-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EoCeZQDll5QYFPHVsA/520vZ+G/aljXhcVyiv8YXIcj3Y3Lhs9cqFgj0BqVwOf7X vI2b45fLFTq72S8yiBtdKw== 0000950149-99-000552.txt : 19990330 0000950149-99-000552.hdr.sgml : 19990330 ACCESSION NUMBER: 0000950149-99-000552 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MCB FINANCIAL CORP CENTRAL INDEX KEY: 0000902789 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 680300300 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-25293 FILM NUMBER: 99576721 BUSINESS ADDRESS: STREET 1: 1248 FIFTH AVE CITY: SAN RAFAEL STATE: CA ZIP: 94901 BUSINESS PHONE: 4154592265 MAIL ADDRESS: STREET 1: 1248 FIFTH AVENUE CITY: SAN RAFAEL STATE: CA ZIP: 94901 10KSB 1 FORM 10KSB FOR THE FISCAL YEAR ENDED 12/31/1998 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [Fee Required] For the fiscal year ended December 31, 1998 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM ____________ TO ____________ . COMMISSION FILE NUMBER: 033-76832 MCB FINANCIAL CORPORATION (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER) CALIFORNIA 68-0300300 (STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.) OR ORGANIZATION)
1248 FIFTH AVENUE, SAN RAFAEL, CALIFORNIA 94901 (415) 459-2265 (ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES) SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT: NONE (TITLE OF CLASS) SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT: PREFERRED STOCK PURCHASE RIGHTS (TITLE OF CLASS) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ]. The issuer's revenues for its most recent fiscal year were $14,214,000. At March 19, 1999, the aggregate market value of the voting stock held by non-affiliates of the issuer was approximately $13,074,000. For purposes of this information, the outstanding shares of Common Stock owned by directors and executive officers of the issuer were deemed to be shares of Common Stock held by affiliates. At March 19, 1999, the issuer had outstanding 1,978,605 shares of Common Stock, no par value, which is the issuer's only class of common stock. DOCUMENTS INCORPORATED BY REFERENCE: The information required to be furnished pursuant to Part III of this Form 10-KSB will be set forth in, and incorporated by reference from, the registrant's definitive proxy statement for the annual meeting of stockholders to be held May 19, 1999, which definitive proxy statement will be filed by the issuer with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended December 31, 1998. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS
PAGE ---- PART I Item 1. Description of Business............................ 1 MCB Financial Corporation.............................. 1 Metro Commerce Bank.................................... 1 Competition............................................ 2 Insurance.............................................. 2 Employees.............................................. 3 Supervision and Regulation................................ 3 Item 2. Description of Property............................ 9 Item 3. Legal Proceedings.................................. 9 Item 4. Submission of Matters to a Vote of Security Holders................................................... 9 PART II Item 5. Market for Common Equity and Related Stockholder Matters................................................... 10 Item 6. Management's Discussion and Analysis............... 10 Item 7. Financial Statements............................... 22 Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.............................. 46 PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act................................... 46 Item 10. Executive Compensation............................. 46 Item 11. Security Ownership of Certain Beneficial Owners and Management................................................ 46 Item 12. Certain Relationships and Related Transactions..... 46 Item 13. Exhibits and Reports on Form 8-K................... 46
i 3 PART I ITEM 1. DESCRIPTION OF BUSINESS MCB FINANCIAL CORPORATION MCB Financial Corporation (the "Company") is a bank holding company registered under the Bank Holding Company Act of 1956, as amended ("BHC Act"). The Company was incorporated under the laws of the State of California on January 20, 1993. On October 1, 1993, the Company began operations as a bank holding company with Metro Commerce Bank (the "Bank") as its wholly-owned subsidiary. The Company's only significant asset is its investment in the Bank. The principal business and activity of the Company is to serve as the bank holding company for the Bank and its principal source of income is dividends paid by the Bank. METRO COMMERCE BANK The Bank was licensed by the Office of the Comptroller of the Currency ("Comptroller") on June 12, 1989, and commenced operations as a national banking association on December 8, 1989. On July 24, 1998, the Bank converted from a national banking association into a California State bank. The Bank is subject to primary supervision, examination and regulation by the State of California Department of Financial Institutions ("DFI") and the Federal Reserve Board ("FRB"). The Bank is also subject to certain other federal laws and regulations. In addition, the Bank is subject to applicable provisions of California law insofar as such provisions do not conflict with or are not preempted by federal banking laws. The deposits of the Bank are insured under the Federal Deposit Insurance Act up to the applicable limits thereof and the Bank is a member of the Federal Reserve System. The Bank is a wholly-owned subsidiary of the Company and presently has no subsidiaries or other affiliates. The Bank is engaged in substantially all of the business operations customarily conducted by independent commercial banks in California. The Bank's banking services include the acceptance of checking and savings deposits, and the making of commercial, construction, mortgage, real estate, small business administration, home equity and other installment loans and term extensions of credit. The Bank also offers travelers' checks, notary public and other customary bank services to its customers. The Bank is not a credit card issuing bank; however, it offers Visa cards through one of its correspondent banks. From 1992 through 1996, the Bank was an active wholesale mortgage lender. Due to continued changes in the mortgage industry and the unfavorable prospects for future improvement, The Bank decided to wind down its wholesale mortgage banking