10-K405 1 FORM 10-K FOR 1994 Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Fee Required) For the fiscal year ended DECEMBER 31, 1994 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required) For the transition period from to ---- ---- Commission file number 0-18015 CUPERTINO NATIONAL BANCORP (Exact name of registrant as specified in its charter) CALIFORNIA 33-0060898 (State of incorporation) (IRS employer identification number) 20230 STEVENS CREEK BOULEVARD, CUPERTINO, CA 95014 (Address of principal executive offices) (408) 996-1144 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered -------------------- ----------------------------------------- NONE NONE 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. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained herein, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X --- The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on March 2, 1995, as reported on the NASDAQ National Market System, was approximately $11,090,833. Shares of Common Stock held by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares of COMMON STOCK, NO PAR VALUE, of registrant outstanding as of March 2, 1995 was 1,559,187. _______________ DOCUMENTS INCORPORATED BY REFERENCE Parts of the following documents are incorporated by reference into Parts I, II, III, and IV of this Form 10-K Report: (1) Proxy Statement for registrant's Annual Meeting of Shareholders to be held May 25, 1995 (Part III), and (2) registrant's Annual Report to Shareholders for the year ended December 31, 1994 (Parts I, II and IV). 1 PART I ITEM 1. BUSINESS GENERAL Cupertino National Bancorp (the "Company") is a California corporation and bank holding company. Cupertino National Bank (the "Bank"), a wholly owned subsidiary of the Company, is a national bank conducting a commercial banking business. The Company was organized in August 1984, and the Bank began operations in May 1985. The Company and the Bank have their principal offices at 20230 Stevens Creek Boulevard, Cupertino CA 95014. The Company's current activities are principally acting as the holding company for the Bank and as the lessee and sublessor to the Bank of the premises on which the Bank is located. The Bank provides a wide range of commercial banking services to small and medium-sized businesses, real estate firms, business executives, professionals and other individuals. Trust services are provided by a separate department of the Bank to support the trust needs of its clients. The Bank's strategy emphasizes acquiring and developing relationships with clients in the Bank's service area. Personal service officers are assigned to each borrowing client to provide continuity to the relationship. The Bank provides commercial loans for working capital and business expansion to small and medium-sized businesses with annual revenues in the range of $1 million to $25 million. Commercial loans typically include revolving lines of credit collateralized by inventory, accounts receivable or leasehold improvements, loans to purchase equipment, and loans for general working capital purposes, collateralized by equipment. The Bank's commercial customers are drawn from a wide variety of manufacturing, wholesale and service businesses, and are not concentrated in any one particular industry. Loans to real estate construction and development companies are primarily for construction of single- family residences in the Bank's primary service area. Such loans typically range between approximately $200,000 and $2,900,000. Loans to professional and other individual clients, whose income typically equals or exceeds the median income for the Bank's service area, cover a full range of consumer services, such as automobile, aircraft, home improvement and home equity loans, and other secured and unsecured lines of credit, including credit cards. The Bank has a Small Business Administration ("SBA") department which makes loans to assist smaller clients and those who are starting new businesses in obtaining financing. The loans are generally 65% to 80% guaranteed by the SBA. In 1994, the Bank was named a Preferred Lender by the SBA. Preferred Lender status is awarded by the SBA to lenders who have demonstrated superior ability to generate, underwrite and service loans guaranteed by the SBA, and results in more rapid turn around of loan applications submitted to the SBA for approval. In May 1994, the Bank opened its Emerging Growth Industries ("EGI") Venture Lending Group to serve the needs of companies in their start-up and development phase. This unit was developed to meet the needs of clients in the Bank's service area by allowing them to access a banking relationship early in their development. The loans to this target group of clients are generally secured by the accounts receivable, inventory and equipment of the companies. The financial strength of these companies also tends to be bolstered by the presence of venture capital investors among the shareholders. The Bank is a member of the Federal Reserve System and the deposits of the Bank's clients are insured up to $100,000 by the Federal Deposit Insurance Corporation ("FDIC"). In 1992, the Bank became a member of the Federal Home Loan Bank of San Francisco ("FHLB")in order to enhance its ability to service its loan clients. This membership allows the Bank to enhance its funding sources as the FHLB allows members to borrow funds by pledging mortgage loans as collateral. 2 MARKET AREA AND CLIENT BASE The Bank concentrates on providing service to clients in Cupertino, San Jose, Palo Alto and the surrounding communities in Santa Clara County and San Mateo County. Cupertino is located in the center of the geographical area which is referred to as "Silicon Valley". The City of Cupertino has a population of approximately 42,000 and its average annual household income exceeds $79,000. Among metropolitan areas, Santa Clara County ranks third in California in median household income. The commercial base of Santa Clara County is diverse and includes computer and semiconductor manufacturing, professional services, printing and publishing, aerospace, defense, real estate construction, and wholesale and retail trade. The Bank has not concentrated on attracting commercial clients from any single industry, although it has in the past emphasized lending to the residential real estate construction industry in its service area. The Bank's headquarters are in Cupertino. In March 1991, the Bank opened its first regional office in downtown San Jose. This office was established to better serve existing clients of the Bank, as well as to gain new relationships from clients based in the growing financial center in the downtown San Jose area. In May 1992, the Bank opened a second regional office in Palo Alto. This office gives the Bank a presence in the financial market in Northern Santa Clara and Southern San Mateo counties. The opening of these regional offices has contributed to the continued growth of the Bank through 1994. Many of the directors of the Company and the Bank, and their affiliates, maintain deposit and loan relationships with the Bank. See Note 11 of Notes to Consolidated Financial Statements in the Company's 1994 Annual Report, incorporated herein by reference, for information regarding loans to affiliates and other significant related party transactions. SOURCES OF FUNDS Most of the Bank's deposits are obtained from small and medium-sized businesses, business executives, professionals and other individuals. At December 31, 1994, the Bank had a total of 4,633 deposit accounts, representing 2,032 non-interest-bearing deposit (checking) accounts with an average balance of approximately $26,700 each, 2,146 interest-bearing demand, money market demand, and savings accounts with an average balance of approximately $41,200 each, and 455 time deposit accounts with an average balance of approximately $99,000 each. Rates paid on deposits vary among the categories of deposits due to different terms, the size of the individual deposit, and rates paid by competitors on similar deposits. The Bank has one large deposit relationship with a title company, in which three of the directors of the Bank serve as directors (one Bank director is also the principal shareholder and Chief Executive Officer of the title company). Deposits from this client ranged between $3.9 million and $12.6 million during 1994; balances related to this client, in both non-interest- bearing demand accounts and money market accounts totaled $4.6 million on December 31, 1994. LENDING ACTIVITIES The Bank's loan portfolio is centered in commercial lending to small and medium-sized businesses in the manufacturing and service industries. The Bank has also been an active lender in residential real estate construction. Due to economic declines in the company's business market, the emphasis on residential real estate construction lending has been reduced. Approximately 59% of the Bank's portfolio was in commercial loans at December 31, 1994. Real estate construction loans represented approximately 13% of total loans at December 31, 1994, primarily for residential projects. In addition, 9% of the Bank's loans were real estate term loans, which are primarily secured by commercial properties. The balance of the portfolio consists of consumer loans and loans held for sale. The Bank's loan clients are primarily located in Cupertino, San Jose, Palo Alto and the surrounding communities in Santa Clara County and San Mateo County. 3 The majority of loans are collateralized. Generally, real estate loans are secured by real property, and commercial and other loans are secured by bank deposits or business and personal assets. Repayment is generally expected from the sale of the related property for real estate construction loans, and from the cash flow of the borrower for commercial and other loans. The interest rates charged for the loans made by the Bank vary with the degree of risk, size and maturity of the loans. Rates are generally affected by competition, associated factors stemming from the client's deposit relationship with the Bank and the Bank's cost of funds. A majority of the loans in the Bank's portfolio have a floating rate. In its commercial loan portfolio, the Bank provides personalized financial services to the diverse commercial and professional businesses in its market area, but does not concentrate on any particular industry. Commercial loans consist chiefly of short-term loans (normally with a maturity of under one year) for working capital. Significant emphasis is placed on the borrower's earnings history, capitalization, secondary sources of repayment (such as accounts receivable), and in some instances, third party guaranties or highly liquid collateral (e.g., time deposits). Commercial loan pricing is generally at a rate tied to the Prime rate (as quoted in the Wall Street Journal) or the Bank's reference rate. While the commercial loan portfolio of the Bank is not concentrated in any one industry, the Bank's service area has a concentration of technology companies, and accordingly, the ability of any of the Bank's borrowers to repay loans may be affected by the performance of this sector of the economy. The California economy has been particularly hard hit by the national recession. There has been a significant decline in the California residential real estate market since late 1990, which has persisted through 1994. This has resulted in an increase in the level of non-performing assets in 1993 and 1994, and has resulted in an increase in loans charged-off and the provision for loan losses in 1993 and 1994. The Bank's portfolio may be adversely affected if economic conditions do not improve, which could result in an increase in non-performing loans, charge-offs and the related provision to the allowance for loan losses. The Bank's residential real estate construction loan activity has focused on providing short-term (less than one year maturity) loans to local individuals, partnerships and corporations in the local residential real estate industry for the construction of single family residences. During 1992 through 1993, the Bank concentrated its construction loan activity in the market for owner-occupied custom residences. During 1994 real estate values began to stabilize and the Bank began to cautiously enter the construction loan market for small townhouse and single family home projects. Residential real estate construction loans are typically secured by first deeds of trust and require guaranties of the borrower. The economic viability of the project and the borrower's credit-worthiness are primary considerations in the loan underwriting decision. Generally, these loans provide an attractive yield, but may carry a higher than normal risk of loss or delinquency, particularly if general real estate values decline or the loan underwriting process is based upon inaccurate appraisals. The Bank utilizes independent local appraisers and conservative loan-to-value ratios (e.g. loans generally not exceeding 65% to 75% of the appraised value of the property). The Bank monitors projects during the construction phase through regular construction inspections and a disbursement program tied to the percentage of completion of each project. In the absence of rapid declines in residential real estate values, ultimate collectibility of such secured loans is usually better than the average mix of commercial loans. Construction loans are generally made on a floating rate basis. The Bank's consumer loan portfolio is divided between installment loans for the purchase of such items as automobiles and aircraft, and home improvement loans and equity lines of credit which are often secured by residential real estate. Installment loans tend to be fixed rate and longer- term (one to five year maturity), while the equity line type loans are generally floating rate, and are reviewed for renewal on an annual basis. The Bank also has a minimal portfolio of credit card loans, issued as an additional service to its clients. LOAN ADMINISTRATION The loan policy of the Bank is approved each year by its Board of Directors and is managed through periodic reviews of such policies in relation to current economic activity and the degree of risk (both credit and interest rate) in the 4 current portfolio. The Directors' Loan Committee supervises the lending activities of the Bank. This committee consists of four outside directors, the Chairman/Chief Executive Officer, the President/Chief Operating Officer (position currently vacant), the Executive Vice President/Senior Credit Officer, Senior Vice President Commercial Lending and the Vice President/Credit Administration. The officers in this group make up the Officers' Loan Committee. Sole lending authority is granted to officers on a limited basis. Loan requests exceeding individual officer approval limits are submitted to the Officers' Loan Committee, and those which exceed its limit are submitted to the Directors' Loan Committee for final approval. Both of these committees meet on a regular basis in order to provide timely responses to the Bank's clients. The Bank has an active credit administration function which includes, in addition to internal reviews, the regular use of an outside loan review firm to review the quality of the loan portfolio. The Bank has an internal asset review committee (IARC) that meets monthly to review delinquencies, non- performing assets, classified assets and other pertinent information for the purpose of evaluating credit risk within the Bank's loan portfolio and to recommend general reserve percentages and specific reserve allocations. The IARC reports to the Board of Directors on a quarterly basis. TRUST DEPARTMENT The Bank's Trust Department commenced operations in July 1988 and offers a full range of fee-based trust services directly to its clients. The Trust Department administers all types of retirement plans, including corporate pension plans, 401(k) plans and individual retirement plans, with an emphasis on the investment management, custodianship and trusteeship of such plans. In addition, the Trust Department acts as executor, administrator, guardian and/or trustee in the administration of the estates of individuals. Investment and custodial services are provided for corporations, individuals and non-profit organizations. Total assets under management by the Trust Department were approximately $157 million at December 31, 1994, as compared to approximately $118 million at December 31, 1993, and $117 million at December 31, 1992. MORTGAGE BANKING DIVISION The Bank opened a Mortgage Banking Division in July 1992. The purpose of this division is to originate residential mortgage loans for sale on the secondary market. The primary revenue of this division is the premium received on the sale of such mortgage loans and their related servicing rights. The Bank funds both loans which are originated directly by a mortgage banking officer and loans purchased through a network of mortgage brokers. The Bank is currently selling both the loans and the related servicing rights through a correspondent. During 1993 the Bank was designated as an approved seller/servicer by the Federal National Mortgage Association and the Federal Home Loan Corporation, known in the industry as Fannie Mae and Freddie Mac, respectively. During 1994 the increased upward pressure on interest rates caused mortgage refinancing and home purchases to significantly decline. This required the Bank in June 1994 to restructure its mortgage operations and focus all of its efforts on the wholesale mortgage market. This change reduced the operating costs within the mortgage business unit; however, the operating results for the last half of 1994 did not return to acceptable levels of return on investment corresponding to the risks involved. Based on these factors the Bank determined to close its mortgage operations effective March 31, 1995. In connection with this action, the Bank anticipates incurring a $180,000 after tax charge related to this operation in the first quarter of 1995. The Bank will continue to offer mortgage loans to its market area and client base through its regional offices. COMPETITION The banking business in the Bank's service area is highly competitive, as it is throughout California. Many of the major branch banking institutions in California have one or more offices in the Bank's service area. The Bank competes in the marketplace for deposits and loans, principally against these banks, other independent community banks, savings and loan associations, credit unions and other financial institutions. 5 The major advantages that larger branch institutions have over the Bank are their ability to provide wide ranging advertising programs; to allocate their investment assets in areas of higher yields and demands; and, by virtue of their greater total capitalization, to utilize substantially higher lending limits than the Bank. These banks can also offer certain services, such as international banking, which are not offered directly by the Bank. However, the Bank is able to offer most of these services indirectly, through its correspondent institutions. Smaller independent banks, including the Bank, have found a market niche by providing specialized services, and by targeting clients whose credit needs are below levels generally sought by the major branch banks. The Bank defines its service area as the cities of Cupertino, San Jose, Palo Alto, and the surrounding cities in Santa Clara County and San Mateo County. Banks and savings and loan operations in Santa Clara County collectively held approximately $21 billion in deposits as of June 30, 1994 (the latest date as of which complete deposit data was available). Based on this data, the Bank had a market share in Santa Clara County of approximately .93% at June 30, 1994. To compete with the major financial institutions in its service area, the Bank relies upon customized services and direct personal contacts by its officers, directors and staff. For clients whose loan demands exceed the Bank's legal lending limit, the Bank seeks to arrange such loans on a participation basis with other lenders, primarily other community banks in the San Francisco Bay Area. EFFECT OF GOVERNMENTAL POLICIES AND LEGISLATION Banking is a business in which profitability depends primarily on interest rate differentials. In general, the difference between the interest rates paid by the Bank on its deposits and its other borrowings and the interest rates received by the Bank on loans extended to its customers and on securities held in the Bank's investment portfolio will be the principal factor affecting the Bank's earnings. The interest rates paid and received by the Bank are sensitive to many factors which are beyond the control of the Bank, including the influence of domestic and foreign economic conditions. The earnings and growth of the Bank and the Company will also be affected not only by general economic conditions, including inflation, recession and unemployment, but also by monetary and fiscal policies of the United States and federal agencies, particularly the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). The Federal Reserve Board can and does implement national monetary policy, such as seeking to curb inflation and/or combat recession, by its open market operations in United States Government securities, by its control of the discount rates applicable to borrowing by banks from the Federal Reserve System and by its establishment of reserve requirements for financial institutions subject to its regulation. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits, and also affect the interest rates charged on loans and paid on deposits. Changes in the financial services industry as a result of such governmental policies and regulations have often contributed to increases in the cost of funds of banks and other depository institutions and may continue to affect such cost, and consequently the earnings of such institutions. However, the degree, timing and full extent of the impact of the laws or of possible changes to the laws on banking in general, and the business of the Bank in particular, presently cannot be predicted. SUPERVISION AND REGULATION The following information is qualified in its entirety by reference to the statutory and regulatory provisions described, which statutes and regulations are subject to change at any time. THE BANK HOLDING COMPANY The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and is subject to supervision by the Federal Reserve Board. As a bank holding company, the Company is required to file with the Federal Reserve Board an annual report and such other additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may also make examinations of the Company and the Bank. Under the BHCA, bank holding companies may not (subject to certain limited exceptions) directly or indirectly acquire the ownership or control of substantially all of the assets or more than 5% of any class of voting shares of any company, including a bank, without the prior written approval of the Federal Reserve Board. The 6 BHCA prohibits the Federal Reserve Board from approving the acquisition by a bank holding company of substantially all the assets or more than 5% of any class of voting shares of any bank (or its holding company) located in a state other than the state in which the operations of the bank holding company's bank subsidiaries are principally conducted, unless the statutes of the state in which the acquiree bank is located expressly permit such an acquisition. In addition, subject to certain exceptions, bank holding companies are prohibited under the BHCA from engaging in non-banking activities. One principal exception to this prohibition is for activities found by the Federal Reserve Board to be so closely related to banking as to be properly incident thereto. For each application to engage in non-banking activities, the Federal Reserve Board is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stocks or securities thereof, and on the taking of any such stock or securities as collateral for loans to any borrowers. Furthermore, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with extensions of credit, the lease or sale of any property or the furnishing of other banking services. The Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the Superintendent of Banks of the State of California (the "Superintendent"). CAPITAL ADEQUACY OF THE COMPANY The Federal Reserve Board has adopted risk based capital guidelines for bank holding companies. The minimum guideline for the ratio of total capital to risk weighted assets (including certain off-balance-sheet activities) is 8%. At least half of the total capital is to be composed of common stockholders' equity, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of perpetual preferred stock, less disallowed intangibles including goodwill ("Tier 1 Capital"). The remainder of a bank's allowable capital may include subordinated debt, other preferred stock and a limited amount of loan loss reserves ("Tier 2 Capital"). In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to total assets, less goodwill) of 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies are generally required to maintain a minimum Tier 1 Capital leverage ratio of 3% plus an additional 100 to 200 basis points. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets (i.e. goodwill, core deposit intangibles and purchased mortgage servicing rights). Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a "tangible Tier 1 Capital leverage ratio" (deducting all intangibles) in evaluating proposals for expansion or new activities. At December 31, 1994, the Company had total capital and leverage capital ratios above the minimums required by the Federal Reserve Board. THE BANK The Bank, as a national banking association, is subject to the National Bank Act and to primary supervision, examination and regulation by the Comptroller of the Currency (the "Comptroller"). The Comptroller regulates the number and locations of branch offices of a national bank. The Bank is also a member of the Federal Reserve System and is subject to applicable provisions of the Federal Reserve Act and regulations issued pursuant thereto. Each 7 depositor's accounts with the Bank are insured by the Bank Insurance Fund, which is managed by the Federal Deposit Insurance Corporation ("FDIC"), to the maximum aggregate amount permitted by law, which is currently $100,000 for all insured deposits of the depositor. For this protection, the Bank pays a semi-annual assessment and is subject to the rules and regulations of the FDIC pertaining to deposit insurance and other matters. The Federal Reserve Board requires banks to maintain non-interest bearing reserves against certain of their transactional accounts (primarily deposit accounts that may be accessed by writing checks) and non-personal time deposits. As a creditor and a financial institution, the Bank is subject to certain regulations promulgated by the Federal Reserve Board including, without limitation, Regulation B (Equal Credit Opportunity Act), Regulation D (Reserves), Regulation E (Electronic Funds Transfers Act) and Regulation F (interbank liabilities), Regulation Z (Truth in Lending Act), Regulation CC (Expedited Funds Availability Act), and Regulation DD (Truth in Savings Act). As creditors on loans secured by real property and as owners of real property, the Bank may be subject to potential liability under various statutes and regulations applicable to property owners including statutes and regulations relating to the environmental condition of the property. The Bank is also subject to applicable provisions of California law, insofar as they do not conflict with or are not preempted by federal banking law. California law exempts banks from the usury laws. The supervision, regulation and examination of the Bank by the bank regulatory agencies are generally intended to protect depositors and are not intended to protect the Company's shareholders. INTERSTATE BANKING AND BRANCHING On September 29, 1994, the Reigle/Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") was signed into law. The Interstate Act effectively permits nationwide banking. The Interstate Act provides that one year after enactment, adequately capitalized and adequately managed bank holding companies may acquire banks in any state, even in those jurisdictions that currently bar acquisitions by out-of-state institutions, subject to deposit concentration limits. The deposit concentration limits provide that regulatory approval by the Federal Reserve Board may not be granted for a proposed interstate acquisition if, after the acquisition, the acquirer on a consolidated basis would control more than 10% of the total deposits nationwide or would control more than 30% of deposits in the state where the acquiring institution is located. The deposit concentration state limit does not apply for initial acquisitions in a state and in every case, may be waived by state regulatory authority. Interstate acquisitions are subject to compliance with the Community Reinvestment Act ("CRA"). States are permitted to impose age requirements not to exceed five years on target banks for interstate acquisitions. States are not allowed to opt-out of interstate banking. Branching between states may be accomplished either by merging separate banks located in different states into one legal entity, or by establishing de novo branches in another state. Consolidation of banks is not permitted until June 1, 1997, provided that the state has not passed legislation "opting-out" of interstate branching. If a state opts-out prior to June 1, 1997, then banks located in that state may not participate in interstate branching. A state may opt-in to interstate branching by bank consolidation or by de novo branching by passing appropriate legislation earlier than June 1, 1997. Interstate branching is also subject to a 30% statewide deposit concentration limit on a consolidated basis, and a 10% nationwide deposit concentration limit. The laws of the host state regarding community reinvestment, fair lending, consumer protection (including usury limits) and the establishment of branches shall apply to the interstate branches. De novo branching by an out-of-state bank is not permitted unless the host state expressly permits de novo branching by banks from out-of-state. The establishment of an initial de novo branch in a state is subject to the same conditions as apply to the initial acquisition of a bank in the host state other than deposit concentration limits. Effective one year after enactment, the Interstate Act permits bank subsidiaries of a bank holding company to act as agents for affiliated depository institutions in receiving deposits, renewing time deposits, closing loans, servicing loans and receiving payments on loans and other obligations. A bank acting as an agent for an affiliate shall not be considered a branch of the affiliate. Any agency relationship between affiliates must be on terms that are consistent with safe and sound banking practices. The authority for an agency relationship for receiving deposits includes the taking of deposits for an existing account, but is not meant to include the opening or origination of new deposit accounts. Subject to certain 8 conditions, insured savings associations which were affiliated with banks as of June 1, 1994, may act as agents for such banks. An affiliate bank or savings association may not conduct any activity as an agent which such institution is prohibited from conducting as a principal. If an interstate bank decides to close a branch located in a low or moderate income area, it must comply with additional branch closing notice requirements. The appropriate regulatory agency is authorized to consult with community organizations to explore options to maintain banking services in the affected community where the branch is to be closed. To ensure that interstate branching does not result in taking deposits without regard to a community's credit needs, the regulatory agencies are directed to implement regulations prohibiting interstate branches from being used as "deposit production offices". The regulations to implement its provisions are due by June 1, 1997. The regulations must include a provision to the effect that if loans made by an interstate branch are less than fifty percent of the average of all depository institutions in the state, then the regulator must review the loan portfolio of the branch. If the regulator determines that the branch is not meeting the credit needs of the community, it has the authority to close the branch and to prohibit the bank from opening new branches in that state. Effective January 1, 1991, California adopted legislation permitting any out-of-state bank holding company to acquire an existing California bank if its state of principal business provides reciprocal rights to California bank holding companies. The Superintendent has determined that substantial reciprocity exists between California and a variety of states including Arizona, Oregon, Washington, and New York. Although these changes have had the impact of increasing competition among banks and between banks and other financial service providers, the long-term effects of this increased competition on the Bank and on the competition which may arise as a result of the Interstate Act, cannot be determined at this time. CAPITAL ADEQUACY OF THE BANK In 1989, the Federal Reserve Board, along with the Comptroller and the FDIC, established an interagency risk-based capital framework that establishes uniform risk-based capital guidelines for certain banking organizations in the United States. Under these guidelines, both assets reported on the balance sheet and certain off-balance sheet items are assigned to certain risk categories. Each category has an assigned risk weight. Capital ratios are then calculated by dividing the capital by a weighted (according to risk) sum of the assets and off-balance sheet items. On February 28, 1991, the FDIC adopted minimum "leverage ratio" standards for certain banking organizations. The leverage ratio is a ration of Tier 1 capital to quarterly average total assets. The minimum required leverage ratio is 3.0% Tier 1 capital for banks that meet certain specified criteria, including having the highest regulatory rating. All other banks are generally required to maintain a leverage ratio of between 4.0% and 5.0% Tier 1 capital. At December 31, 1994, the Bank had capital ratios, both risk-adjusted and leverage, which placed it in the "well capitalized" category. For an analysis of the capital ratios of the Bank as of December 31, 1994, see "Management's Discussion and Analysis of Financial Conditions and Results of Operations - Capital Resources" in the 1994 Annual Report to Shareholders, which is incorporated herein by reference. The Company does not presently expect that compliance with regulatory capital guidelines will have a material adverse effect on the business of the Company or the Bank. The Company anticipates that if significant asset growth continues in the future, such growth may necessitate the addition of capital to comply with regulatory guidelines. FINANCIAL INSTITUTIONS REFORM, RECOVERY AND ENFORCEMENT ACT The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") mandated changes that continue to affect the financial institutions industry. FIRREA substantially revised the regulatory structure of the banking, savings and financial services industries. Many of these changes directly affect the Bank and the Company. Deposits at commercial banks such as the Bank are now insured by the Bank Insurance Fund ("BIF") of the FDIC. 9 FIRREA requires the banking regulatory agencies to make written evaluations after examining a depository institution for compliance with the Community Reinvestment Act ("CRA"). The CRA evaluations now include a public section, including the CRA rating agency assigned to the bank, and a confidential section, which is not released to either the public or the institution, except under limited circumstances. The regulatory guidelines now require each institution to place the written evaluation in its CRA public file at its head office and at one designated office in each local community. FIRREA also revised the rating system for CRA compliance. FIRREA mandated appraisals by state-certified or state-licensed appraisers for loans made by financial institutions over certain amounts. Effective December 31, 1992, an appraisal by a state-certified appraiser is required for the following types of bank loans secured by real estate: (1) any real estate loan transaction having a value of $1 million or more, or (2) any non-residential real estate transaction or complex residential real estate transaction in the amount of $250,000 or more. In addition, an appraisal by a state-licensed appraiser is required for any real-estate transaction having a value of more than $100,000. The State of California has established a program for the licenser and certification of real estate appraisers in order to meet the requirements of FIRREA. FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 On December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1990 ("FDICIA") was signed into law. Among other things, FDICIA recapitalized the BIF, implemented deposit insurance reform, and imposed new supervisory standards requiring annual examinations, independent audits, uniform accounting and management standards and prompt corrective action for problem institutions. As a result of FDICIA, depository institutions and their affiliates are subject to federal standards which govern asset growth, interest rate exposure, executive compensation, and many other areas of depository institution operations. Only the most highly capitalized and well-managed institutions are allowed to expand their operations and activities. Undercapitalized institutions are subject to activity limitations and other restrictions. BIF Recapitalization. FDICIA provides increased funding for the BIF, primarily by increasing the authority of the FDIC to borrow from the U.S. Treasury Department. A significant portion of any such borrowing will be repaid by insurance premiums assessed on BIF members, including the Bank, sufficient to repay any borrowed funds within 15 years and to provide BIF reserves of $1.25 for each $100 of insured deposits. FDICIA also provides authority for special assessments against insured deposits. Risk Based Deposit Insurance Rates. On January 1, 1994, a permanent risk-based deposit premium assessment system became effective under which each depository institution is placed in one of nine assessment categories based on certain capital and supervisory measures. The assessment rates under the system range from 0.23 percent to 0.31 percent of domestic deposits depending on the assessment category into which an insured bank is placed. It is possible that such assessments may be increased or decreased and that there may be additional special assessments in the future. A significant increase in the assessment rate or an additional special assessment could have an adverse impact on the Bank's and the Company's results of operations. Increases in deposit insurance assessment rates add to an insured bank's operating costs. These cost increases can have a measurable effect upon a bank's profitability and capitalization. Increases in deposit insurance assessment expenses do not, however, necessarily lead to equally proportionate declines in bank profits. The Company does not anticipate that an increase or decrease in its deposit insurance assessment rate will significantly impact the Bank's profitability or capitalization. Brokered Deposits. Under FDIC regulations governing the receipt of brokered deposits, a bank cannot accept brokered deposits (which term is defined to mean deposits with an interest rate which exceeds significantly prevailing rates in its market) unless (i) it is well capitalized or (ii) it is adequately capitalized and has received a waiver from the FDIC. Except under certain conditions, a bank that cannot accept brokered deposits also cannot offer "pass- through" insurance on certain employee benefit accounts. The Bank is considered to be well capitalized for purposes of this regulation and in 1994 began accepting limited amounts of brokered deposits to help manage its liquidity position. 