's attendance at all professional seminars relating to the financial services industry for which Employee's attendance would be of benefit to Employer. d. Club. Employer shall pay all ongoing dues related to employee's membership in one "country-club" type club selected by Employee and subject to the express approval of the Employer's Board of Directors, shall pay all membership and/or initiation fees connected with said membership. e. Disability Insurance. Employer shall pay all costs and expenses, including without limitation premiums, to provide disability insurance coverage for Employee, which coverage shall be in an appropriate and customary amount based upon Employee's position and salary hereunder and subject to approval of medical records by the insurer. f. Additional Benefits. Employee shall be entitled to receive the greater of: (1) all employment benefits made available to other officers of the Bank and its affiliates and commensurate with Employee's position and title with the Bank, and (2) all employment benefits currently received by Employee as of the date of this Agreement. Such benefits shall include, but are not limited to, such health insurance, life insurance, sick leave, pension, and retirement plans as are adopted from time to time by the Bank. In the event that any benefit plan or plans adopted by the Bank or all of its employees conflicts with or overlaps any specific benefit set forth in this paragraph 6, Employee shall be entitled to whichever benefit is the greater of the two... 7. Life Insurance. In addition to any life insurance policies paid for by Employer pursuant to Section 6.c, in which Employee is named as its insured and in discretion, may purchase such life insurance policies as it deems necessary or appropriate, naming Employee as the insured and Employer as beneficiary. Employee hereby agrees to submit, at employer's cost, to any reasonable medical examination required for the purchase of such insurance. 8. Expenses. Employee shall be reimbursed for all reasonable expenses incurred by his pursuant to he performance of his duties and responsibilities hereunder. Employee shall keep complete and accurate records, including but not limited to proof of payment of all such expenses, so that he may fully account to the Employer if so requested. 9. Extension of Term Upon Changing Control. In the event that there is a change in control of the Bank and/or Financial, as that term is defined in 12 U.S.C. Section 1817 (Change in Bank Control Act of 1978), whether by merger, acquisition, "friendly" or hostile" "takeover" or otherwise, this Agreement shall be deemed extended for three years from the date of said change in control. During said period of extension, Employee shall be paid his compensation then applicable hereunder, and shall continue his participation in the Bank's Bonus Sharing Program and Deferred Savings Plan in accordance with Section 4.b hereof, and in no case shall Employer have any right to terminate the employment of Employee hereunder, except "for cause," as said term is defined in Section 10.a hereof. Further, in said event, Employee shall receive during the Extended Employment term a minimum of a ten percent (10%) increase in salary per annum each January 1 subsequent to the date of said change in control. 10. Termination of Agreement. a. Termination for Cause. Employer may terminate this Agreement without notice for "cause." For the purposes of this Agreement, "Cause" shall be defined as willful misconduct or willful dishonesty of Employee in his capacity as President and Chief Executive Officer of Bank and/or Financial, or willful material breach or habitual neglect of the duties which Employee is required to perform under the terms of this agreement. b. Effect of Termination. In the event of termination of Employee for cause as set froth in Section 10.a, and assuming that Employer is not in material default hereunder, all future bonuses or other salaries payable to or claimed by Employee are waived, and any additional salary or bonus shall be paid only in the sole and absolute discretion of Employer. In the event Employee voluntarily terminates his employment hereunder, Employee shall be entitled to a pro rata share of bonus compensation based upon the formula contained in Section 10.c hereof. Nothing in this Section 10 shall affect the rights of the parties under Section 12 hereof. c. Disability and Death. If, during the Employment Term Employee should die or suffer any physical or mental illness that renders him incapable of fulfilling his obligations under this Agreement, and such incapacity exists or may reasonably be expected to exist for more than one hundred and fifty (150) consecutive days, Employer may, upon forty-five (45) days written notice to Employee, terminate this Agreement. The determination of Employer that Employee is incapable of fulfilling his obligations under this Agreement, so long as such determination is made in good faith and is supported by a reasonable medical opinion, shall be final and binding. In the event of termination under this Section 10.c, Employee, or his estate, shall be entitled (I) to an amount equal to twelve (12) months' salary payable forthwith, and (ii) to a pro rata share of bonus compensation based upon the ratio of the number of days of the portion of the bonus term then in effect prior to Employee's death or disability, as the case may be, to the number of days of the full bonus term, payable at the time when said bonus is payable to all employees, and (iii) to any other accrued compensation, plus such additional benefits, if any, as may be approved by Employer's Board of Directors. Employee, or his estate, shall, upon termination under the terms of this Section 10.c, be further entitled to additional pro rata compensation based upon the ratio of the number of accrued vacation days, if any, not taken by Employee during the year, as defined for the purposes of vacation, in which Employee was so terminated, to 365 days. d. Communication of Termination. Any termination by Employer of Employee shall be communicated by written notice of termination which shall indicate the specific termination provision of this Agreement relied upon by Employer, and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for such termination. 11. Location. Employee shall not be required to move from or perform his duties hereunder in any geographical area other than the San Diego County area. 12. Non-Competition. a. While Employed. During the Employment Term, Employee shall not, directly or indirectly, either as an employee, employer, consultant, agent, principal partner, stockholder, corporate officer, director, or in any other individual or representative capacity, engage or participate in or acquire, hold, or retain any interest in any business of the Bank in any location, unless such participation or interest is fully disclosed to the Bank and Financial Corp. approval by a majority of the Board of Directors of each. The foregoing notwithstanding, Employee may acquire, hold or retain equity ownership of any publicly-held company, provided that such equity ownership does not exceed five percent (5%) of the issued and outstanding shares of voting stock of such company. b. Upon Early Termination or Termination for Cause. If Employee is terminated for cause (as defined in Section 10.a hereof) or voluntarily resigns from employment hereunder prior to the termination of the Initial Employment Term without the consent of Employer, Employee shall not acquire, hold or retain any interest (direct or indirect) in any business in the County of San Diego, in the State of California, and in such other locations where the Bank is then engaged in business from time to time during the remainder of the Initial Employment Term that is in competition with the business of the Bank until the date on which the employees' employment was to naturally terminate according to the terms hereof; provided, however, that in the event that prior to any such voluntary resignation as aforesaid, Employer has offered in writing to extend the term of this Agreement for an additional year on the same terms and conditions as set forth in this Agreement with compensation increased in accordance with Section 4.a hereof, then Employee's obligation under this Section 12.b shall be extended for an additional one (1) year beyond the Initial Employment Term. c. If any portion of this Section 12 is held to be illegal, unenforceable, void, or voidable, the remainder shall remain in full force and effect, and this Section 12 shall be deemed altered and amended to the minimum extent necessary to bring it within the legal requirements. 13. Unique Services. Employee hereby represents and agrees that the services to be performed under the terms of this Agreement are of a special, unique, unusual, extraordinary and intellectual character that gives them a peculiar value, the loss of which cannot be reasonable or adequately compensated in damages in any action at law. Employee, therefore, expressly agrees that Employer, in addition to any rights or remedies that Employer might possess, shall be entitled to injunctive and other equitable relief to prevent or remedy a breach of this Agreement by Employee. 14. Confidential Information. a. For purposes of this Agreement, "Confidential Information: shall mean information or material proprietary to Employer or Bank or designated as Confidential Information by Employer or Bank and not generally known by non-Bank personnel which Employee develops or of which Employee may obtain knowledge or access through or as a result of Employee's employment with the Employer or Bank (including information conceived, originated, discovered, or developed, in whole or in part, by Employee). The Confidential Information includes, but is not limited to, the following types of information and other information of a similar nature (whether or not reduced to writing): Drawings, specifications, models, data, documentation, diagrams, flow charts, research, development, procedures, marketing techniques and materials, marketing and development plans, customer lists, and names and other information related to customers, pricing and loan policies, financial information and projections customer loans and employee files. Confidential Information also includes any information described above which Employer obtains from another party, and which Employer treats as proprietary or designates as Confidential Information, whether or not owned or developed by Employer, For purposes of this Section a., Employer and/or Bank shall mean the Bank, Financial or any of their affiliates. INFORMATION PUBLICLY KNOWN THAT IS GENERALLY EMPLOYED BY FINANCIAL INSTITUTIONS AT OR AFTER THE TIME EMPLOYEE FIRST HEARS OF SUCH INFORMATION OR GENERIC INFORMATION, OR GENERAL KNOWLEDGE WHICH EMPLOYEE WOULD HAVE LEARNED IN THE COURSE OF SIMILAR EMPLOYMENT OR WORK ELSEWHERE SHALL NOT BE DEEMED PART OF THE CONFIDENTIAL INFORMATION. b. All notes, data, reference materials, sketches, drawings, memoranda, documentation, and records in any way incorporating or reflecting any of the Confidential Information and all proprietary rights therein, including copy rights, shall belong exclusively to Employer, and Employee agrees to turn over all copies of such materials in Employee's possession or control to Employer upon request or upon termination of Employee's employment with Employer. c. Employee agrees during his employment by Employer and thereafter to hold in confidence and not to directly or indirectly reveal, report, publish, disclose, or transfer any of the Confidential Information to any person or entity, or utilize any of the Confidential Information for any purpose, except in the due performance of Employee's services for Employer. d. Because of the unique nature of the Confidential Information, Employee understands and agrees that Employer will suffer irreparable harm in the event that Employee fails to comply with any of his obligations under this Section 14, and that monetary damages will be inadequate to compensate Employer for such breach. Accordingly, Employee agrees that Employer will, in addition to any other remedies available to them at law or in equity, be entitled to injunctive relief to enforce the terms of this Section 14. 15. Notices. Any notices to be given hereunder by either party to the other shall be in writing and may be transmitted by personal delivery or by certified mail, return receipt requested. Mailed notices shall be addressed the parties as follows: If notice is to Financial, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Bank, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Employee, to: Name: Murray L. Galinson Address: 7919 Prospect Place City/State: La Jolla, CA 92037 Either party may change its address by written notice in accordance with this paragraph. Notices delivered personally shall be deemed communicated as of the date of actual receipt; mailed notices shall be deemed communicated as of forty-eight (48) hours after the date of mailing. 16. Entire Agreement. This Agreement, in combination with any collateral documents referred to herein, supersedes any and all other agreements, either oral or in writing, between the parties hereto with respect to the employment of Employee by the Employer and contains all of the covenants and agreements between the parties with respect to said employment. 17. Modifications. Any modification of this Agreement shall be effective only if it is in writing and signed by the parties hereto. 18. Effect of Waiver. The failure of either party to insist on strict compliance with any of the terms, covenants or conditions of this Agreement by the other party shall not be deemed a waiver of that term, covenant, or condition, nor shall any waiver or relinquishment of any right or power at any one time or times be deemed a waiver or relinquishment of that right or power for all or any other times. 19. Partial Invalidity. If any provision of this Agreement is held be a court of competent jurisdiction to be invalid, void, or unenforceable, the remaining provisions shall nevertheless continue in full force without being impaired or invalidated in any way, unless such partial invalidity materially affects the intent of the parties as indicated herein. 20. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the state of California applicable to contracts between residents of California which are wholly executed and performed in California. 21. Assignability. The rights and duties of either party hereunder shall not be assignable by either party, except that this Agreement and all rights and obligations hereunder may be assigned by Employer to, and be assumed by, any corporation or other business entity which succeeds to all or substantially all of the assets and business of Employer through merger, consolidation acquisition of assets, or other corporate reorganization. Subject to the provisions of the immediately preceding sentence, this agreement shall be binding upon and inure to the benefit of the heirs, executors and/or administrators of Employee and to the successors and assigns of Employer. 22. Arbitration. Any controversy or claim arising out of or relating to this agreement, or the breach thereof, shall be settled by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (as such rules shall be in effect on the date a demand for arbitrating is communicated from one party to the other party hereto) in San Diego, California, and judgment upon the award rendered by thereof. Employer shall bay the fees of all arbitrators, witnesses and such other expenses as may be generated by the arbitration's, including without limitation, attorneys' fees of the Parties, unless in the event the arbitration was instituted by Employee, the majority of the Arbitrators conclude that said arbitration was not initiated in good faith by Employee; under said circumstance, the arbitrators shall be authorized to allocate costs and attorneys' fees as they shell deem appropriate with due consideration to both the relative financial abilities of the parties and the merits of the positions of the parties with respect to the dispute underlying the arbitration. 23. Headings. The headings used in this Agreement are for convenience of reference only and are not part of this Agreement and do not in any way limit or amplify the terms and provisions hereof. 24. Further Acts and Documents. The parties hereto agree to perform all further acts and execute all further documents reasonably necessary to implement to purposes of this Agreement. Employer: SDNB Financial Corp. a California Corporation By: /s/Murray L. Galinson /s/Julius Zolezzi Murray L. Galinson Julius Zolezzi President/Chief Executive Officer Vice Chairman of the Board Date: March 27, 1996 Date: March 27, 1996 EXECUTIVE EMPLOYMENT AGREEMENT This is an Employment Agreement (hereinafter referred to as this ("Agreement") made effective as of this 27th day of March , 1996 by and between San Diego National Bank, ("Employer" )and Robert B. Horsman (hereinafter referred to as "Employee"). RECITAL This Agreement is made with reference to the following facts: A. Employee is currently employed as President, San Diego National Bank, a national banking association (hereinafter referred to as the "Bank"). B. Employer believes it to be in its best interest to have Employee continue his/her employment with the Bank in such capacities and in order to induce Employee to accept such continued employment as President, Employer is willing to enter into this Agreement. AGREEMENTS NOW, THEREFORE, in consideration of the mutual covenants contained herein, and for other good and valuable consideration, Employer and Employee covenant and agree as follows: 1. Term of Employment. Employer hereby agrees to cause the Bank to employ Employee and Employee hereby accepts employment with the Bank for a period beginning on the effective date of this Agreement as set forth hereinabove and continuing through and until December 31, 1998 (hereinafter referred to as the "Initial Employment Term"). In the event of any extension of this Agreement for one or more consecutive one (1) year terms upon the agreement of the parties hereto, or pursuant to the provisions of Section 9 hereof, the terms of this Agreement shall be deemed to continue in effect for the term of such extension (hereinafter referred to as the "Extended Employment Term") (the Initial Employment Term and the Extended Employment Term hereinafter collectively referred to as the "Employment Term"). 2. Duties of Employee. Employee shall serve as President of the Bank, throughout the Employment Term. Employee shall have such duties and responsibilities as are presently set forth in the Bylaws of the Bank and as are commensurate with such position, as may be from time to time more particularly set fourth by the Board of Directors of the Bank and Financial. Employee shall devote such portion of his productive time and attention to the business of the Bank as shall be reasonably necessary to carry out his duties during the Employment Term. Employee shall also serve as director of the Bank and Financial and shall be required to serve as an officer and director of all other corporations which are wholly-owned subsidiaries of Financial which exist now or may exist during the Employment Term. Subject to the provision of Section 12 hereof, this Agreement shall not be interpreted to prohibit Employee from making passive personal investments or conducting private business affairs if such activities do not materially interfere with the services required under this Agreement. 3. Indemnification. Employer shall indemnify and hold Employee harmless from all losses, costs, damages, liability, therefor, charges, claims, demands, attorneys' fees and/or expenses, actions and causes of action of any nature or sort, liquidated or unliquidated, past, present and future, of whatsoever kind or character which shall or may at any time incurred, suffered or sustained by Employee arising from the discharge of his duties on behalf of the Bank and/or Financial and/or other subsidiaries of Financial for which Employee provides services. 4. Compensation. As full compensation for the services to be performed hereunder, Employee shall receive the following: a. Basic Salary Subject to approved annual increases as hereinafter provided, basic salary at the rate of One Hundred Twenty Three Thousand Five Hundred and Fifty Dollars ($123,550) per year to be paid in accordance with the payroll schedule established by the Bank's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph may be adjusted on January 1 or each year of the Employment Term at the discretion of the Employer's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph shall be adjusted on January 1 of each year of the Employment Term at the discretion of the Employer's Board of Directors, but in no event shall the adjusted amount less than the amount of Employee's basic annual salary for the preceding year. b. Bonuses and Deferred Savings Plan. Employee shall be entitled to receive such other compensation as may be determined by the Employer's Board of Directors to be appropriate, in its sole discretion, including without limitation any amounts payable to Employee by participation in the Bank's Bonus Program and Deferred Savings Plan in accordance with the terms and conditions of said plans as in effect during the Employment Term. Employer shall not reduce during the Employment Term the proportionate annual share of the total amount of said Bonus Program and Deferred Savings Plan which Employee is eligible to receive based upon said Program and Plan as presently in effect as of the date of this Agreement. Further, if said Program and/or Plan are eliminated by Employer or Bank, Employee shall nevertheless continue to receive during the Employment Term an annual share of the Bank's profits which Employee last received pursuant to said program and/or Plan. 5. Tax Withholding. Employer shall have the right to deduct or withhold from the compensation due to Employee hereunder any and all sums required for any and all federal, social security, state and local taxes now applicable or that may be enacted and become applicable in the future. 