operations at the end of 1996. The Bank will continue to offer limited retail mortgage lending through its commercial bank. Prior to winding down its wholesale operations, the Bank originated and sold its mortgage loans in the secondary market to both government and private mortgage purchasers. Until the end of 1994, the Bank retained servicing rights to certain mortgage loans. Mortgage loan servicing primarily encompasses the collection of payments due, impound accounting, investor remitting and foreclosure processing. The Bank sold all of its mortgage servicing rights in 1994 and discontinued its mortgage servicing operations. In January 1995, the Bank began a Small Business Administration ("SBA") Loan Division. The SBA is an agency of the U.S. Government that offers guaranteed loan programs for small businesses which might not otherwise qualify for standard bank credit. The SBA Loan Division offers various business loan programs secured by both residential and commercial real estate and business property. The Bank primarily sells the guaranteed portion of SBA loans in the secondary market to private investors. Loan fundings through this division began during the first quarter of 1995. The Bank does not operate a trust department; however, it has arranged with a correspondent institution to offer trust services to the Bank's customers upon request. The Bank also does not offer international banking services although such services are offered indirectly through correspondent institutions. 1 4 Currently, the Bank conducts its business operations through its head office located in San Rafael, California, and through its four branch office locations in San Francisco, South San Francisco, Hayward, and Upland, California. An application to establish the branch in San Francisco was approved by the Comptroller on December 10, 1997. This office opened January 8, 1998. An application to establish a branch office in Petaluma was approved by the DFI on November 10, 1998 and by the FRB on January 19, 1999. The Petaluma office is scheduled to open during the second quarter of 1999. The Bank's primary service area is central Marin County along with the cities of San Francisco, South San Francisco, Hayward and Upland. Most of the Bank's loans and deposits originate from small and medium sized businesses and professionals located within the Bank's primary service areas. The Bank's business has little, if any, emphasis on foreign sources and application of funds. The Bank's business, based upon performance to date, does not appear to be seasonal. The Bank is not dependent upon a single customer or group of related customers for a material portion of its deposits, nor is a material portion of the Bank's loans concentrated within a single industry or group of related industries. Management of the Bank is unaware of any material effect upon the Bank's capital expenditures, earnings or competitive position as a result of federal, state or local environmental regulation. The Bank holds no patents, licenses (other than licenses obtained from bank regulatory authorities), franchises or concessions. COMPETITION The banking business in California is highly competitive with respect to both loans and deposits, and is dominated by a relatively small number of major banks with many offices operating over a wide geographic area. The Bank competes for deposits and loans principally with other commercial banks and also with non-bank financial intermediaries, including savings and loan associations, credit unions, thrift and loans, mortgage companies, money market and mutual funds, finance and insurance companies and other financial and non-financial institutions. In addition, other entities (both governmental and private industry) seeking to raise capital through the issuance and sale of debt or equity securities and instruments provide competition for the Bank in the acquisition of deposits. Among the advantages certain of these institutions have over the Bank are their ability to finance wide-ranging and effective advertising campaigns and to allocate their investment resources to regions of highest yield and demand. Many of the major commercial banks operating in the Bank's service area offer certain services (such as international banking and trust services) which are not offered directly by the Bank. In addition, by virtue of their greater total capitalization, such banks have substantially higher lending limits than does the Bank (legal lending limits to each customer are restricted to a percentage of a bank's capital, the exact percentage depending on the nature of the particular loan transaction involved). From the time the Bank commenced its operations, officers and employees of the Bank have continually engaged in marketing activities, including the evaluation and development of new services, involvement in community service groups, and direct marketing in order to retain and improve the Bank's competitive position in its service areas. INSURANCE The Bank maintains insurance at levels deemed adequate by its Board of Directors to protect against certain business risks, operational losses, and property damage. In accordance with rulings promulgated by the DFI and pursuant to the Bank's Articles of Incorporation and certain contractual obligations, the officers and directors are entitled to indemnification by the Bank, under certain circumstances, for certain expenses, liabilities and losses including, but not limited to, costs of defense, settlements and judgments rendered against them. However, indemnification is not authorized when a supervisory action results in a final order assessing civil money penalties or when a supervisory action requires affirmative action in the form of payments by an individual to the Bank. The Bank has directors and officers liability insurance to cover certain costs of indemnification. 