-----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, I1Lg9RaDaSoA5E/ML8e89lw2Pxsq6FknrJSFhnfplP1rxRBlKGorXfL6iBfXOlLp JO5KbUtKC9LI5rLoG+wBuw== 0001047469-98-009543.txt : 19980313 0001047469-98-009543.hdr.sgml : 19980313 ACCESSION NUMBER: 0001047469-98-009543 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980312 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL MERCANTILE BANCORP CENTRAL INDEX KEY: 0000714801 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 953819685 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13015 FILM NUMBER: 98564237 BUSINESS ADDRESS: STREET 1: 1840 CENTURY PARK EAST CITY: LOS ANGELES STATE: CA ZIP: 90067 BUSINESS PHONE: 3102772265 MAIL ADDRESS: STREET 1: 1840 CENTURY PARK EAST CITY: LOS ANGELES STATE: CA ZIP: 90067 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER 0-15982 NATIONAL MERCANTILE BANCORP (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 95-3819685 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1840 CENTURY PARK EAST LOS ANGELES, CALIFORNIA 90067 (Address to principal executive (Zip Code) offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 277-2265 NO SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, NO PAR VALUE (TITLE OF CLASS) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. /X/ Yes / / No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K. / / The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of its Common Stock as reported by the National Association of Securities Dealers Automated Quotation System on February 13, 1998, was approximately $4,223,732. The number of shares of Common Stock, no par value, of the registrant outstanding as of February 13, 1998 was 677,048. DOCUMENTS INCORPORATED BY REFERENCE: Certain portions of the Company's Proxy Statement to be filed with the Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934 in connection with the Company's 1998 Annual Meeting of Shareholders are incorporated by reference in Part III, Items 10-13 of this Annual Report on Form 10-K. THIS REPORT INCLUDES A TOTAL OF 73 PAGES INDEX TO EXHIBITS ON PAGE E-1 NATIONAL MERCANTILE BANCORP TABLE OF CONTENTS FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 PAGE(S) IN FORM 10-K PART I - ------ ITEM 1. BUSINESS ................................................... 1 ITEM 2. PROPERTIES .................................................. 7 ITEM 3. LEGAL PROCEEDINGS .......................................... 7 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ......... 7 PART II - ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS ......................................... 7 ITEM 6. SELECTED FINANCIAL DATA ..................................... 9 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ................................... 11 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ................. 43 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ................................... 43 PART III - -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT .......... 43 ITEM 11. EXECUTIVE COMPENSATION ..................................... 43 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ................................................. 43 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ............. 43 PART IV - ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K .................................................... 44 SIGNATURES ............................................................. 45 Financial Statements .................................................... F-1 Exhibit Index .......................................................... E-1 PART I ITEM 1. BUSINESS Certain matters discussed in this Form 10-K may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act") and as such may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market and statements regarding the Company's mission and vision. The Company's actual results, performance, or achievements may differ significantly from the results, performance, or achievements expressed or implied in such forward-looking statements. For discussion of the factors that might cause such a difference, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Cautionary Statement for Purposes of the `Safe Harbor' Provisions of the Private Securities Litigation Reform Act of 1995". National Mercantile Bancorp (the "Company") is a corporation which was organized under the laws of the State of California on January 17, 1983 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The Company's principal asset is the capital stock of Mercantile National Bank (the "Bank"), which became its wholly owned subsidiary on May 31, 1984. The Company's principal business is to serve as a holding company for the Bank, and for other banking or banking-related subsidiaries which the Company may establish or acquire. Because the Bank comprises substantially all of the business of the Company, references to the "Company" reflect the consolidated activities of the Company and Bank. On February 6, 1986, the Federal Reserve Bank of San Francisco (the "Reserve Bank") approved the Company to engage in lending activities. The Reserve Bank as part of its regulatory oversight may conduct examinations of the Company and its subsidiaries. As a legal entity separate and distinct from its subsidiary, the Company's principal source of funds is currently interest earned from its loans and investments. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company. See Item 14. "Exhibits, Financial Statement Schedules and Reports on Form 8K--Notes to Consolidated Financial Statements for the Three years ended December 31, 1997--Note 14--Availability of Funds from Bank". The Bank was organized on October 29, 1981, as a national banking association and obtained a Certificate of Authority to commence the business of banking from the Office of the Comptroller of the Currency (the "OCC") effective March 22, 1982. From its single location in Century City, the Bank currently provides traditional banking services to the niche markets of business and private banking and entertainment in its primary service area, a four-mile radius from its headquarters. The Bank's primary business activities are to generate deposits and loans. In addition, the Bank provides investment and specialized deposit services in order to accommodate the needs of large deposit clients. COMPETITION The banking business is highly competitive. The Bank's primary service area is dominated by a relatively small number of major banks which have many offices operating over a wide geographical area. The Bank competes for loans and deposits primarily with other commercial banks, savings and loan associations, credit unions, and thrift and loan companies, as well as with non-depository institutions, including mortgage companies, commercial finance lenders and providers of money market mutual funds. Non-depository institutions can be expected to increase the extent to which they act as financial intermediaries. Large institutional users and sources of credit may also increase the extent to which they interact directly, meeting business credit needs outside the banking system. Furthermore, the geographic constraints on portions of the financial services industry can be expected to continue to erode. In addition, many of the major commercial banks operating in the Bank's primary service area offer certain services, such as trust services, which are not offered directly by the Bank and, by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank. To compete with other financial institutions in its primary service area, the Bank relies principally upon personal contact by its officers, directors and employees and providing, through third parties, specialized services such as messenger services and escrow accounting services. For clients whose loan demands exceed the Bank's legal Page 1 lending limit, the Bank has arranged for such loans on a participation basis with other banks. The Bank also assists clients requiring other services not offered by the Bank in obtaining such services from other providers. MONETARY POLICY The earnings of the Bank are affected not only by general economic conditions, but also by the policies of various governmental regulatory authorities in the U.S. and abroad. In particular, the Board of Governors of the Federal Reserve System (Federal Reserve Board) exerts a substantial influence on interest rates and credit conditions, primarily through open market operations in U.S. government securities, varying the discount rate on member bank borrowings and setting reserve requirements against deposits. Federal Reserve Board's monetary policies have had a significant effect on the operating results of financial institutions in the past and are expected to continue to do so in the future. SUPERVISION AND REGULATION Bank holding companies, banks and their non-bank affiliates are extensively regulated under both federal and state law. The following is not intended to be an exhaustive description of the statutes and regulations applicable to the Company's or the Bank's business. The description of statutory and regulatory provisions is qualified in its entirety by reference to the particular statutory or regulatory provisions. Moreover, major new legislation and other regulatory changes affecting the Company, the Bank, banking and the financial services industry in general have occurred in the last several years and can be expected to occur in the future. The nature, timing and impact of new and amended laws and regulations cannot be accurately predicted. BANK HOLDING COMPANIES Bank holding companies are regulated under the BHC Act and are supervised by the Federal Reserve Board. Under the BHC Act, the Company files reports of its operations with the Federal Reserve Board and is subject to examination by it. The BHC Act requires, among other things, the Federal Reserve Board's prior approval whenever a bank holding company proposes to (i) acquire all or substantially all the assets of a bank, (ii) acquire direct or indirect ownership or control of more than 5% of the voting shares of a bank, or (iii) merge or consolidate with another bank holding company. In 1996, legislation was approved that will substantially streamline the application process for well-capitalized and well-managed bank holding companies. In September 1994, the Riegle-Neal Interstate Banking and Branch Efficiency Act (the Riegle-Neal Act) was enacted. Under the Riegle-Neal Act, interstate banking is allowed in three different forms: - Effective September 1995, a bank owned by a holding company may acquire a subsidiary bank anywhere in the United States. - Effective September 1995, a bank owned by a holding company may act as an agent in accepting deposits or servicing loans for any other bank or savings or loan owned by the holding company. - Effective June 1, 1997, a bank itself may establish a branch in another state, but only if the bank's home state permits interstate mergers and branches, and the other state has not passed a law to prohibit interstate mergers or branches. Interstate bank subsidiaries and branch banks are subject to concentration limits, Community Reinvestment Act requirements, bank supervisory controls and other restrictions of the Riegle-Neal Act or of state law. Page 2 California law permits bank holding companies in other states to acquire California banks and bank holding companies, provided the acquiring company's home state has enacted "reciprocal" legislation that expressly authorizes California bank holding companies to acquire banks or bank holding companies in that state on terms and conditions substantially no more restrictive than those applicable to such an acquisition in California by a bank holding company from the other state. The BHC Act also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank and from engaging in any activities without the Federal Reserve Board's prior approval other than (1) managing or controlling banks and other subsidiaries authorized by the BHC Act, or (2) furnishing services to, or performing services for, its subsidiaries. The BHC Act authorizes the Federal Reserve Board to approve the ownership of shares in any company, the activities of which have been determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. Consistent with its "source of strength" policy (see "Capital Adequacy Requirements," below), the Federal Reserve Board has stated that, as a matter of prudent banking, a bank holding company generally should not pay cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the company's capital needs, asset quality and overall financial condition. A bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit. The Federal Reserve Board may, among other things, issue cease-and-desist orders with respect to activities of bank holding companies and nonbanking subsidiaries that represent unsafe or unsound practices or violate a law, administrative order or written agreement with a federal banking regulator. The Federal Reserve Board can also assess civil money penalties against companies or individuals who violate the BHC Act or other federal laws or regulations, order termination of nonbanking activities by nonbanking subsidiaries of bank holding companies and order termination of ownership and control of a nonbanking subsidiary by a bank holding company. NATIONAL BANKS The Bank is a national bank and, as such, is subject to supervision and examination by the OCC and requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and limitations on the types of investments that may be made and services that may be offered. Various consumer laws and regulations also affect the Bank's operations. These laws primarily protect depositors and other customers of the Bank, rather than the Company and its shareholders. "Brokered deposits" are deposits obtained by a bank from a "deposit broker" or that pay above-market rates of interest. Because the Bank is categorized as a well capitalized financial institution, the Bank can accept brokered deposits without the prior approval of the Federal Deposit Insurance Corporation ("FDIC"). Currently, the Bank is not utilizing brokered deposits. The Company's principal asset is its investment in the Bank. The Bank's ability to pay dividends to the Company is limited by certain statutes and regulations. OCC approval is required for a national bank to pay a dividend if the total of all dividends declared in any calendar year exceeds the total of the bank's net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years, less any required transfer to surplus or a fund for the retirement of any preferred stock. A national bank may not pay any dividend that exceeds its retained net profits then on hand after deducting its loan losses and bad debts, as defined by the OCC. At December 31, 1997 the Bank did not have funds available for the payment of cash dividends. The OCC and the Federal Reserve Board have also issued banking circulars emphasizing that the level of cash dividends should bear a direct correlation to the level of a national bank's current and expected earnings stream, the bank's need to maintain an adequate capital base and other factors. National banks that are not in compliance with regulatory capital requirements generally are not permitted to pay dividends. The Bank is in compliance with such Page 3 requirements. The OCC also can prohibit a national bank from engaging in an unsafe or unsound practice in its business. Depending on the bank's financial condition, payment of dividends could be deemed to constitute an unsafe or unsound practice. Except under certain circumstances and with prior regulatory approval, a bank may not pay a dividend if, after so doing, it would be undercapitalized. The Bank's ability to pay dividends in the future is, and could be, further influenced by regulatory policies or agreements and by capital guidelines. The Bank's ability to make funds available to the Company is also subject to restrictions imposed by federal law on the Bank's ability to extend credit to the Company to purchase assets from it, to issue a guarantee, acceptance or letter of credit on its behalf (including an endorsement or standby letter of credit), to invest in its stock or securities, or to take such stock or securities as collateral for loans to any borrower. Such extensions of credit and issuances generally must be secured and are generally limited, with respect to the Company, to 10% of the Bank's capital stock and surplus. The Bank is insured by the FDIC and therefore is subject to its regulations. Among other things, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") provided authority for special assessments against insured deposits and required the FDIC to develop a general risk-based assessment system. During 1995, the Bank Insurance Fund reached its targeted level of 1.25% of estimated insured deposits. The FDIC reduced the minimum assessment rate for well capitalized banks to $2,000 per year for 1996. Beginning January 1, 1997, the FDIC collects an assessment against Bank Insurance Fund-assessable deposits to be paid to the Financing Corporation of approximately 1.29 basis points on total deposits, as defined. Banks and bank holding companies are also subject to the Community Reinvestment Act of 1977, as amended ("CRA"). CRA requires the Bank to ascertain and meet the credit needs of the communities it serves, including low-and moderate-income neighborhoods. The Bank's compliance with CRA is reviewed and evaluated by the OCC, which assigns the Bank a publicly available CRA rating at the conclusion of the examination. Further, an assessment of CRA compliance is also required in connection with applications for OCC approval of certain activities, including establishing or relocating a branch office that accepts deposits or merging or consolidating with, or acquiring the assets or assuming the liabilities of, a federally regulated financial institution. An unfavorable rating may be the basis for OCC denial of such an application, or approval may be conditioned upon improvement of the applicant's CRA record. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve Board will assess the CRA record of each subsidiary bank of the applicant, and such records may be the basis for denying the application. At the conclusion of the most recently completed CRA compliance examination, conducted in 1996, the OCC assigned the Bank a rating of "Satisfactory," the second highest of four possible ratings. From time to time, banking legislation has been proposed that would require consideration of the Bank's CRA rating in connection with applications by the Company or the Bank to the Federal Reserve Board or the OCC for permission to engage in additional lines of business. The Company cannot predict whether such legislation will be adopted, or its effect upon the Bank and the Company if adopted. In April 1995, the federal regulatory agencies issued a comprehensive revision to the rules governing CRA compliance. In assigning a CRA rating to a bank, the new regulations place greater emphasis on measurements of performance in the area of lending (specifically, the bank's home mortgage, small business, small farm and community development loans), investment (the bank's community development investments) and service (the bank's community development services and the availability of its retail banking services), although examiners are still given a degree of flexibility in taking into account unique characteristics and needs of the bank's community and its capacity and constraints in meeting such needs. The new regulations also require increased collection and reporting of data regarding certain kinds of loans. Although the regulation became generally effective on July 1, 1995, various provisions have different effective dates, and the new CRA evaluation criteria will go into effect for examinations beginning on July 1, 1997. Although management cannot predict the impact of the substantial changes in the new rules on the Bank's CRA rating, it will continue to take steps to comply with the requirements in all respects. In 1995, the OCC adopted regulations under FDICIA incorporating guidelines establishing standards for safety and soundness, including operational and managerial standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, assets growth and Page 4 compensation, fees and benefits, as well as prohibiting compensation deemed excessive. If the OCC finds that a bank has failed to meet any applicable standard, it may require the institution to submit an acceptable plan to achieve compliance and, if the bank fails to comply, the OCC must, by order, require it to correct the deficiency. The guidelines are general in nature and are not expected to require material changes in the Bank's operations. Banking agencies have recently adopted final regulations which mandate that regulators take into consideration concentrations of credit risk and risks from non-traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. This evaluation will be made as a part of the institution's regular safety and soundness examination. Banking agencies also have recently adopted final regulations requiring regulators to consider interest rate risk (when the interest rate sensitivity of an institution's assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of a bank's capital adequacy. Concurrently, banking agencies have proposed a methodology for evaluating interest rate risk. After gaining experience with the proposed measurement process, those banking agencies intend to propose further regulations to establish an explicit risk-based capital charge for interest rate risk. The OCC has enforcement powers with respect to national banks for violations of federal laws or regulations that are similar to the powers of the Federal Reserve Board with respect to bank holding companies and nonbanking subsidiaries. See "Bank Holding Companies," above. CAPITAL ADEQUACY REQUIREMENTS Both the Federal Reserve Board and the OCC have adopted similar, but not identical, "risk-based" and "leverage" capital adequacy guidelines for bank holding companies and national banks, respectively. Under the risk-based capital guidelines, different categories of assets are assigned different risk weights, ranging form zero percent for risk-free assets (e.g., cash) to 100% for relatively high-risk assets (e.g., commercial loans). These risk weights are multiplied by corresponding asset balances to determine a risk-adjusted asset base. Certain off-balance sheet items (e.g., standby letters of credit) are added to the risk-adjusted asset base. The minimum required ratio of total capital to risk-weighted assets for both bank holding companies and national banks is presently 8%. At least half of the total capital is required to be "Tier 1 capital," consisting principally of common shareholders' equity, a limited amount of perpetual preferred stock and minority interests in the equity. The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock and a limited amount of the general loan-loss allowance. As of December 31, 1997, the Company had a ratio of total capital to risk-weighted assets (total risk-based capital ratio) of 18.25% and a ratio of Tier 1 capital to risk-weighted assets (Tier 1 risk-based capital ratio) of 16.98%, while the Bank had a total risk-based capital ratio of 11.63% and a Tier 1 risk-based capital ratio of 10.36%. The minimum Tier 1 leverage ratio, consisting of Tier 1 capital to average adjusted total assets, is 3% for bank holding companies and national banks that have the highest regulatory examination rating and are not contemplating significant growth or expansion. All other bank holding companies and national banks are expected to maintain a ratio of at least 1% to 2% or more above the stated minimum. As of December 31, 1997, the Company had a Tier 1 leverage ratio of 10.43%, and the Bank's Tier 1 leverage ratio was 6.48%. The OCC has adopted regulations under FDICIA establishing capital categories for national banks and prompt corrective actions for undercapitalized institutions. The regulations create five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The following table shows the minimum total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage ratios, which must be satisfied for a bank to be classified as well capitalized, adequately capitalized or under-capitalized, respectively, together with the Company's and Bank's ratios at December 31, 1997: Page 5
Total Tier 1 Tier 1 risk-based risk-based leverage capital ratio capital ratio ratio ------------- ------------- -------- Actual: National Mercantile Bancorp ......... 18.25% 16.98% 10.43% Mercantile National Bank. ........... 11.63% 10.36% 6.48% Minimum: Well capitalized (1) ................ 10.00% 6.00% 5.00% Adequately capitalized .............. 8.00% 4.00% 4.00% (2) Undercapitalized .................... 6.00% 4.00% 3.00%
(1) A bank may not be classified as well capitalized if it is subject to a specific agreement with OCC to meet and maintain a specific level of capital. (2) 3% for institutions having a composite rating of 1 in the most recent OCC examination. If any one or more of a bank's ratios are below the minimum ratios required to be classified as undercapitalized, it will be classified as significantly undercapitalized or, if in addition, its ratio of tangible equity to total assets is 2% or less, it will be classified as critically undercapitalized. A bank may be reclassified by the OCC to the next level below that determined by the criteria described above if the OCC finds that it is in an unsafe or unsound condition or if it has received a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent examination and the deficiency has not been corrected, except that a bank cannot be reclassified as critically undercapitalized for such reasons. Under FDICIA and its implementing regulations, the OCC may subject national banks to a broad range of restrictions and regulatory requirements. A national bank may not pay management fees to any person having control of the institution, nor, except under certain circumstances and with prior regulatory approval, make any capital distribution if, after doing so, it would be undercapitalized. Undercapitalized banks are subject to increased monitoring by the OCC, are restricted in their asset growth, must obtain regulatory approval for certain corporate activities, such as acquisitions, new branches and new lines of business, and, in most cases, must submit to the OCC a plan to bring their capital levels to the minimum required in order to be classified as adequately capitalized. The OCC may not approve a capital restoration plan unless each company that controls the bank guarantees that the bank will comply with it. Significantly and critically undercapitalized banks are subject to additional mandatory and discretionary restrictions and, in the case of critically undercapitalized institutions, must be placed into conservatorship or receivership unless the OCC and the FDIC agree otherwise. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to commit resources to support each such bank. In addition, a bank holding company is required to guarantee that its subsidiary bank will comply with any capital restoration plan required under FDICIA. The amount of such a guarantee is limited to the lesser of (i) 5% of the bank's total assets at the time it became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all applicable capital standards as of the time the bank fails to comply with the capital restoration plan. A holding company guarantee of a capital restoration plan results in a priority claim to the holding company's assets ahead of its other unsecured creditors and shareholders that is enforceable even in the event of the holding company's bankruptcy or the subsidiary bank's insolvency. EMPLOYEES As of February 13, 1998, the Company had 6 officers but no employees while the Bank had 43 full-time equivalent employees including 6 of the Company's officers. The Company and the Bank believe that the Bank's relations with its employees are good and it has not encountered a strike or material work stoppage. Page 6 ITEM 2. PROPERTIES The Bank leases space in an office building at 1840 Century Park East, Los Angeles, California. The Bank leases approximately 23,883 square feet under its lease at an effective rent per square foot of approximately $2.33 or $55,666 per month for the period November 1, 1995 to October 31, 2000. The effective rent for the period November 1, 2000 to October 31, 2004 will be $2.83 per square foot or $67,607 per month. The rent is subject to annual adjustments for changes in property taxes and operating costs. Under the provisions of the lease agreement, the Bank issued the landlord a seven-year warrant to purchase up to 9.9% of the shares of capital stock of the Company at an exercise price of $5.00 per common share which has been adjusted for the 9:09 to 1 reverse stock split completed June 20, 1997 and the 100% common stock dividend paid on February 13, 1998, and an exercise price of $10.00 per share of preferred stock (with such stock being convertible into 2 shares of common stock). The Company also granted the landlord registration rights with respect to capital stock purchased by the landlord (or its assignee) pursuant to the Warrant. The Company does not directly own or lease any property. Its administrative offices are located at the Bank's headquarters at 1840 Century Park East, Los Angeles, California 90067. ITEM 3. LEGAL PROCEEDINGS The Company is a party to routine litigation involving various aspects of its business. Based on present knowledge, management is of the opinion that the final outcome of such lawsuits will not have a material adverse effect upon the Company. The Company is not aware of any material proceedings to which any director, officer or affiliate of the Company, any owner of record or beneficially of more than 5% of the voting securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There was no submission of matters to a vote of shareholders during the fourth quarter of the year ended December 31, 1997. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Until March 10, 1997, the common stock, no par value ("Common Stock") of the Company was traded on the NASDAQ national tier of the NASDAQ stock market. Since that date the Common Stock has traded in the over-the-counter market on the Nasdaq SmallCap tier of the Nasdaq Stock Market ("NASDAQ SmallCap Market"), under the symbol MBLA. The 6.5% noncumulative convertible preferred stock ("Preferred Stock") of the Company has traded in the NASDAQ SmallCap Market since issuance on June 30, 1997. The following table shows the high and low trade prices of the Company's Common Stock and Preferred Stock for each quarter of 1996 and 1997 as quoted by the NASDAQ. Additionally, there may have been transactions at prices other than those shown during that time. Page 7
Common Stock Preferred Quarter Ended: High Low High Low -------------- ---- --- ---- --- March 31, 1996............................. 9.36 5.68 n/a n/a June 30, 1996.............................. 10.82 6.82 n/a n/a September 30, 1996......................... 8.54 5.14 n/a n/a December 31, 1996.......................... 5.68 4.55 n/a n/a March 31, 1997............................. 9.66 4.83 n/a n/a June 30, 1997.............................. 8.24 5.68 n/a n/a September 30, 1997......................... 7.25 5.75 14.50 12.75 December 31, 1997.......................... 7.88 6.00 14.69 13.50
The prices of the Common Stock stated above have been restated to reflect both the 9:09 to 1 reverse stock split effective June 20, 1997 and the 100% common stock dividend paid on February 13, 1998. The 100% common stock dividend was accounted for as a 2 for 1 stock split. At February 13, 1998, the closing trade price for the Company's Common Stock and Preferred Stock as quoted by Nasdaq was approximately $6.75 and $14.25 per share, respectively. At February 13, 1998, the Company had approximately 243 registered shareholders of record for its Common Stock and approximately 30 registered shareholders of record for its Preferred Stock. The actual number of shareholders for the Common Stock and Preferred Stock is higher as many of the Company's shareholders hold their shares in "street" name as a single holder. At February 13, 1998, approximately 62% and 70% of the Common Stock and Preferred Stock, respectively, was held in street name. The Company has not paid a cash dividend on the Common Stock since July 1990, nor a cash dividend on the Preferred Stock since its issuance on June 30, 1997 (dividends are not required to be paid on the preferred stock until October 31, 1999), and there can be no assurance that the Company will generate earnings in the future which would permit the declaration of cash dividends. The Company is prohibited from declaring or paying a cash dividend until the Company has sufficient retained earnings as set forth in the Retained Earnings Test under California General Corporation Law. The Retained Earnings Test is defined as the Company's retained earnings (determined on a consolidated basis according to generally accepted accounting principles) or, if after giving effect to such distribution, all of the Company's assets equal 1.25 times the Company's liabilities. Based on the retained earnings of the Company and the Company's assets and liabilities as of December 31, 1997, it is unlikely the Company will be able to legally pay dividends for the foreseeable future. Further, it is anticipated that for the foreseeable future any earnings that may be generated will be retained for the purpose of increasing the Company's capital and reserves to facilitate growth. Page 8 ITEM 6. SELECTED FINANCIAL DATA The following table presents selected consolidated financial and other data of the Company for each of the years in the five-year period ended December 31, 1997. The information below should be read in conjunction with, and is qualified in its entirety by, the more detailed information included elsewhere including the Company's Audited Consolidated Financial Statements and Notes thereto. ITEM 6a. SELECTED FINANCIAL DATA
FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------------------------ 1997 (7) 1996 1995 1994 1993 -------- ------ ------- ------- ------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA: Interest income.............................................. $8,600 $8,757 $11,634 $20,900 $20,612 Interest expense............................................. 2,856 3,079 3,979 5,526 5,920 ------- ------- -------- -------- -------- Net interest income.......................................... 5,744 5,678 7,655 15,374 14,692 Provision for credit losses.................................. - - 2,307 7,330 2,000 ------- ------- -------- -------- -------- Net interest income after provision for credit losses........ 5,744 5,678 5,348 8,044 12,692 Other operating income (loss)................................ 486 502 (1,315) (2,857) 1,474 Other operating expense (1).................................. 6,098 8,003 11,233 13,714 14,058 ------- ------- -------- -------- -------- Income (loss) before income tax benefit and cumulative effect of change in accounting principle................... 132 (1,823) (7,200) (8,527) 108 Income tax benefit........................................... - 579 - - - ------- ------- -------- -------- -------- Net income (loss) before cumulative effect of change in accounting principle........................................ 132 (1,244) (7,200) (8,527) 108 Cumulative effect of change in accounting principle.......... - - - - 63 ------- ------- -------- -------- -------- Net income (loss)............................................ $132 $(1,244) $(7,200) $(8,527) $171 ------- ------- -------- -------- -------- ------- ------- -------- -------- -------- PER SHARE DATA: Net income (loss) basic (2).................................. $0.20 $(1.84) $(10.63) $(12.68) $0.26 Net income (loss) diluted (2)................................ 0.08 (1.84) (10.63) (12.68) 0.25 Book value (period end) (3).................................. 5.02 7.14 8.86 15.23 33.13 Weighted average common shares outstanding (2):.............. 677,202 677,260 677,260 672,296 669,146 BALANCE SHEET DATA - AT PERIOD END: Assets...................................................... $119,405 $109,416 $131,992 $232,979 $303,120 Securities................................................... 40,478 18,630 20,417 62,056 83,674 Loans receivable............................................. 61,252 62,547 82,012 115,284 161,791 Interest-earning assets...................................... 113,880 104,177 123,429 208,634 283,064 Deposits..................................................... 97,388 103,854 120,243 207,815 268,846 Shareholders' equity......................................... 12,440 4,845 6,011 10,308 22,199 AVERAGE BALANCE SHEET DATA - AVERAGE BALANCES: Assets....................................................... $107,801 $112,303 $149,399 $245,555 $291,166 Securities................................................... 29,768 17,398 26,681 79,146 93,914 Loans receivable............................................. 59,336 69,975 95,771 140,079 159,680 Interest-earning assets...................................... 102,007 106,945 138,660 227,009 266,011 Deposits..................................................... 96,445 104,118 134,218 212,755 251,934 Shareholders' equity......................................... 8,541 5,500 9,033 19,086 21,713
Page 9 ITEM 6b.
FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------------------------- 1997 (7) 1996 1995 1994 1993 -------- ------ ------- ------- ------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) SELECTED PERFORMANCE RATIOS: Return (loss) on average assets..................... 0.12% -1.11% -4.82% -3.47% 0.06% Return (loss) on average shareholders' equity....... 1.55% -22.61% -79.71% -44.68% 0.79% Average shareholders' equity to average assets...... 7.92% 4.90% 6.05% 7.77% 7.46% Net interest spread................................. 4.05% 3.71% 3.77% 5.43% 4.44% Net yield on interest-earning assets................ 5.63% 5.31% 5.52% 6.77% 5.56% CAPITAL RATIOS: Company: Tier 1 risk-based.................................. 16.98% 6.96% 6.96% 9.84% 11.94% Total risk-based................................... 18.25% 8.25% 8.25% 11.11% 13.25% Leverage........................................... 10.43% 4.68% 4.68% 5.65% 7.11% Bank: Tier 1 risk-based.................................. 10.36% 6.95% 6.95% 9.80% 11.65% Total risk-based................................... 11.63% 8.24% 8.24% 11.06% 12.95% Leverage........................................... 6.48% 4.67% 4.67% 5.62% 6.93% ASSET QUALITY: Nonaccrual loans.................................... $1,201 $928 $573 $3,426 $7,780 Troubled debt restructurings (4).................... 5,422 5,016 5,167 5,582 5,584 Loans contractually past due ninety days or more with respect to either principal or interest and still accruing interest............... - 300 221 1,507 2,502 ------ ------ ------ ------ ------ Total nonperforming loans.......................... 6,623 6,244 5,961 10,515 15,866 Other real estate owned (5)......................... 777 556 581 1,529 6,175 ------ ------ ------ ------ ------ Total nonperforming assets.......................... $7,400 $6,800 $6,542 $12,044 $22,041 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ASSETS QUALITY RATIOS: Nonaccrual loans to loans receivable................ 2.0% 1.5% 0.7% 3.0% 4.8% Nonaccrual assets to total assets (6)............... 1.7% 1.4% 0.9% 2.1% 4.6% Allowance for credit losses to loans receivable..... 3.3% 4.7% 4.6% 2.7% 4.1% Allowance for credit losses to nonaccrual loans..... 168.4% 319.9% 664.0% 89.4% 86.1% Net charge-offs to average loans receivable......... 1.6% 1.2% 1.6% 7.8% 0.8%
- ----------------------- (1) Includes a legal settlement of $1.0 million for the year ended December 31, 1996. (2) The weighted average number of shares of Common Stock outstanding for the years ended December 31, 1996, 1995 and 1994 was used to compute diluted loss per share data as the use of average shares outstanding including Common Stock equivalents would be antidilutive. The weighted average number of shares used to compute diluted earnings per share in 1997 and 1993 was 1,629,796 and 697,744, respectively. (3) Book value per share numbers are based on the number of shares outstanding at period end (including the assumed conversion of 900,000 shares of Preferred Stock into 1,800,000 shares of Common Stock at December 31, 1997) and does not give effect to outstanding options and warrants to purchase Common Stock. (4) Includes one loan, a trouble debt restructuring with a principal balance of $5.4 million at December 31, 1997 and $4.9 million at December 31, 1996, 1995, 1994 and 1993. This loan is secured by a first deed of trust on a single-family residence which, as of January 1998, had an appraised value of $10.0 million. (5) Includes OREO acquired by the Bank through legal foreclosure and/or deed-in-lieu of foreclosure. (6) Nonaccrual assets are comprised of nonaccrual loans plus OREO. (7) On June 30, 1997 the Company completed the sale of 900,000 shares of Preferred Stock through a private offering and rights offering in which the Company raised net proceeds of $7.35 million ("Capital Offerings"). Page 10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS National Mercantile Bancorp (the "Company") is the holding company for Mercantile National Bank (the "Bank"). In light of the fact that the Bank constitutes substantially all of the business of the Company, references to the Company in this Item 7 reflect the consolidated activities of the Company and the Bank. OVERVIEW The operating results for 1997 reflected a reversal of trends recently experienced by the Company over the past several years. This reversal was evident by the Company's growth in assets during the second half of 1997 along with net income of $344,000 during this same period, which offset declining asset trends and net losses of $212,000 during the first six months of 1997. The 1997 results were the culmination of management's plan to restructure the balance sheet and reduce operating expenses over the past three years combined with the Capital Offerings completed on June 30, 1997. The Company recorded net income for the year ended December 31, 1997 of $132,000 or $0.08 diluted earnings per share, compared with a net loss for the year ended December 31, 1996 of $1.2 million or $1.84 loss per share. The operating results for 1997 reflect the first year in which the Company has recorded net income since 1993. The improvement in earnings during 1997 compared to 1996 was the result of a reduction in other operating expense of $1.9 million and to a lesser extent an increase in the net interest margin brought about by the investment of $7.35 million of net proceeds raised in the Capital Offerings completed on June 30, 1997. Total assets increased during the second half of 1997 reversing a decreasing asset trend which began during 1991. At December 31, 1997, the Company's total assets increased by $10.0 million or 9.1% to $119.4 million from $109.4 million at December 31, 1996. This increase was funded primarily by the net proceeds of $7.35 million raised in the Capital Offerings and an increase in other borrowings and securities sold under agreements to repurchase of $8.5 million. Partially offsetting these increases was a decrease of $6.5 million in deposits, compared to 1996. Substantially all asset growth was in the investment securities portfolio. Investment securities increased to $40.5 million at December 31, 1997 from $18.6 million at December 31, 1996. This increase was primarily due to the purchase of $33.0 million of U.S. government and federal agency securities partially offset by sales and maturities of similar securities totaling $11.3 million. Net unrealized gains on securities available-for-sale at December 31, 1997 was $38,000 compared with losses of $76,000 at December 31, 1996. In addition, during 1997 the Company purchased stock in the Federal Home Loan Bank and Pacific Coast Bankers Bank totaling $413,000. Loans receivable at December 31, 1997 remained relatively unchanged at $61.3 million compared to $62.6 million at December 31, 1996. Loans secured by real estate decreased to 56% of total loans outstanding at December 31, 1997 compared to 64% at December 31, 1996. The allowance for credit losses was $2.0 million or 3.3% of loans receivable at December 31, 1997 compared to $3.0 million or 4.8% of loans receivable at December 31, 1996. This decrease is the result of net loan charge-offs of $946,000 during 1997. Nonaccrual loans increased to $1.2 million at December 31, 1997 or 2.0% of loans receivable compared to $928,000 or 1.5% at December 31, 1996. Other real estate owned totaled $777,000 at year end 1997, an increase of $221,000 from $556,000 a year earlier. Based on its review of the loan portfolio, management considers the allowance for credit losses to be adequate. However, credit quality will be influenced by underlying trends in the economic cycle, particularly for Southern California, among other factors, which are beyond management's control. Consequently, no assurances can be given that the Company will not sustain loan losses, in any particular period, that are sizable in relation to the allowance for credit losses. Additionally, subsequent evaluations of the loan portfolio, in light of factors then Page 11 prevailing, by the Company and its regulators may indicate a requirement for increases in the allowance for credit losses through charges to the provision for credit losses. On June 30, 1997, the Company completed the sale of 900,000 shares of Preferred Stock in the Capital Offerings in which the Company raised net proceeds of $7.35 million. The primary purpose of the Capital Offerings was to enable the Company to downstream capital into the Bank in order to comply with the requirements of the formal agreement ("Formal Agreement") and the Memorandum of Understanding ("MOU") entered into between the Bank and the Office of the Comptroller of the Currency (the "OCC") dated December 14, 1995 and the Company and the Federal Reserve Bank of San Francisco ("the FRB") dated October 26, 1995, respectively. As of September 4, 1997 and November 18, 1997 the MOU and Formal Agreement, respectively, were terminated by the FRB and OCC, respectively. The Company contributed $2.5 million in capital to the Bank on June 30, 1997. The remaining portion of the net proceeds have been retained for general corporate purposes to facilitate the implementation of the business strategies of the Company. As the year 2000 approaches, a critical issue has emerged regarding how existing application software programs and operating systems can accommodate this date value. In brief, many existing application software products in the marketplace were designed to only accommodate a two digit date position which represents the year (e.g., '95' is stored on the system and represents the year 1995). As a result, the year 1999 (i.e., '99') could be the maximum date value these systems will be able to accurately process. Management is in the process of working with its data processing vendors to assure that the Bank is prepared for the year 2000 and has developed a detailed project plan to address the possible exposures related to the impact on its computer systems as well as those of its vendors/partners and key clients. Critical financial information and operational systems have been assessed and a time and action plan has been developed to ensure testing of systems modifications by December 31, 1998. The financial impact of making the required systems changes is not expected to be material to the Company's consolidated financial position, results of operations or cash flows. Table 1 Operations Summary
Year Increase Year Increase Ended (Decrease) Ended (Decrease) Year ended December 31, ------------ ------------ -------------------------- 1997 Amount % 1996 Amount % 1995 1994 1993 ----- ------ --- ----- ----- --- ---- ---- ---- (Dollars in thousands) Interest income . . . . . . . . . . . . . . . . $8,600 $(157) (1.8%) $8,757 $(2,877) (24.7%) $11,634 $20,900 $20,612 Interest expense. . . . . . . . . . . . . . . . 2,856 (223) (7.2%) 3,079 (900) (22.6%) 3,979 5,526 5,920 ------ ------ ----- ------ ------- ------ ------- ------- ------- Net interest income 5,744 66 1.2% 5,678 (1,977) (25.8%) 7,655 15,374 14,692 Provision for credit losses . . . . . . . . . . - - - - (2,307) (100.0%) 2,307 7,330 2,000 Other operating income. . . . . . . . . . . . . 486 (16) (3.2%) 502 1,817 (138.2%) (1,315) (2,857) 1,474 Other operating expense . . . . . . . . . . . . 6,098 (1,905) (23.8%) 8,003 (3,230) 11,233 (2,198) 13,714 14,058 ------ ------ ----- ------ ------- ------ ------- ------- ------- Income (loss) before income taxes and cumulative effect of change in accounting principle. . . . . . . . . . . . . 132 1,955 (107.2%) (1,823) 5,377 (74.7%) (7,200) (8,527) 108 Income tax benefit. . . . . . . . . . . . . . . - 579 (100.0%) (579) (579) 0.0% - - - Income (loss) before cumulative effect of change in accounting principle . . . . . . 132 1,376 (110.6%) (1,244) 5,956 (82.7%) (7,200) (8,527) 108 Cumulative effect of change of accounting principle. . . . . . . . . . . . . - - 0.0% - - 0.0% - - 63 ------ ------ ----- ------ ------- ------ ------- ------- ------- Net income (loss) . . . . . . . . . . . . . . $132 $1,376 (110.6%) $(1,244) $5,956 (82.7%) $(7,200) $(8,527) $171 ------ ------ ----- ------ ------- ------ ------- ------- ------- ------ ------ ----- ------ ------- ------ ------- ------- -------
RESULTS OF OPERATIONS NET INTEREST INCOME The Company's earnings depend largely upon the difference between the income received from its loan and investment portfolios and the interest paid on its liabilities, primarily interest paid on deposits. This difference is net interest income. Net interest income represents the Company's most significant source of earnings. The Company's ability to generate profitable levels of net interest income is largely dependent on its ability to maintain sound asset quality and appropriate levels of capital and liquidity. The Company's inability to maintain strong asset quality, capital or liquidity may adversely affect (i) the ability to accommodate desirable borrowing customers, thereby Page 12 inhibiting growth in quality higher-yielding earning assets; (ii) the ability to attract comparatively stable, lower-cost deposits; and (iii) the costs of wholesale funding sources. 1997 COMPARED TO 1996. Net interest income remained virtually unchanged during 1997 compared to 1996 totaling $5.7 million for each year. However, the components of net interest income changed during 1997, reflecting an increase in interest income from securities offset by a corresponding decrease in interest income from loans, compared to 1996. Average earning assets decreased during 1997 to $102.0 million compared to $106.9 million during 1996. This $4.9 million or 4.6% decrease in average earning assets was primarily the result of a $10.6 million reduction in average loans receivable which was partially offset by the investment of $7.35 million of net proceeds raised form the Capital Offerings combined with an increase in other borrowings and securities sold under agreements to repurchase. During the first half of 1997, the Company's average earning assets decreased primarily due to the reduction of the Company's deposits. However, this trend reversed during the second half of 1997, as the Company began to experience growth of its average earning assets created by the net proceeds of the Capital Offerings and an increase in borrowings. The average yield on interest-earning assets was 8.43% during the year ended December 31, 1997, an increase of 24 basis points from the average yield of 8.19% during the year ended December 31, 1996, primarily as a result of increased volume and yield of investment securities. During 1997, the rates paid on interest-bearing liabilities decreased 10 basis points to 4.38% from 4.48% for 1996. As a result, the net yield on interest-earning assets increased 32 basis points to 5.63% during the year ended December 31, 1997, from 5.31% during the year ended December 31, 1996. Average loans receivable decreased to $59.3 million in 1997 from $70.0 million in 1996, a decrease of $10.7 million or 15.3%. The majority of this decrease was reflected by the payoffs and maturities of loans primarily secured by real estate. The decrease in real estate loans was partially offset by the growth of the commercial loan portfolio due to the Company's emphasis in this area. The Company's loan portfolio continued to experience a decrease during 1997 consistent with the past several years. However, this trend reversed during the fourth quarter of 1997 when the Company experienced an increase in loans receivable. Average total investment securities increased to $29.8 million during 1997 from $17.4 million during 1996. This increase was primarily driven by the net proceeds of the Capital Offerings, reduction in the Company's liquidity needs as a result of the termination of the Formal Agreement and MOU and an increase in the Company's borrowings. The average yield on investment securities increased to 6.52% during 1997 compared to 5.69% during 1996, representing an 83 basis point or 14.6% increase. During 1997 and 1996, the Company disposed of its lower yielding investment securities and reinvested the proceeds into higher yielding investment securities, resulting in the increased yields during 1997. These investment transactions were consistent with the Company's strategy to restructure its balance sheet. Average noninterest-bearing deposits decreased to $33.0 million during 1997 from $36.5 million during 1996, a decrease of $3.5 million or 9.7%. Similarly, average interest-bearing deposits decreased to $63.5 million during 1997 from $67.6 million during 1996, a decrease of $4.1 million or 6.0%. The decreases occurred primarily during the first six months of 1997, prior to the completion of the Capital Offerings and during the time in which the Company was subject to regulatory enforcement actions, specifically the Formal Agreement and MOU. However, during the last six months of 1997, average deposits increased as a result of increased marketing efforts. Average securities sold under agreements to repurchase increased to $1.6 million during 1997 compared to $1.1 million during 1996. This $497,000 or 43.6% increase facilitated the growth of investment securities during 1997 and, to a lesser extent, offset the decrease in average deposits during 1997. In addition, the Company borrowed $3.5 million from the Federal Home Loan Bank ("FHLB") at the end of the fourth quarter of 1997, which accounted for the increase in other borrowings from 1996. Page 13 TABLE 2 RATIOS TO AVERAGE ASSETS
1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ Net interest income . . . . . . . . . . . . . . 5.33% 5.06% 5.12% 6.26% 5.05% Other Operating income (loss) . . . . . . . . . 0.45% 0.45% (0.88%) (1.16%) 0.51% Provision for credit losses . . . . . . . . . . 0.00% 0.00% (1.54%) (2.99%) (0.69%) Other operating expense . . . . . . . . . . . . (5.66%) (7.13%) (7.52%) (5.58%) (4.83%) ------ ------ ------- ------ ------- Income (loss) before income taxes and cumulative effect of change in accounting principle . . . . . . . . . . . . . 0.12% 1.62% (4.82%) (3.47%) 0.04% ------ ------ ------- ------ ------- Net income (loss) before cumulative effect of change in accounting principle. . . . . . . 0.12% (1.11%) (4.82%) (3.47%) 0.04% ------ ------ ------- ------ ------- Net income (loss). . . . . . . . . . . . . . . 0.12% (1.11%) (4.82%) (3.47%) 0.06% ------ ------ ------- ------ ------- ------ ------ ------- ------ -------
1996 COMPARED TO 1995 Net interest income for the year ended December 31, 1996, was $5.7 million, a decrease of $2.0 million from $7.7 million for the year ended December 31, 1995. This decrease was primarily due to the decreased volume of interest- earning assets and the decreased volume of interest-bearing liabilities. The average yield on interest-earning assets was 8.19% during the year ended December 31, 1996, a decrease of 20 basis points from the average yield of 8.39% during the year ended December 31, 1995. During this period, the rates paid on interest-bearing liabilities decreased 14 basis points to 4.48% from 4.62% for the year ended December 31, 1995. As a result, the net yield on interest-earning assets decreased 21 basis points to 5.31% during the year ended December 31, 1996, from 5.52% during the year ended December 31, 1995. Average interest-earning assets decreased $31.8 million to $106.9 million during the year ended December 31, 1996, from $138.7 million during the year ended December 31, 1995. Average interest-bearing liabilities decreased $17.4 million to $68.7 million during the year ended December 31, 1996, from $86.1 million during the year ended December 31, 1995. These reductions were the result of management's restructuring plan that emphasized the reduction of criticized and classified assets and nonstrategic loan and deposit relationships. This planned restructuring was borne by management's intention to improve liquidity and maintain capital levels above regulatory minimums, in response to prolonged operating losses that eroded shareholders' equity. Average loan volume continued to decline, decreasing to $70.0 million during the year ended December 31, 1996, compared to $95.8 million during the same period in 1995. The volume of outstanding loans has continued to decline during 1996 due to scheduled loan amortizations and management's planned restructuring of the loan portfolio to reduce criticized and classified assets and non- strategic loan relationships. COMPARISON OF NET YIELD AND INTEREST RATE SPREAD The Company analyzes its earnings performance using, among other measures, the interest rate spread and net yield on earning assets. The interest rate spread represents the difference between the interest yield received on earning assets and the interest rate paid on interest-bearing liabilities. Net interest income, when expressed as a percentage of average total interest-earning assets, is referred to as the net yield on interest-earning assets or net interest margin. The Company's net yield on interest-earning assets is affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. 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 other competitive factors. These factors are in turn affected by general economic conditions and other factors beyond the Page 14 Company's control, such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters, and the action of the Federal Reserve Board. Table 3 presents information concerning the change in interest income and interest expense attributable to changes in average volume and average rate. Table 4 presents the average yield on each category of earning assets, average rate paid on each category of interest-bearing liability, and the resulting interest rate spread and net yield on earning assets for each year in the three-year period ended December 31, 1997. Yields on tax-exempt investment securities presented in Table 4 have not been adjusted to a fully taxable equivalent to recognize the income tax savings and to facilitate comparison of taxable and tax-exempt assets because of utilized net operating loss carryforwards. The Bank's net yield on interest-earning assets remains high in comparison with the interest rate spread due to the continued significance of noninterest- bearing demand deposits relative to total funding sources. Average noninterest- bearing demand deposits totaled $33.0 million during 1997, representing 34.2% of average deposits, compared to $36.5 million, representing 35.1% of average deposits during 1996. Of these noninterest-bearing demand deposits during 1997, $9.8 million or 29.6% of average deposits were represented by real estate title and escrow company deposits, compared to $8.8 million or 24.0% of average deposits during 1996. While these deposits are noninterest-bearing, they are not cost-free funds. Customer service expenses, primarily costs related to external accounting, data processing and courier services provided to title and escrow company depositors are incurred by the Bank to the extent that certain average noninterest-bearing deposits are maintained by such depositors. Customer service expense is classified as other operating expense. If customer service expenses related to escrow customers were classified as interest expense, the Bank's reported net interest income for the years ended December 31, 1997, 1996, and 1995, would be reduced by $282,000, $349,000 and $489,000, respectively. Similarly, this would create identical reductions in other operating expense. The net yield on interest-earning assets for the years ended December 31, 1997, 1996, and 1995, would have decreased 28 basis points, 33 basis points, and 35 basis points, respectively. Page 15 Table 3 Increase (Decrease) in Interest Income/Expense Due to Change in Average Volume and Average Rate (1)
1997 vs 1996 1996 vs 1995 1995 vs 1994 ------------------------------ ----------------------------- ------------------------------ Increase Increase Increase (Decrease) due to: Net (Decrease) due to: Net (Decrease) due to: Net ------------------- Increase ------------------ Increase ------------------ Increase Volume Rate (Decrease) Volume Rate (Decrease) Volume Rate (Decrease) --------------------------------------------------------------------------------------------- Interest Income: Federal funds sold................. $ (35) $ 37 $(314) $206 $(115) $ 91 $ 357 $243 $600 Interest-bearing deposits with other financial institutions...... - 3 3 (7) - (7) 9 (5) 4 Securities held-to-maturity: U.S. Government and federal agency, and other securities..... 1,192 (60) 1,132 - 62 62 - - - Tax-exempt municipal securities... - - - - - Securities available-for-sale: U.S. Government and federal agency, and other securities..... (264) 82 (182) (526) 71 (455) (2,122) (119) (2,241) Tax-exempt municipal securities.. - - - (12) - (12) (42) 5 (37) Loans receivable (2).............. (1,025) 229 (796) (2,505) (51) (2,556) (5,109) (1,743) (6,852) ------ ---- ----- ------- ---- ------- ------- ------- ------- Total interest-earning assets.... $ (448) $291 $(157) $(2,844) $(33) $(2,877) $(7,517) $(1,619) $(9,136) ------ ---- ----- ------- ---- ------- ------- ------- ------- ------ ---- ----- ------- ---- ------- ------- ------- ------- Interest Expense: Interest-bearing deposits: Demand............................ $ 17 $ (3) $ 14 $ (27) $(34) $ (61) $ (33) $26 $ (7) Money market and savings.......... (6) 6 - (257) (111) (368) (347) 74 (273) Time certificates of deposit: $100,000 or more................ 49 (4) 45 (86) (37) (123) (107) 177 70 Under $100,000.................. (363) 6 (357) (244) (19) (263) (1,675) 556 (1,119) ------ ---- ----- ------- ---- ------- ------- ------- -------- Total time certificates of deposit.......................... (314) 2 (312) (330) (56) (386) (1,782) 733 (1,049) ------ ---- ----- ------- ---- ------- ------- ------- -------- Total interest-bearing deposits... (303) 5 (298) (614) (201) (815) (2,162) 833 (1,329) Other borrowed funds.............. - 7 7 Securities sold under agreements to repurchase and other borrowings...................... 11 57 68 (80) (5) (85) (203) (15) (218) Total interest-bearing liabilities.................... $ (292) $ 69 $(223) $ (694) $(206) $ (900) $(2,365) $ 818 $ (1,547) ------ ---- ----- ------- ---- ------- ------- ------- -------- Net interest income $ (156) $222 $ 66 $(2,150) $173 $(1,977) $(5,152) $(2,437) $ (7,589) ------ ---- ----- ------- ---- ------- ------- ------- -------- ------ ---- ----- ------- ---- ------- ------- ------- --------
(1) The change in interest income or interest expense that is attributable to both changes in average balance and average rate has been allocated to the changes due to (i) average balance and (ii) average rate in proportion to the relationship of the absolute amounts of changes in each. (2) Table does not include interest income that would have been earned on nonaccrual loans. Page 16 TABLE 4 AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
Year ended Year ended Year ended December 31, 1997 December 31, 1996 December 31, 1995 --------------------------- --------------------------- -------------------------- Interest Average Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Amount Expense Rate Amount Expense Rate Amount Expense Rate --------------------------- --------------------------- -------------------------- (Dollars in thousands) Assets: Federal funds sold and securities purchased under agreements to resell.... $ 12,862 $ 710 5.52% $19,572 $ 1,024 5.23% $ 16,034 $ 933 5.82% Interest-bearing deposits with other financial institutions.................. 41 3 7.33% - - - 174 7 4.02% Securities held to maturity: U.S. Treasury and agency, corporate and other securities........................ 17,960 1,194 6.65% 888 62 6.98% - - - Securities available for sale: U.S. Treasury and agency, corporate and other securities................... 11,808 746 6.32% 16,510 928 5.62% 26,636 1,383 5.19% Tax-exempt municipal securities......... - - - - - - 45 12 26.67% Loans receivable (1) (2)................. 59,336 5,947 10.02% 69,975 6,743 9.64% 95,771 9,299 9.71% -------- ------ -------- ------- -------- ------- Total interest earning assets........... 102,007 $8,600 8.43% 106,945 $ 8,757 8.19% 138,660 $11,634 8.39% ------ ------- ------- ------ ------- ------- Noninterest earning assets: Cash and due from banks - demand........ 4,957 5,878 9,403 Other assets............................ 3,491 2,887 4,840 Allowance for credit losses............. (2,654) (3,407) (3,504) -------- -------- -------- Total assets............................ $107,801 $112,303 $149,399 -------- -------- -------- -------- -------- --------
Page 17 TABLE 4 (CONTINUED) AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
Year ended Year ended Year ended December 31, 1997 December 31, 1996 December 31, 1995 --------------------------- --------------------------- -------------------------- Interest Average Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Amount Expense Rate Amount Expense Rate Amount Expense Rate --------------------------- --------------------------- -------------------------- (Dollars in thousands) Liabilities and shareholders' equity: Interest-bearing deposits: Demand.................................. $ 7,239 $ 90 1.24% $ 5,914 $ 76 1.29% $ 7,341 $ 137 1.87% Money market and savings................ 21,359 634 2.97% 21,556 634 2.94% 29,001 1,002 3.46% Time certificates of deposit: $100,000 or more....................... 8,341 464 5.56% 7,465 419 5.61% 8,876 542 6.11% Under $100,000......................... 26,518 1,568 5.91% 32,665 1,925 5.89% 36,754 2,188 5.95% -------- ------ -------- ------- ------- ------ Total time certificates of deposit...... 34,859 2,032 5.83% 40,130 2,344 5.84% 45,630 2,730 5.98% -------- ------ -------- ------- ------- ------ Total interest-bearing deposits......... 63,457 2,756 4.34% 67,600 3,054 4.52% 81,972 3,869 4.72% Other borrowed funds..................... 143 7 4.89% -- -- -- -- -- -- Federal funds purchased and securities sold under agreements to repurchase..... 1,637 93 5.68% 1,140 25 2.19% 4,154 110 2.65% -------- ------ -------- ------- ------- ------ Total interest-bearing liabilities...... 65,237 $2,856 4.38% 68,740 $ 3,079 4.48% 86,126 $3,979 4.62% ------ ------- ------ ------ ------- ------ Noninterest-bearing liabilities: Noninterest bearing demand deposits..... 32,988 36,518 52,246 Other liabilities....................... 1,035 1,545 1,994 Shareholders' equity..................... 8,541 5,500 9,033 -------- -------- ------ Total liabilities and shareholders' equity.................................. $107,801 $112,303 $149,399 -------- -------- -------- -------- -------- -------- Net interest income (spread)............. $5,744 4.05% $ 5,678 3.71% $7,655 3.77% ------ -------- ------ ------ -------- ------ Net yield on earning assets (2)......... 5.63% 5.31% 5.52%
- --------------------- (1) The average balance of nonperforming loans has been included in loans receivable. (2) Yields and amounts earned on loans receivable include loan fees of $130,000, $24,000 and $150,000 for the years ended December 31, 1997, 1996 and 1995 respectively. Page 18 PROVISION FOR CREDIT LOSSES Provisions for credit losses charged to operations reflect management's judgment of the adequacy of the allowance for credit losses and is determined through periodic analysis of the loan portfolio. This analysis includes a detailed review of the classification and categorization of problem and potential problem loans and loans to be charged off; an assessment of the overall quality and collectibility of the portfolio; and consideration of the loan loss experience, trends in problem loan concentrations of credit risk, as well as current and expected future economic conditions (particularly Southern California). Reports produced internally are provided to the Board of Directors. For 1997 and 1996, the Company did not record a provision for credit losses compared to a provision of $2.3 million for 1995. In 1997, net charge offs totaled $946,000 compared to $836,000 in 1996 and $1.6 million in 1995. The combination of the leveling-off of net charge offs, a change in the risk profile of the loan portfolio, the continued reduction in problem loans, and the improvement of the Southern California economy allowed the Company not to record any provision for credit losses in 1997 and 1996. However, credit quality will be influenced by underlying trends in the economic cycle, particularly in Southern California, among other factors, which are beyond management's control. Consequently, no assurances can be given that the Company will not sustain loan losses, in any particular period, that are sizable in relation to the allowance for credit losses. Additionally, subsequent evaluation of the loan portfolio, in light of factors then prevailing, by the Company and its regulators may indicate a requirement for increases in the allowance for credit losses through charges to the provision for credit losses. See "Cautionary Statement for Purposes of the `Safe Harbor' Provisions of the Private Securities Litigation Reform Act of 1995", below. OTHER OPERATING INCOME Other operating income decreased by $16,000 or 3.2% to $486,000 in 1997 compared to $502,000 in 1996. Other operating income increased in 1996 by $1.8 million or 138.2% from a loss of $1.3 million in 1995 resulting from the absence of significant losses from securities transactions which occurred during 1995. A breakdown of other operating income by category is reflected below: TABLE 5 OTHER OPERATING INCOME
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------------------ INCREASE INCREASE (DECREASE) (DECREASE) ---------------- --------------- 1997 AMOUNT % 1996 AMOUNT % 1995 ---- ------ ------ ---- ------ --- ----- (DOLLARS IN THOUSANDS) OTHER OPERATING (LOSSES) INCOME: Securities transactions: Net gain (loss) on sale of securities available- for-sale............................................. $(37) $(34) (1133%) $ (3) $1,230 100% $(1,233) Loss on termination of interest swap................. - - - - 1,294 100% (1,294) FEE INCOME: International services............................... 128 4 3.23% 124 (100) (45%) 224 Investment services.................................. 18 (55) (75%) 73 (181) (71%) 254 Deposit and other customer services.................. 377 69 22.40% 308 (429) (58%) 737 OTHER: Other income-shareholder's insurance claim........... - - - - (730) (100%) 730 Loss on other real estate owned...................... - - - - 733 100% (733) ---- ---- ---- ---- ------ ---- ------- Total other operating (loss) income................. $486 $(16) (3%) $502 $1,817 138% $(1,315) ---- ---- ---- ---- ------ ---- ------- ---- ---- ---- ---- ------ ---- -------
Page 19 SECURITIES TRANSACTIONS During 1997, the Company continued to restructure its investment portfolio in an effort to increase yield, reduce volatility to unexpected market changes, and stagger maturities to meet overall liquidity requirements. Accordingly, during the year ended December 31, 1997, the Company sold $3.9 million of investment securities available-for-sale, realizing a net loss of $37,000 compared to a net loss of $3,300 in 1996 and a net loss of $1.2 million in 1995. The losses realized in 1997 and 1996 resulted from the Company's sale of low yielding securities for reinvestment into higher yielding assets. During 1995, the Bank sold $46.9 million of investment securities available for sale, and terminated a related interest rate swap contract, realizing a net loss of $1.2 million on the sale of securities and a loss of $1.3 million on the termination of the interest rate swap contract. The net unrealized gains on securities available-for-sale increased by $114,000 to $38,000 at December 31, 1997, compared to losses of $76,000 at December 31, 1996. FEE AND OTHER INCOME Fee income related to international, investment and deposit services increased by $18,000 or 3.6% to $523,000 during the year ended December 31, 1997, compared to fee income of $505,000 in 1996. This increase is primarily due to an increased effort to market deposit services combined with a focus on the realization of such fees during a period that the Company experienced an overall decrease in the deposit base. Fee income related to investment services decreased significantly as a result of a restructuring of the means by which the services are delivered, described below. During 1996 fee income related to international, investment and deposit services decreased $710,000 or 58.4% to $505,000 from $1.2 million in 1995. The international services department was closed in December 1995, resulting in reduced letter of credit and foreign exchange functions during 1996. Other income for the year ended December 31, 1995, included $730,000 of income from insurance proceeds resulting from the settlement of a lawsuit, offset by losses on other real estate owned of $733,000. During 1996, the Bank restructured its investment service division by forming a strategic alliance with an investment brokerage firm. This strategic alliance enables the Bank to continue to provide a wide array of products at significantly reduced overhead costs. In addition, the Bank has reviewed the fee structure of its deposit-related services and has made the necessary changes to ensure such services are competitively priced beginning in 1998. OTHER OPERATING EXPENSE Other operating expense totaled $6.1 million in 1997, a decrease of $1.9 million from 1996 which was down $3.2 million from 1995. A breakdown of other operating expense by category is reflected below: Page 20 TABLE 6 OTHER OPERATING EXPENSES
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------------------ INCREASE INCREASE (DECREASE) (DECREASE) ---------------- --------------- 1997 AMOUNT % 1996 AMOUNT % 1995 ---- ------ ------ ---- ------ --- ----- (DOLLARS IN THOUSANDS) OTHER OPERATING EXPENSES: Salaries and related benefits...................... $2,887 $ 169 6% $2,718 $(1,160) (30%) $ 3,878 Severance costs.................................... - - - - (141) (100%) 141 Net occupancy...................................... 806 13 2% 793 (675) (46%) 1,468 Furniture and equipment............................ 200 (98) (33%) 298 (87) (23%) 385 Printing and communications........................ 229 18 9% 211 (59) (22%) 270 Insurance and regulatory assessments............... 516 (113) (18%) 629 (342) (35%) 971 Customer services.................................. 537 (70) (12%) 607 (246) (29%) 853 Computer data processing........................... 292 (67) (19%) 359 (54) (13%) 413 Legal settlement................................... - - - 1,000 1,000 - - Legal services..................................... 172 (331) (66%) 503 (246) (33%) 749 Other professional services........................ 225 (415) (65%) 640 (906) (59%) 1,546 Other real estate owned expenses................... 21 (18) (46%) 39 (2) (5%) 41 Promotion and other expenses....................... 213 7 3% 206 (312) (60%) 518 ------ ------- ---- ------ ------- --- ------- Total other operating expenses.................... $6,098 $(1,905) (24%) $8,003 $(3,230) (29%) $11,233 ------ ------- ---- ------ ------- --- ------- ------ ------- ---- ------ ------- --- -------