6. Employee Benefits. a. Vacation Time. Employee shall be entitled to vacation time as set forth in the Bank's policies each calendar year during the Employment Term without loss of compensation. One increment of such annual vacation time shall be taken by Employee for a period of not less than two (2) consecutive weeks. In the event that Employee does not for any reason take the total amount of vacation time authorized herein during any year, the amount of time not taken in said year shall accumulate, and be available as additional vacation time in subsequent years; however, Employee shall not be permitted at any time to accumulate vacation time in excess of the amount of vacation time authorized for Employee during a two-year period. b. Use of Automobile. Employer shall provide Employee with the use of an "executive class" automobile throughout the Employment Term, or alternatively, at the discretion of Employer, an automobile allowance of Six Hundred ($600) Dollars per month. In addition, whether Employer provides Employee with an automobile or with an automobile allowance, Employer shall pay or reimburse for all operating expense of the automobile used by Employee, including a reasonable gasoline allowance and shall further provide and maintain liability insurance on such automobile, with coverage in amounts to be determined by the Employer's Board of Directors, but in any event not less than the minimum liability coverage required by California law. Employee shall be required to maintain adequate records of all business mileage incurred an all automobile operating expenses, such records to be maintained in compliance with IRS record-keeping guidelines then in effect. c. Seminars. Employer shall reimburse Employee for all costs and expenses, including without limitation registration fees, transportation costs, meals and lodging, incurred by Employee in connection with Employee's attendance at all professional seminars relating to the financial services industry for which Employee's attendance would be of benefit to Employer. d. Club. Employer shall pay all ongoing dues related to employee's membership in one "country-club" type club selected by Employee and subject to the express approval of the Employer's Board of Directors, shall pay all membership and/or initiation fees connected with said membership. e. Disability Insurance. Employer shall pay all costs and expenses, including without limitation premiums, to provide disability insurance coverage for Employee, which coverage shall be in an appropriate and customary amount based upon Employee's position and salary hereunder and subject to approval of medical records by the insurer. f. Additional Benefits. Employee shall be entitled to receive the greater of: (1) all employment benefits made available to other officers of the Bank and its affiliates and commensurate with Employee's position and title with the Bank, and (2) all employment benefits currently received by Employee as of the date of this Agreement. Such benefits shall include, but are not limited to, such health insurance, life insurance, sick leave, pension, and retirement plans as are adopted from time to time by the Bank. In the event that any benefit plan or plans adopted by the Bank or all of its employees conflicts with or overlaps any specific benefit set forth in this paragraph 6, Employee shall be entitled to whichever benefit is the greater of the two... 7. Life Insurance. In addition to any life insurance policies paid for by Employer pursuant to Section 6.c, in which Employee is named as its insured and in discretion, may purchase such life insurance policies as it deems necessary or appropriate, naming Employee as the insured and Employer as beneficiary. Employee hereby agrees to submit, at employer's cost, to any reasonable medical examination required for the purchase of such insurance. 8. Expenses. Employee shall be reimbursed for all reasonable expenses incurred by his pursuant to he performance of his duties and responsibilities hereunder. Employee shall keep complete and accurate records, including but not limited to proof of payment of all such expenses, so that he may fully account to the Employer if so requested. 9. Extension of Term Upon Changing Control. In the event that there is a change in control of the Bank and/or Financial, as that term is defined in 12 U.S.C. Section 1817 (Change in Bank Control Act of 1978), whether by merger, acquisition, "friendly" or hostile" "takeover" or otherwise, this Agreement shall be deemed extended for three years from the date of said change in control. During said period of extension, Employee shall be paid his compensation then applicable hereunder, and shall continue his participation in the Bank's Bonus Sharing Program and Deferred Savings Plan in accordance with Section 4.b hereof, and in no case shall Employer have any right to terminate the employment of Employee hereunder, except "for cause," as said term is defined in Section 10.a hereof. Further, in said event, Employee shall receive during the Extended Employment term a minimum of a ten percent (10%) increase in salary per annum each January 1 subsequent to the date of said change in control. 10. Termination of Agreement. a. Termination for Cause. Employer may terminate this Agreement without notice for "cause." For the purposes of this Agreement, "Cause" shall be defined as willful misconduct or willful dishonesty of Employee in his capacity as President of Bank and/or Financial, or willful material breach or habitual neglect of the duties which Employee is required to perform under the terms of this agreement. b. Effect of Termination. In the event of termination of Employee for cause as set froth in Section 10.a, and assuming that Employer is not in material default hereunder, all future bonuses or other salaries payable to or claimed by Employee are waived, and any additional salary or bonus shall be paid only in the sole and absolute discretion of Employer. In the event Employee voluntarily terminates his employment hereunder, Employee shall be entitled to a pro rata share of bonus compensation based upon the formula contained in Section 10.c hereof. Nothing in this Section 10 shall affect the rights of the parties under Section 12 hereof. c. Disability and Death. If, during the Employment Term Employee should die or suffer any physical or mental illness that renders him incapable of fulfilling his obligations under this Agreement, and such incapacity exists or may reasonably be expected to exist for more than one hundred and fifty (150) consecutive days, Employer may, upon forty-five (45) days written notice to Employee, terminate this Agreement. The determination of Employer that Employee is incapable of fulfilling his obligations under this Agreement, so long as such determination is made in good faith and is supported by a reasonable medical opinion, shall be final and binding. In the event of termination under this Section 10.c, Employee, or his estate, shall be entitled (I) to an amount equal to twelve (12) months' salary payable forthwith, and (ii) to a pro rata share of bonus compensation based upon the ratio of the number of days of the portion of the bonus term then in effect prior to Employee's death or disability, as the case may be, to the number of days of the full bonus term, payable at the time when said bonus is payable to all employees, and (iii) to any other accrued compensation, plus such additional benefits, if any, as may be approved by Employer's Board of Directors. Employee, or his estate, shall, upon termination under the terms of this Section 10.c, be further entitled to additional pro rata compensation based upon the ratio of the number of accrued vacation days, if any, not taken by Employee during the year, as defined for the purposes of vacation, in which Employee was so terminated, to 365 days. d. Communication of Termination. Any termination by Employer of Employee shall be communicated by written notice of termination which shall indicate the specific termination provision of this Agreement relied upon by Employer, and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for such termination. 11. Location. Employee shall not be required to move from or perform his duties hereunder in any geographical area other than the San Diego County area. 12. Non-Competition. a. While Employed. During the Employment Term, Employee shall not, directly or indirectly, either as an employee, employer, consultant, agent, principal partner, stockholder, corporate officer, director, or in any other individual or representative capacity, engage or participate in or acquire, hold, or retain any interest in any business of the Bank in any location, unless such participation or interest is fully disclosed to the Bank and Financial Corp. approval by a majority of the Board of Directors of each. The foregoing notwithstanding, Employee may acquire, hold or retain equity ownership of any publicly-held company, provided that such equity ownership does not exceed five percent (5%) of the issued and outstanding shares of voting stock of such company. b. Upon Early Termination or Termination for Cause. If Employee is terminated for cause (as defined in Section 10.a hereof) or voluntarily resigns from employment hereunder prior to the termination of the Initial Employment Term without the consent of Employer, Employee shall not acquire, hold or retain any interest (direct or indirect) in any business in the County of San Diego, in the State of California, and in such other locations where the Bank is then engaged in business from time to time during the remainder of the Initial Employment Term that is in competition with the business of the Bank until the date on which the employees' employment was to naturally terminate according to the terms hereof; provided, however, that in the event that prior to any such voluntary resignation as aforesaid, Employer has offered in writing to extend the term of this Agreement for an additional year on the same terms and conditions as set forth in this Agreement with compensation increased in accordance with Section 4.a hereof, then Employee's obligation under this Section 12.b shall be extended for an additional one (1) year beyond the Initial Employment Term. c. If any portion of this Section 12 is held to be illegal, unenforceable, void, or voidable, the remainder shall remain in full force and effect, and this Section 12 shall be deemed altered and amended to the minimum extent necessary to bring it within the legal requirements. 13. Unique Services. Employee hereby represents and agrees that the services to be performed under the terms of this Agreement are of a special, unique, unusual, extraordinary and intellectual character that gives them a peculiar value, the loss of which cannot be reasonable or adequately compensated in damages in any action at law. Employee, therefore, expressly agrees that Employer, in addition to any rights or remedies that Employer might possess, shall be entitled to injunctive and other equitable relief to prevent or remedy a breach of this Agreement by Employee. 14. Confidential Information. a. For purposes of this Agreement, "Confidential Information: shall mean information or material proprietary to Employer or Bank or designated as Confidential Information by Employer or Bank and not generally known by non-Bank personnel which Employee develops or of which Employee may obtain knowledge or access through or as a result of Employee's employment with the Employer or Bank (including information conceived, originated, discovered, or developed, in whole or in part, by Employee). The Confidential Information includes, but is not limited to, the following types of information and other information of a similar nature (whether or not reduced to writing): Drawings, specifications, models, data, documentation, diagrams, flow charts, research, development, procedures, marketing techniques and materials, marketing and development plans, customer lists, and names and other information related to customers, pricing and loan policies, financial information and projections customer loans and employee files. Confidential Information also includes any information described above which Employer obtains from another party, and which Employer treats as proprietary or designates as Confidential Information, whether or not owned or developed by Employer, For purposes of this Section a., Employer and/or Bank shall mean the Bank, Financial or any of their affiliates. INFORMATION PUBLICLY KNOWN THAT IS GENERALLY EMPLOYED BY FINANCIAL INSTITUTIONS AT OR AFTER THE TIME EMPLOYEE FIRST HEARS OF SUCH INFORMATION OR GENERIC INFORMATION, OR GENERAL KNOWLEDGE WHICH EMPLOYEE WOULD HAVE LEARNED IN THE COURSE OF SIMILAR EMPLOYMENT OR WORK ELSEWHERE SHALL NOT BE DEEMED PART OF THE CONFIDENTIAL INFORMATION. b. All notes, data, reference materials, sketches, drawings, memoranda, documentation, and records in any way incorporating or reflecting any of the Confidential Information and all proprietary rights therein, including copy rights, shall belong exclusively to Employer, and Employee agrees to turn over all copies of such materials in Employee's possession or control to Employer upon request or upon termination of Employee's employment with Employer. c. Employee agrees during his employment by Employer and thereafter to hold in confidence and not to directly or indirectly reveal, report, publish, disclose, or transfer any of the Confidential Information to any person or entity, or utilize any of the Confidential Information for any purpose, except in the due performance of Employee's services for Employer. d. Because of the unique nature of the Confidential Information, Employee understands and agrees that Employer will suffer irreparable harm in the event that Employee fails to comply with any of his obligations under this Section 14, and that monetary damages will be inadequate to compensate Employer for such breach. Accordingly, Employee agrees that Employer will, in addition to any other remedies available to them at law or in equity, be entitled to injunctive relief to enforce the terms of this Section 14. 15. Notices. Any notices to be given hereunder by either party to the other shall be in writing and may be transmitted by personal delivery or by certified mail, return receipt requested. Mailed notices shall be addressed the parties as follows: If notice is to Financial, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Bank, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Employee, to: Name: Robert Horsman Address: 837 Golden Park Avenue City/State: San Diego, CA 92106 Either party may change its address by written notice in accordance with this paragraph. Notices delivered personally shall be deemed communicated as of the date of actual receipt; mailed notices shall be deemed communicated as of forty-eight (48) hours after the date of mailing. 16. Entire Agreement. This Agreement, in combination with any collateral documents referred to herein, supersedes any and all other agreements, either oral or in writing, between the parties hereto with respect to the employment of Employee by the Employer and contains all of the covenants and agreements between the parties with respect to said employment. 17. Modifications. Any modification of this Agreement shall be effective only if it is in writing and signed by the parties hereto. 18. Effect of Waiver. The failure of either party to insist on strict compliance with any of the terms, covenants or conditions of this Agreement by the other party shall not be deemed a waiver of that term, covenant, or condition, nor shall any waiver or relinquishment of any right or power at any one time or times be deemed a waiver or relinquishment of that right or power for all or any other times. 19. Partial Invalidity. If any provision of this Agreement is held be a court of competent jurisdiction to be invalid, void, or unenforceable, the remaining provisions shall nevertheless continue in full force without being impaired or invalidated in any way, unless such partial invalidity materially affects the intent of the parties as indicated herein. 20. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the state of California applicable to contracts between residents of California which are wholly executed and performed in California. 21. Assignability. The rights and duties of either party hereunder shall not be assignable by either party, except that this Agreement and all rights and obligations hereunder may be assigned by Employer to, and be assumed by, any corporation or other business entity which succeeds to all or substantially all of the assets and business of Employer through merger, consolidation acquisition of assets, or other corporate reorganization. Subject to the provisions of the immediately preceding sentence, this agreement shall be binding upon and inure to the benefit of the heirs, executors and/or administrators of Employee and to the successors and assigns of Employer. 22. Arbitration. Any controversy or claim arising out of or relating to this agreement, or the breach thereof, shall be settled by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (as such rules shall be in effect on the date a demand for arbitrating is communicated from one party to the other party hereto) in San Diego, California, and judgment upon the award rendered by thereof. Employer shall bay the fees of all arbitrators, witnesses and such other expenses as may be generated by the arbitration's, including without limitation, attorneys' fees of the Parties, unless in the event the arbitration was instituted by Employee, the majority of the Arbitrators conclude that said arbitration was not initiated in good faith by Employee; under said circumstance, the arbitrators shall be authorized to allocate costs and attorneys' fees as they shell deem appropriate with due consideration to both the relative financial abilities of the parties and the merits of the positions of the parties with respect to the dispute underlying the arbitration. 23. Headings. The headings used in this Agreement are for convenience of reference only and are not part of this Agreement and do not in any way limit or amplify the terms and provisions hereof. 24. Further Acts and Documents. The parties hereto agree to perform all further acts and execute all further documents reasonably necessary to implement to purposes of this Agreement. Employer: SDNB Financial Corp. a California Corporation /s/Robert Horsman By:/s/Murray L. Galinson Robert Horsman Murray L. Galinson President President/CEO Date: March 27, 1996 Date: March 27, 1996 EXECUTIVE EMPLOYMENT AGREEMENT This is an Employment Agreement (hereinafter referred to as this ("Agreement") made effective as of this 27th day of March , 1996 by and between San Diego National Bank, ("Employer" )and Joyce Chewning (hereinafter referred to as "Employee"). RECITAL This Agreement is made with reference to the following facts: A. Employee is currently employed as Executive Vice President, San Diego National Bank, a national banking association (hereinafter referred to as the "Bank"). B. Employer believes it to be in its best interest to have Employee continue his/her employment with the Bank in such capacities and in order to induce Employee to accept such continued employment as Executive Vice President, Employer is willing to enter into this Agreement. AGREEMENTS NOW, THEREFORE, in consideration of the mutual covenants contained herein, and for other good and valuable consideration, Employer and Employee covenant and agree as follows: 1. Term of Employment. Employer hereby agrees to cause the Bank to employ Employee and Employee hereby accepts employment with the Bank for a period beginning on the effective date of this Agreement as set forth hereinabove and continuing through and until December 31, 1998 (hereinafter referred to as the "Initial Employment Term"). In the event of any extension of this Agreement for one or more consecutive one (1) year terms upon the agreement of the parties hereto, or pursuant to the provisions of Section 9 hereof, the terms of this Agreement shall be deemed to continue in effect for the term of such extension (hereinafter referred to as the "Extended Employment Term") (the Initial Employment Term and the Extended Employment Term hereinafter collectively referred to as the "Employment Term"). 2. Duties of Employee. Employee shall serve as Executive Vice President, throughout the Employment Term. Employee shall have such duties and responsibilities as are presently set forth in the Bylaws of the Bank and as are commensurate with such position, as may be from time to time more particularly set fourth by the Board of Directors of the Bank and Financial. Employee shall devote such portion of his productive time and attention to the business of the Bank as shall be reasonably necessary to carry out his duties during the Employment Term. Employee shall also serve as director of the Bank and Financial and shall be required to serve as an officer and director of all other corporations which are wholly-owned subsidiaries of Financial which exist now or may exist during the Employment Term. Subject to the provision of Section 12 hereof, this Agreement shall not be interpreted to prohibit Employee from making passive personal investments or conducting private business affairs if such activities do not materially interfere with the services required under this Agreement. 3. Indemnification. Employer shall indemnify and hold Employee harmless from all losses, costs, damages, liability, therefor, charges, claims, demands, attorneys' fees and/or expenses, actions and causes of action of any nature or sort, liquidated or unliquidated, past, present and future, of whatsoever kind or character which shall or may at any time incurred, suffered or sustained by Employee arising from the discharge of his duties on behalf of the Bank and/or Financial and/or other subsidiaries of Financial for which Employee provides services. 