-----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, OFkFklTV/3Rbk1GUBV9HaC+zy99ksy7bn5dZ/AtXMIp5grMaaximO9WlsL3okg+e lnRTwFmmbMlJyOfzDGRVSQ== 0001017062-98-000645.txt : 19980331 0001017062-98-000645.hdr.sgml : 19980331 ACCESSION NUMBER: 0001017062-98-000645 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PNB FINANCIAL GROUP CENTRAL INDEX KEY: 0000704693 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 953847640 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: SEC FILE NUMBER: 002-78580 FILM NUMBER: 98577347 BUSINESS ADDRESS: STREET 1: 4665 MACARTHUR COURT CITY: NEWPORT BEACH STATE: CA ZIP: 92660 BUSINESS PHONE: 7148511033 MAIL ADDRESS: STREET 1: 4665 MACARTHUR COURT CITY: NEWPORT BEACH STATE: CA ZIP: 92660 10KSB40 1 FORM 10-KSB405 FISCAL YEAR END 12/31/1997 U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. (FEE REQUIRED) For the fiscal year ended December 31, 1997 ----------------- [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. (NO FEE REQUIRED) For the transition period from to ----------- ------------ Commission file number 2-78580 ----------------- PNB FINANCIAL GROUP (Name of small business issuer in its charter) California 95-3847640 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4665 MacArthur Court, Newport Beach, Ca. 92660 (Address of principal executive offices) (Zip Code) Issuers telephone number, including area code: (714) 851-1033 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No. ----- ----- Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB X ------ Issuer's revenue for its most recent fiscal year ended December 31, 1997 is $33,239,000. The aggregate market value of the voting stock held by nonaffiliates, which excludes shares held by officers, directors, and 10% stockholders of the registrant as of March 30, 1998 was approximately $10.7 million. The approximate average bid and ask price of the Company's stock during March, 1998 which was used to compute the aggregate market value was $25.00 per share. The number of shares of common stock outstanding as of March 30, 1998, was 2,280,680. Transmittal Small Business Disclosure Format (check one): Yes x No ----- ----- ================================================================================ TABLE OF CONTENTS Page(s) ------- PART I Item 1. BUSINESS 3 Item 2. PROPERTIES 30-31 Item 3. LEGAL PROCEEDINGS 31 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 32 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 33 Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 33-38 Item 7. FINANCIAL STATEMENTS 38 Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES 38 PART III Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS 39 Item 10. EXECUTIVE COMPENSATION 39-41 Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 42-43 Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 43 PART IV Item 13. EXHIBITS AND REPORTS ON FORM 8-K 44-45 SIGNATURES 46 PART I Item 1. BUSINESS - ----------------- PNB Financial Group ------------------- PNB Financial Group (the "Bank Holding Company", or, together with Pacific National Bank, the "Company") was organized on June 3, 1982 as a California corporation and is registered as a Bank Holding Company under the federal Bank Holding Company Act of 1956, as amended (the "Act"). The Company commenced business on April 29, 1983 when, pursuant to a reorganization, it acquired all of the voting stock of Pacific National Bank ("PNB" or the "Bank"). At this time, PNB Financial Group's principal business is to serve as a holding company for the Bank. Pacific National Bank --------------------- PNB was organized as a national banking association in 1980. PNB's business consists primarily of attracting deposits from the public and using such deposits, together with capital and other funds, to make loans to individuals and small and medium-size businesses. These loans can be separated into three distinct types: (1) commercial, real estate and consumer loans which the Bank holds for investment, (2) residential mortgage loans which are sold to institutional investors, and (3) Small Business Administration Loans ("SBA") in which the guaranteed portion is generally sold in the secondary market. During 1997, the Bank opened a new mortgage loan production office in Sacramento and closed its commercial loan and depository regional office in the Irvine Spectrum, CA. With these changes, PNB operates three commercial loan and depository regional offices, two full service residential mortgage loan offices and four mortgage loan production offices. With the exception of the four residential mortgage loan production offices, all of the offices are in the Southern California marketplace with deposit taking offices in Newport Beach, Beverly Hills, and Orange, and mortgage division offices in Irvine, and San Diego. The four mortgage loan production offices are located in Phoenix, Flagstaff, and Tucson, Arizona and Sacramento, California. These mortgage loan production offices were responsible for less than 10% of the Bank's 1997 mortgage loan volume. On December 31, 1997 the Bank employed 229 full time equivalent people including 34 commissioned mortgage brokers. The Bank's residential mortgage division accounted for 157 of the employees of the Bank. Several of the Bank's employees also provide services for the Company. PNB's portfolio lending activities are conducted primarily in the Southern California marketplace. As of December 31, 1997, PNB's portfolio loans totaled approximately $117 million of which approximately 39% consisted of commercial loans, 54% in real estate loans and the remainder in consumer loans. In addition, a portion of the Bank's assets are invested in its inventory of mortgage loans held for sale. The balance of the Bank's investable funds are placed in a combination of short and medium-term securities of the United States government and its agencies, mortgage backed securities, and in other short-term money market instruments, including the sale of federal funds to other banks and short term certificates of deposit. The Bank's revenues are derived principally from interest and fees earned on its loan portfolio and other investments, income derived from the origination and sale of residential mortgage loans and the guaranteed portion of SBA loans. Interest on deposits, salaries and commissions, occupancy, and general and administrative costs are the Bank's major expense items. The Bank's marketing efforts for portfolio loans are conducted through the extensive use of personal solicitations by the Bank's officers, directors, and commission sales representatives. All officers and sales representatives are responsible for making regular calls on potential customers to solicit business as well as on existing customers to 3 obtain referrals. Certain officers and commissioned sales representatives use outside brokers who generally earn a commission for services rendered. Through the combined efforts of its employees, officers and directors, the Bank offers its customers the opportunity to deal on an individual basis with professional bankers who have commercial and real estate lending experience, and the resources to promptly serve customers' banking needs. To ensure timely decisions on lending transactions, the Bank's loan committee meets on a regular basis and is available for special meetings where an expedited evaluation of a loan is requested by the customer, and the proposed loan is appropriate for the Bank's expedited review evaluation. In 1992, in order to increase its lending activities to the small business market and increase its fee income, the Bank established an SBA loan department. The SBA department originates loans which are underwritten within guidelines established by the Bank and the U.S. SBA program. Under this program, a portion of the loan is guaranteed by the U.S. Government's agency. The Bank typically sells the guaranteed portion of the loan into the secondary market and earns a premium from the sales. The Bank retains the unguaranteed portion of the loan in its portfolio and continues to service the total loan. As of December 31, 1997, the Bank was servicing approximately $19.9 million of SBA loans for others. The Bank has a preferred lending status with the SBA's Santa Ana, Los Angeles and San Diego District Offices. The preferred lending status gives the Bank designated underwriting from the SBA and has enabled the Bank to offer quicker response time to customer needs. The deposit services offered by the Bank include those traditionally offered by commercial banks, such as checking, savings and time deposits. As of December 31, 1997, approximately 48% of the Bank's deposits were noninterest bearing demand deposits and 26% of the total deposits were interest bearing demand deposits. A portion of the noninterest bearing demand accounts consist of demand accounts maintained by title insurance, escrow and property management companies. It is against California state law to pay interest on these types of accounts. Consistent with banking industry practice, the Bank provides an earnings allowance for these types of accounts and usually provides external services not offered by the Bank to compensate for these deposits. As of December 31, 1997, the Bank maintained approximately $46 million (or 45% of the total noninterest bearing accounts) of noninterest bearing accounts for its title insurance, escrow and property management customers. In order to fund certain short-term cash needs arising from increased activity in the mortgage banking operation, the Bank has utilized a limited amount of short-term brokered deposits. These brokered deposits are utilized as a low cost alternative to traditional financing methods. Management monitors the brokered deposits closely and the board of directors has established limits on the maximum amount of these deposits. The Bank is also in compliance with the comptroller of the currency's regulations regarding the utilization of brokered deposits. As of December 31, 1997, the Bank=s brokered deposits totaled $13.4 million and during 1997, brokered deposits averaged $6.8 million. The Bank opened its residential mortgage loan division in 1986. The Bank=s residential mortgage loan activity is primarily conducted throughout Southern California and Arizona. A small portion of its loan volume is from other areas throughout the United States. The Bank's mortgage loan division operates both wholesale and retail departments. The wholesale department accounts for the majority of the loan volume. The wholesale business is brought to the Bank through a professional commissioned sales staff which services an extensive network of over 500 wholesale mortgage loan brokers. The Bank=s retail sales staff generates mortgage loans through their own efforts in contacting the end consumer. Virtually, all of the mortgage loans the Bank originates are sold to institutional investors. These loans are funded by the Bank and generally delivered to the purchaser within twenty days after funding. The Bank does not maintain the servicing on the loans which it sells. Historically, most of the loans generated by the Bank's residential mortgage division were FHA insured or VA guaranteed loans. During 1996, the Bank expanded its product line to more aggressively market nongovernment guaranteed loans. In 1997 and 1996, 53% and 56% of the mortgage loans originated were FHA insured or VA guaranteed loans. The majority of the mortgage loans which the Bank originates are considered by the market to be "A" rated loans. The Bank also originates a small number of subprime "A minus", "B" and "C" rated loans. For additional information concerning this segment of the Company, please see footnote 10 of the Company's consolidated financial statements on page F-24 of this report. 4 The banking business in Southern California, generally, and in the Bank's primary market area in Orange and Los Angeles Counties, in particular, is highly competitive with respect to both deposits and loans. The area is dominated by a relatively small number of major banks which have many offices operating over a wide geographic area. Many of the major commercial banks operating in the Bank's market area offer certain services which the Bank does not offer. These competitors, which are more highly capitalized than the Bank in terms of absolute dollars, also have higher lending limits. During 1994, several community banks located in the Bank's primary marketing area were taken over by the F.D.I.C. and, subsequently, closed or sold to other banking institutions. During 1995, 1996 and 1997, several other transactions took place where banks, including some of the largest banks and savings and loans in California, were merged or sold. The last four years have seen the number of independent banks in Orange County decrease greatly. From time to time in the ordinary course of business the Company solicits or entertains offers for the sale or merger of the Bank. The Board of Directors entertain such discussions with the goal of maximizing shareholder value. At the present time no such discussions are in process. The Bank competes for deposits primarily on the basis of interest rates paid and the quality of service provided to its customers. The Bank faces strong competition for all types of deposits, including deposits from escrow, title insurance, and property management companies which it has actively marketed. The majority of deposits are placed by depositors in the geographic areas in which the Bank's branches are located. The Bank also uses outside couriers to service depositors not in the geographic area of the Bank's branches. The Bank competes for its portfolio loans principally on the basis of the quality of services it provides borrowers, the types of loans it originates, the underwriting criteria and loan conditions applied and the interest rates and loan fees charged. The Bank believes it attracts customers by offering a higher level of service than that offered by its competition, along with offering loans which can be tailor made for each specific request. The Bank's personnel emphasize highly personalized services and the advantages of dealing with a smaller institution attuned to the particular needs of the borrower. For customers whose loan demands exceed the Bank's lending limit, the Bank may arrange for the funding of such loans on a participation basis with other banks. The Bank also assists customers requiring services not offered by the Bank to obtain these services from its correspondent banks. The mortgage banking business in Southern California is also very competitive. The Bank's mortgage banking competition includes large national mortgage companies which have many offices over the Bank's primary market area, along with local non-bank mortgage companies. These large national mortgage companies also operate wholesale and retail departments along with a correspondent department. The Bank competes with these companies on both a retail and wholesale basis and also sells its loans to the correspondent department of these companies. The loans which are sold to these companies are subject to their underwriting guidelines and pricing which may be different than the underwriting guidelines and pricing which are offered under their own retail and wholesale departments. The large national mortgage companies typically sell their mortgage loans directly to Wall Street investment firms and retain the loan servicing. This, together with their large volume, gives them a competitive advantage over PNB. The excellent service PNB has continued to give, along with the knowledge of the Bank's underwriters and sales staff, encourages the mortgage brokers to send their loans to PNB. This, together with a local presence in the marketplace, gives the Bank an advantage over the large national mortgage company. In addition, the largest advantage the Bank has over most local non-bank mortgage companies, is the Bank's ability to fund loans the same day that the signed loan documents are received. Most non-bank mortgage companies have to use an outside warehousing line which can slow down the funding function. Effect of Governmental Policies and Certain Legislation ------------------------------------------------------- 5 The assets of a commercial banking institution consist largely of interest earning assets, including loans and investment securities. The liabilities of a commercial banking institution consist largely of interest bearing liabilities, including time deposits, money market accounts, and other Bank borrowings. The value and yields of these assets, and the rates paid on these liabilities, are sensitive to changes in prevailing market rates of interest. The earnings and growth of the Company is partially dependent upon its ability to increase the amount and net yield of its interest earning assets, which in turn depends upon growth and the ability of the Company to maintain a favorable differential or "spread" between the yield on interest earning assets and the rate paid on deposits and other interest bearing liabilities. The earnings and growth of the Company are also impacted by the fees and commissions generated by the Bank's mortgage and SBA division. The market place in which these divisions operate are also very sensitive to changes in the prevailing market rates of interest. The earnings and growth of the Company are substantially influenced by general economic conditions, the monetary and fiscal policies of the federal government, and the policies of regulatory agencies, particularly the Federal Reserve Board ("FRB") and the Office of the Comptroller of the Currency ("Comptroller"), the primary regulator of the Bank. The FRB implements national monetary policies by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements, and by varying the discount rate for borrowings by banks which are members of the Federal Reserve System. The Comptroller regulates daily operations of the Bank through an extensive system of regulation, reporting, and accounting. The Comptroller's accounting guidelines and policies are not always the same as generally accepted accounting principles. The actions of the FRB and the Comptroller in these areas influence the growth of Bank loans, investments and deposits and also affect interest rates charged on loans and deposits. The nature and impact of any future changes in monetary, regulatory and accounting policies cannot be predicted. The Bank's SBA department, together with the residential mortgage division utilize federal governmental agencies in providing loans to its customers. On two occasions in November and December, 1995, the U. S. Federal Government was forced to shut down various non-essential agencies due to the Federal budget impasse. During these two occasions, the SBA department and Housing and Urban Development ("HUD") were shut down. A prolonged shutdown of these departments could have a material effect on the Bank's ability to guarantee and/or insure SBA loans and FHA/VA loans. This inability may lead to the Bank limiting or temporarily stopping these lending programs which could have a material effect on the operation of the Bank's SBA department and residential mortgage loan department. During 1996, the budget impasse was resolved, but another budget impasse could occur in the future and may have a material impact on the Bank's operations. The Bank's SBA department is substantially impacted by the policies, guidelines and funding availability established by the U. S. Government's SBA. Periodically, Congress sets the amount of SBA funds available. The level of funding could severely effect the operation of the Bank's SBA department. In 1995 and 1996, the SBA, in an effort to reduce the Federal Government's subsidy of the program, changed a number of its rules several times. Also during this period, legislation was introduced in Congress to abolish the SBA agency. This legislation did not pass, but the Bank's SBA department is subject to operational effects of changes in the SBA, which could have a material impact on revenue generated from the Bank's SBA department. Potential legislation is also being discussed (or has been proposed) which also could affect the business activities of the Company. It is probable that other bills affecting the banking industry will be introduced in the future. Such legislation includes wide-ranging proposals to limit the scope and amount of deposit insurance, to allow the banking industry to sell insurance and other products to customers, to allow banks to pay interest on business demand deposit accounts, consolidation of the regulatory agencies and to move the industry closer to an "interstate banking" system. The extent to which the present or future business of the Company may be affected thereby cannot be predicted. California law currently permits the acquisition of California banks or bank holding companies by out-of-state bank holding companies on a nationwide reciprocal basis. These interstate banking measures could have an impact on 6 the competitive relationships among California financial institutions, since out-of-state institutions, some with relatively large financial and managerial resources, are now able to acquire California banks and thereby engage in a banking business in California. Recently, several southern California banks have been sold to out of state financial institutions. The extent to which these transactions will affect the Company and the banking industry in California cannot be predicted. In August 1989, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") was enacted. This legislation was adopted in order to reform the regulation and supervision of financial institutions and the insurance of deposits of financial institutions. Among the major changes made by this law is a measure requiring the Federal Deposit Insurance Corporation ("FDIC") to assume responsibility for insuring the deposits of financial institutions formerly insured by the Federal Savings and Loan Insurance Corporation. FIRREA establishes two separate insurance funds to be administered by the FDIC. Premiums on deposit insurance will be assessed by the FDIC independently for the Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF"). The FDIC's system charges higher insurance rates to banks that pose greater risks to the deposit insurance funds. The new rules went into effect January 1, 1993 and provide that each institution will be assigned to one of three groups (well capitalized, adequately capitalized, or undercapitalized) based upon its capital ratios. The FDIC will then assign each institution to one of three subgroups based on an evaluation based upon reviews by the institution's primary supervisor, statistical analyses of financial statements and other information relevant to the ongoing risk posed by the institution. The FDIC has the authority to change the deposit insurance premium schedule which it imposes on financial institutions. Due to the overall health of the banking industry and the level of the deposit insurance fund over the last few years, the deposit insurance premium schedule has been lowered to the current rate schedule which ranges from a statutory annual minimum of $2,000 to 27 cents per $100 of deposits depending on the Bank's risk classification. The Bank's FDIC's risk classification is 1A which is considered the lowest risk classification that the FDIC has. An increase in the deposit insurance premium schedule, or a reduction of the Bank's risk classification, would have a material impact on the deposit premiums charged to the Bank. In addition to the deposit insurance premium, effective January 1, 1997, all insured institutions are subject to Financing Corporations (FICO) debt service assessment in accordance with the Deposit Insurance Act of 1996. FICO rates for BIF and SAIF are determined quarterly. During 1997 these rates were approximately 1.2 cents per $100 of deposits for BIF deposits and 6.3 cents per $100 of deposits for SAIF deposits. In 1991, the Bank acquired certain assets and liabilities of the Beverly Hills, California branch of Unity Savings and Loan Association, F.A. Due to this acquisition, some of the deposit base of the Bank is insured under SAIF. In September of 1996, Congress passed legislation to recapitalize the SAIF to 1.25% of total insured deposits. As a result of this legislation, the FDIC levied a one time special assessment to SAIF insured institutions. Accordingly, the Bank paid a one time assessment of $307,000. Due to this special assessment, effective October 1, 1996, the deposit premiums on SAIF insured deposits were adjusted to equal the deposit premiums paid on BIF insured deposits. Management estimates that the reduction in the 1997 and 1998 SAIF insurance premiums will offset the one time special assessment. FIRREA also strengthens the FDIC's regulatory enforcement authority in the following ways: (1) it expands the categories of persons over whom enforcement powers may be exercised; (2) it reduces the threshold for the imposition of civil monetary penalties, including allowing such penalties to be imposed for an inadvertent failure to file a regulatory report in a timely fashion; (3) it substantially increases criminal and civil monetary penalties; (4) it expands available remedies, including "reimbursement" by parties committing a wrong and orders requiring the sale of assets; (5) it enhances provisions for immediate remedies; (6) it expands the FDIC's power to appoint conservators and receivers; and (7) it allows the FDIC to proceed against "commonly controlled insured financial institutions" in the event that the FDIC is required to provide assistance to a troubled financial institution. 7 FIRREA also gives the FDIC authority to approve or require changes in an institution's management in certain circumstances; imposes limitations on certain investment activities and on certain deposit-generating activities; amends the Federal Deposit Insurance Act to permit the acquisition of both healthy and failing savings associations by bank holding companies; and prohibits a bank which does not meet the applicable minimum capital requirements from accepting brokered deposits. In that the Bank now utilizes brokered deposits to, in part, fund lending operations, an adverse change in the FDIC's brokered deposit regulations, or a significant drop in the Bank's capital could have an adverse impact on the liquidity and performance of the Bank. The FDIC Improvement Act of 1991 ("FDICIA") followed on the heels on FIRREA and further served to curb perceived abuses and laxness in the financial institutions marketplace. It established certain safety and soundness guidelines, including accounting reforms, establishing a program for "least cost resolution" when dealing with failing institutions, and other mechanisms to allow prompt corrective action. In addition, FDICIA was enacted to improve certain existing regulations by clarifying or amending a bank's responsibilities and liabilities under the Equal Credit Opportunity Act, Expedited Funds Availability Act, branch closing requirements, Truth In Savings Act and others. A third piece of legislation is the Community Reinvestment Act ("CRA"), which requires banking institutions to address the credit needs of their assessment areas, including low and moderate income areas in which they do business. The Comptroller periodically conducts examinations of banking activities to determine the sufficiency of efforts to meet the credit needs of its assessment area, including low and moderate income neighborhoods, consistent with safe and sound banking practices. FIRREA provisions also require that certain aspects of the Comptroller's CRA performance evaluation be made public. For CRA purposes, PNB qualifies as a Asmall institution,@ which is an independent institution having total assets under $250 million as of either of the prior two calendar year ends or an affiliate of bank holding companies having total banking and thrift assets of less than $1 billion as of either of the prior two calendar year ends. Streamlined evaluation procedures are in place for small institutions. These procedures emphasize CRA performance, reduce unnecessary compliance burden, and permit more effective enforcement against institutions demonstrating poor performance. The Bank's CRA performance will be measured against five performance standards: (1) the reasonableness of its loan to deposit ratio, (2) the percentage of its loans within its assessment area, (3) its record of lending to borrowers of different income levels and businesses and farms of different sizes, (4) the geographic distribution of its loans, and (5) its record of taking action, if warranted, in response to written complaints about its performance in helping to meet credit needs in its assessment area. In 1997, the Bank underwent a CRA examination by the Comptroller and received a "Satisfactory" CRA rating. Insured depository institutions are required by FDICIA to maintain a level of the allowance for possible loan losses that is adequate to absorb "estimated credit losses" associated with the loan portfolio, including all binding commitments to lend. "Estimated credit losses" are defined as an estimate of the current amount of the loan portfolio that is not likely to be collected given the facts and circumstances as of the evaluation date. These estimated credit losses should meet the criteria for accrual of a loss contingency set forth in generally accepted accounting principles as stated in Statement on Financial Accounting Standards No. 5 ("SFAS 5"). The Federal banking agencies' policy regarding the allowance for possible loan losses describes the responsibility of the board of directors and management to maintain the allowance for possible loan losses at an adequate level and prescribes that the allowance for possible loan losses should be no less than the sum of the following items: (1) For loans and classified substandard or doubtful, whether analyzed and provided individually or as part of pools, all estimated credit losses over the remaining effective lives of these loans. (2) For components of the loan portfolio not classified, all estimated credit losses over the upcoming 12 months. (3) Amounts for estimated losses from transfer risk on international loans. 8 The board of directors and management are also responsible to ensure: (1) the institution has an effective loan review system; (2) loans or portions of loans are promptly charged off if determined uncollectible; and (3) the process for determining an adequate level for the allowance for possible loan losses is based on a comprehensive, adequately documented and consistently applied analysis of the loan portfolio. The policy statement describes components of the portfolio which should be reviewed and factors to consider in the estimation of credit losses. Furthermore, the policy statement specifies the steps which will be followed by examiners of the federal banking regulatory agencies in examining the adequacy of the allowance for possible loan losses for individual institutions. These steps include analyzing an institution's policies, practices and historical credit loss experience, and a further check of the reasonableness of Management's methodology by comparing the reported allowance for possible loan losses against the sum of the following amounts: (1) 50 percent of the portfolio that is classified doubtful; (2) 15 percent of the portfolio that is classified substandard; and (3) for the portions of the portfolio that have not been classified (including those loans designated special mention), estimated credit losses over the upcoming twelve months given the facts and circumstances as of the evaluation date (based on the institution's average annual rate of net charge-offs experienced over the previous two or three years on similar loans, adjusted for current conditions and trends). The policy statement cautions that "the amount is neither a 'floor' nor a 'safe harbor' level for an institution's allowance for possible loan losses. However, federal examiners will view a shortfall relative to this amount as indicating a need to more closely review Management's analysis to determine whether it is reasonable and supported by the weight of available evidence, and that all relevant factors have been appropriately considered." Supervision and Regulation -------------------------- PNB Financial Group ------------------- The Company, as a bank holding company, is subject to regulation under the Act. The Bank Holding Company is required to file quarterly and annual reports with the FRB and to provide such additional information as the FRB may require. The FRB also conducts examinations of the Bank Holding Company and any non-bank subsidiaries, if any. The FRB has authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under the Act and regulations adopted by the FRB, a bank holding company and its subsidiaries are prohibited from requiring certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. The FRB also regulates the ability of the bank holding company to establish branches in foreign countries. The Bank Holding Company is required to obtain the prior approval of the FRB for the acquisition of more than 5% of the voting shares or substantially all of the assets of any bank or bank holding company. In addition, the Bank Holding Company is prohibited by the Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging, directly or indirectly, in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Bank Holding Company may, subject to the approval of the FRB, engage in, or acquire shares of companies engaged in any activities which 9 are deemed by the FRB to be so closely related to banking, or managing or controlling banks, as to be a proper incident thereto. The FRB is empowered to differentiate between activities commenced de novo and activities commenced by ------- acquisition, in whole or in part, of a going concern and is prohibited from approving an application by a bank holding company to acquire voting shares of any commercial bank in another state unless such acquisition is specifically authorized by the laws of such other state. Pacific National Bank --------------------- The Bank, as a national banking association, is subject to primary supervision, examination and regulation by the Comptroller. The Bank also is a member of the Federal Reserve System and is subject to applicable provisions of the Federal Reserve Act and regulations issued thereunder. The deposits of the Bank are insured by the FDIC to the maximum extent provided by law. Capital Adequacy ---------------- The Comptroller, the FDIC and the FRB impose risk-based capital requirements on all banking organizations. The risk-based capital guidelines were designed to make regulatory capital requirements more sensitive to the differences in the risk profiles of individual banking organizations. In general, the risk- based capital guidelines provide detailed definitions of which obligations will be treated as capital, and assign different weights to various assets and off-balance sheet items, depending upon the perceived degree of credit risk to which they expose such entities. Each bank is required to maintain a minimum ratio of core capital (Tier 1) and total capital to risk-weighted assets of 4% and 8%, respectively. A bank's risk-based capital ratio is calculated by dividing its qualifying total capital by its risk-weighted assets. A bank's qualifying total capital consists of the sum of two types of capital elements: core capital elements (Tier 1 capital) and supplementary capital elements. Supplementary capital consists primarily of the allowance for loan losses which is limited to 1.25% of total risk-weighted assets. Total risk-weighted assets are ascertained by assigning a bank's balance sheet assets and credit equivalent amounts of off-balance sheet items, such as letters of credit, outstanding loan commitments and interest rate swap agreements to one of four broad risk categories. The risk categories range from 0% for risk-free assets, such as cash and certain U.S. Government securities, to 100% for relatively high-risk assets such as investment loans and investments in fixed assets, premises and other real estate owned. Residential mortgage loans are risk rated 50% if they are not government guaranteed and 20% if they are guaranteed. The aggregate dollar amount of each category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the categories are then added together to determine the total risk-weighted assets. The risk-based capital ratio focuses principally on broad categories of credit risk; however, the ratio does not take into account other factors that can affect a bank or bank holding company's financial condition. Those factors include overall interest rate risk exposure; liquidity, funding and market risks; the quality and level of earnings; investment or loan portfolio concentrations; the quality of loans and investments; the effectiveness of loan and investment policies; and Management's overall ability to monitor and control financial and operating risks. In addition to evaluating capital ratios, an overall assessment of capital adequacy will take into account each of those other factors, including, in particular, the level and severity of problem and adversely classified assets. For this reason, the final supervisory judgement on a bank's capital adequacy may differ significantly from the conclusions that might be drawn solely from the entity's risk-based capital ratio. In light of the foregoing, banks are generally expected to operate above the minimum risk-based capital ratio. The FRB and the Comptroller impose a leverage capital ratio to compliment the risk-based capital guidelines. The leverage capital ratio serves as a backstop to the risk-based capital guidelines, and require every bank holding 10 company, as well as every bank, to maintain a minimum level of equity capital to protect against unforeseen and extraordinary events. In determining compliance with the leverage capital rule, the leverage capital ratio is calculated by dividing Tier 1 capital (as defined earlier) by total adjusted assets. Total adjusted assets are calculated by adding the allowance for possible loan losses to total assets. The minimum leverage ratio for BOPEC 1 bank holding companies and CAMEL 1 banks is 3%. Other bank holding companies and banks will be required to have a minimum leverage ratio of 4% to 5%. The leverage capital rule also provides a general subjective catch-all requirement that financial institutions should hold capital commensurate with the level and nature of all the risks, including the volume and severity of problem loans. At December 31, 1997, the Company's and the Bank's capital ratios were in excess of all minimum capital requirements. The actual capitalization of the Company and the Bank are set forth as follows:
Pacific PNB Regulatory National Financial Requirements Bank Group ------------- --------- ---------- Leverage Capital Ratio 4.0% 8.8% 10.5% Risk Based Capital: Tier I Capital 4.0% 12.3% 14.5% Total Capital 8.0% 13.2% 15.5%
Other Regulations ----------------- Various requirements and restrictions under the laws of the United States affect the operations of the Bank. Federal statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. The Bank also is subject to applicable provisions of California law, insofar as they do not conflict with, or are not preempted by, federal banking law. There has been no effect upon the Bank's capital expenditures, earnings, or competitive position as a result of compliance with federal, state or local provisions regarding the discharge of materials into the environment or the removal of hazardous waste or toxic substances. The Bank is aware of one loan secured by property on which methane gas has been found, but believes that remediation will be accomplished without further cost to the Bank. Distribution of Assets, Liabilities and Shareholders' Equity ------------------------------------------------------------ The following table sets forth the Company's condensed consolidated average balances of each principal category of assets, liabilities and shareholders' equity for each of the past two years. Average balances are based on daily averages for the Bank and monthly averages for the Bank Holding Company, since the Bank Holding Company does not maintain daily average information. In addition, the Bank Holding Company does not calculate the net unrealized loss on investment securities available for sale on a daily basis and, therefore, its average balance is calculated using month end data. Management believes that the difference between monthly and daily average data (where monthly data has been used) is not significant. All dollar amounts are in thousands. 11
PNB Financial Group Average Balance Report Years Ended December 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ---------- Assets ------ Cash and due from banks $ 13,604 $ 11,168 $ 9,620 Interest bearing deposits in other banks -0- 597 -0- Federal funds sold 4,360 9,566 2,286 -------- -------- -------- Total cash and cash equivalents 17,964 21,331 11,906 Securities available for sale 7,177 8,018 14,911 Mortgage loans held for sale 66,307 46,164 21,660 Loans 108,221 99,609 107,713 Allowance for loan losses (1,869) (2,259) (2,674) -------- -------- -------- Net loans 106,352 97,350 105,039 Premises and equipment, net 1,056 1,222 1,485 Other real estate owned 2,685 3,835 2,240 Other assets 2,650 2,109 2,208 -------- -------- -------- Total assets $204,191 $180,029 $159,449 ======== ======== ======== Liabilities and Stockholders' Equity ------------------------------------ Deposits: Noninterest bearing $ 75,992 $ 57,942 $ 51,140 Interest bearing 100,697 101,571 91,976 -------- -------- -------- Total deposits 176,689 159,513 143,116 Short-term borrowings 3,332 723 1,044 Other liabilities 2,667 2,813 1,415 -------- -------- -------- Total liabilities 182,688 163,049 145,575 Stockholders' equity: Capital stock 16,219 16,006 16,130 Retained earnings (deficit) 5,321 1,107 (1,913) Unrealized loss on securities available for sale (37) (131) (343) -------- -------- -------- Total stockholders' equity 21,503 16,980 13,874 -------- -------- -------- Total liabilities and stockholders' equity $204,191 $180,029 $159,449 ======== ======== ========
12 The Company's consolidated earnings are affected by the difference between the income the Company receives from its loan portfolio, investment in mortgage loans held for sale, and securities available for sale and the Company's cost of funds, principally interest paid on deposits and borrowings. Interest rates charged on the Company's loans are affected principally by the demand for such loans, the supply of money available for lending purposes, and competition. In turn, these are influenced by general economic conditions and other factors beyond the Company's control, such as federal economic and tax policies, the general supply of money in the economy, governmental budgetary action, and the actions of the FRB. Information concerning consolidated average interest earning assets along with the average interest rates earned is set forth in the following table. Averages were computed based upon daily balances for the Bank and monthly balances for the Bank Holding Company, and all dollar amounts shown are in thousands.