The primary reason for the 23.8% reduction of other operating expense during 1997 compared to 1996 is attributable to the $1.0 million legal settlement recognized during 1996, discussed below. Salaries and related benefits increased $169,000 to $2.9 million during 1997 compared to $2.7 million in 1996. This increase in salaries and related benefits during 1997 was the result of the Bank's efforts to expand its loan and deposit production staff in response to the recapitalization completed in June 1997. However, significant other operating expense reductions were achieved in 1997 compared to 1996 in the areas of insurance and regulatory assessments, legal services, and other professional services. These reductions were the result of management's continued efforts to reduce operating expenses. During the year ended 1996, other operating expense was $8.0 million (including the settlement of a lawsuit for $1.0 million), a 28.8% decrease from 1995. This $3.2 million decrease was primarily attributable to the reduction in salaries and related expenses of $1.2 million, along with the reductions in occupancy expense, insurance and regulatory assessments, and other professional services. In 1995, the Bank negotiated with its landlord a restructuring of its lease for the Bank's premises. This restructuring of the Bank's lease represents an annual savings of approximately $850,000 over the five years ending December 31, 2000, and significantly contributed to the reductions in net occupancy expense achieved during 1996. See "Item 2 Properties." In addition, the decreases in compensation expense and other professional services is due to reductions in staff and changes in management during 1996. Other operating expense during 1996 includes a litigation settlement of $1.0 million from a settlement agreement reached in relation to counterclaims filed against the Bank by underwriters for Lloyd's ("Lloyd's Underwriters") and certain other parties. In addition, other operating expense for the year ended December 31, 1996, includes $145,000 for consulting services directly related to efforts associated with the federal income tax refund. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Income Taxes." Page 21 INCOME TAXES The Company accounts for income taxes under Statement of Financial Accounting Standards ("SFAS") No. 109. Under this standard, financial statement tax benefit associated with income tax net operating loss carryforwards ("NOL's") and future tax deductions for expenses already incurred for financial statement purposes but not yet deducted for tax return purposes (deferred tax assets) are allowed to be recognized when there is a more likely than not expectation that such benefits will actually be utilized. At December 31, 1997, the Company had $10,190,000 of these deferred tax assets and placed a valuation allowance against 100% of the asset. The Company's deferred tax asset consists primarily of federal and state NOL's which total $22.3 and $11.1 million respectively. Federal income tax laws permit the Company to carry back NOL's three years (two years after 1997) to offset taxable income in those periods, if any, and forward fifteen years (twenty years after 1997) to offset taxable income in those future periods. Under special circumstances losses may be carried back up to 10 years. California franchise tax laws do not provide for the carryback of such losses and generally permit one-half of net operating losses to be carried forward five years. The federal NOL's expire beginning in 2007 through 2011 and the state carryforwards expire beginning in 1998 through 2002. No income tax provision was recorded during 1997 due to the utilization of previously unrecognized tax benefits to offset current period tax liability. During the year ended December 31, 1996 the Company recognized a tax benefit for federal income tax purposes of approximately $579,000 (including $43,000 in interest) related to a refund of prior years taxes from the carryback of a portion of the Company's NOL's for which a tax benefit had not been previously recognized. No income tax benefit was recorded for 1995, due to the uncertainty with respect to the ultimate realization of such benefit. Additionally, federal and state income tax laws provide that, following an ownership change of a corporation with a net operating loss, a net unrealized built-in loss, or tax credit carryovers, the amount of annual post-ownership change taxable income that can be offset by pre-ownership change NOLs or recognized built-in losses generally cannot exceed a prescribed annual limitation. The annual limitation generally equals the product of the fair market value of the corporation immediately before the ownership change (subject to certain adjustments) and the federal long-term tax-exempt rate prescribed monthly by the Internal Revenue Service. If such limitations were to apply to the Company, the ability of the Company to reduce the valuation allowance that is currently placed against the deferred tax asset could be severely limited. CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The Company wishes to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 as to "forward looking" statements in this Form 10-K which are not historical facts. The Company cautions readers that the following important factors could affect the Company's business and cause actual results to differ materially from those expressed in any forward looking statement made by, or on behalf of, the Company. - ECONOMIC CONDITIONS. The Company's results are strongly influenced by general economic conditions in its market area, Southern California, and a deterioration in these conditions could have a material adverse impact on the quality of the Bank's loan portfolio and the demand for its products and services. In particular, changes in economic conditions in the real estate and entertainment industries may affect the Company's performance. - INTEREST RATES. Management anticipates that interest rate levels will remain generally constant in 1998, but if interest rates vary substantially from present levels, this may cause the Company's results to differ materially. Page 22 - GOVERNMENT REGULATION AND MONETARY POLICY. All forward-looking statements presume a continuation of the existing regulatory environment and U.S. Government monetary policies. The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeals of, existing laws may cause results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Bank, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing and bank reserve requirements, and a material change in these conditions would be likely to have an impact on results. - COMPETITION. The Bank competes with numerous other domestic and foreign financial institutions and non-depository financial intermediaries. Results may differ if circumstances affecting the nature or level of competitive change, such as the merger of competing financial institutions or the acquisition of California institutions by out-of-state companies. - CREDIT QUALITY. A significant source of risk arises form the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Bank's credit portfolio, but such policies and procedures may not prevent unexpected losses that could adversely affect the Company's results. - OTHER RISKS. From time to time, the Company details other risks to its business and/or its financial results in its filings with the Securities and Exchange Commission. While management believes that its assumptions regarding these and other factors on which forward-looking statements are based are reasonable, such assumptions are necessarily speculative in nature, and actual outcomes can be expected to differ to some degree. Consequently, there can be no assurance that the results described in such forward-looking statements will, in fact, be achieved. FINANCIAL CONDITION CAPITAL On June 30, 1997, the Company completed the sale of 900,000 shares of Preferred Stock through the Capital Offerings in which the Company raised net proceeds of $7.35 million. The primary purpose of the offerings was to enable the Company to downstream capital into the Bank in order to comply with the requirements of the Formal Agreement and the MOU entered into between the Bank and the OCC, and between the Company and the FRB, respectively. The Company contributed $2.5 million in capital to the Bank on June 30, 1997. The remaining portion of the net proceeds have been retained for general corporate purposes to facilitate the implementation of the business strategies of the Company. Primarily a result of the Capital Offerings and the positive operating results during 1997, Tier 1 capital, which is comprised of shareholders' equity and certain regulatory adjustments, of the Company and Bank increased to $12.4 million and $7.4 million, respectively, at December 1997 compared to Tier 1 capital of $4.9 million for both the Company and Bank at December 31, 1996. The following table sets forth the regulatory standards for well capitalized institutions, and the capital ratios for the Company and the Bank as of December 31, 1997, 1996 and 1995. Page 23 TABLE 7 REGULATORY CAPITAL INFORMATION OF THE COMPANY AND BANK
Well Capitalized December 31, --------------------------------------- Standards 1997 1996 1995 ---------------- --------- --------- --------- COMPANY: Tier 1 leverage......................................... 5.00% 10.43% 4.68% 4.68% Tier 1 risk-based capital............................... 6.00% 16.98% 6.96% 6.96% Total risk-based capital................................ 10.00% 18.25% 8.25% 8.25% BANK: Tier 1 leverage......................................... 5.00% 6.48% 4.67% 4.67% Tier 1 risk-based capital............................... 6.00% 10.36% 6.95% 6.95% Total risk-based capital................................ 10.00% 11.63% 8.24% 8.24%
RESTRICTIONS ON DIVIDENDS As a result of the offerings and the contribution of $2.5 million in capital into the Bank, the Company (parent company only) had cash and investment securities of approximately $3.9 million at December 31, 1997. Despite this fact, the Company is currently prohibited from paying cash dividends by state law. As a California corporation, the Company may not make a distribution to its shareholders (which includes a payment of dividends but not stock dividends) unless the Company has sufficient retained earnings under the Retained Earnings Test. The Retained Earnings Test is defined as the Company's retained earnings (determined on a consolidated basis according to generally accepted accounting principles) or if, immediately after giving effect to the distribution, all of the Company's assets equal 1.25 times the Company's liabilities (the "Retained Earnings Test"). The Company's accumulated deficit of $19.6 million as of December 31, 1997 requires the Company to record cumulative net earnings in excess of $19.6 million before a dividend can be paid under the Retained Earnings Test. If assets equal 1.25 times liabilities subsequent to a distribution, the Company may pay a dividend prior to recording cumulative earnings of $19.6 million, however, it is not anticipated that the Company will ever achieve capital levels to meet this prong of the test. At the present time, the Company does not meet the Retained Earnings Test and no assurance can be made as to when, if ever, such test will be met. The terms of the Preferred Stock provide that dividends on the Preferred Stock may be paid commencing June 30, 1999. Notwithstanding the foregoing, the Company may not pay dividends unless the Bank is in full compliance with federal regulatory capital requirements, the Company is permitted by the FRB to pay dividends and the Company meets the Retained Earnings Test. Dividends on the Preferred Stock will not accumulate. LIQUIDITY MANAGEMENT The objective of liquidity management is the ability to maintain cash flow adequate to fund the Company's operations and meet obligations and other commitments on a timely and cost effective basis. The Company manages to this objective through the selection of asset and liability maturity mixes that it believes best meet the needs of the Company. The Company's liquidity position is enhanced by its ability to raise additional funds as needed in the money markets. The Company's deposit base provides the majority of the Company's funding requirements. This relatively stable and low-cost source of funds has, along with shareholders' equity, provided 97.4% and 97.6% of funding for average total assets in 1997 and 1996, respectively. The remaining funding of average total assets is primarily provided by sales of securities under repurchase agreements. This funding source averaged $1.6 million and $1.1 million during 1997 and 1996, respectively. Additionally, the Bank increased its funding from other borrowings at the end of 1997, specifically Federal Home Page 24 Loan Bank ("FHLB") advances, which averaged $143,000 during 1997. The Company was not a member of the FHLB during 1996. Liquidity is also provided by reductions in assets such as federal funds sold and securities which may be immediately converted to cash at minimal cost. The aggregate of federal funds sold averaged $12.9 million during 1997, down $6.7 million, or 34.3% from $19.6 million during 1996. This decrease resulted from the Company's decision to maintain a substantially lower level of liquidity due to the completion of the Capital Offerings, the stabilization in deposits, the Company's improved operating performance and the termination of the Formal Agreement and MOU during 1997. Liquidity is also provided by the portfolio of available-for-sale securities which total $25.8 million at December 31, 1997. In addition, the unpledged portion of securities at December 31, 1997 totaled $22.2 million and would be available as collateral for borrowing. Maturing loans also provide liquidity, of which $22.4 million of the Bank's loans are scheduled to mature in 1998. ASSET LIABILITY MANAGEMENT The principal objectives of asset/liability management are to maximize the net yield on earning assets or net interest margin subject to margin volatility and liquidity constraints. Margin volatility results when the rate reset (or repricing) characteristics of assets are materially different from those of the Company's liabilities. Liquidity risk results from the mismatching of asset and liability cash flows. Management chooses asset/liability strategies that promote stable earnings and reliable funding. Interest rate risk and funding positions are kept within limits established by the Company's board of directors to ensure that risk-taking is not excessive and that liquidity is properly managed. The Company has established three measurement processes to quantify and manage exposure to interest rate risk: net interest income simulation modeling, gap analysis, and present value of equity analysis. Net interest income simulations, provided to the Company by an outside firm, are used to identify the direction and severity of interest rate risk exposure across a twelve month forecast horizon. Gap analysis provides insight into structural mismatches of assets and liability repricing characteristics. Present value of equity calculations also provided to the Company by an outside firm are used to estimate the theoretical price sensitivity of shareholder equity to changes in interest rates. Table 8 compares the Company's interest rate gap position as of December 31, 1997 and 1996. Generally, an asset sensitive gap indicates that net interest margin will improve during a period of rising interest rates. The gap report shows that the Company's cumulative one year interest rate sensitivity gap decreased to $110,000 at December 31, 1997 from $13.9 million at December 31, 1996. This change resulted from the Company's efforts to lower its exposure to decreases in net interest income due to a rapid decline in interest rates. The Company has increased its investment securities portfolio that reprice after one year to $38.5 million at December 31, 1997 compared to $18.6 million at December 31, 1996. However, a majority of the Company's investment securities portfolio contains securities with an optional principal redemption feature allowing the issuer to "call" the security at specified dates. This call option is generally exercised when rates decrease - see "Investment Securities" below. Because the Company is unable to estimate the extent to which such investment securities will be called, the repricing of such securities in Table 8 is based on final maturity date. Due to the nature of the Company's liabilities which reprice within one year, during a period of slowly rising or falling interest rates it is not expected that rates paid on these liabilities will change to the same degree as the Company's assets since rates paid on the Company's base of interest checking, savings and money market deposit accounts historically have not increased or decreased proportionately with changes in interest rates. Since interest rate changes do not affect all categories of assets and liabilities equally or simultaneously, a cumulative gap analysis alone cannot be used to evaluate the Company's interest rate sensitivity position. To supplement traditional gap analysis, the Company uses simulation modeling to estimate the potential effects of Page 25 changing interest rates. This process allows the Company to fully explore the complex relationships within the gap over time and various interest rate scenarios. At December 31, 1997 and 1996, the Company's distribution of rate-sensitive assets and liabilities was as follows: TABLE 8 RATE-SENSITIVE ASSETS AND LIABILITIES
DECEMBER 31, 1997 ----------------------------------------------------------------- MATURING OR REPRICING IN ----------------------------------------------------------------- LESS AFTER THREE AFTER ONE THAN MONTHS YEAR THREE BUT WITHIN BUT WITHIN AFTER NOT RATE MONTHS ONE YEAR 5 YEARS 5 YEARS SENSITIVE TOTAL ------- ----------- ---------- ------- --------- ----- (DOLLARS IN THOUSANDS) Rate-Sensitive Assets: Interest-bearing deposits with other financial institutions..................... $ - $ 250 $ - $ - $ - $ 250 Federal Funds sold and securities purchased under agreements to resell....... 11,900 - - - - 11,900 Securities held-to-maturity................. - 2,000 12,000 - - 14,000 Securities available-for-sale............... - - 13,946 11,886 - 25,832 Equity investment-FRB & PCBB................ - - - 646 - 646 Loans receivable............................ 26,258 19,520 13,325 2,149 - 61,252 ------- ------- ------- ------- ------- -------- Total rate-sensitive assets................ 38,158 21,770 39,271 14,681 - 113,880 Rate-Sensitive Liabilities: (1) Interest bearing Deposits: Interest-bearing demand, money market and savings......................... 30,601 - - - - 30,601 Time certificates of deposit............... 8,112 12,555 10,721 - - 31,388 Federal funds purchased and securities sold under agreements to repurchase........ 50 5,000 - - - 5,050 Other borrowings............................ - 3,500 - - - 3,500 ------- ------- ------- ------- ------- -------- Total rate-sensitive liabilities........... 38,763 21,055 10,721 - - 70,539 Interest rate-sensitivity gap............... (605) 715 28,550 14,681 - 43,341 ------- ------- ------- ------- ------- -------- ------- ------- ------- ------- ------- -------- Cumulative interest rate-sensitivity gap.... $ (605) $ 110 $28,660 $43,341 43,341 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Cumulative ratio of rate sensitive assets to rate-sensitive liabilities.............. 98% 100% 141% 161% ------- ------- ------- ------- ------- ------- ------- -------
(1) Customer deposits which are subject to immediate withdrawal are presented as repricing within three months or less. The distribution of other time deposits is based on scheduled maturities. Page 26 TABLE 8 RATE-SENSITIVE ASSETS AND LIABILITIES
DECEMBER 31, 1997 ----------------------------------------------------------------- MATURING OR REPRICING IN ----------------------------------------------------------------- LESS AFTER THREE AFTER ONE THAN MONTHS YEAR THREE BUT WITHIN BUT WITHIN AFTER NOT RATE MONTHS ONE YEAR 5 YEARS 5 YEARS SENSITIVE TOTAL ------- ----------- ---------- ------- --------- -------- (DOLLARS IN THOUSANDS) Rate-Sensitive Assets: Interest-bearing deposits with other financial institutions.................... $ - $ - $ - $ - $ - $ - Federal Funds sold and securities purchased under agreements to resell...... 23,000 - - - - 23,000 Securities held-to-maturity................ - - 14,395 - - 14,395 Securities held-for-sale................... - - 1,003 2,999 - 4,002 Equity investment-FRB & PCBB............... - - - 233 - 233 Loans receivable........................... 37,050 15,572 7,913 2,012 - 62,547 ------- ------- ------- ------ ------ -------- Total rate-sensitive assets............... 60,050 15,572 23,311 5,244 - 104,177 Rate-Sensitive Liabilities: (1) Interest bearing Deposits: Interest-bearing demand, money market and savings........................ 28,454 - - - - 28,454 Time certificates of deposit.............. 10,934 22,346 7,368 - - 40,648 Federal funds purchased and securities sold under agreements to repurchase....... - - - - - - Other borrowings........................... - - - - - - ------- ------- ------- ------ ------ -------- Total rate-sensitive liabilities.......... 39,388 22,346 7,368 - - 69,102 Interest rate-sensitivity gap.............. 20,662 (6,774) 15,943 5,244 - 35,075 ------- ------- ------- ------ ------ -------- ------- ------- ------- ------ ------ -------- Cumulative interest rate-sensitivity gap... $20,662 $13,888 $29,831 $35,075 35,075 ------- ------- ------- ------ ------ ------- ------- ------- ------ ------ Cumulative ratio of rate sensitive assets to rate-sensitive liabilities............. 152% 122% 143% 151% ------- ------- ------- ------ ------- ------- ------- ------
(1) Customer deposits which are subject to immediate withdrawal are presented as repricing within three months or less. The distribution of other time deposits is based on scheduled maturities. INVESTMENT SECURITIES The Company classifies its securities as held-to-maturity or available-for- sale. Securities which the Company has the ability and intent to hold to maturity are classified as held-to-maturity securities. All other securities are classified as available-for-sale. HELD-TO-MATURITY Held-to-maturity securities at December 31, 1997 totaled $14.0 million compared to $14.4 million at December 31, 1996. The average expected maturity of held-to-maturity securities was 1.04 years at December 31, 1997. AVAILABLE-FOR-SALE SECURITIES At December 31, 1997, securities available-for-sale totaled $25.8 million, an increase of $21.8 million from $4.0 million at December 31, 1996. This increase was due to the investment of the net proceeds from the Capital Page 27 Offerings and utilization of the Company's excess liquidity position for investment purposes during 1997. The average expected maturity of total available-for-sale securities at December 31, 1997 was 2.44 years. As illustrated in Table 9 below, the Company's investment portfolio generally consisted of U.S. government and federal agency securities and mortgage-backed securities including CMOs, at December 31, 1997 and 1996. The Company's policy is to stagger the maturities of its investments to meet overall liquidity requirements of the Company. Table 10 below sets forth information concerning the maturity of and weighted average yield on the Company's investment portfolio. TABLE 9 ESTIMATED FAIR VALUES OF AND UNREALIZED GAINS AND LOSSES ON INVESTMENT SECURITIES AND DEBT SECURITIES
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996 ---------------------------------------------- -------------------------------------------- TOTAL GROSS GROSS ESTIMATED TOTAL GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSS VALUE COST GAINS LOSS VALUE --------- ---------- ---------- --------- --------- ---------- ---------- --------- (DOLLARS IN THOUSANDS) Securities held-to-maturity: U.S. government and federal agency securities................ $14,000 $ 10 $ - $14,010 $14,395 $ - $40 $14,355 ------- ---- --- ------- ------- --- --- ------- ------- ---- --- ------- ------- --- --- ------- Securities available-for-sale: U.S. Treasury securities.......... $ 1,002 $ 3 $ - $ 1,005 $ - $ - $ - $ - FNMA-issued mortgage pass through certificates........ 4,327 22 - 4,349 - - - - U.S. government and federal agency securities................ 15,488 34 - 15,522 1,000 3 - 1,003 CMO's and REMIC's issued by U.S. government and federal agencies.. 4,977 (21) - 4,956 3,078 - 79 2,999 ------- ---- --- ------- ------- --- --- ------- $25,794 $ 38 $ - $25,832 $ 4,078 $ 3 $79 $ 4,002 ------- ---- --- ------- ------- --- --- ------- ------- ---- --- ------- ------- --- --- -------
Page 28 TABLE 10 MATURITIES OF AND WEIGHTED AVERAGE YIELDS ON INVESTMENT SECURITIES AND DEBT SECURITIES
Carrying amount of investment securities maturing: ---------------------------------------------------------------------------------------------- After one but After five but Within one year within five years within ten years After ten years ----------------- ----------------- ----------------- ----------------- Amount Yield Amount Yield Amount Yield Amount Yield Total Yield -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- (Dollars in thousands) Securities held-to-maturity: Other government-sponsored agency securities............... $2,000 5.86% $12,000 6.72% $ - - $ - - $14,000 6.60% ------ ------- ------- ------ -------- ------- -------- ----- -------- ------- $2,000 5.86% $12,000 6.72% $ - - $ - - $14,000 6.60% ------ ------- ------- ------ -------- ------- -------- ----- -------- ------- ------ ------- ------- ------ -------- ------- -------- ----- -------- ------- Securities available-for-sale: U.S Treasury..................... $ - - $1,005 5.85% $ - - $ - - $ 1,005 5.85% FHLMC/FNMA-issued mortgage pass-through certificates....... - - 923 6.45% 3,426 6.59% - - 4,349 6.56% Other government-sponsored agency securities............... - - 12,018 6.59% 3,504 6.96% - - 15,522 6.67% CMO's and REMIC's issued by U.S. government-sponsored agencies........................ - - - 3,499 6.69% $1,457 6.96% 4,956 6.77% ------ ------- ------- ------ -------- ------- -------- ----- -------- ------- $ - - $13,946 6.53% $10,429 6.75% $1,457 6.96% $25,832 6.64% ------ ------- ------- ------ -------- ------- -------- ----- -------- ------- ------ ------- ------- ------ -------- ------- -------- ----- -------- -------
Actual maturities may differ from contractual maturities to the extent that borrowers have the right to call or repay obligations with or without call or repayment penalties. As of December 31, 1997, the only securities held by the Company where the aggregate book value of the Company's investment in securities of a single issuer exceeded ten percent (10%) of the Bank's shareholders' equity were issued by U.S. government and federal agencies. Investment securities included in Table 10 above include securities issued by Federal Home Loan Bank ("FHLB"), Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"). The majority of these securities contain a optional principal redemption feature (commonly referred to as a "call"), whereby the issuer, at their option, may redeem in whole at par the then outstanding bonds on specified redemption dates. Generally, these securities are called by the issuer when the prevailing market rates at the call date are below the market rates at the date of issue, allowing the issuer to replace such borrowings at a lower cost. Investment securities containing such call features totaled $29.5 million at December 31, 1997. Table 11 below summarizes the Company's callable investment securities in both the available- for-sale and held-to-maturity portfolios at December 31, 1997 indicating the next call period and call frequency. Page 29 TABLE 11 INVESTMENT SECURITIES WITH OPTIONAL PRINCIPAL REDEMPTION AT DECEMBER 31, 1997
Call Period as of December 31, 1997: ---------------------------------------- Weighted Weighted Within Three Six months Call Average Average Three To Six To Issuer Frequency Yield Maturity Months Months One Year Total - -------------------- ------------------------ ---------- ---------- ---------- ---------- ------------- ------- (Dollars in thousands) FHLMC Less than 3 Months 6.510% 3.90 $ 3,000 $ - $ - $ 3,000 FHLB 3 Months 6.422% 2.84 10,489 - - 10,489 FHLB 6 Months 6.777% 4.48 4,999 3,000 5,500 13,499 FNMA 6 Months 6.851% 4.47 2,499 2,499 ---------- ---------- ---------- ---------- ------------- ------- 6.637% 3.83 $18,488 $3,000 $ 7,999 $29,487 ---------- ---------- ---------- ---------- ------------- ------- ---------- ---------- ---------- ---------- ------------- -------
OTHER SECURITIES The Company owns stock in the Federal Reserve Bank, Federal Home Loan Bank and Pacific Coast Bankers Bank. These investments are carried at cost and totaled $646,000 and $233,000 at December 31, 1997 and 1996, respectively. LOAN PORTFOLIO The Company's lending activities are predominantly in Southern California. The Company has no foreign loans. LOANS BY TYPE The loan portfolio decreased by $1.3 million to $61.3 million at December 31, 1997 compared to $62.6 million at December 31, 1996. Table 12 below indicates that the loan portfolio composition at December 31, 1997 had a decreased portion of loans secured by real estate, representing approximately 56% of total loans outstanding as compared to 64% at December 31, 1996. Loans secured by commercial real properties decreased as a percentage of total loans outstanding to 36% at December 31, 1997 from 42% at December 31, 1996 due to loan payoffs and scheduled maturities. Other secured and unsecured commercial loans represented 35% of total loans outstanding at December 31, 1997, an increase from 26% at December 31, 1996 as a result of the Company's increased emphasis in this area. The loan portfolio decreased by $19.4 million to $62.6 million at December 31, 1996 compared to $82.0 million at December 31, 1995. Table 12 below indicates that the loan portfolio mix at December 31, 1996 had a larger portion of loans secured by real estate, representing approximately 64% of total loans outstanding as compared to 60% at December 31, 1995. Other secured and unsecured commercial loans represented 26% of total loans outstanding at December 31, 1996, a decline from 33% at December 31, 1995. Consumer loans to individuals represented 10% of total loans outstanding at December 31, 1996, an increase from 7% at December 31, 1995. Page 30 TABLE 12 LOAN PORTFOLIO COMPOSITION
December 31, ---------------------------------------------------------------------------------- 1997 1996 1995 ---------------------- ----------------------- ----------------------- Amount Percent Amount Percent Amount Percent -------- --------- -------- --------- -------- --------- (Dollars in thousands) Loan Portfolio Composition: Real estate construction and land development............................ $ 3,148 5% $ 3,441 6% $ 4,185 5% Commercial loans: Secured by one to four family residential properties................ 6,545 11% 6,233 10% 9,637 12% Secured by multifamily residential properties................ 2,494 4% 2,879 5% 2,876 3% Secured by commercial real properties............................ 22,324 36% 26,629 42% 28,734 35% Other - secured and unsecured............................. 21,264 35% 16,508 26% 27,393 33% Home equity lines of credit............. 252 0% 581 1% 3,983 5% Consumer installment and unsecured loans to individuals......... 5,508 9% 6,545 10% 5,435 7% -------- --------- -------- --------- -------- --------- Total loans outstanding 61,535 100% 62,816 100% 82,243 100% Deferred net loan origination fees, purchased loan discount and gains on termination of interest rate swap and cap agreements............................. (283) (269) (231) -------- -------- -------- Loans receivable, net................... $61,252 $62,547 $82,012 -------- -------- -------- -------- -------- --------
REAL ESTATE-RELATED AND ENTERTAINMENT INDUSTRY LENDING. In addition to the Company's concentration in loans secured by real estate, the Company is a provider of banking services to the entertainment industry in Southern California. Table 13 presents information about the Company's loans outstanding to entertainment-related customers at December 31, 1997, 1996, and 1995. The concentration of loans to the entertainment-related industry at December 31, 1997, decreased to $6.3 million or 10.2% of the total portfolio, as compared to $6.5 million, or 10.3% at December 31, 1996 and $9.4 million, or 11.4% at December 31, 1995. Management believes that the varying nature of customers represented within this group, as set forth in Table 13, indicates reasonable diversification. In addition, loans for the production of independently produced motion picture and television feature films presented in Table 13, are supported during production by performance bonds from highly-rated insurers, and, either distribution commitments from major studios or, in the case of smaller studios, standby letters of credit from large commercial banks. Management therefore believes that this concentration does not represent an undue concentration of credit risk. Page 31 TABLE 13 INDUSTRY CONCENTRATIONS OF LOANS
December 31, -------------------------------------- 1997 1996 1995 -------- -------- -------- (Dollars in thousands) Entertainment industry-related loans (1): Loans for single productions of motion picture and television feature films........................................................ $ 2,221 $ - $ 1,739 Other loans to entertainment-related enterprises, such as television and film production or distribution.................................. 1,068 1,158 3,020 Loans to individuals involved primarily in the entertainment industry................................................ 1,487 2,516 1,663 Loans to business management, legal and accounting firms, including their principals and employees, serving primarily the entertainmemt industry............................................... 1,479 2,791 2,930 -------- -------- -------- Total entertainment industry-related loans (2)........................ $ 6,255 $ 6,465 $ 9,352 -------- -------- -------- -------- -------- -------- Percent of total loans outstanding.................................... 10.2% 10.3% 11.4%
- --------------- (1) Included are loans secured by liens on residential and commercial real property amounting to $3.0 million and $1.2 million at December 31, 1996 and 1995, respectively. (2) Includes nonperformimg loans of $400,000 at December 31, 1995. LOAN MATURITY AND RATE COMPOSITION Floating rate or adjustable rate loans comprised 66.3% of total loans outstanding at December 31, 1997 and 74.3% at December 31, 1996. Total loans at December 31, 1997 were comprised of 36.4% due in one year or less, 50.0% due in 1--5 years and 13.6% due after 5 years. The loan maturities shown in Table 14 below are based on contractual maturities. As is customary in the banking industry, loans that meet sound underwriting criteria can be renewed by mutual agreement between the Company and the borrower. Because the Company is unable to estimate the extent to which its borrowers will renew their loans the table is based on contractual maturities. Page 32 TABLE 14 LOAN MATURITIES
At December 31, 1997 ----------------------------------------- Interest rates Interest rates are floating are fixed or or adjustable predetermined Total ---------------- -------------- --------- (Dollars in thousands) Aggregate maturities of total loans outstanding: Real estate construction and development: In one year or less................................ $ 321 $ - $ 321 After one year but within five years............... 2,827 - 2,827 After five years................................... - - - Commercial secured by real estate In one year or less................................ 5,218 1,060 6,278 After one year but within five years............... 8,387 9,972 18,359 After five years................................... 4,163 2,563 6,726 Commecial other secured and unsecured In one year or less................................ 10,073 2,773 12,846 After one year but within five years............... 4,205 3,032 7,237 After five years................................... 1,181 - 1,181 Other - In one year or less................................ 2,309 632 2,941 After one year but within five years............... 1,814 554 2,368 After five years................................... 295 156 451 ---------- --------- --------- Total loans outstanding $40,793 $20,742 $61,535 ---------- --------- --------- ---------- --------- ---------
CREDIT RISK MANAGEMENT The risk of nonpayment of loans is an inherent feature of the banking business. That risk varies with the type and purpose of the loan, the collateral which is utilized to secure payment, and ultimately, the creditworthiness of the borrower. To minimize this credit risk, the Bank requires that all loans of $250,000 to $750,000 be approved by an officers' loan committee. Larger loans must be approved by the loan committee of the Board of Directors. The Bank has implemented a process by which it reviews and manages the credit quality of the loan portfolio. An officers' loan committee has been established with the Bank's senior officers serving as voting members. The committee reviews delinquencies and documentation exceptions and assigns a risk-rating grade to each loan. Loan loss exposure and grade performance histories are tracked and used as a part of the quarterly loan migration analysis to determine the level of the allowance for credit losses. The ongoing credit control process includes a risk rating system and regular monitoring of classified and criticized assets as graded by the Bank's internal grading system. Under the Bank's internal grading system, loans are graded from "pass" to "loss," depending on credit quality. Loans in the "pass" category generally perform in accordance with their terms, and are provided to companies which have profit records, adequate capital for normal operations and cash flow sufficient to service the loan. When a loan shows signs of potential weakness that may affect repayment of the loan or the collateral, the loan is reclassified as "special mentioned." A loan which has further deterioration and exhibits defined weaknesses in the borrower's capacity to repay is reclassified as "substandard." When loan repayment is questionable or not supported by collateral, the loan is labeled "doubtful," reserves are established to offset the estimated risk and when loans decline further, the partial or anticipated loss is charged off. Page 33 NONPERFORMING ASSETS Nonperforming assets consist of nonperforming loans and other real estate owned. Nonperforming loans are those loans which have (i) been placed on nonaccrual status, (ii) been subject to troubled debt restructurings, or (iii) become contractually past due ninety days with respect to principal or interest, and have not been restructured or placed on nonaccrual status, as described below. Other real estate owned consists of real properties securing loans of which the Bank has taken title in partial or complete satisfaction of the loan. Information about nonperforming assets is presented in Table 15. TABLE 15 NONPERFORMING ASSETS
December 31, ----------------------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- ------- -------- (Dollars in thousands) Nonaccrual loans.............................$ 1,201 $ 928 $ 573 $ 3,426 $ 7,780 Troubled debt restructurings................. 5,422 5,016 5,167 5,582 5,584 Loans contractually past due ninety or more days with respect to either principal or interest and still accruing interest....... - 300 221 1,507 2,502 -------- -------- -------- ------- -------- Nonperforming loans.......................... 6,623 6,244 5,961 10,515 15,866 Other real estate owned...................... 777 556 581 1,529 6,175 -------- -------- -------- ------- -------- Total nonperforming assets...................$ 7,400 $ 6,800 $ 6,542 $12,044 $ 22,041 -------- -------- -------- ------- -------- -------- -------- -------- ------- -------- Allowance for credit losses as a percent of nonaccrual loans........................ 168.4% 319.9% 664.0% 89.4% 86.1% Allowance for credit losses as a percent of nonperforming loans..................... 30.5% 47.5% 63.8% 29.1% 42.2% Total nonperforming assets as a percent of loans receivable........................ 12.1% 10.9% 8.0% 10.4% 13.6% Total nonperforming assets as a percent of total shareholders' equity.............. 59.5% 140.4% 108.8% 116.8% 99.3%