4. Compensation. As full compensation for the services to be performed hereunder, Employee shall receive the following: a. Basic Salary Subject to approved annual increases as hereinafter provided, basic salary at the rate of One Hundred Five Thousand Nine Hundred Thirty Dollars , ($105,930) per year to be paid in accordance with the payroll schedule established by the Bank's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph may be adjusted on January 1 or each year of the Employment Term at the discretion of the Employer's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph shall be adjusted on January 1 of each year of the Employment Term at the discretion of the Employer's Board of Directors, but in no event shall the adjusted amount less than the amount of Employee's basic annual salary for the preceding year. b. Bonuses and Deferred Savings Plan. Employee shall be entitled to receive such other compensation as may be determined by the Employer's Board of Directors to be appropriate, in its sole discretion, including without limitation any amounts payable to Employee by participation in the Bank's Bonus Program and Deferred Savings Plan in accordance with the terms and conditions of said plans as in effect during the Employment Term. Employer shall not reduce during the Employment Term the proportionate annual share of the total amount of said Bonus Program and Deferred Savings Plan which Employee is eligible to receive based upon said Program and Plan as presently in effect as of the date of this Agreement. Further, if said Program and/or Plan are eliminated by Employer or Bank, Employee shall nevertheless continue to receive during the Employment Term an annual share of the Bank's profits which Employee last received pursuant to said program and/or Plan. 5. Tax Withholding. Employer shall have the right to deduct or withhold from the compensation due to Employee hereunder any and all sums required for any and all federal, social security, state and local taxes now applicable or that may be enacted and become applicable in the future. 6. Employee Benefits. a. Vacation Time. Employee shall be entitled to vacation time as set forth in the Bank's policies each calendar year during the Employment Term without loss of compensation. One increment of such annual vacation time shall be taken by Employee for a period of not less than two (2) consecutive weeks. In the event that Employee does not for any reason take the total amount of vacation time authorized herein during any year, the amount of time not taken in said year shall accumulate, and be available as additional vacation time in subsequent years; however, Employee shall not be permitted at any time to accumulate vacation time in excess of the amount of vacation time authorized for Employee during a two-year period. b. Use of Automobile. Employer shall provide Employee with the use of an "executive class" automobile throughout the Employment Term, or alternatively, at the discretion of Employer, an automobile allowance of Six Hundred ($600) Dollars per month. In addition, whether Employer provides Employee with an automobile or with an automobile allowance, Employer shall pay or reimburse for all operating expense of the automobile used by Employee, including a reasonable gasoline allowance and shall further provide and maintain liability insurance on such automobile, with coverage in amounts to be determined by the Employer's Board of Directors, but in any event not less than the minimum liability coverage required by California law. Employee shall be required to maintain adequate records of all business mileage incurred an all automobile operating expenses, such records to be maintained in compliance with IRS record-keeping guidelines then in effect. c. Seminars. Employer shall reimburse Employee for all costs and expenses, including without limitation registration fees, transportation costs, meals and lodging, incurred by Employee in connection with Employee's attendance at all professional seminars relating to the financial services industry for which Employee's attendance would be of benefit to Employer. d. Club. Employer shall pay all ongoing dues related to employee's membership in one "country-club" type club selected by Employee and subject to the express approval of the Employer's Board of Directors, shall pay all membership and/or initiation fees connected with said membership. e. Disability Insurance. Employer shall pay all costs and expenses, including without limitation premiums, to provide disability insurance coverage for Employee, which coverage shall be in an appropriate and customary amount based upon Employee's position and salary hereunder and subject to approval of medical records by the insurer. f. Additional Benefits. Employee shall be entitled to receive the greater of: (1) all employment benefits made available to other officers of the Bank and its affiliates and commensurate with Employee's position and title with the Bank, and (2) all employment benefits currently received by Employee as of the date of this Agreement. Such benefits shall include, but are not limited to, such health insurance, life insurance, sick leave, pension, and retirement plans as are adopted from time to time by the Bank. In the event that any benefit plan or plans adopted by the Bank or all of its employees conflicts with or overlaps any specific benefit set forth in this paragraph 6, Employee shall be entitled to whichever benefit is the greater of the two... 7. Life Insurance. In addition to any life insurance policies paid for by Employer pursuant to Section 6.c, in which Employee is named as its insured and in discretion, may purchase such life insurance policies as it deems necessary or appropriate, naming Employee as the insured and Employer as beneficiary. Employee hereby agrees to submit, at employer's cost, to any reasonable medical examination required for the purchase of such insurance. 8. Expenses. Employee shall be reimbursed for all reasonable expenses incurred by his pursuant to he performance of his duties and responsibilities hereunder. Employee shall keep complete and accurate records, including but not limited to proof of payment of all such expenses, so that he may fully account to the Employer if so requested. 9. Extension of Term Upon Changing Control. In the event that there is a change in control of the Bank and/or Financial, as that term is defined in 12 U.S.C. Section 1817 (Change in Bank Control Act of 1978), whether by merger, acquisition, "friendly" or hostile" "takeover" or otherwise, this Agreement shall be deemed extended for three years from the date of said change in control. During said period of extension, Employee shall be paid his compensation then applicable hereunder, and shall continue his participation in the Bank's Bonus Sharing Program and Deferred Savings Plan in accordance with Section 4.b hereof, and in no case shall Employer have any right to terminate the employment of Employee hereunder, except "for cause," as said term is defined in Section 10.a hereof. Further, in said event, Employee shall receive during the Extended Employment term a minimum of a ten percent (10%) increase in salary per annum each January 1 subsequent to the date of said change in control. 10. Termination of Agreement. a. Termination for Cause. Employer may terminate this Agreement without notice for "cause." For the purposes of this Agreement, "Cause" shall be defined as willful misconduct or willful dishonesty of Employee in his capacity as Executive Vice President of Bank and/or Financial, or willful material breach or habitual neglect of the duties which Employee is required to perform under the terms of this agreement. b. Effect of Termination. In the event of termination of Employee for cause as set froth in Section 10.a, and assuming that Employer is not in material default hereunder, all future bonuses or other salaries payable to or claimed by Employee are waived, and any additional salary or bonus shall be paid only in the sole and absolute discretion of Employer. In the event Employee voluntarily terminates his employment hereunder, Employee shall be entitled to a pro rata share of bonus compensation based upon the formula contained in Section 10.c hereof. Nothing in this Section 10 shall affect the rights of the parties under Section 12 hereof. c. Disability and Death. If, during the Employment Term Employee should die or suffer any physical or mental illness that renders him incapable of fulfilling his obligations under this Agreement, and such incapacity exists or may reasonably be expected to exist for more than one hundred and fifty (150) consecutive days, Employer may, upon forty-five (45) days written notice to Employee, terminate this Agreement. The determination of Employer that Employee is incapable of fulfilling his obligations under this Agreement, so long as such determination is made in good faith and is supported by a reasonable medical opinion, shall be final and binding. In the event of termination under this Section 10.c, Employee, or his estate, shall be entitled (I) to an amount equal to twelve (12) months' salary payable forthwith, and (ii) to a pro rata share of bonus compensation based upon the ratio of the number of days of the portion of the bonus term then in effect prior to Employee's death or disability, as the case may be, to the number of days of the full bonus term, payable at the time when said bonus is payable to all employees, and (iii) to any other accrued compensation, plus such additional benefits, if any, as may be approved by Employer's Board of Directors. Employee, or his estate, shall, upon termination under the terms of this Section 10.c, be further entitled to additional pro rata compensation based upon the ratio of the number of accrued vacation days, if any, not taken by Employee during the year, as defined for the purposes of vacation, in which Employee was so terminated, to 365 days. d. Communication of Termination. Any termination by Employer of Employee shall be communicated by written notice of termination which shall indicate the specific termination provision of this Agreement relied upon by Employer, and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for such termination. 11. Location. Employee shall not be required to move from or perform his duties hereunder in any geographical area other than the San Diego County area. 12. Non-Competition. a. While Employed. During the Employment Term, Employee shall not, directly or indirectly, either as an employee, employer, consultant, agent, principal partner, stockholder, corporate officer, director, or in any other individual or representative capacity, engage or participate in or acquire, hold, or retain any interest in any business of the Bank in any location, unless such participation or interest is fully disclosed to the Bank and Financial Corp. approval by a majority of the Board of Directors of each. The foregoing notwithstanding, Employee may acquire, hold or retain equity ownership of any publicly-held company, provided that such equity ownership does not exceed five percent (5%) of the issued and outstanding shares of voting stock of such company. b. Upon Early Termination or Termination for Cause. If Employee is terminated for cause (as defined in Section 10.a hereof) or voluntarily resigns from employment hereunder prior to the termination of the Initial Employment Term without the consent of Employer, Employee shall not acquire, hold or retain any interest (direct or indirect) in any business in the County of San Diego, in the State of California, and in such other locations where the Bank is then engaged in business from time to time during the remainder of the Initial Employment Term that is in competition with the business of the Bank until the date on which the employees' employment was to naturally terminate according to the terms hereof; provided, however, that in the event that prior to any such voluntary resignation as aforesaid, Employer has offered in writing to extend the term of this Agreement for an additional year on the same terms and conditions as set forth in this Agreement with compensation increased in accordance with Section 4.a hereof, then Employee's obligation under this Section 12.b shall be extended for an additional one (1) year beyond the Initial Employment Term. c. If any portion of this Section 12 is held to be illegal, unenforceable, void, or voidable, the remainder shall remain in full force and effect, and this Section 12 shall be deemed altered and amended to the minimum extent necessary to bring it within the legal requirements. 13. Unique Services. Employee hereby represents and agrees that the services to be performed under the terms of this Agreement are of a special, unique, unusual, extraordinary and intellectual character that gives them a peculiar value, the loss of which cannot be reasonable or adequately compensated in damages in any action at law. Employee, therefore, expressly agrees that Employer, in addition to any rights or remedies that Employer might possess, shall be entitled to injunctive and other equitable relief to prevent or remedy a breach of this Agreement by Employee. 14. Confidential Information. a. For purposes of this Agreement, "Confidential Information: shall mean information or material proprietary to Employer or Bank or designated as Confidential Information by Employer or Bank and not generally known by non-Bank personnel which Employee develops or of which Employee may obtain knowledge or access through or as a result of Employee's employment with the Employer or Bank (including information conceived, originated, discovered, or developed, in whole or in part, by Employee). The Confidential Information includes, but is not limited to, the following types of information and other information of a similar nature (whether or not reduced to writing): Drawings, specifications, models, data, documentation, diagrams, flow charts, research, development, procedures, marketing techniques and materials, marketing and development plans, customer lists, and names and other information related to customers, pricing and loan policies, financial information and projections customer loans and employee files. Confidential Information also includes any information described above which Employer obtains from another party, and which Employer treats as proprietary or designates as Confidential Information, whether or not owned or developed by Employer, For purposes of this Section a., Employer and/or Bank shall mean the Bank, Financial or any of their affiliates. INFORMATION PUBLICLY KNOWN THAT IS GENERALLY EMPLOYED BY FINANCIAL INSTITUTIONS AT OR AFTER THE TIME EMPLOYEE FIRST HEARS OF SUCH INFORMATION OR GENERIC INFORMATION, OR GENERAL KNOWLEDGE WHICH EMPLOYEE WOULD HAVE LEARNED IN THE COURSE OF SIMILAR EMPLOYMENT OR WORK ELSEWHERE SHALL NOT BE DEEMED PART OF THE CONFIDENTIAL INFORMATION. b. All notes, data, reference materials, sketches, drawings, memoranda, documentation, and records in any way incorporating or reflecting any of the Confidential Information and all proprietary rights therein, including copy rights, shall belong exclusively to Employer, and Employee agrees to turn over all copies of such materials in Employee's possession or control to Employer upon request or upon termination of Employee's employment with Employer. c. Employee agrees during his employment by Employer and thereafter to hold in confidence and not to directly or indirectly reveal, report, publish, disclose, or transfer any of the Confidential Information to any person or entity, or utilize any of the Confidential Information for any purpose, except in the due performance of Employee's services for Employer. d. Because of the unique nature of the Confidential Information, Employee understands and agrees that Employer will suffer irreparable harm in the event that Employee fails to comply with any of his obligations under this Section 14, and that monetary damages will be inadequate to compensate Employer for such breach. Accordingly, Employee agrees that Employer will, in addition to any other remedies available to them at law or in equity, be entitled to injunctive relief to enforce the terms of this Section 14. 15. Notices. Any notices to be given hereunder by either party to the other shall be in writing and may be transmitted by personal delivery or by certified mail, return receipt requested. Mailed notices shall be addressed the parties as follows: If notice is to Financial, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Bank, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Employee, to: Name: Joyce Chewning Address: 3206 Cottonwood Springs Lane City/State: Jamul, CA 91935 Either party may change its address by written notice in accordance with this paragraph. Notices delivered personally shall be deemed communicated as of the date of actual receipt; mailed notices shall be deemed communicated as of forty-eight (48) hours after the date of mailing. 16. Entire Agreement. This Agreement, in combination with any collateral documents referred to herein, supersedes any and all other agreements, either oral or in writing, between the parties hereto with respect to the employment of Employee by the Employer and contains all of the covenants and agreements between the parties with respect to said employment. 17. Modifications. Any modification of this Agreement shall be effective only if it is in writing and signed by the parties hereto. 18. Effect of Waiver. The failure of either party to insist on strict compliance with any of the terms, covenants or conditions of this Agreement by the other party shall not be deemed a waiver of that term, covenant, or condition, nor shall any waiver or relinquishment of any right or power at any one time or times be deemed a waiver or relinquishment of that right or power for all or any other times. 19. Partial Invalidity. If any provision of this Agreement is held be a court of competent jurisdiction to be invalid, void, or unenforceable, the remaining provisions shall nevertheless continue in full force without being impaired or invalidated in any way, unless such partial invalidity materially affects the intent of the parties as indicated herein. 20. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the state of California applicable to contracts between residents of California which are wholly executed and performed in California. 21. Assignability. The rights and duties of either party hereunder shall not be assignable by either party, except that this Agreement and all rights and obligations hereunder may be assigned by Employer to, and be assumed by, any corporation or other business entity which succeeds to all or substantially all of the assets and business of Employer through merger, consolidation acquisition of assets, or other corporate reorganization. Subject to the provisions of the immediately preceding sentence, this agreement shall be binding upon and inure to the benefit of the heirs, executors and/or administrators of Employee and to the successors and assigns of Employer. 22. Arbitration. Any controversy or claim arising out of or relating to this agreement, or the breach thereof, shall be settled by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (as such rules shall be in effect on the date a demand for arbitrating is communicated from one party to the other party hereto) in San Diego, California, and judgment upon the award rendered by thereof. Employer shall bay the fees of all arbitrators, witnesses and such other expenses as may be generated by the arbitration's, including without limitation, attorneys' fees of the Parties, unless in the event the arbitration was instituted by Employee, the majority of the Arbitrators conclude that said arbitration was not initiated in good faith by Employee; under said circumstance, the arbitrators shall be authorized to allocate costs and attorneys' fees as they shell deem appropriate with due consideration to both the relative financial abilities of the parties and the merits of the positions of the parties with respect to the dispute underlying the arbitration. 23. Headings. The headings used in this Agreement are for convenience of reference only and are not part of this Agreement and do not in any way limit or amplify the terms and provisions hereof. 24. Further Acts and Documents. The parties hereto agree to perform all further acts and execute all further documents reasonably necessary to implement to purposes of this Agreement. Employer: SDNB Financial Corp. a California Corporation /s/Joyce Chewning By:/s/Murray L. Galinson Joyce Chewning Murray L. Galinson Executive Vice President President/CEO Date: March 27, 1996 Date: March 27, 1996 EXECUTIVE EMPLOYMENT AGREEMENT This is an Employment Agreement (hereinafter referred to as this ("Agreement") made effective as of this 27th day of March , 1996 by and between San Diego National Bank, ("Employer" )and Howard Brotman (hereinafter referred to as "Employee"). RECITAL This Agreement is made with reference to the following facts: A. Employee is currently employed as Senior Vice President and Cheif Financial Officer, San Diego National Bank, a national banking association (hereinafter referred to as the "Bank"). B. Employer believes it to be in its best interest to have Employee continue his/her employment with the Bank in such capacities and in order to induce Employee to accept such continued employment as Senior Vice President and Chief Finanical Officer, Employer is willing to enter into this Agreement. AGREEMENTS NOW, THEREFORE, in consideration of the mutual covenants contained herein, and for other good and valuable consideration, Employer and Employee covenant and agree as follows: 1. Term of Employment. Employer hereby agrees to cause the Bank to employ Employee and Employee hereby accepts employment with the Bank for a period beginning on the effective date of this Agreement as set forth hereinabove and continuing through and until December 31, 1998 (hereinafter referred to as the "Initial Employment Term"). In the event of any extension of this Agreement for one or more consecutive one (1) year terms upon the agreement of the parties hereto, or pursuant to the provisions of Section 9 hereof, the terms of this Agreement shall be deemed to continue in effect for the term of such extension (hereinafter referred to as the "Extended Employment Term") (the Initial Employment Term and the Extended Employment Term hereinafter collectively referred to as the "Employment Term"). 