2 5 EMPLOYEES Except for its officers, currently the Company has no full-time or part-time employees. It is anticipated that the Company will rely on its officers and will utilize the employees of the Bank until it becomes actively engaged in additional business activities. The Company reimburses the Bank for a fair and reasonable amount for all services furnished to it. As of December 31, 1998, the Bank had a total of 55 full-time equivalent employees. The management of the Bank believes that its employee relations are satisfactory. SUPERVISION AND REGULATION BANK HOLDING COMPANY REGULATION The Company is a bank holding company registered under the BHC Act and is subject to the supervision of the FRB. As a bank holding company, the Company must obtain the approval of the FRB before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. With certain limited exceptions, the Company is prohibited from engaging in or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company engaged in non-banking activities, unless the FRB determines that such activities are so closely related to banking as to be a proper incident thereof. The FRB has the authority to examine the Company periodically. In 1997, the FRB adopted a policy for risk-focused supervision of small bank holding companies that do not engage in significant non-banking activities. Under this policy, examinations will focus on whether the Company has systems in place to manage the risks inherent in its business. In analyzing risk, the FRB will look at the financial condition of the Company and the Bank, management, compliance with laws and regulations, inter-company transactions and any new or contemplated activities. The Company and any subsidiary which it may acquire or organize in the future are deemed to be affiliates of the Bank within the meaning set forth in the Federal Reserve Act and are subject to the Federal Reserve Act. This means, for example, that there are limitations on loans by the Bank to affiliates, on investments by the Bank in any affiliate's stock and on the Bank's taking any affiliate's stock as collateral for loans to any borrower. All affiliate transactions must satisfy certain limitations and otherwise be on terms and conditions that are consistent with safe and sound banking practices. In this regard, the Bank generally may not purchase from any affiliate a low-quality asset (as that term is defined in the Federal Reserve Act). Also, transactions by the Bank with an affiliate must be on substantially the same terms as would be available for non-affiliates. The Company and the Bank are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. The Company and the Bank are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit. For example, the Bank generally may not extend credit on the condition that the customer obtain some additional service from the Bank or the Company, or refrain from obtaining such service from a competitor. DIVIDENDS PAYABLE BY THE COMPANY Holders of Common Stock of the Company are entitled to receive dividends as and when declared by the Company's Board of Directors out of funds legally available therefor under the laws of the State of California. A California corporation such as the Company may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. In the event sufficient retained earnings are not available for the proposed distribution, such a corporation may nevertheless make a distribution to its shareholders if, after giving effect to the distribution, the corporation's assets equal at least 3 6 125 percent of its liabilities and certain other conditions are met. Since the 125 percent ratio translates into a minimum capital ratio of 20 percent, most bank holding companies, including the Company based on its current capital ratios, are unable to meet this last test and so must have sufficient retained earnings to fund the proposed distribution. The FRB has advised bank holding companies that it believes that payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory action. As a result of this policy, banks and their holding companies may find it difficult to pay dividends out of retained earnings from historical periods prior to the most recent fiscal year or to take advantage of earnings generated by extraordinary items such as sales of buildings or other large assets in order to generate profits to enable payment of future dividends. Further, the FRB's position that holding companies are expected to provide a source of managerial and financial strength to their subsidiary banks potentially restricts a bank holding company's ability to pay dividends. BANK REGULATION The Bank is subject to regulation, supervision and regular examination by the DFI and FRB. The deposits of the Bank are insured up to the maximum legal limits by the Bank Insurance Fund ("BIF"), which is managed by the Federal Deposit Insurance Corporation ("FDIC"), and the Bank is therefore subject to applicable provisions of the Federal Deposit Insurance Act. The regulations of these agencies affect most aspects of the Bank's business and prescribe permissible types of loans and investments, the amount of required reserves, requirements for branch offices, the permissible scope of the Bank's activities and various other requirements. SUPERVISION AND EXAMINATIONS Federal law mandates frequent examinations of all banks, with the costs of examinations to be assessed against the bank being examined. In the case of the Bank, its primary Federal regulator is the FRB. The Federal banking regulatory agencies have substantial enforcement powers over the depository institutions that they regulate. Civil and criminal penalties may be imposed on such institutions and persons associated with those institutions for violations of any law or regulation. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") places limits on brokered deposits and extends the limits to any bank that is not "well capitalized" or is notified that it is in "troubled condition." Previously, the limitations applied only to troubled banks. A well-capitalized institution (which generally includes an institution that is considered well capitalized for purposes of the prompt corrective action regulations discussed below) may still accept brokered deposits without restriction, unless it has been informed by its appropriate Federal regulatory agency that it is in "troubled condition." All other insured depository institutions are prohibited from accepting brokered deposits unless a waiver is obtained from the FDIC. If a waiver is obtained, the interest paid on such deposits may not exceed the rate paid for deposits in its normal market area, or the national rate as determined in the FDIC's regulation. If a depository institution solicits deposits by offering interest rates significantly higher than rates being offered in its market area, it is deemed under FDICIA to be a deposit broker. Therefore, depending on its capital category, it may be prohibited from such practice, or need a prior waiver from the FDIC in order to offer such rates. The FDIC's regulations specify that an institution that is not well capitalized may offer rates that exceed the prevailing effective rates offered in the normal market area only if the institution obtains a waiver, but the institution may not offer rates more than 75 basis points above such prevailing rates. The Bank is at this time considered well capitalized and not in a "troubled condition," and it is not, therefore, subject to the brokered-deposit limitations. If the Bank's status changes in the future, these regulations could restrict the ability to attract such deposits. 