At December 31, 1997, nonperforming assets totaled $7.4 million or 12.1% of total loans outstanding, representing a $600,000 increase from $6.8 million at December 31, 1996. The increase in nonperforming assets was due primarily to the refinancing of an existing loan representing a troubled debt restructuring from $4.9 million to $5.4 million as a result of the Bank consenting to increase the loan balance due by the amount of the past due real estate property taxes in order to protect its security interest. In addition, as a result of this refinancing, the Bank realized an increased yield which now approximates market. At December 31, 1997 this loan was performing in accordance with its refinanced terms and is secured by a first deed of trust on a single family residence with an appraised value as of January 1998 of $10.0 million. At December 31, 1996, total nonperforming assets were $6.8 million representing a $258,000 increase from the level at December 31, 1995. The balance at December 31, 1996 was comprised of $928,000 of nonaccrual loans, $300,000 of loans delinquent for 90 days or more but still accruing interest, $5.0 million of restructured loans and $556,000 of OREO. Nonperforming assets represented 10.9% of total loans outstanding at December 31, 1996. One loan, a troubled debt restructure, represents $4.9 million of the total $6.8 million of nonperforming assets. NONACCRUAL LOANS. Nonaccrual loans are those for which management has discontinued accrual of interest because there exists reasonable doubt as to the full and timely collection of either principal or interest. It is the Bank's policy that a loan will be placed on nonaccrual status if either principal or interest payments are past due in excess of ninety days unless the loan is both well secured and in process of collection, or if full collection of interest or principal becomes uncertain, regardless of the time period involved. When a loan is placed on nonaccrual status, all interest previously accrued but uncollected is reversed against current period operating results. Income on such loans is then recognized only to the extent that cash is received, Page 34 and, where the ultimate collection of the carrying amount of the loan is probable, after giving consideration to the borrower's current financial condition, historical repayment performance, and other factors. Accrual of interest is resumed only when (i) principal and interest are brought fully current, and (ii) such loans are either considered, in management's judgment, to be fully collectible or otherwise become well secured and in the process of collection. (See "Net Interest Income" for a discussion of the effects on operating results of nonperforming loans.) Nonaccrual loans at December 31, 1997, increased to $1.2 million from $928,000 at December 31, 1996. Nonaccrual loans at December 31, 1997 were comprised primarily of entertainment and Small Business Administration ("SBA") loans. The additional interest income that would have been recorded from nonaccrual loans, if the loans had not been on nonaccrual status was $177,000, $171,000 and $160,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Interest payments received on nonaccrual loans are applied to principal unless there is no doubt as to ultimate full repayment of principal, in which case, the interest payment is recognized as interest income. Interest income not recognized on nonaccrual loans reduced the net yield on earning assets by 17, 16, and 12 basis points for the years ended December 31, 1997, 1996, and 1995, respectively. TROUBLED DEBT RESTRUCTURINGS. Included within nonperforming assets are troubled debt restructurings ("TDR"). TDR is defined in SFAS Nos. 15 and 114 (see discussion above) as a loan for which the Company has, for economic or legal reasons related to a borrower's financial difficulties, granted a concession to the borrower it would not otherwise consider, including modifications of loan terms to alleviate the burden of the borrower's near-term cash flow requirements in order to help the borrower to improve its financial condition and eventual ability to repay the loan. At December 31, 1997, a single TDR loan represented $5.35 million of the total $5.40 million of TDRs. This loan is secured by a first deed of trust on residential real property which, at January 1998, had an appraised value of $10.0 million. At December 31, 1997 this loan was performing in accordance with its restructured terms and the property is currently being marketed for sale. No assurance can be given that the property will sell for its appraised value. Loans for which the Company had modified the terms by reductions in interest rates to below-market rates for loans with similar credit risk characteristics or extensions of maturity dates are presented in Table 15. LOANS CONTRACTUALLY PAST DUE 90 OR MORE DAYS. Loans contractually past due 90 or more days are those loans which have become contractually past due at least ninety days with respect to principal or interest. Interest accruals may be continued for loans that have become contractually past due ninety days when such loans are well secured and in the process of collection and, accordingly, management has determined such loans to be fully collectible as to both principal and interest. For this purpose, loans are considered well secured if they have collateral having a realizable value in excess of the amount of principal and accrued interest outstanding and/or are guaranteed by a financially capable party. Loans are considered to be in the process of collection if collection of the loan is proceeding in due course either through legal action or through other collection efforts which management reasonably expects to result in repayment of the loan or its restoration to a current status in the near future. Loans contractually past due 90 or more days and still accruing interest decreased to zero at December 31, 1997, from $300,000 at December 31, 1996. The Financial Accounting Standards Board ("FASB") issued SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" which was amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures", which eliminates the provisions of SFAS No. 114 regarding how a creditor should report income on an impaired loan and clarifies certain disclosure requirements. SFAS No. 114 prescribes the recognition criterion for loan impairment and the measurement methods for certain impaired loans and loans whose terms are modified in troubled debt restructurings. Due to the size and nature of the Bank's loan portfolio, impaired loans are determined by a periodic evaluation on an individual loan basis. SFAS No. 114 states that a loan is impaired when it is probable that a creditor will be unable to collect all principal and interest amounts due according to the contractual terms of the loan agreement. A creditor is required to measure impairment by discounting expected future cash flows at the loan's effective interest rate, by reference to an observable market price, or by determining the fair value of the collateral for a collateral dependent asset. Page 35 At December 31, 1997, the Bank had classified $6.6 million of its loans as impaired under SFAS No. 114, for which the related specific reserves was $15,000. The average recorded investment in, and the amount of interest income recognized on those impaired loans during the year ended December 31, 1997, were $6.4 million and $539,000 respectively. Of the loans considered to be impaired at December 31, 1997, $5.35 million or 81% of impaired loans was represented by one loan, a troubled debt restructuring. Due to the size and nature of the Bank's loan portfolio, impaired loans are determined based on a periodic evaluation on an individual loan basis. Foregone interest income attributable to nonperforming loans amounted to $177,000 for the year ended December 31, 1997 and $171,000 for the same period in 1996. This resulted in a reduction in yield on average loans receivable of 30 basis points and 24 basis points for the years ended December 31, 1997 and 1996, respectively. Although the Bank sold a large portion of the nonperforming loans in February 1995, to the extent that additional loans are identified as nonperforming in future periods, operating results will continue to be adversely affected. POTENTIAL NONPERFORMING LOANS. At December 31, 1997, management could not identify any significant amounts of loans about which it had serious doubts as to the ability of the borrowers to comply with the present loan payment terms in the future, beyond the loans disclosed above as past due, nonaccrual or restructured. If economic conditions change, adversely or otherwise, or if additional facts on borrowers' financial condition come to light, then the amount of potential problem loans may change, possibly significantly. ALLOWANCE FOR CREDIT LOSSES The Bank has a process by which it reviews and manages the credit quality of the loan portfolio. The ongoing credit control process includes a stringent risk rating system, enhanced underwriting criteria, early identification of problem credits, regular monitoring of any classified assets graded as "criticized" by the Bank's internal grading system, and an independent loan review process. The loan approval process is also tied to the risk rating system. The Classified Asset Committee ("CAC") meets on a quarterly basis to review, monitor, take corrective action upon all criticized assets, and review the adequacy of the allowance for credit losses. This Committee is currently chaired by the President and CEO, with the results of the CAC's meetings reviewed by the Officers and Directors' Loan Committees quarterly. The calculation of the adequacy of the allowance for credit losses is based on a variety of factors, including loan classifications and underlying cash flow and collateral values. On a periodic basis (three times per year), management engages an outside loan review firm to review the Bank's loan portfolio, risk grade accuracy and the reasonableness of loan evaluations. Annually, this outside loan review team analyzes the Bank's methodology for calculating the ALLL based on the Bank's loss histories and policies. The Bank uses a migration analysis as part of its ALLL evaluation which is a method by which specific charge-offs are related to the prior life of the same loan compared to the total loan pools in which the loan was graded. This method allows for management to use historical trends that are relative to the Bank's portfolio rather than use outside factors that may not take into consideration trends relative to the specific loan portfolio. In addition, this analysis takes into consideration other trends that are qualitative relative to the Bank's marketplace, demographic trends, amount and trends in nonperforming assets and concentration factors. The Board of Directors reviews the adequacy of the allowance for credit losses on a quarterly basis. Management utilizes its judgment to determine the provision for credit losses and establish the allowance for credit losses. Management believes that the allowance for credit losses at December 31, 1997, was adequate to absorb estimated losses in the existing portfolio, including commitments under commercial and standby letters of credit. However, no assurance can be given on how continued weaknesses in the real estate market or future changes in economic conditions might affect the Bank's principal market area, and may result in increased losses in the Bank's loan portfolio. Table 16 presents, for the five-year period ended December 31, 1997, the composition of the Company's allocation of the allowance for credit losses to specific loan categories designated by management for this purpose. Page 36 The Bank's current practice is to make specific allocations of the allowance for credit losses to criticized and classified loans, and unspecified allocations to each loan category based on management's risk assessment. This allocation should not be interpreted as an indication that loan charge-offs will occur in the future in these amounts or proportions, or as an indication of future charge-off trends. In addition, the portion of the allowance allocated to each loan category does not represent the total amount available for future losses that may occur within such categories, since the total allowance is applicable to the entire portfolio. TABLE 16 ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
December 31, -------------------------------------------------------------------------------------------------- 1997 %(1) 1996 %(1) 1995 %(1) 1994 %(1) 1993 %(1) -------- ------- -------- ------ ------ ------- ------ ------ ------- ------- (Dollars in thousands) Allocation of the Allowance for Credit Losses: Real Estate construction and land development..............$ 63 5% $ 42 6% $ 11 5% 17 1% $ 30 1% Commercial loans: Secured by one to four family residential properties........ 154 11% 479 10% 205 12% 77 16% 499 12% Secured by multifamily residential properties........ 49 4% 41 5% 25 3% 51 2% 472 3% Secured by commercial real properties.................... 512 36% 590 42% 454 35% 674 28% 1,422 25% Other - secured and unsecured. 1,055 35% 1,642 26% 2,521 33% 1,645 37% 3,130 41% Home equity lines of credit..... 2 0% 13 1% 64 5% 18 2% 149 3% Consumer installment and unsecured loans to individuals (1)...... 187 9% 161 10% 523 7% 578 14% 988 15% ------- ------- ------ ------ ------ ------ ------ ------ ------ ----- Allowance allocable to loans receivable.................... 2,022 100% 2,968 100% 3,803 100% 3,060 100% 6,690 100% Commitments to extend credit under standby and commercial letters of credit............. 1 - 1 - 2 - 3 - 7 - ------- ------- ------ ------ ------ ------ ------ ------ ------ ----- Total allowance for credit losses........................$ 2,023 100% $2,969 100% $3,805 100% $3,063 100% $6,697 100% ------- ------- ------ ------ ------ ------ ------ ------ ------ ----- ------- ------- ------ ------ ------ ------ ------ ------ ------ -----
_______________ (1) Percentage of loans in each category to total loans. LOAN CHARGE-OFFS AND RECOVERIES Management regularly monitors the loan portfolio to identify loans that may become nonperforming and conducts an ongoing evaluation of the Company's exposure to potential losses arising from such loans, as discussed above. Credit losses are fully or partially charged against the allowance for credit losses when, in management's judgment, the full collectability of a loan's principal is in doubt. However, there is no precise method of predicting specific losses which ultimately may be charged against the allowance in future periods. Loan charge-offs for the year ended December 31, 1997 of $1.3 million were primarily attributable to loans secured by residential properties, commercial--other secured and unsecured loans, and consumer loans pertaining to loans purchased in 1993 from the FDIC ("FDIC loans") and to a lesser extent the SBA portfolio. Loan charge-offs for the year ended December 31, 1996 were $1.3 million, primarily related to two loans in the commercial--other secured and unsecured portfolio pertaining to the international division and purchased lease financing contracts. Loan charge-offs for the year ended December 31, 1995 of $2.6 million included $1.7 million of FDIC loans, and $700,000 for loans generated by the international division. This decrease from 1994 was predominantly the consequence of declining loan balances from the sale of loans. Recoveries of loans previously charged-off amounted to $369,000 and $464,000 for the years ended December 31, 1997 and 1996, respectively, and were primarily the result of recoveries of business banking and entertainment related loans. The majority of these loans were in the commercial--other secured and unsecured category. Recoveries of loans previously charged-off for the year ended December 31, 1995 of $1.1 million included $700,000 of business banking and entertainment related lending and $150,000 related to the FDIC Loans. Recoveries pertaining to the commercial--other secured and unsecured loan portfolio included $400,000 of business banking and entertainment related lending and $100,000 FDIC loans. Page 37 TABLE 17 ANALYSIS OF CHANGES IN ALLOWANCE FOR CREDIT LOSSES
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------ 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ (DOLLARS IN THOUSANDS) Balance, beginning of period........................... $2,969 $3,805 $3,063 $6,697 $6,009 Loan charged off: Real estate construction and land development......... - - - 45 558 Commercial loans: Secured by one to four family residential properties. 310 9 120 2,215 72 Secured by multifamily residential properties........ 256 - - 702 - Secured by commercial real properties................ 56 - - 1,407 581 Other - secured and unsecured........................ 350 1,183 1,913 6,781 774 Home equity lines of credit........................... - - - 257 - Consumer installment and unsecured loans to individuals (1)...................................... 343 108 599 2,810 450 ------ ------ ------ ------ ------ Total loan charge-offs................................ 1,315 1,300 2,632 14,217 2,435 Recoveries of loans previously charged off: Real estate construction and land development......... - - 200 - 4 Commercial loans: Secured by one to four family residential properties. 71 26 11 288 7 Secured by commercial real properties................ 4 - - - - Other - secured and unsecured........................ 202 398 588 2,205 945 Home equity lines of credit........................... - - - 38 38 Consumer installment and unsecured loans to individuals (1)...................................... 92 40 268 722 129 ------ ------ ------ ------ ------ Total recoveries of loans previously charged off..... 369 464 1,067 3,253 1,123 ------ ------ ------ ------ ------ Net charge-offs...................................... 946 836 1,565 10,964 1,312 Provision for credit losses.......................... - - 2,307 7,330 2,000 ------ ------ ------ ------ ------ Balance, end of period............................... $2,023 $2,969 $3,805 $3,063 $6,697 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Net loan charge-offs as a percentage of allowance for credit losses.................................. 46.76% 28.16% 41.13% 357.95% 19.59% Provision for credit losses as a percent of net loan charge-offs during period...................... - - 147.41% 66.86% 152.44% Net loans charge-offs as a percent of average gross loans outstanding during the period........... 1.54% 1.19% 1.63% 7.83% 0.82% Recoveries of loans previously charged off as a percent of loans charged off in the previous year....................................... 28.38% 17.60% 7.50% 133.60% 17.30%
OFF-BALANCE SHEET CREDIT COMMITMENTS AND CONTINGENT OBLIGATIONS The Company is a party to financial instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of its clients. In addition to undisbursed commitments to extend credit under loan facilities, these instruments include conditional obligations under standby and commercial letters of credit. The Company's exposure to credit loss in the event of nonperformance by customers is represented by the contractual amount of the instruments. Page 38 Standby letters of credit are conditional commitments issued by the Company to secure the financial performance of a client to a third party and are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients. The Company uses the same credit underwriting policies in accepting such contingent obligations as it does for loan facilities. When deemed necessary, the Company holds appropriate collateral supporting those commitments. The nature of collateral obtained varies and may include deposits held in financial institutions and real properties. Management does not anticipate any material losses as a result of commitments under letters of credit. A portion of the allowance for credit losses has been allocated to these contingent obligations, as presented in Table 16. Losses, if any, are charged against the allowance for credit losses. At December 31, 1997 and 1996, standby letters of credit amounted to $600,000 and $175,000, respectively, and there were no commercial letters of credit outstanding. Undisbursed commitments under revocable and irrevocable loan facilities amounted to $9.4 million and $7.9 million at December 31, 1997 and 1996, respectively. Many of these commitments are expected to expire without being drawn upon and, as such, the total commitment amounts do not necessarily represent future cash requirements. OTHER REAL ESTATE OWNED ("OREO") When appropriate or necessary to protect the Bank's interests, real estate pledged as collateral on a loan may be acquired by the Bank through foreclosure or a deed in lieu of foreclosure. Real property acquired in this manner by the Bank is known as OREO. OREO is carried on the books of the Bank as an asset, at the lesser of the Bank's recorded investment or the fair value. The Bank periodically revalues OREO properties and charges other expenses for any further write-downs. OREO represents an additional category of "nonperforming assets." OREO at December 31, 1997 consisted of three properties totaling $777,000 representing two undeveloped commercially zoned parcels, one residential parcel and a single-family residence. The single-family residence closed escrow during January 1998. While the Bank is currently marketing the remaining properties for sale, no assurances can be given that they will be sold at 100% of the value at which the properties were carried by the Bank at December 31, 1997. OREO at December 31, 1997 increased to $777,000, from $556,000 at December 31, 1996. Page 39 DEPOSITS As indicated in Table 18, the Bank experienced a 7.4% decline in average total deposits during 1997 compared to 1996. The decline in deposits occurred throughout various deposit categories causing the overall mix of deposits during 1997 to remain relatively consistent with 1996, except for the disproportionate decrease in money desk deposits, which was consistent with management's restructuring plan. TABLE 18 DEPOSIT COMPOSITION (BALANCES ARE AVERAGES)
YEAR ENDED DECEMBER 31, -------------------------------------------------------- 1997 1996 1995 ---------------- ----------------- ----------------- (DOLLARS IN THOUSANDS) Noninterest-bearing demand deposits: Real estate title and escrow company customers.... $ 9,764 10% $ 9,280 9% $ 10,933 8% Other noninterest-bearing demand...................... 23,224 24% 27,238 26% 41,313 31% Interest-bearing demand, money market and savings.... 28,598 30% 27,470 26% 36,342 27% Time certificates of deposit: Money Desk.................. 23,789 25% 27,014 26% 33,806 25% Other: $100,000 or more............ 5,320 6% 5,302 5% 6,506 5% Under $100,000.............. 5,750 6% 7,814 8% 5,318 4% ---------------- ----------------- ----------------- Total time certificates of deposit..................... 34,859 36% 40,130 39% 45,630 34% ---------------- ----------------- ----------------- Total Deposits.............. $ 96,445 100% $104,118 100% $ 134,218 100% ---------------- ----------------- ----------------- ---------------- ----------------- -----------------
As indicated in Table 19, time certificates of deposit of $100,000 or more from money desk (wholesale institutional funds) operations represented a more significant source of funding during 1997 than in 1996. At December 31, 1997, 39.5% of total time certificates of deposit of $31.4 million were represented by accounts individually in excess of $100,000 as compared to 22.7% of total time certificates of deposit of $40.6 million at December 31, 1996. Time certificates of deposit in excess of $100,000 from the money desk operation comprised 51.3% of total time certificates of deposit in excess of $100,000 in 1997 as compared to 25.5% in 1996. Page 40 TABLE 19 MATURITIES OF TIME CERTIFICATES OF DEPOSIT $100,000 OR MORE
AT DECEMBER 31, 1997 ------------------------------------ MONEY ALL DESK OTHER TOTAL ------ ------ ------- (DOLLARS IN THOUSANDS) Aggregate maturities of time certificates of deposit: In three months or less.............................. $ 108 $4,472 $4,580 After three months but within six months............. - 746 746 After six months but within twelve months............ 805 822 1,627 After twelve months.................................. 5,449 - 5,449 ------ ------ ------- Total time certificates of deposit $100,000 or more. $6,362 $6,040 $12,402 ------ ------ ------- ------ ------ -------
AT DECEMBER 31, 1997 ------------------------------------ MONEY ALL DESK OTHER TOTAL ------ ------ ------- (DOLLARS IN THOUSANDS) Aggregate maturities of time certificates of deposit: In three months or less.............................. $206 $5,390 $5,596 After three months but within six months............. 300 667 967 After six months but within twelve months............ 1,335 803 2,138 After twelve months.................................. 513 - 513 ------ ------ ------- Total time certificates of deposit $100,000 or more. $2,354 $6,860 $9,214 ------ ------ ------- ------ ------ -------
BORROWED FUNDS Borrowings and related weighted average rates are summarized below in Table 20. TABLE 20 BORROWED FUNDS
1997 1996 1995 ----------------------------- ----------------------------- ----------------------------- BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE YEAR-END BALANCE RATE YEAR-END BALANCE RATE YEAR-END BALANCE RATE ----------- ------- ------- ----------- ------- ------- ----------- ------- ------- (Dollars in thousands) Securities sold under repurchase agreements...... $ 5,050 $ 1,637 5.68% - - - $4,497 $4,154 2.65% Other borrowings............ 3,500 143 4.89% - - - - - -
The maximum amount of securities sold with agreements to repurchase at any month end was $5.0 million, $1.5 million and $7.0 million during 1997, 1996 and 1995, respectively. The maximum amount of other borrowings at any month end was $3.5 million during 1997. The Bank did not utilize other borrowings during 1996 and 1995. At December 31, 1997, the total balance of borrowed funds are scheduled to mature during 1998. Page 41 REGULATORY AGREEMENTS FORMAL AGREEMENT AND MEMORANDUM OF UNDERSTANDING The Bank entered into the Formal Agreement with the OCC on December 14, 1995 which superceded and replaced a similar agreement entered into in 1991. Effective November 18, 1997 the OCC terminated the Formal Agreement. Prior to its termination, the Bank was required to maintain stipulated regulatory capital levels, appoint a new chief financial officer, make certain determinations as to the reasonableness of any salary, consulting fee, expense reimbursement or other type of compensation, review the need for, and the reasonableness of, all existing consulting, employment and severance contracts, prepare a written analysis of any new products or services, maintain the Bank's liquidity at a level sufficient to sustain current and anticipated operations, develop a three year capital plan and strategic plan, and improve the Bank's loan administration. The Company entered into a Memorandum of Understanding ("MOU") on October 26, 1995 with the FRB which superceded and replaced a similar agreement entered into in 1991. Effective September 4, 1997 the MOU was terminated by the FRB. Prior to its termination, the MOU prohibited the Company from paying dividends without prior approval of the FRB, required the submission of a plan to increase the Bank's capital ratios, required the Company to conduct a review of the senior and executive management of the Company and the Bank, prohibited the incurrence or renewal of debt without the FRB's approval, restricted cash expenditures in excess of $10,000 in any month and prohibited the Company from making acquisitions or divestitures or engaging in new lines of business without the FRB's approval. RECENT ACCOUNTING PRONOUNCEMENTS In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share" which specifies the computation, presentation, and disclosure requirements for earnings per share ("EPS") for entities with publicly held common stock or potential common stock. SFAS No. 128 eliminates both "primary" and "fully diluted" EPS, and requires the computation and disclosures of "basic" EPS and "diluted" EPS. SFAS No. 128 is effective for financial statements for both interim and annual periods ending after December 15, 1997, and earlier application is not permitted. EPS disclosures presented herein have been calculated in accordance with SFAS No. 128. See "Notes to Consolidated Financial Statements - Summary of Significant Accounting Policies - Earnings (Loss) Per Share". The FASB recently issued SFAS No. 129, "Disclosure of Information about Capital Structure," SFAS No. 130, "REPORTING COMPREHENSIVE INCOME" and SFAS No. 131, "DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION." SFAS No. 129 applies to all entities that issue any securities other than ordinary common stock and continues the existing requirements to disclose the pertinent rights and privileges of all securities. SFAS No. 130 provides guidance for reporting and display of comprehensive income and its components in the financial statements and SFAS No. 131 establishes standards for the way that public entities report information about operating segments in annual financial statements and requires that those entities report selected information about operating segments in interim financial reports issued to shareholders. These Statements are effective for fiscal years beginning after December 15, 1997. The Company will incorporate these disclosures at the time these pronouncements are adopted. Page 42 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements required by this Item are included herewith as a separate section of this Report, commencing on page F-1. The supplementary data pursuant to Item 8 is included in "Note 18--Quarterly Financial Data (unaudited)"--of the Notes to Consolidated Financial Statements" on page F-28. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item will appear under the captions "Proposal 1: Nomination and Election of Directors," "Directors and Executive Officers," and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive proxy statement for the 1998 Annual Meeting of Shareholders (the "1998 Proxy Statement"), and such information either shall be (i) deemed to be incorporated herein by reference to that portion of the 1998 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Company's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A. ITEM 11. EXECUTIVE COMPENSATION The information required by this item will appear under the captions "Directors and Executive Officers--Compensation of Directors," "Directors and Executive Officers--Executive Compensation," "Report of the Compensation Committee on Executive Compensation", "Directors and Executive Officers-- Stock Option Grants," "Directors and Executive Officers--Option Exercises and Holdings," "Directors and Executive Officers--Compensation Committee Interlocks and Insider Participation." and "Performance Graph" in the 1998 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference to those portions of the 1998 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Company's most recently completed fiscal year, or (ii) included in amendment to this report filed with the Commission on Form 10-K/A. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item will appear under the captions "Outstanding Securities and Voting Rights" and "Security Ownership of Principal Shareholders and Management" in the 1998 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference to that portion of the 1998 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Company's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item will appear under the caption "Certain Relationships and Related Transactions" in the 1998 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference to that portion of the 1998 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Company's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A. Page 43 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents have been filed as part of this report: 1. FINANCIAL STATEMENTS PAGE ---- Independent Auditors' Report. . . . . . . . . . . . . . . . . . . . . . F-1 Consolidated Balance Sheets at December 1997 and 1996 . . . . . . . . . F-2 Consolidated Statements of Operations for the years ended December 31, 1997, 1996, and 1995. . . . . . . . . . . . . F-3 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995. . . . . . F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 . . . . . . . . . . . . . . . . F-5 Notes to Consolidated Financial Statements for the three years ended December 31, 1997. . . . . . . . . . . . . . . . . . F-6 2. FINANCIAL STATEMENT SCHEDULES None. (b) Reports on Form 8-K None. (c) Exhibits See Index to Exhibits on page E-1 of this Report on Form 10-K (d) See Item 14(a) above. Page 44 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NATIONAL MERCANTILE BANCORP (Registrant) By /s/ SCOTT A. MONTGOMERY -------------------------- Scott A. Montgomery Chief Executive Officer By /s/ JOSEPH W. KILEY III -------------------------- Joseph W. Kiley III Chief Financial Officer Date: March 11, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ ROBERT E. GIPSON - ------------------------------------ Robert E. Gipson Chairman of the Board March 11, 1998 /s/ ROBERT E. THOMSON - ------------------------------------ Robert E. Thomson Vice Chair March 11, 1998 /s/ DONALD E. BENSON - ------------------------------------ Donald E. Benson Director March 11, 1998 /s/ ALAN GRAHM - ------------------------------------ Alan Grahm Director March 11, 1998 /s/ JOSEPH W. KILEY, III - ------------------------------------ Joseph W. Kiley, III Director and Chief Financial Officer March 11, 1998 /s/ SCOTT A. MONTGOMERY - ------------------------------------ Scott A. Montgomery Director and Chief Executive Officer March 11, 1998 /s/ DION G. MORROW - ------------------------------------ Dion G. Morrow Director March 11, 1998
Page 45 INDEPENDENT AUDITORS' REPORT To the Board of Directors National Mercantile Bancorp Los Angeles, California We have audited the accompanying consolidated balance sheets of National Mercantile Bancorp and subsidiary (the "Company") as of December 31, 1997 and 1996 and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of National Mercantile Bancorp and subsidiary as of December 31, 1997 and 1996 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. Deloitte & Touche LLP Los Angeles, California January 23, 1998 F-1 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996
1997 1996 ---------- ---------- (Dollars in thousands) ASSETS Cash and due from banks-demand. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 4,186 $ 5,113 Federal funds sold and securities purchased under agreements to resell . . . . . . . . . . . . . . . . 11,900 23,000 ---------- ---------- Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,086 28,113 Interest-bearing deposits with other financial institutions . . . . . . . . . . . . . . . . . . . . . . 250 - Securities available-for-sale, at fair value; aggregate amortized cost of $25,794 and $4,078 at December 31, 1997 and 1996, respectively . . . . . . . . . . . . . . . . . . . . . . . . . 25,832 4,002 Securities held-to-maturity, at amortized cost; aggregate market value of $14,010 and $14,355 at December 31, 1997 and 1996, respectively. . . . . . . . . . . . . . . . . . . . . . . . . 14,000 14,395 FRB and other stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 646 233 Loans receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61,252 62,547 Allowance for credit losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,023) (2,969) ---------- ---------- Net loans receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,229 59,578 Premises and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 943 Other real estate owned, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 777 556 Accrued interest receivable and other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 1,596 ---------- ---------- Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 119,405 $ 109,416 ---------- ---------- ---------- ---------- LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 35,399 $ 34,752 Interest-bearing demand. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,431 7,292 Money market accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,646 15,512 Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,524 5,650 Time certificates of deposit: $100,000 or more. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,402 9,214 Under $100,000. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,986 31,434 ---------- ---------- Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97,388 103,854 Securities sold under agreements to repurchase. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,050 - Other borrowed funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500 - Accrued interest payable and other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,027 717 ---------- ---------- Total liabilities.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106,965 104,571 Shareholders' equity: Preferred stock, 6.5% noncumulative convertible preferred stock; $10.00 stated value, authorized 1,000,000 shares; issued and outstanding 900,000 and 0 at December 31, 1997 and 1996, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,350 - Common stock, no par value; authorized 10,000,000 shares; issued and outstanding 677,144 and 677,260 at December 31, 1997 and 1996, respectively . . . . . . . . . . . . . . . . . 24,613 24,614 Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (19,561) (19,693) Net unrealized gain (loss) on securities available-for-sale. . . . . . . . . . . . . . . . . . . . . 38 (76) ---------- ---------- Total shareholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,440 4,845 ---------- ---------- Total Liabilities and Shareholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 119,405 $ 109,416 ---------- ---------- ---------- ----------