2. Duties of Employee. Employee shall serve as Senior Vice President and Chief Financial Officer throughout the Employment Term. Employee shall have such duties and responsibilities as are presently set forth in the Bylaws of the Bank and as are commensurate with such position, as may be from time to time more particularly set fourth by the Board of Directors of the Bank and Financial. Employee shall devote such portion of his productive time and attention to the business of the Bank as shall be reasonably necessary to carry out his duties during the Employment Term. Employee shall also serve as director of the Bank and Financial and shall be required to serve as an officer and director of all other corporations which are wholly-owned subsidiaries of Financial which exist now or may exist during the Employment Term. Subject to the provision of Section 12 hereof, this Agreement shall not be interpreted to prohibit Employee from making passive personal investments or conducting private business affairs if such activities do not materially interfere with the services required under this Agreement. 3. Indemnification. Employer shall indemnify and hold Employee harmless from all losses, costs, damages, liability, therefor, charges, claims, demands, attorneys' fees and/or expenses, actions and causes of action of any nature or sort, liquidated or unliquidated, past, present and future, of whatsoever kind or character which shall or may at any time incurred, suffered or sustained by Employee arising from the discharge of his duties on behalf of the Bank and/or Financial and/or other subsidiaries of Financial for which Employee provides services. 4. Compensation. As full compensation for the services to be performed hereunder, Employee shall receive the following: a. Basic Salary Subject to approved annual increases as hereinafter provided, basic salary at the rate of One Hundred One Thousand Six Hundred Fifty Eight ($101,658) per year to be paid in accordance with the payroll schedule established by the Bank's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph may be adjusted on January 1 or each year of the Employment Term at the discretion of the Employer's Board of Directors for all Bank employees as in effect from time to time. The basic annual salary set forth in this paragraph shall be adjusted on January 1 of each year of the Employment Term at the discretion of the Employer's Board of Directors, but in no event shall the adjusted amount less than the amount of Employee's basic annual salary for the preceding year. b. Bonuses and Deferred Savings Plan. Employee shall be entitled to receive such other compensation as may be determined by the Employer's Board of Directors to be appropriate, in its sole discretion, including without limitation any amounts payable to Employee by participation in the Bank's Bonus Program and Deferred Savings Plan in accordance with the terms and conditions of said plans as in effect during the Employment Term. Employer shall not reduce during the Employment Term the proportionate annual share of the total amount of said Bonus Program and Deferred Savings Plan which Employee is eligible to receive based upon said Program and Plan as presently in effect as of the date of this Agreement. Further, if said Program and/or Plan are eliminated by Employer or Bank, Employee shall nevertheless continue to receive during the Employment Term an annual share of the Bank's profits which Employee last received pursuant to said program and/or Plan. 5. Tax Withholding. Employer shall have the right to deduct or withhold from the compensation due to Employee hereunder any and all sums required for any and all federal, social security, state and local taxes now applicable or that may be enacted and become applicable in the future. 6. Employee Benefits. a. Vacation Time. Employee shall be entitled to vacation time as set forth in the Bank's policies each calendar year during the Employment Term without loss of compensation. One increment of such annual vacation time shall be taken by Employee for a period of not less than two (2) consecutive weeks. In the event that Employee does not for any reason take the total amount of vacation time authorized herein during any year, the amount of time not taken in said year shall accumulate, and be available as additional vacation time in subsequent years; however, Employee shall not be permitted at any time to accumulate vacation time in excess of the amount of vacation time authorized for Employee during a two-year period. b. Use of Automobile. Employer shall provide Employee with the use of an "executive class" automobile throughout the Employment Term, or alternatively, at the discretion of Employer, an automobile allowance of Six Hundred ($600) Dollars per month. In addition, whether Employer provides Employee with an automobile or with an automobile allowance, Employer shall pay or reimburse for all operating expense of the automobile used by Employee, including a reasonable gasoline allowance and shall further provide and maintain liability insurance on such automobile, with coverage in amounts to be determined by the Employer's Board of Directors, but in any event not less than the minimum liability coverage required by California law. Employee shall be required to maintain adequate records of all business mileage incurred an all automobile operating expenses, such records to be maintained in compliance with IRS record-keeping guidelines then in effect. c. Seminars. Employer shall reimburse Employee for all costs and expenses, including without limitation registration fees, transportation costs, meals and lodging, incurred by Employee in connection with Employee's attendance at all professional seminars relating to the financial services industry for which Employee's attendance would be of benefit to Employer. d. Club. Employer shall pay all ongoing dues related to employee's membership in one "country-club" type club selected by Employee and subject to the express approval of the Employer's Board of Directors, shall pay all membership and/or initiation fees connected with said membership. e. Disability Insurance. Employer shall pay all costs and expenses, including without limitation premiums, to provide disability insurance coverage for Employee, which coverage shall be in an appropriate and customary amount based upon Employee's position and salary hereunder and subject to approval of medical records by the insurer. f. Additional Benefits. Employee shall be entitled to receive the greater of: (1) all employment benefits made available to other officers of the Bank and its affiliates and commensurate with Employee's position and title with the Bank, and (2) all employment benefits currently received by Employee as of the date of this Agreement. Such benefits shall include, but are not limited to, such health insurance, life insurance, sick leave, pension, and retirement plans as are adopted from time to time by the Bank. In the event that any benefit plan or plans adopted by the Bank or all of its employees conflicts with or overlaps any specific benefit set forth in this paragraph 6, Employee shall be entitled to whichever benefit is the greater of the two... 7. Life Insurance. In addition to any life insurance policies paid for by Employer pursuant to Section 6.c, in which Employee is named as its insured and in discretion, may purchase such life insurance policies as it deems necessary or appropriate, naming Employee as the insured and Employer as beneficiary. Employee hereby agrees to submit, at employer's cost, to any reasonable medical examination required for the purchase of such insurance. 8. Expenses. Employee shall be reimbursed for all reasonable expenses incurred by his pursuant to he performance of his duties and responsibilities hereunder. Employee shall keep complete and accurate records, including but not limited to proof of payment of all such expenses, so that he may fully account to the Employer if so requested. 9. Extension of Term Upon Changing Control. In the event that there is a change in control of the Bank and/or Financial, as that term is defined in 12 U.S.C. Section 1817 (Change in Bank Control Act of 1978), whether by merger, acquisition, "friendly" or hostile" "takeover" or otherwise, this Agreement shall be deemed extended for three years from the date of said change in control. During said period of extension, Employee shall be paid his compensation then applicable hereunder, and shall continue his participation in the Bank's Bonus Sharing Program and Deferred Savings Plan in accordance with Section 4.b hereof, and in no case shall Employer have any right to terminate the employment of Employee hereunder, except "for cause," as said term is defined in Section 10.a hereof. Further, in said event, Employee shall receive during the Extended Employment term a minimum of a ten percent (10%) increase in salary per annum each January 1 subsequent to the date of said change in control. 10. Termination of Agreement. a. Termination for Cause. Employer may terminate this Agreement without notice for "cause." For the purposes of this Agreement, "Cause" shall be defined as willful misconduct or willful dishonesty of Employee in his capacity as Senior Vice President and Chief Financial Officer of Bank and/or Financial, or willful material breach or habitual neglect of the duties which Employee is required to perform under the terms of this agreement. b. Effect of Termination. In the event of termination of Employee for cause as set froth in Section 10.a, and assuming that Employer is not in material default hereunder, all future bonuses or other salaries payable to or claimed by Employee are waived, and any additional salary or bonus shall be paid only in the sole and absolute discretion of Employer. In the event Employee voluntarily terminates his employment hereunder, Employee shall be entitled to a pro rata share of bonus compensation based upon the formula contained in Section 10.c hereof. Nothing in this Section 10 shall affect the rights of the parties under Section 12 hereof. c. Disability and Death. If, during the Employment Term Employee should die or suffer any physical or mental illness that renders him incapable of fulfilling his obligations under this Agreement, and such incapacity exists or may reasonably be expected to exist for more than one hundred and fifty (150) consecutive days, Employer may, upon forty-five (45) days written notice to Employee, terminate this Agreement. The determination of Employer that Employee is incapable of fulfilling his obligations under this Agreement, so long as such determination is made in good faith and is supported by a reasonable medical opinion, shall be final and binding. In the event of termination under this Section 10.c, Employee, or his estate, shall be entitled (I) to an amount equal to twelve (12) months' salary payable forthwith, and (ii) to a pro rata share of bonus compensation based upon the ratio of the number of days of the portion of the bonus term then in effect prior to Employee's death or disability, as the case may be, to the number of days of the full bonus term, payable at the time when said bonus is payable to all employees, and (iii) to any other accrued compensation, plus such additional benefits, if any, as may be approved by Employer's Board of Directors. Employee, or his estate, shall, upon termination under the terms of this Section 10.c, be further entitled to additional pro rata compensation based upon the ratio of the number of accrued vacation days, if any, not taken by Employee during the year, as defined for the purposes of vacation, in which Employee was so terminated, to 365 days. d. Communication of Termination. Any termination by Employer of Employee shall be communicated by written notice of termination which shall indicate the specific termination provision of this Agreement relied upon by Employer, and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for such termination. 11. Location. Employee shall not be required to move from or perform his duties hereunder in any geographical area other than the San Diego County area. 12. Non-Competition. a. While Employed. During the Employment Term, Employee shall not, directly or indirectly, either as an employee, employer, consultant, agent, principal partner, stockholder, corporate officer, director, or in any other individual or representative capacity, engage or participate in or acquire, hold, or retain any interest in any business of the Bank in any location, unless such participation or interest is fully disclosed to the Bank and Financial Corp. approval by a majority of the Board of Directors of each. The foregoing notwithstanding, Employee may acquire, hold or retain equity ownership of any publicly-held company, provided that such equity ownership does not exceed five percent (5%) of the issued and outstanding shares of voting stock of such company. b. Upon Early Termination or Termination for Cause. If Employee is terminated for cause (as defined in Section 10.a hereof) or voluntarily resigns from employment hereunder prior to the termination of the Initial Employment Term without the consent of Employer, Employee shall not acquire, hold or retain any interest (direct or indirect) in any business in the County of San Diego, in the State of California, and in such other locations where the Bank is then engaged in business from time to time during the remainder of the Initial Employment Term that is in competition with the business of the Bank until the date on which the employees' employment was to naturally terminate according to the terms hereof; provided, however, that in the event that prior to any such voluntary resignation as aforesaid, Employer has offered in writing to extend the term of this Agreement for an additional year on the same terms and conditions as set forth in this Agreement with compensation increased in accordance with Section 4.a hereof, then Employee's obligation under this Section 12.b shall be extended for an additional one (1) year beyond the Initial Employment Term. c. If any portion of this Section 12 is held to be illegal, unenforceable, void, or voidable, the remainder shall remain in full force and effect, and this Section 12 shall be deemed altered and amended to the minimum extent necessary to bring it within the legal requirements. 13. Unique Services. Employee hereby represents and agrees that the services to be performed under the terms of this Agreement are of a special, unique, unusual, extraordinary and intellectual character that gives them a peculiar value, the loss of which cannot be reasonable or adequately compensated in damages in any action at law. Employee, therefore, expressly agrees that Employer, in addition to any rights or remedies that Employer might possess, shall be entitled to injunctive and other equitable relief to prevent or remedy a breach of this Agreement by Employee. 14. Confidential Information. a. For purposes of this Agreement, "Confidential Information: shall mean information or material proprietary to Employer or Bank or designated as Confidential Information by Employer or Bank and not generally known by non-Bank personnel which Employee develops or of which Employee may obtain knowledge or access through or as a result of Employee's employment with the Employer or Bank (including information conceived, originated, discovered, or developed, in whole or in part, by Employee). The Confidential Information includes, but is not limited to, the following types of information and other information of a similar nature (whether or not reduced to writing): Drawings, specifications, models, data, documentation, diagrams, flow charts, research, development, procedures, marketing techniques and materials, marketing and development plans, customer lists, and names and other information related to customers, pricing and loan policies, financial information and projections customer loans and employee files. Confidential Information also includes any information described above which Employer obtains from another party, and which Employer treats as proprietary or designates as Confidential Information, whether or not owned or developed by Employer, For purposes of this Section a., Employer and/or Bank shall mean the Bank, Financial or any of their affiliates. INFORMATION PUBLICLY KNOWN THAT IS GENERALLY EMPLOYED BY FINANCIAL INSTITUTIONS AT OR AFTER THE TIME EMPLOYEE FIRST HEARS OF SUCH INFORMATION OR GENERIC INFORMATION, OR GENERAL KNOWLEDGE WHICH EMPLOYEE WOULD HAVE LEARNED IN THE COURSE OF SIMILAR EMPLOYMENT OR WORK ELSEWHERE SHALL NOT BE DEEMED PART OF THE CONFIDENTIAL INFORMATION. b. All notes, data, reference materials, sketches, drawings, memoranda, documentation, and records in any way incorporating or reflecting any of the Confidential Information and all proprietary rights therein, including copy rights, shall belong exclusively to Employer, and Employee agrees to turn over all copies of such materials in Employee's possession or control to Employer upon request or upon termination of Employee's employment with Employer. c. Employee agrees during his employment by Employer and thereafter to hold in confidence and not to directly or indirectly reveal, report, publish, disclose, or transfer any of the Confidential Information to any person or entity, or utilize any of the Confidential Information for any purpose, except in the due performance of Employee's services for Employer. d. Because of the unique nature of the Confidential Information, Employee understands and agrees that Employer will suffer irreparable harm in the event that Employee fails to comply with any of his obligations under this Section 14, and that monetary damages will be inadequate to compensate Employer for such breach. Accordingly, Employee agrees that Employer will, in addition to any other remedies available to them at law or in equity, be entitled to injunctive relief to enforce the terms of this Section 14. 15. Notices. Any notices to be given hereunder by either party to the other shall be in writing and may be transmitted by personal delivery or by certified mail, return receipt requested. Mailed notices shall be addressed the parties as follows: If notice is to Financial, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Bank, to: Board of Directors SDNB Financial Corp. 1420 Kettner Blvd. San Diego National Bank If notice is to Employee, to: Name: Howard Brotman Address: 2455 Amity Street City/State: San Diego, CA 92109 Either party may change its address by written notice in accordance with this paragraph. Notices delivered personally shall be deemed communicated as of the date of actual receipt; mailed notices shall be deemed communicated as of forty-eight (48) hours after the date of mailing. 16. Entire Agreement. This Agreement, in combination with any collateral documents referred to herein, supersedes any and all other agreements, either oral or in writing, between the parties hereto with respect to the employment of Employee by the Employer and contains all of the covenants and agreements between the parties with respect to said employment. 17. Modifications. Any modification of this Agreement shall be effective only if it is in writing and signed by the parties hereto. 18. Effect of Waiver. The failure of either party to insist on strict compliance with any of the terms, covenants or conditions of this Agreement by the other party shall not be deemed a waiver of that term, covenant, or condition, nor shall any waiver or relinquishment of any right or power at any one time or times be deemed a waiver or relinquishment of that right or power for all or any other times. 19. Partial Invalidity. If any provision of this Agreement is held be a court of competent jurisdiction to be invalid, void, or unenforceable, the remaining provisions shall nevertheless continue in full force without being impaired or invalidated in any way, unless such partial invalidity materially affects the intent of the parties as indicated herein. 20. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the state of California applicable to contracts between residents of California which are wholly executed and performed in California. 21. Assignability. The rights and duties of either party hereunder shall not be assignable by either party, except that this Agreement and all rights and obligations hereunder may be assigned by Employer to, and be assumed by, any corporation or other business entity which succeeds to all or substantially all of the assets and business of Employer through merger, consolidation acquisition of assets, or other corporate reorganization. Subject to the provisions of the immediately preceding sentence, this agreement shall be binding upon and inure to the benefit of the heirs, executors and/or administrators of Employee and to the successors and assigns of Employer. 22. Arbitration. Any controversy or claim arising out of or relating to this agreement, or the breach thereof, shall be settled by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (as such rules shall be in effect on the date a demand for arbitrating is communicated from one party to the other party hereto) in San Diego, California, and judgment upon the award rendered by thereof. Employer shall bay the fees of all arbitrators, witnesses and such other expenses as may be generated by the arbitration's, including without limitation, attorneys' fees of the Parties, unless in the event the arbitration was instituted by Employee, the majority of the Arbitrators conclude that said arbitration was not initiated in good faith by Employee; under said circumstance, the arbitrators shall be authorized to allocate costs and attorneys' fees as they shell deem appropriate with due consideration to both the relative financial abilities of the parties and the merits of the positions of the parties with respect to the dispute underlying the arbitration. 