Years ended December 31, ----------------------------------------------- 1997 1996 ---------- ---------- Average Interest Average Average Interest Average Balance Income Rate Balance Income Rate ---------- --------- ------- --------- --------- ------- Earning Assets - -------------- Total loans (1) (2) $108,221 $10,654 9.8% $ 99,609 $ 9,392 9.4% Mortgage loans held for sale 66,307 5,117 7.7% 46,164 3,623 7.8% Securities available for sale 7,177 422 5.9% 8,018 438 5.5% Federal funds sold 4,360 228 5.2% 9,566 493 5.2% Interest-bearing deposits with banks - - - 597 32 5.4% -------- ------- --- -------- ------- --- Total interest-earning assets $186,065 $16,421 8.8% $163,954 $13,978 8.5% -------- ------- --- -------- ------- ---
Year ended December 31, 1995 ------------------------------------------ Average Interest Average Balance Income Rate --------- -------- --------- Earning Assets - -------------- Total loans (1) (2) $107,713 $10,335 9.6% Mortgage loans held for sale 21,660 1,681 7.8% Securities available for sale 14,911 762 5.1% Federal funds sold 2,286 128 5.6% Interest-bearing deposits with banks - - - -------- ------- --- Total interest-earning assets $146,570 $12,906 8.8% -------- ------- ---
13 (1) Net loan fees, which are deferred and amortized over the life of the loan, are included in interest earned on loans. Total loan fees included in interest income was $337,000, $292,000 and $189,000 for the years ended December 31, 1997,1996 and 1995, respectively. (2) Average loan balances includes average loans on nonaccrual status of $2,144,000, $6,333,000 and $7,592,000 in 1997, 1996 and 1995, respectively, and are recorded net of average unearned income of $537,000, $505,000 and $287,000 as of December 31, 1997, 1996 and 1995, respectively. Without nonaccrual loans, the average rate on loans would be 10.0%, 10.1% and 10.3% for the years ended December 31, 1997, 1996 and 1995, respectively. Information concerning consolidated average interest bearing liabilities, along with the average interest rates paid, is set forth in the following table. Averages were computed based upon daily balances for the Bank and monthly balances for the Bank Holding Company, and all dollar amounts are in thousands.
Years ended December 31, -------------------------------------------------- 1997 1996 ---------- ---------- Average Interest Average Average Interest Average Balance Expense Rate Balance Expense Rate ---------- ---------- ----------- ---------- ---------- ----------- Deposits and Borrowed Money - --------------------------- Interest bearing demand deposits $ 52,804 $1,458 2.8% $ 54,126 $1,416 2.6% Time deposits 36,393 1,901 5.2% 42,725 2,293 5.4% Savings deposits 4,741 114 2.4% 4,720 116 2.5% Brokered deposits 6,759 379 5.6% - - - Short-term borrowings 3,331 192 5.8% 723 63 8.7% -------- ------ --- -------- ------ --- Total interest-bearing liabilities $104,026 $4,044 3.9% $102,294 $3,888 3.8% ======== ====== === ======== ====== ===
Year ended December 31, 1995 ---------------------------------------------- Average Interest Average Balance Expense Rate ---------- ---------- ----------- Deposits and Borrowed Money - --------------------------- Interest bearing demand deposits $49,241 $1,266 2.6% Time deposits 37,023 1,935 5.2% Savings deposits 5,711 154 2.7% Brokered deposits - - - Short-term borrowings 1,044 49 4.7% ------- ------ --- Total interest-bearing liabilities $93,019 $3,404 3.7% ======= ====== ===
14 Net interest earnings (in thousands) and net yield on average earning assets are shown in the table below:
Years ended December 31, --------------------------------- 1997 1996 1995 --------- --------- --------- Total interest income (1) $ 16,421 $ 13,978 $ 12,906 Total interest expense 4,044 3,888 3,404 -------- -------- -------- Net Interest Earnings $ 12,377 $ 10,090 $ 9,502 ======== ======== ======== Average earning assets (2) $186,065 $163,954 $146,570 Net yield on average earning assets (3) 6.7% 6.2% 6.5%
(1) Net loan fees, which are deferred and amortized over the life of the loan, are included in interest earned on loans. (2) Average earning assets include average loans on nonaccrual status of $2,144,000, $6,333,000 and $7,593,000 in 1997, 1996 and 1995, respectively, and are recorded net of average unearned income of $537,000, $505,000 and $287,000 as of December 31, 1997, 1996 and 1995, respectively. (3) Without average nonaccrual loans, net yield on average earning assets would be 6.7%, 6.4% and 6.8% for the years ended December 31, 1997, 1996 and 1995, respectively. The Bank purchases external services on behalf of certain banking customers in consideration of their noninterest bearing accounts. These external services are limited to what a larger bank with the ability to provide in-house services, such as courier, bookkeeping and payroll accounting services could provide. In these larger banks, these costs could be reflected as increased payroll, rent and other administrative costs. At PNB, these costs are reflected as other deposit expense. The effects of these arrangements in relationship to the approximate average deposit balances are presented below. All dollar amounts are in thousands.
Years ended December 31, ------------------------------------------- 1997 1996 ---------- ---------- Average Deposit Average Average Deposit Average Balance Expense Rate Balance Expense Rate ------- ------- ------- ------- ------- ------- Approximate noninterest bearing accounts for which external services are provided $38,000 $1,424 3.7% $25,000 $1,039 4.2% ======= ====== === ======= ====== ===
Year ended December 31, 1995 ------------------------------- Average Deposit Average Balance Expense Rate ------- ------- ------- Approximate noninterest bearing accounts for which external services are provided $20,000 $944 4.7% ======= ==== ===
The effects of these arrangements together with the average interest-bearing liabilities and average interest rates paid from page 14 of this report are presented below. All dollar amounts are in thousands. 15
Years ended December 31, ---------------------------------------------------------------------------------- 1997 1996 ---------- ---------- Average Deposit Average Average Deposit Average Balance Expense Rate Balance Expense Rate ---------- ---------- ----------- ---------- ---------- ----------- Noninterest bearing accounts for which external services are provided and interest bearing liabilities $142,026 $5,468 3.8% $127,294 $4,927 3.9% ======== ====== === ======== ====== ===
Year ended December 31, 1995 -------------------------------------- Average Deposit Average Balance Expense Rate ---------- ---------- --------- Non interest bearing accounts for which external services are provided and interest bearing liabilities $113,019 $4,348 3.8% ======== ====== ===
The effects of these arrangements on net interest earnings and net yield on average earning assets are shown in the table below. All dollar amounts are in thousands.
Years ended December 31, -------------------------------- 1997 1996 1995 -------- --------- --------- Net interest earnings $ 12,377 $ 10,090 $ 9,502 Other deposit expense 1,424 1,039 944 -------- -------- -------- Net interest earnings after other deposit expense $ 10,953 $ 9,051 $ 8,558 ======== ======== ======== Average earning assets $186,065 $163,954 $146,570 Net yield on average earning assets after other deposit expense 5.9% 5.5% 5.8%
The Company's rate and volume analysis for the interest bearing assets and interest bearing liabilities for 1997 as compared to 1996, as well as 1996 compared to 1995, and 1995 compared to 1994, is summarized in the tables set forth below. The total change is separated into the change attributable to variations in volume and the change attributable to variations in interest rates. For purposes of this table, changes which are not due solely to volume or interest rate changes have been allocated evenly among changes attributable to variations in volume and rate. Nonaccrual loans are included in average loans. Other deposit expense is not included in this analysis. 16
Change in Net Interest Income in 1997 from 1996 ----------------------------------------------- (In Thousands) Volume Rate Total ------------- ------------- ------------- Interest income: Loans $ 797 $273 $1,070 Mortgage loans held for sale 1,568 (74) 1,494 Securities available for sale (48) 32 (16) Deposits in other banks (32) - (32) Federal funds sold (270) 6 (264) ------ ---- ------ Total 2,015 237 2,252 Change in loan fees 191 - 191 ------ ---- ------ Total change in interest and loan fee income $2,206 $237 $2,443 ====== ==== ====== Interest expense: Interest bearing demand deposits $ (36) $ 78 $ 42 Time deposits (includes brokered deposits) 23 (36) (13) Savings deposits - (1) (1) Short-term borrowings 191 (63) 128 ------ ---- ------ Total change in interest expense $ 178 $(22) $ 156 ====== ==== ====== Change in net interest and loan fee income $2,028 $259 $2,287 ====== ==== ====== Change in Net Interest Income in 1996 from 1995 ----------------------------------------------- (In Thousands) Volume Rate Total ------------- ------------- ------------- Interest income: Loans $ (752) $(294) $(1,046) Mortgage loans held for sale 1,912 30 1942 Securities available for sale (364) 40 (324) Deposits in other banks 32 0 32 Federal funds sold 391 (26) 365 ------ ----- ------- Total 1,219 (250) 969 Change in loan fees 103 - 103 ------ ----- ------- Total change in interest and loan fee income $1,322 $(250) $ 1,072 ====== ===== ======= Interest expense: Interest bearing demand deposits $ 127 $ 23 $ 150 Time deposits 301 56 357 Savings deposits (25) (12) (37) Short-term borrowings (22) 36 14 ------ ----- ------- Total change in interest expense $ 381 $ 103 $ 484 ====== ===== ======= Change in net interest and loan fee income $ 941 $(353) $ 588 ====== ===== =======
17
Change in Net Interest Income in 1995 from 1994 ----------------------------------------------- (In Thousands) Volume Rate Total ------------- ------------- ------------- Interest income: Loans $ 421 $1,165 $1,586 Mortgage loans held for sale 647 (36) 611 Securities available for sale (522) 54 (468) Deposits in other banks (20) (20) (40) Federal funds sold (270) 97 (173) ----- ------ ------ Total 256 1,260 1,516 Change in loan fees (7) - (7) ----- ------ ------ Total change in interest and loan fee income $ 249 $1,260 $1,509 ===== ====== ====== Interest expense: Interest bearing demand deposits $ (43) $ 114 $ 71 Time deposits 157 493 650 Savings deposits (13) (2) (15) Short-term borrowings 30 16 46 ----- ------ ------ Total change in interest expense $ 131 $ 621 $ 752 ===== ====== ====== Change in net interest and loan fee income $ 118 $ 639 $ 757 ===== ====== ======
Securities Available for Sale ----------------------------- As required by SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" all investments in equity securities that have readily determinable fair values and all investments in debt securities are carried at fair value unless they meet the criteria to be classified as held to maturity. Securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. All equity securities are classified as available for sale. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available for sale are carried at fair value. Unrealized gains or losses net of any income tax effect, for securities available for sale is excluded from earnings and reported as a net amount in a separate component of stockholders' equity. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. The Company has classified all of its securities as available for sale and on December 31, 1997, 1996 and 1995, has recorded $9,000, $(63,000) and ($84,000), respectively as unrealized gains (losses), net of income tax effect, as a separate component of stockholders' equity. The Company has no securities classified as held to maturity or trading. The Bank has an equity investment in the Federal Home Loan Bank which was required to acquire membership in this institution. The Bank sought membership into this institution to obtain favorable financing arrangements which the Federal Home Loan Bank offers. In 1997, the Bank Holding Company invested in a private Real Estate Investment Trust (the "REIT"). The shares of stock which the Bank Holding Company owns were issued as a private placement and, as of December 31,1997, there was no established market for this investment. As such, the equity securities in the REIT are not reportable under SFAS 115 and are reported in the other assets section of the Company's Consolidated Financial Statements. For more information regarding the REIT investment, please see footnote 4 of the Company's Consolidated Financial Statements on page F-15 of this report. 18 The book value of securities available for sale as of December 31, 1997, 1996 and 1995 are shown in the table below.
1997 1996 1995 ----------- ----------- ----------- U. S. Treasury securities $1,014,000 $1,185,000 $ 4,734,000 U. S. Government agencies securities 2,034,000 2,096,000 2,221,000 Mortgage backed securities 2,577,000 2,930,000 3,331,000 Federal Reserve Bank stock 340,000 340,000 340,000 Federal Home Loan Bank stock 945,000 830,000 -0- ---------- ---------- ----------- $6,910,000 $7,381,000 $10,626,000 ========== ========== ===========
The maturity distribution for securities available for sale, as well as the weighted average yield for each range of maturity at December 31, 1997, is as follows. Actual maturities may differ from contractual maturities in mortgage backed securities because mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary. All dollar amounts are in thousands.
Weighted Average Fair Value Yield ---------- -------- U.S. Government Securities -------------------------- Maturities one year or less $1,014 4.76% Maturities over one year through five years - - U.S. Government Agency Securities --------------------------------- Maturities one year or less - - Maturities over one year through five years 2,034 6.45% Mortgage backed securities 2,577 6.00% Federal Reserve Board stock 340 6.00% Federal Home Loan Bank stock 945 6.23%
Mortgage Banking and Mortgage Loans Held for Sale ------------------------------------------------- Although all risks associated with mortgage banking cannot be easily summarized, the following are some of the risks involved. One risk associated with mortgage banking is the liability associated with representations and warranties made to purchasers and insurers of the mortgage loans. Under certain circumstances, the Bank may become liable for the unpaid principal and interest if there has been a breach of representation or warranties. One of the representations the Bank makes with respect to the mortgage loans sold is that the mortgage loan does not contain any fraudulent information. Such fraud generally relates to false or materially inaccurate information on the borrower or on the underlying collateral which was provided to the Bank by the borrower or broker presenting the loan to the Bank. During the life of the loan, if the investor finds that there was fraud in the loan package, the Bank may be required to either repurchase the loan or indemnify the investor against any losses incurred from the loan. In addition, some mortgage loans are sold with a recourse provision. The Bank has different recourse provisions with each separate investor. Generally, loans sold under the recourse provision are required to be repurchased by the Bank if the loan becomes delinquent within a range of two to six months of funding, depending upon the investor. The Bank has the choice to not purchase the loan, but to indemnify the investor for any and all costs and losses associated with the investor's collection of the loan. The Bank may become liable for the unpaid and uninsured portion of the principal and delinquent interest on mortgage loans either repurchased or indemnified. 19 After October 1, 1996, the majority of the mortgage loans sold were to investors who did not have a recourse provision tied to loan delinquency. This significantly reduced the number of delinquent loans which the Bank indemnified during 1997. The Bank limits these risks by using Certified Direct Endorsement Underwriters, thereby assuring itself of having qualified personnel with the necessary underwriting skills. The Bank also performs prefunding audits of randomly and specifically selected loans by the Bank's quality control department. The quality control department also performs post funding audits of randomly and specifically selected loans to ensure that its credit quality is being adhered to. The risks associated with the recourse provisions are further reduced as a majority of the loans originated by the Bank have FHA insurance or VA guarantees which reduce the potential losses, if any. The risks associated with nongovernment loans are reduced due to stricter underwriting guidelines and generally lower loan to value requirements. In addition, some of the nongovernment loans also are required to have mortgage insurance. If the Bank incurs a loss, the Bank generally has recourse and attempts to recover the loss from the broker who provided the loan to the Bank. In many cases, the broker does not have the financial capacity or the willingness to reimburse the Bank for the loss. In these cases, the only course of action open to the Bank may be to stop conducting any further business with that particular broker. Management is continually assessing its risks associated with both representations and warranties and the recourse provisions on mortgage loans sold and has created a reserve for the estimated future losses. Management believes that this risk has been adequately reserved in the Company's financial statements. The following is a summary of transactions affecting this reserve for the years ending December 31, 1997, 1996 and 1995.
1997 1996 1995 --------- ---------- --------- Beginning balance $ 461,000 $ 232,000 $ 246,000 Provision for losses 276,000 1,080,000 385,000 Amounts charged to reserve, net of recoveries (355,000) (851,000) (399,000) --------- ---------- --------- Ending balance $ 382,000 $ 461,000 $ 232,000 ========= ========== =========
The following table indicates the obligations which have been incurred in connection with representations and warranties and the recourse provision for the years ending December 31, 1997, 1996 and 1995. All dollar amounts, except for the number of loans, are in thousands.