4 7 RISK-BASED DEPOSIT INSURANCE ASSESSMENTS In addition, FDICIA required the FDIC to develop and implement a system to account for risks attributable to different categories and concentrations of assets and liabilities in assessing deposit insurance premiums. The FDIC adopted a risk-assessment system effective January 1, 1994. Under this system, each bank's deposit insurance premium assessment is calculated based on information relevant to evaluating the risk posed by the institution. CALIFORNIA LAW The activities of the Bank are also regulated by state law. State law, for example, regulates certain loans to any officer of the Bank, directly or indirectly, or to any related corporation in which such officer is a stockholder, director, officer or employee. California law permits California state-chartered banks to invest in the stock and equity securities of other corporations, to engage directly in or invest directly in subsidiaries which conduct real estate related activities (including property management and real estate appraisal), and to participate in management consulting and data processing services for third parties. FDICIA limits the powers, including investment authority and subsidiaries, of state banks to those activities that are either permitted to national banks, or activities that the FDIC finds do not pose a significant risk to the deposit insurance fund. In November 1998, the FDIC announced it will make it easier for well run state banks to engage in real estate and securities underwriting, if permitted by state law. State banks are now required to file notice of intention to engage in such activities. CAPITAL STANDARDS The FRB and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with high credit risk, such as commercial loans. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. See Notes to Consolidated Financial Statements for the capital ratios of the Company and the Bank at December 31, 1998. DIVIDENDS PAYABLE BY THE BANK TO THE COMPANY The Bank is a legal entity which is separate and distinct from the Company. Aside from raising capital on its own, the exercise of stock options or borrowing funds for operating capital, it is anticipated that the Company may receive additional income through dividends paid by the Bank. Subject to the regulatory restrictions described below, future cash dividends by the Bank will depend upon management's assessment of future capital requirements, contractual restrictions and other factors. The power of the Board of Directors of the Bank to declare a cash dividend is subject to California law, which restricts the amount available for cash dividends to the lesser of the retained earnings or the bank's net income for its last three fiscal years (less any distributions to shareholders made during such period). Where 5 8 the above test is not met, cash dividends may still be paid, with the prior approval of the California Commissioner of Financial Institutions, in an amount not exceeding the greatest of (1) the retained earnings of the bank; (2) the net income of the bank for its last fiscal year; or (3) the net income of the bank for its current fiscal year. See the Notes to Consolidated Financial Statements for the amount of funds the Bank had available for the payment of dividends at December 31, 1998. Under the Federal Deposit Insurance Act, bank regulators also have authority to prohibit a bank from engaging in business practices which are considered to be unsafe or unsound. It is possible, depending upon the financial condition of the bank in question and other factors, that such regulators could assert that the payment of dividends or other payments might, under certain circumstances, be an unsafe or unsound practice, even if technically permissible. PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS Federal banking agencies possess broad powers to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. At December 31, 1998, the Company and the Bank exceeded the required ratios for classification as "well capitalized". An institution that, based upon its capital levels, is classified as "well capitalized," "adequately capitalized" or "undercapitalized" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as "critically undercapitalized" unless its capital ratio actually warrants such treatment. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. IMPACT OF MONETARY POLICIES Banking is a business which depends in large part on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowings and the interest rate received by the Bank on loans extended to its customers and securities held in the Bank's portfolio comprise a major portion of the Bank's earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly, the earnings and growth of the Bank and the Company are subject to the influence of domestic and foreign economic conditions, including recession, unemployment and inflation. The commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the FRB. The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial institutions and intermediaries subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted. 6 9 ENVIRONMENTAL REGULATION Federal, state and local regulations regarding the discharge of materials into the environment may have an impact on both the Company and the Bank. Under federal law, liability for environmental damage and the cost of cleanup may be imposed upon any person or entity who owns or operates contaminated property. State law provisions, which were modeled after Federal law, impose substantially similar requirements. Both federal and state laws were amended in 1996 to provide generally that a lender who is not actively involved in operating the contaminated property will not be liable to clean up the property, even if the lender has a security interest in the property or becomes an owner of the property through foreclosure. The Economic Growth Act includes protection for lenders from liability