See accompanying notes to consolidated financial statements. F-2 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 --------- --------- --------- (Dollars in thousands, except per share data) Interest income: Loans, including fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,947 $ 6,743 $ 9,299 Securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,194 62 - Securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . 746 928 1,395 Federal funds sold and securities purchased under agreements to resell. . . . . . . 710 1,024 933 Interest-bearing deposits with other financial institutions . . . . . . . . . . . . 3 - 7 --------- --------- --------- Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,600 8,757 11,634 Interest expense: Interest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 76 137 Money market and savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 634 634 1,002 Time certificate of deposits: $100,000 or more . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 464 419 542 Under $100,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,568 1,925 2,188 --------- --------- --------- Total interest expense on deposits. . . . . . . . . . . . . . . . . . . . . . 2,756 3,054 3,869 Federal funds purchased and securities sold under agreements to repurchase. . . . . 93 25 110 Other borrowed funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 - - --------- --------- --------- Total interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,856 3,079 3,979 --------- --------- --------- Net interest income before provision for credit losses. . . . . . . . . . . . 5,744 5,678 7,655 Provision for credit losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 2,307 --------- --------- --------- Net interest income after provision for credit losses . . . . . . . . . . . . . . . 5,744 5,678 5,348 Other operating income (losses): Net loss on sale of securities available-for-sale . . . . . . . . . . . . . . . . . (37) (3) (1,233) Loss on termination of interest-rate swap . . . . . . . . . . . . . . . . . . . . . - - (1,294) International services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 124 224 Investment division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 73 254 Deposit-related and other customer services . . . . . . . . . . . . . . . . . . . . 377 308 737 Other income-shareholders' insurance claim. . . . . . . . . . . . . . . . . . . . . - - 730 Loss on other real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . - - (733) --------- --------- --------- Total other operating income (loss) . . . . . . . . . . . . . . . . . . . . . 486 502 (1,315) Other operating expenses: Salaries and related benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,887 2,718 3,878 Severance costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 141 Net occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 806 793 1,468 Furniture and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 298 385 Printing and communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229 211 270 Insurance and regulatory assessments. . . . . . . . . . . . . . . . . . . . . . . . 516 629 971 Customer services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537 607 853 Computer data processing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 359 413 Legal settlement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 1,000 - Legal services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 503 749 Other professional services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 640 1,546 Other real estate owned expenses. . . . . . . . . . . . . . . . . . . . . . . . . . 21 39 41 Promotion and other expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 206 518 --------- --------- --------- Total other operating expenses. . . . . . . . . . . . . . . . . . . . . . . . 6,098 8,003 11,233 --------- --------- --------- Net income (loss) before income tax benefit . . . . . . . . . . . . . . . . . . . . 132 (1,823) (7,200) Income tax benefit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (579) - --------- --------- --------- Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200) --------- --------- --------- --------- --------- --------- Earnings (loss) per share: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.20 $ (1.84) $ (10.63) --------- --------- --------- --------- --------- --------- Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.08 $ (1.84) $ (10.63) --------- --------- --------- --------- --------- ---------
See accompanying notes to consolidated financial statements. F-3 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Net Unrealized Gain (Loss) Preferred Stock Common Stock on Securities Accumulated Available- Shares Amount Shares Amount Deficit for-sale Total -------- --------- ---------- -------- ------------- ------------- -------- (Dollars in thousands except share data) Balance at January 1, 1995 . . . . . . . . . $ 3,078,146 $ 24,614 $ (11,249) $ (3,057) $ 10,308 Net unrealized gain on securities available-for-sale . . . . . . . . . . 2,903 2,903 Net loss. . . . . . . . . . . . . . . . . (7,200) (7,200) -------- --------- ---------- -------- ------------ ------------- -------- Balance at December 31, 1995 . . . . . . . . - - 3,078,146 24,614 (18,449) (154) 6,011 Net unrealized gain on securities available-for-sale . . . . . . . . . . 78 78 Net loss. . . . . . . . . . . . . . . . . (1,244) (1,244) -------- --------- ---------- -------- ------------ ------------- -------- Balance at December 31, 1996 . . . . . . . . - - 3,078,146 24,614 (19,693) (76) 4,845 9.09 to 1 reverse stock split effective June 20, 1997. . . . . . . . (2,739,516) Return of fractional common shares due to reverse stock split. . . . . . . . . . . . . . . . . (58) (1) (1) Net unrealized gain on securities available-for-sale . . . . . . . . . . 114 114 Issuance of 6.5% noncumulative convertible preferred stock, $10.00 stated value, net . . . . . . . 900,000 7,350 7,350 100 % stock dividend declared on January 8, 1998. . . . . . . . . . . . 338,572 Net income. . . . . . . . . . . . . . . . 132 132 -------- --------- ---------- -------- ------------ ------------- -------- Balance at December 31, 1997.. . . . . . . . 900,000 $ 7,350 677,144 $ 24,613 $ (19,561) $ 38 $ 12,440 -------- --------- ---------- -------- ------------ ------------- -------- -------- --------- ---------- -------- ------------ ------------- --------
See accompanying notes to consolidated financial statements. F-4 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOW YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 --------- --------- --------- (Dollars in thousands) Net cash flow from operating activities: Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Accretion of sublease loss . . . . . . . . . . . . . . . . . . . . . . . . . . . - - (458) Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . . . 179 194 365 Gain on sale of fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . - (1) - Provision for credit losses. . . . . . . . . . . . . . . . . . . . . . . . . . . - - 2,307 Provision for other real estate owned. . . . . . . . . . . . . . . . . . . . . . - - 733 Net loss on sale of securities available-for-sale. . . . . . . . . . . . . . . . 37 3 1,233 Net amortization of (discounts) premiums on securities . . . . . . . . . . . . . (28) 57 57 Net accretion of discounts on loans purchased. . . . . . . . . . . . . . . . . . (36) (9) (163) (Increase) decrease in accrued interest receivable and other assets. . . . . . . (204) (201) 723 Increase (decrease) in accrued interest payable and other liabilities. . . . . . 310 (524) (287) --------- --------- --------- Net cash provided by (used in) operating activities . . . . . . . . . . . . 390 (1,725) (2,690) Cash flows from investing activities: Net (increase) decrease in interest-bearing deposits with other financial institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (250) - 195 Purchase of securities held-to-maturity. . . . . . . . . . . . . . . . . . . . . (6,972) (14,395) - Purchase of securities available-for-sale. . . . . . . . . . . . . . . . . . . . (26,428) (1,000) (8,013) Proceeds from sales of securities available-for-sale . . . . . . . . . . . . . . 3,836 10,632 46,862 Proceeds from repayments and maturities of securities available-for-sale . . . . 421 6,568 4,276 Proceeds from repayments and maturities of secutiries-held-to-maturity . . . . . 7,400 - - Proceeds from sale of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . - - 6,599 Loan originations and principal collections, net . . . . . . . . . . . . . . . . 164 18,638 31,870 Purchase of other real estate owned. . . . . . . . . . . . . . . . . . . . . . . - (43) - Proceeds from sale of other real estate owned. . . . . . . . . . . . . . . . . . - 62 215 Net purchases of premises and equipment. . . . . . . . . . . . . . . . . . . . . (21) (10) (105) --------- --------- --------- Net cash (used in) provided by investing activities.. . . . . . . . . . . . (21,850) 20,452 81,899 Cash flows from financing activities: Net increase (decrease) in demand deposits, money market and savings accounts. . 2,794 (9,938) (58,649) Net decrease in time certificates of deposit . . . . . . . . . . . . . . . . . . (9,260) (6,451) (28,923) Net increase (decrease) in securities sold under agreements to repurchase and federal funds purchased.. . . . . . . . . . . . . . . . . . . . . . . . 5,050 (4,497) (8,075) Net increase in other borrowed funds. . . . . . . . . . . . . . . . . . . . . . 3,500 - - Payment for fractional shares of common stock. . . . . . . . . . . . . . . . . . (1) - - Net proceeds from issuance of 900,000 shares of preferred stock. . . . . . . . . 7,350 - - --------- --------- --------- Net cash provided by (used in) financing activities.. . . . . . . . . . . . 9,433 (20,886) (95,647) --------- --------- --------- Net decrease in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . (12,027) (2,159) (16,438) Cash and cash equivalents, January 1. . . . . . . . . . . . . . . . . . . . . . . . . 28,113 30,272 46,710 --------- --------- --------- Cash and cash equivalents, December 31. . . . . . . . . . . . . . . . . . . . . . . . $ 16,086 $ 28,113 $ 30,272 --------- --------- --------- --------- --------- ---------
See accompanying notes to consolidated financial statements F-5 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 AND 1995 NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS AND BASIS OF PRESENTATION The consolidated financial statements include the accounts of National Mercantile Bancorp (the "Company") and its wholly owned subsidiary, Mercantile National Bank (the "Bank"). All significant intercompany transactions and balances have been eliminated. The Bank is the Company's only subsidiary. The Bank operates as a commercial bank in the Los Angeles area. The accounting and reporting policies of the Company and the Bank conform with generally accepted accounting principles and general practice within the banking industry. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks-demand, federal funds sold and securities purchased under agreements to resell. Cash flows from interest-rate swap agreements and collar and floor contracts that are accounted for as hedges of loans and investments available-for-sale are reflected in cash flows from operating activities, rather than cash flows from investing activities. INVESTMENTS IN DEBT SECURITIES Investments in debt securities are classified into three categories based on the Company's intent at acquisition date. The categories are: (1) held-to-maturity, (2) available-for-sale, and (3) trading securities. Debt securities held-to-maturity are carried at amortized cost. Debt securities available-for-sale are carried at estimated fair value. Unrealized holding gains and losses are excluded from earnings and reported in a separate component of shareholders' equity until realized. Because the Bank has net operating loss carryforwards, no tax benefit has been recorded from the unrealized loss. Gains or losses on sales of securities are determined using the specific identification method. LOANS Loans are generally carried at principal amounts outstanding less unearned income. Unearned income includes deferred unamortized fees net of direct incremental loam origination costs. Interest income is accrued as earned. Net deferred fees are accreted into interest income using the interest method or straight line method if not materially different as described below. Nonaccrual loans are those for which management has discontinued accrual of interest because (i) there exists reasonable doubt as to the full and timely collection of either principal or interest, or (ii) such loans have become contractually past due ninety days with respect to principal or interest. Interest accruals may be continued for loans that have become contractually past due ninety days when such loans are well secured and in the process of collection and, accordingly, management has determined such loans to be fully collectible as to both principal and interest. For this purpose, loans are considered well secured if they are collateralized by property having a realizable value in excess of the amount of principal and accrued interest outstanding or are guaranteed by a financially capable party. Loans are considered to be in the process of collection if collection of the loan is proceeding in due course either through legal action or through other collection efforts which management reasonably expects to result in repayment of the loan or its restoration to a current status in the near future. F-6 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 When a loan is placed on nonaccrual status, all interest previously accrued but uncollected is reversed against current period operating results. Income on such loans is then recognized only to the extent that cash is received and where the ultimate collection of the carrying amount of the loan is probable, after giving consideration to borrowers' current financial condition, historical repayment performance and other factors. The Company considers a loan to be impaired when it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement. Once a loan is determined to be impaired, the impairment is measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, the impairment is measured by using the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measurement of the impaired loan is less than the recorded amount of the loan, an impairment is recognized by creating a valuation allowance with a corresponding charge to the provision for credit losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to the provision for credit losses. The Company's policy is to record cash receipts received on impaired loans first as reductions to principal and then to interest income. LOAN ORIGINATION AND CREDIT-RELATED FEES Nonrefundable fees and direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. Deferred net fees and costs are recognized in interest income over the loan term using a method which generally produces a level yield on the net investment in the loan. Nonrefundable fees associated with the issuance of loan commitments are deferred and recognized over the life of the loan as an adjustment of yield. Fees for commitments which expire unexercised are recognized in other operating income upon the expiration of the commitment. Fees received for standby letters of credit written are recognized as other operating income over the term of the related commitment. ALLOWANCE FOR CREDIT LOSSES Provisions for credit losses charged to operations reflect management's judgment of the adequacy of the allowance for credit losses and are determined through periodic analysis of the loan portfolio. This analysis includes a detailed review of the classification and categorization of problem and potential problem loans and loans to be charged off; an assessment of the overall quality and collectibility of the portfolio; and consideration of the loan loss experience, trends in problem loan concentrations of credit risk, as well as current and expected future economic conditions (particularly Southern California). OTHER REAL ESTATE OWNED Other Real Estate Owned ("OREO") includes real property acquired in full or partial satisfaction of loans through foreclosure, including direct foreclosure or deed in lieu of foreclosure. Foreclosed property is initially recognized at the property's estimated fair value at the date of foreclosure, with any excess of the net investment in the loan over the property's fair value charged against the allowance for credit losses. F-7 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 OREO is classified as held for sale and carried at the lower of estimated fair value or cost. Subsequent write-downs of OREO resulting from declining fair values are recorded in the periods in which they become known. Costs of holding OREO are reflected in other operating expense as incurred. PREMISES AND EQUIPMENT, NET Premises and equipment are presented at cost less accumulated amortization and depreciation. Depreciation of furniture, fixtures and equipment is determined using the straight-line method over the estimated useful lives of the related assets, which range from 3 to 7 years. Leasehold improvements are amortized using the straight-line method over the term of the related leases or the service lives of the improvements, whichever is shorter. INCOME TAXES The Company and the Bank file consolidated federal and combined state income tax returns on a calendar year basis. Deferred tax assets and liabilities are recognized for the expected future tax consequences of existing differences between financial reporting and tax reporting bases of assets and liabilities, as well as for operating losses and tax credit carryforwards using enacted tax laws and rates. Deferred tax expense represents the net change in deferred tax asset or liability balance during the year. This amount, together with income taxes currently payable or refundable in the current year, represents the total tax expense or benefit for the year. EARNINGS (LOSS) PER SHARE In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share" which specifies the computation, presentation, and disclosure requirements for earnings per share ("EPS") for entities with publicly held common stock or potential common stock. SFAS No. 128 eliminates both "primary" and "fully diluted" EPS, and requires the computation and disclosures of "basic" EPS and "diluted" EPS. SFAS No. 128 shall be effective for financial statements for both interim and annual periods ending after December 15, 1997, and earlier application is not permitted. EPS disclosures presented herein have been calculated in accordance with SFAS No. 128. F-8 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 Basic earnings (loss) per share is computed using the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding used in computing basic earnings (loss) per share for the years ended December 31, 1997, 1996 and 1995 was 677,202, 677,260, and 677,260, respectively. The weighted average number of common shares and common shares equivalents outstanding used in computing diluted earnings per share for the year ended December 31, 1997 was 1,629,796. Loss per share computations, for 1996 and 1995, exclude common share equivalents, since the effect would be to reduce the loss per share amount. All periods presented were restated to reflect the 9:09 to 1 reverse stock split effective June 20, 1997 and the 100% common stock dividend declared January 8, 1998 to be paid February 13, 1998. The 100% stock dividend was accounted for as a 2 for 1 stock split. The following table is a reconciliation of income (loss) and shares used in the computation of basic and diluted earnings per share:
Net Income Per share (loss) Shares amount ---------- ---------- ---------- (in thousands) FOR THE YEAR ENDED 1997: Basic EPS. . . . . . . . . . . . . . . . $ 132 677,202 $ 0.20 ---------- ---------- Effect of dilutive securities: Options and warrants. . . . . . . . 40,265 Convertible preferred stock . . . . 912,329 ---------- ---------- Diluted EPS. . . . . . . . . . . . . . . $ 132 1,629,796 $ 0.08 ---------- ---------- ---------- ---------- ---------- ---------- FOR THE YEAR ENDED 1996: Basic and diluted EPS. . . . . . . . . . $ (1,244) 677,260 $ (1.84) ---------- ---------- ---------- ---------- ---------- ---------- FOR THE YEAR ENDED 1995: Basic and diluted EPS. . . . . . . . . . $ (7,200) 677,260 $ (10.63) ---------- ---------- ---------- ---------- ---------- ----------
On January 8, 1998, subsequent to year end 1997, a 100% stock dividend was declared by the Board of Directors for shareholders of record on February 4, 1998. The stock dividend is payable on February 13, 1998. The stock dividend will be accounted for as a 2 for 1 stock split and all related share data in the consolidated financial statements reflect the effect of the stock dividend for all periods presented. INTEREST-RATE SWAP AGREEMENTS AND HEDGING CONTRACTS During 1994, the Company entered into interest-rate swap agreements as a means of moderating the impact of changes in the prime interest rate on income from loans and investment securities. The differential to be received (paid) in interest-rate swap agreements is recognized in interest income from loans or investments over the life of the related agreements. Upon termination of a swap agreement, the Company recognizes the remaining interest differential to be received (paid) and unrealized gain or loss to income or expense in the period the swap is terminated. The Company does not use interest-rate swaps for trading purposes. Interest-rate swap agreements used to hedge the available-for-sale investment securities are carried at fair value and the unrealized gain or loss is included with the unrealized gain or loss on its investment securities available-for-sale as a separate component of equity. Interest-rate swaps used to hedge the loan portfolio are carried off balance sheet. F-9 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 The Company did not enter into any interest-rate swap or other derivative agreements during 1997, 1996 and 1995. There were no such agreements outstanding as of December 31, 1997 and 1996. FAIR VALUE OF FINANCIAL INSTRUMENTS Estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data and to develop the estimates of fair value. Accordingly, the estimates of fair value in the financial statements are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and estimation methodologies may have a material effect on the estimated fair value amounts. 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. STOCK OPTIONS Prior to January 1, 1996 the Company accounted for its stock option plans in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996 the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period, the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. RECLASSIFICATIONS Certain items in the 1996 and 1995 financial statements have been reclassified to conform to the 1997 presentation. NEW ACCOUNTING PRONOUNCEMENTS The FASB recently issued SFAS No. 129, "Disclosure of Information about Capital Structure," SFAS No. 130, "REPORTING COMPREHENSIVE INCOME" and SFAS No. 131, "DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION." SFAS No. 129 applies to all entities that issue any securities other than ordinary common stock and continues the existing requirements to disclose the pertinent rights and privileges of all securities. SFAS No. 130 provides guidance for reporting and display of comprehensive income and its components in the financial statements and SFAS No. 131 establishes standards for the way that public entities report information about operating segments in annual and interim financial statements. These statements are effective for fiscal years beginning after December 15, 1997. The Company will incorporate these disclosures into its financial statements and notes thereto at the time these pronouncements are adopted. F-10 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE 2--REGULATORY MATTERS The Bank entered into a Formal Agreement with the Office of the Comptroller of the Currency ("OCC") on December 14, 1995 (the "Formal Agreement"). Effective November 18, 1997 the OCC terminated the Formal Agreement. Prior to its termination the Bank was required to maintain certain regulatory capital levels, appoint a new chief financial officer, make certain determinations as to the reasonableness of any salary, consulting fee, expense reimbursement or other type of compensation, review the need for, and the reasonableness of, all existing consulting, employment and severance contracts, prepare a written analysis of any new products or services, maintain the Bank's liquidity at a level sufficient to sustain current and anticipated operations, develop a three-year capital plan and strategic plan, and improve the Bank's loan administration. The Company entered into a Memorandum of Understanding ("MOU") on October 26, 1995 with the Federal Reserve Bank of San Francisco (the "FRB"). Effective September 4, 1997 the MOU was terminated by the FRB. Prior to its termination, the MOU prohibited the Company from paying dividends without prior approval of the FRB, required the submission of a plan to increase the Bank's capital ratios, required the Company to conduct a review of the senior and executive management of the Company and the Bank, prohibited the incurrence or renewal of debt without the FRB's approval, restricted cash expenditures in excess of $10,000 in any month and prohibited the Company from making acquisitions or divestitures or engaging in new lines of business without the FRB's approval. REGULATORY CAPITAL REQUIREMENTS The Federal Reserve Board and the OCC have issued guidelines (the "guidelines") regarding risk-based capital requirements. The guidelines provide detailed definitions of regulatory capital and assign different weights to various assets and credit equivalent amounts of off-balance-sheet financial instruments, depending upon the perceived degree of credit risk to which they expose such entities. Each banking organization is required to maintain a specified minimum ratio of capital to the total of such risk-adjusted assets and off-balance sheet financial instruments. The Company and the Bank are subject to various capital requirements administered by the federal banking regulatory 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 financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgment 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 1 capital (primarily common stock and retained earnings less goodwill) to risk-weighted assets, and of Tier 1 capital to average assets. At December 31, 1997, the most recent notification from the OCC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. At December 31, 1996, the OCC categorized the Bank as adequately capitalized. Under this framework, the Bank's current capital levels allow the acceptance of brokered deposits without prior approval. At December 31, 1997, brokered deposits were 0.3% of total deposits. There are no conditions or events since the most recent notification which management believes have changed the Bank's category. F-11 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 The actual and required capital ratios of the Company and the Bank at December 31:
TO BE CATEGORIZED AS WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION -------------------- -------------------- -------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------- -------- ------- ------- ------- ------- As of December 31, 1997 (Dollars in thousands) Total Capital to Risk Weighted Assets Company.. . . . . . . . . . . . . . . . . . . $13,329 18.25% $ 5,844 > =8.0% n/a Bank. . . . . . . . . . . . . . . . . . . . . 8,296 11.63% 5,705 > =8.0% $ 7,132 > =10.0% Tier 1 Capital to Risk Weighted Assets Company.. . . . . . . . . . . . . . . . . . . 12,402 16.98% 2,922 > =4.0% n/a Bank. . . . . . . . . . . . . . . . . . . . . 7,390 10.36% 2,853 > =4.0% 4,279 > =6.0% Tier 1 Capital to Average Assets Company.. . . . . . . . . . . . . . . . . . . 12,402 10.43% 4,756 > =4.0% n/a Bank. . . . . . . . . . . . . . . . . . . . . 7,390 6.48% 4,559 > =4.0% 5,699 > =5.0% As of December 31, 1996 Total Capital to Risk Weighted Assets Company . . . . . . . . . . . . . . . . . . . 5,831 8.25% 5,657 > =8.0% n/a Bank. . . . . . . . . . . . . . . . . . . . . 5,820 8.24% 5,657 > =8.0% 7,071 > =10.0% Tier 1 Capital to Risk Weighted Assets Company . . . . . . . . . . . . . . . . . . . 4,921 6.96% 2,828 > =4.0% n/a Bank. . . . . . . . . . . . . . . . . . . . . 4,911 6.95% 7,071 > =10.0% (1) 4,243 > =6.0% Tier 1 Capital to Average Assets Company . . . . . . . . . . . . . . . . . . . 4,921 4.68% 4,210 > =4.0% n/a Bank. . . . . . . . . . . . . . . . . . . . . 4,911 4.67% 6,841 > =6.5% (1) 5,262 > =5.0%
(1) Ratio required by the Formal Agreement, terminated September 4, 1997. NOTE 3--AVERAGE FEDERAL RESERVE REQUIREMENTS All depository institutions which are member banks are required to maintain reserves on deposits representing transaction accounts in the form of balances with the Federal Reserve Bank. The average reserve requirements for the Bank were $667,000 and $657,000 for the years ended December 31, 1997 and 1996, respectively. Neither the Company nor the Bank is required to maintain compensating balances to assure credit availability under existing borrowing arrangements. NOTE 4--SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL The Company enters into purchases of securities under agreements to resell ("reverse repurchase agreements") with primary dealers, as designated by the Federal Reserve Bank of New York, only. Amounts advanced under these agreements represent short-term invested cash included in cash and cash equivalents in the consolidated balance sheets. Securities subject to reverse repurchase agreements are held in the name of the Company or Bank by the dealers who arrange the transactions. Overnight reverse repurchase agreements contain no provisions to ensure that the fair value of the underlying securities remains sufficient to prevent loss to the Company in the event of default by the counterparty. With respect to agreements having terms in excess of one day, in the event that the fair value of securities decreases below the F-12 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 carrying amount of the related reverse repurchase agreements, the counterparties are required to designate an equivalent amount of additional securities in the name of the Company. Reverse repurchase agreements relating to mortgage-backed securities and U.S. Treasury and government agency securities represent agreements to resell the same securities. There were no reverse repurchase agreements outstanding during 1997 and 1996. NOTE 5--INVESTMENT SECURITIES The following is a summary of realized gains and losses on securities available-for-sale and interest income on securities held-to-maturity and available for sale:
YEAR ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Gains and Losses: Securities available-for-sale: Gross realized gains. . . . . . $ 3 $ 17 $ 67 Gross realized losses . . . . . (40) (20) (1,300) --------- --------- --------- Net realized losses. . . . . . . . . $ (37) $ (3) $ (1,233) --------- --------- --------- --------- --------- --------- Interest Income: Securities held-to-maturity: Tax-exempt. . . . . . . . . . . $ - $ - $ - Taxable . . . . . . . . . . . . 1,194 62 - --------- --------- --------- $ 1,194 $ 62 $ - --------- --------- --------- --------- --------- --------- Securities available-for-sale: Tax-exempt. . . . . . . . . . . $ - $ - $ 12 Taxable . . . . . . . . . . . . 746 928 1,383 --------- --------- --------- $ 746 $ 928 $ 1,395 --------- --------- --------- --------- --------- ---------
At December 31, 1997, a portion of the Company's investment securities portfolio was pledged as collateral for retail (customer) repurchase agreements, institutional repurchase agreements, FHLB borrowings, FRB discount lines and other deposits. Securities pledged for these purposes totaled $17.6 million. (Also see Note 10--Borrowed Funds.) The Company regularly monitors its investment portfolio for any deterioration in the issuer's creditworthiness expected to continue for a prolonged period of time which may result in a permanent impairment of the security's value. In such a circumstance, any permanent decline in value is charged against earnings. F-13 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair values of the Company's investment securities held-to-maturity and available-for-sale at December 31, 1997 and 1996, are presented below:
1997 1996 --------------------------------------------- --------------------------------------------- TOTAL GROSS GROSS ESTIMATED TOTAL GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE --------- ---------- ---------- --------- --------- ---------- ---------- --------- (DOLLARS IN THOUSANDS) . Securities held-to-maturity: Other government sponsored agency securities . . . . . . $ 14,000 $ 10 $ - $ 14,010 $ 14,395 $ - $ 40 $ 14,355 --------- ---------- ---------- --------- --------- ---------- ---------- --------- Securities available-for-sale: U.S. Treasury securities . . . . $ 1,002 $ 3 $ - $ 1,005 $ $ - $ - $ - FNMA-issued mortgage pass- through certificates. . . . . 4,327 22 - 4,349 - - - - Other government-sponsored agency securities . . . . . . 15,488 34 - 15,522 1,000 3 - 1,003 CMO's and REMIC's issued by U.S. government sponsored agencies 4,977 (21) - 4,956 3,078 - 79 2,999 --------- ---------- ---------- --------- --------- ---------- ---------- --------- $ 25,794 $ 38 $ - $ 25,832 $ 4,078 $ 3 $ 79 $ 4,002 --------- ---------- ---------- --------- --------- ---------- ---------- --------- --------- ---------- ---------- --------- --------- ---------- ---------- ---------
The carrying value and estimated fair values of investment securities at December 31, 1997 by contractual maturity, are shown below:
CARRYING AMOUNT OF INVESTMENT SECURITIES MATURING: ------------------------------------------------------------------------------------------------ AFTER ONE BUT AFTER FIVE BUT WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS AFTER TEN YEARS ---------------- ----------------- ----------------- ---------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL YIELD ------ ------- ------- ------- ------- ------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Securities held-to-maturity: Other government-sponsored agency securities. . . . . . $2,000 5.86% $12,000 6.72% $ - - $ - - $14,000 6.60% ------ ------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------- ------- ------- ------- ------- ------- ------- ------- Securities available-for-sale: U.S. Treasury securities . . . $ - - $ 1,005 5.85% $ - - $ - - $ 1,005 5.85% FHLMC/FNMA-issued mortgage pass-through certificates. . - - 923 6.45% 3,426 6.59% - - 4,349 6.56% Other government sponsored agency securities. . . . . . - - 12,018 6.59% 3,504 6.96% - - 15,522 6.67% CMO's and REMIC's issued by U.S. government sponsored agencies . . . . . . . . . . - - - - 3,499 6.69% 1,457 6.96% 4,956 6.77% ------ ------- ------- ------- ------- ------- ------- ------- ------- ------- $ - - $13,946 6.53% $10,429 6.75% $ 1,457 6.96% $25,832 6.64% ------ ------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------- ------- ------- ------- ------- ------- ------- -------
The Company owns stock in the Federal Reserve Bank, Federal Home Loan Bank and Pacific Coast Bankers Bank. These investments are carried at cost and totaled $646,000 and $233,000 at December 31, 1997 and 1996, respectively. F-14 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE 6--LOANS RECEIVABLE The following is a summary of the major categories of loans receivable outstanding at December 31, 1997 and 1996:
1997 1996 --------- -------- (Dollars in thousands) Real estate construction and land development. . . . . . . . . . . . . $ 3,148 $ 3,441 Commercial loans: Secured by one to four family residential properties. . . . . . . 6,545 6,233 Secured by multifamily residential properties . . . . . . . . . . 2,494 2,879 Secured by commercial real properties . . . . . . . . . . . . . . 22,324 26,629 Other, secured and unsecured. . . . . . . . . . . . . . . . . . . 21,264 16,508 Home equity lines of credit. . . . . . . . . . . . . . . . . . . . . . 252 581 Consumer installment and unsecured loans to individuals. . . . . . . . 5,508 6,545 --------- -------- 61,535 62,816 Deferred net loan origination fees. . . . . . . . . . . . . . . . (283) (269) --------- -------- $ 61,252 $ 62,547 --------- -------- --------- -------- Weighted average yield for loans at December 31 . . . . . . . . . 9.69% 9.34%
The following is a summary of activity in the allowance for credit losses for the years ended December 31, 1997, 1996 and 1995:
1997 1996 1995 ------- ------- ------- (Dollars in thousands) Balance, beginning of year. . . . . . . . . . $ 2,969 $ 3,805 $ 3,063 Provision for credit losses . . . . . . . . . - - 2,307 Loans charged off.. . . . . . . . . . . . . . (1,315) (1,300) (2,632) Recoveries of loans previously charged off. . 369 464 1,067 ------ ------- ------- Balance, end of year. . . . . . . . . . . . . $ 2,023 $ 2,969 $ 3,805 ------ ------- ------- ------ ------- -------
At December 31, 1997 and 1996, the Bank had classified $0.2 million and $1.6 million, respectively, of its loans as impaired with specific reserves of $15,000 and $710,000, respectively. In addition, $6.4 million and $5.6 million of the Bank's loans are classified as impaired with no related specific loss reserve at December 31, 1997 and 1996, respectively. The average recorded investment and interest income recognized on impaired loans during the years ended December 31, 1997, 1996, and 1995 was $6.4 million, $7.8 million, and $9.9 million, and $0.5, $0.7 million and $0.8 million, respectively. F-15 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 The following is a summary of nonperforming loans at December 31, 1997, 1996, respectively.
1997 1996 -------- -------- (DOLLARS IN THOUSANDS) Nonaccrual loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,201 $ 928 Troubled debt restructurings. . . . . . . . . . . . . . . . . . . . . . . . 5,422 5,016 Loans contractually past due ninety or more days with respect to either principal or interest and still accruing interest. . . . . . - 300 ------- ------- $ 6,623 $ 6,244 ------- ------- ------- -------
Interest foregone on nonperforming loans outstanding during the years ended December 31, 1997, 1996 and 1995 was $177,000, $171,000 and $160,000, respectively. The ability of the Company's borrowers to honor their contracts is substantially dependent upon economic conditions and real estate market values throughout the Company's market area. At December 31, 1997, loans aggregating $34.5 million were collateralized by liens on residential and commercial real properties. While the Company's loan portfolio is generally diversified with regard to the industries represented, at December 31, 1997, the Company's loans to businesses and individuals engaged in entertainment industry-related activities amounted to $6.3 million, none of which are collateralized by real property. In the normal course of business, the Bank may make loans to officers and directors as well as loans to companies and individuals affiliated with or guaranteed by officers and directors of the Company and the Bank. Such loans are made in the ordinary course of business at rates and terms no more favorable than those offered to other customers with a similar credit standing. The aggregate dollar amounts of these loans were $1,133,000 and $191,000 at December 31, 1997 and 1996, respectively. During 1997 there were $1.0 million of advances and $58,000 of repayments. Interest income recognized on these loans amounted to $16,000, $22,000 and $27,000 during 1997, 1996 and 1995, respectively. At December 31, 1997, none of these loans were on nonaccrual status. Based on analysis of information presently known to management about the loans to officers and directors and their affiliates, management believes all have the ability to comply with the present loan repayment terms. NOTE 7--PREMISES AND EQUIPMENT AND LEASE COMMITMENTS The following is a summary of the major components of premises and equipment at December 31, 1997 and 1996.