1997 1996 1995 ---------- --------- --------- Total mortgage loans sold $1,094,000 $794,000 $337,000 Number of loans repurchased/indemnified 48 94 26 Dollar volume of loans repurchased/indemnified $ 5,657 $ 11,038 $ 3,163
Another risk which the Bank has in regard to its mortgage lending operation is the refund of servicing premiums which were earned in connection with the sale of the mortgage loan, if the mortgage loan is paid off within a short period of time after sale. The period of time that the Bank is responsible for the refund of the servicing premium is different with each investor and ranges from 0 to 90 days after the investor's purchase of the loan. The Bank minimizes its risk of refinancing by limiting the amount of broker rebate and enhancing its underwriting policies to discourage loans which appear to be frequently refinanced. Mortgage loans held for sale are reported at the lower of cost or market. A portion of mortgage loans held for sale are not funded until the Bank obtains a purchase commitment from a third party. The risk specifically associated with this portion of mortgage loans held for sale is that the Bank will fail to deliver the loans to the purchaser by the commitment date. Policies and procedures are in place to insure that all mortgage loans held for sale are shipped 20 to the purchaser within the required time frames. The total amount of mortgage loans which had purchase commitments at December 31, 1997, 1996 and 1995 was $59,644,000, $38,690,000 and $23,898,000, respectively. The portion of mortgage loans held for sale that are not allocated to an existing purchase commitment, and unfunded rate-locked loans, create interest rate exposure. The Bank monitors this exposure daily and limits the potential exposure by the purchase of mandatory forward commitments to sell whole loans. Management estimates the amount of unfunded rate-locked loans that will actually fund and purchases mandatory forward commitments based upon this estimate and based upon the general interest rate environment. Management does not speculate on interest rate movement and uses mandatory forward commitments purely as a hedge against interest rate swings which could effect the value of its unfunded pipeline of rate-locked loans and unallocated loans held for sale. The estimates which management uses can differ from actual loan fundings and, therefore, interest rate risk does exist. Management believes that it is minimizing this risk by employing experienced personnel who are following conservative secondary marketing policies. The Bank also reduces interest rate exposure by limiting customer rate commitments to varying periods of less than sixty days. Loans in process for which interest rates were committed to the mortgage broker/borrower totaled $30,465,000, $27,174,000 and $17,266,000 as of December 31, 1997, 1996 and 1995. At December 31, 1997, 1996 and 1995, the Bank had $56,000,000, $43,000,000 and $34,000,000, respectively, of mandatory forward commitments to sell whole loans relating to their unfunded pipeline of rate-locked loans and unallocated funded loans held for sale. Gains and losses on mandatory forward commitments are realized in the period settlement occurs. Unrealized gains and losses on forward commitments are included in the analysis of lower of cost or market valuation for mortgage loans held for sale. At December 31, 1997, 1996 and 1995, the unrealized (loss) gain on the Bank mandatory forward commitments was ($286,000), $270,000 and ($200,000), respectively. Loan Portfolio -------------- Although all risks relating to lending cannot be easily summarized, certain loan risks are inherent in certain types of loans. Risks associated with commercial loans include the competency of the Management of the borrower, the industry in which the borrower is operating, the economy and the strength of the product or service rendered. Risks associated with installment loans include the strength of the income stream of the borrower and the value of the collateral. Real estate construction loan risks include building activity, marketing abilities, financing conditions, the economy, and the supply and demand of the product in the specific area being developed. To minimize the risks associated with its investment lending, the board has established certain maximum loan-to-value ratios on real estate dependent loans and certain maximum accounts receivable or inventory advance rates on commercial business loans. The Bank's loan policy includes certain owner occupied and non owner occupied commercial construction loans. The maximum loan-to-value ratio on owner occupied and non owner occupied commercial construction loans is 75% and 70% respectively, and on affordable single family residential construction loans is 70%. The loan-to-value requirements on all construction loans are periodically reviewed to assure conservative ratios based upon current economic conditions. Commercial loans based upon accounts receivable or inventory are generally limited to borrowings of a maximum of 80% of the asset base. In many situations, the Bank further limits its risks on commercial loans by securing real estate and other assets as additional collateral. The Bank monitors the cash flow and financial condition of a commercial borrower by obtaining and reviewing the financial statements of the borrower on a monthly, quarterly or annual basis. Construction loans are reviewed by Management as to the status of the loan, as well as the construction project which serves as its collateral, on at least a monthly basis. This frequent review allows Management to monitor for unforeseen circumstances or events. By undertaking this supervision, the risks inherent in construction loans remain under constant review by Management. A portion of the Bank's real estate loan portfolio consists of non-owner 21 occupied real estate mortgage loans. The Bank monitors the properties cash flow and the financial condition of the borrower as extensively as the documentation of each loan allows and are visited as frequently as necessary. The Bank's loan portfolio is analyzed and reviewed regularly by the Audit Committee of the Bank. The quantitative review includes analysis of delinquent loans, nonaccrual loans, classified loans, loans held for sale, concentrations, trends in portfolio volume, off balance sheet items, historical loan loss experiences, and the economy. All loans are internally graded and all classified loans are carefully reviewed on a loan-by-loan basis. The Audit Committee also relies on an annual review by the Comptroller and a regular monthly loan review by an outside third party. This third party loan review audits certain loans based upon guidelines set by the Audit Committee, and reports its findings directly to the Audit Committee. In 1997, the Bank opened an Accounts Receivables Factoring Department. Factoring is a form of accounts receivable financing in which the Bank purchases the customer's invoices. This form of financing is more dependent upon the paying ability of the customer's debtors than the Bank's typical asset based borrowers. Consequently, field audits are required prior to funding and periodically during the duration of the contract. The product is priced by discounting the amount paid for each invoice to achieve a targeted yield. In addition, to reduce the risk, an additional discount is set aside as a reserve account to cover charge backs of purchased invoices. The reserve is established by the Bank's underwriting criteria and generally ranges from 15% to 50% of purchased invoices. The Company's loans are summarized in the following table according to loan types. Loans have been recorded net of loan purchase discounts of $551,000, $598,000, $729,000, $995,000 and $1,269,000, and unearned income of $551,000, $347,000, $251,000, $297,000 and $149,000 as of December 31, 1997, 1996, 1995, 1994 and 1993, respectively. Such purchase discounts will be amortized to income over the life of the loans, which range from one to twenty years as of December 31, 1997. The Company has no foreign loans. All dollar amounts are in thousands. During 1996, certain loans were reclassified from commercial loans to real estate loans as management determined that they had more characteristics of a real estate loan than a commercial loan. The Company has no foreign loans. All dollar amounts are in thousands.
Years ended December 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- Commercial loans $ 46,218 $ 38,666 $ 55,291 $ 57,741 $ 48,840 Real estate loans 48,892 43,556 26,984 26,050 29,177 Construction loans 15,996 14,301 12,001 10,345 18,326 Consumer loans 7,078 7,703 9,461 10,790 12,920 -------- -------- -------- -------- -------- Total Loans 118,184 104,226 103,737 104,926 109,263 Allowance for possible loan losses (1,558) (1,812) (2,659) (2,727) (3,473) -------- -------- -------- -------- -------- Net loans $116,626 $102,414 $101,078 $102,199 $105,790 ======== ======== ======== ======== ========
Maturities and Sensitivities of Loans to Changes in Interest Rates ------------------------------------------------------------------ A significant portion of the commercial loan portfolio normally does not actually payoff when the loans mature. There are several factors which cause actual repayments to differ from scheduled maturities. On a commercial loan, the Company typically will establish an annual maturity date. This enables the Company to monitor the borrower's financial condition and past performance along with their compliance with any loan conditions. If the Company determines that the loan still meets its underwriting criteria, the loan may be renewed. Often times the loan will not be renewed but will be restructured so that the loan is still within the Company's underwriting guidelines. Under either of these circumstances, the commercial loan is renewed, not repaid. Before renewing a loan, the Company has the opportunity to adjust or change the interest rate charged on the loan. Therefore, in regards to the sensitivity of loans to interest rates, the maturities are important. 22 Delays in the construction or marketing period might cause a construction loan not to be paid off upon maturity. The borrower may need additional time to complete the project and an extension is approved provided no other defaults have occurred. As with commercial loans, if a construction loan is renewed or extended, the Company may change the interest rate charged and/or charge additional loan fees. Scheduled maturities of all investment loans outstanding at December 31, 1997 are summarized in the table set forth below. As discussed above, the Company does not expect a majority of the commercial loans to be repaid upon maturity. As of December 31, 1997, a majority of the Company's construction loan portfolio is scheduled to mature in one year or less. The Company does not keep records as to the actual amount repaid upon maturity. Information regarding the loan maturities within the individual loan classifications presented above is not available. All dollar amounts are in thousands
Total Loans ----------- In one year or less $ 44,876 After one year but less than five 34,453 Over 5 years 38,855 -------- Total loans $118,184 ========
On a floating interest rate loan, the Company may impose a minimum floor and/or maximum ceiling interest rate which the floating rate cannot be either reduced below or above. In doing this, the Company limits its exposure to large decreases in interest rates but also risks not receiving as much interest as possible if interest rates were to increase significantly in a short time period. Loans which have these floors or ceilings are reported as floating interest rate loans below. The total amount of loans as of December 31, 1997 due after one year, categorized as to those loans which have predetermined interest rates and those which have floating interest rates are summarized in the table set forth below. Information regarding the fixed interest rate versus variable interest rate by loan classifications presented above is not available. All dollar amounts are in thousands. Loan balances due after one year which have:
Total Loans ----------- Fixed interest rates $19,347 Floating interest rates 53,961 ------- Total Loans $73,308 =======
Interest Rate Sensitivity Analysis ---------------------------------- Management attempts to match the maturities of rate sensitive assets and rate sensitive liabilities to the extent believed necessary to minimize interest rate risk. Management monitors rates and maturities of rate sensitive assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities which mitigate the Bank's overall interest rate risk. The Company's interest rate sensitivity is measured by dividing the Company's rate sensitive assets by its rate sensitive liabilities. The interest rate sensitivity ratio ("GAP") indicates what effect a change in interest rate would have on the net interest margin of a financial institution. Generally, in a positive GAP environment an increase in interest rates would increase the net interest margin while a decrease in interest rates would have a negative impact on the net interest margin. The following table sets forth the Company's interest rate sensitivity analysis as of December 31, 1997. All dollar amounts are in thousands. 23
Greater Less than 3 - 12 1 - 5 than 3 Months Months Years 5 years Total -------- ------- ------- ------- -------- Rate Sensitive Assets: Loans (1) $ 72,312 $14,461 $16,395 $13,779 $116,947 Interest rate swap (2) (20,000) - 20,000 - - Mortgage loans held for sale 96,852 - - - 96,852 Investment securities (3) 1,360 1,243 4,291 - 6,894 Federal funds sold - - - - - -------- ------- ------- ------- -------- Total Rate Sensitive Assets $150,524 $15,704 $40,686 $13,779 $220,693 Rate Sensitive Liabilities: Time deposits $ 33,821 $13,647 $ 2,895 $ 123 $ 50,486 Interest bearing demand deposits 54,906 - - - 54,906 Savings deposits 4,355 - - - 4,355 Other demand deposits (4) 35,798 - - - 35,798 Borrowings on line of credit 5,000 - - - 5,000 -------- ------- ------- ------- -------- Total Rate Sensitive Liabilities 133,880 13,647 2,895 123 150,545 Cumulative GAP $ 16,644 $18,701 $56,492 $70,148 ======== ======= ======= ======= Cumulative Rate Sensitive Assets as a Percentage of Rate Sensitive Liabilities 1.12 1.13 1.38 1.47 ======== ======= ======= =======
(1) Loans do not include nonaccrual loans of $1,237,000 as of December 31, 1997. (2) The Bank has entered into an interest rate swap agreement with a total notional principal amount of $20 million. Management entered into the agreement to reduce the impact of a decrease in interest rates on its balance sheet. The agreement effectively transfers variable rate assets to fixed rate assets. The agreement provides for the Bank to pay a variable rate of prime on the notional amount with the counterpart paying a fixed rate. The agreement terminates in April 2000. (3) Securities are recorded at their amortized cost and mortgage back securities are included at their estimated repayment dates. (4) These deposits consist of the rate sensitive portion of the noninterest bearing demand deposits of escrow and title companies. A portion of these deposits are considered to be rate sensitive because the Bank provides them with an earnings allowance which fluctuates with an interest rate index. As the gap analysis demonstrates, the Company is in a positive one year gap position. The Company's one year gap ratio at December 31, 1997, was 1.13% and is within the acceptable range of 1.25% as determined by the Company's asset/liability policy. While the gap analysis is a useful asset/liability management tool, it does not fully assess interest rate risk. Gap analysis does not address the effects of customer options (such as early withdrawal of time deposits and options to prepay loans) and Company strategies, (such as delaying increases in interest rates paid on interest-bearing deposit accounts) on the Company=s net interest income. Therefore, a gap analysis is only one tool with which to analyze interest rate risk and must be reviewed in conjunction with other asset/liability management reports. Nonperforming Loans ------------------- The Company's current policy is generally to cease accruing interest and to charge-off all accrued and unpaid interest on loans which are past due as to principal and/or interest for 90 days, or at an earlier time as Management determines timely 24 collection of interest to be in doubt. As a result of placing loans on nonaccrual status, the Company did not accrue interest of approximately $126,000, $343,000 and $650,000 during 1997, 1996 and 1995, respectively, which would have been earned had such loans been performing throughout the year. On certain nonaccrual loans deemed by Management to be fully collectible, accrued interest is not charged-off. Additionally, loans which are 90 days or more past due may continue accruing interest if they are, in the opinion of Management and the Bank's Audit Committee, both well secured and in the process of collection. As of December 31, 1997, $78,000 of loans classified past due 90 days or more consists of FHA insured mortgage loans which have been repurchased and, in the opinion of Management, have no principal or interest loss exposure. Certain loans which are performing to their contractual obligation may be recorded as a nonaccrual loan. In some of these cases, the full amount of the payment received is used to reduce the principal balance of the loan and no interest income is recorded. These loans are recorded as such because in the opinion of Management and the Bank's audit committee or the opinion of the Comptroller, there are serious doubts as to the ability of the borrower to continue to comply with the present loan repayment terms. The interest income not recognized and applied to principal is only recognized when the loan is fully repaid. At December 31, 1997, the Bank had 12 loans totaling $248,000 which are being accounted for in this manner. Additionally, some loans which are performing to their contractual obligations may be carried as a nonaccrual loan, but interest income is being recognized on a cash received basis. In these cases, the loan is not accruing interest, but when a payment is received, the payment is being applied to principal and interest income as if the loan was on accrual status. During the year ended December 31, 1997, the Company has no loans which were being accounted for in this manner. The following table sets forth the total amount of nonperforming loans and the percentage of nonperforming loans to total loans for December 31, 1997, 1996, 1995, 1994 and 1993, respectively. All dollar amounts are in thousands.
1997 1996 --------------------- -------------------- Percent of Percent of Total Total Amount Loans Amount Loans ------- ---------- ------ ---------- Performing loans accounted for on a nonaccrual basis $ 248 .2% $ 878 .8% Nonperforming loans accounted for on a nonaccrual basis 989 .9% 2,342 2.3% Accruing loans contractually past due 90 days or more 160 .1% 277 .3% ------ --- ------ --- Total $1,397 1.2% $3,497 9.7% ====== === ====== === Loans not included above which are "troubled debt restructuring" as defined in SFAS 15 $4,100 3.5% $4,100 4.0% 1995 1994 --------------------- ---------------------- Percent of Percent of Amount Total Loans Amount Total Loans ------- ----------- ------ ----------- Performing loans accounted for on a nonaccrual basis $ 3,684 3.6% $1,502 1.4% Nonperforming loans accounted for on a nonaccrual basis 5,983 5.7% 1,634 1.6% Accruing loans contractually past due 90 days or more 382 .4% 826 .8% ------- --- ------ --- Total $10,049 9.7% $3,962 3.8% ======= === ====== === Loans not included above which are "troubled debt restructuring" as defined in SFAS 15 - - - -
25
1993 -------------------- Percent of Total Amount Loans ------- ---------- Performing loans accounted for on a nonaccrual basis $ - - Nonperforming loans accounted for on a nonaccrual basis 9,005 8.2% Accruing loans contractually past due 90 days or more 4,826 4.4% ------- ---- Total $13,831 12.6% ======= ==== Loans not included above which are "troubled debt restructuring" as defined in SFAS 15 - -
As of December 31, 1997, the Company had no loans in a current status where there were serious doubts as to the ability of the borrower to comply with the present loan repayment terms. Yet, due to the risks inherent in the Company's loan portfolio, Management recognizes that loans now current may become doubtful as to repayment. Other Real Estate Owned ----------------------- The Company's policy is to acquire real estate in settlement of loans when all other repayment alternatives have been exhausted and when the Company can reasonably estimate that it can recover all or a portion of its original loan. The Company's policy is to evaluate the potential recovery based upon the fair market value of the property less estimated selling costs and any senior encumbrances which might be attached to the property. The Company's other real estate owned ("OREO") is carried at its fair market value less estimated selling costs. As of December 31, 1997, 1996 and 1995, all of the Company's OREO was acquired in settlement of real estate or construction loans. The following table sets forth the type of property which is included in other real estate owned as of December 31, 1997, 1996 and 1995. All amounts are in thousands.
Type of Real Estate 1997 1996 1995 - ------------------------------ ----- ------- ------ Single family residence $ 309 $1,535 $ - Commercial and Industrial - 1,258 283 Condominium 102 626 254 Land 64 64 405 Apartment building - - 395 ----- ------ ------ Total $ 476 $3,483 $1,337 ===== ====== ======
Summary of Loan Loss Experience ------------------------------- The Company maintains an allowance for loan losses, which is reduced by loan charge-offs and increased by loan recoveries and the provision for loan losses which are charged to operating expense. The level of the allowance for loan losses is continually evaluated and is based upon the Company's loan loss experience (using a migration analysis), performance of loans in the Company's portfolio, evaluation of collateral for such loans, cash flows or net worth of the respective borrowers or guarantors, prevailing economic conditions, and such other factors as, in Management's judgment, deserve current recognition in the estimation of loan losses. The Bank maintains a program which ensures that the Bank maintains an adequate allowance. The Bank's program is consistent with Banking Circular #201 (revised) dated February 20, 1992. In general, this methodology is referred to as a migration analysis. A migration analysis uses historical loan loss experience within pools of similar loans to determine the allowance necessary for each loan pool. The Bank began using this methodology for the year ended December 31, 1992 and has continued to use it on a quarterly basis since such date. 26 As required by SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", as amended by SFAS No. 118, impaired loans subject to the statement are required to be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Company had $1,237,000 of impaired loans as of December 31, 1997, of which the majority were collateral dependent. The total allowance for loan losses relating to $99,000 of impaired loans was $ 50,000 on December 31, 1997. Impaired loans for which there is no specific allowance for loan losses at December 31, 1997, is $1,138,000. The following table summarizes loan balances and changes in the allowance for loan losses arising from loan charge-offs and recoveries as of the dates and for the periods indicated. All dollar amounts are in thousands.
1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Balance of allowance for loan losses at beginning of period $ 1,812 $ 2,659 $ 2,727 $ 3,473 $ 2,131 Loans changed off: Commercial 1,178 340 616 800 391 Consumer 24 20 32 39 80 Real Estate 399 1,695 1,097 1,350 1,927 -------- -------- -------- -------- -------- Total loans charged-off $ 1,601 $ 2,055 $ 1,745 $ 2,189 $ 2,398 Recoveries of loans previously charged-off: Commercial 270 257 62 347 185 Consumer 12 5 10 38 10 Real Estate 195 43 102 146 145 -------- -------- -------- -------- -------- Total loan recoveries 477 305 174 531 340 -------- -------- -------- -------- -------- Net loans charged off 1,124 1,750 1,571 1,658 2,058 Provision charged to operating expense 870 903 1,503 912 3,400 -------- -------- -------- -------- -------- Balance of allowance for loan losses at end of period $ 1,558 $ 1,812 $ 2,659 $ 2,727 $ 3,473 ======== ======== ======== ======== ======== Amount of loans outstanding at end of period $118,184 $104,226 $103,737 $104,926 $109,263 Average amount of loans outstanding during the year $108,221 $ 99,609 $107,713 $102,964 $114,627 Ratio of net charge-offs during the period to average loans outstanding during the period 1.04% 1.76% 1.46% 1.61% 1.80% ======== ======== ======== ======== ========
Allocation of Allowance for Loan Losses - --------------------------------------- In determining the level and adequacy of the allowance for loan losses, the Bank utilizes a migration analysis as recommended by the Comptroller. Due to the small size of its portfolio, the Bank Holding Company determines its allowance on a loan by loan basis. At December 31, 1997, the allowance for loan losses was approximately $1,026,000 in excess of the amounts computed using the migration analysis discussed above. This excess was determined necessary because certain historical loss percentages as indicated in the migration analysis were considered to be below the minimum amount that management believes is necessary to establish an adequate allowance for loan losses. The following tables set forth the loan pools the Company utilizes and its respective 27 allowance established for December 31, 1997, 1996, 1995, 1994 and 1993, respectively. All dollar amounts are in thousands.
December 31, 1997 December 31, 1996 ------------------------ ------------------------ Percent of Percent of Percent of Percent of Loans to Allowance Allowance Loans to Allowance Allowance Total Loans Amount to Loans Total Loans Amount to Loans ------------ --------- ----------- ------------ --------- ----------- Classified loans - ---------------- Construction loans 1.7% $ 159 7.9% .9% $ 58 5.9% First trust deed loans 2.3% 229 8.6% 2.6% 274 10.3% Real estate commercial borrowers .3% 56 13.8% .9% 237 26.7% Guaranteed mortgage loans - - - .7% 55 7.9% All other loans .3% 67 19.6% .8% 125 14.6% ---- ------ ---- ---- ------ ---- Total classified loans 4.6% $ 511 9.4% 5.8% $ 749 12.3% ---- ------ ---- ---- ------ ---- Nonclassified loans - ------------------- Construction loans 10.9% $ - - 10.7% $ - -% First trust deed loans 35.8% - - 39.4% 232 .6% All other loans 48.7% 21 - 44.1% 32 - Unallocated reserve - 1,026 N/A - 799 N/A ---- ------ ---- ---- ------ ---- Total nonclassified loans 95.4% 1,047 .9% 94.2% 1,063 1.1% ---- ------ ---- ---- ------ ---- Total 100% $1,558 1.3% 100% $1,812 1.7% ==== ====== ==== ==== ====== ==== December 31, 1995 December 31, 1994 ------------------------ ------------------------ Percent of Percent of Percent of Percent of Loans to Allowance Allowance Loans to Allowance Allowance Total Loans Amount to Loans Total Loans Amount to Loans ------------ --------- ----------- ------------ --------- ----------- Classified loans - ---------------- Construction loans 4.2% $ 608 14.0% 2.3% $ 407 16.9% First trust deed loans 7.1% 887 12.0% 8.9% 876 9.4% Real estate commercial borrowers 2.8% 538 18.6% 2.1% 234 10.8% Guaranteed mortgage loans - - - 1.1% 46 3.8% All other loans 1.4% 139 9.3% 3.7% 442 11.4% ---- ------ ---- ---- ------ ---- Total classified loans 15.6% $2,172 13.5% 18.1% $2,005 10.6% ---- ------ ---- ---- ------ ---- Nonclassified loans - ------------------- Construction loans 8.7% $ - - 11.3% $ 100 .8% First trust deed loans 16.0% 91 .6% 16.0% 35 - All other loans 59.6% 396 .7% 54.6% 536 .9% Unallocated reserve - - - - 51 N/A ---- ------ ---- ---- ------ ---- Total nonclassified loans 84.4% 487 .6% 81.9% 671 .8% ---- ------ ---- ---- ------ ---- Total 100% $2,659 2.6% 100% $2,727 2.6% ==== ====== ==== ==== ====== ====
28
December 31, 1993 --------------------- Percent of Percent of Loans to Allowance Allowance Total Loans Amount to Loans ------------ --------- ----------- Classified loans - ---------------- Construction loans 7.9% $ 188 2.2% First trust deed loans 9.1% 1,101 11.0% Real estate commercial borrowers 1.8% 477 24.7% Guaranteed mortgage loans 3.5% 46 1.2% All other loans 4.2% 934 20.4% ---- ------ ---- Total classified loans 26.5% $2,746 9.5% ---- ------ ---- Nonclassified loans - ------------------- Construction loans 12.1% $ 230 1.7% First trust deed loans 16.9% 5 - All other loans 44.5% 492 1.0% Unallocated reserve - - N/A ---- ------ ---- Total nonclassified loans 73.5% 727 .9% ---- ------ ---- Total 100% $3,473 3.2% ==== ====== ====
Deposits - -------- As a well capitalized Bank, as defined by the FDIC, the Bank can obtain brokered deposits without any restriction by the regulators. The Bank utilizes brokered deposits to help fund its mortgage loans held for sale. Management monitors its use of brokered deposits very closely and the board of directors of the Bank has placed limits on the use of brokered deposits. Due to the lower cost, management anticipates the utilization of brokered deposits when necessary to fund its mortgage loans held for sale. The average amounts of deposits and the average rates paid thereon for the periods indicated are summarized below. The Bank does not have any significant foreign deposits. All dollar amounts are in thousands.