10 Prompt Corrective Regulatory Action. FDICIA categorizes banking institutions as well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A bank is subject to corrective action if it is not adequately capitalized. Significantly and critically undercapitalized banks are subject to extensive federal regulatory control, including closure. A bank's capital tier depends upon where its capital levels are in relation to various relevant capital measures, which include a risk-based capital measure and a leverage capital measure, and upon certain other factors. The federal banking authorities adopted regulations effective December 19, 1992, which define the capital measures a bank must meet in order to be considered well capitalized as a ratio of total capital to risk- weighted assets of not less than 10.0%, a ratio of Tier 1 capital to risk- weighted assets of not less than 6.0% and a leverage ratio of Tier 1 capital to average quarterly assets of not less than 5.0%. A bank will be considered adequately capitalized if it has a ratio of total capital to risk-weighted assets of not less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of not less than 4.0%, and a leverage ratio of Tier 1 capital to average quarterly assets of not less than 4.0%. The capital levels for the undercapitalized category are defined as any level under 8.0% for the total risk-based capital ratio, under 4.0% for the Tier 1 risk-based capital ratio, or under 4.0% for the Tier 1 leverage ratio. A bank will be considered significantly undercapitalized if it has a ratio of total capital to risk- weighted assets that is less than 6.0%, a ratio of Tier 1 capital to risk- weighted assets that is less than 3.0%, or a Tier 1 leverage ratio that is less than 3.0%. A bank will be considered critically undercapitalized if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. In addition to FDICIA's capital requirements, a financial institution may be reclassified and subject to corrective action if it receives a less than satisfactory rating in its most recent examination for its assets, management, earnings or liquidity. The Company and the Bank were considered "well capitalized" at December 31, 1994. FDICIA also requires an insured institution which does not meet any one of the statutory or regulatory capital requirements applicable to it to submit a capital restoration plan for improving its capital. In addition, FDICIA prohibits an insured institution from making a capital distribution if it fails to meet any capital requirements. FDICIA also contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts, and places restrictions on a bank's dealings with "large customers" if a principal officer or director of the "large customer" is a member of the bank's audit committee. Real Estate Lending. As required by FDICIA, on December 19, 1992, the federal banking agencies adopted uniform regulations prescribing standards for real estate lending effective March 19, 1993. The uniform rules require depository institutions to adopt and maintain comprehensive written real estate lending policies that are consistent with safe and sound banking practices, as well as establish loan-to-value limitations on real estate lending by insured depository institutions. The loan-to-value limits do not apply to loans guaranteed by the U.S. Government or backed by the full faith and credit of a state government; loans facilitating the sale of real estate acquired by the lending institution in the ordinary course of collecting a debt previously contracted; loans where real estate is taken as additional collateral solely through an abundance of caution by the lender; loans renewed, refinanced, or restructured by the original lender to the same borrower, without the advancement of new funds; or loans originated prior to the effective date of the regulation. The new regulations also allow lending institutions to make a limited amount of loans that do not conform to the regulations' loan-to-value limitations. The Bank has amended its real estate lending policies to comply with this legislation; such amendments are not expected to adversely affect the Bank's operations or profitability. Standards for Safety and Soundness. In September of 1992 the FDIC proposed regulations to require management to establish and maintain an internal control structure and procedures to ensure compliance with laws and regulations concerning bank safety and soundness on matters such as loan underwriting and documentation, asset quality, earnings, internal rate risk exposure and compensation and other employee benefits. The proposals, among other things, establish the maximum ratio of classified assets to total capital at 1.0 and the minimum level of earnings sufficient to absorb losses without impairing capital. The proposals provide that a bank's earnings are sufficient to absorb losses without impairing capital if the bank is in compliance with minimum capital requirements and the bank would, if its net income or loss over the last four quarters continued over the next four quarters, remain in compliance with minimum capital requirements. Any institution which fails to comply with these standards must submit a compliance plan. The failure to submit a plan or to comply with an approved plan will subject the institution to further enforcement action. Finally, independent auditors would be required to attest to or report separately on assertions in management's report, by using audit procedures agreed upon by the FDIC for determining the extent of compliance with laws and regulations 11 concerning bank safety and soundness. In anticipation of the adoption by the FDIC of the proposed regulations, the Bank is in the process of documenting and establishing additional internal control structures and procedures, as necessary, to ensure compliance with new requirements imposed by FDICIA and the regulations thereunder concerning the Bank's safety and soundness. The Bank's audit committee is composed entirely of outside directors. PAYMENT OF DIVIDENDS There are statutory and regulatory requirements applicable to the payment of dividends by the Bank to the Company and by the Company to its shareholders. By the Company. The Company began paying cash dividends in December 1994. The Company anticipates continuing to pay cash dividends on a semi-annual basis to the shareholders of the Company, when and as declared by its Board of Directors, out of funds legally available therefor, subject to the restrictions set forth in the California General Corporation Law (the "Corporation Law"). The amount of the annual dividend is anticipated to range between 10% to 25% of estimated annual earnings. The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Corporation Law further provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets the following two generally stated conditions: (i) the corporation's assets equal at least 1.25 times its liabilities, and (ii) the corporation's current assets equal at least its current liabilities or, if the average of the corporation's earnings before taxes on income and interest expense for the two preceding fiscal years was less than the average of the corporation's interest expense for such fiscal years, the corporation's current assets must equal at least 1.25 times it current liabilities. The primary source of funds for payment of dividends by the Company would be obtained from dividends received from the Bank. By the Bank. The board of directors of a national bank may declare the payment of dividends from funds legally available therefore, depending upon the earnings, financial condition and cash needs of the bank and general business conditions. A national bank may not pay dividends from its capital. All dividends must be paid out of net profits then on hand, after deducting losses and bad debts. A national bank is further restricted from declaring a dividend on its shares of common stock until its surplus fund equals the amount of capital stock, or, if the surplus fund does not equal the amount of capital stock, until one-tenth of the bank's net profits of the preceding half year in the case of quarterly or semiannual dividends, or the preceding two consecutive half-year periods in the case of an annual dividend, are transferred to the surplus fund. Furthermore, if the total of all dividends declared by a bank in any calendar year would exceed the total of its retained net profits of that year combined with its net profits of the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred stock, then the approval of the Comptroller is required for the payment of any dividends. Guidelines of the Comptroller set forth factors which are to be considered by a national bank in determining the payment of dividends. A national bank, in assessing the payment of dividends, is to evaluate the bank's capital position, its maintenance of an adequate allowance for loan and lease losses, and the need to revise or develop a comprehensive capital plan, complete with financial projections, budgets and dividend guidelines. The Comptroller has broad authority to prohibit a national bank from engaging in banking practices which it considers to be unsafe and unsound. It is possible, depending upon the financial condition of the national bank in question and other factors, that the Comptroller may assert that the payment of dividends or other payments by a bank is considered an unsafe or unsound banking practice and, therefore, direct the bank to implement corrective action to address such a practice. Accordingly, the future payment of cash dividends by the Bank to the Company will not only depend upon the Bank's earnings during any fiscal period, but also upon the assessment of the Bank's Board of Directors of the capital requirements of the Bank and other factors, including dividend guidelines and the maintenance of an adequate allowance for loan and lease losses. POLICY STATEMENT ON ALLOWANCE FOR LOAN LOSSES In 1993, the Federal banking agencies, through the Federal Financial Institutions Examination Council, issued a uniform policy statement on the adequacy of the reserves for loan and lease losses. The policy statement establishes a 12 benchmark equal to the sum of (a) 100% of assets classified as uncollectible, (b) 50% of assets classified as doubtful, (c) 15 % of assets classified substandard and (d) estimated credit losses on other assets over the upcoming 12 months. Federal bank examiners will measure the reasonableness of a banks' methodology for computing its reserves against this benchmark which is designed to be neither a floor nor a safe harbor. COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS The CRA requires banks, as well as other lenders, to identify the communities served by the bank's offices and to identify the types of credit the bank is prepared to extend within such communities. The CRA also requires an assessment of the performance of the bank in meeting the credit needs of its community and to take such assessment into consideration in reviewing applications for mergers, acquisitions, and other transactions. An unsatisfactory CRA rating may be the basis for denying such an application. The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and CRA activities. In addition to substantive penalties and corrective measures that may be required for a violation of certain fair lending laws, the Federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. On March 8, 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement, which became effective April 15, 1994, on discrimination in lending. The policy statement describes the three methods that Federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact. In connection with its assessment of CRA performance, the regulators assign a rating of "outstanding," "satisfactory," needs to improve," or "substantial noncompliance." The OCC conducts examinations of a bank's CRA performance as part of its regular examination process. PENDING LEGISLATION AND REGULATIONS Certain legislative and regulatory proposals which could affect the Company, the Bank and the banking business in general are pending, or may be introduced, before the U.S. Congress, the California State Legislature, and Federal and State government agencies. The U.S. Congress is considering numerous bills that could reform the banking laws substantially, particularly if the current legal barriers between commercial banking and investment banking are eliminated, as is now being proposed. It is not known to what extent, if any, these proposals will be enacted or what effect such legislation would have on the structure, regulation, or competitive relationship of financial institutions. It is likely, however, that many of these proposals would subject the Company and the Bank to increased regulation, disclosure and reporting requirements and would increase competition to the Bank and its cost of doing business. In addition to pending legislative changes, the various banking regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. FDICIA requires the regulatory agencies to adopt numerous rules, regulations, standards and guidelines over the next several years. Some of these regulations have been proposed. With respect to others, the agencies have solicited comments from the industry on the form the regulations should take. It cannot be predicted whether or in what form any such legislation or regulations will be enacted or the effect that such legislation may have on the business of the Company and the Bank. COMPETITORS Commercial banks, in general, have historically been less restricted in the types of loans they may lawfully make than have been non-bank financial institutions. However, the Depository Institutions Deregulation and Monetary Control Act, enacted in 1980, has increased the ability of non-banking institutions to compete with banks in lending activities. Federally chartered savings and loan associations may now invest up to 10% of their assets in commercial corporate, business or agricultural loans, and may offer credit card services. Federal credit unions have previously been authorized 13 by law to offer certain types of consumer loans. Additionally, since December 31, 1980, banks and other financial institutions, nationwide, have been permitted to offer check-like services, such as negotiable order of withdrawal (NOW) accounts, on which interest or dividends may be paid under certain circumstances. SELECTED STATISTICAL INFORMATION The following tables present selected financial information regarding the Bank's loans and deposits. This information should be read in conjunction with the company's Consolidated Financial Statements and the notes thereto and Management's Discussion and Analysis of Financial condition and Results of Operations included in the Company's 1994 annual Report to Shareholders, which has been incorporated herein by reference. TABLE I - LOAN MATURITIES - The following table details the maturity structure of the Bank's Commercial, SBA, Technology and Real Estate Construction and Land loan portfolio at December 31, 1994.
(Dollars in thousands) Commercial, Real Estate, SBA and Construction and Technology Land ------------------------------------------------------------------------------- One year or less: Floating Rate $46,508 $16,760 Fixed Rate 4,034 420 One to Five Years: Floating Rate 29,086 788 Fixed Rate 2,032 149 After Five Years: Floating Rate 24 -- Fixed Rate 11 -- ------- ------- Total $81,695 $18,117 ======= =======
TABLE II - COMPOSITION OF LOANS - The following tables details the composition of the Bank's gross loan portfolio at:
December 31 ------------------------------------------------------------------------------------------------------------------------------- 1994 1993 1992 1991 1990 (Dollars in Millions) $ % $ % $ % $ % $ % ------------------------------------------------------------------------------------------------------------------------------- Commercial 81.7 58.6 77.7 57.7 73.5 56.9 60.6 57.8 46.6 48.9 Real Estate Construction and Land 18.1 13.0 19.1 14.2 23.0 17.8 17.0 16.3 26.5 27.8 Real Estate Term 13.1 9.4 12.1 9.0 11.2 8.7 9.6 9.2 5.8 6.1 Consumer 21.1 15.1 18.2 13.5 16.6 12.8 17.5 16.7 16.3 17.2 ------------------------------------------------------------------------------------------------------------------------------- Total 134.0 96.1 127.1 94.4 124.3 96.2 104.7 100.0 95.2 100.0 ------------------------------------------------------------------------------------------------------------------------------- Loans Held For Sale 5.4 3.9 7.6 5.6 4.9 3.8 -- -- -- -- ------------------------------------------------------------------------------------------------------------------------------- Total Loans $139.4 100.0 $134.7 100.0 $129.2 100.0 $104.7 100.0 $95.2 100.0 ===============================================================================================================================
TABLE III - NON-PERFORMING LOANS -The following table details the Bank's non- performing loan portfolio for the last five years.
December 31 (Dollars in thousands) 1994 1993 1992 1991 1990 ---------------------------------------------------------------------- Non-accrual $3,244 $ 997 $ 513 $ 738 $ -- Accruing Loans Past Due 1,371 1,903 -- 55 -- 90 days or more Restructured Loans -- -- -- -- 1,380 ---------------------------------------------------------------------- Total $4,615 $2,900 $ 513 $ 793 $1,380 ======================================================================
14 TABLE IV - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES - The Bank's allocation of its allowance for loan losses for the past five years is detailed as follows for years ended December 31:
1994 1993 1992 1991 1990 (Dollars in thousands) $ % $ % $ % $ % $ % ------------------------------------------------------------------------------------------------------------------------------ Amount of allowance allocated to: Commercial 1,846 60.2 1,511 59.1 1,216 58.0 1,018 57.8 558 48.9 Real Estate Construction and land 180 13.3 308 14.5 263 18.2 184 16.3 295 27.8 Real Estate Term 495 9.7 391 9.2 56 8.9 48 9.2 42 6.1 Consumer 245 15.5 10 13.8 190 13.1 217 16.7 187 17.2 Loans Held for Sale 14 4.0 27 5.8 23 3.8 Unallocated 138 (2.7) -- (2.4) -- (2.0) 3 -- 219 -- ------------------------------------------------------------------------------------------------------------------------------- Total $2,918 100.0 $2,247 100.0 $1,748 100.0 $1,470 100.0 $1,301 100.0 ===============================================================================================================================
TABLE V - The following table summarizes the activity in the Bank's allowance for loan losses for the past five years:
1994 1993 1992 1991 1990 ------------------------------------------------------------------------------------------------------------------------- Allowance for loan losses: Balance at the beginning of period $ 2,247 $ 1,748 $1,470 $1,301 $1,107 Charge Offs: Commercial (748) (1,069) (520) (23) (142) Real Estate-Construction (123) -- (62) (188) -- Real Estate- term -- -- -- -- -- Consumer installment (141) (159) (145) (2) -- -------------------------------------------------------------------------------------------------------------------------- Total (1,012) (1,228) (727) (213) (142) Recoveries: Commercial 57 -- 4 -- 5 Real Estate-construction -- -- 95 -- -- Real Estate-term -- -- -- -- -- Consumer installment 6 48 4 -- -- -------------------------------------------------------------------------------------------------------------------------- Total 63 48 103 -- 5 -------------------------------------------------------------------------------------------------------------------------- Net charge-offs (949) (1,180) (624) (213) (137) Provision charged to income 1,620 1,679 902 382 331 ========================================================================================================================== Balance at the end of period $ 2,918 $ 2,247 $1,748 $1,470 $1,301
15 Table VI - MATURITIES OF CERTIFICATES OF DEPOSIT The following table presents the Bank's maturities of certificates of deposit over $100,000 issued by the Bank as of December 31, 1994.