1997 1996 ------- ------- (DOLLARS IN THOUSANDS) Leasehold improvements . . . . . . . . . . . . . . . . $ 1,680 $ 1,680 Furniture, fixtures and equipment. . . . . . . . . . . 3,229 3,208 ------- ------- 4,909 4,888 Less accumulated amortization and depreciation . . . . (4,124) (3,945) ------- ------- $ 785 $ 943 ------- ------- ------- -------
F-16 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 Rent amortization and depreciation expense, and rental income for the years ended December 31, 1997, 1996 and 1995 are summarized below.
1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Rent expense . . . . . . . . . . . . . . . . $ 650 $ 668 $ 1,939 Sublease income. . . . . . . . . . . . . . . - (16) (246) Accretion of sublease loans. . . . . . . . . - - (457) ------- ------- ------- Net rent expense. . . . . . . . . . . . 650 652 1,236 Amortization of leasehold improvements . . . 93 77 135 Other occupancy expense. . . . . . . . . . . 63 64 97 ------- ------- ------- Total occupancy expense . . . . . . . . $ 806 $ 793 $ 1,468 ------- ------- ------- ------- ------- ------- Depreciation expense . . . . . . . . . . . . $ 85 $ 117 $ 220 Other furniture and equipment expense. . . . 115 181 165 ------- ------- ------- Total furniture and equipment expense . $ 200 $ 298 $ 385 ------- ------- ------- ------- ------- -------
The Bank has leased, under lease agreements modified by a Lease Restructure Agreement as of December 31, 1995, 23,883 square feet of office space in west Los Angeles. The leases expire in October 2004. The leases are subject to annual adjustments for increases in property taxes and operating costs. Under the provisions of the Lease Restructure Agreement, the Bank assigned its interests in its subleases to the landlord. In conjunction with the execution of the Lease Restructure Agreement, the Company has issued the landlord a seven-year warrant to purchase up to 9.9% of the shares of common stock of the Company at a current exercise price of $5.00 per share and 9.9% of the shares of preferred stock of the Company at a current exercise price of $10.00 per share. The Company also granted the landlord registration rights with respect to shares purchased by the landlord (or its assignee) pursuant to the Warrant Agreement. No value has been assigned to those warrants for disclosure purposes in the consolidated financial statements. Minimum annual rental commitments under these leases at December 31, 1997 are summarized below.
(DOLLARS IN THOUSANDS) ---------- Year Ended December 31, 1998 . . . . . . . . . . . . . . . . . . . . $ 668 1999 . . . . . . . . . . . . . . . . . . . . 668 2000 . . . . . . . . . . . . . . . . . . . . 692 2001 . . . . . . . . . . . . . . . . . . . . 692 2002 and thereafter. . . . . . . . . . . . . 2,418 ---------- $ 5,138 ---------- ----------
NOTE 8--OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce the impact on the Company's operating results of F-17 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 fluctuations in market or managed index interest rates. These financial instruments include commitments to extend credit, conditional obligations under standby letters of credit, and interest-rate swap agreements and collar contracts. These financial instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of the Company's involvement in those financial instruments. With respect to irrevocable commitments to extend credit and standby letters of credit, the Company's exposure to credit loss in the event of nonperformance by customers is represented by the contractual amount of those instruments, less the realizable value of any collateral held. For interest-rate swap and collar transactions, notional amounts do not represent exposure to credit loss. Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of these commitments are expected to expire without being drawn upon. As such, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit underwriting policies in granting or accepting such commitments or contingent obligations as it does for on-balance-sheet instruments, evaluating customers' creditworthiness individually. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. The nature of collateral obtained varies and may include deposits held in financial institutions; marketable securities; accounts receivable, inventory, and plant and equipment; and residential or income-producing commercial real properties. Standby letters of credit written are conditional commitments issued by the Company to guarantee the financial performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. When deemed necessary, the Company holds appropriate collateral supporting those commitments. Management does not anticipate any material losses as a result of these transactions. Losses, if any, from standby letters of credit are charged against the allowance for credit losses. Undisbursed commitments under revocable and irrevocable loan facilities amounted to $9.4 million and $7.9 million at December 31, 1997 and 1996, respectively. Contingent obligations under standby letters of credit totaled $600,000 and $175,000 at December 31, 1997 and 1996, respectively. At December 31, 1997, $100,000 of standby letters of credit was collateralized by either cash or property; substantially all standby letters of credit expire within one year and one such obligation for $100,000 extends to the year 2001. Interest-rate swap transactions involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying notional (principal) amounts. The Company minimizes the credit risk associated with interest-rate swap agreements by performing normal credit reviews of and establishing transaction limits with counterparties. While the notional amounts are often used to indicate the extent of involvement with these transactions, the amounts potentially subject to credit risk are much less. In December 1994, the Bank entered into an interest-rate swap contract. Under the terms of the agreement the Bank received a floating three-month Libor rate, initial rate of 6.8%, and paid an 8.2% fixed rate. The payments were calculated on a $30 million notional amount based on a three-year term to be paid semi annually. The swap was intended to hedge the market value fluctuations of a portion of the available-for-sale securities portfolio, and was terminated early in the second quarter of 1995. The Bank realized a loss of $1,294,000 on the early termination of the swap. F-18 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 In October 1993, the Bank entered into an interest-rate swap contract. Under the terms of the agreement, the Bank received 6.0% fixed and paid floating-rate prime for 21 months on a $10 million notional amount. The swap expired in August, 1995. The Company did not enter into any interest-rate swap or other derivative agreements during 1997 and 1996. There were no such agreements outstanding as of December 31, 1997 and 1996. NOTE 9--LITIGATION Because of the nature of their activities, the Company and the Bank are subject to pending and threatened legal actions which arise out of the normal course of business. In the opinion of management, based upon opinions of legal counsel, the disposition of all suits will not have a material adverse effect on the consolidated financial position or results of operations of the Company. In February 1995, counterclaims were filed against the Bank in an action commenced by British & Commonwealth Merchant Bank ("BCMB"), as agent for itself and the Bank, in England against Lloyd's Underwriters and certain other parties (collectively, "Lloyd's"). The Bank and BCMB claimed that Lloyd's owed them a further $120,659 of insurance proceeds relating to a claim filed by BCMB (for itself and the Bank) for approximately $7.8 million under policies insuring repayment of a loan from the Bank and BCMB to Performance Guarantees, Inc. for production of a film entitled "Barr Sinister." On or about November 1991, Lloyd's paid approximately $7.8 million in insurance proceeds, which Lloyd's sought to recover a half each from the Bank and BCMB. In its counterclaim, Lloyd's contended that the Leading Underwriter lacked authority to issue the insurance policies and endorsements on behalf of all of the insurers under which payment was made and secondly, that material misrepresentations were made to the Leading Underwriter as to the likely budget for the film and that if the Leading Underwriter had known the true position he would not have accepted the film under the relevant policies. Lloyd's position, therefore, was that such payment should be returned to Lloyd's. The Bank reached an agreement with Lloyd's for the settlement of the Bank's claim against Lloyd's and Lloyd's counterclaims against the Bank. The Bank entered into the settlement not as a result of the Bank's conclusions as to the merits of Lloyd's counterclaims against the Bank, but solely as a matter of resolving those counterclaims in connection with the Bank's effort to recapitalize. The settlement was originally conditioned on the recapitalization of the Bank on or before March 31, 1997, and, in light of that condition, "tolling" agreements were entered into with various third parties to preserve the Bank's ability to institute, if necessary, further proceedings against those third parties for potential losses that may have arisen from the continuation of Lloyd's counterclaims, if the settlement had not been concluded. The settlement agreement originally provided that the Bank would pay $500,000 to Lloyd's on the earlier of the seventh day following the completion of the Bank's recapitalization through the Offerings or March 31, 1997 and an additional $500,000 on the second anniversary of that payment. The agreement also provided that BCMB will release the Bank from any claim that BCMB might have against the Bank should BCMB suffer loss in connection with Lloyd's counterclaims against BCMB in the continuing litigation. Prior to December 31, 1996, the Company and all affected parties agreed to a single payment of the settlement on a discounted lump-sum basis, which payment was made. NOTE 10--BORROWED FUNDS The Company enters into sales of securities under agreements to repurchase ("repurchase agreements"). Repurchase agreements are treated as financings with the related investment securities and obligations to repurchase those securities reported in the balance sheet as assets and liabilities, respectively. F-19 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 As part of its money management services offered to customers, the Company offers retail repurchase agreements secured by U.S. government and federal agency securities for the short-term investment of funds. Securities subject to repurchase agreements are retained by the Company's custodian under written agreements that recognize the customers' interests in the securities. For wholesale (dealer) repurchase agreements, investment securities subject to such agreements are delivered to the dealers who arrange the transactions. The dealers may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of operations and have agreed to resell to the Company identical securities at the repurchase agreements' maturities. The Company may be required to deliver additional securities if the fair value of the investment securities sold declines below the price initially paid to the Company for those securities. The maximum amount of securities sold with agreements to repurchase at any month end was $5.0 million, $1.5 million and $7.0 million during 1997, 1996 and 1995, respectively. Other borrowings is comprised of Federal Home Loan Bank advances, secured by U.S. government and agency securities, and mature on June 29, 1998 with a fixed rate of 5.79%. The maximum amount of other borrowings outstanding at any month end was $3.5 million during 1997. The Bank did not utilize other borrowings during 1996 and 1995. The following summarizes borrowed funds and weighted average rates.
1997 1996 1995 ------------------------------- ------------------------------- ----------------------------- BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE BALANCES AT AVERAGE AVERAGE YEAR-END BALANCE RATE YEAR-END BALANCE RATE YEAR-END BALANCE RATE ----------- ------- ------- ----------- ------- ------- ----------- ------- ------- (Dollars in thousands) Securities sold under repurchase agreements. . . $ 5,050 $ 1,637 5.68% $ - $ - - $ 4,497 $ 4,154 2.65% Other borrowings. . . . . . . 3,500 143 4.89% - - - - - -
NOTE 11--INCOME TAXES No income tax provision was recorded during 1997 due to the utilization of previously unrecognized tax benefits to offset the current period tax liability. During the year ended December 31, 1996 the Company recognized a tax benefit for federal income tax purposes of approximately $579,000 (including $43,000 in interest) related to a refund of prior year taxes from the carryback of a portion of the NOL's for which tax benefit had not previously been recognized. No income tax benefit was recorded for 1995, due to the uncertainty with respect to the ultimate realization of such benefit. A reconciliation of the amounts computed by applying the federal statutory rate of 35% for 1997, 1996 and 1995 to the loss or income before tax benefits and the effective tax rate follows: F-20 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ----------------- ----------------- ------------------ (Dollars in thousands) Tax provision (benefit) at statuory rate . . . . . . . . . . . . $ 46 35.0% $ (638) (35.0%) $(2,545) (35.0%) Increase (reduction) in taxes resulting from: Tax-exempt income on state municipal securities and loans . - - (67) (1.0%) Valuation allowance on deferred tax asset . . . . . . . . . (47) (35.6%) - 2,302 31.7% Other, net. . . . . . . . . . . . . . . . . . . . . . . . . 1 0.6% 59 3.0% 310 4.3% ------- ------- ------- ------- ------- ------- $ - - $ (579) (32.0%) $ - - ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
The major components of the net deferred tax asset at December 31, 1997 and 1996 are as follows:
1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Deferred tax assets: Net operating losses. . . . . . . . . . . . . . $ 9,013 $ 9,143 OREO reserves . . . . . . . . . . . . . . . . . 448 434 Accrued expenses. . . . . . . . . . . . . . . . 222 234 Alternative minimum tax credits . . . . . . . . 218 218 Bad debt expense. . . . . . . . . . . . . . . . 230 455 Nonaccrual interest . . . . . . . . . . . . . . 36 108 Other . . . . . . . . . . . . . . . . . . . . . 19 18 -------- -------- Total deferred tax liabilities. . . . . . . . . 10,186 10,610 -------- -------- Deferred tax liabilities: State taxes . . . . . . . . . . . . . . . . . . (1) (1) Depreciation. . . . . . . . . . . . . . . . . . 58 88 Loan Fees . . . . . . . . . . . . . . . . . . . (61) (36) -------- -------- Total deferred tax liabilities. . . . . . . . . (4) 51 -------- -------- Net deferred tax asset . . . . . . . . . . . . . . . 10,190 10,559 Valuation allowance. . . . . . . . . . . . . . . . . (10,190) (10,559) -------- -------- Deferred tax asset, net of valuation allowance . . . $ - $ - -------- -------- -------- --------
Management believes that the temporary differences resulting in the ending deferred tax asset (exclusive of net operating losses) are expected to reverse within the next three to five years. These temporary differences will generate deductions which will be available to offset future taxable income in the period that these differences reverse. To the extent that these reversing timing differences are in excess of taxable income, they will generate additional operating loss carryforwards. A valuation allowance has been placed against 100% of the net deferred tax asset due to the uncertainty as to its ultimate realization. For tax purposes at December 31, 1997, the Company had federal net operating loss carryforwards of $22.3 million, which begin to expire in the year 2007. The Company has California net operating loss carryforwards of $11.1 million, of which $686,000 expire in 1998, $5.5 million expire in 1999 and the remaining expire thereafter. In addition, the Company has an Alternate Minimum Tax credit at December 31, 1997 of $218,000 which may be carried forward indefinitely. NOTE 12--BENEFIT PLANS F-21 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 STOCK OPTION PLANS. The Company has four stock option plans established in 1983, 1990, 1994, and 1996 (together, the "Plans"). The Plans offer executives and other key employees an opportunity to purchase shares of the Company's common stock. The Plans provide for both nonqualified and incentive stock options and specify a maximum ten-year term for each option granted. Options are granted at exercise prices not less than the fair market value of the stock at the date of grant and are exercisable as determined by the Board of Directors. Stock appreciation rights entitling the holder to exercise an option by taking any appreciation over the option exercise price in stock or, with the consent of the Board of Directors Stock Option Committee, in cash, also may be granted under the 1990 plan. A stock associated option is exercisable only for such period as the Stock Option Committee may determine. As of December 31, 1997, 200,000 appreciation rights had been granted under the 1990 plan. At December 31, 1997, 47,764 option shares were vested and exercisable under the Plans. The remaining shares under option become exercisable as follows: 1998--42,513; 1999--42,482; and 2000--33,669. Following is a summary of changes in stock options under the Plans.
OPTION PRICE RANGE PER SHARE ----------------------------- Outstanding, January 1, 1995 . . . 60,335 $ 13.04 - $ 22.73 Granted . . . . . . . . . . . 17,602 14.23 - 16.50 Cancelled . . . . . . . . . . (11,726) 13.04 - 22.73 Exercised . . . . . . . . . . - -------- Outstanding, December 31, 1995 . . 66,211 13.64 - 22.73 Granted . . . . . . . . . . . 59,350 4.82 - 8.52 Cancelled . . . . . . . . . . (64,137) 6.27 - 22.73 Exercised . . . . . . . . . . - - -------- Outstanding, December 31, 1996 . . 61,424 4.82 - 8.52 Granted . . . . . . . . . . . 111,258 5.00 - 7.96 Cancelled . . . . . . . . . . (6,254) 5.75 - 8.52 Exercised . . . . . . . . . . - - -------- Outstanding, December 31, 1997 . . 166,428 $ 4.82 - $ 8.52 -------- --------
On June 19, 1997 the Board of Directors granted an option to purchase 1,100 shares of the Company's common stock to an outside director of the Company at a price of $7.23 per share. As of December 31, 1997 none of the 1,100 shares were vested nor exercisable. The estimated fair value of options granted during 1997 and 1996 was $7.63 and $2.86 per share, respectively. The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock option and purchase plans. Accordingly, no compensation cost has been recognized for its stock option plans. SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method of SFAS No. 123, the Company's net income for the year ended December 31, 1997 would have been decreased by $57,000. The Company's net loss for the year ended December 31, 1996 would have been increased by $23,000. Basic and diluted earnings per share would have decreased by $.05 for 1997. Basic and diluted loss per share would not have changed for 1996. F-22 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 The fair values of options granted under the Company's fixed stock option plan during 1997 and 1996 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used: 1997-no dividend yield, expected volatility of 73%, risk-free interest rate of 5.74%, and an expected life of 10 years; 1996-no dividend yield, expected volatility of 81%, risk-free interest rate of 6.3% and an expected life of 10 years. DEFINED CONTRIBUTION RETIREMENT PLAN. The Company maintains a defined contribution retirement Plan under section 401(k) of the Internal Revenue Code. Employees are eligible to participate following six months of continuous employment. Under the plan, employee contributions were partially matched by the Company through August 31, 1995. The plan remains in force for employee contributions only. Such matching becomes vested when the employee reaches three years of service. Plan expense was $16,000 in 1995. NOTE 13--PARENT COMPANY INFORMATION The following financial information presents the statements of condition of the Company on a parent-only basis as of December 31, 1997 and 1996, and the related statements of operations and cash flows for each of the years in the three-year period ended December 31, 1997. STATEMENTS OF CONDITION
DECEMBER 31, ------------------------- 1997 1996 ---------- ---------- (DOLLARS IN THOUSANDS) Cash with Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 29 $ 11 Federal Funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,900 - Securities held-to-maturity. . . . . . . . . . . . . . . . . . . . . . 2,000 - Loan receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,036 - Investment in the Bank . . . . . . . . . . . . . . . . . . . . . . . . 7,428 4,834 Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 - ----------- ----------- Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,440 $ 4,845 ----------- ----------- ----------- ----------- Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ - Shareholders' equity: Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,613 24,614 Preferred stock. . . . . . . . . . . . . . . . . . . . . . . . . . . 7,350 - Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . (19,561) (19,693) Net unrealized (loss) gain on securities available-for-sale. . . . . 38 (76) ----------- ----------- Total shareholders' equity . . . . . . . . . . . . . . . . . . . . . 12,440 4,845 ----------- ----------- Total liabilities and shareholder's equity . . . . . . . . . . . . . $ 12,440 $ 4,845 ----------- ----------- ----------- -----------
F-23 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) DECEMBER 31, 1997, 1996 AND 1995 STATEMENTS OF OPERATIONS
Years ended December 31, --------------------------------- 1997 1996 1995 -------- -------- ------- (Dollars in thousands) Interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 151 $ 2 $ 2 Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 - 730 -------- -------- ------- Total operating income . . . . . . . . . . . . . . . . . . . . . . . . . . 152 2 732 Other operating expense. . . . . . . . . . . . . . . . . . . . . . . . . . - 145 85 -------- -------- ------- Income (loss) before equity in undistributed net loss of the Bank . . . 152 (143) 647 Equity in undistributed net loss of the Bank . . . . . . . . . . . . . . . (20) (1,680) (7,847) -------- -------- ------- Net income (loss) before income tax benefit . . . . . . . . . . . . . . . 132 (1,823) (7,200) Income tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (579) - -------- -------- ------- Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200) -------- -------- ------- -------- -------- -------
STATEMENTS OF CASH FLOW
YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) Cash flows from operating activities: Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 132 $ (1,244) $ (7,200) Adjustment to reconcile net loss to net cash provided by (used in) operating activities.: Equity in undistributed net loss (income) of the Bank, net. . . . . . 20 1,680 7,847 Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (47) - - -------- -------- -------- 105 436 647 Cash flows from investing activities: Investment in Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . (2,500) (434) (700) Purchase of securities held-to maturity . . . . . . . . . . . . . . . . (2,000) - - Purchase of loans participated. . . . . . . . . . . . . . . . . . . . . (1,036) - - -------- -------- -------- Net cash used in investing activities . . . . . . . . . . . . . . . . (5,536) (434) (700) Cash flows from financing activities: Net proceeds from issuance of Preferred Stock . . . . . . . . . . . . . 7,350 - - Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1) - - -------- -------- -------- Net cash provided by financing activities . . . . . . . . . . . . . . 7,349 - - -------- -------- -------- Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . 1,918 2 (53) Cash and cash equivalents, beginning of the year . . . . . . . . . . . . . 11 9 62 -------- -------- -------- Cash and cash equivalents, end of the year . . . . . . . . . . . . . . . . $ 1,929 $ 11 $ 9 -------- -------- -------- -------- -------- --------
F-24 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE 14--AVAILABILITY OF FUNDS FROM BANK The Company is a legal entity separate and distinct from the Bank. At present, substantially all of the Company's revenues come from interest earned on deposits, investments and loans (see Note 13). Management believes the Company's cash balance plus interest revenues, on a separate-entity basis, are adequate to cover its modest level of operating expenses. The prior approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year exceeds the Bank's net income for that year combined with its retained net income for the preceding two years, less any required transfers to surplus. As a result of these limitations and net losses incurred by the Bank in prior years, the Bank could not have declared dividends to the Company at December 31, 1997 without the prior approval of the OCC. The OCC also has authority under the Financial Institutions Supervisory Act to prohibit the Bank from engaging in activities that the OCC regards as unsafe or unsound in conducting its business. It is possible that, depending upon the financial condition of the Bank and other factors, the OCC could assert that the payment of dividends or other payments is, under some circumstances, considered to be an unsafe or unsound practice. Further, future cash dividends by the Bank to the Company will depend upon management's assessment of the Bank's future capital requirements (see Note 2). In addition, federal law restricts the Bank's extension of credit to, or the issuance of a guarantee or letter of credit on behalf of, the Company. Investments in stock or other securities of the Company are similarly restricted as is the taking of such securities as collateral for loans. Restrictions prevent the Company from borrowing from the Bank unless the loans are secured by designated amounts of marketable obligations. Further, secured loans to and investments in the Company or its affiliates by the Bank are limited to 10% of the Bank's capital stock and surplus (as defined by federal regulations) and are limited, in the aggregate, to 20% of the Bank's contributed capital (as defined by federal regulations). NOTE 15--SUPPLEMENTAL CASH FLOW INFORMATION The following information supplements the statements of cash flows:
1997 1996 1995 ------- ------- ------- (Dollars in thousands) Interest paid. . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,825 $ 3,147 $ 4,294 Income tax refund. . . . . . . . . . . . . . . . . . . . . . . . - 579 77 Non-Cash Investing and Financing Transactions: Unrealized gain on securities available-for-sale. . . . . . . 114 78 2,903 Transfers to OREO from loans receivable, net . . . . . . . . . . 221 - -
NOTE 16--SEVERANCE COSTS In connection with the Company's restructuring of the Bank to reduce operating expenses, employees were terminated, resulting in severance costs of $141,000 for the year ended December 31, 1995. F-25 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE 17--DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of financial instruments at December 31, 1997 and 1996, are presented below.
DECEMBER 31, 1997 DECEMBER 31, 1996 --------------------- -------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE --------- --------- --------- -------- (DOLLARS IN THOUSANDS) Financial Assets: Cash, cash equivalents and certificates of deposit. . . . $ 16,336 $ 16,336 $ 28,113 $ 28,113 Securities available-for-sale . . . . . . . . . . . . . . 25,832 25,832 4,002 4,002 Securities held-to-maturity . . . . . . . . . . . . . . . 14,000 14,010 14,395 14,355 Loans, net of allowance for credit losses . . . . . . . . 59,229 59,478 59,578 59,450 Financial Liabilities: Demand deposits, money market and savings . . . . . . . . 66,000 66,000 63,206 63,206 Time certificates of deposit. . . . . . . . . . . . . . . 31,388 31,938 40,648 41,015 Securities sold under agreement to repurchase . . . . . . 5,050 5,050 - - Other borrowed funds. . . . . . . . . . . . . . . . . . . 3,500 3,500 - - Off-Balance-Sheet Financial Instruments: Commercial and standby letters of credit. . . . . . . . . - 600 - 175
The estimated fair value amounts have been determined using pertinent information available to management as of December 31, 1997 and 1996. Considerable judgment is required to interpret this information and develop the estimates of fair value. Although management is not aware of any factors which would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented therein. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate that value. CASH, CASH EQUIVALENTS AND INTEREST-BEARING DEPOSITS: For those short-term investments, the carrying amount is a reasonable estimation of fair value, except for securities purchased under agreements to resell, for which fair value is based on quoted market prices. INVESTMENT SECURITIES: For securities held for trading purposes, held-to-maturity and available-for-sale, fair values are based on dealer quotes or quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. LOANS: Variable rate loans have carrying amounts that approximate fair value. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. In computing the estimated fair value for all loans, estimated future cash flows have been reduced by specific and general reserves for loan losses. It was not practicable to estimate the fair value of nonaccrual loans of approximately $1.2 million at December 31, 1997, and $900,000 at December 31, 1996, because it is not practicable to reasonably assess the credit adjustment that would be applied in the marketplace for such loans. F-26 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 DEMAND DEPOSITS AND TIME CERTIFICATES OF DEPOSIT: The fair value of demand deposits, money market accounts and savings deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar maturities. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: The carrying value for this short-term debt is a reasonable approximation of its fair value. OTHER BORROWED FUNDS: The carrying value for this short-term debt is a reasonable approximation of its fair value. COMMERCIAL AND STANDBY LETTERS OF CREDIT: The fair value of standby and commercial letters of credit is based on fees currently charged for similar agreements. F-27 NATIONAL MERCANTILE BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE 18--QUARTERLY FINANCIAL DATA (UNAUDITED) Quarterly financial information for the years ended December 31, 1997 and 1996 is presented below.
THREE MONTHS ENDED -------------------------------------------- MARCH 31, JUNE 30, SEPT. 30 DEC. 31 1997 1997 1997 1997 -------- -------- -------- -------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Interest income . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,015 $ 1,996 $ 2,228 $ 2,361 Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . 711 654 704 787 -------- -------- -------- -------- Net interest income. . . . . . . . . . . . . . . . . . . . . . 1,304 1,342 1,524 1,574 Net loss on sale of securities available-for-sale . . . . . . . . - - (12) (25) Other operating income. . . . . . . . . . . . . . . . . . . . . . 118 110 119 176 -------- -------- -------- -------- Other operating expense . . . . . . . . . . . . . . . . . . . . . (1,557) (1,529) (1,537) (1,475) Net income (loss) before income tax benefit . . . . . . . . . . . (135) (77) 94 250 Income tax benefit. . . . . . . . . . . . . . . . . . . . . . . . - - - - -------- -------- -------- -------- Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . $ (135) $ (77) $ 94 $ 250 -------- -------- -------- -------- -------- -------- -------- -------- Basic earnings (loss) per share . . . . . . . . . . . . . . . . . $ (0.20) $ (0.11) $ 0.14 $ 0.37 Diluted earnings (loss) per share . . . . . . . . . . . . . . . . $ (0.20) $ (0.11) $ 0.04 $ 0.10
THREE MONTHS ENDED -------------------------------------------- MARCH 31, JUNE 30, SEPT. 30 DEC. 31 1997 1997 1997 1997 -------- -------- -------- -------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Interest income.. . . . . . . . . . . . . . . . . . . . . . . . . $2,345 $2,228 $2,121 $2,063 Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . 892 781 718 688 -------- -------- -------- -------- Net interest income. . . . . . . . . . . . . . . . . . . . . . 1,453 1,447 1,403 1,375 Net loss on sale of securities available-for-sale . . . . . . . . (1) - - (2) Other operating income. . . . . . . . . . . . . . . . . . . . . . 169 116 124 96 Other operating expense . . . . . . . . . . . . . . . . . . . . . (1,757) (2,839) (1,709) (1,698) -------- -------- -------- -------- Net income (loss) before income tax benefit . . . . . . . . . . . (136) (1,276) (182) (229) Income tax benefit. . . . . . . . . . . . . . . . . . . . . . . . - (579) - - -------- -------- -------- -------- Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . $(136) $(697) $(182) $(229) -------- -------- -------- -------- -------- -------- -------- -------- Basic earnings (loss) per share . . . . . . . . . . . . . . . . . $(0.18) $(1.06) $(0.28) $(0.32) Diluted earnings (loss) per share . . . . . . . . . . . . . . . . $(0.18) $(1.06) $(0.28) $(0.32)
F-28 INDEX TO EXHIBITS
EXHIBIT NO. - ------- 3.1 Amended and Restated Articles of Incorporation, dated June 20, 1997 * 3.2 Bylaws of the Company, as amended, restated as of December 18, 1992 (1) 10.1 Employment Agreement and Addendum dated June 21, 1996 between Mercantile National Bank and Scott A. Montgomery (2) 10.2 Amendment No. 2 to Employment Agreement dated December 20, 1996 between Mercantile National Bank and Scott A. Montgomery * 10.3 Letter Agreement dated June 5, 1996 between Mercantile National Bank and Carol A. Ward (2) 10.4 Letter Agreement dated July 17, 1996 between Mercantile National Bank and Joseph W. Kiley III (3) 10.5 Form of Indemnity Agreement between the Company and its directors (4) 10.6 First Floor Lease at 1840 Century Park East, Los Angeles, California, dated as of December 21, 1982 between Northrop Corporation and Mercantile National Bank (1) 10.7 Second Floor Lease at 1840 Century Park East, Los Angeles, California, dated as of December 21, 1982 between Northrop Corporation and Mercantile National Bank for space at 1840 Century Park East, Los Angeles, California, as amended by Amendment to Second Floor Lease dated as of June 7, 1986, and as amended by Second Amendment to Second Floor Lease dated as of December 18, 1992 between California State Teachers' Retirement System and Mercantile National Bank (1) 10.8 Lease Restructure Agreement dated December 31, 1995 by and between California State Teachers' Retirement System and Mercantile National Bank (5) 10.9 Warrant Agreement dated December 31, 1995 by and between the Company and California State Teachers' Retirement System (5) 10.10 Registration Rights Agreement dated December 31, 1995 by and between the Company and California State Teachers' Retirement System (5) 10.11 Warrant Agreement dated April 30, 1996 between the Company and U.S. Stock Transfer Corporation (2) 10.12 National Mercantile Bancorp 1983 Stock Option Plan, as amended March 22, 1991 (6) 10.13 Form of Stock Option Agreement under the 1983 Stock Option Plan (1) 10.14 National Mercantile Bancorp 1990 Stock Option Plan (7) 10.15 Form of Stock Option Agreement under the 1990 Stock Option Plan (1) 10.16 National Mercantile Bancorp 1994 Stock Option Plan (8) 10.17 Form of Stock Option Agreement under the 1994 Stock Option Plan (9) 10.18 National Mercantile Bancorp 1996 Stock Incentive Plan (10) E-1 10.19 Form of Stock Option Agreement under the 1996 Stock Incentive Plan (10) 10.20 Registration Rights Agreement between the Company and Conrad Company (11) 10.21 Registration Rights Agreement between the Company and Wildwood Enterprises Inc. Profit Sharing Plan and Trust (11) 10.22 Bank Service Agreement dated April 21, 1997 between RH Investment Corporation and Mercantile National Bank * 10.23 Investment Management Agreement dated December 1, 1997 between Mercantile National Bank and Windsor Financial Group, Inc * 11. Statement regarding computation of per share earnings (see "Note 1--Summary of Significant Accounting Policies--Earnings (Loss) Per Share"--of the "Notes to the Consolidated Financial Statements" in Item 8. Financial Statements in this Annual Report on Form 10-K) 21. Subsidiaries of the Registrant (12) 23. Consent of Deloitte & Touche LLP, Independent Auditors * 27. Financial Data Schedule *
____________ * Included in this Report (1) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference. (2) Filed as an exhibit to the Company's Report on Form 10-Q for the quarter ended June 30, 1996 and incorporated herein by reference. (3) Filed as an exhibit to the Company's Report on Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. (4) Filed as an exhibit to Company's Annual Report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference. (5) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference. (6) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference. (7) Filed as an exhibit to the Company's Proxy Statement dated May 24, 1990 and incorporated herein by reference. (8) Filed as an exhibit to the Company's Proxy Statement dated April 18, 1994 and incorporated herein by reference. (9) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 and incorporated herein by reference. (10) Filed as an exhibit to the Company's Registration Statement on Form S-8 dated August 7, 1997 and incorporated herein by reference. (11) Filed as an exhibit to the Company's Registration Statement on Form S-2 dated February 10, 1997 and amendments thereto and incorporated herein by reference. (12) Filed as an exhibit to the Company's annual report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference.