December 31, 1997 December 31, 1996 December 31, 1995 ------------------- ------------------- ------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate -------- -------- -------- -------- -------- -------- Noninterest-bearing demand deposits $ 75,992 0% $ 57,942 0% $ 51,140 0% Interest-bearing demand deposits 52,804 2.8% 54,126 2.6% 49,241 2.6% Savings deposits 4,741 2.4% 4,750 2.5% 5,711 2.7% TCD's of $100,000 or more 21,784 5.1% 20,708 5.3% 18,269 5.5% Other time deposits 14,609 5.3% 22.017 5.4% 18,754 5.0% Broker deposits 6,759 5.6% - - - - -------- --- -------- --- -------- --- Total $176,689 $159,513 $143,115 ======== ======== ========
29 The following table shows the maturity schedule of time certificate of deposits of $100,000 or more at December 31, 1997. All of the Bank's brokered deposits, as of December 31, 1997, have a maturity date of three months or less. Three months or less $27,852 Over 3 through 6 months 3,554 Over 6 through 12 months 4,473 Over 12 months 308 ------- Total $36,187 =======
Return on Equity and Assets - --------------------------- The following table sets forth certain consolidated financial ratios relative to the Company's consolidated financial performance for the periods indicated:
Years ended December 31, 1997 1996 1995 ------- ------- ------- Net interest spread on average assets 6.1% 5.6% 6.0% Return on average assets 2.5% 2.0% 1.3% Return on average equity 23.3% 20.9% 14.7% Dividend payout rate None None None Average equity on average assets 10.5% 9.4% 8.7%
Short-Term Borrowings - --------------------- From time to time during the year ended December 31, 1997, the Bank borrowed on its short-term borrowing facilities. These borrowings, together with the Bank's brokered deposits were used to fund the Bank's mortgage loans held for sale which could not be fully funded by the Bank's deposits. These back up sources of liquidity include $8.5 million of unsecured lines with other banks, a line of credit with the Federal Home Loan Bank (See Note 5 of the Company's Consolidated Financial Statements on page F-17 of this report), and borrowings against the Bank's securities available for sale. The primary source of borrowed funds was the Bank's credit line with the Federal Home Loan Bank of San Francisco. As a member of this federally assisted government agency, the Bank has secured a line of credit collateralized by certain portfolio loans of the Bank. As the mortgage loans held for sale are generally presold to institutional investors via the mandatory forward commitments, the risk to the Bank that the Bank cannot repay these short term borrowings by the ultimate sale of the mortgage loans is minimal. The Company had no category of short-term borrowings of which the average balance for the year was greater than 30% of consolidated shareholders' equity at December 31, 1997, 1996 or 1995. Item 2. PROPERTIES - ------------------ As of December 31, 1997 the Bank leases nine properties. The properties are used as administrative offices, branch offices, and mortgage banking offices. Other than real estate acquired through foreclosed loans, neither the Bank Holding Company nor the Bank owns any real property. All of the leased premises are suitable for their intended use. In the opinion of Management, all of the leased properties are adequately insured. The Bank Holding Company does not lease any property. The following table sets forth certain information with respect to leases of the Bank. 30
Lease 1997 1997 ---------- -------- -------------- Location Square Expiration Rental Effective - -------- ------ ---------- -------- -------------- Branch Offices Feet Date Expense Lease Rate (8) - -------------- ------ ---------- -------- -------------- 4665 MacArthur Court, Newport Beach (1) 17,130 12/31/00 $421,000 $1.85 8501 Wilshire Boulevard, Beverly Hills (2) 4,040 04/30/01 88,000 1.95 1045 West Katella Boulevard, Orange (3) 7,465 02/28/99 138,000 1.45 Mortgage Banking - ---------------- 41 Corporate Park, Irvine (4) 22,186 07/31/02 285,000 1.32 6390 Greenwich Drive, Suite 240, San Diego 2,531 09/30/99 40,000 1.30 Mortgage Loan Production Offices - -------------------------------- 4041 North Central Ave., Phoenix, AZ (5) 2,556 04/01/00 27,000 1.00 5546 E. 4th Street, Suite 112, Tucson AZ 273 06/30/98 2,300 1.41 405 No. Beaver Street, #1, Flagstaff, AZ (6) 250 02/25/98 3,540 1.18 3550 Watt Ave., #140, Sacramento, CA (7) 200 06/30/98 0 2.02
(1) During 1997, the Bank subleased approximately 2,700 square feet of these premises on a month to month basis and received rental income from the sublease of $35,000. This sublease ended on 10/31/97. Senior Management, financial services department, loan administration, the Bank's SBA department, and its construction loan department occupy approximately 7,000 square feet of the Newport Beach location. (2) The lease expires on 4/30/01, but the Bank has the right to cancel the lease for a small cancellation charge, on or after March 1, 1999 with six months notification to the landlord. (3) Approximately 2,000 square feet of this location is utilized for the Bank's data processing center. (4) On July 31, 1997, the Bank entered into a new lease agreement whereby the Bank increased its rentable square footage and extended its current lease to 7/31/02. The Bank's effective lease rate during the lease term is $1.43 per square foot. (5) The Bank subleases this space. The expiration of the sublessor's master lease expires 4/1/00. The Bank's sublease terminates on 4/1/00, but the Bank has the right to cancel the lease with a four month notification to the sublessor. (6) The Bank has subleased one third portion of a CPA's office. The approximately square footage is indicated. After the initial lease term, the lease term converts to month-to-month. (7) This lease consists of one office within an executive office suite. Other services, such as phone and receptionist, are included in the rental fee. This lease went into effect on January 1, 1998. (8) Calculated as monthly charge per actual square foot over the life of the lease, except for 41 Corporate Park, Irvine, which, due to a lease extension in July 1997, is calculated as an average paid during 1997. Item 3. LEGAL PROCEEDINGS - -------------------------- There are no material pending legal proceedings to which the Company is a party or to which any of their respective properties are subject, other than ordinary routine litigation incidental to the Company's business. 31 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - --------------------------------------------------- During the Bank Holding Company's Annual Meeting of Shareholders on November 20, 1997, the shareholders voted on three matters. They elected all of the nominees of the board of directors, approved the appointment of McGladrey & Pullen, LLP as the Company's independent public auditors for 1997, and increased the aggregate number of shares of common stock available for grant under the Corporation's 1995 Incentive Stock Option Plan from 200,000 to 250,000 shares. The following schedule sets forth the number of votes cast for, against, and withheld, as well as the number of abstentions and broker non-votes, including a separate tabulation with respect to each nominee for office.
Votes Broker For Withheld Abstain Non-Votes --------- -------- ------- --------- Election of Directors: - ---------------------- Allen C. Barbieri 1,182,700 0 0 287,449 Martin T. Hart 1,182,700 0 0 287,449 G. Mitchell Morris 1,180,445 2,255 0 287,449 Jon A. Salquist 1,182,700 0 0 287,449 Bernard E. Schneider 1,182,700 0 0 287,449 Appointment of Independent Public - --------------------------------- Auditors - -------- McGladrey & Pullen, LLP 1,179,700 0 3,000 287,449 Increase in Shares of Common 1,174,100 4,990 3,610 287,449 - ---------------------------- Stock Available Under 1995 - -------------------------- Incentive Stock Option Plan - ---------------------------
32 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------------- The Bank Holding Company's common stock is traded on the NASDAQ Bulletin Board market under the symbol of PNBF. The Bank Holding Company is aware of three security dealers who seek to handle trades in its stock: Mitchell Securities Corporation of Portland, Oregon, Sutro and Company of San Francisco, California, and Hoefer & Arnett of San Francisco, California. The number of shareholders of record as of January 1, 1998 was approximately 338. The following table shows the range of bid quotations for each quarter within the last two fiscal years from Mitchell Securities Corporation. Such over-the- counter quotations are to the best knowledge of Management and reflect interdealer prices, without retail mark up, mark down or commissions, and may not necessarily represent actual transactions. The Bank Holding Company has not historically paid dividends on any of its shares. However, management periodically reviews the possibility of paying dividends and may decide to pay dividends in the future.
High Low Fourth Quarter, 1997 $19.75 $16.50 Third Quarter, 1997 16.50 14.50 Second Quarter, 1997 14.50 11.50 First Quarter, 1997 11.50 11.50 Fourth Quarter, 1996 $11.50 $11.00 Third Quarter, 1996 7.50 6.50 Second Quarter, 1996 7.00 6.00 First Quarter, 1996 6.00 5.00
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATION ------------ CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS This annual report contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, which represent the Company's expectations or beliefs including, but not limited to, statements regarding the growth of the Company, the future profitability of the Company and the sufficiency of the Company's liquidity and capital. For this purpose, any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "intend," "estimate" or "continue" or the negative or other variations thereof or comparable terminology are intended to identify forward- looking statements. These statements by their nature involve substantial risks and uncertainties, including those described below. SUMMARY - ------- The Company's diluted earnings per common and common equivalent share was $2.13 in 1997, a 36% increase over its diluted earnings per common and common equivalent shares of $1.57 in 1996. The Company's return on average assets was 2.5% in 1997 compared to 2.0% in 1996, and its return on average stockholder's equity was 23.3% in 1997 compared to 20.9% in 1996. Due to net operating loss carryforwards and the elimination of its valuation allowance on deferred tax assets, the Company's income tax expense was less than the tax at the statutory rates in 1996. On a fully taxed basis, the Company's return on average assets would have been 1.5% for 1996 and its return on average equity would have been 15.6%. RESULTS OF OPERATIONS - --------------------- The Company reported a record net profit of $5,020,000 in 1997 compared to a net profit of $3,556,000 in 1996. The 1997 net income is the highest earnings the Company has reported since its inception in 1982. The increase in net income was due to an increase in the Bank's net interest margin, along with an increase in income from the Bank's residential 33 mortgage division. The increase in net interest income in 1997 compared to 1996 was a result of an increase in total assets along with a decrease in nonperforming assets. The Company reduced its nonperforming assets from $6.7 million, or 3.4% of total assets at December 31, 1996, to $1.7 million, or .7% of total assets at December 31, 1997. The Bank's residential mortgage division contributed $4,319,000 to pretax profit during 1997 compared to a pretax profit of $2,725,000 during 1996. The increase in profit of this division was a result of increased lending activity and a significant reduction of problem loan indemnification expense. During 1997, the Bank funded 8,552 mortgage loans totaling $1.13 billion compared to 1996 during which the Bank funded 6,528 mortgage loans totaling $815 million. During the year ended December 31, 1997, the Company had total average assets of $204.2 million, total average portfolio loans of $108.2 million and total average deposits of $176.7 million compared to total average assets of $180.0 million, total average portfolio loans of $99.6 million and total average deposits of $159.5 million during the year ended December 31, 1996. The increase in average assets primarily occurred within the mortgage loans held for sale and portfolio loan products. In 1997, the average balance of mortgage loans held for sale increased 44% and the average balance of portfolio loans increased 9% over 1996 levels. The increase in average deposits in 1997 compared to 1996 is primarily due to an increase in noninterest bearing demand deposits. A portion of this increase was due to an increased level of deposits from the Bank's escrow customers. The increases in loans and deposits were the result of continued marketing efforts and a strong economy in Southern California. NET INTEREST INCOME - ------------------- Although fee generating activity such as the Bank's mortgage division and the Bank's SBA division are an integral part of the Company's revenue, the Company's primary source of revenue is its net interest income. Net interest income before the provision for loan losses totaled $12,377,000 in 1997 compared to $10,090,000 in 1996. The increase of net interest income of $2,287,000 (23%), in 1997 compared to 1996 was primarily due to an increase in the Company's interest income which was partially offset by an increase in the Company's interest expense. The increase of interest income was primarily due to an increase in the average balance of mortgage loans held for sale and portfolio loans. During 1997, the balance of mortgage loans held for sale averaged $66.3 million compared to an average of $46.2 million in 1996. In addition, the balance of portfolio loans average $108.2 million in 1997 compared to an average of $99.6 million in 1996. The average yield on total interest bearing assets was 8.8% in 1997 compared to 8.5% in 1996, an increase of 30 basis points. The primary reasons for the increase in average yield was a increase in the average interest rates earned on portfolio loans from 9.4% in 1996, to 9.8% in 1997. The primary reason for this increase is the reduction of nonperforming loans in 1997 as compared to 1996. The average cost of interest bearing liabilities was 3.9% in 1997 compared to 3.8% in 1996, an increase of 10 basis points. This increase was primarily attributed to the increase in the volume of short term borrowings and brokered deposits. These higher costing liabilities were used to partially fund the growth of the Bank's assets. As a result of its normal operations, the Company assumes the risk that general interest rate levels will change. Management regularly monitors this risk, but substantial change in the interest rate environment could have an impact on the Company's net interest income and profitability. A significant portion of the Company's portfolio loans are based on a variable interest rate tied to prime. The Company mitigates the risk of a decrease in interest income due to a lower prime rate by entering into an interest rate swap agreement totaling $20 million. The agreement effectively transfers $20 million of variable rate assets tied to prime for assets with a fixed rate of 8.49% through April 1998 and 9.10% from April 1998 to April 2000. The rate the Company earns on its mortgage loans held for sale is not based on prime, but rather on the prevailing mortgage loan interest rates. During the last three months of 1997, fixed rate mortgage interest rates decreased to approximately 7.0% This reduction increased the volume of mortgage loan refinancings but reduced the interest earned on the Company's inventory of mortgage loans held for sale. Future changes in the prevailing residential mortgage rate environment can effect the volume and the interest earnings of the Bank's mortgage loans held for sale. 34 PROVISIONS FOR LOAN LOSSES -------------------------- The Company's provision for loan losses was $870,000 in 1997 compared to $903,000 in 1996. This resulted in an allowance of $1,558,000 at December 31, 1997 compared to $1,812,000 at December 31, 1996. The decrease in the allowance for loan losses was a result of, among other factors, a significant decrease in the classified and nonaccrual loans as of December 31, 1997. Nonaccrual loans were $1.2 million on December 31, 1997, compared to $3.2 million on December 31, 1996. Classified loans decreased 15% during 1997 from $6.1 million to $5.4 million. These decreases, along with a nominal historical loss percentage on the Company's nonclassified loans during the past three years and a strong Southern California economy have been the most significant reason for the reduction in the allowance for loan loss. The allowance for loan loss is a result of Management's analysis of the estimated inherent losses in the Company's loan portfolio. This analysis takes into consideration the level and trend of loan losses, loan delinquencies, classified loan levels and Management analysis of current economic conditions. As an integral part of its examination process, the Comptroller reviews the Bank's allowance. The Comptroller may require the Bank to recognize additions to the allowance based upon judgments different from those of Management. Management believes that the allowance at December 31, 1997 is adequate to absorb the inherent risks in the Company's loan portfolio. The table below provides more specific data relative to the Company's allowance and nonperforming assets. All dollar amounts are in thousands.
December 31, 1997 December 31, 1996 Allowance for possible loan losses $1,558 $1,812 Loans past due 90 days or more and accruing 160 277 Nonaccrual loans 1,237 3,220 Classified loans 5,433 6,087 Troubled debt restructuring 4,102 4,108 Other real estate owned 476 3,483 Allowance for possible loan losses as a percent of: Total loans 1.3% 1.7% Nonaccruing loans 125.9% 56.3% Classified loans 28.7% 29.8% Nonperforming loans and real estate owned as a percent of total assets: .7% 3.4%
OTHER INCOME ------------ Residential mortgage loan processing fees, premiums earned on the sale of residential mortgage loans held for sale and SBA loans, and service charges and other fees charged to Bank customers continue to be the primary components of other income. Mortgage division gross income was $15.1 million in 1997, an increase of 36% from the 1996 gross income of $11.1 million. The increase in the mortgage division's gross revenue was a direct result of an increase in the volume of mortgage loans originated and sold. The increased volume is a result of the division's continued reputation for quality service and competitive pricing, along with a continual effort to increase its market share within its current market and expand into new marketing areas. In addition, the strong economic environment in Southern California, and the lower interest rate environment added to a strong home buyer's market in 1997. Purchase money loans dominated the Bank's mortgage loan volume in 1996 and 1997. These loans are less volatile to changes in mortgage loan interest rates than refinancing mortgage loans, but are more dependent on a good economy. With the reduction of fixed mortgage interest rates in the fourth quarter of 1997 the Bank experienced an increase in the volume of loan refinancings. As the volume of mortgage loan refinancings increase 35 more mortgage companies enter the industry. This creates more competition along with increased demand for knowledgeable mortgage loan employees. If the low interest rate environment continues, management anticipates an increase in the volume of mortgage loan refinancings and increases in salaries and wages. When the low interest rate environment changes, the competition becomes fierce, pricing margins tend to tighten significantly, and the loan volume tends to decrease. These changes could have a significant impact on the profitability of this department. During 1997, the Bank's SBA department had gain on the sale of SBA loans of $638,000 compared to $463,000 in 1996. Including interest income on SBA loans held in portfolio and loan servicing income on SBA loans sold, the Bank's SBA department contributed $937,000 to pretax profit compared to a contribution of $649,000 in 1996. The increase in gross revenue in this department is due to an increase in SBA loan activity which is due to management's efforts to grow this department of the Bank. The Bank has a Preferred Lender status with the Santa Ana, Los Angeles, and San Diego Counties' SBA District Offices. These SBA offices cover all loans within Orange, Los Angeles, San Bernardino, Riverside, Ventura, Santa Barbara and San Diego counties. This status has enabled the Bank to give quicker loan approval and better customer service. From time to time, the government changes its SBA policies, guidelines, and funding availability. These changes could have a material impact on the Bank's ability to continue to generate a profit from this department. OTHER EXPENSES -------------- Total other expenses were $19,744,000 in 1997, compared to other expenses of $17,513,000 in 1996. Outside of the mortgage division, the Company's other expenses increased $35,000 while the Bank's residential mortgage division's expenses increased $2,196,000. The increase in the mortgage division expenses is a direct result of the large increase in the loan activity of the department. The increase in mortgage division expenses is primarily due to an increase in salaries and benefits, commissions, occupancy and other direct costs associated with the origination and sale of mortgage loans. These increases were partially offset with a decrease of problem loan indemnification expenses. This expense, which relates to the Bank's liability associated with representations, warranties and certain recourse provisions tied to loan delinquencies made to purchasers and insurers of mortgage loans was $276,000 in 1997 compared to $1,080,000 in 1996. This reduction was due in part to the elimination of certain delinquency recourse provisions in the purchase contracts of several mortgage loan purchasers. These more favorable contract provisions took effect in the fourth quarter of 1996. Aside from the mortgage division expenses, increases in the Company's salaries and other deposit expenses were offset with reductions in insurance, occupancy and legal expenses. The increase in salaries was primarily due to an employee performance bonus plan that was based on a combination of the increase in net income of the Company along with the reduction of nonperforming assets. The increase in other deposit expense is a result of the increase of noninterest bearing demand deposits for which the Bank provides an earnings allowance and purchases external services on behalf of these customers. The decrease in insurance was the result of lower SAIF deposit insurance premiums in 1997 as a result of a one time special assessment of $307,000 to recapitalize the SAIF fund in 1996. The decrease in occupancy costs was partially a result of the full depreciation of the Bank's data processing equipment along with a reduction of telephone costs. PROVISION FOR INCOME TAXES -------------------------- The Company recognized a provision for income tax of $3,561,000 during 1997 compared to a provision for income taxes of $945,000 in 1996. The 1997 provision for income tax represents a full income tax provision of 42% of pretax income. During 1997, management eliminated the valuation allowance on deferred tax assets as they believe that it was more likely than not that the Company's deferred tax assets will be realized in the future. This elimination of the valuation allowance lowered the Company's 1997 effective tax rate on the statement of income from 42% to 21%. The Company expects to record a full income tax provision of 42% of the pretax income in 1998. 36 LIQUIDITY --------- Liquidity as it relates to banking, represents the ability to obtain funds to meet loan requirements and to satisfy demand for deposit withdrawal. The principal source of funds that provide liquidity to the Bank are cash balances, federal funds sold, securities available for sale and a portion of mortgage loans held for sale. The Bank's portfolio loan-to-deposit ratio (excluding brokered deposit) at December 31, 1997 was 59.0% as compared to 60.0% at December 31, 1996. The Bank's total nonbrokered deposits increased $27.7 million (16.2%) from December 31, 1996 to December 31, 1997. A large portion of the Bank's deposits consist of deposits maintained by escrow companies and, to a lesser degree, title insurance companies. At December 31, 1997, escrow and title insurance companies' deposits totaled $45.4 million or 22.9% of total nonbrokered deposits. This compared to escrow and title insurance deposits of approximately $28.2 million or 16.6% of total deposits at December 31, 1996. The Bank's policy is to maintain these deposits at a level not to exceed 25% of total deposits. The Bank monitors the deposit levels of this group closely. The Bank's residential mortgage division utilizes the Bank's funding sources to fund its mortgage loans held for sale. During 1997, the average time between funding and sale of a mortgage loan was 22 days. Management can slow down or speed up the shipping and sale of these loans, and manages the balance of the mortgage loans held for sale to match its funds available. In this way, management maximizes the yield on its liquid assets. In 1997, mortgage loans held for sale earned 7.7%, while federal funds sold earned 5.2%. Due to fluctuations in funding and sale of mortgage loans, along with changes in the deposit balances of the Bank, the matching of liquid assets and mortgage loans held for sale is not always achieved. At certain times during 1996, and throughout 1997, the Bank utilized its back up borrowing relationships, along with brokered deposits, to help fund the mortgage loans held for sale. These back up sources include unsecured lines of credit with other banks, a line of credit with the Federal Home Loan Bank and borrowings against the Bank's securities available for sale. During 1997 the average balance of short term borrowing and brokered deposits was $3.3 million and $6.8 million, respectively. Liquidity as its relates to the Bank Holding Company represents the ability to obtain funds to support investment activities and operating needs. The Bank Holding Company's principal sources of funds are its cash balances and loan portfolio, as well as its ability to raise capital by selling additional shares of common stock. Another common source of liquidity to a bank holding company is cash dividends from its subsidiary bank. During 1997 the Bank paid a $2.0 million cash dividend to the Bank Holding Company. This dividend, along with the principal payments of its loan portfolio, helped the Bank Holding Company fund a $2.5 million investment in Alta Residential Mortgage, Inc. ("Alta"). Alta is a newly formed real estate investment trust which will focus on the investment in and management of residential mortgage loans. CAPITAL RESOURCES ----------------- The capital adequacy of a financial institution is generally measured by relating the amount of capital to total assets. Risk-based capital guidelines require that each bank holding company and bank maintain a minimum ratio of core capital and total capital to risk-weighted assets of 4% and 8%, respectively. Leverage capital guidelines serve as a backstop to the risk- based capital rules, and require every bank holding company, as well as every bank, to maintain a minimum level of equity to adjusted assets. During 1997, the Company's strong earnings out paced the Company's growth in assets and, therefore, its capital ratios increased. The Bank's earnings, after the dividend to the Bank Holding Company, were proportional to the growth of the Bank's assets and, therefore, its capital ratios remained relatively stable. At December 31, 1997 and 1996, the Company's and the Bank's capital ratios were well in excess of all the minimum required levels. The federally mandated minimum capital requirements and the actual capitalization of the Company and the Bank are set forth below. 37
1997 1996 ---------------------- ---------------------- Pacific PNB Pacific PNB National Financial National Financial Regulatory Requirement Bank Group Bank Group ----------------------- --------- ---------- --------- ---------- Leverage Capital Ratio 4.0% 8.8% 10.5% 8.8% 10.0% Risk Based Capital Tier I Capital 4.0% 12.3% 14.5% 12.0% 13.7% Total Capital 8.0% 13.2% 15.5% 13.3% 14.9%
YEAR 2000 COMPUTER COMPLIANCE ----------------------------- The Bank has conducted a comprehensive review of its computer systems to identify the systems that could be affected by the "Year 2000" issue and is developing an implementation plan to resolve the issue. The Year 2000 issue is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any of the Bank's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. The Bank presently believes that, with modifications to existing software and converting to new software, the Year 2000 problem will not pose significant operational problems for the Bank's computer systems as so modified and converted. However, if such modifications and conversions are not completed timely, the Year 2000 may have a material impact on the operations of the Bank. In addition, management does not expect the modifications to existing software or new software which is purchased to have a material impact on future earnings. Item 7. FINANCIAL STATEMENTS ---------------------------- The financial statements of the Company are included in a separate section of this annual report beginning on page F-1, following signature page 46. Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ----------------------------------------------------------------------- FINANCIAL DISCLOSURES --------------------- None 38 PART III Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS - --------------------------------------------------------------------- As of December 31, 1997, the board of directors of the Company consists of five (5) members, all of whose terms expire at the next annual meeting of shareholders. Executive officers of the Company serve at the pleasure of the board of directors. The following table sets forth certain information concerning the directors and executive officers of the Company.