(Dollars in Thousands) December 31, 1994 Three months or less $19,502 Three to six months 4,674 Six to twelve months 1,344 Over twelve months --- ------- Total $25,520 =======
For information regarding certain required disclosures of the maturities of investments, refer to Note 2 in the Company's 1994 Annual Report to Shareholders which is incorporated herein by reference. EMPLOYEES --------- The Company has no salaried employees, since all officers of the Company are employees of the Bank. At December 31, 1994, the Bank had 111 full time equivalent employees. Management believes that its employee relations are good and that the benefits provided by the Bank to its employees are competitive. ITEM 2. PROPERTIES The Company leases, from an unaffiliated party, approximately 19,000 square feet of office space, consisting of a portion of the first and second floors of a two-story building at the intersection of Stevens Creek Boulevard and Torre Avenue in Cupertino, California. The lease commenced on October 1, 1992, and has a term of ten years, with two consecutive five-year renewal options. The current minimum monthly rental payments are approximately $42,000, and are subject to annual adjustments depending on the percentage increase in the consumer price index over the prior period. The rent is further subject to adjustment upon exercise of each renewal option, to an amount equal to the then current market rental rate for similar properties. At December 31, 1994, the Company subleased all 19,000 square feet of the leased premises to the Bank for an amount equivalent to the Company's expense related to such premises. The Bank has entered into a lease for 3,900 square feet of office space on the ground floor of Sixty South Market Street, San Jose, CA, effective August 1, 1993. The lease has a term of five years, with an option to extend for an additional five years. The monthly rent is approximately $5,200 and is subject to annual adjustments. The rent is subject to adjustment upon exercise of the renewal option to an amount equal to the then current market rental rate for similar space. Effective March 28, 1994, the Bank extended its lease for 5,300 square feet of office space at 3 Palo Alto Square in Palo Alto, CA, which currently accommodates its Palo Alto regional banking office, and its Emerging Growth Industries division. The term is for eight years, with a base rent of $11,125 per month, with scheduled annual increases. The Company has an option to extend the lease for two additional five-year periods. Effective June 16, 1994, the Bank leased 2,100 square feet of office space at 3530 Camino Del Rio North, San Diego, CA. This space is currently utilized by the Banks wholesale mortgage origination unit. The term of the lease is approximately 21 months, with a base rent of approximately $2,200 per month. The Company believes that its facilities are well maintained and adequate to meet its current requirements. 16 ITEM 3. LEGAL PROCEEDINGS LEGAL PROCEEDINGS. On January 25, 1994, Sumitomo Bank ("Sumitomo") as ----------------- trustee for the California Dental Guild Real Estate Mortgage Fund II ("Fund II"), filed suit against the Bank in the Superior Court of the State of California, Santa Clara County, alleging negligence by the Bank and, by amendment of the complaint, one of its officers, in connection with the administration of a trust account. Sumitomo brought suit in its capacity as successor trustee for Fund II, and currently seeks monetary damages of approximately $2.2 million. Discovery for this litigation is still in process and no trial date has currently been scheduled. After consultation with its litigation counsel, the Bank believes that it has defenses to the claims made by Sumitomo and will vigorously defend the suit. However, litigation is subject to inherent uncertainties, especially in cases such as this where issues of trustee standards of care may be decided by a lay jury. Accordingly, no assurance can be given that Sumitomo's claims will be decided in favor of the Bank. The Bank believes that, if there were to be an unfavorable outcome of this suit, the Bank's litigation reserves and, based upon advice of litigation counsel, its coverages under a professional liability and director and officer insurance policies, would be adequate to cover any reasonably determined liability for the alleged claims. In any event, the Bank believes that the Sumitomo suit will not have a material adverse effect on the financial statements of the Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The information required by this Item is incorporated by reference to the section entitled "Stock Activity" on page 21 of the Company's 1994 Annual Report to Shareholders. At December 31, 1994 there were approximately 403 holders of record of the Company's Common Stock. ITEM 6. SELECTED FINANCIAL DATA The information required by this Item is incorporated herein by reference to the table entitled "Financial Highlights" on page 1 of the Company's 1994 Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item is incorporated herein by reference to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 10 through 21 of the Company's 1994 Annual Report to Shareholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is incorporated herein by reference to the Company's Consolidated Financial Statements and the notes thereto, and the Independent Auditor's Report thereon, set forth on pages 22 through 38 of the Company's 1994 Annual Report to Shareholders. 17 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES The information required to be reported on this item has been previously reported in a Form 8-K filed on October 20, 1994. PART III Certain information required by Part III is omitted from this Report in that the Company intends to file its definitive proxy statement pursuant to Regulation 14A (the "Proxy Statement") not later than 120 days after the end of the fiscal year covered by this Report, and certain information therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated herein by reference to the information relating to the directors of the Company set forth under the captions "Election of Directors" and "Compliance with Section 16)a) of the Securities Exchange Act of 1934" in the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to the information relating to executive compensation set forth under captions "Executive Compensation and Other Matters" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated herein by reference related to ownership of equity securities as set forth under the caption "General Information - Stock Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to the information relating to certain relationships and related transactions set forth under the caption "Compensation Committee Interlocks and Insider Participation" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this Report: (1) Financial Statements. The following Consolidated Financial Statements of Cupertino National Bancorp and Independent Auditors' Report are contained in and incorporated by reference herein to the Company's 1994 Annual Report to Shareholders: Consolidated Balance Sheets - At December 31, 1994 and 1993 Consolidated Statements of Income - For the years ended December 31, 1994, 1993 and 1992. 18 Consolidated Statements of Shareholders' Equity -For the years ended December 31, 1994, 1993 and 1992. Consolidated Statements of Cash Flows - For the years ended December 31, 1994, 1993 and 1992. Notes to Consolidated Financial Statements. Independent Auditors' Reports. With the exception of the information incorporated by reference to the Company's 1994 Annual Report to Shareholders in Parts I, II and IV of this Form 10-K, the Company's 1994 Annual Report to Shareholders is not to be deemed filed as part of this Report. (2) Financial Statement Schedules. All financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in Management's Discussion and Analysis of Financial Condition and Results of Operations or in the Consolidated Financial Statements and Notes thereto contained in the Company's 1994 Annual Report to Shareholders, which are incorporated herein by reference. (3) Exhibits. The exhibits listed on the accompanying Exhibit Index are filed as part of, or are incorporated by reference into, this Report. Exhibit Nos. 10.2, 10.5, 10.7, 10.8, 10.9 and 10.10 are management contracts or are compensatory plans or arrangements covering executive officers or directors of the Company. (b) Reports on Form 8-K. The Company filed the following reports on Form 8-K during the fourth quarter of fiscal 1994: Date of Report Items Reported -------------- -------------- September 7, 1994 Pursuant to Item 5, the Company reported the announcement of the resignation of Scott Montgomery as an officer and director of the Company and as a director of the Bank effective September 30, 1994. October 20, 1994 Pursuant to Item 4, the Company reported changing its independent public accountants from Deloitte & Touche, LLP to Coopers & Lybrand, L.L.P. 19 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. CUPERTINO NATIONAL BANCORP By: /s/ C. Donald Allen ------------------------------- C. Donald Allen, Director and Chief Executive Officer Dated: POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints C. Donald Allen and Steven C. Smith or either of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her, and in his or her name, place and stead, in any and all capacities to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchanges Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue of hereof. 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 in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ C. Donald Allen Director and --------------------- Chief Executive Officer C. Donald Allen (Principal Executive Officer) /s/ Steven C. Smith Executive Vice President, CFO, --------------------- Acting Chief Operating Officer Steven C. Smith and Corporate Secretary (Principal Financial and Accounting Officer) /s/ David K. Chui Director --------------------- David K. Chui /s/ Carl E. Cookson Director --------------------- Carl E. Cookson
20
Signature Title Date --------- ----- ---- /s/ Jerry R. Crowley Director March 30, 1995 --------------------- Jerry R. Crowley /s/ Janet M. DeCarli Director March 30, 1995 --------------------- Janet M. DeCarli /s/ John M. Gatto Director March 30, 1995 --------------------- John M. Gatto /s/ William H. Guengerich Director March 30, 1995 ------------------------- William H. Guengerich /s/ James E. Jackson Director March 30, 1995 ------------------------- James E. Jackson /s/ Rex D. Lindsay Director and March 30, 1995 ------------------------- Vice Chairman of the Board Rex D. Lindsay /s/ Glen McLaughlin Director and March 30, 1995 ------------------------- Chairman of the Board Glen McLaughlin /s/ Norman Meltzer Director March 30, 1995 ------------------------- Norman Meltzer /s/ Dick J. Randall Director March 30, 1995 ------------------------- Dick J. Randall /s/ Dennis S. Whittaker Director March 30, 1995 ------------------------- Dennis S. Whittaker
21 INDEX TO EXHIBITS
Sequentially Number Exhibit Numbered Page ------ ------- ------------- 3.1 Amended Articles of Incorporation of Cupertino National Bancorp-filed as Exhibit 4.1 of Registrant's Exhibits to Form S-8 Registration Statement (No. 33-36057), as filed with the Securities and Exchange Commission (the "Commission") on July 25, 1990 and incorporated herein by reference. 3.2 Bylaws of Cupertino National Bancorp--filed as Exhibit of Registrant's Exhibits to Form S-8 Registration Statement (No. 33-36057), as filed with the Commission on July 25, 1990 and incorporated herein by reference. 4.1 Specimen Stock Certificate filed as Exhibit 4.1 of Registrant's Exhibits to Form S-2 Registration Statement (No. 33-30297), as filed with the Commission on August 2, 1989 and incorporated herein by reference. 10.1 Lease - Banking Facility--filed as Exhibit 10.1 of Registrant's Exhibits to Amendment No. 1 to Form S-18 Registration Statement (No. 2-94390), as filed with the Commission on December 11, 1984 and incorporated herein by reference. 10.2* 1985 Stock Option Plan, filed as Exhibit 10.2 of Registrant's Exhibits to Form 10-K for the fiscal year ended December 31, 1993, as filed with the Commission on March 25, 1994 and incorporated herein by reference. 10.3 Form of incentive stock option agreement for use with 1985 Stock Option Plan filed--as Exhibit 4.4 of Registrant's Exhibits to Form S-8 Registration Statement (No. 33-36057), as filed with the Commission on July 25, 1990 and incorporated herein by reference. 10.4 Form of non-statutory stock option agreement or use with 1985 Stock Option Plan--incorporated herein by reference and filed as Exhibit 4.5 of Registrant's Exhibits to Form S-8 Registration Statement (No. 33-36057), as filed with the Commission on July 25, 1990. 10.5* 1986 Non-Qualified Stock Option Plan--filed as Exhibit 10.3 of Registrant's Exhibits to Form 10-K for the fiscal year ended December 31, 1986, as filed with the Commission on March 31, 1987 and incorporated herein by reference. 10.6 Form of non-qualified stock option agreement for use with 1986 Non-Qualified Stock Option Plan--filed as Exhibit 10.7 of Registrant's Exhibits to Form 10-K for the fiscal year ended December 31, 1986, as filed with the Commission on March 31, 1987 and incorporated herein by reference .
22
Sequentially Number Exhibit Numbered Page ------ ------- ------------- 10.7* 1989 Non-Qualified Stock Option Plan--filed as Exhibit 10.11 of Registrant's Form S-2 registration statement (No. 33-30297), filed with the Commission on August 2, 1989 and incorporated herein by reference. 10.8* Employment Agreement with C. Donald Allen dated July 1, 1990--filed as Exhibit 10.9 of Registrant's Exhibits to Form 10-K for the fiscal year ended December 31, 1990, as filed with the Commission on March 30, 1991 and incorporated herein by reference. 10.9* Cupertino National Bancorp Stock Purchase Plan--filed as Exhibit 10.10 of Registrant's Exhibits to Form 10-K for the fiscal year ended December 31, 1990, as filed with the Commission on March 30, 1991, and incorporated herein by reference. 10.10* Salary Continuation Agreement with C. Donald Allen dated August 1, 1993, filed as Exhibit 10.10 of Registrant's Exhibits to Form 10-K for the fiscal year ended December 31, 1993, as filed with the Commission on March 25, 1994, and incorporated herein by reference. 10.11* Salary Continuation Agreement with Scott Montgomery dated August 1, 1993, filed as Exhibit 10.11 of Registrants Exhibits to Form 10-K for the fiscal year ended December 31, 1993, as filed with the Commission on September 7, 1994, and incorporated herein by reference. 13.1 1994 Annual Report to Shareholders (to be deemed filed only to the extent required by the instructions to exhibits for Reports on Form 10-K) 22 Subsidiaries of the Registrant--filed as Exhibit 22.1 of Registrant's Exhibits to Form 10-K for the fiscal year ended December 31, 1985, as filed with the Commission on March 31, 1986 and incorporated herein by reference. 23.1 Independent Auditor's Consent - Coopers & Lybrand, L.L.P. 23.2 Independent Auditor's Consent - Deloitte & Touche, LLP 25.1 Power of Attorney. Reference is made to page 21 of this report. 27.0 Financial Data Schedule
_____ *A management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c). 23 EX-13.1 2 ANNUAL REPORT (MD&A/FIN) EXHIBIT 13.1 Cupertino National Bancorp Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Provision for Loan Losses The provision for loan losses is the annual cost of providing an allowance or reserve for future losses on loans. The loan loss provision amount for each year is dependent on many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in the Bank's market area. The Bank performs a monthly assessment of the risk inherent in its loan portfolio, as well as a review of each asset determined to have identified weaknesses. Based on this analysis, which includes reviewing historical loss trends, current economic conditions, industry concentrations and specific reviews of assets classified with identified weaknesses, the Bank allocates reserves to its loans and other risk asset portfolio. The reserve has specific allocations for credits where the probability of a loss can be defined and reasonably determined, while the balance of the reserve allocations are based on historical data, including delinquency trends, economic conditions in our market area, combined with industry loss averages. The provision for loan losses in 1994 was $1.6 million, compared to $1.7 million in 1993 and $.9 million in 1992. The increase in the loan loss provision in 1994 and 1993 when compared to 1992 continues to reflect the weakness in the economic conditions within the Bank's market area and the credit risk inherent in its loan portfolio. The Bank believes that adverse economic conditions in its market area have contributed to this trend. Other Income Total other income decreased to $3.1 million in 1994, compared to $3.2 million in 1993 and $1.7 million in 1992. The following table summarizes the sources of other income in:
(Dollars in thousands) 1994 1993 1992 --------------------------------------------------------------------- Gain on sale of mortgage loans $ 993 $1,525 $ 250 Gain on sale of SBA loans 685 435 337 Trust fees 593 494 462 Loan documentation fees, net 276 284 115 Depositor service fees 267 252 264 Gain on sale of investment securities -- -- 61 Other 265 164 175 ------------------------ Total $3,079 $3,154 $1,664 ------------------------
The largest portion of the decrease in other income is due to the mortgage banking business unit, which began operations in July 1992. The division generated $993,000 in gains on the sale of mortgage loans in 1994, compared to $1,525,000 in 1993, and $250,000 in 1992. The sharp rise in interest rates during 1994 had the largest impact on mortgage income, causing a reduction in the volume of refinancing and origination in the residential mortgage markets. In part to counteract a reduction in mortgage income due to a rise in interest rates in 1994, and expand into new, growing markets, the Bank opened a mortgage loan origination office in San Diego, California in June 1994. While this improved the Bank's loan funding capabilities, it did not offset the overall market decline. During the first two months of 1995, this decline continued and the Bank determined it was in the best interest of the shareholders to close the mortgage operations effective March 31, 1995. Loan documentation income, which represents the charge to clients for expenses incurred by the Bank to document and process loans, decreased slightly to $276,000 for 1994, as compared to $284,000 in 1993 and $115,000 in 1992. The decrease in loan documentation income in 1994 as compared to 1993, is primarily attributable to a reduction in the quantity of loan originations in 1994 as compared to 1993. Fees received by the Trust Department of the Bank increased to $593,000 in 1994, as compared to $494,000 in 1993 and $462,000 in 1992. The Trust Department had approximately $157 million in total assets at December 31, 1994, compared with approximately $118 million in 1993 and approximately $117 million in 1992. The fiduciary assets of the Trust Department at December 31, 1994, consisted of 50% in employee benefit plans, 26% in individual trusts, with custodial, court trusts and other similar arrangements providing the balance. Premiums recognized on the sale of SBA loans increased to $685,000 for 1994, as compared to $435,000 in 1993 and $337,000 in 1992. During 1994 the Bank's SBA division was granted Preferred Lender status by the Small Business Administration. This status should enhance the Bank's ability to increase its market share by improving loan application turnaround time. Service charges on depositor accounts remained stable with $267,000 in 1994, $252,000 in 1993 and $264,000 in 1992. Operating Expenses Operating expenses totaled $10.4 million for 1994, compared to $10.2 million for 1993, and $6.7 million for 1992. The ratio of operating expenses to average assets for these periods was 5.3%, 5.6%, and 4.2%, respectively. The following table represents the major components of operating expenses for the years ended December 31:
(Dollars in thousands) 1994 1993 1992 ----------------------------------------------------------------------------- Compensation and benefits $ 5,724 $ 5,014 $3,592 Occupancy and equipment 1,400 1,226 956 Professional services and legal costs 911 1,379 391 FDIC Insurance and regulatory assessments 485 414 341 Other real estate, net 48 288 (80) Other 1,500 1,425 1,030 ----------------------------- Total before client services 10,068 9,746 6,230 Client services 376 478 456 ----------------------------- Total $10,444 $10,224 $6,686 ----------------------------- Efficiency ratio before client services 71.10% 73.16% 59.06% ----------------------------- Efficiency ratio 73.75% 76.75% 63.39% ----------------------------- Total operating expenses to average assets 5.27% 5.58% 4.24% =============================
The efficiency ratio is computed by dividing total non-interest expenses by net interest income and other income. An increase in the ratio indicates that more resources are being allocated to generate the same (or greater) volume of income while a decrease would indicate a more efficient allocation of resources. The Company's efficiency ratio for the last half of 1994 was 67.42% as the Company continued to focus on controlling operating expenses. Compensation expenses increased in 1994 to $5.7 million compared to $5.0 million in 1993 and $3.6 million in 1992, primarily due to expanded operations, including the establishment of the Emerging Growth Industries division and the mortgage loan production office in San Diego, California. Occupancy and equipment expenses increased as a result of growth in staff, technological improvements in the Bank's computer system and the investment in the Emerging Growth Industries division and the mortgage loan production office in San Diego, California. Expenses for professional services, including legal, consulting and audit services, decreased to $911,000 in 1994, as compared to $1.4 million in 1993 and $391,000 in 1992. While the 1994 decrease was primarily due to a non-recurring legal settlement and related legal fees of $720,000 recorded in 1993, the increasing trend from 1992 to 1994 was caused by increased legal fees related to the loan collection and workout activity created in part by the continuing troubled economic conditions in California. Client service expenses decreased to $376,000 in 1994, compared to $478,000 in 1993 and $456,000 in 1992 as a result of a decrease in the volume of non- interest bearing demand deposits for which the Bank provides services. FDIC and OCC regulatory assessments increased to $485,000 in 1994, compared to $414,000 in 1993 and $341,000 in 1992 as a result of increased deposit growth. The FDIC assessment may decline in future years as the FDIC Bank Insurance Fund is estimated to be fully funded in late 1995. This could result in a significant reduction in FDIC assessment expense for the last quarter 1995 and in future years. Cupertino National Bancorp Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Other operating expenses increased by $75,000 in 1994 from 1993 primarily due to increased lending volume and general growth of the Bank. The $395,000 increase in other operating expense from 1992 to 1993 was due to increased costs related to the lending and mortgage banking operations. Income Taxes The Company's effective income tax rate for 1994 was 35.0%, compared to 37.5% in 1993 and 40.4% in 1992. The decrease in this rate is due primarily to the effect of the California Franchise Tax Enterprise Zone Credit recognized in 1994 and the impact of tax exempt municipal income in both 1994 and 1993 when compared to 1992. Financial Condition Assets Total assets increased to $223.1 million at December 31, 1994, an increase of 15.8% from the $192.6 million at December 31, 1993, which was an 11.6% increase from the $172.5 million one year earlier. The growth in 1994 assets is primarily centered in the investment portfolio combined with marginal growth in the loan portfolio. Loans Total loans, excluding loans held for sale, increased 5.4% to $134.0 million at December 31, 1994 compared to $127.1 million at December 31, 1993. Total loans increased 2.2% in 1993 from $124.3 million at year-end 1992. The Bank's loan portfolio is concentrated in commercial (primarily manufacturing, service and technology) and real estate lending. The Bank's lending is focused in the Santa Clara and San Mateo Counties. While no specific industry concentration is significant, the Bank's lending is concentrated in an area that is highly dependent on the technology industry and its supporting companies. Thus, the Bank's borrowers could be adversely impacted by a downturn in this sector of the economy and this could impact their ability to repay their loans. The following table presents the composition of the loan portfolio at the end of each of the last three years:
1994 1993 1992 ------------------ ----------------- ------------------ (Dollars in thousands) Amount % Amount % Amount % ------------------------------------------------------------------------------------------------ Commercial $ 81,695 60.2% $ 77,699 59.1% $ 73,523 57.9% Real estate construction & land 18,117 13.3 19,090 14.5 23,049 18.2 Real estate term 13.133 9.7 12,075 9.2 11,225 8.9 Consumer & other 21,059 15.5 18,214 13.8 16,551 13.1 ----------------------------------------------------------- Total 134,004 98.7 127,078 96.6 125,348 98.1 Deferred fees and discounts (847) (0.6) (923) (0.7) (693) (0.5) Allowance for loan losses (2,918) (2.1) (2,247) (1.7) (1,748) (1.4) ----------------------------------------------------------- Net loans 130,239 96.0 123,908 94.2 121,907 96.2 Loans held for sale 5,383 4.0 7,625 5.8 4,841 3.8 ----------------------------------------------------------- Total loans $135,622 100.0% $131,533 100.0% $126,748 100.0% ===========================================================
Credit Quality The Bank's objective is to limit the risk inherent in its loan portfolio through stringent loan policies and loan review procedures. The loan policy of the Bank is approved each year by its Board of Directors and is managed through periodic reviews of such policies in relation to current economic activity and the degree of risk (both credit and interest rate) in the current portfolio. A Director's Loan Committee supervises the lending activities of the Bank. This committee consists of four outside directors and the Chairman/CEO, the President/COO, the Executive Vice President/Senior Credit Officer (currently vacant), the Senior Vice President/Commercial Manager and the Vice President/Credit Administration. The officers in this group make up the Officer's Loan Committee. Loan requests exceeding individual officer approval limits are submitted to the Officer's Loan Committee, and those which exceed its limits are submitted to the Director's Loan Committee for final approval. The Bank has an active credit administration function which includes, in addition to internal reviews, the regular use of an outside loan review firm to review the quality of the loan portfolio. Senior management and the Director's Loan Committee review and monitor problem loans on a regular basis. Management generally places loans on non-accrual when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on non-accrual status, any interest, previously accrued but not collected is reversed from income. Loans are charged off when management determines that collection has become unlikely. Restructured loans are those where the Bank has granted a concession on the interest paid or original repayment terms due to financial difficulties of the borrower. Other real estate owned consists of real property acquired through foreclosure on the related collateral underlying defaulted loans. The following table summarizes non- accrual loans, loans past due 90 days and still accruing, restructured loans, and other real estate owned at December 31:
(Dollars in thousands) 1994 1993 1992 ------------------------------------------------------------------------------ Non-performing assets Non-accrual loans $ 3,244 $ 997 $ 513 Accruing loans past 90 days or more 1,371 1,903 -- Restructured loans -- -- -- Other real estate owned 375 618 3,717 ----------------------------- Total non-performing assets $ 4,990 $ 3,518 $4,230 ----------------------------- Ratio of the reserve for loan losses to total non-performing assets 58% 64% 41%
The following table details the Bank's classified assets for the years ended December 31:
(Dollars in thousands) 1994 1993 1992 ----------------------------------------------------------------------------- Classified assets: Loans Substandard $10,927 $ 9,885 $10,906 Doubtful 1,781 942 649 Loss -- -- -- ----------------------------- Total 12,708 10,827 11,555 OREO 375 618 3,717 ----------------------------- Total classified assets $13,083 $11,445 $15,272 ----------------------------- Ratio of classified assets to: Total assets 5.9% 5.9% 8.9% Total loans and OREO 9.4% 8.5% 11.5% Ratio of reserve for loan losses to classified assets 22.3% 19.6% 11.4% ============================
The increase in non-performing and classified assets reflects the continued lethargy in the Northern California economy. The increase is primarily related to a $2.3 million loan to one borrower ($1.7 million real estate secured). The Bank is aggressively pursuing collection of this loan. Cupertino National Bancorp Management's Discussion Analysis of Financial Condition and Results of Opertions (Continued)
The following table summarizes activity in the allowance for loan losses for the past three years. Summary of Loan Loss Experience (Dollars in thousands) Years ended December 31, 1994 1993 1992 ------------------------------------------------------------------------------------------------ Loans, net of unearned income: Average outstanding during period $127,264 $127,210 $114,780 ------------------------------- Allowance for loan losses: Balance at beginning of period $ 2,247 $ 1,748 $ 1,470 Charge-Offs: Commercial (748) (1,069) (520) Real estate - construction (123) -- (62) Real estate - term -- -- -- Consumer installment (141) (159) (145) ------------------------------- Total (1,012) (1,228) (727) ------------------------------- Recoveries: Commercial 57 -- 4 Real estate - construction -- -- 95 Real estate - term -- -- -- Consumer installment 6 48 4 ------------------------------- Total 63 48 103 ------------------------------- Net charge-offs (949) (1,180) (624) Provision charged to income 1,620 1,679 902 ------------------------------- Balance at end of period $ 2,918 $ 2,247 $ 1,748 ------------------------------- Net charge-offs to average loans outstanding during period .75% .93% .54% ------------------------------- Allowance as a percentage of loans 2.09% 1.67% 1.35% ===============================
Management considers changes in the size and character of the loan portfolio, changes in non-performing and past due loans, historical loan loss experience, and the existing and prospective economic conditions when determining the adequacy of the loan loss reserve. The allowance for loan loss increased at December 31, 1994 to 2.09% of outstanding loans compared to 1.67% at December 31, 1993 and 1.35% at December 31, 1992. The following table details the allocation of the reserve for loan losses:
Allocation of Loan Loss Reserve 1994 1993 1992 ---------------------- -------------------- --------------------- Percent of Percent of Percent of (Dollars in thousands) Amount Total Loans Amount Total Loans Amount Total Loans ---------------------------------------------------------------------------------------------------------------------- Commercial $1,846 60.2% $1,511 59.1% $1,216 58.0% Real estate - construction 180 13.3 308 14.5 263 18.2 Real estate - term 495 9.7 391 9.2 56 8.9 Consumer installment 245 15.5 10 13.8 190 13.1 Loans held for sale 14 4.0 27 5.8 23 3.8 Unallocated - deferred fees, commitments and loss reserves 138 (2.7) -- (2.4) -- (2.0) ----------------------------------------------------------------------- Total $2,918 100.0% $2,247 100.0% $1,748 100.0% =======================================================================
Although management believes that the allowance for loan losses is adequate, future provisions will be subject to continuing evaluations of the inherent risk in the portfolio. Further or continued downturns in the economy and other factors could make additional provisions necessary. Deposits Deposits reached $186.7 million at December 31, 1994, an increase of 6.3% as compared to deposits of $175.7 at December 31, 1993. Deposits in 1993 increased 12.2% from $156.6 million at December 31, 1992. Total average deposits increased 3.5% to $172.4 million for 1994, compared to an average of $166.6 for 1993. Average deposits in 1993 represented an increase of 16.9% over average deposits of $142.5 in 1992. The increase in deposits was primarily due to the continued marketing efforts directed at commercial business clients and continued growth in the Bank's regional offices in San Jose and Palo Alto. Non-interest bearing deposits were $53.9 million at December 31, 1994, compared to $62.8 million at December 31, 1993, and $62.3 million at December 31, 1992. On average, non-interest bearing deposits in 1994 were $50.4 million, compared to $55.7 million in 1993 and $45.4 million in 1992. The decrease in non-interest bearing deposits was due to a decline in title company balances, which were larger in 1993 due to the large volume of real estate financing activity during the favorable interest rate environment at that time. However, the Bank continues to focus on non-interest bearing deposits to help maintain its effective net interest yield. As its regional offices expand the Bank anticipates this funding source to remain stable. Money market and other interest-bearing demand accounts reached $82.0 million at year-end 1994, an increase of 21.3% from the prior year. The continued efforts by the Bank to market these low cost deposit products contributed significantly toward the continued growth. Time certificates of deposit of $100,000 or more, savings and other time deposits totaled $50.9 million or 27.3% of total deposits at December 31, 1994, compared to $45.4 million (25.8% of total deposits) at December 31, 1993, and $43.3 million (27.7% of total deposits) at December 31, 1992. Time certificates of deposit $100,000 or more, represented 13.7% of total deposits at December 31, 1994, compared with 17.8% and 16.8% at December 31, 1993 and 1992, respectively. Substantially all of the Bank's deposits originate in Cupertino, San Jose, Palo Alto and the surrounding communities in Santa Clara and San Mateo Counties. The Bank has one large deposit relationship with a local title company in which three directors of the Company serve as members of the board, and one of the directors has an ownership interest. Average monthly deposits from this client, including both non-interest and interest bearing demand accounts, averaged between $3.9 million and $12.6 million during 1994, compared to a range of $11.3 million and $19.0 million for 1993. The balance at December 31, 1994 was $4.6 million, compared to $14.7 million for December 31, 1993. Management believes that the loss of this client would not have a materially adverse effect on the Bank's liquidity, but might impact the Bank's net interest margin on a short-term basis. Liquidity Liquidity management is defined as the ability of a company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Bank's ability to meet the day-to-day cash flow requirements of the Bank's clients, who either wish to withdraw funds or require funds to meet their credit needs. Without proper liquidity management, the Bank would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. The primary function of asset and liability management is not only to assure adequate liquidity in order for the Bank to meet the needs of its client base, but to maintain an appropriate balance between interest-sensitive assets and liabilities so that the Bank can also meet the return on investment requirements of its shareholders. Daily monitoring of the sources and uses of funds is necessary to maintain an acceptable cash position that meets both requirements. Contingency plans exist and could be implemented on a timely basis to minimize any risk associated with dramatic changes in market conditions. An example of this is the Bank's $17 million in Fed Fund's purchase lines which provide back- up liquidity, $100 million in institutional deposit or brokered deposit lines and $60 million in reverse repurchase lines. All of these sources combine to provide a solid liquidity base for growth. The asset portion of the balance sheet provides liquidity primarily through loan principal repayments, maturities of investment securities and, to a lesser extent, sales of loans available for sale. Other short-term investments such as federal funds sold and maturing interest bearing deposits with other banks are additional sources of liquidity funding. The liability portion of the balance sheet provides liquidity through various clients' interest bearing and non- interest bearing deposit CUPERTINO NATIONAL BANCORP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) accounts. Federal funds purchased and other short term borrowings are additional sources of liquidity and basically represent the Company's incremental borrowing capacity. These sources of liquidity are short-term in nature and are used as necessary to fund asset growth and meet short-term liquidity needs. Interest Rate Risk Management Interest rate risk management is a function of the repricing characteristics of the Bank's portfolio of assets and liabilities. These repricing characteristics are subject to changes in interest rates either as replacement, repricing or maturity during the life of the instruments. Interest rate risk management focuses on the maturity structure of assets and liabilities and their repricing characteristics during periods of changes in market interest rates. Effective interest rate risk management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of interest rate movements on net interest income. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in the Bank's current portfolio that are subject to repricing at various time horizons: one day or immediate, two days to six months, seven to twelve months, one to three years, three to five years, over five years and on a cumulative basis. The differences are known as interest sensitivity gaps. The following table shows the Bank's interest sensitivity gaps for different intervals as of December 31, 1994:
INTEREST SENSITIVITY ANALYSIS Repricing Periods Greater Greater Than Than Greater Total Total Immediate 2 Days To Months 1 Year 3 Yrs Than Rate Non-Rate (Dollars in thousands) One Day 6 Months 7-12 to 3 Yrs to 5 Yrs 5 Yrs Sensitive Sensitive Total ----------------------------------------------------------------------------------------------------------------------------------- Assets: Cash and due from banks $ 9,326 $ 9,326 Short term investments $ 10,400 $10,400 10,400 Investment securities $ 4,328 $10,444 $13,966 $ 8,159 $22,675 59,572 934 60,506 Loans 119,246 2,332 624 5,331 3,680 3,376 134,589 4,501 130,090 Loan loss/unearned fees (3,765) (3,765) Other assets 7,282 7,282 --------------------------------------------------------------------------------------------------- Total assets 129,646 6,660 11,068 19,297 11,839 26,051 204,561 18,278 222,839 =================================================================================================== Liabilities and Equity: Deposits Demand 54,278 54,278 Now, MMDA, and savings 88,355 88,355 88,355 Time deposits 41,591 2,980 376 26 44,973 44,973 Other borrowed funds 17,256 17,256 17,256 Other liabilities 1,126 1,126 Shareholders' equity 16,851 16,851 --------------------------------------------------------------------------------------------------- Total liabilities and equity 105,611 41,591 2,980 376 26 150,584 72,255 222,839 =================================================================================================== Total asset GAP GAP $ 24,035 $(34,931) $ 8,088 $18,921 $11,813 $26,051 $53,977 $(53,977) $ -- Cumulative GAP $ 24,035 $(10,896) $ (2,808) $16,113 $27,926 $53,977 $53,977 $ -- $ -- Cumulative GAP/total assets 10.78% (4.89)% (1.26)% 7.23% 12.53% 24.22% 24.22% --% --%
Changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing of both the asset and its supporting liability can remain the same, thus impacting net interest income. This characteristic is referred to as a basis risk and, generally, relates to the repricing characteristics of short-term funding sources such as certificates of deposit. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities which are not reflected in the interest sensitivity analysis table. These prepayments may have significant effects on the Bank's net interest margin. Because of these factors an interest sensitivity gap report may not provide a complete assessment of the Bank's exposure to changes in interest rates. The Bank currently has a negative cumulative GAP position for periods up to one year, and a positive cumulative GAP thereafter. A positive cumulative GAP position would be expected to provide increased net interest income during periods of rising interest rates and would decrease net interest income during periods of falling rates. While the Company's current negative one year GAP portion would indicate net interest income should decrease during periods of rising interest rates, the actual impact would be an increase to net interest income. The primary reason this occurs is the lagging effect between the repricing characteristics of the Company's interest earning assets and interest bearing liabilities. In a simulation analysis on the impact of rising interest rates, the rates on the Company's interest bearing liabilities reprice at a slower pace than its assets, thus providing increased net interest income. This positive impact is aided by the currently high level of core deposit liabilities retained by the Bank. To maximize yield and increase its net interest income, the Company increased its portfolio of investment securities during the latter part of the second and early third quarter of 1994. These securities have an expected average life of 3 years to 5 years, and are being funded with short term liabilities, which created the negative GAP position, but allowed the Bank to improve its overall net interest income. To the extent rates continue to rise the positive impact of this strategy would decline, but is expected to be offset by the repricing of its assets, since the majority of the loan portfolio floats with the Prime Rate. Capital Resources Shareholders' equity at December 31, 1994 increased to $18.0 million, from $16.2 million at December 31, 1993, and $15.2 million at December 31, 1992. During 1994 the company paid a 5% stock dividend and a cash dividend of $.10 per share. The Company believes that a strong capital position is vital to the continued profitability of the Company, and promotes depositor and investor confidence, while providing a solid foundation for the future growth of the organization. The Company has provided the majority of its capital requirements through the retention of earnings. Under banking regulatory risk-based capital measures for banks and bank holding companies, a banking organization's reported balance sheet is converted to risk-based amounts by assigning each asset to a risk category, which is then multiplied by the risk weight for that category. Off-balance sheet exposures are converted to risk-based amounts through a two-step process. First, off-balance sheet assets and credit equivalent amounts (e.g., standby letters of credit) are multiplied by a credit conversion factor depending on the defined categorization of the particular item. Then the converted items are assigned to a risk category that weights items according to their relative risk. The total of the risk weighted on- and off-balance sheet amounts represents a banking organization's risk-adjusted assets for purposes of determining capital ratios under the risk- based guidelines. Risk-adjusted assets can either exceed or be less than reported assets, depending on the risk profile of the banking organization. A banking organization's total qualifying capital includes two components, core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core capital, which must comprise at least half of total capital, includes common stockholders' equity, qualifying perpetual preferred stock, and minority interests, less goodwill. Supplementary capital includes the allowance for loan losses (subject to certain limitations), other perpetual preferred stock, certain other capital instruments, and term subordinated debt. The Company's major capital components are stockholders' equity in core capital, and the allowance for loan losses in supplementary capital. At December 31, 1994, the minimum risk-based capital requirements were 4.0% for core capital, and 8.0% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (not-risk adjusted) for the preceding quarter. The minimum leverage ratio is 3.0% although banking organizations are expected to exceed that amount by 1.0% - 2.0% or more, depending on their circumstances. Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), the Federal Reserve Board, the Comptroller and the FDIC have adopted regulations, effective December 19, 1992, setting forth a five-tier scheme for measuring the capital adequacy of the financial institutions they supervise. The two highest levels recognized under these regulations are as follows: CUPERTINO NATIONAL BANCORP MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Tier 1 Risk-Based Total Risk-Based Leverage Capital Ratio Capital Ratio Ratio ---------------------------------------------------------------------------- Well-capitalized 6.0% 10.0% 5.0% Adequately capitalized 4.0% 8.0% 4.0%
At December 31, 1994, the Company's risk-based capital ratios were 10.8% for Tier 1 risk based capital and 12.1% for total risk-based capital, compared to December 31, 1993 ratios of 10.6% and 12.1% respectively. The Company's leverage ratio was 8.4% at December 31, 1994, and 8.4% at December 31, 1993. These ratios exceeded the well-capitalized guidelines shown above.