23. Headings. The headings used in this Agreement are for convenience of reference only and are not part of this Agreement and do not in any way limit or amplify the terms and provisions hereof. 24. Further Acts and Documents. The parties hereto agree to perform all further acts and execute all further documents reasonably necessary to implement to purposes of this Agreement. Employer: SDNB Financial Corp. a California Corporation /s/Howard Brotman By:/s/Murray L. Galinson Howard Brotman Murray L. Galinson Sr. Vice President/ President/CEO Chief Financial Officer Date: March 27, 1996 Date: March 27, 1996 EX-13 3 EXHIBIT "13" ANNUAL REPORT TO SHAREHOLDERS SDNB Financial Corp. Annual Report 1995 cover page. (Cover page includes four graphics illustrating concepts of Diversification, International, Community and Branching Out.) DIVERSIFICATION, GROWTH AND PROFITABILITY SIGNIFY THE SUCCESS OF SDNB FINANCIAL CORP. IN 1995. WE COMMISSIONED TOM VOSS, A LOCAL SAN DIEGO ILLUSTRATOR, TO CREATE ART THAT REPRESENTS FOUR AREAS OF ACHIEVEMENT FOR SDNB FINANCIAL CORP. EACH WORK OF ART DEPICTS A SEGMENT OF OUR GROWTH THROUGH THE EYES OF THE ARTIST. AS A SUPPORTER OF THE SAN DIEGO COMMUNITY AND THE ARTS, WE ARE PROUD TO DISPLAY THE ORIGINAL ART IN OUR DOWNTOWN OFFICE. SELECTED FINANCIAL DATA 1995 1994 1993 1992 1991 FOR THE YEAR, IN THOUSANDS Total interest income $12,743 $11,818 $11,930 $12,334 $15,116 Net interest income 9,527 8,912 8,571 8,321 8,468 Securities gains, net 11 0 0 25 80 Provision for loan losses 200 1,850 2,950 1,320 1,270 Net income (loss) 212 (159) (2,562) (2,211) (511) AT YEAR END, IN THOUSANDS Assets $178,572 $173,185 $170,693 $194,689 $205,232 Deposits 140,409 138,276 138,150 164,739 154,979 Loans, net 90,329 94,910 108,511 130,010 119,817 Investment securities 34,441 27,231 30,227 17,943 15,006 Long term obligations 7,989 10,158 10,379 10,630 10,881 Shareholders' equity 16,686 8,969 9,488 12,050 14,261 PER SHARE Net income (loss) $0.10 ($0.10) ($1.67) ($1.44) ($0.33) Cash dividends paid 0.00 0.00 0.00 0.00 0.08 Shareholders' equity 5.43 5.83 6.17 7.83 9.27 LETTER TO OUR SHAREHOLDERS Dear Shareholders, it is fair to say this was a very significant year! In 1995, SDNB Financial Corp's vision for expansion and diversification became a reality. We welcomed 300 new shareholders and gave thanks to 700 existing shareholders who reconfirmed their support by participating in our capital offering. Our capital grew from $9 million to $16.7 million. We also refinanced the San Diego National Bank headquarters building, increasing the book value of each share of stock by 48 cents. Good news from the bottom line: 1995 brought a significant turn in profits for the holding company and San Diego National Bank. SDNB Financial Corp enjoyed earnings of $212,000, a dramatic improvement over 1994's loss of $159,000. The bank gave a stellar performance with increased earnings of $989,000, compared to the year-earlier profits of $328,000. 1995 brought to a close the final chapter and costs of the Pioneer Mortgage Company litigation. We believed 1995 was ripe for capturing the disgruntled and besieged victims of the megamerger frenzy going on with San Diego banks. For those who did not find "bigger to be better," San Diego National Bank offered itself as the friendly alternative to the corporate indifference of large banks. While giant banks wrestled for turf and acquisitions, we concentrated on building our assets by meeting the needs of customers. Innovative product lines and state-of-the-art banking technologies were designed to match businesses with industry-sensitive services tailored to specific types of businesses. For example, we created a package of services for property management companies and home owners associations to meet their individual processing needs. In addition to building on our solid customer following in the legal, medical and accountancy professions, we branched out into select new areas, like manufacturing and wholesaling. At the end of the year, we proudly announced our new international division. Concerned that San Diego would miss the boat without local financial institution backing to ensure local entrepreneurs the necessary support to compete, we decided to get involved. This was done with the recognition that this new area is for serious bankers - bankers who are willing to do everything it takes to extend themselves in assisting local companies to enter the global market place. We are excited by the staff (continued on page 6) (Graphic picture illustating Diversification & Growth) Diversification & Growth 1995 WAS A PROSPEROUS YEAR FOR SDNB FINANCIAL CORP. THE ANNUAL HARVEST BROUGHT DIVERSIFICATION AND GROWTH IN SERVICES, NEW FINANCIAL MARKETS AND PROFITS. THE MANY DIFFERENT FRUITS OF OUR LABOR WERE REALIZED WHEN WE OPENED OUR NEW INTERNATIONAL DEPARTMENT AND AN OFFICE IN THE SOUTH BAY. (Graphic picture illustating International) International SDNB FINANCIAL CORP. LOOKED TO THE FUTURE AND PLANTED SEEDS THAT WOULD ALLOW SAN DIEGO AND THE COMPANY TO PARTICIPATE IN THE EMERGING GLOBAL ECONOMY. THE NEWLY-OPENED INTERNATIONAL DEPARTMENT NOT ONLY FILLS A VOID IN SAN DIEGO'S FINANCIAL COMMUNITY, BUT ESTABLISHES OUR PRESENCE IN AN EVOLVING AND FERTILE MARKET. (Graphic picture illustating Branching Out) Branching Out NEW BRANCHES ARE A FIRST SIGN OF GROWTH. A SIGN OF OUR GROWTH BEGINS WITH OUR NEW BRANCH IN CHULA VISTA, STRENGTHENING OUR COMMITMENT TO SERVING THE GREATER SAN DIEGO REGION AND YIELDING NEW BUSINESS OPPORTUNITIES BOTH FOR THE COMPANY AND THE SOUTH BAY. (Graphic picture illustating Community) Community DEEPLY ROOTED IN THE COMMUNITY AND REMEMBERING THE IMPORTANCE OF GIVING BACK TO OUR COMMUNITY, THE PEOPLE OF SDNB CONTINUED TO EXPAND SERVICE AND PARTICIPATION IN BETTERING THE QUALITY OF LIFE IN SAN DIEGO THROUGH INVOLVEMENT IN SOCIAL AND HEALTH SERVICE ORGANIZATIONS, THE ARTS AND CIVIC PROGRAMS. LETTER TO OUR SHAREHOLDERS Continued from page 1 and resources we have put together, as well as the challenge and opportunity international banking offers, for both the San Diego business community and your company. Our expansion and diversification of product lines, services and markets culminated with the opening of our new South Bay office, located in Chula Vista. Always a good customer source for the bank, the timing and proximity to the international border and developing manufacturing and wholesale clientele was a perfect fit. We expect great things from this enthusiastic and energetic office. The courier service continued to extend our customer reach countywide. San Diego National Bank and courier banking have become synonymous, setting the standard for bringing banking to the office. For SDNB employees, directors and management, service to the community extended past closing time and beyond banking business. As San Diego's leading community bank, we invested in the civic, charitable, arts and culture infrastructure that make up the heart of our community. Time, expertise and monetary contributions went to more than 100 charities and organizations. None of this would have been possible without your faith and vision. The vision that became reality in 1995 was also the result of top-notch banking professionals, working together with a collective mission of excellence and service. Looking to superior achievements every year, we are pleased to announce a number of promotions. Robert Horsman has been named President of San Diego National Bank, and Joyce Chewning, Executive Vice President. Howard Brotman will join the Board Of Directors of SDNB Financial Corp and Mark Mandell will be joining the senior management team of the bank, along with Ron Bird, Senior Vice President and Director of the Business Services Department. It was a great year. Thanks to all of you for sharing it with us. Sincerely, /s/ Murray L. Galinson MURRAY L. GALINSON PRESIDENT AND CEO (picture of Murray L. Galinson next to his signature) /s/ Charles I. Feurzeig CHARLES I. FEURZEIG CHAIRMAN OF THE BOARD (picture of Charles I. Feurzeig next to his signature) MANAGEMENT'S DISCUSSION AND ANALYSIS SDNB Financial Corp. and Subsidiaries OVERVIEW The operations and financial condition of the Company improved substantially during 1995. The Company recorded a profit in 1995 of $212,000 compared to losses of $159,000 and $2,562,000 in 1994 and 1993, respectively. In addition to the return to profitability, the Company also benefited by: 1. A successful capital infusion program which added a net of $5.7 million to capital. 2. Refinancing of the mortgage on the San Diego National Bank Building which resulted in a gain of $1.46 million credited to shareholders' equity. 3. Settlement of the long standing Pioneer Mortgage litigation against San Diego National Bank. 4. Opening of the new South Bay Office and International Department of the Bank. For the past several years, the Company and the Bank had been adversely affected by a number of factors emanating primarily from the condition of the economy in San Diego. These factors, which are more fully described herein, have included: a. The continued need for a high loan loss provisions. b. OREO losses and expenses from higher than normal levels of OREO property. c. Reduction in the level of the loan portfolio resulting from continuing low loan demand. Additionally, the Company has incurred substantial expense in connection with legal fees and provisions for settlement costs of the Pioneer Mortgage litigation (see "Other Non-Interest Expenses"). Loan loss provision and OREO losses and expenses were reduced dramatically in 1995 and as cited above, the Pioneer Mortgage litigation has been settled, although there was still substantial expense in 1995. While the Company reports a profit in 1995 and a much reduced loss in 1994 than in 1993, there can be no assurances of the factors noted above, or other factors, will not continue to adversely impact the Company and the Bank. Discussion of the individual elements of the Company's operations is contained in subsequent sections of this report. Liquidity and Asset/Liability Management By the nature of its commercial/wholesale focus, the Bank has moderate interest-rate risk exposure in a declining-rate environment. This phenomenon can be seen in the "Static Gap Summary" (Table 1). At December 31, 1995, approximately 70% of the Bank's earning assets adjust immediately to changes in interest rates. Within three months, this increases to 86% of earning assets. Consequently, the Bank utilizes deposit liabilities that also adjust relatively quickly. Within the same three- month period, approximately 92% of the Bank's interest-bearing liabilities (mostly deposits) adjust to current rates. The Bank's cumulative gap position at the three month repricing interval has increased approximately $10.8 million, or 43% from $26.0 million at December 31, 1994 to $35.8 million at December 31, 1995. Volume of assets and liabilities have both increased from the year earlier. Increases of $13.0 million in securities and $4.5 million in deposits are partially offset by a decrease of $1.2 million in loans within the three month horizon. During February 1995, the Bank entered into an interest rate swap to hedge against the effects on income of falling interest rates. If the prime interest rate falls below eight percent during the life of the contract, the Bank will receive payments amounting to the difference between the then existing prime rate and eight percent on the contract amount of $20 million. These payments continue while the prime interest rate stays below eight percent or until expiration of the contract, February 3, 1998. This contract helps to stabilize the Bank's net interest spread which, absent any hedge, decreases during periods of rapidly falling interest rates. To date, there have been no payments received under this contract. The Bank's liquidity needs are projected by comparing anticipated funding needs against current resources and anticipated deposit growth. Any current surplus of funds is invested to maximize income while maintaining safety and providing for future liquidity. During the year ended December 31, 1995, cash and cash equivalents increased $3.6 million. Operating activities provided $1.2 million during the period. Approximately $2.3 million was used by investing activities. The two major components were net investment of $6.5 million in securities ($27.1 million purchases of securities offset by $20.6 million of sales, maturities, and calls) and decrease in gross loans totaling $4.3 million. Financing activities provided $4.7 million during the period. Deposits increased $2.1 million while borrowings decreased $3.1 million. The issuance of new stock during the year provided a net amount of $5.7 million. Liquidity is provided on a daily basis by federal funds sold and on a longer-term basis by the structuring of the Bank's investment portfolio to provide a steady stream of maturing issues. Additionally, the Bank may raise additional funds from time to time through money desk operations or via the sale of loans to another institution. The Bank has never purchased high-yield securities or participated in highly-leveraged transactions.
TABLE 1. STATIC GAP SUMMARY DECEMBER 31, 1995 Immediately Non-rate Adjustable 1 Day Sensitve Or 1 Day Through 3 Through 6 Through And Over (In thousands) Maturity 3 Months 6 Months 12 Months 12 Months Total Loans (net) 82,630 1,881 982 1,263 5,575 92,331 Investment securities - 22,580 1,963 1,001 8,425 33,969 Certificates of deposit in other banks - - 1,490 793 - 2,283 Federal funds sold 24,700 - - - - 24,700 Total interest earning assets 107,330 24,461 4,435 3,057 14,000 153,283 Non-interest earning assets - - - - 14,367 14,367 Total assets 107,330 24,461 4,435 3,057 28,367 167,650 Deposits: Savings, NOW accounts and money markets 68,330 - - - - 68,330 Time deposits - 14,762 4,680 3,157 136 22,735 Total deposits 68,330 14,762 4,680 3,157 136 91,065 Securities sold under agreement to repurchase 12,934 - - - - 12,934 Total interest bearing liabilities 81,264 14,762 4,680 3,157 136 103,999 Non-interest bearing liabities - - - - 50,036 50,036 Shareholders' equity - - - - 13,615 13,615 Total liabilities and shareholders' equity 81,264 14,762 4,680 3,157 63,787 167,650 Interest rate sensitivity gap 26,066 9,699 (245) (100) (35,420) Cumulative interest rate sensitivity gap 26,066 35,765 35,520 35,420 -
Capital Resources Since its initial capitalization in 1981, the Company had relied primarily on internally generated income to fund its growth and provide for depositor protection. During 1994, the Company concluded that additional capital would be beneficial and proposed a plan for additional capitalization which was approved by regulatory authorities on March 9, 1995, and by the shareholders of the Company on March 17, 1995. The plan encompassed the following steps: 1. Sale of 510,121 newly issued shares of the Company's Common Stock to two limited partnerships managed by WHR Management Corp. ("WHR") at $4.34 per share for a gross amount of $2,213,925. This step was completed on March 28, 1995. 2. A rights offering to existing shareholders and, pursuant to a best- efforts underwriting agreement, to third parties encompassing 769,582 shares of newly issued Common Stock at a subscription price of $4.34 per share for a gross amount of $3,339,986. This step was completed on September 28, 1995. 3. Sale to WHR of an additional 255,193 newly issued shares of Common Stock at $4.34 per share for a gross amount of $1,107,538. This step was completed on October 6, 1995. Additionally, in 1995 the Company issued the following warrants to purchase shares of Common Stock: 1. A warrant to purchase 37,363 shares at $4.34 per share to Torrey Pines Securities, Inc. pursuant to a Rights Agent Agreement as further compensation for its services in connection with the rights offering to existing shareholders. 2. A warrant to purchase 150,000 shares at a price of $5.44 per share to PKH Kettner Investors, LLC as additional consideration for granting a loan secured by a first trust deed on the Bank Building. The net proceeds from the sale of Common Stock have been used for general corporate purposes which include the following: 1. $250,000 loan to San Diego National Bank Building Joint Venture ("Joint Venture") which in turn made a partial payment on a note (the "PV Note") owed to PVCC, Inc. which was secured by a second trust deed on the Bank Building. PVCC, Inc. is a corporation controlled by Charles I. Feurzeig, chairman of the Company's Board of Directors. 2. $630,000 to pay off Company notes payable which included $390,000 due to officers and/or directors of the Company. 3. $1,125,640 to purchase customer notes from the Bank, at par, which were then assigned to the Joint Venture, which in turn assigned the notes to PVCC, Inc. as further payment of the PV Note. 4. $1,188,172, which along with $8,000,000 in proceeds of a new note secured by a first trust deed on the Bank Building, to refinance the Bank Building, paying $8,579,000 to WHR (and realizing a prepayment discount of $1,579,000) and $524,360 to pay the balance of the PV Note. 5. $1,000,000 additional invested in San Diego National Bank. The remaining proceeds will be used for general corporate purposes, which may include investments in or extensions of credit to the Company's subsidiaries, reduction of existing debt, or financing possible future acquisitions of other banking institutions or related businesses. At the present time, the Company does not have any specific plans, agreements or understandings, written or oral, pertaining to the proposed acquisition of any banking institution or related business. As a national bank subject to the regulation of the Office of the Comptroller of the Currency (the "Comptroller"), the Bank is subject to legal limitations on the source and amount of dividends it is permitted to pay to the Company. The approval of the Comptroller is required for any dividend by a national bank if the total of all dividends declared by the bank in any calendar year would exceed the total of its net profits, as defined by the Comptroller, for that year, combined with its retained net profits for the preceding two years. As of January 1, 1996, the Bank had available for dividends approximately $1,370,000 without the approval of the Comptroller. The payment of dividends by the Bank may also be affected by other factors, such as requirements for the maintenance of adequate capital. In addition, the Comptroller and the Federal Deposit Insurance Corporation (the "FDIC") are authorized to determine under certain circumstances relating to the financial condition of a national bank whether the payment of dividends would be an unsafe or unsound banking practice and to prohibit payment thereof. Finally, under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), an insured depository institution is prohibited from making any capital distribution to its owner, including any dividend, if, after making such distribution, the depository institution fails to meet the required minimum level for any relevant capital measure, including the risk-based capital adequacy and leverage standards discussed under "Capital" below. The Company and the Federal Reserve Bank of San Francisco ("Reserve Bank") entered into an agreement on November 20, 1992, pursuant which the Company must obtain the approval of the Reserve Bank prior to, among other actions, the declaration of any cash dividends. The Comptroller has established a framework for supervisory requirements of national banks based upon capital ratios. Based upon this framework, a bank's capitalization is defined as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized. Under the Comptroller's framework a bank is well capitalized if its ratios are greater than or equal to 6% and 10% for tier 1 capital and risk weighted capital, respectively. As of December 31, 1995, the Bank was considered "well capitalized". The Federal Reserve Board ("Reserve Board"), as the regulatory body of the Company, has capital ratio requirements. Under the Reserve Board's Capital Adequacy Guidelines, all bank holding companies should meet a minimum ratio of qualifying total capital to weighted-risk assets of 8 percent, of which at least 4.0 percentage points should be in the form of tier 1 capital. The Reserve Board and the Comptroller have also imposed a leverage standard to supplement their risk-based ratios. This leverage standard focuses on a banking institution's ratio of Tier 1 capital to average total assets adjusted for goodwill and other certain items. Under these guidelines, banking institutions that meet certain criteria, including excellent asset quality, high liquidity, low interest rate exposure and good earnings, and have received the highest regulatory rating must maintain a ratio of Tier 1 capital to total assets of at least 3%. Institutions not meeting this criteria, as well as institutions with supervisory, financial or operational weaknesses, along with those experiencing or anticipating significant growth are expected to maintain a Tier 1 capital to total assets ratio equal to at least 4% to 5%. As reflected in the following table, the risk-based capital ratios and leverage ratios of the Company and the Bank as of December 31, 1995, exceeded the fully phased-in regulatory risk-based capital adequacy guidelines and the leverage standard. Capital Components and Ratios December 31, 1995 December 31, 1994 (dollars in thousands) Company Bank Company Bank Capital Components: Tier 1 Capital $16,726 $13,656 $9,329 $11,667 Total Capital 18,207 15,006 10,868 13,081 Risk-weighted assets and off-balance sheet instruments 117,967 107,310 122,833 112,672 Tier 1 risk-based: Actual 14.18% 12.73% 7.59% 10.35% Required 4.00% 6.00% 4.00% 6.00% Excess 10.18% 6.73% 3.59% 4.35% Total risk-based: Actual 15.43% 13.98% 8.85% 11.61% Required 8.00% 10.00% 8.00% 10.00% Excess 7.43% 3.98% 0.85% 1.61% Leverage: Actual 9.37% 8.43% 5.33% 7.09% Required 5.00% 5.00% 5.00% 5.00% Excess 4.37% 3.43% .33% 2.09% Investment Securities As reflected in the consolidated financial statements and in the accompanying notes thereto, the investment portfolio of the Bank has recovered a substantial portion of the loss in market value experienced in 1994. That loss was due to higher interest rates during 1994, compounded by adverse market conditions for "structured notes" and other derivative securities. Management believes that there is sufficient current liquidity and available sources of liquidity to allow all structured notes (which are issued by United States government agencies) to mature as scheduled and thus avoid realization of any material amount of loss due to decline in market value. Net Interest Income/Net Interest Margin Net interest income for 1995 was $9,527,000 compared to $8,912,000 for 1994 and $8,571,000 for 1993, which represents increases of 7% and 4%, respectively. Net interest income is determined by the spread of earnings on assets over the cost of funds. The three-year history is shown in the following chart: 1995 1994 1993 NET INTEREST SPREAD Yield on average earnings assets (taxable equivalent) 9.12% 7.75% 7.60% Cost of funds 2.29% 1.89% 2.11% Net interest spread 6.83% 5.86% 5.49%