Position in PNB Served Financial Group Since Age ----------------------- ------ --- Allen C. Barbieri Director/President/CEO 1994 39 Martin T. Hart Director 1990 62 Doug L. Heller Chief Financial Officer 1990 40 G. Mitchell Morris Director 1997 77 Jon A. Salquist Director 1996 53 Bernard E. Schneider Director/Chairman 1991 52
A brief summary of the background and business experience of each of the above persons during the past five years is set forth below. Allen C. Barbieri has been the President and Chief Executive Officer of the ----------------- Bank since 1994, and is currently the President and Chief Executive Officer of the Company. Mr. Barbieri has worked in the banking industry since 1986. He received a Masters Degree in Business/Finance from the Massachusetts Institute of Technology. Martin T. Hart is an active private investor. He serves on the board of -------------- directors of private and publicly held companies, including Mass Mutual Corporate Investors, Inc., Mass Mutual Participation Investors, PJ America, Schuler Homes, Inc., Optical Securities Group, Inc., Ardent Software Inc., and T-Netix Communications. Mr. Hart is a graduate of Regis College. Doug L. Heller has been the Executive Vice President and Chief Financial -------------- Officer of the Bank, and Chief Financial Officer of the Company since 1990. Mr. Heller graduated from the University of Colorado Business School and earned his certified public accountant license in 1983. G. Mitchell Morris is retired and a private investor. Mr. Morris is a ------------------ graduate of the University of Pennsylvania. Jon A. Salquist is an active private investor. He holds a Masters Degree --------------- from Stanford University. Bernard E. Schneider is a partner and an attorney with the international law -------------------- firm of McDermott, Will and Emery. Mr. Schneider has served as Chairman of the Board of the Company since 1996 and the Bank since 1993. Mr. Schneider graduated from Whittier College and received his Juris Doctor from the University of Southern California. Item 10. EXECUTIVE COMPENSATION - -------------------------------- The total compensation paid or accrued by the Company and the Company's subsidiaries for the years ended December 31, 1997, 1996 and 1995, to the Company's Chief Executive Officer ("CEO") and the four most highly compensated executive officers ("Named Executive Officers") are presented below in the summary compensation table. 39 SUMMARY COMPENSATION TABLE --------------------------
Other Annual Name (1) Year Salary Bonus Comp.(2) Options - -------- ---- ------ ------- -------- ------- Allen C. Barbieri 1997 $150,000 $250,000 440 125,000 1996 146,833 120,000 1,292 0 1995 131,000 35,000 1,493 0 Doug L. Heller 1997 130,000 100,000 224 20,000 1996 128,333 60,000 864 0 1995 120,000 20,000 808 0 Allan Gibson 1997 120,000 60,000 1,880 5,000 1996 120,000 32,500 1,780 0 1995 120,000 10,000 1,831 0 Gregory M. Savino 1997 114,000 20,000 900 5,000 1996 114,000 35,000 284 3,000 1995 114,000 10,000 536 0 Herb Reynolds 1997 125,812 40,000 1,539 3,750 1996 125,812 12,500 1,492 0 1995 129,058 5,000 1,391 0
(1) Allen C. Barbieri President and Chief Ex ecutive Officer of Pacific National Bank and the Company Doug L. Heller Executive Vice President and Chief Financial Officer of Pacific National Bank, Chief Financial Officer of the Company Allan Gibson Executive Vice President and Chief Operating Officer of Pacific National Bank Gregory M. Savino Executive Vice President and Senior Loan and Credit Officer of Pacific National Bank Herb Reynolds Executive Vice President (2) Other fringe benefits. The Company has no stock appreciation rights, restricted stock awards or long term incentive plan payouts. The following table sets forth the number of stock options granted in 1997 for the named executive officers: Options Granted in Last Fiscal Year -----------------------------------
Number of Percent of Total Options Exercise or Securities Underlying Granted to Base Price Expiration Options Granted (#) Employees in Fiscal Year ($/Share) Date ---------------------- ------------------------- ------------------------- ----------- Allen C. Barbieri 125,000 71.3% $11.50 3/1/08 Doug L. Heller 20,000 11.4% 11.50 3/1/08 Allan Gibson 5,000 2.9% 11.50 3/1/08 Gregory M. Savino 5,000 2.9% 11.50 3/1/08 Herb Reynolds 3,750 2.1% 11.50 3/1/08
The following table sets forth the number of unexercised stock options, along with the value of unexercised in-the-money options as of December 31, 1997 for the named executive officers. For the purpose of calculating the value of unexercised in-the-money options, the fair market value of the Company's stock was estimated at $19.75 per share based upon the high bid price for the 4th quarter of 1997 as reported by Mitchell Securities. 40 Aggregate Options Exercised in Last Fiscal Year and --------------------------------------------------- Fiscal Year End Options Value -----------------------------
Shares Number of Unexercised Value of Unexercised Acquired Options in-the-money options on at FY-End(#) at FY-End($) Exercise Value Exercisable/ Exercisable/ Name (#) Realized Unexerciseable Unexerciseable ---- -------- -------- --------------------- -------------------- Allen C. Barbieri N/A N/A 75,000/100,000 $1,018,750/$825,000 Doug L. Heller 10,000 $130,000 14,000/16,000 195,500/132,000 Allan Gibson N/A N/A 11,000/4,000 170,750/33,000 Gregory M. Savino 2,000 16,000 9,000/4,000 138,250/33,000 Herb Reynolds 2,000 16,000 0/3,000 0/24,500
The Bank Holding Company and the Bank have entered into employment agreements with its three key executive officers, Allen Barbieri, Doug Heller and Allan Gibson, which set forth the terms and conditions under which each would be employed by the Bank Holding Company or the Bank. Other than a termination clause and a not to compete clause, this agreement is consistent with all normal employment policies of the Company. The agreements set forth that each employee's initial term of employment shall be for one year and shall be extended by the board for additional successive terms of one year. The board may terminate their employment for cause without any additional compensation at any time during the term of the agreement. If their employment is terminated without cause, or if the Bank Holding Company or the Bank gives written notice to either Messrs. Barbieri, Heller or Gibson of its intention not to renew for a successive term, then the employee is entitled to an amount equal to one times his annual base salary. In addition, the agreement stipulates that if the employee terminates his employment or if the Bank Holding Company or the Bank terminates the employment for cause, the employee agree for a one year period, effective on the date of termination, not to engage in any business which is in competition with the business of the Company within the general location of the Company, or not to contact or solicit any person or entity which is a customer or employee of the Company or the Bank. If the Bank Holding Company or the Bank terminates the employment without cause, then the noncompete clause is limited to a three month period effective on the date of termination. This agreement shall be assignable to and shall be binding upon and inure to the benefit of any successor of the Bank Holding Company or the Bank including the transfer, directly or indirectly, of all or substantially all of the assets of the Bank Holding Company or the Bank whether by merger, consolidation, sale or otherwise. The Bank compensates its outside directors for their participation in board of directors meetings along with other committee meetings. The amount for each committee is based upon several factors including an estimation of the time devoted to the preparation of each meeting and the length of time at each meeting. Due to the extra time devoted, the chairman of each committee is compensated double the normal committee fee. The Bank Holding Company does not compensate its outside directors for their participation in the board of directors meetings or any other committee meeting. The Bank Holding Company does reimburse its directors for travel expenses associated with their attendance at the board meetings. The schedule below sets forth the compensation which each outside Bank director was paid during 1997 for their participation in each committee meeting along with the frequency of each committee meeting.
Committee Company Fee Frequency - --------- ------- --- ---------- Board of Directors Bank 500 Monthly Audit Committee Bank 200 Bi-Monthly Loan Committee Bank 200 Weekly Asset Liability Committee Bank 200 Quarterly Community Reinvestment Act Committee Bank 200 As needed Compensation Committee Bank 200 As needed
41 Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ The following table sets forth, as of March 17, 1998, information with respect to the securities holdings of all persons which the Registrant has reason to believe may be deemed the beneficial owners of more than 5% of the Registrant's outstanding Common Stock. The following table indicates the beneficial ownership of such individuals numerically calculated based upon the total number of shares of common stock outstanding. Also set forth in the table is the beneficial ownership of all shares of the Registrant's outstanding stock, as of such date, of all directors and named executive officers, individually, and all directors and executive officers as a group.
Name and Address Amount and Nature % of Beneficial Owner of Beneficial Ownership Ownership - ---------------- ----------------------- --------- Allen C. Barbieri 278,958(1) 11.70% 9 Carnelian Irvine, CA 92614 Allan Gibson 15,000(2) * 4704 East Hastings Orange, CA 92667 Martin T. Hart 411,022 18.02% 875 Race Street Denver, CO 80206 Doug L. Heller 55,191(3) 2.40% 14 Estrella Irvine, CA 92714 G. Mitchell Morris 241,312 10.58% 4277 Park Terrace Drive Salt Lake City, UT 84124 Herb Reynolds -0- 0% 213 Louise Drive Placentia, CA 92870 Jon A. Salquist 266,000 ll.66% 2725 N. W. Circle A Drive Portland, OR 97229 Gregory M. Savino 14,080(4) * 28461 Rancho De Juana Laguna Niguel, CA 92656 Bernard E. Schneider 20,000 * 326 Emerald Bay Laguna Beach, CA 92651
42 James Schuler 380,062 16.66% 828 Fort Street Mall Honolulu, Hawaii 96813 All Directors and Executive Officers 1,301,563(5) 54.09% as a Group (9 Persons)
(1) Includes options to purchase 100,000 shares of the Company stock pursuant to the Company's stock option plan, which are exercisable within 60 days. (2) Includes options to purchase 12,000 shares of common stock of the Company pursuant to the Company's stock option plan, which are exercisable within 60 days. (3) Includes options to purchase 18,000 shares of the Company stock pursuant to the Company's stock option plan which are exercisable within 60 days. (4) Includes options to purchase 10,000 shares of common stock of the Company pursuant to the Company's stock option plan which are exercisable within 60 days. (5) Includes options to purchase 140,000 shares of the Company stock pursuant to the Company's stock option plan which are exercisable within 60 days. * Less than 1% Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------------------------------------------------------- The Bank Holding Company and the following directors, executive officers and principal shareholders of the Company, Messrs. Barbieri, Hart, Heller, Morris, Salquist, Schneider and Schuler have invested in, and are shareholders of Alta Residential Mortgage, Inc. ("Alta"). Alta is a privately held real estate investment trust which was capitalized on 12/24/97 by issuing 1,951,500 shares of common stock at $10.00 per share and warrants to purchase an additional 1,951,500 shares of Alta's common stock. The warrants are exercisable at $10.00 per common share and are exercisable for a period of 5 years from issuance. The Bank Holding Company purchased 100,000 shares of common stock at $10 per share, and was granted warrants to purchase an additional 100,000 shares at a price of $10 per share. In addition, the Bank Holding Company loaned $1.5 million to Alta as convertible debt which will convert into 150,000 shares of common stock at such time as Alta increases its capitalization to 5 million shares of issued and outstanding common stock. Upon conversion of the 1.5 million convertible debt, the Bank Holding Company will be issued a warrant to purchase an additional 150,000 shares of Alta's common stock at $10.00 per share. As of December 31, 1997, the Bank Holding Company and Messrs. Barbieri, Hart, Heller, Morris, Salquist, Schneider and Schuler own 5.12%, 2.05%, 3.84%, .92%, 2.56%, 9.74%, .13% and 2.56%, respectively, of the outstanding common shares of Alta. In addition to the security holdings, Messrs. Barbieri, Hart and Salquist are board members of Alta. Along with his position in the Bank Holding Company and the Bank, Mr. Barbieri is also the Chairman and C.E.O. of Alta. In connection with his position in Alta, effective January 1998, Alta is reimbursing the Bank $100,000 of Mr. Barbieri's salary. The Bank has also entered into two agreements with Alta. The agreements provide that Alta will be given a first right of refusal to purchase residential mortgage loans originated by the Bank and that the Bank will provide certain administrative and other services to Alta. All transactions between the two companies have been based upon the fair market value for such services or sales of mortgage loans. 43 PART IV Item 13. EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- Financial Reports - ----------------- The following consolidated financial statements of the Company are included in a separate section of this annual report on form 10-KSB on the page numbers specified below: Page(s) ------- Report of Independent Auditors for 1997 and 1996 F-1 Consolidated Balance Sheets F-2 Consolidated Statements of Income F-3 Consolidated Statements of Stockholders' Equity F-4 Consolidated Statements of Cash Flows F-5 Notes to Consolidated Financial Statements F-6 through F-30 Exhibits - -------- No. Exhibit --- ------- 3.1 Restated Articles of Incorporation (1) 3.2 Bylaws of the Company (2) 3.3 Amended Articles of Incorporation (3) 4 Section Eight of the By-laws of the Company (2) 10.1 1985 Incentive Stock Option Plan (4) 10.2 1985 Amended Non Qualified Stock Option Plan (5) 10.3 1996 Incentive Stock Option Plan (6) 10.4 Executive Officer Employment Contracts 21 Subsidiaries of the Company 23.1 Consent of McGladrey & Pullen, LLP 27 Financial Data Schedule (1) Filed as Exhibit 3.1 to registrant's 1989 Annual Report on Form 10-K, which is incorporated herein by reference. (2) Filed as Exhibit 6, to Registrant's Registration Statement on Form S-14 (File No. 2-78580), which exhibits are incorporated herein by reference. 44 (3) Filed as Exhibit 3.3 to Registrant's 1990 Annual Report on Form 10-K, which is incorporated herein by reference. (4) Filed on Form S-8 on April 5, 1989, which is incorporated herein by reference. (5) Files on Form S-8 on December 16, 1996, File # 333-17997, which is incorporated herein by reference. (6) Filed on Form S-8 on December 16, 1996, File #333-17999, and amended on September 24, 1997, File #333-36255 which is incorporated herein by reference. Reports on Form 8-K. - ------------------- During the last quarter of 1997, the Company filed no reports on Form 8-K. 45 SIGNATURES In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 28th day of March 1998. PNB FINANCIAL GROUP (Registrant) BY: /s/ BERNARD E. SCHNEIDER ------------------------------------ BERNARD E. SCHNEIDER Chairman of the Board In accordance with the Security Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ ALLEN C. BARBIERI President and Director March 30, 1998 - -------------------------------- ALLEN C. BARBIERI /s/ DOUG L. HELLER Chief Financial Officer March 30, 1998 - -------------------------------- DOUG L. HELLER /s/ MARTIN T. HART Director March 30, 1998 - -------------------------------- MARTIN T. HART /s/ G. MITCHELL MORRIS Director March 30, 1998 - -------------------------------- G. MITCHELL MORRIS /s/ JON A. SALQUIST Director March 30, 1998 - -------------------------------- JON A. SALQUIST 46 INDEPENDENT AUDITOR'S REPORT To the Board of Directors PNB Financial Group Newport Beach, California We have audited the accompanying consolidated balance sheets of PNB Financial Group and subsidiary as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for the years then ended. These consolidated 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 consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PNB Financial Group and subsidiary as of December 31, 1997 and 1996, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. Anaheim, California January 29, 1998 F-1
PNB FINANCIAL GROUP CONSOLIDATED BALANCE SHEETS December 31, 1997 and 1996 ASSETS 1997 1996 - --------------------------------------------------------------------------------------------------- Cash and Due from Banks (Note 14) $ 15,185,000 $ 12,700,000 Federal Funds Sold - 6,000,000 ------------------------------ Total cash and cash equivalents 15,185,000 18,700,000 Securities Available for Sale (Notes 2 and 6) 6,910,000 7,381,000 Mortgage Loans Held for Sale (Note 3) 96,852,000 62,620,000 Loans, net of allowance for loan losses 1997 $1,558,000; 1996 $1,812,000 (Notes 3, 5 and 6) 116,626,000 102,414,000 Premises and Equipment (Note 4) 1,094,000 1,150,000 Other Real Estate Owned 476,000 3,483,000 Other Assets (Notes 4 and 9) 5,731,100 2,450,000 ------------------------------ Total assets $242,874,000 $198,198,000 ============================== LIABILITIES AND STOCKHOLDERS' EQUITY - --------------------------------------------------------------------------------------------------- Deposits (Note 5) Noninterest bearing $101,343,000 $ 70,754,000 Interest bearing 109,747,000 99,285,000 ------------------------------ Total deposits 211,090,000 170,039,000 Line of Credit (Note 5) 5,000,000 7,000,000 Other Liabilities 2,787,000 2,476,000 ------------------------------ Total liabilities 218,877,000 179,515,000 ------------------------------ Commitments and Contingencies (Notes 3, 6 and 14) Stockholders' Equity (Notes 7 and 14) Common stock, no par value; 20,000,000 shares authorized; 2,265,280 and 2,170,783 shares issued and outstanding at December 31, 1997 and 1996, respectively 16,234,000 16,012,000 Retained earnings 7,754,000 2,734,000 Unrealized gain (loss) on securities available for sale, net (Note 2) 9,000 (63,000) ------------------------------ Total stockholders' equity 23,997,000 18,683,000 ------------------------------ $242,874,000 $198,198,000 ==============================
See Notes to Consolidated Financial Statements. F-2 PNB FINANCIAL GROUP CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1997 and 1996
1997 1996 - ------------------------------------------------------------------------------- Interest Income (Note 8) $16,421,000 $13,978,000 Interest Expense (Note 8) 4,044,000 3,888,000 ------------------------- Net interest income 12,377,000 10,090,000 Provision for Loan Losses (Note 3) 870,000 903,000 ------------------------- Net interest income after provision for loan losses 11,507,000 9,187,000 ------------------------- Other Income Commissions and other revenue from mortgage banking operations (Note 10) 15,146,000 11,129,000 Service charges, fees and other (Note 2) 1,034,000 1,235,000 Gain on sale of SBA loans (Note 3) 638,000 463,000 ------------------------- 16,818,000 12,827,000 ------------------------- Other Expenses Mortgage banking operations (Notes 3 and 10) 10,585,000 8,390,000 Salaries and employee benefits 4,303,000 3,953,000 Other deposit expense (Note 5) 1,424,000 1,039,000 Occupancy (Note 6) 1,380,000 1,538,000 Other expenses (Note 8) 2,052,000 2,593,000 ------------------------- 19,744,000 17,513,000 ------------------------- Income before provision for income taxes 8,581,000 4,501,000 Provision for Income Taxes (Note 9) 3,561,000 945,000 ------------------------- Net income $ 5,020,000 $ 3,556,000 ========================= Earnings per Share Basic $ 2.27 $ 1.64 ========================= Diluted $ 2.13 $ 1.57 =========================
See Notes to Consolidated Financial Statements. F-3 PNB FINANCIAL GROUP CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1997 and 1996
Unrealized Gain (Loss) Common Stock Retained on Securities Total --------------------------- Earnings Available Stockholders' Shares Amount (Deficit) for Sale, net Equity - --------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 2,187,933 $16,134,000 $ (822,000) $(840,000) $15,228,000 Exercise of stock options 7,500 29,000 - - 29,000 Repurchase of common stock (24,650) (151,000) - - (151,000) Decrease in unrealized loss on securities available for sale, net - - - 21,000 21,000 Net income - - 3,556,000 - 3,556,000 ----------------------------------------------------------------------------- Balance, December 31, 1996 2,170,783 16,012,000 2,734,000 (63,000) 18,683,000 Exercise of stock options 127,500 453,000 - - 453,000 Repurchase of common stock (33,003) (521,000) - - (521,000) Tax benefit on exercise of stock options - 290,000 - - 290,000 Decrease in unrealized loss on securities available for sale, net - - - 72,000 72,000 Net income - - 5,020,000 - 5,020,000 ----------------------------------------------------------------------------- Balance, December 31, 1997 2,265,280 $16,234,000 $ 7,754,000 $ 9,000 $23,997,000 =============================================================================
See Notes to Consolidated Financial Statements. F-4 PNB FINANCIAL GROUP CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1997 and 1996
1997 1996 - -------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Net income $ 5,020,000 $ 3,556,000 Adjustments to reconcile net income to net cash (used in) operating activities: Depreciation and amortization 541,000 585,000 Provision for loan losses 870,000 903,000 Provision for indemnification losses 276,000 1,080,000 Gain on sale of other real estate owned (288,000) (472,000) Gain on sale of mortgage loans held for sale, net (9,584,000) (7,842,000) Proceeds from sale of mortgage loans held for sale 1,103,690,000 802,208,000 Origination of mortgage loans held for sale (1,128,338,000) (815,018,000) Change in other assets and liabilities, net (37,000) (1,573,000) -------------------------------- Net cash (used in) operating activities (27,850,000) (16,573,000) -------------------------------- Cash Flows from Investing Activities Proceeds from sale of available for sale securities 2,052,000 3,052,000 Proceeds from maturities of available for sale securities 568,000 1,000,000 Purchase of available for sale securities (2,206,000) (830,000) Net change in loans (17,273,000) (6,178,000) Proceeds from sale of other real estate owned 5,464,000 2,329,000 Acquisitions of premises and equipment (402,000) (380,000) Investment and convertible debt in REIT (Note 4) (2,500,000) - -------------------------------- Net cash (used in) investing activities (14,297,000) (1,007,000) -------------------------------- Cash Flows from Financing Activities Proceeds from borrowings on notes payable 794,228,000 15,360,000 Payments on notes payable (796,579,000) (8,009,000) Net change in deposits 41,051,000 12,737,000 Sale of common stock 453,000 29,000 Repurchase of common stock (521,000) (151,000) -------------------------------- Net cash provided by financing activities 38,632,000 19,966,000 -------------------------------- Net increase (decrease) in cash and cash equivalents (3,515,000) 2,386,000 Cash and Cash Equivalents Beginning of year 18,700,000 16,314,000 -------------------------------- End of year $ 15,185,000 $ 18,700,000 ================================ Supplemental Disclosures (Note 13)
See Notes to Consolidated Financial Statements. F-5 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 1. Nature of Banking Activities and Significant Accounting Policies Nature of business: PNB Financial Group is a bank holding company whose wholly-owned subsidiary, Pacific National Bank, provides bank related services including the granting of commercial, real estate, installment, construction, and Small Business Administration (SBA) loans, mortgage brokerage and mortgage banking services to customers. The Bank operates three commercial loan and depository regional offices, two mortgage loan offices and four mortgage loan production offices. With the exception of the four mortgage loan production offices, all of the offices are in the Southern California marketplace with deposit taking offices in Newport Beach, Beverly Hills, and Orange, and mortgage division offices in Irvine and San Diego. The four mortgage loan production offices are located in Phoenix, Flagstaff, and Tucson, Arizona and Sacramento, California. A summary of the Company's significant accounting policies are as follows: Use of estimates in the preparation of financial statements: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principles of consolidation: The consolidated financial statements include the accounts of PNB Financial Group (the Company) and its wholly-owned subsidiary, Pacific National Bank (the Bank). All significant intercompany balances have been eliminated in consolidation. Cash and cash equivalents: For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less and federal funds sold to be cash equivalents. The Company has deposits at other banks in excess of insured limits. The Company has not experienced any losses in such accounts. F-6 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) Securities available for sale: Securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity and equity securities in the Federal Home Loan Bank and the Federal Reserve Bank which is a required investment to acquire membership privileges in those institutions. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available for sale are carried at fair value. These fair values are based on quoted prices when such quotes are available. In the absence of quoted market prices, securities are priced based on quotes obtained from certain brokers who estimate the fair value based upon quoted prices for similar securities. There can be no assurance that prices estimated for such securities can be realized upon ultimate sale. Unrealized gains or losses are reported as increases or decreases in stockholders' equity, net of any related deferred tax effect. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Mortgage loans held for sale: Mortgage loans held for sale are reported at the lower of cost or fair value which is computed by the aggregate method. Gains and losses on the sale of mortgage loans are adjusted by gains and losses generated from corresponding hedging transactions entered into to protect the mortgage loan inventory value from fluctuations in interest rates. Hedge positions are also maintained to protect the pipeline of loan applications in process from changes in interest rates. Gains and losses which occur during the commitment and warehousing period related to the pipeline and mortgage loans held for sale are recognized in the period loans are sold. Unrealized hedging losses are recognized currently if deferring such losses would result in mortgage loans held for sale and the pipeline being valued in excess of their estimated fair value. Interest income on these loans is accrued daily. Loan origination fees and cost are deferred and recognized as income or expense when the loan is sold. Loans: Loans are stated at amounts advanced less payments received, unearned fees and loan discounts. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or as an expedient at the loan's observable market price or the fair value of the collateral less estimated selling cost if the loan is collateral dependent. A loan is impaired when it is probable the creditor will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Interest income on loans is accrued daily except where reasonable doubt exists as to the collectibility of the interest, in which case the accrual of interest income is discontinued. Cash payments received after the accrual of interest income is discontinued is applied to principal. The Company's current policy is generally to cease accruing interest and to charge off all accrued and unpaid interest on loans which are past due as to principal and/or interest for 90 days, or at an earlier time, if management determines timely collection of interest is in doubt. Loan origination fees and certain incremental direct costs relating to loan originations are deferred and amortized over the life of the loan. Discounts on loans purchased are credited to income over the life of the loan using the interest method. F-7 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) Loans: (continued) The adequacy of the allowance for loan losses is determined by management based on a number of factors, including historical loan loss experience (migration analysis), changes in the nature and volume of the loan portfolio, review of problem loans, quality of the overall portfolio and current economic conditions. While management uses the best information available to provide for possible losses, future adjustments to the allowance may be necessary due to economic, operating, regulatory or other conditions that may be beyond the Company's control. Loans considered uncollectible are charged to the allowance for loan losses and subsequent recoveries are added to the allowance. Premises and equipment: Premises and equipment are stated at cost, less accumulated depreciation and amortization which is charged to expense on a straight-line basis over the estimated useful lives of the assets. The useful life of equipment is estimated to be from three years to five years. Improvements to leased property are amortized over the lesser of the term of the lease or life of the improvements. Other real estate owned: Other real estate owned, which represents real estate acquired in settlement of loans, is held for sale and is recorded at the lower of cost or fair value less estimated cost of disposal. Any write-down to fair value at the time of transfer to other real estate owned is charged to the allowance for loan losses. Any subsequent operating expenses or income, reduction in estimated fair values, or gains or losses on disposition of such properties are charged or credited to current operations. Other real estate owned is evaluated regularly by management and reductions of the carrying amounts are recorded as necessary. Income taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Interest rate exchange agreements: Interest rate exchange agreements (swaps) used in asset/liability management activities are accounted for using the accrual method. Net interest income or expense resulting from the differential between exchanging floating and fixed rate interest payments is recorded on an accrual basis. F-8 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) Earnings per share: Effective December 31, 1997, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 128, "Earnings Per Share", which supersedes Account Principles Board (APB) Opinion No. 15. Statement No. 128 requires the presentation of earnings per share by all entities that have common stock or potential common stock, such as options, warrants and convertible securities outstanding that trade in a public market. Under Statement No. 128, the Company is required to present basic and diluted earnings per share amounts. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce a loss or increase the income per common share from continuing operations. The Company initially applied Statement No. 128 for its annual and interim period ending December 31, 1997. The reported earnings per share for 1996 have been restated to conform to the new requirements. The weighted average shares outstanding for computing basic and diluted earnings per share were 2,212,558 and 2,361,045, respectively, for the year ended December 31, 1997 and 2,169,000 and 2,263,371, respectively, for the year ended December 31, 1996. The difference in the weighted average shares outstanding for computing basic and diluted earnings per share is due to dilutive stock options of 148,487 and 94,034 in 1997 and 1996, respectively. Accounting for transfers and servicing of financial assets: Effective January 1, 1997, the Company adopted FASB Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", which distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. The Statement also establishes standards on the initial recognition and measurement of servicing assets and other retained interests and servicing liabilities, and their subsequent measurement. The Statement requires that debtors reclassify financial assets pledged as collateral and that secured parties recognize those assets and their obligation to return them in certain circumstances in which the secured party has taken control of those assets. In addition, the Statement requires that a liability be derecognized only if the debtor is relieved of its obligation through payment to the creditor or by being legally released from being the primary obligor under the liability either judicially or by the creditor. The adoption of this Statement did not have a material effect on the financial statements. F-9 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 1. Nature of Banking Activities and Significant Accounting Policies (Continued) New accounting pronouncements: During the year, FASB issued several accounting pronouncements that will effect or possibly effect the accounting and reporting of the Company. Following are the requirements of these pronouncements: Reporting comprehensive income: In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive Income". Statement No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose consolidated financial statements. It does not address issues of recognition or measurement for comprehensive income and its components. The Statement requires a company to disclose in the financial statements the various components of comprehensive income. The provisions of this Statement will be effective for the Company's financial statements issued for the year ending December 31, 1998. Segment disclosure: The FASB has also issued Statement No. 131 "Disclosures about Segments of an Enterprise and Related Information." Statement No. 131 modifies the disclosure requirements for reportable segments and is effective for the Company's year ending December 31, 1998. The Company has not determined the effect, if any, the adoption of this Statement will have on the Company's reported segments. Note 2. Securities Available for Sale Securities available for sale as of December 31, 1997 and 1996 consist of the following:
1997 -------------------------------------------------------- Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ------------------------------------------------------------------------------------------ U.S. Treasury securities $ 1,018,000 $ - $ (4,000) $ 1,014,000 U.S. Government agencies securities 2,004,000 30,000 - 2,034,000 Mortgaged-backed securities 2,587,000 9,000 (19,000) 2,577,000 Federal Reserve Bank stock 340,000 - - 340,000 Federal Home Loan Bank stock 945,000 - - 945,000 ----------------------------------------------------- $ 6,894,000 $ 39,000 $(23,000) $ 6,910,000 =====================================================
F-10 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 2. Securities Available for Sale (Continued)
1996 ----------------------------------------------------- Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ------------------------------------------------------------------------------------------ U.S. Treasury securities $ 1,202,000 $ - $ (17,000) $ 1,185,000 U.S. Government agencies securities 2,112,000 - (16,000) 2,096,000 Mortgage-backed securities 3,004,000 - (74,000) 2,930,000 Federal Reserve Bank stock 340,000 - 340,000 Federal Home Loan Bank stock 830,000 - 830,000 ------------------------------------------------------ $ 7,488,000 $ - $(107,000) $ 7,381,000 ======================================================
The amortized cost and fair value of securities available for sale as of December 31, 1997 by contractual maturity are shown below. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary:
Amortized Cost Fair Value - -------------------------------------------------------------------------- Due in one year or less $ 1,018,000 $ 1,014,000 Due after one year through five years 2,004,000 2,034,000 Mortgage-backed securities 2,587,000 2,577,000 Bank stocks 1,285,000 1,285,000 ---------------------------- $ 6,894,000 $ 6,910,000 ============================
Gross realized losses from the sale of securities available for sale were $11,000 and $1,000 for the years ended December 31, 1997 and 1996, respectively. There were no gross realized gains from the sale of securities available for sale for the years ended December 31, 1997 and 1996. As of December 31, 1997 and 1996, securities available for sale with a fair value of $1,950,000 and $2,650,000, respectively, were pledged as collateral for various purposes as required or permitted by law. F-11 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 3. Loans Loan portfolio composition: The composition of the Company's loan portfolio as of December 31, 1997 and 1996 are as follows:
1997 1996 - ------------------------------------------------------------------- Commercial $ 46,218,000 $ 38,666,000 Real estate and construction 64,888,000 57,857,000 Consumer 7,078,000 7,703,000 Allowance for loan losses (1,558,000) (1,812,000) ------------------------------- $116,626,000 $102,414,000 ===============================
Loans have been recorded net of purchase discounts of $551,000 and $598,000 and net deferred origination fees of $193,000 and $158,000 as of December 31, 1997 and 1996, respectively. Such amounts will be amortized to income over the lives of the loans. A majority of the Bank's commercial and consumer loan portfolio is with customers located in California throughout its primary market area of Orange and Los Angeles Counties. The Bank grants commercial and consumer loans to borrowers in a number of different industries. The Bank's real estate and construction loan portfolio, which is 56% of the Bank's net loan portfolio, consists of loans on real estate located throughout Southern California. Changes in economic conditions in Southern California may result in losses that cannot be reasonably predicted at this time. In addition, various regulatory agencies as an integral part of their examination process periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. Allowance for loan losses: The following is a summary of transactions affecting the allowance for loan losses for the years ended December 31:
1997 1996 - --------------------------------------------------------------------------- Balance, beginning $ 1,812,000 $ 2,659,000 Provision for loan losses 870,000 903,000 Amounts charged off (1,601,000) (2,055,000) Recoveries 477,000 305,000 ---------------------------- Balance, ending $ REF $ 1,812,000 ============================
F-12 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 3. Loans (Continued) SBA loans: The Bank sells the guaranteed portion of substantially all of its SBA loans it originates in the secondary market. The Bank sells these loans to generate sales premiums and servicing income along with providing additional funds for lending. Under such agreements, the Bank continues to service the loans and the buyer receives the principal collected together with interest. In connection with these sales, the Bank serviced approximately $19,861,000 and $13,619,000 of SBA loans for others as of December 31, 1997 and 1996, respectively, which are not included in the accompanying consolidated balance sheets. The Bank has issued various representations and warranties associated with the sale of SBA loans. These representations and warranties may require the Bank to repurchase loans for a period of 90 days after the date of sale as defined per the applicable sales agreement. The Bank experienced no losses during the years ended December 31, 1997 and 1996 regarding these representations and warranties. The Bank's SBA Department, together with the residential mortgage division, utilize federal governmental agencies in providing loans to its customers. A prolonged shutdown or slowdown of the SBA Department and Housing and Urban Development ("HUD") could have a material effect on the Bank's ability to guarantee and/or insure SBA loans and FHA/VA loans. This inability may lead to the Bank limiting or temporarily stopping these lending programs which could have a material effect on the operation of the Bank's SBA Department and Residential Mortgage Loan Department. The Bank's SBA Department is substantially impacted by the policies, guidelines and funding availability established by the U.S. Government's SBA. Periodically, Congress sets the amount of SBA funds available and changes the fees charged by the SBA. The level of funding and changes to the fee structure could severely effect the operation of the Bank's SBA Department. Nonaccrual and impaired loans: Loans on which the accrual of interest has been discontinued amounted to $1,237,000 and $3,220,000 at December 31, 1997 and 1996, respectively. If nonaccrual loans had been maintained in accordance with their terms, additional interest income of approximately $126,000 ($.06 per share, basic) and $343,000 ($.16 per share, basic) would have been recorded during the years ended December 31, 1997 and 1996, respectively. Impaired loans having recorded investments of $1,237,000 and $3,220,000 at December 31, 1997 and 1996, respectively, have been recognized in conformity with FASB Statement No. 114 as amended by FASB Statement No. 118. The total allowance for loan losses related to these loans was $50,000 and $397,000 at December 31, 1997 and 1996, respectively. Impaired loans for which there is no specific allowance for loan losses at December 31, 1997 and 1996 is $1,138,000 and $721,000, respectively. The average recorded investment for all impaired loans during 1997 and 1996 was $2,218,630 and $6,333,000, respectively. No interest income was recognized on impaired loans in 1997 and $120,000 was recognized in 1996, all of which was recognized using a cash-basis method of accounting during the time within that period that the loans were impaired. F-13 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 3. Loans (Continued) Mortgage loans held for sale: In the ordinary course of business, the Bank has liability under representations and warranties made to purchasers and insurers of mortgage loans. Under certain circumstances, the Bank may become liable for the unpaid principal and interest on defaulted loans (whether recourse or nonrecourse) or other loans if there has been a breach of representations or warranties. Until September 30, 1996, substantially all mortgage loans were sold with a recourse provision. After October 1, 1996, the majority of the loans sold were without a recourse provision. Generally, loans sold under the recourse provision are required to be purchased back by the Bank if the loan becomes delinquent within two to six months of funding. The Bank has the choice to not purchase the loan, but to indemnify the investor for any and all costs associated with the investors collection of the loan. During 1997 and 1996, the Bank chose to indemnify the majority of the loans subject to a recourse provision. The Bank estimates its loss exposure to loans sold under the recourse and representation and warranty provisions and has recorded this estimate at December 31, 1997 and 1996. The following is a summary of transactions affecting this reserve for the years ended December 31, 1997 and 1996:
1997 1996 - ------------------------------------------------------------------------------ Balance, beginning $ 461,000 $ 232,000 Provision for losses, included in mortgage banking operations expenses 276,000 1,080,000 Amounts charged to reserve, net of recoveries (355,000) (851,000) ---------------------- Balance, ending $ 382,000 $ 461,000 ======================
Related party loans: Certain stockholders of the Company, officers and directors of the Company and the Bank, including their families and companies of which they are principal owners, are considered to be related parties. These related parties were loan customers of, and had other transactions with, the Company and the Bank in the ordinary course of business. In management's opinion, these loans and transactions were on the same terms as those for comparable loans and transactions with nonrelated parties. The activity in related party loans for the year ended December 31, 1997 is as follows:
- ---------------------------------------------------------- Balance, beginning $ 4,961,000 Additional advances 1,453,000 Repayments (2,716,000) Loans no longer with related parties (1,626,000) ----------- Balance, ending $ 2,072,000 =========== Maximum balance during the year (month-end balances) $ 4,953,000 ===========
At December 31, 1997, none of the related party loans were past due, impaired, on nonaccrual, or restructured to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower. F-14 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 4. Premises and Equipment and Other Assets Premises and equipment: Components of premises and equipment are as follows at December 31:
1997 1996 - --------------------------------------------------------------------------- Furniture, fixtures and equipment $ 2,704,000 $ 2,442,000 Leasehold improvements 1,288,000 1,402,000 ------------------------------ 3,992,000 3,844,000 Accumulated depreciation and amortization (2,898,000) (2,694,000) ------------------------------ $ 1,094,000 $ 1,150,000 ==============================
Other assets: In December 1997, the Company invested in a real estate investment trust (REIT) by purchasing 100,000 shares of stock in the REIT (approximately 4.7% of total shares outstanding) for $1 million. In addition, the Company loaned $1.5 million to the REIT as convertible debt which can be converted into 150,000 shares of common stock at such time as the REIT increases its capitalization to 5 million shares of issued and outstanding common stock. Also in December 1997, the Company was issued a warrant to purchase an additional 100,000 shares of the REIT's common stock at $10.00 per share. Upon conversion of the $1.5 million convertible note into 150,000 shares of common stock of the REIT, the Company will be issued a warrant to purchase an additional 150,000 shares of REIT common stock at $10.00 per share. The warrants are exercisable at the discretion of the Company in part or in whole at any time for a period of five years from issuance. The REIT will focus on the investment in and management of residential mortgage loans. The REIT shall be headquartered in West Los Angeles and, with the exception of Allen C. Barbieri who is the Chairman and C.E.O. of the REIT and is currently the President and C.E.O. of PNB Financial Group, shall be managed by a separate and outside management team. Additionally, two of REIT's four outside board seats shall be held by current board members of PNB Financial Group. In addition to the equity investment of $1 million and the convertible loan in the amount of $1.5 million, the Company has also entered into agreements to perform operational services to the REIT through the Bank and also grant the REIT a first right of refusal to purchase residential mortgages from the Bank. F-15 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 5. Deposits and Line of Credit Deposits: The composition of the Bank's interest bearing deposits as of December 31, 1997 and 1996 is as follows:
1997 1996 - -------------------------------------------------------------------------------- Demand $ 54,906,000 $ 49,720,000 Savings 4,355,000 5,390,000 Time certificates of deposit of $100,000 or more 36,187,000 24,976,000 Other time deposits 14,299,000 19,199,000 --------------------------- $109,747,000 $ 99,285,000 ===========================
As of December 31, 1997 and 1996, approximately $46,000,000 and $25,000,000, respectively, of the Bank's noninterest bearing demand deposits consist of demand accounts currently maintained by title insurance, escrow and property management companies. These industries are dependent upon the real estate market in Southern California. The Bank provides an earnings allowance for these customers and purchases external services on behalf of these customers based on the amount of the earnings allowance less any internal charges incurred. These external services, which are commonly offered in the banking industry, include courier, bookkeeping and payroll accounting services. The expense of these external services totaled $1,424,000 and $1,039,000 for the years ended December 31, 1997 and 1996, respectively, and is classified as other deposit expense in the accompanying consolidated statements of income. During 1997 the Bank obtained deposits through brokers in order to fund a portion of its mortgage loans held for sale. At December 31, 1997, the Bank had $13,400,000 of these deposits which are included in time certificates of deposit of $100,000 or more above. At December 31, 1997, the scheduled maturities of certificates of deposit are as follows:
- ------------------------------------------------------------------------------ Three months or less $ 33,822,000 Over three months through one year 13,647,000 Over one year through three years 2,305,000 Over three years 712,000 ------------ $ 50,486,000 ============
F-16 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 5. Deposits and Line of Credit (Continued) Line of credit: The Bank has a line of credit with the Federal Home Loan Bank (FHLB). Borrowings on the line are collateralized by certain loans with a carrying value totaling $30,337,000 at December 31, 1997. Borrowings bear interest at the FHLB daily reference rate (6.57% at December 31, 1997 with an average rate for the month of December 1997 of 5.97%). The maximum amount the Bank may borrow under this agreement is limited to the lesser of the eligible collateral and borrowing base established in the agreement or 25% of the Bank's total assets. At December 31, 1997, the maximum available was $12,700,000 of which $5,000,000 was outstanding. The Bank has a line of credit facility with Union Bank of California for $5,000,000 which expires on July 31, 1998. There was no outstanding balance as of December 31, 1997. The Bank also has two other nonbinding agreements with financial institutions to borrow up to $3,500,000. Note 6. Commitments and Contingencies Operating leases: At December 31, 1997, all of the Company's operations are conducted in leased facilities under noncancelable operating leases expiring at various dates through 2006. Several of the leases contain options to extend the lease terms. The Company incurred rental expense of $1,189,000 and $1,025,000, during the years ended December 31, 1997 and 1996, respectively. The future minimum lease payments required under operating leases total $6,035,000 and are due in the years ending: 1998 $1,049,000; 1999 $916,000; 2000 $906,000; 2001 $911,000; 2002 $743,000, and thereafter $1,510,000. Financial instruments with off-balance sheet risk: In the normal course of business, the Bank is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include unfunded commitments to extend credit and obligations under standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank's exposure to credit loss in the event of nonperformance by the other party as a result of commitments to extend credit and obligations under standby letters of credit is represented by the contractual amount of those instruments. At December 31, 1997 and 1996, the Bank had unfunded commitments related to its portfolio loans to extend credit of $35,691,000 and $24,442,000 and obligations under standby letters of credit of $358,000 and $635,000, respectively. F-17 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 6. Commitments and Contingencies (Continued) Financial instruments with off-balance sheet risk (continued): These commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn down, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. All standby letters of credit issued by the Bank are for a fixed period not to exceed one year. The Bank uses the same credit policies in making commitments and conditional obligations as it does for extending loan facilities to customers. The Bank evaluates each customer's credit worthiness 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 cash, accounts receivable, inventories, property, plant and equipment, and residential and commercial properties. The Bank enters into financial arrangements to mitigate the exposure of fluctuating interest rates in the normal course of business through origination and selling of mortgage loans. These financial instruments include commitments to fund mortgage loans and mandatory forward commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk. Interest rate risk is managed by the Bank by entering into agreements with Wall Street investment bankers and with investors meeting the credit standards of the Bank. At any time, the exposure to the Bank, in the event of default by the counterparty under a mandatory forward commitment is the difference between the contract price and current market value, which amount would only be a fractional percentage of the outstanding commitments. Until a rate commitment is extended by the Bank to a mortgage broker/borrower, there is no market interest rate risk to the Bank. The Bank reduces interest rate exposure by limiting these rate commitments to varying periods of less than sixty days. Loans in process for which interest rates were committed to the mortgage broker/borrower totaled $38,465,000 as of December 31, 1997. These commitments as well as $35,797,000 of uncommitted mortgage loans held for sale are hedged by the Bank by entering into mandatory forward commitments. At December 31, 1997, the Bank had $56,000,000 of mandatory forward commitments to sell whole loans relating to their unfunded pipeline of rate-locked loans and loans held for sale uncommitted to investors. Gains and losses on mandatory forward commitments are realized in the period the commitment is terminated. Unrealized gains and losses on forward commitments are included in the analysis of lower of cost or market valuation for mortgage loans held for sale. At December 31, 1997, the unrealized (loss) on the Bank's mandatory forward commitments was $(283,000). The Bank has also committed to sell loans that have already been funded that are pending purchases by an investor. The total amount of such committed loans at December 31, 1997 was $59,592,000. F-18 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 6. Commitments and Contingencies (Continued) Interest rate swap: The Bank is a party to an interest rate swap agreement with a total notional principal amount of $20,000,000. Management entered into the agreement to reduce the impact of changes in interest rates on its balance sheet. The agreement effectively transfers interest rate risk on a portion of the excess of interest bearing assets over interest bearing liabilities. The agreement provides for the Bank to pay a variable rate of prime on the notional amount with the counterparty paying a fixed rate. The agreement terminates in April 2000 and requires the Bank to maintain collateral with the counterparty totaling 4% of the notional amount. In accordance with the agreement, $808,000 of securities were pledged at December 31, 1997 by the Bank with a similar amount being pledged by the counterparty. Note 7. Stockholders' Equity Stock option plans: During 1995, the Company's 1985 Incentive Stock Option Plan and the 1985 Nonqualified Stock Option Plan expired. As of December 31, 1997, options for 17,000 and 142,500 shares, respectively, of the Company's common stock were outstanding under these Plans. In 1995, the Company adopted a 1995 Incentive Stock Option (ISO) Plan which provides for a maximum of 50,000 options to be granted. During 1997, the stockholders' increased the number of options that can be granted under the ISO Plan to 250,000. As of December 31, 1997, 183,750 options under the 1995 Plan have been granted of which 750 had been exercised. Under terms of the incentive and nonqualified stock option plans, options of the Company's common stock may be granted to officers, key employees and directors of the Company and the Bank, and others. Under the Plans, options are granted with an exercise price not less than fair market value of the common stock at the date the options are granted. All options expire ten years from the date of grant and vest and are available for exercise either at the grant date or for those granted in 1997 over a four-year period with 20% immediately and 20% each year thereafter. A summary of the status of the stock option plans at December 31, 1997 and 1996 and changes during the years ended on those dates is as follows:
1997 1996 ---------------------------------------------------------- Weighted- Weighted- Average Average Shares Exercise Price Shares Exercise Price - ------------------------------------------------------------------------------------------------ Outstanding, beginning of year 294,750 $ 3.62 295,750 $3.52 Granted 175,250 11.50 8,500 7.44 Exercised (127,500) 3.55 (7,500) 3.83 Expired -- -- (2,000) 3.50 -------- ------- Outstanding, end of year 342,500 $ 7.68 294,750 $3.62 ======== ======= Exercisable, end of year 202,300 294,750 ======== =======
F-19 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 7. Stockholders' Equity (Continued) A further summary about options outstanding at December 31, 1997 is as follows:
Outstanding Exercisable --------------------------------------------------------- Weighted- Weighted- Average Average Remaining Remaining Number Contractual Number Contractual Exercise Prices Outstanding Life Outstanding Life --------------------------------------------------------------------------- $ 3.50 157,500 5.8 years 157,500 5.8 years 4.50 2,000 7.9 2,000 7.9 7.00 6,000 8.6 6,000 8.6 8.50 2,500 8.8 2,500 8.8 11.50 174,500 9.3 34,300 9.3 ------- ------- 342,500 7.4 years 202,300 6.1 years ======= =======
The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for its Plans. Accordingly, no compensation cost has been recognized. The Company has elected not to adopt FASB Statement No. 123, "Accounting for Stock-Based Compensation" for options issued to employees. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under this Plan consistent with the method of Statement No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
1997 1996 - --------------------------------------------------------------------------- Net income As reported $5,020,000 $3,556,000 Pro forma 4,820,000 3,546,000 Earnings per share As reported Basic $ 2.27 $ 1.64 Diluted 2.13 1.57 Pro forma Basic $ 2.18 $ 1.63 Diluted 2.04 1.57
The pro forma compensation cost was recognized for the fair value of the stock options granted, which was estimated using the Black-Scholes model with the following weighted-average assumptions for 1997 and 1996, respectively: expected volatility of 27.6% and 25.3%, risk-free interest rate of 6.6% and 6.3%, expected life of 5 years and no expected dividends for all years. The estimated weighted-average fair value of stock options granted in 1997 and 1996 was $4.28 and $3.68, respectively. Preferred stock: The Company has authorized 10,000,000 shares, no par value, preferred stock. No shares of preferred stock have been issued. F-20 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 7. Stockholders' Equity (Continued) Dividend restrictions: The Company and the Bank are limited as to the amount of dividends which can be paid. Dividends declared by national banks that exceed the net income (as defined) for the current year plus retained net income for the preceding two years must be approved by the Comptroller of the Currency. Regardless of formal regulatory restrictions, the Company and the Bank may not pay dividends that would result in its capital levels being reduced below the minimum regulatory requirements (see Note 14). Note 8. Income Statement Information Interest income and interest expense for the years ended December 31, 1997 and 1996 consists of the following:
1997 1996 - ------------------------------------------------------------------------------------- Interest income: Interest and fees on loans (Note 3) $15,771,000 $13,015,000 Interest on investment securities 422,000 438,000 Interest on federal funds sold 228,000 493,000 Interest on deposits in other banks -- 32,000 -------------------------- $16,421,000 $13,978,000 ========================== - ------------------------------------------------------------------------------------- Interest expense: Demand $ 1,458,000 $ 1,446,000 Savings 114,000 116,000 Time certificates of deposit of $100,000 or more 1,504,000 1,100,000 Other time deposits 776,000 1,193,000 Short term borrowings 192,000 33,000 -------------------------- $ 4,044,000 $ 3,888,000 ==========================
F-21 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 8. Income Statement Information (Continued) Other expense: Other expense for the years ended December 31, 1997 and 1996 consists of the following:
1997 1996 - ---------------------------------------------------------------------- Other real estate owned expense $ 510,000 $ 400,000 Professional services 408,000 472,000 Insurance 268,000 672,000 Business development expense 213,000 181,000 Legal 213,000 322,000 Supplies 182,000 212,000 Miscellaneous 258,000 334,000 ------------------------ $2,052,000 $2,593,000 ========================
In September 1996, Congress passed legislation which began the process of merging the bank (BIF) and savings and loans (SAIF) insurance funds into one fund. As a result of the legislation, all institutions that had SAIF deposits were required to pay a one time assessment for those deposits that brought up the SAIF fund to a level commensurate with the BIF fund. During 1996, the Bank paid approximately $307,000 for this special one time assessment which is included in insurance expense. This payment will reduce the Bank's future SAIF deposit insurance premiums. Note 9. Income Taxes The provision for income taxes consists of the following:
1997 1996 - --------------------------------------------------------------- Current Federal $2,729,000 $ 896,000 State 482,000 505,000 Deferred 350,000 (456,000) ----------------------- Provision for income taxes $3,561,000 $ 945,000 =======================
F-22 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 9. Income Taxes (Continued) The provision for income taxes resulted in an effective tax rate different from the federal income tax statutory rate. The reasons for this difference is as follows:
1997 1996 - ---------------------------------------------------------------------------------------------- Federal income tax computed at a statutory rate of 35% $3,003,000 $1,575,000 State franchise tax, net of federal income tax benefit 632,000 278,000 Change in valuation allowance -- (890,000) Other items (74,000) (18,000) ------------------------- Total provision for income taxes $3,561,000 $ 945,000 =========================
Components of the Company's deferred tax assets and liabilities at December 31, are as follows:
1997 1996 - ----------------------------------------------------------------------------- Nonaccrual interest income $ 12,000 $ 170,000 Indemnification reserve 158,000 188,000 Mortgage loans held for sale 273,000 281,000 State income taxes 242,000 167,000 Other 72,000 92,000 ----------------------- Total deferred tax assets 757,000 898,000 ----------------------- Loan loss reserve (353,000) (68,000) Discount on loans (146,000) (145,000) Other (108,000) (69,000) Premises and equipment -- (116,000) ----------------------- Total deferred tax liabilities (607,000) (398,000) ----------------------- Net deferred tax assets included in other assets $ 150,000 $ 500,000 =======================
F-23 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 9. Income Taxes (Continued) During 1996, management eliminated the valuation allowance on deferred tax assets as they believe it is more likely than not that the deductible temporary differences will be realized. Management considered the Company's recent past and expected future performance in making the determination to eliminate the valuation allowance. If the Company is unable to generate the income necessary to recognize the deferred tax assets recorded, a valuation allowance will need to be provided in the future. Note 10. Segment Data, Mortgage Banking Operations The Bank operates a residential mortgage division for the origination and sale of mortgage loans. The operations of this division are very sensitive to changes in the prevailing market rates of interest. Substantially all of the mortgage loans the Bank originates are located in Los Angeles, Orange, San Bernardino and San Diego Counties and all loans are sold to institutional investors. The majority of the loans were sold to two investors for the years ended December 31, 1997 and 1996. For the years ended December 31, 1997 and 1996, 35% of the loans were sold to Countrywide Home Loans, Inc. and for 1997 and 1996, 38% and 27%, respectively, were sold to Norwest Funding, Inc. The Bank does not maintain the servicing on the loans which it sells. The mortgage division operates both a wholesale and retail department. During 1997, approximately 91% of the loan volume was originated from the wholesale department, and approximately 53% of the mortgage loans originated were FHA- insured or VA-guaranteed loans. In addition, approximately 73% of the mortgage loan volume originated in 1997 were purchase money loans. All revenue earned by this division is from unaffiliated third parties. Income from operations of the mortgage division was $4,319,000 and $2,725,000 for the years ended December 31, 1997 and 1996, respectively. Income from the mortgage division operations is calculated before income tax and allocation of corporate expenses such as administration, data processing, legal and accounting. Income from operations of the mortgage division does not include the interest income or expense associated with the funding and holding of mortgage loans before they are sold. Total assets related to the mortgage division, which include the inventory of mortgage loans held for sale as well as certain furniture and equipment were $101,176,000 and $66,253,000 as of December 31, 1997 and 1996, respectively. As of December 31, 1997, the Bank employed 229 people, of whom 156 were engaged in the mortgage division. F-24 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 11. Estimated Fair Value of Financial Instruments In accordance with FASB Statement No. 107, "Disclosures About Fair Value of Financial Instruments," a summary of the estimated fair value of the Company's consolidated financial instruments as of December 31, 1997 and 1996 is presented below. The estimated fair value amounts have been determined by management using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Statement No. 107 excludes certain financial instruments and all nonfinancial assets and liabilities from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
1997 1996 --------------------------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value - ------------------------------------------------------------------------------------------- (In Thousands) ASSETS Cash and due from banks $ 15,185 $ 15,185 $ 12,700 $ 12,700 Federal funds sold -- -- 6,000 6,000 Securities available for sale 6,910 6,910 7,381 7,381 Mortgage loans held for sale 96,852 97,452 62,620 62,979 Loans 116,626 116,742 102,414 102,381 Investment in REIT 1,000 1,000 -- -- Convertible note from REIT 1,500 1,500 -- -- Accrued interest receivable 950 950 848 848 Liabilities Savings and demand deposits 160,604 160,604 125,864 125,864 Time deposits 50,486 50,517 44,175 44,147 Borrowing on line of credit 5,000 5,000 7,000 7,000 Accrued interest payable 287 287 205 205 Gain (Loss) on Off-Balance Sheet Financial Instruments Mandatory forward commitments -- (286) -- 270 Mortgage loan commitments -- 345 -- (172) Interest rate swap -- 194 -- 61 Portfolio loan commitments -- (178) -- (122)
The fair value of cash and due from banks, federal funds sold, accrued interest receivable and payable, and borrowings on the line of credit, approximate their carrying amounts. The fair value of securities available for sale, mortgage loans held for sale and mandatory forward commitments are based on quoted market prices when such quotes are available. In the absence of quoted market prices, securities are priced based on prices obtained from certain brokers. These brokers estimate the fair value based upon quoted prices for similar securities. There can be no assurance that the prices estimated for such securities can be realized upon ultimate sale. F-25 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 11. Estimated Fair Value of Financial Instruments (Continued) For variable rate loans that reprice frequently, and that have experienced no significant change in credit risk, fair values are based on carrying values. At December 31, 1997 and 1996, variable rate loans comprised approximately 82% and 79%, respectively, of the loan portfolio. Fair values for all other loans are estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. Prepayments prior to the repricing date are not expected to be significant. Loans not held for sale are expected to be held to maturity and any unrealized gains or losses are not expected to be realized. The fair value of the Company's investment in the REIT is estimated to be equal to the carrying value of the investment as the REIT was capitalized in late December and operations have not commenced on any significant level. Fair values disclosed for demand deposits equal their carrying amounts, which represent the amount payable on demand. The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation. This calculation uses interest rates currently being offered on certificates with similar maturities. Early withdrawals of fixed rate certificates of deposit are not expected to be significant. The fair value of mortgage loan commitments is estimated by taking into account the rates being demanded on mortgage loans without the value of servicing. The fair value of portfolio loan commitments is based on fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and the counterparty credit standings. The fair value of the interest rate swap at December 31, 1997 and 1996, is estimated based on the present value of the payments currently being received over the swaps contractual life. Changes in the interest rate will have a significant effect on the swaps fair value. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1997 and 1996. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since that date and, therefore, current fair value estimates may differ significantly from amounts presented herein. F-26 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 11. Estimated Fair Value of Financial Instruments (Continued) Interest rate risk: The Bank assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, fair value of the Bank's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Bank. Management attempts to match maturities of rate sensitive assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to repay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of rate sensitive assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Bank's overall interest rate risk. Note 12. Condensed Financial Information - Parent Company Only A condensed summary of financial information of PNB Financial Group (parent company only) is as follows: CONDENSED BALANCE SHEETS
ASSETS 1997 1996 - -------------------------------------------------------------------------------------- Cash $ 327,000 $ 338,000 Loans, net 1,285,000 1,879,000 Investment in subsidiary 19,850,000 16,778,000 Investment and convertible debt in REIT (Note 4) 2,500,000 -- Other assets 39,000 75,000 --------------------------- Total assets $24,001,000 $19,070,000 =========================== LIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------------- Liabilities $ 4,000 $ 387,000 Stockholders' equity 23,997,000 18,683,000 --------------------------- Total liabilities and stockholders' equity $24,001,000 $19,070,000 ===========================
F-27 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 12. Condensed Financial Information - Parent Company Only (Continued)
CONDENSED STATEMENTS OF INCOME 1997 1996 - ------------------------------------------------------------------------------ Revenues, including dividends received from Bank of $2,000,000 in 1997 $ 2,219,000 $ 469,000 Expenses 199,000 263,000 --------------------------- Income before equity in net income of subsidiary 2,020,000 206,000 Equity in net income of subsidiary 3,000,000 3,350,000 --------------------------- Net income $ 5,020,000 $ 3,556,000 =========================== CONDENSED STATEMENTS OF CASH FLOWS - ------------------------------------------------------------------------------ Net income $ 5,020,000 $ 3,556,000 Equity in net income of subsidiary (3,000,000) (3,350,000) Other 295,000 346,000 --------------------------- Cash flows from operating activities 2,315,000 552,000 Cash flows (used in) investing activities (1,906,000) (864,000) Cash flows (used in) financing activities (420,000) (122,000) --------------------------- Net (decrease) in cash (11,000) (434,000) Cash at beginning of year 338,000 772,000 --------------------------- Cash at end of year $ 327,000 $ 338,000 ===========================
During 1997, the Bank paid dividends to the Company totaling $2,000,000. There were no dividends paid from the Bank to the Company during the year ended December 31, 1996. F-28 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 13. Disclosure of Cash Flow Information Supplemental cash flow information and disclosure of noncash activity for the years ended December 31 is as follows:
1997 1996 - -------------------------------------------------------------------------------------------- Supplemental Disclosure of Cash Flow Information Interest paid $3,974,000 $3,929,000 ========================= Income taxes paid, net $3,851,000 $1,282,000 ========================= Supplemental Disclosure of Noncash Investing Activities Real estate acquired in settlement of loans $2,238,000 $7,343,000 ========================= Loans to facilitate sale of other real estate owned $1,537,000 $2,423,000 =========================
Note 14. Regulatory Matters Bank regulations require that all banks maintain a percentage of their deposits as reserves at the Federal Reserve Bank. At December 31, 1997 and 1996, total required reserves were $5,582,000 and $3,521,000, respectively. These amounts are included in cash and due from banks. The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve qualitative measures of the Company and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997, that the Company and the Bank met all capital adequacy requirements to which it is subject. As of December 31, 1997, the Company and the Bank are categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios as set forth in the table. There are no conditions or events since that management believes have changed the institution's category. F-29 PNB FINANCIAL GROUP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 14. Regulatory Matters (Continued) The Company and the Bank's actual capital amounts and ratios, along with the minimum capital amounts and ratios for both capital adequacy purposes and to be well capitalized under prompt corrective action provisions, are presented in the following tables. All amounts are in thousands. The Bank:
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio - ---------------------------------------------------------------------------------------------------------- As of December 31, 1997 Total Capital (to Risk Weighted Assets) $21,225 13.2% $12,834 8.0% $16,043 10.0% Tier I Capital (to Risk Weighted Assets) $19,723 12.3% $ 6,417 4.0% $ 9,626 6.0% Tier I Capital (to Average Assets) $19,723 8.8% $ 8,937 4.0% $11,171 5.0% As of December 31, 1996 Total Capital (to Risk Weighted Assets) $18,025 13.3% $10,868 8.0% $13,589 10.0% Tier I Capital (to Risk Weighted Assets) $16,327 12.0% $ 5,434 4.0% $ 8,151 6.0% Tier I Capital (to Average Assets) $16,327 8.8% $ 7,461 4.0% $ 9,326 5.0%
The Company:
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio - ---------------------------------------------------------------------------------------------------------- As of December 31, 1997 Total Capital (to Risk Weighted Assets) $25,428 15.5% $13,148 8.0% $16,435 10.0% Tier I Capital (to Risk Weighted Assets) $23,870 14.5% $ 6,574 4.0% $ 9,861 6.0% Tier I Capital (to Average Assets) $23,870 10.5% $ 9,052 4.0% $11,315 5.0% As of December 31, 1996 Total Capital (to Risk Weighted Assets) $20,463 14.9% $10,986 8.0% $13,733 10.0% Tier I Capital (to Risk Weighted Assets) $18,746 13.7% $ 5,493 4.0% $ 8,240 6.0% Tier I Capital (to Average Assets) $18,746 10.0% $ 7,553 4.0% $ 9,441 5.0%
F-30 EX-10.4 2 EXECUTIVE OFFICER EMPLOYMENT CONTRACTS EXHIBIT 10.4 EXECUTIVE OFFICER EMPLOYMENT CONTRACTS EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into --------- effective as of the 1st day of March, 1998, by and between PNB FINANCIAL GROUP, a California corporation ("PNBFG"), and ALLEN C. BARBIERI, an individual ----- ("Barbieri"). - ---------- R E C I T A L S - - - - - - - - A. PNBFG desires to employ Barbieri and Barbieri desires to be employed by PNBFG. B. Barbieri and PNBFG desire to enter into an employment agreement to set forth the terms of Barbieri's employment by PNBFG. NOW, THEREFORE, in consideration of the foregoing premises and of the mutual covenants, conditions, and agreements hereinafter set forth, the parties hereto agree as follows: A G R E E M E N T - - - - - - - - - 1. Employment. PNBFG hires and employs Barbieri, and Barbieri agrees to ---------- serve PNBFG, under and subject to all of the terms, conditions, and provisions of this Agreement, as President and Chief Executive Officer of PNBFG, as President and Chief Executive Officer of PNBFG's wholly-owned subsidiary PACIFIC NATIONAL BANK, a national banking association (the 1 "Bank"), and in such other executive capacity or capacities as the Board of ---- Directors of PNBFG may from time to time designate. Barbieri's duties shall be subject to such policies and directions as may be established or given by the Boards of Directors of PNBFG or the Bank from time to time. 2. Term of Employment. The term of employment of Barbieri shall commence ------------------ on March 1, 1998 and shall continue for a period of one (1) year thereafter (the "Initial Term") unless sooner terminated as provided herein. The Initial Term ------------ shall be extended for an additional term of one year following the Initial Term ("Successive Term") and thereafter for additional Successive Terms of one year --------------- following each Successive Term, unless prior to the end of, in the first instance, the Initial Term, and thereafter, each Successive Term, either party gives written notice to the other party of its intention not to renew. Such notice must be given in writing no later than ninety (90) days prior to the beginning of the subsequent Successive Term. 3. Compensation. For all services rendered by Barbieri under this ------------ Agreement, Barbieri shall be paid as compensation an annual salary of $50,000 ("Base Salary") to be paid in equal semi-monthly installments. Except as - ------------- specifically provided in this Agreement, Barbieri shall not be entitled to additional compensation of any kind, except as may be agreed to 2 from time to time after the date hereof by the Board of Directors of PNBFG or the Bank. It is contemplated that, at the sole discretion of PNBFG, Barbieri may be granted certain options by PNBFG. Such grant, if any is made, will be evidenced by a separate agreement. 4. Executive Benefits. Barbieri shall also receive the following ------------------ benefits: (a) Medical insurance benefits pursuant to the Bank's personnel policy as it may change from time to time; (b) Participation in the Bank's 401(k) plan consistent with its terms as they may change from time to time; (c) Paid vacation pursuant to the Bank's personnel policy as that policy shall change from time to time; and (d) Sick leave pursuant to the Bank's personnel policy as that policy shall change from time to time. 5. Termination by PNBFG. Barbieri's employment may be terminated by -------------------- PNBFG without any breach of this Agreement under the circumstances described below: (a) Death. Barbieri's employment shall terminate upon his death. ----- 3 (b) Disability. If, as a result of Barbieri's incapacity due to physical ---------- or mental illness, Barbieri shall have been absent from his duties for a period of one hundred twenty (120) consecutive days, and, within thirty (30) days after written notice of PNBFG's intention to exercise its rights under this Section 5(b) is given (which may not be given prior to the expiration of such one hundred twenty (120) day period) shall not have returned to the performance of his duties on a full time basis ("Barbieri's Disability"), PNBFG may terminate --------------------- Barbieri's employment by giving written notice to such effect to Barbieri. In the event of the termination of Barbieri's employment pursuant to this Section 5(b), the date of termination shall be the date on which notice of termination is received by Barbieri or his personal representative. (c) For Cause. PNBFG may terminate Barbieri's employment under this --------- Agreement at any time for cause. For purposes of this Agreement, the term "cause" shall be limited to the following: (i) acts by Barbieri involving moral turpitude which reflect materially and adversely on PNBFG, its reputation, or its assets; (ii) gross neglect by Barbieri of his duties; (iii) conviction of a crime involving moral turpitude, including, without limitation, theft or embezzlement; (iv) alcohol or drug abuse; (v) any instance in which the Federal 4 Reserve Bank, Federal Deposit Insurance Corporation or the Office of the Comptroller of Currency directs or indicates in any fashion that Barbieri should cease serving as President or Chief Executive Officer of PNBFG or the Bank; (vi) failure to follow any policy, order, or directive of the Board of Directors of PNBFG or the Bank; or (vii) a material breach of this Agreement. Termination pursuant to this Section 5(c) shall be by written notice to Barbieri which notice shall specify the cause for termination. (d) Without Cause. PNBFG may, at any time upon the vote of a majority of ------------- the directors of PNBFG then in office, terminate Barbieri without cause. For the purposes of this Agreement, the term "without cause" shall mean termination for grounds other than those specified in Subsections (a), (b), or (c) of this Section 5. In the event that Barbieri is terminated without cause, Barbieri shall be entitled to the payments provided in Section 7(d). 6. Termination by Barbieri. ----------------------- (a) Three Month Notice. Barbieri may terminate his employment hereunder ------------------ only upon three (3) months' written notice to PNBFG. If Barbieri terminates his employment hereunder, PNBFG shall pay Barbieri his full Base Salary, and other benefits earned or accrued through the date of termination 5 specified in Barbieri's written notice of termination, at the rate in effect on the date notice of termination is given. (b) Termination for "Good Reason". Notwithstanding Section 6(a), if ---------------------------- Barbieri provides written notice of termination for Good Reason (as defined below), he shall be entitled to any and all severance rights as set forth in Section 7(d). Barbieri is considered to have terminated his employment for "Good Reason" if, and only if, his termination is based upon the occurrence of one of the following: (i) the assignment to Barbieri, by PNBFG or Bank or any successor of either of them, of duties substantially and materially inconsistent with the position and nature of his employment as set forth in Section 1; (ii) a reduction of compensation and benefits, by PNBFG or any successor thereof, that would substantially diminish the aggregate value of Barbieri's compensation; or (iii) the failure by PNBFG to obtain from any successor to PNBFG or the Bank an agreement to assume and perform this Agreement. 7. Compensation Upon Termination or Disability. ------------------------------------------- (a) Death. If Barbieri's employment is terminated by his death, PNBFG ----- shall pay Barbieri's full Base Salary, and any accrued benefits through the date of his death. 6 (b) Disability. During any period that Barbieri fails to perform his ---------- duties as a result of incapacity due to physical or mental illness (the "Disability Period") Barbieri shall continue to receive his full Base Salary and ----------------- other benefits at the rate in effect for such period until his employment is terminated by PNBFG for Barbieri's Disability pursuant to Section 5(b), provided that payments so made to Barbieri during the Disability Period shall be reduced by the sum of the amounts, if any, which were paid to Barbieri at or prior to the time of such payment under any disability benefit plans of PNBFG or the Bank and which were not previously applied to reduce any such payment. (c) For Cause by PNBFG. If Barbieri's employment shall be terminated for ------------------ cause by PNBFG pursuant to Section 5(c), PNBFG shall pay Barbieri his full Base Salary, and other benefits earned or accrued through the date of termination at the rate in effect on the date on which notice of termination is received. (d) Without Cause. If Barbieri's employment is terminated without cause ------------- pursuant to Section 5(d), or if PNBFG gives written notice to Barbieri of its intention not to renew for a Successive Term pursuant to Section 2, or if Barbieri terminates his employment with PNBFG for Good Reason pursuant to 7 Section 6(b), then PNBFG shall pay to Barbieri, on or before the effective date of termination, an amount equal to the sum of $150,000. 8. Covenant Not to Compete. Barbieri agrees that he will not, without ----------------------- the consent of Board of Directors of PNBFG, and subject to regulatory restrictions (if any), during his employment with PNBFG, act as an officer, director, consultant to or employee of, any business competing in the business of PNBFG or the Bank. In addition, Barbieri will not, except on behalf of PNBFG or the Bank, directly or indirectly, solicit or accept business in competition with PNBFG or the Bank from any persons or entities which have been customers of PNBFG or the Bank during the period from the commencement of the Initial Term to the date of Barbieri's termination. If Barbieri terminates his employment with PNBFG other than for Good Reason, or if Barbieri is terminated for cause, Barbieri will not, for a period beginning on the date of termination and ending one (1) year thereafter, directly or indirectly: (1) enter into the employ of, assume an interest in (in any capacity) or render any services to, any person or entity engaged in any business competitive with the business of PNBFG or the Bank within Orange or Los Angeles Counties in California or 8 within a one hundred (100) mile radius of any location where PNBFG or the Bank proposes to engage in business on or prior to the termination of employment; (2) engage in any such business on his own account; (3) contact or solicit any person or entity which is a customer of PNBFG or the Bank or who has been contacted orally or in writing by PNBFG or the Bank as a potential customer on or prior to the termination of employment; or (4) hire, subcontract, employ, engage, contact or solicit for the purpose of hiring any person or entity who is an employee of PNBFG or the Bank or who had been employed by PNBFG or the Bank at any time within six (6) months preceding the date of Barbieri's termination. If PNBFG terminates the employment of Barbieri without cause or Barbieri terminates his own employment with PNBFG for Good Reason, then the provisions of the preceding paragraph shall be effective from the date of termination and ending three (3) months after the date of termination. Barbieri and PNBFG agree and stipulate that the period of time and geographical area specified in the preceding two paragraphs are fair and reasonable in view of the nature of the business of PNBFG and the Bank, Barbieri's access to PNBFG and the Bank's confidential information and knowledge of PNBFG and the Bank's business. However, in the event that a court should decline to enforce these provisions, Barbieri and PNBFG agree that 9 the provisions shall be deemed to be modified to restrict Barbieri's competition with PNBFG and the Bank to the maximum extent, in both time and geography, which the court shall find enforceable. In no event will the covenant be interpreted as more restrictive to Barbieri. Notwithstanding the foregoing, PNBFG and Barbieri agree that this Section 8 will not pertain to, and will not limit in any way, Barbieri's ability to act as an officer and/or director of Alta Residential Mortgage, Inc. 9. Miscellaneous. ------------- (a) All notices which are required or permitted to be given pursuant to this Agreement shall be in writing and shall be sufficient in all respects if given in writing and delivered personally or by registered or certified airmail, postage prepaid, addressed as follows: If to PNBFG: PNB FINANCIAL GROUP c/o Bernard Schneider Chairman, Board of Directors 1301 Dove Street, Suite 500 Newport Beach, California 92660 10 If to Barbieri: ALLEN C. BARBIERI 7 Winterbranch Irvine, California 92714 Notice shall be deemed to have been given upon receipt thereof as to communications which are personally delivered and five (5) days after deposit of the same in any United States mail post office box in the state to which the notice is addressed, or seven (7) days after deposit of same in any such post office box other than in the state in which the notice is addressed, postage prepaid, addressed as set forth above. Notice shall not be deemed given under the preceding sentence unless and until notice is given to all addressees above other than the sender. The addresses and addressees for the purpose of this Section may be changed by giving written notice of such change in the manner provided herein for giving notice. Unless and until such written notice is given, the addresses and addressees as stated by prior written notice, or as provided herein if no written notice of change has been given, shall be deemed to continue in effect for all purposes hereunder. (b) If any portion of this Agreement is held unenforceable or invalid, the remaining portions shall nevertheless remain valid and in full force and effect. 11 (c) This Agreement constitutes the entire agreement between the parties pertaining to the subject matter hereof and fully supersedes any and all prior agreements or understandings whether oral or written. Any amendment to this Agreement shall be effective only upon the written consent of each of the parties. Any waiver by any party of any of its rights under this Agreement is effective only if set forth in a writing delivered to the other party, and no course of dealing and no delay by any party in exercising any right, power, or remedy shall operate as a waiver thereof or otherwise prejudice such party's rights, powers, or remedies. (d) If any legal action or arbitration or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, default, or breach in connection with any of the provisions of this Agreement, the successful or prevailing party or parties shall be entitled to recover reasonable attorneys' fees, expenses, and other costs incurred in that action or proceeding in addition to any other relief to which it or he may be entitled. The right to such attorneys' fees, expenses, and costs shall be deemed to have accrued upon the commencement or such action and shall be enforceable whether or not such action is prosecuted to judgment. 12 (e) This Agreement is being delivered and is intended to be performed in the State of California and shall be construed and enforced in accordance with and governed by the laws of the State of California other than and without giving effect to the laws of the State of California relating to choice of law. (f) The parties agree that any action, at law or in equity, arising under this Agreement shall be filed and conducted in and only in the Superior Court of the State of California for the County of Orange or the United States District Court for the Central District of California. The parties hereby submit to the in personam jurisdiction and venue of such courts in the State of ----------- California for the purposes of litigating any such action. (g) Except as expressly provided herein, neither this Agreement nor any of the rights or obligation of Barbieri hereunder shall be assignable or delegable by Barbieri. Neither this Agreement nor any other rights or obligations of PNBFG hereunder shall be assignable by PNBFG; provided, however, that this Agreement shall be assignable to and shall be binding upon and inure to the benefit of any successor of PNBFG or the Bank, including, directly or indirectly, all or substantially all of the assets of PNBFG or the Bank whether by merger, 13 consolidation, sale or otherwise (and such successor shall thereafter be deemed "PNBFG" for the purposes of this Agreement), but shall not otherwise be assignable by PNBFG. Entered into this 1st day of March, 1998 at Newport Beach, California. --- ----- PNB FINANCIAL GROUP By:/s/ BERNARD SCHNEIDER ---------------------------- BERNARD SCHNEIDER Chairman, Board of Directors /s/ ALLEN C. BARBIERI ---------------------------- ALLEN C. BARBIERI 14 EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into --------- effective as of the 1st day of March, 1998, by and between PACIFIC NATIONAL BANK, a national banking association (the "Bank"), and ALLAN GIBSON, an individual ("Gibson"). ------ R E C I T A L S - - - - - - - - A. The Bank desires to employ Gibson and Gibson desires to be employed by the Bank. B. Gibson and the Bank desire to enter into an employment agreement to set forth the terms of Gibson's employment by the Bank. NOW, THEREFORE, in consideration of the foregoing premises and of the mutual covenants, conditions, and agreements hereinafter set forth, the parties hereby agree as follows: A G R E E M E N T - - - - - - - - - 1. Employment. The Bank hires and employs Gibson, and Gibson agrees to ---------- serve the Bank, under and subject to all of the terms, conditions, and provisions of this Agreement, as Executive Vice President and Chief Operating Officer of the Bank and in such other executive capacity or capacities as the Board -1- of Directors of the Bank may from time to time designate. Gibson's duties shall be subject to such policies and directions as may be established or given by the Board of Directors of the Bank from time to time. Gibson further agrees to serve the Bank well and faithfully in the executive capacities to which he is appointed and to devote his full time, attention, and energy to such services during normal business hours. 