(Dollars in thousands) 1994 1993 1992 -------------------------------------------------------------------------------- Tier 1 capital: Shareholders' equity $ 18,037 $ 16,219 $ 15,174 -------------------------------- Tier 2 capital: Allowance for loan losses 2,918 2,247 1,748 -------------------------------- Allowable amount for Tier 2 Capital 2,082 2,298 2,168 -------------------------------- Total Risk Based Capital 20,119 18,466 16,922 -------------------------------- Risk-adjusted assets 166,552 153,177 144,514 -------------------------------- Total assets 223,144 192,574 172,526 -------------------------------- Tier 1 capital/risk adjusted assets: Company's capital ratio 10.8% 10.6% 10.5% Minimum regulatory requirement 4.0% 4.0% 4.0% Total Risk-based capital/risk adjusted assets: Company's capital ratio 12.1% 12.1% 11.7% Minimum regulatory requirement 8.0% 80% 8.0% Tier 1 capital/total assets: Company's leverage ratio 8.4% 8.4% 8.8% Minimum regulatory requirement 3.0% 3.0% 3.0% --------------------------------
BUSINESS RISKS Certain characteristics and dynamics of the Bank's business and of the financial markets may create risks to the Bank's long-term success and its financial results. These risks include: Geographic Concentration and Santa Clara Valley Economy -- All of the Bank's operations are located in Santa Clara County in Northern California. As a result of this geographic concentration, the Bank's results of operations depend largely upon local economic conditions, which have been relatively volatile in recent years. Accordingly, there can be no assurance that the Bank's existing and prospective customers will be responsive to, or have the need for, the services offered by the Bank. Further, no assurance can be given that the Bank will not be adversely affected if the economic downturn persists or if economic conditions otherwise worsen. Key Employees; Recent Changes in Management -- The Bank's future performance is substantially dependent upon its ability to attract and retain qualified personnel. Since January 1, 1994, several members of senior management have left the Bank, including its President, its Executive Vice President of Technology Lending, and two Chief Credit Officers. While the loss of the services of key employees could have a material adverse effect upon the Bank, the losses to date have not had a material adverse impact on the Bank's operations or financial condition. The competition for key employees is intense and there is no assurance that the Bank will be able to retain its existing personnel or attract, retain and motivate additional qualified personnel in the future. However, the Bank believes it provides a quality work environment and competitive benefits package for its employees, as well as providing excellent opportunities for professional growth for all of its personnel. Accordingly, the Bank believes these factors will continue to allow it to attract qualified personnel. Government Regulation and Recent Legislation -- The Bank and its operations are subject to extensive state and federal supervision, regulation and legislation. The turmoil in the savings and loan industry has spawned significant new legislation, and increased regulatory scrutiny of lending practices, among other changes. These trends frequently affect the Bank in ways that increases the Bank's cost of doing business. The Bank cannot predict the precise impact of recent legislation, nor the probable course or impact of future legislation or regulatory actions affecting the financial services industry. Effects of Inflation-- The impact of inflation on a financial institution differs significantly from that exerted on an industrial concern, primarily because its assets and liabilities consist largely of monetary items. The most direct effect of inflation is higher interest rates. However, the Bank's earnings are affected by the spread between the yield on earning assets and rates paid on interest-bearing liabilities rather than the absolute level of interest rates. Additionally, there may be some upward pressure on the Company's operating expenses, such as adjustments in staff expense and occupancy expense, based upon consumer price indexes. In the opinion of management, inflation has not had a material effect on the consolidated results of operations. Pending Litigation -- The Bank is involved in a lawsuit in which the plaintiff alleges the Bank and one of its officers were negligent in the performance of their duties as trustee. The suit seeks monetary damages of approximately $2.2 million. After consultation with counsel, the Bank believes that it has defenses to the claims; however, litigation is subject to inherent uncertainties and accordingly, no assurance can be given that Sumitomo's claim will be decided in favor of the Bank. In any event, the Bank believes that any liability that could arise from the alleged claim would not have a material adverse effect on the financial statements of the Bank. Potential Combination -- As previously announced, the Bank is engaged in preliminary discussions with South Valley Bancorporation regarding a potential business combination. Given the preliminary nature of the discussion, there is no assurance that such a transaction will be consummated or that, if consummated, such transaction will benefit shareholders. Such a transaction, if any, would be subject to the execution of definitive agreements by the parties and any required regulatory and shareholder and other corporate approvals. In May 1993, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS') No. 114 "Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114") which was subsequently amended by SFAS No. 118. Under the provisions of SFAS No. 114, a loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreements. SFAS No. 114 requires creditors to measure impairment of a loan based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral ("the value"). If the value of the impaired loan is less than the recorded investment in the loan, a creditor shall recognize the impairment by creating a valuation allowance with a corresponding charge to bad debt expense. This statement also applies to restructured loans and loans previously accounted for as in-substance foreclosures. SFAS No. 114 and SFAS No. 118 apply to financial statements for fiscal years beginning after December 15, 1994. Earlier implementation is permitted. The Bank does not expect a material impact on its financial statements from adopting SFAS No. 114 and SFAS No 118. Stock Activity -- The common stock of the Company is traded on the NASDAQ National Market System under the symbol CUNB. There were 403 holders of record of the Company's common stock at December 31, 1994. The following table presents the high and low prices of the Company's common stock, as reported on the NASDAQ National Market System during 1994, 1993 and 1992, adjusted for the effect of stock dividends:
1994 1993 1992 -------------- -------------- ------------- High Low High Low High Low ------------------------------------------------------------- Quarter: First $10.00 $8.81 $10.80 $7.56 $7.89 $6.70 Second $10.38 $9.00 $10.80 $9.07 $8.42 $6.70 Third $10.00 $9.00 $10.89 $9.52 $8.53 $7.56 Fourth $10.00 $8.75 $10.80 $8.57 $8.42 $7.34
On November 30, 1994, the Company paid a $.10 per share dividend to its shareholders. The Company anticipates continuing to pay cash dividends on a semi-annual basis to the shareholders of the Company. Cupertino National Bancorp CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands) December 31, 1994 1993 ------------------------------------------------------------------------------------------------------------ Assets: Cash and due from banks $ 9,326 $ 10,550 Federal funds sold 10,400 3,800 ------------------------------------- Cash and cash equivalents 19,726 14,350 Other short-term investments (cost approximates market) -- 3,097 Investment securities 60,506 36,342 Loans, net 130,239 123,908 Loans held for sale 5,383 7,625 ------------------------------------- Total loans, net 135,622 131,533 Premises and equipment, net 1,434 1,408 Other real estate owned 375 618 Interest receivables and other assets 5,481 5,226 ------------------------------------- Total $223,144 $192,574 ===================================== Liabilities and Shareholders' Equity: Deposits: Demand, non-interest-bearing $53,880 $ 62,751 NOW 8,331 6,769 Money Market Demand Accounts 73,623 60,803 Savings 5,951 6,343 Other time certificates 19,417 7,799 Time certificates, $100 and over 25,520 31,275 ------------------------------------ Total deposits 186,722 175,740 Other borrowings 17,256 -- Other liabilities 1,129 615 ------------------------------------ Total liabilities 205,107 176,355 Commitments (Note 12) Shareholders' Equity: Preferred stock, no par value: 4,000,000 shares authorized; none issued -- -- Common stock, no par value: 6,000,000 shares authorized;sharesoutstanding: 1,557,008 in 1994 and 1,401,826 in 1993 14,901 13,582 Retained earnings 3,136 2,637 -------------------------------------- Total shareholders' equity 18,037 16,219 -------------------------------------- Total $223,144 $192,574 ======================================
See notes to consolidated financial statements. Cupertino National Bancorp Consolidated Statements of Operations
(Dollars in thousands, except per share amounts) For the years ended December 31, 1994 1993 1992 ---------------------------------------------------------------------------------------------------------------------- Interest Income: Interest on loans $12,608 $ 11,895 $ 11,150 Interest on investment securities: Taxable 2,451 830 622 Non-taxable 94 145 204 ------------------------------- Total investment securities 2,545 975 826 Other interest income 208 463 450 ------------------------------- Total interest income 15,361 13,333 12,426 ------------------------------- Interest Expense: Interest on deposits 3,897 3,156 3,540 Interest on short-term borrowings 382 10 2 ------------------------------- Total interest expense 4,279 3,166 3,542 ------------------------------- Net interest income 11,082 10,167 8,884 Provision for loan losses 1,620 1,679 902 ------------------------------- Net interest income after provision for loan losses 9,462 8,488 7,982 ------------------------------- Other Income: Gain on sale of mortgage loans 993 1,525 250 Gain on sale of SBA loans 685 435 337 Trust fees 593 494 462 Loan documentation fees, net 276 284 115 Depositor service fees 267 252 264 Gain on sale of investment securities -- -- 61 Other 265 164 175 ------------------------------- Total other income 3,079 3,154 1,664 ------------------------------- Operating Expenses: Compensation and benefits 5,724 5,014 3,592 Occupancy and equipment 1,400 1,226 956 Professional services and legal costs 911 1,379 391 FDIC insurance and regulatory assessments 485 414 341 Client services 376 478 456 Other real estate, net 48 288 (80) Other 1,500 1,425 1,030 ------------------------------- Total operating expenses 10,444 10,224 6,686 ------------------------------- Income before income tax expense 2,097 1,418 2,960 Income tax expense 734 538 1,197 ------------------------------- Net income $ 1,363 $ 880 $ 1,763 =============================== Net income per common and common equivalent share $ 0.84 $ 0.55 $ 1.16 ===============================
See notes to consolidated financial statements. CUPERTINO NATIONAL BANCORP Consolidated Statements of Shareholders' Equity
Common Stock For the years ended December 31, 1994, 1993 and 1992 ------------------------------ Retained Shareholders' (Dollars in thousands) Shares Amount earnings equity ------------------------------------------------------------------------------------------------------------------------------------ Balance, January 1, 1992 1,115,819 $ 10,814 $ 2,497 $ 13,311 Stock options exercised 12,354 68 -- 68 Stock issued in Employee Stock Purchase Plan 4,716 36 -- 36 Two 5% stock dividends -- fractional shares paid in cash 115,357 1,066 (1,070) (4) Net income -- -- 1,763 1,763 -------------------------------------------------------------- Balance, December 31, 1992 1,248,246 11,984 3,190 15,174 Stock options exercised 16,472 106 -- 106 Stock issued in Employee Stock Purchase Plan 7,604 63 -- 63 Two 5% stock dividends -- fractional shares paid in cash 129,504 1,429 (1,433) (4) Net income -- -- 880 880 --------------------------------------------------------------- Balance, December 31, 1993 1,401,826 13,582 2,637 16,219 Stock options exercised 74,468 543 -- 543 Stock issued in Employee Stock Purchase Plan 8,238 69 -- 69 One 5% stock dividend -- fractional shares paid in cash 72,476 707 (708) (1) Cash dividend $.10 per share -- -- (156) (156) Net income -- -- 1,363 1,363 --------------------------------------------------------------- Balance, December 31, 1994 1,557,008 $ 14,901 $ 3,136 $ 18,037 ==============================================================
See notes to consolidated financial statements. Cupertino National Bancorp Consolidated Statements of Cash Flows
(Dollars in thousands) For the years ended December 31, 1994 1993 1992 ----------------------------------------------------------------------------------------------------------- Cash Flows - Operating Activities: Net income $ 1,363 $ 880 $ 1,763 Reconciliation of net income to net cash from operations: Provision for loan losses 1,620 1,679 902 Depreciation and leasehold amortization 490 477 334 Deferred income taxes 128 (246) (81) Accrued interest receivable and other assets (255) (627) (394) Accrued interest payable and other liabilities 514 (187) (19) Deferred loan fees (76) 229 204 Gain on sale of investment securities -- -- 61 Proceeds from sales of loans held for sale 125,342 152,982 26,208 Origination of loans for resale (123,100) (151,518) (30,462) Other real estate owned, net 48 221 (80) ---------------------------------------- Operating cash flows, net 6,074 3,890 (1,564) ---------------------------------------- Cash Flows - Investing Activities: Sales of investment securies -- -- 1,670 Maturities of investment securities and other short-term investments 12,983 31,125 22,434 Purchase of investments securities and other short-term investments (34,050) (42,983) (38,584) Loans, net (8,250) (8,157) (23,632) Investment in other real estate owned -- (219) (1,057) Sale of other real estate owned 576 3,097 893 Premises and equipment (516) (850) (498) Purchase of life insurance policies -- (2,175) -- Other, net 21 -- -- ---------------------------------------- Investing cash flows, net (29,236) (20,162) (38,774) ---------------------------------------- Cash Flows - Financing Activities: Net change in non-interest-bearing deposits (8,871) 458 19,473 Net change in interest-bearing deposits 19,853 18,732 13,102 Net change in short-term borrowings 17,256 -- (2,500) Stock issued 457 169 104 Payment of stock dividend fractional shares (1) (4) (4) Cash dividend (156) -- -- ---------------------------------------- Financing cash flows, net 28,538 19,355 30,175 ---------------------------------------- Net increase (decrease) in cash and cash equivalents 5,376 3,083 (10,163) Cash and cash equivalents at beginning of year 14,350 11,267 21,430 ---------------------------------------- Cash and cash equivalents at end of year $ 19,726 $ 14,350 $ 11,267 ======================================== Cash flows - supplemental disclosures: Cash paid during the period for: Interest on deposits and other borrowings $ 4,148 $ 3,181 $ 3,679 Income taxes 535 722 1,171 Non-cash transactions: Additions to other real estate owned 375 -- 2,913 ========================================