under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") by adding a new section which specifies the actions a lender may take with respect to lending and foreclosure activities without incurring environmental clean-up liability or responsibility. Under the new section typical contractual provisions regarding environmental issues in the loan documentation and due diligence inspections conducted in connection with lending transactions will not lead to lender liability for clean-up, and a lender may foreclose on contaminated property, so long as the lender merely maintains the property and moves to divest it at the earliest possible time. Under California law, a lender generally will not be liable to the State for the cost associated with cleaning up contaminated property unless the lender realized some benefit from the property, failed to divest the property promptly, caused or contributed to the release of the hazardous materials, or made the loan primarily for investment purposes. This amendment to California law became effective with respect to judicial proceedings filed and orders issued after January 1, 1997. The extent of the protection provided by both the federal and state lender protection statutes will depend on the interpretation of those statutes administrative agencies and courts, and the Bank cannot predict whether it will be adequately protected for the types of loans made by the Bank. In addition, the Company and the Bank remain subject to the risk that a borrower's financial position will be impaired by liability under the environmental laws and that property securing a loan made by the Bank may be environmentally impaired and therefore not provide adequate security for the Bank. California law provides some protection against the second risk by establishing certain additional, alternative remedies for a lender in circumstances where the property securing a loan is later found to be environmentally impaired, permitting the lender to pursue remedies against the borrower other than foreclosure under the deed of trust. The Bank attempts to protect its position against the remaining environmental risks by performing prudent due diligence. Environmental questionnaires and information on use of toxic substances are requested as part of the Bank's underwriting procedures. The Bank makes lending decisions based upon its evaluation of the collateral, the net worth of the borrower and the borrower's capacity for unforeseen business interruptions or risks. PUBLIC INTEREST LAWS, CONSUMER AND LENDING LAWS In addition to the other laws and regulations discussed herein, the Bank is subject to certain consumer and public interest laws and regulations that are designed to protect customers in transactions with banks. While the list set forth below is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act and the Community Reinvestment Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans and providing other services. The Bank must comply with the applicable provisions of these laws and regulations as part of its ongoing customer relations. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to 7 10 enforcement actions, injunctions, fines or criminal penalties, punitive damages to consumers and the loss of certain contractual rights. AMERICANS WITH DISABILITIES ACT The Americans With Disabilities Act ("ADA"), in conjunction with similar California legislation, has increased the cost of doing business for banks. The legislation requires employers with 15 or more employees and all businesses operating "commercial facilities" or "public accommodations" to accommodate disabled employees and customers. The ADA has two major objectives: (1) to prevent discrimination against disabled job applicants, job candidates and employees, and (2) to provide disabled persons with ready access to commercial facilities and public accommodations. Commercial facilities, such as the Bank, must ensure that all new facilities are accessible to disabled persons, and in some instances may be required to adapt existing facilities to make them accessible. NEW AND PENDING LEGISLATION Certain legislative and regulatory proposals that could affect the Company, the Bank and the banking business in general are pending or may be introduced, before the United States Congress, the California State Legislature, and Federal, state and local government agencies. ATM FEES. Legislation has been proposed in the past in the Congress and the California legislature and measures are currently being proposed in local jurisdictions to regulate the amount of ATM fees that operators of ATMs may charge, and to further regulate the disclosure of such fees. If the collection of interchange fees by the operator of an ATM were prohibited, as some of these bills have proposed, the Bank's income from its ATM network would be severely reduced. Management believes that the possible reduction in ATM income would not have a material impact on the Company's consolidated financial statements. BANKING REFORM BILLS. A new financial service reform bill was introduced early in the 1999 session of the House of Representatives, patterned on the Senate version which was considered last year but not passed. A similar bill passed the House in 1998. The new Bill, H.R. 10, would repeal the Glass Steagall Act prohibitions on bank affiliation with securities firms. It would allow bank affiliates to engage in certain securities underwriting and other securities activities. It expands bank powers by allowing them to engage in activities 'financial in nature' rather than be limited by the current standard, 'closely related to banking'. It would allow banks to underwrite and broker insurance products, and requires the FRB to defer to the State and Federal agencies on securities and insurance law issues. It also requires a satisfactory CRA rating for a bank to be eligible for new powers and expands compliance with CRA requirements to other financial companies created by H.R. 10. Similar legislation permitting cross ownership of banks and commercial businesses and continuation of the thrift charter is expected to be introduced in the Senate for consideration this year. EXPANSION IN CREDIT UNION MEMBERSHIP. A broad rule has been adopted by the National Credit Union Administration ("NCUA"), relaxing limits of credit union membership. The new rule takes effect January 1, 1999. The NCUA will now approve credit unions with memberships of more than 300,000 residents with