2. Term of Employment. The term of employment of Gibson shall commence ------------------ on March 1, 1998 and shall continue for a period of one (1) year thereafter (the "Initial Term") unless sooner terminated as provided herein. The Initial Term ------------ shall be extended for an additional term of one year following the Initial Term ("Successive Term") and thereafter for additional Successive Terms of one year --------------- following each Successive Term, unless prior to the end of, in the first instance, the Initial Term, and thereafter, each Successive Term, either party gives written notice to the other party of its intention not to renew. Such notice must be given no later than ninety (90) days prior to the beginning of the subsequent Successive Term. 3. Compensation. For all services rendered by Gibson under this ------------ Agreement, Gibson shall be paid as compensation an annual salary of $130,000 ("Base Salary") to be paid in equal semi-monthly installments. Except as - ------------- specifically provided in -2- this Agreement, Gibson shall not be entitled to additional compensation of any kind, except as may be agreed to from time to time after the date hereof by the Board of Directors. It is contemplated that Gibson may be granted certain options by the Bank's parent, PNB Financial Group, Inc. ("PNBFG"), but any such ----- grant is outside the scope of this Agreement and the Bank has no power or authority to obligate or bind PNBFG. Such grant, if any is made, will be evidenced by separate agreement between Gibson and PNBFG. 4. Executive Benefits. Gibson shall also receive the following ------------------ benefits: (a) Medical insurance benefits pursuant to the Bank's personnel policy as it may change from time to time; (b) Participation in the Bank's 401(k) plan consistent with its terms as they may change from time to time; (c) Paid vacation pursuant to the Bank's personnel policy as that policy shall change from time to time; and (d) Sick leave pursuant to the Bank's personnel policy as that policy shall change from time to time. -3- 5. Termination by the Bank. Gibson's employment hereunder may be ----------------------- terminated by the Bank without any breach of this Agreement under the circumstances described below: (a) Death. Gibson's employment hereunder shall terminate upon ----- his death. (b) Disability. If, as a result of Gibson's incapacity due to ---------- physical or mental illness, Gibson shall have been absent from his duties for a period of one hundred twenty (120) consecutive days, and, within thirty (30) days after written notice of the Bank's intention to exercise its rights under this Section 5(b) is given (which may not be given prior to the expiration of such one hundred twenty (120) day period) shall not have returned to the performance of his duties on a full time basis ("Gibson's Disability"), the ------------------- Bank may terminate Gibson's employment hereunder by giving written notice to such effect to Gibson. In the event of the termination of Gibson's employment pursuant to this Section 5(b), the date of termination shall be the date on which notice of termination is received by Gibson or his personal representative. (c) For Cause. Bank may terminate Gibson's employment under --------- this Agreement at any time for cause. For purposes of this Agreement, the term "cause" shall be limited to the following: (i) acts by Gibson involving moral turpitude -4- which reflect materially and adversely on the Bank, its reputation, or its assets; (ii) gross neglect by Gibson of his duties; (iii) conviction of a crime involving moral turpitude, including, without limitation, theft or embezzlement; (iv) alcohol or drug abuse; (v) any instance in which the Federal Reserve Bank, Federal Deposit Insurance Corporation or the Office of the Comptroller of Currency directs or indicates in any fashion that Gibson should cease serving as Executive Vice President or Chief Operating Officer of the Bank; or (vi) a material breach of this Agreement. Termination pursuant to this Section 5(c) shall be by written notice to Gibson which notice shall specify the cause for termination. (d) Without Cause. The Bank may, at any time upon the vote of a ------------- majority of the directors of the Bank then in office, terminate Gibson without cause. For the purposes of this Agreement, the term "without cause" shall mean termination for grounds other than those specified in Subsections (a), (b), or (c) of this Section 5. In the event that Gibson is terminated without cause, Gibson shall be entitled to the payments provided in Section 7(d). 6. Termination by Gibson. Gibson may terminate his employment --------------------- hereunder only upon three (3) months' written notice to the Bank. If Gibson terminates his employment hereunder, -5- Bank shall pay Gibson his full Base Salary, and other benefits earned or accrued through the date of termination specified in Gibson's written notice of termination, at the rate in effect on the date notice of termination is given. 7. Compensation Upon Termination or Disability. ------------------------------------------- (a) Death. If Gibson's employment is terminated by his death ----- during the Initial Term, the Bank shall pay Gibson's full Base Salary for the remainder of the Initial Term and any accrued benefits through the date of his death. If Gibson's employment is terminated by his death after the Initial Term, the Bank shall pay Gibson's full Base Salary, and any accrued benefits through the date of his death. (b) Disability. During any period that Gibson fails to perform ---------- his duties as a result of incapacity due to physical or mental illness (the "Disability Period") Gibson shall continue to receive his full Base Salary and ----------------- other benefits at the rate in effect for such period until his employment is terminated by the Bank for Gibson's Disability pursuant to Section 5(b), provided that payments so made to Gibson during the Disability Period shall be reduced by the sum of the amounts, if any, which were paid to Gibson at or prior to the time of such payment under any disability benefit plans of -6- the Bank and which were not previously applied to reduce any such payment. (c) For Cause by the Bank. If Gibson's employment shall be --------------------- terminated for cause by the Bank pursuant to Section 5(c), the Bank shall pay Gibson his full Base Salary, and other benefits earned or accrued through the date of termination at the rate in effect on the date on which notice of termination is received. (d) Without Cause. If Gibson's employment is terminated ------------- by the Bank without cause pursuant to Section 5(d) or the Bank gives written notice to Gibson of its intention not to renew for a Successive Term pursuant to Section 2, then the Bank shall pay to Gibson, on or before the effective date of termination, an amount equal to the sum of (i) that portion of Gibson's Base Salary and benefits earned or accrued through the effective date of termination and (ii) an amount equal to the Base Salary. Payment of such severance amounts will be paid by Bank in equal monthly installments for the three (3) months subsequent to the effective date of termination. 8. Covenant Not to Compete. Gibson agrees that he will not, ----------------------- without the consent of Board of Directors of the Bank, and subject to regulatory restrictions (if any), during his employment with the Bank, act as an officer, director, -7- consultant to or employee of, any business competing in the business of the Bank. In addition, without limitation and notwithstanding the foregoing, Gibson will not, except on behalf of the Bank, directly or indirectly, solicit or accept business in competition with the Bank from any persons or entities which have been customers of the Bank during the period from the commencement of the Initial Term to the date of Gibson's termination. If Gibson terminates his employment with the Bank, Gibson will not, for a period beginning on the date of termination and ending one (1) year thereafter, directly or indirectly: (1) enter into the employ of, assume an interest in (in any capacity) or render any services to, any person or entity engaged in any business competitive with the business of the Bank within Orange or Los Angeles Counties in California, or within a one hundred (100) mile radius of any location where the Bank proposes to engage in business on or prior to the termination of employment; (2) engage in any such business on his or her own account; (3) contact or solicit any person or entity which is a customer of the Bank or has been contacted orally or in writing, by the Bank as a potential customer on or prior to the termination of employment; or (4) hire, subcontract, employ, engage, contact -8- or solicit for the purpose of hiring any person or entity who is an employee of the Bank or who had been employed by the Bank at any time within six (6) months preceding the date of Gibson's termination. If the Bank terminates the employment of Gibson with or without cause, the provisions of the preceding paragraph shall be effective from the date of termination and ending three (3) months after the date of termination. Gibson and the Bank agree and stipulate that the period of time and geographical area specified in the preceding two paragraphs are fair and reasonable in view of the nature of the business of the Bank, and Gibson's access to the Bank's confidential information and knowledge of the Bank's business. However, in the event that a court should decline to enforce these provisions, Gibson and the Bank agree that the provisions shall be deemed to be modified to restrict Gibson's competition with the Bank to the maximum extent, in both time and geography, which the court shall find enforceable. In no event will the covenant be interpreted as more restrictive to Gibson. 9. Miscellaneous. ------------- (a) All notices which are required or permitted to be given pursuant to this Agreement shall be in writing and -9- shall be sufficient in all respects if given in writing and delivered personally or by telegraph or by registered or certified airmail, postage prepaid, addressed as follows: If to the Bank: PACIFIC NATIONAL BANK 4665 MacArthur Court Newport Beach, California 92660 Attention: President and Chief Executive Officer If to Gibson: ALAN GIBSON 4665 MacArthur Court Newport Beach, California 92660 Notice shall be deemed to have been given upon receipt thereof as to communications which are personally delivered and five (5) days after deposit of the same in any United States mail post office box in the state to which the notice is addressed, or seven (7) days after deposit of same in any such post office box other than in the state in which the notice is addressed, postage prepaid, addressed as set forth above. Notice shall not be deemed given under the preceding sentence unless and until notice is given to all addressees above other than the sender. The addresses and addressees for the purpose of this Section may be changed by giving written notice of such change in the manner provided herein for giving notice. Unless and until such written notice is given, the addresses and addressees as stated by prior written notice, or -10- as provided herein if no written notice of change has been given, shall be deemed to continue in effect for all purposes hereunder. (b) If any portion of this Agreement is held unenforceable or invalid, the remaining portions shall nevertheless remain valid and in full force and effect. (c) This Agreement constitutes the entire agreement between the parties pertaining to the subject matter hereof and fully supersedes any and all prior agreements or understandings whether oral or written. Any amendment to this Agreement shall be effective only upon the written consent of each of the parties. Any waiver by any party of any of its rights under this Agreement is effective only if set forth in a writing delivered to the other party, and no course of dealing and no delay by any party in exercising any right, power, or remedy shall operate as a waiver thereof or otherwise prejudice such party's rights, powers, or remedies. (d) If any legal action or arbitration or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, default, or breach in connection with any of the provisions of this Agreement, the successful or prevailing party or parties shall be entitled to recover reasonable attorneys' fees, expenses, and other costs incurred -11- in that action or proceeding in addition to any other relief to which it or he may be entitled. The right to such attorneys' fees, expenses, and costs shall be deemed to have accrued upon the commencement or such action and shall be enforceable whether or not such action is prosecuted to judgment. (e) This Agreement is being delivered and is intended to be performed in the State of California and shall be construed and enforced in accordance with and governed by the laws of the State of California other than and without giving effect to the laws of the State of California relating to choice of law. (f) The parties agree that any action, at law or in equity, arising under this Agreement shall be filed and conducted in and only in the Superior Court of the State of California for the County of Orange or the United States District Court for the Central District of California. The parties hereby submit to the in personam jurisdiction and venue of such courts in the -- -------- State of California for the purposes of litigating any such action. (g) Except as expressly provided herein, neither the Agreement nor any of the rights or obligation of Gibson hereunder shall be assignable or delegable by Gibson. Neither this Agreement nor any other rights or obligations of the Bank -12- hereunder shall be assignable by the Bank; provided, however, that this Agreement shall be assignable to and shall be binding upon and inure to the benefit of any successor of the Bank, including, directly or indirectly, all or substantially all of the assets of the Bank whether by merger, consolidation, sale or otherwise (and such successor shall thereafter be deemed "the Bank" for the purposes of this Agreement), but shall not otherwise be assignable by the Bank. Entered into this 25 day of March, 1998 at Newport -- ----- Beach, California. PACIFIC NATIONAL BANK By: /s/ ALLEN BARBIERI ----------------------------- ALLEN C. BARBIERI President and Chief Executive Officer /s/ ALLAN GIBSON ---------------------------- ALLAN GIBSON -13- EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into as of --------- the 1st day of March, 1998, by and between PNB FINANCIAL GROUP, a California corporation ("PNBFG"), and DOUGLAS HELLER, an individual ("Heller"). ----- ------ R E C I T A L S - - - - - - - - A. PNBFG desires to employ Heller and Heller desires to be employed by PNBFG. B. Heller and PNBFG desire to enter into an employment agreement to set forth the terms of Heller's employment by PNBFG. NOW, THEREFORE, in consideration of the foregoing premises and of the mutual covenants, conditions, and agreements hereinafter set forth, the parties hereto agree as follows: A G R E E M E N T - - - - - - - - - 1. Employment. PNBFG hires and employs Heller, and Heller agrees to ---------- serve PNBFG, under and subject to all of the terms, conditions, and provisions of this Agreement, as Chief Financial Officer of PNBFG, as Executive Vice President and Chief Financial Officer of PNBPG's wholly-owned subsidiary PACIFIC NATIONAL BANK, a national banking association (the 1 "Bank"), and in such other executive capacity or capacities as the Board of ---- Directors of PNBFG may from time to time designate. Heller's duties shall be subject to such policies and directions as may be established or given by the Boards of Directors of PNBFG or the Bank from time to time. Heller further agrees to serve PNBFG and the Bank well and faithfully in the executive capacities to which he is appointed and to devote his full time, attention, and energy to such services during normal business hours. 2. Term of Employment. The term of employment of Heller shall commence ------------------ on March 1, 1998 and shall continue for a period of one (1) year thereafter (the "Initial Term") unless sooner terminated as provided herein. The Initial Term shall be extended for an additional term of one year following the Initial Term ("Successive Term") and thereafter for additional Successive Terms of one year --------------- following each Successive Term, unless prior to the end of, in the first instance, the Initial Term, and thereafter, each Successive Term, either party gives written notice to the other party of its intention not to renew. Such notice must be given in writing no later than ninety (90) days prior to the beginning of the subsequent Successive Term. 3. Compensation. For all services rendered by Heller under this ------------ Agreement, Heller shall be paid as 2 compensation an annual salary of $130,000 ("Base Salary") to be paid in equal semi-monthly installments. Except as specifically provided in this Agreement, Heller shall not be entitled to additional compensation of any kind, except as may be agreed from time to time after the date hereof by the Board of Directors of PNBFG or the Bank. It is contemplated that, at the sole discretion of PNBFG, Heller may be granted certain options by PNBFG. Such grant, if any is made, will be evidenced by a separate agreement. 4. Executive Benefits. Heller shall also receive the following benefits: ------------------ (a) Medical insurance benefits pursuant to the Bank's personnel policy as it may change from time to time; (b) Participation in the Bank's 401(k) plan consistent with its terms as they may change from time to time; (c) Paid vacation pursuant to the Bank's personnel policy as that policy shall change from time to time; and (d) Sick leave pursuant to the Bank's personnel policy as that policy shall change from time to time. 3 5. Termination by PNBFG. Heller's employment may be terminated by PNBFG -------------------- without any breach of this Agreement under the circumstances described below: (a) Death. Heller's employment hereunder shall terminate upon his death. ----- (b) Disability. If, as a result of Heller's incapacity due to physical ---------- or mental illness, Heller shall have been absent from his duties for a period of one hundred twenty (120) consecutive days, and, within thirty (30) days after written notice of PNBFG's intention to exercise its rights under this Section 5(b) is given (which may not be given prior to the expiration of such one hundred twenty (120) day period) shall not have returned to the performance of his duties on a full time basis ("Heller's Disability"), PNBFG may terminate ------------------- Heller's employment hereunder by giving written notice to such effect to Heller. In the event of the termination of Heller's employment pursuant to this Section 5(b), the date of termination shall be the date on which notice of termination is received by Heller or his personal representative. (c) For Cause. PNBFG may terminate Heller's employment under this --------- Agreement at any time for cause. For purposes of this Agreement, the term "cause" shall be limited to the following: (i) acts by Heller involving moral turpitude 4 which reflect materially and adversely on PNBFG, its reputation, or its assets; (ii) gross neglect by Heller of his duties; (iii) conviction of a crime involving moral turpitude, including, without limitation, theft or embezzlement; (iv) alcohol or drug abuse; (v) any instance in which the Federal Reserve Bank, Federal Deposit Insurance Corporation or the Office of the Comptroller of Currency directs or indicates in any fashion that Heller should cease serving as Chief Financial Officer of PNBFG or the Bank, or Executive Vice President of the Bank; (vi) failure to follow any policy, order, or directive of the Board of Directors of PNBFG or the Bank; or (vii) a material breach of this Agreement. Termination pursuant to this Section 5(c) shall be by written notice to Heller which notice shall specify the cause for termination. (d) Without Cause. PNBFG may, at any time upon the vote of a majority of ------------- the directors of PNBFG then in office, terminate Heller without cause. For the purposes of this Agreement, the term "without cause" shall mean termination for grounds other than those specified in Subsections (a), (b), or (c) of this Section 5. In the event that Heller is terminated without cause, Heller shall be entitled to the payments provided in Section 7(d). 5 6. Termination by Heller. Heller may terminate his employment hereunder --------------------- only upon three (3) months' written notice to PNBFG. If Heller terminates his employment hereunder, PNBFG shall pay Heller his full Base Salary, and other benefits earned or accrued through the date of termination specified in Heller's written notice of termination, at the rate in effect on the date notice of termination is given. 7. Compensation Upon Termination or Disability. ------------------------------------------- (a) Death. If Heller's employment is terminated by his death, PNBFG ----- shall pay Heller's full Base Salary, and any accrued benefits through the date of his death. (b) Disability. During any period that Heller fails to perform his ---------- duties as a result of incapacity due to physical or mental illness (the "Disability Period") Heller shall continue to receive his full Base Salary and ----------------- other benefits at the rate in effect for such period until his employment is terminated by PNBFG for Heller's Disability pursuant to Section 5(b), provided that payments so made to Heller during the Disability Period shall be reduced by the sum of the amounts, if any, which were paid to Heller at or prior to the time of such payment under any disability benefit plans of PNBFG and which were not previously applied to reduce any such payment. 6 (c) For Cause by PNBFG. If Heller's employment shall be terminated for ------------------ cause by PNBFG pursuant to Section 5(c), PNBFG shall pay Heller his full Base Salary, and other benefits earned or accrued through the date of termination at the rate in effect on the date on which notice of termination is received. (d) Without Cause. If Heller's employment is terminated without cause ------------- pursuant to Section 5(d) or if PNBFG gives written notice to Heller of its intention not to renew for a Successive Term pursuant to Section 2 then PNBFG shall pay to Heller, on or before the effective date of termination, an amount equal to the sum of (i) that portion of Heller's Base Salary and benefits earned or accrued through the effective date of termination and (ii) an amount equal to the Base Salary. Payment of such severance amounts will be paid by Bank in equal monthly installments for the three (3) months subsequent to the effective date of termination. 8. Covenant Not to Compete. Heller agrees that he will not, without the ----------------------- consent of Board of Directors of PNBFG, and subject to regulatory restrictions (if any), during his employment with PNBFG, act as an officer, director, consultant to or employee of, any business competing in the business of PNBFG or the Bank. 7 In addition, without limitation and notwithstanding the foregoing, Heller will not, except on behalf of PNBFG or the Bank, directly or indirectly, solicit or accept business in competition with PNBFG or the Bank from any persons or entities which have been customers of PNBFG or the Bank during the period from the commencement of the Initial Term to the date of Heller's termination. If Heller terminates his employment with PNBFG or if Heller is terminated for cause, Heller will not, for a period beginning on the date of termination and ending one (1) year thereafter, directly or indirectly: (1) enter into the employ of, assume an interest in (in any capacity) or render any services to, any person or entity engaged in any business competitive with the business of PNBFG or the Bank within Orange or Los Angeles Counties in California or within a one hundred (100) mile radius of any location where PNBFG or the Bank proposes to engage in business on or prior to the termination of employment; (2) engage in any such business on his own account; (3) contact or solicit any person or entity which is a customer of PNBFG or the Bank or who has been contacted orally or in writing by PNBFG or the Bank as a potential customer on or prior to the termination of employment; or (4) hire, subcontract, employ, engage, contact or solicit for the purpose of hiring any person or entity who is an 8 employee of PNBFG or the Bank or who had been employed by PNBFG or the Bank at any time within six (6) months preceding the date of Heller's termination. If PNBFG terminates the employment of Heller without cause then the provisions of the preceding paragraph shall be effective from the date of termination and ending three (3) months after the date of termination. Heller and PNBFG agree and stipulate that the period of time and geographical area specified in the preceding two paragraphs are fair and reasonable in view of the nature of the business of PNBFG and the Bank, Heller's access to PNBFG and the Bank's confidential information and knowledge of PNBFG and the Bank's business. However, in the event that a court should decline to enforce these provisions, Heller and PNBFG agree that the provisions shall be deemed to be modified to restrict Heller's competition with PNBFG and the Bank to the maximum extent, in both time and geography, which the court shall find enforceable. In no event will the covenant be interpreted as more restrictive to Heller. 9. Miscellaneous. ------------- (a) All notices which are required or permitted to be given pursuant to this Agreement shall be in writing and 9 shall be sufficient in all respects if given in writing and delivered personally or by telegraph or by registered or certified airmail, postage prepaid, addressed as follows: If to PNBFG: PNB FINANCIAL GROUP c/o Allen C. Barbieri President 4665 MacArthur Court Newport Beach, California 92660 If to Heller: DOUGLAS HELLER 4665 MacArthur Court Newport Beach, California 92660 Notice shall be deemed to have been given upon receipt thereof as to communications which are personally delivered and five (5) days after deposit of the same in any United States mail post office box in the state to which the notice is addressed, or seven (7) days after deposit of same in any such post office box other than in the state in which the notice is addressed, postage prepaid, addressed as set forth above. Notice shall not be deemed given under the preceding sentence unless and until notice is given to all addressees above other than the sender. The addresses and addressees for the purpose of this Section may be changed by giving written notice of such change in the manner provided herein for giving notice. Unless and until such written notice is given, the 10 addresses and addressees as stated by prior written notice, or as provided herein if no written notice of change has been given, shall be deemed to continue in effect for all purposes hereunder. (b) If any portion of this Agreement is held unenforceable or invalid, the remaining portions shall nevertheless remain valid and in full force and effect. (c) This Agreement constitutes the entire agreement between the parties pertaining to the subject matter hereof and fully supersedes any and all prior agreements or understandings whether oral or written. Any amendment to this Agreement shall be effective only upon the written consent of each of the parties. Any waiver by any party of any of its rights under this Agreement is effective only if set forth in a writing delivered to the other party, and no course of dealing and no delay by any party in exercising any right, power, or remedy shall operate as a waiver thereof or otherwise prejudice such party's rights, powers, or remedies. (d) If any legal action or arbitration or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, default, or breach in connection with any of the provisions of this Agreement, the successful or prevailing party or parties shall be entitled to recover 11 reasonable attorneys' fees, expenses, and other costs incurred in that action or proceeding in addition to any other relief to which it or he may be entitled. The right to such attorneys' fees, expenses, and costs shall be deemed to have accrued upon the commencement or such action and shall be enforceable whether or not such action is prosecuted to judgment. (e) This Agreement is being delivered and is intended to be performed in the State of California and shall be construed and enforced in accordance with and governed by the laws of the State of California other than and without giving effect to the laws of the State of California relating to choice of law. (f) The parties agree that any action, at law or in equity, arising under this Agreement shall be filed and conducted in and only in the Superior Court of the State of California for the County of Orange or the United States District Court for the Central District of California. The parties hereby submit to the in personam jurisdiction and venue of such courts in the State of ----------- California for the purposes of litigating any such action. (g) Except as expressly provided herein, neither this Agreement nor any of the rights or obligation of Heller hereunder shall be assignable or delegable by Heller. Neither 12 this Agreement nor any other rights or obligations of PNBFG hereunder shall be assignable by PNBFG; provided, however, that this Agreement shall be assignable to and shall be binding upon and inure to the benefit of any successor of PNBFG or the Bank, including, directly or indirectly, all or substantially all of the assets of PNBFG or the Bank whether by merger, consolidation, sale or otherwise (and such successor shall thereafter be deemed "PNBFG" for the purposes of this Agreement), but shall not otherwise be assignable by PNBFG or the Bank. Entered into this 11th day of March, 1998 at Newport Beach, California. ---- ----- PNB FINANCIAL GROUP By:/s/ ALLEN C. BARBIERI ----------------------------- ALLEN C. BARBIERI President and Chief Executive Officer /s/ DOUGLAS HELLER ----------------------------- DOUGLAS HELLER 13 EX-21 3 SUBSIDIARIES OF THE COMPANY EXHIBIT NO. 21 SUBSIDIARIES OF THE COMPANY SUBSIDIARIES OF PNB FINANCIAL GROUP ----------------------------------- At December 31, 1997, the only subsidiary of PNB Financial Group was Pacific National Bank. EX-23.1 4 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS To The Board of Directors PNB Financial Group Newport Beach, CA We consent to the incorporation of our report dated January 29, 1998, included in this form 10KSB in the previously filed Registration Statements of PNB Financial Group on Form S-8 (Commission file Numbers 333-03241, 333-17997, 333- 17999 and 333-36255. McGladrey & Pullen, LLP Anaheim, California March 30, 1998 EX-27 5 FINANCIAL DATA SCHEDULE
9 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 15,185 0 0 0 103,762 0 0 118,184 1,558 242,874 211,090 5,000 2,787 0 0 0 16,234 7,763 242,874 15,771 422 228 16,421 3,852 4,044 12,377 870 (11) 19,744 8,581 8,581 0 0 5,000,000 2.07 2.13 6.65 1,237 160 4,102 5,433 1,812 1,601 477 1,558 1,558 0 0
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