See notes to consolidated financial statements. Cupertino National Bancorp Notes to Consolidated Financial Statements NOTE I - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation -- The consolidated financial statements include the accounts of Cupertino National Bancorp ('CUNB or the Company') and its subsidiary Cupertino National Bank & Trust ("CNB or the Bank"). CUNB is the holding company of CNB. All significant intercompany transactions and balances have been eliminated. Certain reclassifications have been made to prior years' consolidated financial statements to conform to the 1994 presentation. Cash and Cash Equivalents -- For purposes of cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. CNB is required by the Federal Reserve System to maintain non-interest earning cash reserves against certain of its transaction accounts. At December 31, 1994 the required reserves totaled $982,000. Investment Securities -- In accordance with Statement of Financial Accounting Standard No. 115, ("SFAS 115") "Accounting for Certain Investments in Debt and Equity Securities" which was adopted by the Company on January 1, 1994, all investment securities are classified as held-to-maturity because management has the positive intent and ability to hold all of the debt securities until maturity. Accordingly, these securities are carried at their remaining unpaid principal balances, net of unamortized and discounts are accredited using the level yield method over the estimated remaining term of the underlying security. Prior to the adoption of SFAS No. 115, all investment securities were considered held for investment because the Company had the ability and management had the intent to hold these securities to maturity. Accordingly, these securities were carried at amortized cost. Loans -- Interest on loans is credited to income as earned and is accrued only if deemed collectible. Accrued interest is generally reversed against current income on loans over 90 days contractually delinquent and on other loans which have developed inherent problems prior to being 90 days delinquent. The Bank charges fees for originating loans, which are recognized as an adjustment of the loan yield over the life of the loan by a method approximating the effective interest method. Direct costs of originating the loan are capitalized and recognized over the life of the loan as a reduction of the yield. When a loan is sold, unamortized fees and capitalized direct costs are recognized in the statement of operations. Other loan fees and charges representing service costs for the repayment of loans, for delinquent payments or for miscellaneous loan services are recognized when collected. Other Real Estate Owned -- Real estate acquired through foreclosure is carried at the lower of cost, or fair value less anticipated cost of disposition. Subsequent decreases in fair value are recognized as charges to expense and the net costs of maintaining and operating foreclosed properties are expensed as incurred. Premises and Equipment -- Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the lesser of the lease terms or estimated useful lives of the assets, which are generally 3 to 10 years. Income Taxes -- Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes," was adopted by CUNB on a prospective basis, effective January 1, 1993. Under SFAS 109 the Company changed from the deferred method to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates to the differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Under SFAS 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Allowance for Loan Losses -- The allowance for loan losses is maintained at a level deemed appropriate by Management to adequately provide for known and unidentified losses in the loan portfolio. The allowance is based upon a number of factors, including prevailing and anticipated economic trends, industry experience, industry and geographic concentrations, estimated collateral values, management's assessment of credit risk on known and unidentified losses in the loam portfolio, delinquency trends, historical loss experience, CNB's underwriting practices and other relevant factors. Additions to the allowance, in the form of provisions are reflected in current operations, while charge-offs to the allowance are made when a loss is determined to have occurred. Income Per Share -- Income per share, adjusted for stock dividends, is based on weighted average common and common equivalent shares outstanding of 1,628,500 in 1994, 1,587,000 in 1993 and 1,510,700 in 1992. Sales and Servicing of Small Business Administration (SBA) Loans -- The Company originates loans to customers under SBA programs that generally provide for SBA guarantees of 70% to 90% of each loan. The Company generally sells the guaranteed portion of each loan to an investor and retains the unguaranteed portion in its own portfolio. Gains on these sales are earned through the sale of the guaranteed portion of the loan for an amount in excess of the adjusted carrying value of the portion of the loan sold. The Company allocates the carrying value of such loans between the portion sold, the portion retained and a value assigned to the right to service the loan. The difference between the adjusted carrying value of the portion retained and the face amount of the portion retained is amortized to interest income over the life of the related loan using a method which approximates the interest method. The value assigned to the right to service is also amortized over the estimated life of the loan. Loan Sales -- In addition to SBA loans, the Company originates real estate loans for sale and sells participations in other commercial loans. All loans held for sale are carried at the lower of aggregate cost or market. The Company recognizes gains or losses upon the sale of loans and participating interest in loans. The gain or loss is based on consideration received, unpaid loan balances, contractual interest rates, imputed loan servicing fees, estimated remaining life of the loans and stipulated interest to be paid to the purchaser. Any resulting deferred premium or discount is included in other assets and amortized into operations over the estimated remaining life of the loans sold using a method which approximates the interest method. The value assigned to the right to service the loans is also amortized over the estimated life of the loans. NOTE 2 - CASH EQUIVALENTS AND INVESTMENT SECURITIES U.S. Government and agency obligations, municipal securities and other securities are summarized as follows:
(Dollars in thousands) December 31, 1994 Book Value Unrealized Gains Unrealized Losses Market Value ------------------------------------------------------------------------------------------------------------------------------- U.S. Treasury obligations $10,420 $-- $ 115 $10,305 U.S. Agency obligations: Mortgage-backed obligations 8,989 -- 415 8,574 Fixed and variable rate notes 34,348 3 1,563 32,788 State and political subdivisions 1,482 4 2 1,484 Other mortgage-backed obligations 4,334 -- 228 4,106 ---------------------------------------------------------------- Total securities held to maturity 59,573 7 2,323 57,257 ---------------------------------------------------------------- Other securities Federal Reserve Bank stock 230 -- -- 230 Federal Home Loan Bank stock 703 -- -- 703 ---------------------------------------------------------------- Total other securities 933 -- -- 933 ---------------------------------------------------------------- Total securities $60,506 $ 7 $2,323 $58,190 ================================================================ Weighted average yield /(1)/ 6.0% ---------------------------------------------------------------- December 31, 1993 U.S. Treasury obligations $12,031 $11 $ 10 $12,032 U.S. Agency obligations - fixed and variable rate notes 21,035 43 74 21,004 State and political subdivisions 2,374 43 -- 2,417 Other mortgage-backed obligations -- -- -- -- Federal Reserve Bank stock 230 -- -- 230 Federal Home Loan Bank stock 672 -- -- 672 ---------------------------------------------------------------- Total securities held for investment $36,342 $97 $ 84 $36,355 ---------------------------------------------------------------- Weighted average yield /(1)/ 3.9% ================================================================
/(1)/ Yield includes unadjusted tax exempt obligations. The tax equivalent yield was 6.1% and 4.1% as of December 31, 1994 and 1993, respectively. Cupertino National Bancorp Notes to Consolidated Financial Statements (Continued) Securities with a carrying value of $24,868,000 and $11,935,000 at December 31, 1994 and 1993, respectively were pledged to secure public deposits and for other purposes required by law or contract. The following table shows book value and estimated market value of the Company's investment securities by maturities at December 31, 1994 (yields on tax-exempt obligations have not been adjusted to a tax equivalent basis).
1996 2000 2005 and (Dollars in thousands) 1995 through 1999 through 2005 Thereafter --------------------------------------------------------------------------------------------------------- U.S. Treasury obligations $ 7,457 $ 2,963 $ 0 $ 0 U.S. Agency obligations Mortgage-Backed obligations /(1)/ -- 111 2,851 6,027 Fixed and variable rate notes /(2)/ 5,833 19,050 6,472 2,993 State and Political Subdivisions 1,482 -- -- -- Other Mortgage-Backed obligations /(1)/ -- -- -- 4,334 ----------------------------------------------------- Total investment securities (held to maturity) 14,772 22,124 9,323 13,354 ----------------------------------------------------- Other securities Federal Reserve Bank stock 230 -- -- -- Federal Home Loan Bank stock 703 -- -- -- ----------------------------------------------------- Total other securities 933 0 0 0 ----------------------------------------------------- Total securities $15,705 $22,124 $9,323 $13,354 ----------------------------------------------------- Market value 15,524 21,040 8,860 12,766 ----------------------------------------------------- Weighted average yield 4.5% 5.3% 7.4% 7.8% =====================================================
(1) Mortgage-backed securities are shown at contractual maturity, however the average life of these Mortgage-backed securities may be much less due to principal prepayments. (2) Certain U.S. Agency fixed and variable rate note obligations may be called, without penalty, at the discretion of the issuer. This may cause the actual maturities to differ significantly from the contractual maturity dates. Federal Reserve Bank Stock and Federal Home Loan Bank Stock are investments required to be maintained in the Federal Reserve Bank and Federal Home Loan Bank to maintain membership and support activity levels. NOTE 3 - LOANS The following is a summary of loans by category as of December 31:
(Dollars in thousands) 1994 1993 --------------------------------------------------------------- Commercial $ 81,695 $ 77,699 Real estate construction and land 18,117 19,090 Real estate term 13,133 12,075 Consumer and other 21,059 18,214 ------------------- Total 134,004 127,078 Less deferred loan fees and discounts 847 923 Less allowance for loan losses 2,918 2,247 ------------------- Total loans, net 130,239 123,908 Loans held for sale 5,383 7,625 ------------------- Total loans $135,622 $131,533 ===================
SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" which was subsequently amended by SFAS No. 118, effective for years beginning after December 15, 1994, requires creditors to account for loans that are impaired (loans where the creditor does not anticipate receiving all amounts due according to the contractual term of the loan agreement) based primarily on the present value of expected future cash flows discounted at the effective loan rate or the fair value of the underlying collateral. The Bank does not expect a material impact on its financial statements from adopting SFAS No. 114 and SFAS No. 118. The Bank's service area has a concentration of high technology companies, and accordingly, the ability of any of the Bank's borrower to repay loans may be affected by the performance of this sector of the economy. Virtually all loans are collateralized. Generally, real estate loans are secured by real property, and commercial and other loans are secured by bank deposits and business or personal assets. Repayment is generally expected from the sale of the related property for real estate construction loans and from the cash flow of the borrower for commercial and other loans. As discussed in Note 1, the Company originates loans guaranteed by the U. S. Small Business Administration (SBA). The Company sells to outside investors, usually at a price in excess of par, the guaranteed portion of these loans and retains the remaining unguaranteed portion in its loan portfolio. When the Company sells the guaranteed portion of such loans, it transfers the SBA guarantee to the buyer and retains the servicing function. At December 31, 1994 and 1993, the Company serviced $23,339,122 and $15,633,230 in SBA loans, respecively. In addition, the Company retained an interest in loans guaranteed by the SBA in the amounts of $4,783,053, and $3,234,929, respectively, for 1994 and 1993. The Company and the SBA would share in any losses on these loans on a pro rata basis. NOTE 4 - ALLOWANCE FOR LOAN LOSSES The following summarizes the activity in the allowance for loan losses for the years ended December 31:
(Dollars in thousands) 1994 1993 1992 ------------------------------------------------------------- Balance January 1 $2,247 $1,748 $1,470 Loans charged off (1,012) (1,228) (727) Recoveries 63 48 103 Provision for loan losses 1,620 1,679 902 ------------------------- Balance December 31 $2,918 $2,247 $1,748 =========================
The following table sets forth non-performing loans as of December 31, 1994, 1993 and 1992. Non-performing loans are defined as loans which are on non- accrual status, loans which have been restructured, and loans which are 90 days past due but are still accruing interest. Interest income foregone on the following non-performing loans totaled $275,000, $129,000 and $23,000 for the years ended December 31, 1994, 1993 and 1992, respectively. Interest income recognized on the non-performing loans approximated $50,000, $25,000 and $25,000 for the years ended December 31, 1994, 1993 and 1992, respectively .