TABLE 2. VOLUME/RATE VARIANCE ANALYSIS 1995 COMPARED TO 1994 1994 COMPARED TO 1993 1993 COMPARED TO 1992 Volume Rate Total Volume Rate Total Volume Rate Total INCREASE (DECREASE) IN INTEREST ON EARNING ASSETS: Loans Commercial loans (856) 1,159 303 (1,320) 316 (1,004) (466) 36 (430) Real estate loans (71) 351 280 (275) 452 177 258 (269) (11) Installment loans (20) 27 7 (25) (52) (77) (51) 71 20 Total loans (947) 1,537 590 (1,620) 716 (904) (259) (162) (421) Investment securities U.S. Treasury securities 73 60 133 18 18 36 (5) (58) (63) Securities of government agencies (109) 132 23 312 67 379 376 (82) 294 State and political obligations (167) (14) (181) 130 (139) (9) (25) (5) (30) Other securities 61 3 64 (13) (3) (16) (65) 19 (46) Total investment securities (142) 181 39 447 (57) 390 281 (126) 155 Certificates of deposit in other bank 42 32 74 (1) (3) (4) (78) (27) (105) Federal funds sold (127) 299 172 172 196 368 19 (63) (44) Total interest income change (1,174) 2,049 875 (1,002) 852 (150) (37) (378) (415) INCREASE (DECREASE) IN INTEREST PAID ON LIABILITIES: Interest on deposits Savings, NOW accounts, and money markets (49) 314 265 158 90 248 (194) (279) (473) Other domestic time deposits (170) 336 166 (794) (103) (897) 76 (326) (250) Total interest on deposits (219) 650 431 (636) (13) (649) (118) (605) (723) Securities sold under agreement to repurchase and federal funds purchased (129) 17 (112) 171 11 182 101 (60) 41 Short-term debt (64) 32 (32) 5 30 35 29 (10) 19 Long-term debt (18) 194 176 (15) (37) (52) (20) (140) (160) Total interest expense change (430) 893 463 (475) (9) (484) (8) (815) (823) Net change in net interest income (744) 1,156 412 (527) 861 334 (29) 437 408 Note: Change in interest income or expense can be attributed to (a) changes in volume (change in volume times old rate), (b) changes in rate (change in rate times old volume),and (c) changes in rate/volume (change in rate times the change in volume). The rate/volume variances are allocated proportionally between the rate and the volume variances based on their absolute values.
Since the vast majority of the Bank's loans (91% at December 31, 1995) are at variable rates, changes in the prime interest rate impact the yield shown above. The Wall Street Prime interest rate during this period was as follows: 1995 1994 1993 High 9.00% 8.50% 6.00% Low 8.50% 6.00% 6.00% Average 8.83% 7.14% 6.00% In addition to interest rates, changes in the volumes of assets and liabilities also affect net interest income. The volume/rate variance analysis (Table 2) shows the change in net interest income that is attributable to changes in volume versus changes in rates. As reflected in Table 2, net interest spread is affected by several factors, including: 1. The reduction of average loan balances, which began in 1993, continued during 1995, resulting in a substantial decrease in interest earned based on volume. 2. The amount of time deposits has declined from $45.3 million average in 1993 to $18.5 million average in 1995. The decline in time deposits is attributable to two major factors: a. In response to slowing loan demand, the Bank priced "money desk" certificates of deposit unattractively, assuring that those funds already in the Bank would be withdrawn at maturity. b. Continuing depositors have apparently chosen to shift to the more flexible money market accounts as the interest rate differential between those accounts and time certificates diminished. Loans and Allowance and Provision for Loan Losses Management employs a 'migration analysis method' to establish the required amount of loan loss allowance. This process tracks realized loan losses back through the prior two years to estimate loss exposure on the classified and unclassified loan portfolios. Additionally, loss experience is tracked in pools of loans with similar characteristics to estimate the loss exposure unique to various loan types. The measured loss exposure is then applied to the current loan portfolio and further adjusted for 'qualitative factors' such as: Changes in the trends of the volume and severity of past due and classified loans; and trends in the volume of non-accrual loans, troubled debt restructurings and other loan modifications; Changes in the nature and volume of the portfolio; Changes in the experience, ability, and depth of lending management and staff; Changes in lending policies and procedures, including underwriting standards and collections, charge-offs and recovery practices; Changes in national and local economic and business conditions and developments, including the condition of various market segments; The existence and effect of any concentrations of credit, and changes in the level of such concentrations; Changes in the quality of the loan review system and the degree of oversight by the Board of Directors; and The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the current portfolio. This method of establishing loan loss reserves complies with the policies of the Office of the Comptroller of the Currency as reflected in Banking Circular 201, revised, dated February 20, 1992, and in Banking Bulletin 93-60, dated December 21, 1993. The Company began testing this new method during 1992 and comparing its results to results reached by the previously existing procedures employed by the Company. The test proved that the two methods were comparable, and the Company adopted the new migration analysis method during 1993. Evaluation and classification of problem loans is an ongoing process involving grading by loan officers, evaluation by the credit administration department of the Bank, and a review on a regular basis by an independent loan review firm. Additionally, in response to the problems in the economy and increases in the level of classified loans, in 1993 the Bank established a Special Assets Department to deal solely with problem loans including identification, modification where appropriate, and early recognition of loss potential. The introduction of the Special Assets Department has resulted in improved early recognition of problem loans and opportunity to restructure them, thereby increasing the amount of loans reported as nonperforming (both those that are current in payment and those that are not current), but improving the collection record on such loans. The migration analysis adequately recognizes the loss potential included in those credits. Accordingly, the Company believes its method for establishing the loan loss allowance is sound. But no method, however valid, can consistently predict future events with complete accuracy. In recent years, several factors used by the Bank to establish loan loss allowances have been subject to considerable volatility, and this in turn has affected the volatility of nonperforming loans, charge-offs, and the coverage ratio. In addition, the Bank's method of reporting, particularly its conservative listing of loans as nonperforming, is not always an accurate indicator of actual future losses. The economy in San Diego suffered a sharp downturn in recent years, particularly in the real estate market. The Bank is a community bank with a relatively small loan portfolio comprised of mostly commercial/real estate loans that tend to be individually larger in amount than loans made by retail banks. As a result of these and other factors, the Bank can experience large swings in nonperforming loans, charge-offs, and the coverage ratio when one or a few loans are transferred from one category to another. These factors are not reasons for changing a valid method of determining loan loss allowances and are not always accurate predictors of losses, but they do have short-term effects on those allowances and related reported figures. Significant components of the loan loss charge-offs in 1994 ($1.2 million of a total of $2.4 million) and in 1993 ($660,000 of a total of $2.7 million) were attributable in each year to a single loan which became a problem loan late in the year. In both cases, the Bank responded with a partial charge-off, consistent with its conservative reporting of problem loans. Conservative reporting of nonperforming loans is a useful management tool, but it is not always a good predictor of loan losses (nor is it intended to be) and there is no direct correlation between nonperforming loans and the proper level of loan loss reserves (nor should there be). As the following chart shows, a significant portion of the loans reported as "nonperforming" are in fact performing in that payments on those loans are current. (See the percentages in the final line of the chart.) Also, many of the Bank's loans are collateralized (84% were collateralized at December 31, 1995), and that collateral can improve the recovery on troubled loans. Loans reported as non-performing at December 31: (in thousands) 1995 1994 1993 CURRENT AND NONCURRENT Non-accrual loans 6,969 6,046 5,343 Restructured loans (still accruing) 1,364 2,316 3,162 Loans 90 days past due 93 20 481 8,426 8,382 8,986 Other real estate owned 181 268 1,050 Total 8,607 8,650 10,036 NONCURRENT Non-accrual loans 3,160 1,276 3,373 Restructured loans (still accruing) 0 0 0 Loans 90 days past due 93 20 481 3,253 1,296 3,854 Other real estate owned 181 268 1,050 Total 3,434 1,564 4,904 Loans reported as nonperforming but which are current, as a percentage of total loans reported as nonperforming 61% 82% 51% Miscellaneous Other Operating Income During 1994, the Bank and its directors' and officers' insurer settled their dispute regarding the Bank's legal and settlement costs in the Pioneer Mortgage federal class action and state court cases (see notes to consolidated financial statements). Under the terms of the settlement, the insurer paid the Bank $712,500 (in addition to the $750,000 the insurer had previously advanced toward the Bank's settlement with the plaintiffs) which was credited to miscellaneous other operating income. Other Non-Interest Expenses Included in other non-interest expenses are the following: 1. Legal fees and settlement costs (and provisions therefor) in connection with the Pioneer Mortgage Company and Pioneer Liquidating Corporation litigation: In 1995 $988,000 In 1994 $504,000 In 1993 $592,000 Matters pertaining to the federal class action and state court cases resulting from the 1991 Pioneer Mortgage Company litigation, including the Bank's claim against its insurer, have been settled. The 1993 litigation brought by Pioneer Liquidating Corporation was settled in 1995. 2. Other Real Estate Owned ("OREO") losses and expenses: In 1995 $129,000 In 1994 $462,000 In 1993 $754,000 OREO property, which peaked at approximately $5 million in 1991, continued to decline in 1995 (to $181,000 at December 31, 1995) as Management continued vigorous efforts to dispose of repossessed property. Management expects that there will be other repossessions in the future but intends to continue to dispose of such properties as quickly as is prudent. 3. Miscellaneous expense in 1993 includes provision for a loss in the amount of $500,000 due to an unfavorable arbitration decision which required the Bank to rescind the 1988 sale of a single family residence which it had taken in foreclosure in 1987. The property was resold in 1994. Subsidiary Data San Diego National Bank. The Bank earned $989,000 in 1995 and $382,000 in 1994 compared to a loss of $1,870,000 in 1993. Return on average assets (ROA) was 0.65%, 0.23%, and (1.07%), respectively. Return on average equity (ROE) was $8.07%, 3.20%, and (14.65%), respectively. The reasons for the change in Bank earnings have been enumerated in the preceding pages. See notes to the consolidated financial statements and "Capital Resources" for information regarding the Bank's capital ratios. San Diego National Bank Building Joint Venture. The Joint Venture recorded pre-consolidation gross building revenues of $1,947,000, $2,046,000, and $2,048,000 in 1995, 1994, and 1993, respectively, resulting in pre- consolidation pre-tax losses of $769,000, $447,000, and $453,000, respectively. Depreciation and amortization expenses were $601,000, $636,000, and $640,000 in 1995, 1994 and 1993, respectively. The increased loss in 1995 is attributable primarily to the reduced revenues (see discussion below) and increased interest payable to the Company on advances used to pay down the building mortgage loans, which is eliminated from the financial statements in consolidation (see "Capital Resources"). At the beginning of the Joint Venture, the limited partners' share of its losses were charged against the investment capital accounts of the limited partners. During 1990, these capital accounts reached zero, requiring the Company to absorb additional operating losses of approximately $288,000 in 1995, $168,000 in 1994 and $194,000 in 1993 which would otherwise have been charged to the limited partners. In 1995, the limited partners' cumulative share of the operating losses absorbed by the Company was reduced by their share of the gain on the prepayment discount on the mortgage (see below; approximately $562,000) resulting in net losses absorbed by the Company of $1,017,000 as of December 31, 1995. There is substantial amount of vacant office space in downtown San Diego. A recent study indicated that the downtown occupancy level was approximately 79% (29th lowest among 31 U.S. cities included in the survey). This creates a highly competitive rental market, generally requiring the granting of generous lease concessions and/or low rental rates to obtain new tenants or retain existing ones. Some tenants with limited time remaining on existing leases have negotiated for lower current rental rates in exchange for extensions of their leases. At the end of 1995, the building was approximately 98% leased, although concessions to some tenants who are not utilizing all of their leased premises would reduce the effective occupancy to approximately 93%. In November 1994, the then existing first mortgage loan on the building was purchased by the two limited partnerships managed by WHR Management Corp. which subsequently purchased the Company's stock (see "Capital Resources"). In January 1995, the Joint Venture and WHR entered into a modification agreement which, inter alia, allowed for prepayment of the loan at a discount. On November 30, 1995 the loan was paid off at a discount of $1,579,000 from face value resulting in a net gain, after expenses and taxes of $1,457,000. Because the mortgage was held by a related party, the gain has been credited directly to shareholders' equity. Business Environment Through the 1990's, economic recovery of San Diego and the entire Southern California area has lagged behind that of the nation as a whole. Interest rates began to fall during 1995 after rising in 1994. Should interest rates continue to decline, net interest spread will be negatively impacted. The majority of the Bank's variable rate loans adjust on the day that a rate reduction is made. The offsetting reduction in interest paid on deposits is delayed until certificates of deposit mature and, additionally, competitive pressure from savings institutions and non-bank money funds may inhibit reduction in rates paid on these and other interest- bearing accounts. CONSOLIDATED BALANCE SHEETS SDNB Financial Corp. and Subsidiaries December 31, (dollars in thousands) 1995 1994 ASSETS Cash and due from banks $ 13,440 $11,936 Interest bearing deposits in other banks 2,780 1,381 Investment securities held-to-maturity 7,408 17,321 Investment securities available-for-sale 27,033 9,910 Federal funds sold 24,700 24,000 Loans 92,331 97,058 Less allowance for loan losses 2,002 2,148 Net loans 90,329 94,910 Premises and equipment, net 10,975 11,089 Other real estate owned 181 268 Accrued interest receivable and other assets 1,726 2,370 $ 178,572 $173,185 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits: Non-interest bearing $ 49,505 $45,693 Interest bearing 90,904 92,583 Total deposits 140,409 138,276 Securities sold under agreement to repurchase 12,934 12,285 Accrued interest payable and other liabilities 554 953 Notes payable 7,989 12,702 Total liabilities 161,886 164,216 Commitments and contingencies (notes 9, 10 and 11) Shareholders' equity: Common stock, no par value; authorized 15,000,000 shares, issued and outstanding 3,073,260 in 1995 and 1,538,364 in 1994 20,314 14,585 Accumulated deficit (3,587) (5,256) Net unrealized holding losses on available-for-sale securities (41) (360) Total shareholders' equity 16,686 8,969 $178,572 $173,185 The accompanying notes are an integral part of the financial statements. CONSOLIDATED STATEMENTS OF OPERATIONS SDNB Financial Corp. and Subsidiaries Years ended December 31, (dollars in thousands except per share amounts) 1995 1994 1993 Interest Income: Interest and fees on loans $10,090 $9,500 $10,404 Interest on federal funds sold 904 732 364 Interest on investment securities: Taxable 1,655 1,394 899 Exempt from federal income tax 94 192 263 Total interest income 12,743 11,818 11,930 Interest Expense: Deposits 2,928 2,497 3,146 Short-term borrowings 288 409 213 Total interest expense 3,216 2,906 3,359 Net interest income 9,527 8,912 8,571 Provision For Loan Losses 200 1,850 2,950 Net interest income after provision for loan losses 9,327 7,062 5,621 Other Operating Income: Security gains, net 11 0 0 Building income 903 1,067 1,088 Miscellaneous 816 1,580 1,017 Total other operating income 1,730 2,647 2,105 Other Operating Expenses: Salaries and employee benefits 4,056 3,630 3,371 Occupancy 532 492 486 Building operating expenses, including interest expense of $941, $788, and $820 for 1995, 1994 and 1993, respectively 2,422 2,296 2,310 Other non-interest expenses 3,830 3,447 4,355 Total other operating expenses 10,840 9,865 10,522 Income (loss) before income tax and cumulative effect of accounting change 217 (156) (2,796) Income Tax 5 3 0 Income (loss) before cumulative effect of accounting change 212 (159) (2,796) Cumulative Effect of Accounting Change ($0.15 Per Share) 0 0 234 Net income (loss) $ 212 $(159) $(2,562) Net income (loss) per share $ 0.10 $(0.10) $ (1.67) The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY SDNB Financial Corp. and Subsidiaries Net unrealized holding losses in For years ended December 31, 1995, 1994 and 1993 Common Accumulated available-for-sale (dollars in thousands) Stock Deficit securities Total Balances at January 1, 1993 $ 14,585 $ (2,535) $0 $12,050 Net loss 0 (2,562) 0 (2,562) Balances at December 31, 1993 14,585 (5,097) 0 9,488 Effect of adopting Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS No.115"), on January 1, 1994 0 0 (10) (10) Net change in fair value of available-for-sale securities 0 0 (350) (350) Net loss 0 (159) 0 (159) Balances at December 31, 1994 $ 14,585 ($ 5,256) ($ 360) $ 8,969 Proceeds from issuance of common stock, 1,534,896 shares issued at $4.34/share less associated costs of $932. A warrant to purchase 37,363 shares of common stock at $4.34 per share until September 29, 1997 was issued to Torrey Pines Securities, Inc. which acted as underwriter in the stock offering. 5,729 0 0 5,729 Gain on early payment of loan (Note 22) 0 1,457 0 1,457 Net change in fair value of available-for-sale securities 0 0 319 319 Net income 0 212 0 212 Balances at December 31, 1995 $ 20,314 $( 3,587) ($ 41) $ 16,686 The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS SDNB Financial Corp. and Subsidiaries Years ended December 31, (dollars in thousands) 1995 1994 1993 OPERATING ACTIVITIES: Net income (loss) $ 212 $(159) $(2,562) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Provision for loan losses 200 1,850 2,950 Provision for depreciation and amortization 1,279 1,332 1,102 Cumulative effect of accounting change 0 0 (234) Amortization of investment security discounts (240) (65) (84) Other expense not utilizing (providing) cash 173 175 106 Unearned loan fees 157 104 (5) Taxes refundable 33 (30) 477 Interest receivable and other assets (807) (144) (691) Interest payable and other liabilities (399) (66) 545 Total adjustments 396 3,156 4,166 Net cash provided by operating activities 608 2,997 1,604 INVESTING ACTIVITIES: Proceeds from maturities of held for investment securities 0 0 10,699 Proceeds from maturities of held-to-maturity securities 6,504 9,443 0 Proceeds from called held-to-maturity securities, including gross realized gains of $10 1,802 0 0 Proceeds from maturities of available-for-sale securities 6,993 6,927 0 Proceeds from sales of available-for-sale securities, including gross realized gains of $1 5,324 0 0 Purchases of held for investment securities 0 0 (23,037) Purchases of held-to-maturity securities (2,000) (8,847) 0 Purchases of available-for-sale securities (25,097) (4,950) 0 Net change in gross loans 4,320 11,508 18,549 Proceeds from OREO properties 556 889 1,041 Purchases of OREO properties 0 (520) 0 Purchases of premises and equipment (737) (232) (221) Net cash provided (used) by investing activites (2,335) 14,218 7,031 FINANCING ACTIVITIES: Net change in deposits 2,133 126 (26,589) Net change in short-term borrowings (1,894) 3,172 4,619 Proceeds from issuance of long-term debt, net of associated costs of $48 7,952 0 0 Payments of long-term borrowings (8,590) (222) (251) Proceeds from issuance of common stock 6,661 0 0 Payments of costs associated with issuance of common stock (932) 0 0 Net cash provided (used) by financing activities 5,330 3,076 (22,221) Change in cash and cash equivalents 3,603 20,291 (13,586) Cash and cash equivalents at beginning of year 37,317 17,026 30,612 Cash and cash equivalents at end of year $40,920 $37,317 $17,026 For the purpose of the statement of cash flows, the Company considers cash and cash equivalents to be as follows at December 31, 1995 1994 1993 Cash and due from banks $13,440 $11,936 $9,044 Interest-bearing deposits in other banks 2,780 1,381 1,682 Federal funds sold 24,700 24,000 6,300 Totals $40,920 $37,317 $17,026 Supplemental cash flow information: 1995 1994 1993 CASH PAID FOR: Interest $4,316 $3,661 $4,163 Income Taxes $1 $3 $0 Non-cash items: transfer of loans to OREO $553 $0 $739 The accompanying notes are an integral part of the financial statements. NOTES TO FINANCIAL STATEMENTS SDNB Financial Corp. and Subsidiaries NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of SDNB Financial Corp. (the Company) and subsidiaries are in accordance with generally accepted accounting principles and conform to general practices within the banking industry. 