E-2 EX-3.1 2 EXHIBIT 3.1 AMENDED AND RESTATED ARTICLES OF INCORPORATION OF NATIONAL MERCANTILE BANCORP A CALIFORNIA CORPORATION The undersigned certify that: 1. They are the president and chief executive officer and chief financial officer, respectively, of National Mercantile Bancorp, a California Corporation. 2. The Articles of Incorporation of this corporation are amended and restated to read as set forth in EXHIBIT A attached hereto. 3. The attached amendment and restatement of the Articles of Incorporation has been duly approved by the board of directors. 4. The attached amendment and restatement of the Articles of Incorporation has been duly approved by the required vote of shareholders in accordance with Section 902, California Corporation Code. The total number of outstanding shares of the class of common stock entitled to vote with respect to the amendment was 3,078,146. There are no other amendment equaled or exceeded the vote required. The percentage vote required was more than 50%. Articles IV, V, VI, VII, VII and IX have not been amended or repealed, which amendment or repeal would have required the affirmative vote of the holders of not less than two-thirds (2/3) of the total voting power of all outstanding shares of the voting stock of National Mercantile Bancorp. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of our own knowledge. DATE: June 24, 1997 By /s/ SCOTT A. MONTGOMERY ----------------------------- ------------------------------------- Scott A. Montgomery President and Chief Executive Officer By /s/ JOSEPH W. KILEY, III ------------------------------------- Joseph W. Kiley, III Executive Vice President & CFO EXHIBIT A AMENDED AND RESTATED ARTICLES OF INCORPORATION OF NATIONAL MERCANTILE BANCORP A CALIFORNIA CORPORATION I The name of the Corporation shall be: NATIONAL MERCANTILE BANCORP II The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code. III The liability of the directors of the corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. IV The Corporation is authorized to issue two (2) classes of shares to be designated respectively common and preferred. The number of common shares authorized is Ten Million (10,000,000). The number of preferred shares authorized is One Million (1,000,000). The preferred shares may be issued in one or more series. The Board of Directors is authorized to fix the number of any such series of preferred shares and to determine the designation of any such series. The Board of Directors is further authorized to determine or alter the rights, preferences, privileges, and restrictions granted to or imposed upon any wholly unissued series of preferred shares and, within the limits and restrictions stated in any resolution or resolutions of the Board of Directors originally fixing the number of shares constituting any series, to increase or decrease (but not below the number of shares of such series then outstanding) the number of shares of any such series subsequent to the issuance of shares of that series. 2 V Elections shall be by written ballot. VI The affirmative vote of the holders of not less than two-thirds (2/3) of the total voting power of all outstanding shares of voting stock of this Corporation shall be required for the approval of any proposal (1) that this Corporation merge or consolidate with any other corporation if such other corporation and its affiliates singly or in the aggregate are directly or indirectly the beneficial owners of more than twenty percent (20%) of the total voting power of all outstanding shares of the voting stock of this Corporation (such other corporation being herein referred to as a "Related Corporation"), or (2) that this Corporation sell or exchange all or substantially all of its assets or business to or with such Related Corporation, or (3) that this Corporation issue or deliver any stock or other securities of its issue in exchange or payment for any properties or assets of such Related Corporation or securities issued by such Related Corporation or in a merger of any affiliate of this Corporation with or into such Related Corporation or any of its affiliates, if to effect such transaction the approval of shareholders of this Corporation is required by law; provided, however, that the foregoing shall not apply to any such merger, consolidation, sale or exchange, or issuance or delivery of stock or other securities which was (i) approved by resolution of the Board of Directors adopted by the affirmative vote of not less than two-thirds (2/3) of the then authorized number of directors, or (ii) approved by resolution of the Board of Directors prior to the acquisition of the beneficial ownership of more than twenty percent (20%) of the total voting power of all outstanding shares of the voting stock of this Corporation by such Related Corporation and its affiliates, nor shall it apply to any such transaction solely between this Corporation and another corporation fifty percent (50%) or more of the voting stock of which is owned by this Corporation. For the purposes hereof, an "affiliate" is any person (including a corporation, partnership, trust, estate or individual) who directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with the person specified; "control" means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise; and in computing the percentage of outstanding voting stock beneficially owned by any person the shares outstanding and the shares owned shall be determined as of the record date fixed to determine the shareholders entitled to vote with respect to such proposal. The shareholder vote, if any, required for mergers, consolidations, sales or exchanges of assets or issuances of stock or other securities not expressly provided for in this Article, shall be such as may be required by applicable law. VII No action shall be taken by the shareholders except at an annual or special meeting of shareholders. 3 VIII If at any time the Corporation has a variable board, the shareholders of the Corporation may not change the exact number of directors within the limits specified in the bylaws, except by the vote of the holders of not less than two-thirds (2/3) of the total voting power of all outstanding shares of voting stock of the Corporation. After the issuance of shares, any action by the shareholders to specify or change the fixed number of directors (if the Corporation does not have a variable board) or the maximum or minimum number of directors (if the Corporation has a variable board) or to change from a fixed to a variable board or vice versa shall not be made, repealed, altered, amended or rescinded except by the vote of the holders of not less than two-thirds (2/3) of the total voting power of all outstanding shares of voting stock of the Corporation; provided, however, that a bylaw reducing the fixed number or the minimum number of directors to a number less than five (5) cannot be adopted if the votes cast against its adoption at a meeting are equal to more than sixteen and two-thirds percent (16-2/3%) of the outstanding shares entitled to vote. IX The Corporation reserves the right to amend, alter, change or repeal any provision contained in these Articles of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred on shareholders herein are granted subject to this reservation. Notwithstanding the foregoing, the provisions set forth in Articles IV, V, VI, VII, VIII and this Article IX may not be repealed or amended in any respect unless such repeal or amendment is approved by the affirmative vote of the holders of not less than two-thirds (2/3) of the total voting power of all outstanding shares of voting stock of this Corporation. X Upon filing with the Secretary of State of the State of California of these Amended and Restated Articles of Incorporation, every 9.09 outstanding shares of common shares prior to the filing of these Articles shall be combined and converted into one (1) share of newly issued common shares (the "Reverse Stock Split"). The number of authorized shares of common shares ("Common Stock") shall remain as 10,000,000. 4 XI Pursuant to the authority conferred upon the Board of Directors by Article IV of these Amended and Restated Articles of Incorporation (and with the approval of more than a majority of the outstanding shares of Common Stock), the preferred shares (the "Preferred Stock") shall consist of 990,000 shares of Series A Noncumulative Convertible Perpetual Preferred Stock (the "Series A Preferred Stock") and 10,000 shares undesignated as to series. The shares of Common Stock and Preferred Stock are referred to herein collectively as the "capital stock". (A) VOTING PRIVILEGES OF SERIES A PREFERRED STOCK. (1) GENERAL. Each holder of Series A Preferred Stock shall have that number of votes on all matters submitted to the shareholders that is equal to the number of shares of Common Stock into which such holder's shares of Series A Preferred Stock are then convertible, as hereinafter provided. (2) ADDITIONAL CLASS VOTES BY SERIES A PREFERRED STOCK. In addition to any class votes required by the California General Corporation Law, without the affirmative vote or written consent of the holders (acting together as a class) of a majority of the shares of Series A Preferred Stock at the time outstanding, the Corporation shall not: (a) authorize any additional shares of Series A Preferred Stock, or authorize or issue any shares of capital stock having priority over Series A Preferred Stock or ranking on a parity therewith as to the payment or distribution of (i) assets upon the liquidation or dissolution, voluntary or involuntary, of the Corporation, or (ii) dividends; or (b) amend, alter or repeal any of the provisions of the Amended and Restated Articles of Incorporation of the Corporation or adopt any Certificate of Determination of Rights and Preferences with respect to any class or series of capital stock so as to adversely affect the rights, preferences and privileges relating to Series A Preferred Stock or the holders thereof or waive any of the rights granted to the holders of the Series A Preferred Stock by the Amended and Restated Articles of Incorporation of the Corporation; or (c) amend, alter or repeal any of the provisions of the Amended and Restated Articles of Incorporation, or the bylaws, of the Corporation with respect to the election of directors by cumulative voting; or (d) issue any authorized shares of Series A Preferred Stock except in connection with (i) an offering of rights to holders of Common Stock to purchase shares of the Series A Preferred Stock (the "Rights Offering") consummated on or before June 30, 1997, (ii) an offering of shares of the Series A Preferred Stock to certain institutional investors for purchase (the "Standby Purchaser Offering") consummated on or before June 30, 1997, (iii) a sale of shares of Series A Preferred Stock to certain private purchasers (the "Private Purchaser Offering") consummated on or before June 30, 5 1997, and (iv) the exercise of a warrant to purchase shares of the Series A Preferred Stock pursuant to a certain Warrant Agreement dated December 31, 1995, between the Corporation and California State Teachers' Retirement System. The Rights Offering, the Private Purchasers Offering and the Standby Purchasers Offering are referred to collectively as the "Offerings." (B) DIVIDENDS. (1) Unless otherwise prohibited by law, the Series A Preferred Stock shall be entitled to receive non-cumulative cash dividends at the annual rate of 6.5% of the Liquidation Amount (as defined in Paragraph C below) per share, payable quarterly on the first day of January, April, July and October in each year, commencing October 1, 1999, with respect to the three months then ending, before any distribution by way of dividend or otherwise shall be declared or paid upon, or set apart for, the shares of Common Stock or any other class of shares of the Corporation ranking junior to the Series A Preferred Stock with respect to the payment of dividends or upon liquidation, dissolution or winding up of the Corporation (the "Junior Stock"). Each such dividend will be payable to holders of record as they appear on the books of the Corporation on or about the fifteenth day of the month preceding the payment dates thereof, as shall be fixed by the Board of Directors of the Corporation. The amount of dividends payable for each quarterly dividend period shall be computed by dividing by four the dividend due on the basis of the 6.5% annual rate. Dividends payable on the Series A Preferred Stock for any period shorter than a full three months shall be computed on the basis of 30-day months and a 360-day year. (2) No dividend (other than dividends or distributions paid in shares of, or options, warrants or rights to subscribe for or purchase shares of, such class or series of stock ranking on parity with the Series A Preferred Stock as to dividends) may be paid upon, or declared or set apart for, any class or series of stock ranking on a parity with the Series A Preferred Stock as to dividends, for any dividend period, prior to October 1, 1999, and thereafter, unless there shall be or have been declared on the Series A Preferred Stock dividends for the then current quarterly period coinciding with or ending before such quarterly period, ratably in proportion to the respective annual dividend rates fixed therefor. (3) No dividend (other than dividends or distributions paid in shares of, or options, warrants or rights to subscribe for or purchase shares of, Junior Stock and other than as provided in subparagraph (2) of this paragraph (B)) shall be declared or paid or set aside for payment or other distribution declared or made upon any Junior Stock or any capital stock ranking on a parity with the Series A Preferred Stock as to dividends or upon liquidation or dissolution (the "Parity Stock"), nor shall any Junior Stock or Parity Stock be redeemed, purchased or otherwise be acquired for any consideration (or any monies to be paid to or made available for a sinking fund for the redemption of any shares of Junior Stock or Parity Stock) by the Corporation (except by conversion into or exchange for Junior Stock or Parity Stock), in each case, prior to October 1, 1999, and thereafter, unless full dividends on all outstanding shares of Series A Preferred Stock shall have been paid for 6 the then current dividend period or declared and a sum sufficient for the payment thereof set aside for such payment. (C) OTHER TERMS OF THE SERIES A PREFERRED STOCK. (1) LIQUIDATION PREFERENCE. In the event of an involuntary or voluntary liquidation or dissolution of the Corporation at any time, the holders of shares of Series A Preferred Stock shall be entitled to receive out of the assets of the Corporation an amount equal to $10.00 per share (appropriately adjusted to reflect stock splits, stock dividends, reorganizations, consolidations and similar changes hereafter effected) (the "Liquidation Amount"), plus dividends declared and unpaid thereon, if any. In the event of either an involuntary or a voluntary liquidation or dissolution of the Corporation payment shall be made to the holders of shares of Series A Preferred Stock in the amounts herein fixed before any payment shall be made or any assets distributed to the holders of the Common Stock or any other class or series of capital stock of the Corporation ranking junior to the Series A Preferred Stock with respect to payment upon dissolution or liquidation of the Corporation. If upon any liquidation or dissolution of the Corporation the assets available for distribution shall be insufficient to pay the holders of all outstanding shares of Series A Preferred Stock and any other class or series of capital stock ranking on a parity with the Series A Preferred Stock as to payments upon dissolution or liquidation of the Corporation the full amounts to which they respectively shall be entitled, then such assets or the proceeds thereof shall be distributed among such holders ratably in accordance with the respective amounts which would be payable on such shares if all amounts payable thereon were paid in full. At any time, in the event of the merger or consolidation of the Corporation into or with another Corporation or the merger or consolidation of any other Corporation into or with the Corporation or a plan of exchange between the Corporation and any other Corporation (in which consolidation or merger or plan of exchange any shareholders of the Corporation receive distributions of cash or securities or other property) or the sale, transfer or other disposition of all or substantially all of the assets of the Corporation, then, such transaction shall be deemed, solely for purposes of determining the amounts to be received by the holders of the Series A Preferred Stock in such merger, consolidation, plan of exchange, sale, transfer or other disposition, and for purposes of determining the priority of receipt of such amounts as between the holders of the Series A Preferred Stock and the holders of other classes or series of capital stock, to be a liquidation or dissolution of the Corporation. Nothing hereinabove set forth shall affect in any way the right of each holder of shares of Series A Preferred Stock to convert such shares at any time and from time to time in accordance with subparagraph (3) below. (2) REDEMPTION. (a) The shares of Series A Preferred Stock shall not be redeemable by the Corporation prior to July 1, 2000. On and after July 1, 2000, the Corporation, at its sole option, 7 may redeem shares of Series A Preferred Stock, in whole or in part, at any time or from time to time, to the extent the Corporation has funds legally available therefor, at the redemption prices set forth below (expressed as a percentage of the Liquidation Amount) and upon the approval of the Board of Governors of the Federal Reserve System. If less than all of the outstanding shares of Series A Preferred Stock are to be redeemed, the Corporation will select the shares to be redeemed by lot, pro rata (as nearly may be), or in such other equitable manner as the Board of Directors of the Corporation may determine. If redeemed during the twelve-month period beginning July 1
Year Price Per Share ---- --------------- 2000 ....................... 105% 2001 ....................... 104% 2002 ....................... 103% 2003 ....................... 102% 2004 ....................... 101%
at the price indicated above, and from and after July 1, 2005, at the price per share of 100% of the Liquidation Amount, plus in each case declared and unpaid dividends thereon to the date fixed for redemption (the total sum so payable on any such redemption being herein referred to as the "redemption price"). (b) In no event shall the Corporation redeem less than all the outstanding shares of Series A Preferred Stock, unless dividends for the then-current dividend period (without accumulation of any accrued and unpaid dividends for prior dividend periods unless previously declared and without interest) to the date fixed for redemption shall have been declared and paid or set apart for payment on all outstanding shares of Series A Preferred Stock; provided, however, that the foregoing shall not prevent, if otherwise permitted, the purchase or acquisition by the Corporation of shares of Series A Preferred Stock pursuant to a tender or exchange offer made on the same terms to holders of all the outstanding shares of Series A Preferred Stock and mailed to the holders of record of all such outstanding shares at such holders' addresses as the same appear on the books of the Corporation; and provided further that if some, but less than all, of the shares of Series A Preferred Stock are to be purchased or otherwise acquired pursuant to such a tender or exchange offer and the number of such shares so tendered exceeds the number of shares so to be purchased or otherwise acquired by the Corporation, the shares of Series A Preferred Stock so tendered shall be purchased or otherwise acquired by the Corporation on a pro rata basis (with adjustments to eliminate fractions) according to the number of such shares duly 8 tendered by each holder so tendering shares of Series A Preferred Stock for such purchase or exchange. (c) Notice of any redemption pursuant to this subparagraph (2) shall be mailed at least 30, but not more than 60, days in advance of the date designated for such redemption (herein called the "redemption date") to the holders of record of shares of Series A Preferred Stock so to be redeemed at their respective addresses as the same shall appear on the books of the Corporation. To facilitate the redemption of shares of Series A Preferred Stock, the Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock to be redeemed not more than 60 days prior to the redemption date. Each such notice shall state: (i) the redemption date; (ii) the number of shares of Series A Preferred Stock to be redeemed and, if less than all the shares held by such holder are to be redeemed, the number of such shares to be redeemed from such holder; (iii) the redemption price; (iv) that the shares of Series A Preferred Stock called for redemption may be converted at any time prior to the date fixed for redemption; (v) the applicable conversion price or rate; (vi) the place or places where certificates for such shares are to be surrendered for payment of the redemption price; and (vii) that dividends on the shares to be redeemed will cease to accrue on such redemption date. If less than all the shares represented by any such surrendered certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. (d) The Corporation shall, on or prior to the date fixed for redemption of any shares, but not earlier than 45 days prior to the date fixed for redemption, deposit with its transfer agent or other redemption agent selected by the Board of Directors, as a trust fund, a sum sufficient to redeem the shares called for redemption, with irrevocable instructions and authority to such transfer agent or other redemption agent to give or complete the notice of redemption thereof and to pay to the respective holders of such shares, as evidenced by a list of such holders certified by an officer of the Corporation, the redemption price upon surrender of their respective share certificates. Such deposit shall be deemed to constitute full payment of such shares to their holders; and from and after the date of such deposit, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, rights to receive dividends and distributions shall cease to accrue from and after the redemption date, and all rights of the holders of the Series A Preferred Stock called for redemption, as shareholders of the Corporation with respect to such shares, shall cease and terminate, except the right to receive the redemption price, without interest, upon the surrender of their respective certificates, and except the right to convert their shares into Common Stock as provided in subparagraph (3) of this paragraph (C), until the close of business on the redemption date. In case the holders of any shares shall not, within six years after such deposit, claim the amount deposited for redemption thereof, such transfer agent or other redemption agent shall, upon demand, pay over 9 to the Corporation the balance of such amount so deposited. Thereupon, such transfer agent or other redemption agent shall be relieved of all responsibility to the holders thereof and the sole right of such holders shall be as general creditors of the Corporation. To the extent that shares of Series A Preferred Stock called for redemption are converted into Common Stock prior to the date fixed for redemption, the amount deposited by the Corporation to redeem such shares shall immediately be returned to the Corporation. Any interest accrued on any funds so deposited shall belong to the Corporation, and shall be paid to it from time to time on demand. (e) Redemption of any shares of Series A Preferred Stock is subject to the prior approval of any federal regulatory agency with jurisdiction over such matters. (3) CONVERSION RIGHT. At the option of the holders thereof, the shares of Series A Preferred Stock shall be convertible, at the office of the Corporation (or at such other office or offices, if any, as the Board of Directors may designate), into fully paid and nonassessable shares (calculated as to each conversion to the nearest 1/100th of a share) of Common Stock of the Corporation, at the conversion price, determined as hereinafter provided, in effect at the time of conversion, each share of Series A Preferred Stock being deemed to have a value of $10.00 for the purpose of such conversion. The price at which shares of Common Stock shall be delivered upon conversion (herein called the "conversion price") shall be initially $10.00 per share of Common Stock (I.E., at an initial conversion rate of one share of Common Stock for each share of Series A Preferred Stock); PROVIDED, HOWEVER, that such initial conversion price shall be subject to adjustment from time to time in certain instances as hereinafter provided. In the case of the call for redemption of any shares of Series A Preferred Stock, such right of conversion shall cease and terminate as to the shares designated for redemption on the day such shares are actually redeemed by the Corporation. The following provisions shall govern such right of conversion: (a) To convert shares of Series A Preferred Stock into shares of Common Stock of the Corporation, the holder thereof shall surrender at any office hereinabove mentioned the certificate or certificates therefor, duly endorsed to the Corporation or in blank, and give written notice to the Corporation at such office that such holder elects to convert such shares. Shares of Series A Preferred Stock shall be deemed to have been converted immediately prior to the close of business on the day of the surrender of such shares for conversion as herein provided, and the person entitled to receive the shares of Common Stock of the Corporation issuable upon such conversion shall be treated for all purposes as the record holder of such shares of Common Stock at such time. As promptly as practicable on or after the conversion date, the Corporation shall issue and deliver or cause to be issued and delivered at such office a certificate or certificates for the number of shares of Common Stock of the Corporation issuable upon such conversion. (b) The conversion price shall be subject to adjustment from time to time as hereinafter provided. Upon each adjustment of the conversion price each holder of shares of 10 Series A Preferred Stock shall thereafter be entitled to receive the number of shares of Common Stock of the Corporation obtained by multiplying the conversion price in effect immediately prior to such adjustment by the number of shares issuable pursuant to conversion immediately prior to such adjustment and dividing the product thereof by the conversion price resulting from such adjustment. (c) In case the Corporation shall (i) declare a dividend upon the Common Stock payable in Common Stock (other than a dividend declared to effect a subdivision of the outstanding shares of Common Stock, as described in subparagraph (d) below) or Convertible Securities, or in any rights or options to purchase Common Stock or Convertible Securities, or (ii) declare any other dividend or make any other distribution upon the Common Stock payable otherwise than out of earnings or earned surplus, then thereafter each holder of shares of Series A Preferred Stock upon the conversion thereof will be entitled to receive the number of shares of Common Stock into which such shares of Series A Preferred Stock have been converted, and, in addition and without payment therefor, each dividend described in clause (i) above and each dividend or distribution described in clause (ii) above which such holder would have received by way of dividends or distributions if continuously since such holder became the record holder of such shares of Series A Preferred Stock such holder (i) had been the record holder of the number of shares of Common Stock then received, and (ii) had retained all dividends or distributions in stock or securities (including Common Stock or Convertible Securities, and any rights or options to purchase any Common Stock or Convertible Securities) payable in respect of such Common Stock or in respect to any stock or securities paid as dividends or distributions and originating directly or indirectly from such Common Stock. For the purposes of the foregoing a dividend or distribution other than in cash shall be considered payable out of earnings or earned surplus only to the extent that such earnings or earned surplus are charged an amount equal to the fair value of such dividend or distribution as determined by the Board of Directors of the Corporation. (d) In case the Corporation shall at any time subdivide its outstanding shares of Common Stock into a greater number of shares, the conversion price in effect immediately prior to such subdivision shall be proportionately reduced, and conversely, in case the outstanding shares of Common Stock of the Corporation shall be combined into a smaller number of shares (other than the Reverse Stock Split), the conversion price in effect immediately prior to such combination shall be proportionately increased. (e) If any capital reorganization or reclassification of the capital stock of the Corporation, or consolidation or merger of the Corporation with another Corporation, or the sale of all or substantially all of its assets to another Corporation shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganization, reclassification, consolidation, merger or sale, and subject to 11 subparagraph (1) above, lawful and adequate provision shall be made whereby the holders of Series A Preferred Stock shall thereafter have the right to receive upon the basis and upon the terms and conditions specified herein and in lieu of the shares of the Common Stock of the Corporation immediately theretofore receivable upon the conversion of Series A Preferred Stock, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of such Common Stock equal to the number of shares of such stock immediately theretofore receivable upon the conversion of Series A Preferred Stock had such reorganization, reclassification, consolidation, merger or sale not taken place, plus all declared dividends unpaid and accumulated or accrued thereon to the date of such reorganization, reclassification, consolidation, merger or sale, and in any such case appropriate provision shall be made with respect to the rights and interests of the holders of Series A Preferred Stock to the end that the provisions hereof (including without limitation provisions for adjustments of the conversion price and of the number of shares receivable upon the conversion of Series A Preferred Stock) shall thereafter be applicable, as nearly as may be in relation to any shares of stock, securities or assets thereafter receivable upon the conversion of Series A Preferred Stock. The Corporation shall not effect any such consolidation, merger or sale, unless prior to the consummation thereof the successor Corporation (if other than the Corporation) resulting from such consolidation or merger or the Corporation purchasing such assets shall assume by written instrument executed and mailed to the registered holders of Series A Preferred Stock, at the last addresses of such holders appearing on the books of the Corporation, the obligation to deliver to such holders such shares of stock, securities or assets as, in accordance with the foregoing provisions, such holders may be entitled to receive. (f) Upon any adjustment of the conversion price, then and in each case the Corporation shall give written notice thereof, by first-class mail, postage prepaid, addressed to the registered holders of Series A Preferred Stock, at the addresses of such holders as shown on the books of the Corporation, which notice shall state the conversion price resulting from such adjustment and the increase or decrease, if any, in the number of shares receivable at such price upon the conversion of Series A Preferred Stock, setting forth in reasonable detail the method of calculation and the facts upon which such calculation is based. 12 (g) In case at any time: (i) the Corporation shall pay any dividend payable in stock upon its Common Stock or make any distribution (other than regular cash dividends) to the holders of its Common Stock; (ii) the Corporation shall offer for subscription pro rata to the holders of its Common Stock any additional shares of stock of any class or other rights; (iii) there shall be any capital reorganization, or reclassification of the capital stock of the Corporation, or consolidation or merger of the Corporation with, or sale of all or substantially all of its assets to, another Corporation; or (iv) there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Corporation; then, in any one or more of said cases, the Corporation shall give written notice, by first-class mail, postage prepaid, addressed to the registered holders of Series A Preferred Stock at the addresses of such holders as shown on the books of the Corporation, of the date on which (i) the books of the Corporation shall close or a record shall be taken for such dividend, distribution or subscription rights, or (ii) such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up shall take place, as the case may be. Such notice also shall specify the date as of which the holders of Common Stock of record shall participate in such dividend, distribution or subscription rights, or shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation, or winding up, as the case may be. Such written notice shall be given at least 20 days prior to the action in question and not less than 20 days prior to the record date or the date on which the Corporation's transfer books are closed in respect thereto. (h) As used in this paragraph (3) the term "Common Stock" shall mean and include the Corporation's presently authorized Common Stock and also shall include any capital stock of any class of the Corporation hereafter authorized which shall not be limited to a fixed sum or percentage in respect of the rights of the holders thereof to participate in dividends or in the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Corporation, provided that the shares receivable pursuant to conversion of shares of Series A Preferred Stock shall include shares designated as Common Stock of the Corporation as of the date of issuance of such shares of Series A Preferred Stock, or, in case of any reclassification of the outstanding shares thereof, the stock, securities or assets provided for in subparagraph (e) above. 13 (i) No fractional shares of Common Stock shall be issued upon conversion, but, instead of any fraction of a share which would otherwise be issuable, the Corporation shall pay a cash adjustment in respect of such fraction in an amount equal to the same fraction of the market price per share of Common Stock as of the close of business on the day of conversion. "Market price" shall mean if the Common Stock is traded on a securities exchange or on the Nasdaq Stock Market, the closing price of the Common Stock on such exchange or the Nasdaq Stock Market, or, if the Common Stock is otherwise traded in the over-the-counter market, the closing bid price, in each case averaged over a period of 20 consecutive business days prior to the date as of which "market price" is being determined. If at any time the Common Stock is not traded on an exchange or the Nasdaq Stock Market, or otherwise traded in the over-the-counter market, the "market price" shall be deemed to be the higher of (i) the book value thereof as determined by any firm of independent public accountants of recognized standing selected by the Board of Directors of the Corporation as of the last day of any month ending within 60 days preceding the date as of which the determination is to be made, or (ii) the fair value thereof determined in good faith by the Board of Directors of the Corporation as of a date which is within 15 days of the date as of which the determination it to be made. XII Each holder of Common Stock shall have one vote on all matters submitted to the shareholders for each share of Common Stock standing in the name of such holder on the books of the Corporation. Except as otherwise provided herein, and except as otherwise required by law, the shares of capital stock of the Corporation shall vote as a single class on all matters submitted to the shareholders. XIII TRANSFER RESTRICTIONS (A) GENERAL. The shares of capital stock may not be transferred by any person (the "Initial Transferor") in any manner to any extent to any other person (other than persons to whom the Corporation is contractually obligated on or before the date of issuance of the Series A Preferred Stock in the Offerings to transfer up to 4.9% of the Corporation's stock) if such other person is or would become by reason of the transfer a beneficial owner of more than 4.5% (or 4.9% as described above) of the Corporation's stock (a "Prohibited Transferee"), as the term "stock" is defined and such ownership is determined under Section 382 of the Internal Revenue Code of 1986, as amended, and regulations thereunder (collectively "Section 382"). For purposes of this provision, transfers to a Prohibited Transferee shall include transfers directly with or through trusts, estates, corporations, partnerships or other entities as defined under Internal Revenue Code Regulation Section 1.382-3(a), and attribution through such entities shall be determined pursuant to Section 382. 