proof that they function as a community. The effect is to substantially expand credit union membership and make credit unions, as tax exempt entities serving credit needs of large communities, more competitive to banks. Litigation attacking the new rule is pending. THE OFFICE OF THRIFT SUPERVISION ("OTS") EXPANSION OF CHARTERS TO INSURANCE INDUSTRY. In 1998 the OTS granted its ninth charter for an insurance company to operate a thrift or savings and loan subsidiary. These new charters to the insurance industry are expected to result in yet more competition for banks. PROPOSED "KNOW YOUR CUSTOMER RULE"; PRIVACY. The "Know Your Customer" rule was proposed by the Federal Reserve to enforce the Bank Secrecy Act, and requires bank management to determine the identity of their customers and their customers' source of funds and then monitor the accounts for unusual events. Suspicious events are then to be reported to law enforcement authorities by the banks. The rule has been widely criticized as requiring an additional expenditure of resources by banks as well as requiring invasion 8 11 of the privacy of customers. At the same time, other regulatory agencies are proposing privacy rules to prevent such information from being provided. It is not known whether the know your customer rule will be finally adopted, but it is expected that banks will be required to adopt privacy policies allowing customers to object to the banks' providing confidential customer information to affiliates of the banks as well as third parties (other than law enforcement officials). INTEREST ON BUSINESS CHECKING. Legislation has again been introduced during 1999 to lift the current ban on the payment of interest on business checking accounts. Legislation lifting the ban on paying interest on business checking accounts is expected to be considered in 1999 in the Shelby-Mack Regulatory Relief Bill. The adoption of this legislation would permit the Bank to compete more directly for commercial deposits, but increase its costs of funds. It is not known to what extent these proposals will be enacted and what effect such legislation would have on the structure, regulation and 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. It cannot be predicted whether or in what form any such legislation or regulations will be enacted or the effect that such legislation or regulations may have on the Bank's business. ITEM 2. DESCRIPTION OF PROPERTY Currently, the Company does not own or lease any property. The Company is not actively engaged in any business activities outside of the activities of the Bank. Therefore, the Bank's property is not significantly used by the Company. The Company will continue to utilize the premises of the Bank until it becomes actively engaged in additional business activities. The Company currently reimburses the Bank for a fair and reasonable amount for all services furnished to it. The Bank leases the land and the buildings at which its office facilities are located. The Bank has five full-service banking offices. The head office of the Bank is located at 1248 Fifth Avenue, San Rafael, California and consists of approximately 10,000 square feet of office space. The Bank occupies the premises for its head office under a lease which will expire in June 2014, with two five-year options to renew. The Bank's four branch offices in San Francisco, South San Francisco, Hayward and Upland, California occupy approximately 2,015, 12,300, 14,000 and 5,000 square feet, respectively, under leases that expire at various dates through the year 2005. In the second quarter of 1999, the Company expects to open a branch office in Petaluma. The Bank's lease for the Petaluma branch commenced March 1, 1999. The lease covers 4,635 square feet and expires in 2009. The Bank believes that its existing facilities are adequate for its current needs and anticipated growth. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any pending legal proceeding and is unaware of any proceeding being contemplated against it by any governmental authority. There are various legal actions pending against the Company arising from the normal course of business. Management, upon the advice of legal counsel handling such actions, believes that the ultimate resolution of these actions will not have a material effect on the financial position of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 9 12 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is not listed on any exchange nor is it listed on the NASDAQ system. U.S. Stock Transfer Corporation is the Company's transfer agent. The Company's stock trades over-the-counter under the ticker symbol MCBF. The Company is aware of two securities dealers, Black & Co. in Portland, OR and Monroe Securities in Rochester, NY which make a market in its common stock. There were approximately 416 shareholders as of December 31, 1998. The following high and low prices reflect actual transactions which may not include retail markups, markdowns, or commissions. Prices are adjusted to reflect stock dividends and stock splits.
1997 1998 -------------- ---------------- HIGH LOW HIGH LOW ----- ----- ------ ------ First quarter............................. $6.07 $5.12 $10.83 $ 8.00 Second quarter............................ 6.07 5.60 13.33 10.58 Third quarter............................. 7.25 5.90 12.33 7.75 Fourth quarter............................ 8.44 7.19 10.00 8.13
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion presents information pertaining to the financial condition and results of operations of the Company that may not otherwise be apparent from the financial statements and related notes. This discussion should be read in conjunction with the financial statements and notes found in Item 7 of this report as well as other information presented throughout this report. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances. This document may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those indicated. For a discussion of factors that could cause actual results to differ, please see the discussion contained herein and in the Company's publicly available Securities and Exchange Commission filings and press releases. OVERVIEW EARNINGS SUMMARY. The Company reported net income of $1,621,000, or $0.79 per share basic and $0.74 per share diluted, for 1998 compared to net income of $1,350,000, or $0.67 per share basic and $0.64 per share diluted, in 1997 and net income of 1,971,000, or $1.00 per share basic and $0.99 diluted, in 1996. The results for 1996 reflected a recovery of approximately $1.8 million (pre-tax) in litigation expenses originally recorded in the prior year. Return on average assets for 1998 was 1.03% compared to 0.97% in 1997 and 1.56% in 1996. Return on average equity for 1998 was 12.61% compared to 12.22% in 1997 and 20.97% in 1996. FINANCIAL CONDITION SUMMARY. Assets increased by 21.2% during 1998 versus 6.4% and 7.5% in 1997 and 1996, respectively. The increase in assets during 1998 resulted primarily from growth in existing operations, largely due to improved economic conditions in the Company's market areas. LOANS. Loans held for investment increased by $22.8 million, or 26.1% in 1998, as compared to an increase of $7.1 million, or 8.8%, during 1997. Strong demand for commercial real estate and construction loans resulted in the loan growth for 1998. In the normal practice of extending credit, the Bank accepts real estate collateral on loans that have primary sources of repayment from commercial operations. Loans secured by real estate totaled $92.6 million, or 83.3% of all loans, at December 31, 1998 versus $71.3 million, or 81.8% of all loans, a year earlier. Due to the Bank's limited marketing area, its real estate collateral is primarily concentrated in the San Francisco Bay 10 13 Area and Southern California. Management believes that its prudent underwriting standards for real estate secured lending provide an adequate safeguard against changing real estate prices. The Bank focuses its portfolio lending on commercial, commercial real estate, and construction loans. These loans generally carry a higher level of risk than conventional real estate loans, and accordingly, yields on these loans are typically higher than those on other loans. The performance of commercial and construction loans is generally dependent upon future cash flows from business operations (including the sale of products, merchandise and services) and the successful completion or operation of large real estate projects. Risks attributable to such loans can be significantly increased, often to a greater extent than on other loans, by regional economic factors, real estate prices, the demand for commercial and retail office space, and the demand for products and services of industries which are concentrated within the Bank's loan portfolio. As of December 31, 1998, the two largest industry concentrations within the loan portfolio were real estate and related services at 29.0% and the business/personal service industry at 22.6% of the portfolio. Because credit concentrations increase portfolio risk, the Bank places significant emphasis on the purpose of each loan and the related sources of repayment. NONPERFORMING ASSETS. The Company carefully monitors the quality of its loan portfolio and the factors that affect it, including regional economic conditions, employment stability, and real estate values. The accrual of interest on loans is discontinued when the payment of principal or interest is considered to be in doubt, or when a loan becomes contractually past due by 90 days or more with respect to principal or interest, except for loans that are well secured and in the process of collection. As of December 31, 1998, the Company had nonperforming assets in the amount of $967,000, of which $563,000 represented three nonaccrual loans. Had these nonaccrual loans performed under their contractual terms approximately $34,000 in additional interest income would have been recognized during 1998. Also, as of December 31, 1998, the Company had two loans 90 days or more past due and still accruing in the amount of $404,000. These loans are well secured and in the process of collection. The following table sets forth the balance of nonperforming assets as of the dates indicated (dollar amounts in thousands):
DECEMBER 31, DECEMBER 31, 1997 1998 NONPERFORMING ASSETS ------------ ------------ Nonaccrual loans................................... $ 69 $563 Loans 90 days or more past due and still accruing......................................... 40 404 ---- ---- $109 $967 ==== ==== As a percent of total loans........................ 0.12% 0.87% As a percent of total assets....................... 0.08% 0.57%
ALLOWANCE FOR POSSIBLE CREDIT LOSSES. The Company maintains an allowance for possible credit losses (the "APCL") which is reduced by credit losses and increased by credit recoveries and provisions to the APCL charged against operations. Provisions to the APCL and the total of the APCL are based, among other factors, upon the Company's credit loss experience, the performance of loans within the portfolio, evaluation of loan collateral value, and the prospects or worth of respective borrowers and guarantors. In determining the adequacy of its APCL, the Company segments its loan portfolio into pools of homogeneous loans that share similar risk factors. Each pool is given a risk assessment factor that largely reflects the expected future losses from each category. These risk assessment factors change as economic conditions shift and actual loan losses are recorded. The APCL totaled $1,117,000, or 1.01% of total loans, as of December 31, 1998 versus $1,007,000 or 1.14% of total loans, a year earlier. In both periods, the APCL was determined to be an adequate allowance against foreseeable future losses. Note 3 to the consolidated financial statements provides a summary of the activity in the APCL for the three years ended December 31, 1998. 11 14 The following table summarizes, for the periods indicated, loan balances at the end of each period and average balances during the period, changes in the allowance for possible credit losses arising from credit losses, recoveries of credits losses previously incurred, additions to the allowance for possible credit losses charged to operating expense, and certain ratios relating to the allowance for possible credit losses: ANALYSIS OF THE ALLOWANCE FOR POSSIBLE CREDIT LOSSES