(Dollars in thousands) 1994 1993 1992 ------------------------------------------------------------------------- Non-accrual loans $3,244 $ 997 $513 Accruing loans past due 90 days or more 1,371 1,903 -- Restructured loans -- -- -- ------------------------------ Total 4,615 $2,900 $513 ==============================
CUPERTINO NATIONAL BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5 - OTHER REAL ESTATE OWNED Other real estate owned consists of the following at December 31:
(Dollars in thousands) 1994 1993 ------------------------------------------------------------------------------ Real estate acquired through foreclosure $ 375 $ 780 Allowance for estimated losses -- (162) ----------------- Total $ 375 $ 618 =================
The following summarizes other real estate operations for the years ended December 31:
(Dollars in thousands) 1994 1993 1992 ------------------------------------------------------------------------------ Income (loss) from: Real estate operations, net $ (6) $ 10 $ 170 Provision for estimated losses (42) (231) (90) -------------------------- Real estate owned, net (48) $ (221) $ 80 ==========================
NOTE 6 - PREMISES AND EQUIPMENT Premises and equipment at December 31, are comprised of the following:
(Dollars in thousands) 1994 1993 ------------------------------------------------------------------------------ Leasehold improvements $ 993 $ 889 Furniture and equipment 2,463 2,050 Automobiles 140 141 ------------------ Total 3,596 3,080 Accumulated depreciation and amortization (2,162) (1,672) ------------------- Premises and equipment, net $ 1,434 $ 1,408 ==================
NOTE 7 - SHORT TERM BORROWINGS Short term borrowings are detailed as follows (in thousands):
December 31 1994 1993 1992 ------------------------------------------------------------------------------ Federal funds purchased Balance at December 31 $ 7,000 $ -- $ -- Average balance 1,800 277 55 Maximum amount outstanding at any month end 12,000 -- -- Average interest rate: During the year 4.18% 3.56% 3.68% At December 31 6.50% -- -- Securities sold under agreements to repurchase Balance at December 31 $10,256 -- -- Average balance 5,908 -- -- Maximum amount outstanding at any month end 24,153 -- -- Average interest rate: During the year 5.13% -- -- At December 31 6.29% -- --
Federal funds purchased generally mature the day following the date of purchase while securities sold under agreements to repurchase generally mature within 30 days from the various dates of sale. The Bank has unused Federal Funds Purchased lines of $10 million at December 31, 1994. NOTE 8 - INCOME TAXES Income tax expense was comprised of the following for the years ended December 31:
(Dollars in thousands) 1994 1993 1992 ------------------------------------------------------------- Current: Federal $ 518 $ 539 $ 890 State 88 245 388 ----------------------- Total current expense 606 784 1,278 ----------------------- Deferred: Federal 125 (148) (25) State 3 (98) (56) ----------------------- Total deferred expense (benefit) 128 (246) (81) ----------------------- Total expense $ 734 $ 538 $1,197 =======================
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Significant components on the Company's deferred income tax assets (liabilities) as of December 31, 1994 and 1993 are as follows:
(Dollars in thousands) 1994 1993 ------------------------------------------- Loan loss reserves $ 904 $ 768 OREO valuation -- 78 Deferred compensation 48 65 State income taxes 243 19 Other (124) 13 --------------- Deferred tax asset $1,071 $ 943 ===============
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes" on a prospective basis effective January 1, 1993. This standard supersedes Accounting Principles Board Opinion (APB) No.11 which was previously used by the Company to account for income taxes. There was no cumulative effect on the Company's 1993 financial statements of adopting SFAS No. 109. Due to the availability of net operating loss carrybacks, no valuation allowance under SFAS No. 109 has been provided in 1994 and 1993. For the year ended December 31, 1992, the Company accounted for income taxes in accordance with APB No. 11. The components of the deferred tax expense (benefit), which results from differences in the recognition of certain items for tax and financial reporting purposes, were as follows: Cupertino National Bancorp Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands) 1994 1993 1992 ---------------------------------------------------------------------------- Provision for loan losses $ 136 $ (97) $(116) Cash basis income tax reporting -- (12) 19 State income taxes 224 93 (6) Other (232) (230) 22 ----- ----- ----- Total deferred expense (benefit) $ 128 $(246) $ (81) ===== ===== =====
A reconciliation from the statutory income tax rate to be consolidated effective income tax rate follows, for the years ended December 31:
1994 1993 1992 -------------------------------------------------------------------------------- Statutory federal income tax rate 35.0% 35.0% 34.0% California franchise tax expense, net of federal income tax benefit 2.9 6.9 7.4 Exempt income (4.1) (3.2) (2.1) Other, net 1.2 (1.2) 1.1 ----- ---- ---- Effective income tax rate 35.0% 37.5% 40.4% ===== ==== ====
NOTE 9 - OTHER OPERATING EXPENSES The major components of other noninterest expense are as follows for the years ended December 31:
(Dollars in thousands) 1994 1993 1992 ----------------------------------------------------------------------------- Supplies $ 197 $ 153 $ 99 Telephone 163 113 76 Director fees 145 142 113 Insurance 144 137 54 Correspondent bank charges 118 106 87 Advertising 87 88 83 Other 646 686 518 ------ ------ ------ Total $1,500 $1,425 $1,030 ====== ====== ======
NOTE 10 - EMPLOYEE BENEFIT PLANS The Company has stock option plans under which incentive and non-statutory stock options may be granted to employees and directors to purchase up to 346,802 shares of common stock at prices not less than the fair market value of such stock at the date the options are granted. Options generally expire 10 years after the date of grant and generally become exercisable in annual installments of 20 percent to 33 percent. As of December 31, 1994 options for 235,661 shares were exercisable and options for 28,550 shares were available for future grant. Additional stock option information follows:
Options outstanding Number of shares Option price per share --------------------------------------------------------------------------- Balance, January 1, 1992 338,500 $3.98 - $ 8.10 Granted 24,245 6.66 - 8.02 Exercised (15,494) 3.98 - 5.50 Canceled (4,173) 5.50 - 8.10 ------------------------------------ Balance, December 31,1992 343,078 $4.24 - $ 8.10 Granted 12,806 7.99 - 10.65 Exercised (18,781) 4.54 - 8.10 Canceled (6,707) 7.60 - 8.10 ------------------------------------- Balance, December 31,1993 330,396 $4.24 - $10.65 Granted 75,465 8.81 - 10.00 Exercised (76,888) 4.67 - 8.50 Canceled (10,721) 4.46 - 9.88 ------------------------------------- Balance, December 31, 1994 318,252 $4.25 - $10.66 =====================================
Adjusted for stock dividends in 1994, 1993 and 1992 The Company has a 401(k) tax deferred savings plan under which eligible employees may elect to defer a portion of their salary as a contribution to the plan. The Company matches the employee contributions at a rate set by the Board of Directors (currently 50% of the first 6% of deferral of an individual's salary). The matching contribution vests ratably over the first three years of employment. The Company contributed $72,500 to the plan in 1994, $67,000 in 1993 and $52,000 in 1992. The Company has established an Employee Stock Purchase Plan under section 423(b) of the tax code which allows eligible employees to set aside up to 10% of their compensation toward the purchase of the Company's stock. Under the plan, the purchase price is 85% of the lower of the fair market value at the beginning or end of each three month offering period. During 1994, employees purchased 8,238 shares of common stock for an aggregate purchase price of $69,000 compared to the purchase of 7,604 shares of common stock for an aggregate purchase price of $63,000 in 1993. At December 31, 1994, 15,486 shares were reserved for future issuance under the plan. NOTE 11 - RELATED PARTY TRANSACTIONS Loans are made to executive officers, directors and their affiliates, subject to approval by the Directors' Loan Committee and the Board of Directors. An analysis of total loans to related parties for the year ended December 31, 1994 is shown below:
(Dollars in Thousands) --------------------------------------------------------------------------- Balance, January 1, 1994 $ 2,435 Additions 2,519 Repayment (1,967) ------------------------------------- Balance December 31, 1994 $ 2,987 =====================================
Three of the Company's directors are also directors (one of whom is the principal shareholder) of a title company which has a deposit relationship with the Bank. Average monthly deposits from this title company ranged between $ 3.9 million and $ 12.6 million for the year. At December 31, 1994 the deposit balance from this title company was $ 4.6 million. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES The Company leases the facilities from which it operates all of its activities. Future minimum lease commitments under all non-cancelable operating leases are as follows:
(Dollars in Thousands) 1994 ---------------------------------- 1995 $ 666 1996 654 1997 665 1998 644 1999 608 1,614 ------ Total $4,851 ======
Total rent expense was approximately $589,000, $475,000 and $393,000, for 1994, 1993, and 1992, respectively. In the normal course of business, various commitments and contingent liabilities are outstanding, such as guarantees and commitments to extend credit, that are not reflected in the accompanying consolidated financial statements. At December 31, 1994, commitments to fund loans and outstanding standby letters of credit were approximately $60.6 million and $2.5 million, respectively. At December 31, 1994 no losses are anticipated as a result of these commitments. Loan commitments which typically have fixed expiration dates and require the payment of a fee are typically contingent upon the borrower meeting certain financial and other covenants. Approximately $17.4 million of these commitments relate to real estate construction and land loans and are expected to fund within the next 12 months. However, the remainder relate primarily to revolving lines of credit or other commercial loans, and many of these commitments are expected to expire without being drawn upon, therefore the total commitments do not necessarily represent future cash requirements. The Bank evaluates each potential borrower and the necessary collateral on an individual basis. Collateral varies, but may include real property, bank deposits, debt or equity securities, or business assets. Stand-by letters of credit are conditional commitments written by the Bank to guarantee the performance of a client to a third party. These guarantees are issued primarily relating to purchases of inventory by the Bank's commercial clients, and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to clients, and the Bank accordingly uses evaluation and collateral requirements similar to those for loan commitments. Virtually all such commitments are collateralized. The Company is a defendant in a number of lawsuits, the most significant of which alleges that the Company did not perform its fiduciary duties as trustee properly and, as a result, the trust incurred losses on real estate investments that were purchased. The plaintiff is seeking damages of approximately $2.2 million related to this lawsuit. The Company's management believes ultimate liability with respect to any of the aforementioned matters will not have a material adverse effect on the consolidated financial statements of the Company. NOTE 13 - REGULATORY MATTERS The Company and the Bank are subject to capital guidelines issued by the Federal Reserve Board of Governors (the "FRB") and the Office of the Comptroller of the Currency (the OCC). These agencies have established uniform risk-based capital guidelines for commercial banks. Under this framework, balance sheet assets and certain off balance sheet commitments are weighted by risk and compared to capital. Capital is assigned to tiers, with common equity included in Tier 1 capital and the allowance for loan losses included in Tier II capital. Additionally, regulatory agencies have adopted a 3% minimum leverage ratio of Tier 1 capital to total assets. Banks anticipating significant asset growth are expected to maintain leverage ratios in excess of the minimum, between 4% to 5%. The capital ratios, as detailed below, for the Company exceed the regulatory guidelines at December 31, 1994, 1993 and 1992. The capital ratios for the Company are presented in the following table:
1994 1993 1992 ------------------------------------------------------ Capital ratios: Tier 1 leverage 8.4% 8.4% 8.8% Regulatory minimum 3.0% 3.0% 3.0% Tier 1 risk-based capital 10.8% 10.6% 10.5% Regulatory minimum 4.0% 4.0% 4.0% Total risk-based capital 12.1% 12.1% 11.7% Regulatory minimum 8.0% 8.0% 8.0% =====================
Banks that exceed a leverage ratio of 5%, a Tier 1 risk-based capital ratio of 6% and a total risk-based capital ratio of 10% are deemed to be "well- capitalized" under FDICIA's "prompt corrective action" regulations. NOTE 14 - RESTRICTIONS ON SUBSIDIARY TRANSACTIONS One of the principal sources of cash for the Company is dividends from its subsidiary Bank. Total dividends which may be declared by the Bank without receiving prior approval from regulatory authorities are limited to the lesser of the Bank's retained earnings or the net income of the Bank for the latest three fiscal years, less dividends previously declared during that period. Under these restrictions and considering minimum regulatory capital requirements, the Bank is able to declare dividends not exceeding $4,000,000 at December 31, 1994. The Bank is subject to certain restrictions under the Federal Reserve Act, including restrictions on the extension of credit to affiliates. In particular, the Bank is prohibited from lending to the Company unless the loans are secured by specified types of collateral. Such secured loans and other advances from the Bank are limited to 10% of the Bank's Shareholders' Equity, or a maximum of $1,685,000 at December 31, 1994. No such advances were made during 1994. NOTE 15 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION The financial statement of Cupertino National Bancorp (parent company only) follow:
Parent Company Only Statement of Financial Condition (Dollars in thousands) December 31, 1994 1993 ------------------------------------------------------------------------------ Assets Cash and cash equivalents $ 883 $ 690 Investment in bank 16,851 15,472 Other assets 305 100 ------------------- Total $18,039 $16,262 =================== Liabilities and shareholders' equity: Other liabilities $ 2 $ 43 ------------------- Total liabilities $ 2 $ 43 ------------------- Shareholders' equity: Common stock 14,901 13,582 Retained earnings 3,136 2,637 ------------------- Total shareholders' equity 18,037 16,219 ------------------- Total liabilities and shareholders' equity $18,039 $16,262 ===================
CUPERTINO NATIONAL BANCORP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Parent Company Only Statements of Operations (Dollars in thousands) Years ended December 31, 1994 1993 1992 ------------------------------------------------------------------------------ Income: Interest income $ 17 $ 14 $ 17 Other income 14 12 22 ----------------------- Total 31 26 39 ----------------------- Expenses: Occupancy and equipment 410 384 333 Less rentals received from the bank (409) (384) (328) ----------------------- Net occupancy and equipment 1 -- 5 Other expense 46 20 17 ----------------------- Total 47 20 22 ----------------------- Income before income taxes and equity in undistributed net income of the Bank (16) 6 17 Income tax expense -- 2 16 ----------------------- Income (loss) before equity in undistributed net income of the Bank (16) 4 1 Equity in undistributed net income of the Bank 1,379 876 1,762 ----------------------- Net income $1,363 $ 880 $1,763 ======================= Parent Company Only Statements of Cash Flows (Dollars in thousands) Years ended December 31, 1994 1993 1992 ------------------------------------------------------------------------------ Cash flows-operating activities: Net income $ 1,363 $ 880 $1,763 Reconciliation of net income to net cash from operations: Equity in undistributed net income of the Bank (1,379) (876) (1,762) Other assets (205) (100) 5 Other liabilities (41) -- 16 ------------------------- Operating cash flows, net (262) (96) 22 ------------------------- Cash flows -- financing activities: Stock issued 613 169 104 Payment of stock dividend fractional shares (2) (4) (4) Payment of cash dividend (156) -- -- ------------------------- Financing cash flows, net 455 165 100 ------------------------- Net increase in cash and cash equivalents 193 69 122 Cash and cash equivalents at the beginning of year 690 621 499 ------------------------- Cash and cash equivalents at end of the year $ 883 $ 690 $ 621 =========================
Cupertino National Bancorp Consolidated Balance Sheets NOTE 16-FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of financial instruments of the Company as of December 31, 1994 and 1993 are as follows: The estimated fair value of financial instruments of the Company as of December 31, 1994 and 1993 are as follows:
1994 1993 Carrying Fair Carrying Fair (Dollars in thousands) Amount Value Amount Value ------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $ 19,726 $19,726 $ 14,350 $ 14,350 Other short-term investment securities -- -- 3,097 3,097 Investment securities 60,506 58,190 36,342 36,358 Loans, net 130,239 130,000 123,908 124,000 Loans held for sale 5,383 5,383 7,625 7,625 --------------------------------------------------- Total loans, net $135,622 $135,383 $131,533 $131,625 Financial liabilities: Deposits: Demand, non-interest-bearing $ 53,880 $53,880 $ 62,751 $ 62,751 NOW 8,331 8,331 6,769 6,769 Money Market Demand Accounts 73,623 73,623 60,803 60,803 Savings 5,951 5,951 6,343 6,343 Other time certificates 19,417 19,410 7,799 7,810 Time certificates, $100 and over 25,520 25,513 31,275 31,309 --------------------------------------------------- Total deposits $186,722 $186,708 $175,740 $175,785 Off balance sheet financial instruments Commitments to extend credit $ 60,612 $60,612 $ 46,681 $ 46,681 Standby letters of credit 2,481 2,481 2,082 2,082 ---------------------------------------------------
The estimated fair values do not represent actual amounts that may be realized upon any sale or liquidation of the related assets or liabilities. The values do not give effect to discounts or premiums to fair value which may occur when financial instruments are sold in large quantities. The fair value amounts presented above represent the Company's best estimate of fair value using the methodologies discussed below: Cash and cash equivalents -- The carrying value reported in the balance sheet for cash and cash equivalents approximates fair value. Securities -- Fair values for investment securities are based on quoted market prices. Loans -- The fair value of 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. Deposit liabilities -- The fair value for all deposits without fixed maturities is considered to be equal to carrying value. The fair value for time deposits is based upon the appropriate discount rates for similar pools. Off-balance sheet instruments -- The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. For fixed- rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The Bank's commitments to extend credit approximate fair value at December 31, 1994 and 1993. Cupertino National Bancorp Report of Independent Accountants The Board of Directors and Shareholders, Cupertino National Bancorp: We have audited the accompanying consolidated balance sheet of Cupertino National Bancorp and Subsidiary as of December 31, 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for the year then ended. 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 audit. The financial statements of Cupertino National Bancorp and Subsidiary for the years ended December 31, 1993 and 1992 were audited by other auditors, whose report, dated January 18, 1994, expressed an unqualified opinion on those statements. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Cupertino National Bancorp and Subsidiary at December 31, 1994, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Coopers & Lybrand L.L.P. San Francisco, California January 30, 1995 EX-23.1 3 COOPERS & LYBRAND CONSENT EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Cupertino National Bancorp and Subsidiary on Forms S-8 (File No. 33-17368, No. 33-17369, and No. 33-31193) of our report dated January 30, 1995, on our audit of the consolidated financial statements of Cupertino National Bancorp and Subsidiary as of December 31, 1994 and for the year ended December 31, 1994 which report is incorporated by reference in this Annual Report on Form 10-K. /s/ Coopers & Lybrand, L.L.P. San Francisco, California March 28, 1995 EX-23.2 4 DELOITTE & TOUCHE CONSENT EXHIBIT 23.2 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in Registration Statements No. 33- 17368, No. 33-17369 and No. 33-31193 of Cupertino National Bancorp on Forms S-8 of our report dated January 18, 1994, included in this Annual Report on Form 10- K of Cupertino National Bancorp for the year ended December 31, 1994. /s/ DELOITTE & TOUCHE LLP San Jose, California March 28, 1995 EX-27 5 FDS FOR 10-K 12/31/94
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ANNUAL REPORT AND 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1994 JAN-01-1994 DEC-31-1994 9,326 0 10,400 0 0 60,506 58,190 133,157 2,918 223,144 186,722 17,256 1,129 0 14,901 0 0 3,136 223,144 12,608 2,545 208 15,361 3,897 4,279 11,082 1,620 0 10,444 2,097 1,363 0 0 1,363 0.84 0.84 6.16 3,244 1,371 0 0 2,247 1,012 63 2,918 2,780 0 138