14 (B) PROHIBITED STOCK. Transfers made in violation of paragraph (A) of this Article XIII shall not be effective to transfer ownership of the shares of Preferred Stock or Common Stock subject thereto ("Prohibited Stock"). (1) Upon the transfer of Prohibited Stock, the Corporation shall have thirty (30) days from discovery of such prohibited transfer to demand the transfer of the Prohibited Stock from the Prohibited Transferee to the agent designated by the Board of Directors (the "Agent"). Further, the Agent shall demand the transfer of any distributions received on such Prohibited Stock by the Prohibited Transferee. Discovery shall be deemed to have been made pursuant to provisions of Section 382 regarding discovery of ownership changes. If a Prohibited Transferee shall refuse or fail upon demand by the Corporation to transfer such Prohibited Stock and distributions received thereon, the Corporation shall take all necessary action at law or equity to compel such transfer as soon as possible. (2) Upon transfer by the Prohibited Transferee of the Prohibited Stock, together with distributions received thereon, the Agent shall sell such Prohibited Stock as soon as practicable thereafter in an arm's length transaction and in a manner consistent with the restriction set forth in this paragraph upon the refusal by the Prohibited Transferee. Proceeds from such sale shall not inure to the benefit of the Corporation or the Agent but shall be remitted to the Prohibited Transferee in an amount not to exceed the amount paid by the Prohibited Transferee for such Prohibited Stock, or, if the transfer made in violation of this paragraph was by gift, inheritance or similar transfer, the fair market value of such shares at the time of receipt of such shares by the Prohibited Transferee. For purposes of the foregoing, the fair market value per share of the Prohibited Stock shall not be less than: (i) the average of the highest and lowest selling price at the time of receipt of such shares by the Prohibited Transferee or if there were no sales on such date, then not less than the mean between the bid and asked price on such date, if the Prohibited Stock was listed on a national securities exchange or quoted on the Nasdaq Stock Market on such date; (ii) the mean between the bid and asked price on such date or, if there was no bid and asked price on such date, then on the next prior business day on which there was a bid and asked price if the Prohibited Stock was traded otherwise than on a national securities exchange or the Nasdaq Stock Market on such date; or (iii) as determined by the Board of Directors. (3) Any sale of Prohibited Stock by a Prohibited Transferee received in violation of this Article XIII shall be deemed to have been made solely by the Agent, and the Agent shall demand of the Prohibited Transferee the proceeds from such sale together with distributions received from such Prohibited Stock. Such demand shall be made within thirty (30) days of discovery (as that term is described in paragraph (B) of this Article XIII) by the Agent of the transfer of the Prohibited Stock to the Prohibited Transferee. If the Prohibited Transferee shall refuse or fail upon demand by the 15 Agent to surrender such proceeds and distributions, the Agent shall take all necessary action at law or in equity to compel the transfer of such proceeds and distributions. The Agent, at its discretion, may make demand of such proceeds in the amount net of the amount which the Prohibited Transferee would have received from the Agent had the Agent rather than the Prohibited Transferee sold such Prohibited Stock. (4) Any proceeds received by the Agent as a result of the sale of the Prohibited Stock, whether by the Agent or by the Prohibited Transferee, and the distributions received on such Prohibited Stock, shall be transferred to the Initial Transferor, less any amounts remitted to or retained by the Prohibited Transferee as otherwise described in Article XIII. If such Initial Transferor cannot be determined by the Agent within ninety (90) days after receipt by the Agent of such proceeds and distributions, the Agent may pay any such amounts due the Initial Transferor into a court or governmental agency, if applicable law permits, and otherwise must irrevocably transfer such amounts to a charity designated by the Agent. In no event shall amounts due to such Initial Transferor inure to the benefit of the Agent, but such amounts may be used to reimburse the Agent, if any, for reasonable expenses incurred in attempting to identify the Initial Transferor. (5) The Board of Directors is expressly empowered to waive application of this Article XIII to any specific transaction, provided that such waiver is by resolution of the Board of Directors duly considered and approved by at least a majority of the Board of Directors prior to any such transfer of stock described within this Article XIII. (C) LEGEND. Certificates representing shares of the capital stock shall, upon issuance, bear the following legend: THE AMENDED AND RESTATED ARTICLES OF INCORPORATION OF NATIONAL MERCANTILE BANCORP (THE "COMPANY") PROHIBIT THE TRANSFER OF THE SHARES OR INTERESTS REPRESENTED BY THIS CERTIFICATE TO ANY PERSON IF SUCH PERSON IS OR WOULD BECOME BY REASON OF SUCH TRANSFER THE BENEFICIAL OWNER OF MORE THAN 4.5% (OR 4.9% IF THE TRANSFEREE IS A PERSON TO WHOM THE COMPANY IS CONTRACTUALLY OBLIGATED ON OR BEFORE THE DATE OF ISSUANCE OF THESE SHARES OR INTERESTS TO TRANSFER UP TO 4.9% OF THE COMPANY'S STOCK) OF THE COMPANY'S STOCK, AS THE TERM "STOCK" IS DEFINED, AND SUCH OWNERSHIP IS DETERMINED, UNDER SECTION 382 OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED. (D) TERMINATION. This Article XIII shall have no applicability and shall be of no force and effect, notwithstanding notations to the contrary on any certificates evidencing ownership of any 16 securities of the Corporation, (i) on or after July 1, 2000 or (ii) upon the occurrence of any transaction in which holders of all outstanding shares of capital stock receive, or are offered the opportunity to receive, cash, stock or other property for all such shares and upon the consummation of which the acquiror will own at least a majority of the outstanding shares of capital stock. XIV This corporation is authorized to provide indemnification of agents (as defined in Section 317 of the General Corporation Law of California) for breach of duty to the corporation and its shareholders through bylaw provisions or through agreements with the agents, or both, in excess of the indemnification otherwise permitted by Section 317 of the General Corporation Law of California, subject to any limitations on indemnification under the General Corporation Law of California which cannot be waived. 17 EX-10.2 3 EXHIBIT 10.2 AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT This AMENDMENT No. 2 TO EMPLOYMENT AGREEMENT ("Second Amendment") is made as of the 20th day of December, 1996 between Mercantile National Bank (the "Bank"), a national banking association organized and existing under the laws of the United States, and Scott A. Montgomery, an individual ("Montgomery") and amends that certain Employment Agreement dated June 21, 1996 between the Bank and Montgomery as amended by that certain Addendum dated June 21, 1996 (collectively, the "Employment Agreement"). RECITAL WHEREAS, the Bank and Montgomery desire to amend the Employment Agreement to reflect the following terms and conditions. NOW, THEREFORE, Bank and Montgomery hereby agree as follows: 1. Section 3.4 of the Agreement shall be deleted in its entirety and replaced with the following: Bancorp has granted to Montgomery options to purchase 200,000 shares of Bancorp common stock (the "Stock Options") under the National Mercantile Bancorp 1990 Stock Option Plan (the "1990 Plan") on December 20, 1996. The terms and conditions of such Stock Options shall be set forth in a separate option agreement. Such Granted Stock Options shall be deemed incentive options to the maximum extent permitted by law and the 1990 Plan. Such stock option agreement, which must be executed by Montgomery and Bancorp, shall include, among others, the following terms and conditions: 2. The term "Non-Qualified Stock Options" used in subsection 3.4.2, 3.4.3, 3.4.4 and 3.4.5, shall be deleted and replaced with the term "Granted Stock Options" and the word "Non-Qualified" used in subsections 3.4.6 and 3.4.7 shall be deleted and replaced with the term "Granted." 3. The first phrase of the second sentence of Section 3.4.4 shall be deleted in its entirety and replaced with the following: 1 Bancorp shall adopt the 1996 Stock Incentive Plan to authorize 500,000 (pre Reverse Stock Split shares contemplated by the Board of Directors to occur in connection with the Recapitalization) additional shares (the "1996 Plan") and submit the 1996 Plan for approval at the next annual or special shareholders meeting. Bancorp's Board of Directors shall recommend and solicit approval of the 1996 Plan. Subject to such approval, 4. Subsection 3.4.4(g) shall be amended by adding the following: (i) For purposes of this Agreement, any adjustments contemplated by Section 3.4.4 hereof to occur after a Recapitalization shall be required to occur only once and with respect only to the first such Recapitalization to occur on or before December 31, 1999. 5. Subsection 3.4.4(h) is deleted in its entirety and replaced with the following: (h) Montgomery acknowledges that at present there are not sufficient shares available under the National Mercantile Bancorp 1990 or 1994 Stock Option Plans (collectively, the "Plans") to grant Montgomery the Additional Options (or the Option and Tandem SAR referred to in paragraph 3.5), and that shareholder approval for the 1996 Plan providing for additional shares is required. Bancorp agrees to adopt the 1996 Plan and to submit the 1996 Plan to the shareholders of Bancorp for approval at the next annual or special shareholders meeting. Bancorp's Board of Directors shall recommend and solicit approval of the 1996 Plan. 6. Subsection 3.4.5 shall be amended by adding the words "or the 1996 Plan, as the case may be" immediately before the period. 7. A new sentence shall be added to the end of subsection 3.4.6 as follows: In no event shall Montgomery be permitted to exercise any options granted by the Company to him, and, as a result hereof, hold more than 4.9% of the Company's capital stock at any time during the period commencing on the date 2 hereof and continuing for a period of three years following the Recapitalization. 8. Section 3.5 shall be amended by deleting the first sentence and replacing it with the following: Pursuant to a separate stock rights agreement, and subject to shareholder approval of the 1996 Plan, Bancorp shall grant to Montgomery a non-qualified stock option ("Option") and tandem stock appreciation right ("Tandem SAR") with respect of 75,000 shares of Bancorp Common Stock (the "Option and Tandem SAR") under the 1996 Plan. 9. Subsections 3.4.4(e) and 3.5.5 shall be amended by deleting all references to the 1990 Plan and replacing such references with "1996 Plan". 10. Subsection 3.5.6 shall be deleted in its entirety and replaced with the following: 3.5.6 Montgomery acknowledges that at present there are not sufficient shares available under the Plans to grant Montgomery the Option and Tandem SAR (or the Additional Options referred to in paragraph 3.4.4), and that shareholder approval for the 1996 Plan providing for additional shares is required. Bancorp agrees to adopt the 1996 Plan and to submit the amendment to the shareholders of Bancorp for approval at the next annual or special shareholders meeting. Bancorp's Board of Directors shall recommend and solicit approval of the 1996 Plan. 11. Subsection 3.5.7 shall be amended by deleting the words "the 1990 Plan" and adding the words "the 1996 Plan." 12. Montgomery acknowledges that on December 20, 1996 the Stock Option Committee of the Board of Directors cancelled the grant of options of 200,000 shares of Common Stock to Montgomery on June 21, 1996 and granted Montgomery options of 200,000 shares of Common Stock at $1.25 per share. 3 13. All other terms and conditions contained in the Employment Agreement shall remain in full force and effect. MERCANTILE NATIONAL BANK By /s/ HOWARD P. LADD ------------------------------------- Howard P. Ladd Chairman By /s/ SCOTT A. MONTGOMERY ------------------------------------- Scott A. Montgomery Agreed as to the obligations of National Mercantile Bancorp specified in the foregoing Agreement. NATIONAL MERCANTILE BANCORP By /s/ HOWARD P. LADD ------------------------------------- Howard P. Ladd Chairman, President & CEO 4 14. INTERPRETATION AND CONSTRUCTION. The interpretation and construction of this Agreement b the Committee shall be final, binding and conclusive. The section headings in this Agreement are for conveniences of reference only and shall not be deemed part of, or germane to the interpretation or construction of, this Agreement. NATIONAL MERCANTILE BANCORP By /s/ HOWARD P. LADD ------------------------------------- Howard P. Ladd Chairman of the Board By /s/ SCOTT A. MONTGOMERY ------------------------------------- Scott A. Montgomery Optionee By her signature below, the spouse of the Optionee agrees to be bound by all of the terms and conditions of the foregoing Agreement. By /s/ ELAINE BELL MONTGOMERY ------------------------------------- Elaine Bell Montgomery 5 EX-10.22 4 EXHIBIT 10.22 BANK SERVICE AGREEMENT Agreement ("Agreement") made this, the 21st day of April, 1997, between R H Investment Corporation, Inc. (hereinafter referred to as "RHI") and Mercantile National Bank (hereinafter referred to as "Bank"). W I T N E S S E T H: WHEREAS, the Bank desires to make a broad array of securities and investment services available to its Customers (hereinafter referred to as "Customers"); and WHEREAS, RHI desires to provide the Bank's Customers with such securities and investment services. NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth, and other good and valuable consideration, the receipt of which is hereby acknowledged, the parties covenant and agree as follows: 1. The Bank and RHI each agree that they will share with the other such information regarding the Customer, as may be reasonably necessary to carry out the intent of this Agreement. 2. SERVICES TO BE PERFORMED BY RHI - RHI may accept, establish, and maintain securities and other investment accounts for Customers of the Bank in conformity with its policies, as may be changed from time to time by RHI, and in accordance with all applicable rules, regulations, laws, and procedures, including those pursuant to the Securities Exchange Act of 1934, and the National Association of Securities Dealers, Inc., and such other regulatory authorities as to which RHI may be subject. a.) RHI will cause to be prepared, printed, and mailed; monthly statements and confirmations to the accounts, as shown on the books and records of RHI. b.) RHI will comply with any, and all, prospectus delivery requirements relating to options or other securities. c.) RHI will maintain books and records of all transactions executed through it, in accordance with any applicable rules, regulations or laws, in conformity with industry standards. d.) RHI will provide any required information pursuant to federal, state or local tax laws, rules, or regulations, as may be in effect from time to time, and shall be responsible for causing the withholding of dividend payments as may be required, pursuant to federal law. e.) RHI will comply with Bank policy pertaining to the Investment Services Division and all applicable bank regulatory guidelines for retail non deposit investment sales. f.) RHI will provide the Bank with all necessary material and forms required for its Customers to open and maintain securities and other investment accounts with RHI, and RHI shall be responsible for the compliance of such items with all applicable laws, rules or regulations. f.) RHI will designate, which designation may be changed form time to time by RHI, an individual to whom the Bank may address inquiries about the implementation and maintenance of this agreement, and such accounts as shall be opened pursuant hereto. g.) RHI reserves the right, at its sole discretion, to accept or reject any accounts for any Customer of the Bank, any order from any such Customer of the Bank, whether said Customer has an existing account with RHI or not, and to terminate any account previously accepted by RHI for such Customer. RHI agrees that it will not act unreasonably in exercising such discretion. h.) ORDERS - RHI shall be responsible for screening orders prior to execution, acceptance or rejection of such orders, errors in execution and settlement of Customer contracts; i.) RESTRICTED SECURITIES - RHI shall be responsible for its own compliance with, and the obtaining of, information on any sale of restricted/control stock. 3. SERVICES TO BE PROVIDED BY THE BANK - The bank will use its best efforts, with its Customers, to promote, develop, and maintain accounts with RHI. The Bank will render all reasonable assistance to its Customers, as shall be necessary in order to open accounts on their behalf with RHI. a.) The Bank shall make available to its Customers appropriate new account forms and such documentation as shall be necessary to open and maintain accounts with RHI. The Bank will render all reasonable assistance to its Customers as shall be necessary in order to open accounts on their behalf with RHI. b.) The Bank will perform only such clerical and ministerial functions as shall be necessary to open and operate accounts on behalf of its Customers, unless those Bank employees, performing more than clerical or ministerial functions, are duly qualified and registered with RHI as registered representatives, pursuant to the appropriate regulatory requirements. c.) Bank agrees that no employee of the bank shall receive commission related compensation for any brokerage activities unless such employee is duly licensed and registered with RHI. d.) The Bank shall clearly identify RHI as the entity performing all such brokerage services, and will further advise its Customers that such services are being provided by RHI on a fully disclosed basis. 4. REPRESENTATIONS AND WARRANTIES OF RHI - RHI represents and warrants as follows: a.) RHI is a member, in good standing, of the National Association of Securities Dealers, Inc. b.) RHI is and, during the term of this Agreement, will remain duly licensed and in good standing as a broker/dealer under applicable federal and state laws and regulations. c.) RHI has the requisite authority, in conformity with all applicable laws and regulations, to enter into and perform the services contemplated by this Agreement. d.) RHI is in compliance with and, during the term of this Agreement, will remain in compliance with the capital and financial reporting requirements of each national securities exchange or association of which it is a member, the Securities and Exchange Commission, and in each state in which it is licensed. e.) RHI will keep confidential any information not otherwise generally available to the public, which it may acquire as a result of this Agreement regarding the business and affairs of the Bank. RHI will treat the names of account holders and Customers as confidential, and shall not provide such names to third parties, other than its corporate affiliates, as shall be reasonably necessary to implement this Agreement, except as authorized in writing, by the Bank, or the Customer, or as required by applicable statutes, rules or regulations. The provisions of this paragraph shall survive the termination of this Agreement. f.) RHI has full legal right, power and authority to enter into and perform this Agreement, and this Agreement has been duly authorized, executed and delivered by RHI and constitutes a legal, valid and binding Agreement of RHI. g.) RHI is authorized to contact the customer directly to service the accounts and activities contemplated by this Agreement. 5. REPRESENTATIONS AND WARRANTIES OF BANK - Bank represents and warrants as follows: a.) The Bank has full legal right, power, and authority to enter into and perform this Agreement, and that this Agreement has been duly authorized, executed, and delivered by the Bank, and constitutes a legal, valid and binding obligation of the Bank. The Bank has all of the requisite authority and conformity, with applicable law and regulations, to enter into this Agreement. b.) The Bank is entering into this Agreement pursuant to an exemption from registration as a broker/dealer, as provided by Rule 3b-9, promulgated pursuant to the Securities Exchange Act of 1934, as amended. It will continue to qualify for such exemption, or it will be duly registered as a broker/dealer throughout the term of this Agreement. c.) The Bank is, and will remain, in compliance with all applicable laws, rules and regulations that may apply to it from time to time by any state blue sky law, banking laws, or other applicable requirements of regulatory bodies or agencies having jurisdiction. d.) The Bank shall not permit any activity on its behalf, or by its employees, insofar as such acts may relate to this Agreement, which is not in compliance with all applicable laws, rules, and regulations of federal, state and local law. e.) The Bank shall keep confidential any information not otherwise generally available to the public, which it may acquire as a result of this Agreement regarding the business affairs of RHI, which requirement shall survive the termination of this Agreement. 6. DESIGNATION OF ACCOUNTS - RHI shall maintain, on its books and records, a notation of each account opened with a Customer of the Bank. Not less than annually, RHI will forward to the Bank, a list of all such accounts which have been opened with Customers of the Bank, and the Bank, within thirty days of receipt of such list, shall verify to RHI the accuracy of such list. The purpose of the preparation and verification of this list is for the Bank to be able to verify that it is being paid the fees to which it is entitled, pursuant to this Agreement, and for RHI to verify that the persons or entities with whom it is dealing are, in fact, Customers of the Bank. 7. SUPERVISORY RESPONSIBILITY a.) EMPLOYEES - The Bank shall have the sole and exclusive responsibility for supervising activities of its employees involved in carrying out the functions encompassed in this Agreement. RHI shall have the sole and exclusive responsibility for supervising the activities of its employees involved in the activities encompassed by this Agreement. In the event that there are employees who are dually employed by the Bank and RHI, the Bank shall have supervisory responsibility for the employees' bank related activities and RHI shall have supervisory responsibility for the employees' securities related activities. b.) CUSTOMERS - RHI shall have sole responsibility for complying with the requirements of knowing Customers with whom it is dealing, knowing their investment objectives and rendering investment advice to such Customers, to the extent that such investment advice may be given. 8. INDEMNIFICATION - RHI shall indemnify and hold Bank harmless against any losses, claims, damages, liabilities or expenses (which shall include, but not be limited to, all costs of defense and investigation, and all reasonable attorney's fees), to which the bank may be subject, insofar as such losses, claims, damages, liabilities or expenses arise out of, or are based upon, any of the following: a.) The gross negligence or willful misconduct of RHI or its employees to perform any of its obligations under this agreement or any act or omission in connection herewith.. b.) The failure of RHI to perform its obligations under this Agreement, including the provisions of the Independent Registered Representative Agreement for each bank employee registered with RHI; c.) The loss of securities or cash after receipt by RHI, prior to receipt of securities or cash by the Bank from RHI; d.) The operation of margin accounts in a manner not in conformity with applicable laws, provided that such lack of conformity is not the result of the failure by the Bank to follow instructions of RHI, as provided herein; e.) Failure of RHI to remain a duly licensed broker/dealer in good standing under applicable law; f.) Failure of the forms and materials, provided by RHI in connection to the services contemplated hereunder, to comply with any applicable securities laws, regulations and rules; g.) Failure of any marketing materials, which RHI approves, to comply with any applicable securities laws, regulations and rules; h.) Failure of RHI to comply with Bank policy pertaining to the Investment Services Division and all applicable bank regulatory guidelines for retail non deposit investment sales. 9. The Bank shall indemnify and hold RHI harmless against any losses, claims, damages, liabilities or expenses (which shall include, but not be limited to, all costs of defense and investigation, and all attorney's fees) to which RHI may become subject, insofar as such losses, claims, damages, liabilities, or expenses arise out of, or are based upon, any of the following: a.) The gross negligence or willful misconduct of the Bank or its employees to perform any of its obligations under this agreement or any act or omission in connection herewith. b.) Failure of the Bank and/or its employee/representative to satisfactorily perform its obligations under this Agreement and the Independent Registered Representative Agreement; The parties agree that upon receipt of any claim or notice of any action prompt written notice of such claim or action shall be communicated to all parties to this Agreement. Upon assumption by any party of the defense of a claim or action by counsel reasonable acceptable to the indemnified party within the scope of its indemnity, such party shall not thereafter be responsible for legal, accounting or paralegal expenses of the indemnified party. Any indemnified party may at its own expense retain counsel and the indemnifying party and its counsel shall reasonably keep informed any such additional counsel selected by an indemnified party. 10. FEES AND COMMISSIONS; a.) RHI will distribute fifty percent (50%) of "net commissions" to the Bank received by it on all transactions of RHI at a Bank branch in connection with existing and future customers through the Bank. Such fees shall be paid on a monthly basis and shall include fees and commissions generated by transactions in branch office customer accounts payable to and received by RHI. RHI shall exercise reasonable and diligent efforts to collect all fees and commissions due it in connection with such transactions. "NET COMMISSIONS" for purposes of this agreement is defined to include commissions and fees net of all clearing and brokerage charges set forth in "10c" below and any direct cost mutually agreed upon by the Bank and RHI. b.) Employees of the Bank will receive discounts on all personal securities trades in their accounts. c.) The following schedule sets for the total commission and brokerage charges for securities transactions executed through RHI. This schedule is subject to change upon written notice by RHI to the Bank or pursuant mutual agreement by the parties hereto.
Order Variable Charges ----- ---------------- Listed: $25.00 + $0.20/share (Market orders 1-4, 999 shares) Stocks + $0.30/share (Limit orders 1-4, 999 shares) or + $0.25/share (Market or Limit 5,000 shares and over) Bonds $50.00 OTC Principal: Stocks $35.00 + $0.25/share (Market or Limit orders on shares under $5,000) + $0.150/share (5,000 and over) GNMA $50.00 Muni $50.00 Corporate $50.00 Treasury $50.00 Syndicate $50.00 Mutual Funds: Load $50.00 No-Load $50.00 Exchange Fee $50.00
11. TERM, TERMINATION, EVENT OF DEFAULT - This Agreement shall continue for an initial term of two (2) years form the date first executed and may be canceled by either party upon ninety (90) days written notice of termination to the other party. Notwithstanding the foregoing, the Bank may terminate this Agreement effective immediately, if the Bank's decision is a result of an order by a court or regulator, or is made as a result of litigation, challenging the offering of this service in which the Bank is a party defendant. During the term of this Agreement, the Bank will not offer or promote the services contemplated by the Agreement through or by any broker or similar provider other than RHI. In the event of termination of this Agreement, RHI agrees to release to the Bank, at the Bank's request, all information the Bank may reasonably require to continue servicing such Customers. RHI may notify and service the Bank's Customers, if the Bank terminates the service contemplated by this Agreement, and the Bank does not, within ninety (90) days thereafter, provide or arrange for similar services to be provided to its Customers. Customers may terminate their accounts at any time. In the event of a challenge by a regulatory body, individual, or other entity relating to the legality of the performance, by either party, of its obligations under the provisions of the Agreement, which challenge may impact the ability to make payments to the Bank hereunder, then the amounts which would have been paid to the Bank hereunder shall be held in escrow by RHI, pending resolution of such challenge. If the making of such challenge is terminated by a settlement agreement, which does not preclude or limit the making of such payments, such escrow funds will be paid over to the Bank, with interest; the escrow funds are to be invested in an account at any federally insured national bank. If the making of such payment is ultimately determined to be impermissible, or is precluded or limited pursuant to a settlement agreement relating to such challenge, such amounts shall be retained by RHI; and the parties hereto shall discuss the disposition of such amounts, consistent with the original intent of this Agreement, and the determination of impermissibility of settlement. 12. MISCELLANEOUS - Neither the Bank nor RHI shall hold itself out as an agent of the other, or any of the subsidiaries, or the companies controlled directly or indirectly by, or affiliated with, the other. Neither the Bank nor RHI shall, without having obtained prior approval of the other, (which approval shall not be unreasonably withheld), distribute solicitation material, place or agree to place any advertisement in any manner that makes reference to the other and/or any of the services embodied in this Agreement. This Agreement shall inure to the benefit of, and be binding upon, the successors and assignees of the parties hereto. This Agreement may not be assigned by any party without the prior written consent of the other parties. Neither this Agreement, nor activity hereunder, is intended to be and shall not be treated as, a general or limited partnership, association or joint venture. Neither party hereto shall use any service mark, trade name, or trademark of the other party without the prior written consent of the other, which consent shall not be unreasonably withheld. Each party shall have the exclusive right to any such name or mark developed by it in connection with services performed by it under this Agreement. For the purposes of any and all notices, consents, directions, approvals, requests or other communications required or permitted to be delivered hereunder: If to RHI, as follows: R H Investment Corporation, Inc. Attn: A. L. "Bud" Byrnes, III 15760 Ventura Blvd., Suite 2040 Encino, CA 91436 If to Bank, as follows: Mercantile National Bank 1840 Century Park East Los Angeles, CA 90067 This Agreement shall be construed in accordance with the laws of the State of California. Any disputes under this Agreement, including interpretation of its terms and conditions, and any rights and obligations of the parties hereunder shall be arbitrated in accordance with the Rules of the N.A.S.D. with such arbitration to occur in Los Angeles, California. All obligations of the parties herein with respect to matters through the date of termination of this Agreement shall survive the termination of this Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as delivered as of the day and year first above written. R H INVESTMENT CORPORATION, INC. MERCANTILE NATIONAL BANK By /s/ A.L. "BUD" BYRNES, III By /s/ JOSEPH W. KILEY III -------------------------------- ------------------------------------ A.L. "Bud" Byrnes, III Joseph W. Kiley III Chief Executive Officer Executive Vice President & CFO EX-10.23 5 EXHIBIT 10.23 WINDSOR FINANCIAL GROUP, INC. INVESTMENT MANAGEMENT AGREEMENT This Agreement made this first day of December, 1997 by and between Mercantile National Bank, ("CLIENT") and Windsor Financial Group, Inc., ("WFG"). WHEREAS, CLIENT wishes to retain WFG as its investment adviser to invest and reinvest certain assets upon the terms and conditions set forth below; and WHEREAS, WFG is willing to provide such investment advisory services to CLIENT pursuant to these terms and conditions. NOW, THEREFORE, the parties agree as follows: 1. INVESTMENT MANAGEMENT SERVICES. WFG will provide CLIENT with the investment management services outlined in Schedule A attached hereto. As CLIENT's investment advisor, WFG will keep CLIENT's investment portfolio under continuous supervision. WFG will have no discretionary authority with respect to specific investment decisions; rather, WFG will make investment recommendations to an officer(s) designated by CLIENT for approval prior to execution. 2. SAFEKEEPING OF ASSETS. All assets for which WFG acts as investment adviser shall at all times be held by a custodian bank or broker/dealer in a segregated safekeeping account. CLIENT shall furnish WFG with a copy of all custody agreements between CLIENT and any designated custodian. WFG will not be responsible for the safekeeping of CLIENT's securities held by a custodian. 3. EXECUTION OF INVESTMENT DECISIONS. In order to execute CLIENT's investment decisions, WFG will: a. purchase, sell, invest and reinvest the assets of the portfolio according to CLIENT's instructions; and b. develop and maintain with CLIENT such procedures as are needed to effect proper delivery of securities purchased and sold; to facilitate payments, collections and the transmittal of funds; and to ensure the prompt investment of any available cash, including income, the proceeds of sales or redemptions, and such additional capital as may be allocated from time to time to CLIENT's account. 4. COMPENSATION FOR SERVICES. The investment management fee for services provided by WFG is set forth in Schedule B attached hereto. All fee statements will be sent out at the beginning of each calendar quarter and are due upon receipt. 5. REPORTS/MEETINGS. WFG will submit a quarterly status report to CLIENT listing the assets of the portfolio and the portfolio's value as of the end of the quarter. WFG will meet the CLIENT at least once per year, and more frequently at CLIENT's request, to discuss the performance of CLIENT's investment portfolio and any other matters relating to this Agreement. 6. SELECTION OF BROKERS. The board of directors will have sole discretion to select brokers from a list provided by WFG to perform brokerage services in connection with the purchase and sale of assets in the portfolio. 7. PAYMENT OF EXPENSES. WFG shall be responsible for the payment of all costs and expenses related to the management of CLIENT's account, except for the following expenses which shall be CLIENT's obligation: a. Fees paid for account or legal services rendered to the portfolio at CLIENT's request; a. Brokerage commissions and charges, including transfer taxes and similar taxes incurred in the purchase and sale of securities for CLIENT's account; and c. Interest and taxes imposed upon CLIENT's portfolio with respect to its income or ownership of securities. 8. SERVICES TO THIRD PARTIES. WFT is free to render services to third parties similar to those rendered to CLIENT under this Agreement, except that no services rendered to third parties may inhibit or interfere with WFG's performance of services hereunder. 9. EFFECTIVE DATE/TERMINATION. The effective date of this Agreement shall be January 1, 1998 and it shall continue into effect until December 31, 1998, whereupon it may be terminated by either party with 30 days of prior written notice. Client will be entitled to a refund of any unearned advisory fees as of the date of termination. 10. NOTICES. Any written notice required under this Agreement shall be personally delivered or forwarded by first class mail, postage prepaid, addressed to WFG as follows: Windsor Financial Group, Inc. 222 South Ninth Street, Suite 2790 Minneapolis, MN 55402 Attention: James A. Powell, Managing Director and addressed to CLIENT as follows: Mr. Joseph W. Kiley III Executive Vice President & CFO Mercantile National Bank 1840 Century Park East Los Angeles, CA 90067 or at such other address or place as shall be directed in writing by the parties. 11. GOVERNING LAW. This Agreement shall be construed and enforced in accordance with the laws of the State of Minnesota. 12. LIABILITY OF WFG. WFG, its officers, employees and agents, shall not be liable for any losses sutained by CLIENT's investment portfolio as a result of the decrease in value of any securities in the portfolio or for any other reason, whether or not such losses are attributable to any opinion, action or failure to act by WFG, unless WFG fails to act in good faith or is guilty of gross negligence or willful misconduct. Nothing herein shall in any way constitute a waiver or limitation of CLIENT's rights under state and federal securities laws. 13. ASSIGNMENT. This Agreement is not assignable by either party without the written consent of the other party. 14. INVESTMENT ADVISERS ACT. WFG is, and will continue to be during the term of this Agreement, registered under and in compliance with the Investment Advisers Act of 1940. IN WITNESS WHEREOF, the parties executed this Agreement as of the day and year first written above. WINDSOR FINANCIAL GROUP, INC. CLIENT By /s/ JAMES A. POWELL By /s/ JOSEPH W. KILEY III -------------------------------- ------------------------------------- James A. Powell Joseph W. Kiley III Managing Director Executive Vice President & CFO Receipt is hereby acknowledged of a copy of Form ADV, Part II, as required by the Securities Exchange Commission under Rule 204-3, under the Investment Adviser's Act of 1940. By /s/ JOSEPH W. KILEY III -------------------------------- Joseph W. Kiley III ATTACHMENT A BANK INVESTMENT MANAGEMENT SERVICES PROVIDED I. Fee based professional portfolio management to assist in the development of appropriate investment asset strategies by qualified investment professionals. II. Enhanced reporting capabilities including quarterly performance evaluation against an established benchmark. III. Development of investment portfolio policies and strategies within the context of bank management goals. IV. Credit review of asset purchases. V. Regular contact with professional portfolio manager regarding the development of specific bank strategies. VI. Client meetings as appropriate or deemed necessary by management with a minimum of an annual on site meeting. VII. Execution on all trades as necessary to implement bank investment strategies. VIII. Quantitative analysis of all purchases. IX. Assistance in the pricing of public and other large deposits. SCHEDULE B INVESTMENT PORTFOLIO MANAGEMENT WINDSOR FINANCIAL GROUP, INC. FEE SCHEDULE FOR 1/1/98 THROUGH 12/31/98 Par Value of the Portfolio as of 12/31/97 times .0007 (7 basis points) To be paid in four installments at the beginning of each calendar quarter. EX-23 6 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the 1990 Stock Option Plan Registration Statement No. 33-23303, the 1994 Stock Option Plan Registration Statement No. 33-94828 and the 1996 Stock Incentive Plan Registration Statement No. 333-33139 of our report dated January 23, 1998, appearing in this Annual Report on Form 10-K of National Mercantile Bancorp for the year ended December 31, 1997. Los Angeles, California March 11, 1998 EX-27 7 EXHIBIT 27
9 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 4,186 250 11,900 0 26,478 14,000 14,010 61,252 2,023 119,405 97,388 8,550 1,027 0 0 7,350 24,613 (19,523) 119,405 5,947 1,940 713 8,600 2,756 2,856 5,744 0 (37) 6,098 132 132 0 0 132 0.20 0.08 5.63 1,201 0 5,422 0 2,969 1,315 369 2,023 1,424 0 599
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