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 iabilities and disclosure of contingent assets and liabilities at the date(s) of the financial statements and the reported amounts of revenues and expenses during the reporting period(s). Actual results differ from those estimates. The following is a summary of the more significant policies: BASIS OF PRESENTATION All dollar amounts are presented in thousands unless otherwise indicated. The consolidated financial statements include the accounts of SDNB Financial Corp. and all companies which are more than 50% owned, directly or indirectly, including San Diego National Bank (the Bank), 100% owned, the Company's principal subsidiary. All significant inter-company items are eliminated. INVESTMENT SECURITIES The Company implemented Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS No. 115") effective January 1, 1994. The impact of adoption was immaterial. SFAS No. 115 was issued in May 1993 and addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Investments are to be classified in three categories and accounted for as follows: CLASSIFICATION ACCOUNTING Held-to-maturity Reported at amortized cost Trading securities Reported at fair value; unrealized gains and losses included in net income Available-for-sale Reported at fair value; unrealized gains and losses included as a separate component of shareholders' equity Prior to adoption of SFAS No. 115, due to management's intent and ability to hold to maturity, all securities in the investment portfolio were classified as held for investment and were stated at cost, adjusted for amortization of premiums and accretion of discounts. Such amortization and accretion were recognized as adjustments to interest income on investment securities. On November 15, 1995, the Financial Accounting Standards Board ("FASB") authorized a one-time transfer between classifications which was required to be made no later than December 31, l995. Pursuant to such authority, the Bank transferred securities with an amortized cost of $3.8 million and an unrealized loss of $19 thousand from "held to maturity" to "available for sale." Realized gains or losses, if any, are determined using the specific identification method. LOANS Interest on loans is credited to income based on the principal amount outstanding. Loan fees received, to the extent they exceed origination costs, are deferred and amortized over the expected loan term. Effective January 1, 1995, the Company implemented Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan ("SFAS No. 114") as amended by Statement of Financial Accounting Standards No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures ("SFAS No. 118"). Under SFAS No. 114, a loan is considered impaired, based on current information and events, if it is probable the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that collateral dependent loans are measured for impairment based on the fair value of the collateral. Adoption of SFAS No. 114 did not have a material effect on the Company's financial statements. Loans are placed on non-accrual when a reasonable doubt exists as to the collectibility of interest or principal. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment in an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower. While a loans is classified as non-accrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case of a partially charged-off loan, interest income is limited to that which would have been recognized on the remaining recorded loan balance. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. ALLOWANCE FOR LOAN LOSSES An allowance for loan losses is maintained at the level deemed appropriate by management to provide for known and inherent risks in the loan portfolio. The allowance is based on a continuing review of the portfolio, past loan loss experience, current economic conditions which may affect the borrowers' ability to pay, and the underlying collateral value of the loans. Loans which are deemed to be uncollectible are charged off and deducted from the allowance. The provision for loan losses and recoveries on loans previously charged off are added to the allowance. The allowance for possible loan losses 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. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation. Depreciation is charged to operating expense using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are capitalized and amortized to operating expense over the term of the respective lease or the estimated useful life of the improvement, whichever is shorter. When assets are sold or retired, the assets and accumulated depreciation are removed from the accounts. Gains or losses on disposals are credited or charged to income. OTHER REAL ESTATE OWNED (OREO) OREO property is accounted for at the lower of the recorded investment in the loan satisfied or its appraised value at the time of transfer to the OREO category, less estimated selling costs. Investment in the loan satisfied is the unpaid balance of the loan increased by accrued and uncollected interest, unamortized premium, and loan acquisition costs, if any, and decreased by previous direct write-down, finance charges, and unamortized discount, if any. Any excess of the recorded investment in the loan satisfied over the appraised value of the property is charged against the allowance for loan losses. Legal fees and direct costs of acquiring the property and costs of carrying the property subsequent to recording as OREO are expensed as incurred. Any reduction in the value of the property subsequent to its being recorded as OREO is charged directly to expense and is recorded as an allowance. The allowance for OREO at December 31, 1995 and 1994 was $14 and $20, respectively. INCOME TAXES The Company files a consolidated federal income tax return and a combined California state franchise tax return with its subsidiaries. Amounts equal to tax benefits of those companies having taxable losses or credits are reimbursed by those companies which incur tax liabilities. Any excess of alternative minimum tax over regular tax determined on a consolidated basis will be borne by the parent company. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS No. 109"), which requires the use of the liability method in the computation of income tax expense and current and deferred income taxes payable. Under SFAS No. 109, income tax expense consists of taxes payable for the year and the changes during the year in deferred tax assets and liabilities. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. EARNINGS PER SHARE Net income per share for 1995 is based on 2,197,615 weighted average shares outstanding. Net loss per share for 1994 and 1993 are based on 1,538,364 shares outstanding. EMPLOYEE STOCK COMPENSATION PLANS In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, Accounting for Stock- Based Compensation ("SFAS No. 123"). Under the provisions of SFAS No. 123, the Company is encouraged, but not required, to measure compensation costs related to its employee stock compensation plans under the fair value method. Under this method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. If the Company elects not to recognize compensation expense under this method it is required to disclose the pro forma net income and earnings per share effects based on the SFAS No. 123 fair value methodology. SFAS No. 123 applies to financial statements for fiscal years beginning after December 15, 1995. Earlier implementation is permitted. The Company will implement the requirements of SFAS No. 123 in 1996 and will only adopt the disclosure provisions of this statement. NOTE 2: CASH AND DUE FROM BANKS The Bank is required to maintain reserves with the Federal Reserve Bank. Reserve requirements are based on a percentage of deposit liabilities. The average amounts held at the Federal Reserve Bank for the years ended December 31, 1995 and 1994 were approximately $1,706 and $1,371, respectively. NOTE 3: INVESTMENT SECURITIES The amortized cost and estimated market values of investment securities are summarized as follows at December 31, 1995: Gross Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value DECEMBER 31, 1995: Available for sale: U.S. Treasury $13,532 $0 $(17) $13,515 U.S. Government agencies 12,797 28 (52) 12,773 Other 472 0 0 472 Federal Reserve Bank stock 273 0 0 273 $27,074 $28 $(69) $27,033 Held to maturity: U.S. Treasury $1,000 $0 $(2) $998 U.S. Government agencies 4,021 10 (61) 3,970 States and municipalities 1,637 6 (12) 1,631 Other 750 0 0 750 $7,408 $16 $(75) $7,349 DECEMBER 31, 1994: Available for sale: U.S. Government agencies $9,997 $0 $(360) $9,637 Federal Reserve Bank stock 273 0 0 273 $10,270 $0 $(360) $9,910 Held to maturity: U.S. Treasury $1,998 $0 $(45) $1,953 U.S. Government agencies 11,397 0 (602) 10,795 States and municipalities 3,176 0 (33) 3,143 Other 750 0 0 750 $17,321 $0 $(680) $16,641 Estimated Amortized Market Cost Value DECEMBER 31, 1995: Available for sale: Due in one year or less $15,804 $15,786 Due after one year through five years 10,997 10,974 Due after five years through ten years 0 0 Federal Reserve Bank stock 273 273 $27,074 $27,033 Held to maturity: Due in one year or less $3,000 $2,997 Due after one year through five years 3,137 3,082 Due after five years through ten years 1,271 1,270 $7,408 $7,349 Investment securities with a carrying value of $3,778 and $3,276 at December 31, 1995 and 1994, respectively, were pledged as security for public deposits and other purposes. NOTE 4. LOANS AND RELATED ALLOWANCE FOR LOAN LOSSES At December 31, 1995 and 1994 loans consist of the following: 1995 1994 Commercial $54,628 $57,808 Real estate 35,192 37,534 Installment 2,877 2,239 Unearned loan fees (366) (523) $92,331 $97,058 In the normal course of business, the Bank has made loans to certain executive officers and directors or entities with which these individuals are associated under terms consistent with the Bank's general lending policies. In October 1990, the Bank discontinued further lending to such persons or entities (except for cash secured loans) beyond the maturity of existing loans. Exceptions to this policy were granted to one director where the amounts of loans outstanding are less than the amounts outstanding when the policy was adopted and to another whose guarantee of a loan was made prior to his becoming a director. A summary of the activity in the allowance for loan losses is as follows: 1995 1994 1993 Balance at beginning of year $2,148 $2,522 $2,111 Provision charged to operating expenses 200 1,850 2,950 Loans charged off (655) (2,362) (2,716) Recoveries 309 138 177 Balance at end of year $2,002 $2,148 $2,522 As of December 31, 1995 and 1994, restructured loans were $6,925 and $3,460, respectively. Of these totals, $1,364 and $2,316 were accruing at December 31, 1995 and 1994, respectively. The difference between interest income recorded as restructured and interest income that would have been recorded if not restructured was immaterial. As of December 31, 1995, the recorded investment in loans for which impairment has been recognized in accordance with SFAS No. 114 totaled $5,422. Of this total , $1,265 related to loans with no valuation allowance, either because the loans have been partially written down through charge-offs or because collateral value exceeds contractual amounts due. The remaining $4,157 related to to loans with a valuation allowance of $241. For the year ended December 31, 1995, the average recorded investment in impaired loans was approximately $2,951. The Company recognized $212 of interest on impaired loans (during the portion of the year they were impaired) all of which represents income recognized using a cash basis method of accounting during the time within the year the loans were impaired. NOTE 5: PREMISES AND EQUIPMENT Premises and equipment at December 31, 1995 and 1994 are summarized as follows: 1995 1994 Building $11,705 $11,708 Furniture, fixtures and equipment 2,936 2,855 Leasehold improvements 4,010 4,356 18,651 18,919 Less accumulated depreciation and amortization 7,676 7,830 $10,975 $11,089 NOTE 6: DEPOSITS The year-end balances for deposits by major classification are as follows: 1995 1994 Non-interest bearing demand $ 49,505 $ 45,693 Interest bearing demand 64,185 69,839 Savings 3,982 4,844 Time deposits of $100 or more 12,748 10,374 Other time deposits 9,989 7,526 $140,409 $138,276 Interest expense on deposits was comprised of the following: 1995 1994 1993 Interest bearing demand $1,873 $1,623 $1,373 Savings 92 77 79 Time deposits of $100 or more 471 347 725 Other time deposits 492 450 969 $2,928 $2,497 $3,146 Domestic time deposits over $100 at December 31, 1995 mature in the following periods: Time Certificates All Other of Deposit Time Deposits Three months or less $6,167 $201 Over three through six months 3,360 200 Over six through twelve months 2,498 0 Over twelve months 0 322 $12,025 $723 NOTE 7: NOTES PAYABLE Notes payable consist of the following: 1995 1994 Note payable to a limited liability company payable in monthly installments of $76 which include interest at 9.8%. The loan is collateralized by the bank building and is due December 1, 2005. As additional consideration for the loan the Company issued warrants to purchase 150,000 shares of Common Stock at $5.44 per share until November 30, 1999. $7,989 $0 Note payable to two limited partnerships, managed by WHR Management Corp. (owner of 24.9% of the Company's Common Stock) paid November 29, 1995 at a discount (see Note 22). 0 10,158 Note payable to a corporation (which is owned by a member of the Company's Board of Directors); paid November 29, 1995. 0 1,900 Notes payable to individuals (officers and/or directors of the Company)paid September 30, 1995. 0 390 Notes payable to individuals paid March 31, 1995. 0 240 Notes payable to a corporation paid May 9, 1995. 0 14 $7,989 $12,702 NOTE 8: INCOME TAXES The Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS No. 109"), as of January 1, 1993. The cumulative effect of this change in accounting for income taxes increased 1993 net income by $234 ($0.15 per share) and is reported separately in the consolidated statement of operations. The components of income tax expense attributable to continuing operations for the years ended December 31, are as follows: 1995 1994 1993 Current: Federal $2 $0 $0 State 3 3 0 Total current 5 3 0 Deferred: Federal 0 0 0 State 0 0 0 Total deferred 0 0 0 Income tax expense $5 $3 $0 Income tax expense attributable to operations differs from the amounts computed using the federal statutory income tax rate as a result of the following at December 31: 1995 1994 1993 Computed expected taxes $74 $(57) $(951) California franchise tax,net of federal income tax benefit 3 0 0 Nontaxable interest income (30) (113) (84) Alternative minimum tax 2 0 0 Net operating loss (57) 0 0 Adjustment of the valuation allowance 0 168 1,003 Other 13 5 32 Income tax expense $5 $3 $0 The components of net deferred taxes at December 31, 1995 and 1994 are as follows: Deferred December (Expense) December 31,1994 Benefit 31,1995 OREO gains/losses ($438) $483 $45 Joint venture (313) 28 (285) Bad debt allowance 373 94 467 Deferred compensation 14 2 16 Land lease 163 (114) 49 Depreciation (149) (49) (198) Miscellaneous 30 37 67 Net operating loss 2,292 (1,071) 1,221 Debt refinance 0 622 622 AMT credit carryforward 0 148 148 Net deferred tax asset 1,972 180 2,152 Valuation allowance (1,972) (180) (2,152) $0 $0 $0 At December 31, 1995, the Company has net operating loss ("NOL") carryforwards for Federal tax purposes of approximately $3,083, to offset future Federal taxable income. The Company also has NOL carryforwards for California Franchise Tax purposes of approximately $4,944, of which 50% is available to offset future state taxable income, subject to the limitations below. The Federal NOLs begin to expire in 2007 and the California NOLs begin to expire in 1997. The Company also has Alternative Minimum Tax credits for financial reporting purposes to offset future federal taxes of approximately $148. Current tax statutes impose substantial limitations under certain circumstances on the use of carryforwards upon the occurrence of an "ownership change". An ownership change can result from the issuance of equity securities by the Company, purchases of the Company's securities in the secondary market or a combination of the foregoing. NOTE 9: LEASE COMMITMENTS At December 31, 1995, minimum rental payments due under the Company's operating leases having initial or remaining non-cancelable lease terms in excess of one year are as follows: 1996 $ 1,122 1997 1,029 1998 1,033 1999 1,033 2000 988 Thereafter 17,994 $ 23,199 Total minimum lease payments include $6,787 of rental payments to the Joint Venture (the Company's 62%-owned subsidiary). The other primary component of the minimum lease payments is the Joint Venture's rental payments under a 99 year ground lease. Total rental expense under operating leases was $1,337 in 1995, $1,289 in 1994, and $1,259 in 1993. There are no contingent rental payments applicable to any of the leases. All leases provide that the Company pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased premises or property in addition to the monthly minimum payments. Certain of the leases contain renewal clauses at the option of the lessee. NOTE 10: CONTINGENCIES In the ordinary course of business, there are outstanding various commitments to extend credit and guarantees, as well as certain claims resulting from law suits, which are not reflected in the accompanying consolidated financial statements. Management does not believe that these items will have a material adverse effect on the consolidated financial condition of the Company. In January 1993, the Bank was named as a defendant in an adversary proceeding filed by Pioneer Liquidating Corporation ("PLC"), successor to six bankrupt Pioneer Mortgage Company entities (collectively, "Pioneer") in the Bankruptcy Court of the Southern District of California. Investors in Pioneer had previously filed suit against the Bank, which litigation was settled in 1992. The PLC case was settled with the final settlement agreement approved by the Federal District Court for the Southern District of California on November 29, 1995. A preliminary agreement between the Bank and PLC contemplated that the Bank would make payment to PLC on execution of the settlement agreement and assign to PLC certain charged-off loans, without recourse. The preliminary agreement further provided that after being given credit for the payment by the Bank and the collections on the assigned charged- off loans, payment of the remaining balance of the total settlement amount was to be guaranteed by Charles I. Feurzeig, Chairman of the Board of the Company, and PVCC, Inc., a corporation controlled by Mr. Feurzeig (collectively, the "Feurzeig Entities"). Such guarantee was being given by the Feurzeig Entities for consideration independent of Mr. Feurzeig's investment in the Company. Subsequent negotiations led to the settlement agreement approved by the Court whereby the Bank paid $600 to PLC and the Feurzeig Entities paid $1,050 to PLC upon execution of the settlement agreement and the Feurzeig Entities took the place of PLC with respect to assignment of the charged-off loans. In consideration of the modification of the original list of charged-off loans to eliminate certain loans which had been only partially charged-off, the Bank agreed to assign additional newly charged-off loans (90 days after charge-off) to the Feurzeig Entities, until the first to occur of: (a) Five years after the date of the settlement agreement; or (b) Such time as the Feurzeig Entities have collected on such loans $1,050 plus a return equal to the rate of 9.5% per year on the unpaid portion of such $1,050. Pursuant to the settlement agreement the Feurzeig Entities do not have recourse or a claim against the Bank should the collections on the assigned charged-off loans amount to less than $1,050. Should the collections exceed $1,050 plus the return referred to above, the Feurzeig Entities have agreed to pay to the Bank 50% of such excess collections. NOTE 11: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments may include loan commitments, interest rate exchange contracts, and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. The Bank's exposure to credit loss in the event of non-performance by the other party for loan commitments and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Bank has no significant concentrations of credit risk with any individual counterparty or groups of counterparties to originate loans. The Bank's lending is concentrated in San Diego County. Variable rate loans totaled $84,076 at December 31, 1995. The total contract amounts of financial instruments with off-balance sheet risk at December 31 are as follows: 1995 1994 LOAN COMMITMENTS: Variable rate $42,667 $48,140 Fixed rate 707 431 Letters of credit 2,633 1,997 $46,007 $50,568 Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on Management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and residential and income-producing properties. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. During February 1995, the Bank entered into an interest rate swap to hedge against the effects of falling interest rates on income. If the prime interest rate falls below eight percent during the life of the contract, the Bank will receive payments amounting to the difference between the then existing prime rate and eight percent on the contract amount of $20 million. These payments continue while the prime interest rate stays below eight percent or until expiration of the contract, February 3, 1998. The Bank's exposure to credit loss in the event of non-performance of the counterparty is represented by the amount of these payments, which is presently undeterminable. NOTE 12: EMPLOYEE BENEFIT PLANS The Bank maintains a Profit Sharing Plan and Deferred Savings Plan for the benefit of all employees. Contributions to the Profit Sharing Plan are made at the discretion of the Board. The Deferred Savings Plan provides a 401(k) plan for which the Bank may make discretionary matching contributions on a percentage basis. The Bank accrued $59 under the plans in 1995. No accrual was made for the years 1994 and 1993. NOTE 13: AVAILABILITY OF FUNDS FROM SUBSIDIARIES Funds available for the payment of dividends by the Company would be obtained from the Bank. There are legal limitations on the ability of the Bank to provide funds for the Company. Under federal banking law, dividends declared by the Bank in any calendar year may not, without the approval of the Comptroller of the Currency, exceed its net income, as defined, for that year combined with its retained net income for the preceding two years. At January 1, 1996, the Bank had available for dividends to the Company approximately $1,370 without approval of the Comptroller. Federal banking law also restricts the Bank from extending credit to the Company in excess of 10% of capital stock and surplus, as defined, of the Bank. Any such extensions of credit are subject to strict collateral requirements. The Company and the Federal Reserve Bank of San Francisco ("Reserve Bank") entered into an agreement on November 20, 1992, pursuant to which the Company must obtain the approval of the Reserve Bank prior to the declaration of any cash dividends. NOTE 14: STOCK OPTIONS In 1994 the Board of Directors adopted the "1994 Stock Option Plan" ("1994 Plan"), which was approved by the Company's shareholders on March 17, 1995. The Company has reserved 400,000 shares for issuance under the plan. Options are granted under the plan at a price not less than the fair market value of the Company's common stock on the date of grant. The options are exercisable in increments over a number of years as determined by the Board of Directors but not to exceed 10 years and expire three months after termination of employment or cessation of affiliation as a director. The plan expires September 10, 2004, as to any shares not at the time subject to option. Options can, depending on the circumstances of issuance, be either incentive stock options, which are qualified under provisions of the Internal Revenue Code for certain tax-advantaged treatment, or non-qualified options. The 1994 Plan replaced a similar plan, the "1984 Stock Option Plan" ("1984 Plan") which had expired. As of December 31, 1995, there were non-qualified options outstanding under the 1984 Plan for 168,294 shares at exercise prices ranging from $3.25 to $7.94 per share and Incentive Stock Options outstanding for 250,401 shares at exercise prices ranging from $3.25 to $11.13 per share. As of December 31, 1995, there were non-qualified options outstanding under the 1994 Plan for 98,000 shares at a price of $6.00 per share and Incentive Stock Options outstanding for 67,000 shares at prices ranging from $3.25 to $6.00 per share. NOTE 15: LEASE INCOME The Joint Venture (the Company's 62%-owned subsidiary) is the lessor of the Building in which the Bank has its main office. The lease term is 20 years. Certain of the Building leases contain renewal clauses at the option of the lessees. At December 31, 1995, minimum lease payments to be received by the Joint Venture on non-cancelable operating leases are as follows: 1996 $ 1,724 1997 1,471 1998 1,302 1999 1,199 2000 1,155 Thereafter 3,800 $10,651 NOTE 16: INVESTMENT IN JOINT VENTURE The Company's wholly-owned subsidiary, SDNB Development Corp ("Devco") was the general partner with a 62% interest in a joint venture with a limited partnership, Kettner Building Associates, Ltd. ("KBA"), in the ownership and operation of the Building in which the Company has its headquarters. On July 1, 1993, Devco was merged into the Company and the Company became the general partner. The results of operations attributable to the Company's controlling interest in the Joint Venture are included in consolidated results of operations with an appropriate allocation to the minority interest, the remaining limited partners in KBA. During 1990, however, the allocation exhausted the contributed capital of the remaining limited partners and the Company began absorbing the entire loss. NOTE 17: PARENT COMPANY INFORMATION The following financial information represents the condensed balance sheets of SDNB Financial Corp. (parent company only) as of December 31, 1995 and 1994, and the related condensed statements of income and cash flows for each of the three years in the period ended December 31, 1995. CONDENSED BALANCE SHEETS 1995 1994 ASSETS Cash in San Diego National Bank $142 $30 Interest bearing deposits in other banks 497 0 Investment securities available-for-sale 472 0 Investment in San Diego National Bank 13,615 11,307 Investment in SDNB Building Joint Venture (2,647) (3,375) Investment in SDNB Mortgage Bankers 6 6 Note receivable from Joint Venture 4,558 1,413 Other assets 119 462 $16,762 $9,843 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Due to subsidiaries for income taxes $7 $32 Other liabilities 69 212 Notes payable 0 630 Total Liabilities $76 $874 Shareholder's equity: Common Stock, no par value; authorized 15,000,000 shares, issued 3,073,260 in 1995 and 1,538,364 in 1994 20,314 14,585 Accumulated Deficit (3,587) (5,256) Net unrealized holding losses on available-for-sale securities (41) (360) Total shareholders' equity 16,686 8,969 $16,762 $9,843 CONDENSED STATEMENTS OF OPERATIONS 1995 1994 1993 Management income $39 $41 $21 Interest income 311 136 66 Rental income 198 225 218 Total income 548 402 305 Operating expenses 584 498 433 Loss before income taxes and equity in undistributed income (loss) of subsidiaries and cumulative effect of accounting change (36) (96) (128) Allocated income tax 21 (1) 0 Loss before equity in undistributed income (loss) of subsidiaries and cumulative effect of accounting change (15) (97) (128) Equity in undistributed income (loss) of subsidiaries 227 (62) (2,313) Income (loss) before cumulative effect of accounting change 212 (159) (2,441) Cumulative effect of accounting change 0 0 (121) Net income (loss) $212 $(159) $(2,562) CONDENSED STATEMENTS OF CASH FLOWS 1995 1994 1993 OPERATING ACTIVITIES: Net income (loss) $212 $(159) $(2,562) Adjustments to reconcile net income (loss) to net cash used by operating activities: Net change in taxes payable 0 (30) (600) Provision for depreciation and amortization 15 4 6 Cumulative effect of accounting changes 0 0 (121) Net change in other assets 345 (267) 16 Net change in other liabilities (148) 59 50 (Income) loss of wholly-owned subsidiaries (227) 62 2,434 Total adjustments (15) (172) 1,785 Net cash provided (used) by operating activities 197 (331) (777) INVESTING ACTIVITIES: Purchase of investment activities (3,336) 0 0 Sales of investment securities 2,864 0 0 Purchase of leasehold improvements 0 0 30 Advances to subsidiaries (4,161) 0 0 Payments from subsidiaries 0 100 173 Net cash provided (used) by investing activities (4,633) 100 203 FINANCING ACTIVITIES Proceeds from short-term borrowings 0 275 440 Repayments of short-term borrowings (630) (85) 0 Proceeds from advances from subsidiaries 0 83 488 Repayment of advances from subsidiaries (54) (26) (516) Proceeds from issuance of common stock 5,729 0 0 Payments for costs associated with issuance of common stock (932) 0 0 Net cash provided by financing activities 5,045 247 412 Increase (decrease) in cash 609 16 (162) Cash at beginning of year 30 14 176 Cash at end of year $639 $30 $14 NOTE 18: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS In 1992, the Company adopted SFAS 107 which requires the disclosure of the estimated fair value of its financial instruments. The following methods and assumptions were used to estimate the fair value of the other classes of financial instruments for which it is practice to estimate that value. Carrying value approximates fair value for cash and due from banks, federal funds sold and securities sold under agreements to repurchase. Interest Bearing Deposits In Other Banks For privately placed certificates of deposit, fair value is estimated using the rates currently offered for deposits of similar remaining maturities. 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 Fair value for variable rate loans is determined by using the present value of cash flows discounted from the first repricing opportunity. For fixed rate loans, the cash flows to maturity are discounted to achieve the present value. In each case, the discount rate is equal to the rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Non-accrual loans are discounted based on cash flows including principal repayment only at maturity. Deposit Liabilities The fair value of demand deposits, savings accounts, NOW accounts and money market accounts is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Acceptances Outstanding And Commercial Letters Of Credit Settlement value approximates fair value. Notes Payable Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Commitments, Guarantees And Standby Letters Of Credit The fair values approximate the carrying amounts which are comprised of unamortized fee income. Interest Rate Contracts The fair value approximates the carrying amount which represents remaining unamortized contract price. Carrying amount Fair value FINANCIAL ASSETS: Cash and due from banks $13,440 $13,440 Interest bearing deposits in other banks 2,780 2,782 Investment securities held-to-maturity 7,408 7,349 Investment securities available-for-sale 27,033 27,033 Federal funds sold 24,700 24,700 Loans 92,331 Less allowance for loan losses 2,002 Net loans 90,329 90,312 FINANCIAL LIABILITIES: Deposits: Non-interest bearing $49,505 $49,505 Interest bearing 90,904 90,922 Total deposits 140,409 140,427 Securities sold under agreements to repurchase 12,934 12,934 Notes payable 7,989 7,989 UNRECOGNIZED FINANCIAL INSTRUMENTS: Acceptances outstanding and commercial letters of credit $785 Commitments, guarantees and standby letters of credit $128 Interest rate contracts $ 27 NOTE 19: MISCELLANEOUS OPERATING INCOME Miscellaneous operating income consists of the following: 1995 1994 1993 Service charge on deposits $ 583 $ 633 $ 737 Other service charges 162 149 165 OREO income 44 55 93 Other 27 743 22 $ 816 $1,580 $1,017 NOTE 20: OTHER NON-INTEREST EXPENSES Other non-interest expenses consist of the following: 1995 1994 1993 Data Processing $ 210 $ 223 $ 239 FDIC insurance premiums and OCC assessments 273 442 487 Professional fees 865 506 758 Provision for litigation settlement 350 250 150 Loan and collection expense 416 330 318 OREO expense 52 59 168 Losses on OREO property 77 403 586 Miscellaneous 1,587 1,234 1,649 $3,830 $3,447 $4,355 NOTE 21: CAPITAL RATIOS The Comptroller of the Currency ("OCC") has established a framework for supervisory requirements of national banks based upon capital ratios. Based upon this framework, a bank's capitalization is defined as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized. As of December 31, 1995, the Bank's capital ratios were 12.73% and 13.98% for tier 1 capital and risk weighted capital, respectively. Under the OCC framework, a bank is well capitalized if its ratios are greater than or equal to 6% and 10% for tier 1 capital and risk weighted capital, respectively. The Federal Reserve Bank ("FRB"), as the regulatory body of the Company, has capital ratio requirements. Under the FRB Capital Adequacy Guidelines, all bank holding companies should meet a minimum ratio of qualifying total capital to weighted-risk assets of 8 percent, of which at least 4.0 percentage points should be in the form of tier 1 capital. At December 31, 1995, the Company's capital ratios were 14.18% and 15.43% for tier 1 capital and risk weighted capital, respectively. NOTE 22: GAIN ON EARLY PAYMENT OF LOAN In January 1995, the note payable to the two limited partnerships managed by WHR Management Corp. was modified to provide for a discount for early payment. In November 1995, the note was paid in full. Because the transaction was with a related party, the gain, $1,457, net of expenses and income taxes, has been credited directly to shareholders' equity. REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of SDNB Financial Corp. We have audited the accompanying consolidated balance sheets of SDNB Financial Corp. and the subsidiaries (the "Company") as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 consolidated 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 consolidated financial position of SDNB Financial Corp. and subsidiaries at December 31, 1995 and 1994, the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. As discussed in notes 1 and 8 to the consolidated financial statements, the Company changed its method of accounting for income taxes effective January 1, 1993. /s/Coopers & Lybrand L.L.P. San Diego, California February 5, 1996 INVESTOR RELATIONS INFORMATION Availability Of Form 10-K The Company will furnish, without charge, upon written request of any shareholder, a copy of the Company's annual report to the Securities and Exchange Commission on Form 10-K (including financial statements and financial statement schedules, but without exhibits) for the fiscal year ended December 31, 1995. Requests should be addressed to: Howard W. Brotman, Secretary SDNB Financial Corp. Post Office Box 12605 San Diego, CA 92112-3605 Direct Mailing To "Street Name" Holders Shareholders who have certificates of SDNB Financial Corp. common stock held in brokerage accounts or otherwise not in their own names should receive the Company's annual reports from their brokers or other record holders. If you are such a shareholder and desire to receive those and other reports directly from SDNB Financial Corp. at the same time as record holders, please contact in writing: Howard W. Brotman, Secretary SDNB Financial Corp. Post Office Box 12605 San Diego, CA 92112-3605 Independent Accountants Coopers & Lybrand L.L.P. 402 West Broadway San Diego, CA 92101 Stock Transfer Agent American Stock Transfer & Trust Company 40 Wall Street New York, NY 10005 Stock Information Since October 6, 1987 the Company's common stock has been listed on the NASDAQ National Market System. There is only a limited market for the Company's common stock. The Company had approximately 1,000 shareholders as of December 31, 1995. Price Information By Period 1995 1994 First quarter Low $3.25 $2.50 High 4.25 3.25 Second quarter Low 3.625 2.50 High 4.25 3.25 Third quarter Low 3.50 2.50 High 4.50 4.75 Fourth quarter Low 4.50 3.00 High 6.25 4.75 Dividend Information There were no stock or cash dividends declared in 1995 or 1994. Common Stock Listing The Company's common stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol: SDNB. BOARD OF DIRECTORS SDNB Financial Corp. (Individual pictures of SDNB Financial Corp. Board of Directors. From left to right (top row) Charles I. Feurzig, Douglas E. Barnhart, Howard W. Brotman, Julius H. Zolezzi, Karla Hertzog, (bottom row) Mark P. Mandell, Margaret "Midge" Costanza, Murray L. Galinson, Patricia L. Roscoe and Robert B. Horsman.) (Group picture of SDNB Senior Management Team (from left to right): Robert B. Horsman, Murray L. Galinson, Ronald P. Bird, Mark P. Mandell, Joyce Chewning-Johnson, Howard W. Brotman.) Board of Directors Douglas E. Barnhart Howard W. Brotman Chief Executive Officer, Director, Douglas E. Barnhart, Inc. SDNB Financial Corp. Senior Vice President, San Diego National Bank Margaret "Midge" Costanza Charles I. Feurzeig Partner, Chairman of the Board, Martin & Costanza SDNB Financial Corp; Communications President, PVCC, Inc. Murray L. Galinson Karla J. Hertzog Chief Executive Officer, President, San Diego National Bank TOPS Total Personnel Services, President, Chief Executive Officer, Inc. SDNB Financial Corp. Robert B. Horsman Mark P. Mandell President, Attorney-at-Law San Diego National Bank Patricia L. Roscoe Julius H. Zolezzi Chairman, President, Patti Roscoe & Associates, Inc. Zolezzi Enterprises Officers of SDNB Financial Corp. Murray L. Galinson Robert B. Horsman President, President, Chief Executive Officer San Diego National Bank Howard W. Brotman Joyce Chewning-Johnson Senior Vice President, Secretary, Executive Vice President Chief Financial Officer San Diego National Bank Business Advisory Council John L. Baldwin Betty Byrnes President, Medical Administrator Baldwin Pacific Corp. Shlomo Caspi Marvin Cohen President, Architect Caspi, Inc. & Caspi Enterprises Michael H. Dessent Norman Eisenberg, CPA Dean, Eisenberg & Bonk California Western School Of Law James T. Gianulis Wayne L. Hanson President, President, Pacific Income Properties, Inc. Cygnus Corp. Warren O. Kessler, M.D. Ed Mendelsohn Hillcrest Urological President, Medical Group ESM & Associates Rebecca Newman James S. Nierman Real Estate Broker Real Estate Investor Gordon W. Parkman Reint Reinders President, President, Parkman Realty Corp. San Diego Convention and Visitors Bureau Winifred Reno Nancy L. Scott Owner, President, The Plantry Capital Equities of La Jolla C. Randolph Strada William Verbeck President, President, First San Diego Co.,Inc. WNV, Inc. Arnold Winston President, BancCorp Companies, Inc. San Diego National Bank Senior Management Committee Murray L. Galinson Robert B. Horsman Chief Executive Officer President Joyce Chewning-Johnson Howard W. Brotman Executive Vice President Senior Vice President, Chief Financial Officer Ronald P. Bird Mark P. Mandell Senior Vice President, Director of Strategic Planning Director of Business Services and Business Development San Diego National Bank Officers Gail Jensen-Bigknife Richard Nance Senior Vice President, Senior Vice President, Real Estate Department Credit Administration Nancy A. Aul Paul A. Fairweather Vice President, Vice President, Commercial Banking Group Commercial Banking Group, Manager Julius J. Kukta Eric W. Larson Vice President, Vice President, Corporate Banking Group Finance Rafael Martinez Pamela A. McMahon Vice President, Vice President, Manager, International Banking Corporate Banking Group John K. McNulty Debra Perkins Vice President, Vice President, Business Development Manager Compliance Connie M. Reckling Roger Remnant Vice President, Vice President Human Resources Real Estate Department Carlos Rivera Dawn Serafin Vice President, Vice President, Lending Manager, Operations South Bay Office Margherita Stutz John G. Weaver Vice President, Vice President, Corporate Banking Group Commercial Banking Group Don R. Wolfe Kristy Gregg Vice President, Assistant Vice President, Corporate Administration Community Relations Manager Kaye Hobson JoAnn Piper Assistant Vice President, Assistant Vice President, Finance Business Services Carol A. States Cynthia Velez Assistant Vice President, Assistant Vice President, Commercial Banking Group Operations Willie Armas Barbara J. Bellini Operations Officer Operations Officer Daryl Durham Linda Eggen EDP Manager Real Estate Administration Officer Susie Mummery Jacqueline M. Murphy Administrative Officer Operations Officer Susan Ohlendorf William D. Scheffel Operations Officer, Corporate Banking Lending Officer Bankcard Services Thomas S. Sperla Mary Beth Wilder Special Assets Manager Financial Analyst SDNB Financial Corp., 1420 Kettner Boulevard, San Diego, CA 92101, (619) 231-4989 SAN DIEGO NATIONAL BANK is a member of FDIC and an Equal Housing Lender EX-22 4 EXHIBIT "22" SUBSIDIARIES OF REGISTRANT 1. San Diego National Bank, a national banking association 2. SDNB Mortgage Bankers, a California corporation 3. San Diego National Bank Building Joint Venture, a California general partnership EX-23.A 5 EXHIBIT "23 (a)" CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by refernce in the registration statement of SDNB Financial Corp. on Form S-8 of our report dated February 5, 1996, on our audits of the financial statements and financial statement schedules of SDNB Financial Corp. as of December 31, 1995 and 1994, and for the years ended December 31, 1995, 1994 and 1993, which report is included (or incorporated by reference) in the Annual Report on Form 10-K. /s/Coopers & Lybrand, L.L.P. San Diego, California March 27, 1996 EX-27 6
9 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 AND IS QUALIFIED IN ITS ENTIRETY BY REFERNCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1995 DEC-31-1995 13,440 2,780 24,700 0 27,033 7,408 7,349 92,331 2,002 178,572 140,409 12,934 554 7,989 0 0 20,314 (3,587) 178,572 10,090 1,749 904 12,743 2,928 3,216 9,527 200 11 10,840 217 217 0 0 212 0.10 0.10 6.16 6,969 93 1,364 0 2,148 655 309 2,002 1,264 0 738
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