1997 1998 --------- ---------- (DOLLARS IN THOUSANDS) ALLOWANCE FOR LOAN LOSSES: Beginning balance......................................... $ 944 $ 1,007 Provision for loan losses................................. 120 153 Charge-offs: Commercial.............................................. 105 53 Consumer................................................ 3 ------- -------- Total charge-offs............................... 108 53 ------- -------- Recoveries: Commercial.............................................. 51 9 Consumer................................................ 1 ------- -------- Total recoveries................................ 51 10 ------- -------- Net charge-offs........................................... 57 43 ------- -------- Ending balance............................................ $ 1,007 $ 1,117 ======= ======== LOANS (NET OF UNEARNED INCOME) OUTSTANDING AT DECEMBER 31(1).......................................... $88,186 $111,075 ------- -------- AVERAGE LOANS (NET OF UNEARNED INCOME) OUTSTANDING AT DECEMBER 31(1).......................................... $82,959 $100,130 ------- -------- RATIOS: Allowance to loans (net of unearned income)............... 1.14% 1.01% Net charge-offs to average loans (net of unearned income)................................................. .07% .04% Net charge-offs to allowance.............................. 5.66% 3.85%
- --------------- (1) Includes mortgage loans sold and mortgage loans held for sale reported on the Consolidated Balance Sheets. The following table sets forth the allocation of the allowance for possible credit losses as of the dates indicated: ALLOCATION OF THE ALLOWANCE FOR POSSIBLE CREDIT LOSSES
1997 1998 -------------------------------- -------------------------------- PERCENT OF PERCENT OF LOANS LOANS ALLOWANCE IN EACH ALLOWANCE IN EACH FOR POSSIBLE CATEGORY TO FOR POSSIBLE CATEGORY TO CREDIT LOSSES TOTAL LOANS CREDIT LOSSES TOTAL LOANS ------------- ---------------- ------------- ---------------- (DOLLARS IN THOUSANDS) Commercial......................... $ 570 41.79% $ 641 42.79% Real estate........................ 245 52.39 245 53.27 Consumer........................... 43 5.82 38 3.94 Not allocated...................... 149 N/A 193 N/A ------ ------ ------ ------ Total.................... $1,007 100.00% $1,117 100.00% ====== ====== ====== ======
12 15 The allowance is available to absorb losses from all loans, although allocations have been made for certain loans and loan categories. The allocation of the allowance as shown below should not be interpreted as an indication that charge-offs in future periods will occur in these amounts or proportions, or that the allocation indicates future charge-off trends. In addition to the most recent analysis of individual loans and pools of loans, management's methodology also places emphasis on historical loss data, delinquency and nonaccrual trends by loan classification category and expected loan maturity. This analysis, management believes, identifies potential losses within the loan portfolio and therefore results in allocation of a large portion of the allowance to specific loan categories. INVESTMENTS. Total investment securities increased by $6,522,000, or 18.3% in 1998, as compared to an increase of $476,000, or 1.4% in 1997. In 1998, investment securities held to maturity decreased $19.2 million as the decline in interest rates during the year resulted in many of the Company's callable bonds to be called. Investment securities available for sale increased $25.7 million as the Company reinvested the proceeds of the called bonds and as the increase in deposits during the year provided funds available for investment. At December 31, 1998, $6.1 million, or 14.4% of the Company's investment securities were invested in callable government agency debentures compared to $26.2 million, or 71.0% at December 31, 1997. These securities offer above market yields, but may be called if interest rates fall below certain levels. If these securities are called, the Company may not be able to reinvest the proceeds to obtain the same yield. DEPOSITS. Total deposits increased by $28.8 million, or 22.8%, during 1998 as compared to an increase of $6.3 million, or 5.2%, during 1997. The increase in 1998 was primarily the result of growth in existing operations, largely due to improved economic conditions in the Company's market areas. The Company's cost of funds declined to 3.23% during 1998 from 3.36% during 1997 as the Company lowered the rates paid on deposits in response to the decline in overall interest rates during the year. The following table summarizes the distribution of average deposits and the average rates paid for the periods indicated (dollar amounts in thousands):
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------------------------- 1996 1997 1998 ------------------- ------------------- ------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE BALANCE RATE BALANCE RATE -------- ------- -------- ------- -------- ------- Noninterest-bearing demand deposits..................... $ 22,607 $ 27,019 $ 31,371 Interest-bearing transaction deposits (includes money market deposit accounts)..... 70,533 4.11% 78,521 4.10% 88,255 3.93% Savings deposits............... 2,363 1.95% 1,928 1.93% 1,845 1.92% Time deposits, $100,000 and over......................... 9,023 5.50% 10,214 5.42% 12,493 5.31% Other time deposits............ 10,009 5.40% 8,080 5.13% 8,194 5.06% -------- -------- -------- Total interest-bearing... 91,928 4.34% 98,743 4.28% 110,787 4.14% -------- -------- -------- Total deposits....... $114,535 3.48% $125,762 3.36% $142,158 3.23% ======== ======== ========
13 16 RESULTS OF OPERATIONS NET INTEREST INCOME/NET INTEREST MARGIN. Net interest income increased by $1,348,000, or 18.6%, during 1998 to reach $8.6 million. This compares to net interest income of $7.2 million in 1997 and $6.4 million in 1996. The increase in 1998 was primarily due to the growth in average loans, largely due to improved economic conditions in the Company's market areas. The following table sets forth average assets, liabilities, and shareholders' equity; the amount of interest income or interest expense; the average yield or rate for each category of interest-bearing assets and interest- bearing liabilities; and the net interest margin for the periods indicated (dollar amounts in thousands):
1996 1997 1998 --------------------------- --------------------------- --------------------------- AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE -------- -------- ----- -------- -------- ----- -------- -------- ----- ASSETS Federal funds sold................... $ 4,465 $ 233 5.22% $ 6,613 $ 356 5.38% $ 9,005 $ 473 5.25% Interest-bearing deposits with banks.............................. 656 41 6.25% 348 21 6.03% 286 17 5.94% Investment securities................ 38,736 2,375 6.18% 38,797 2,485 6.41% 36,431 2,156 5.93% Mortgage loans....................... 1,433 117 8.16% 66 5 7.58% Loans................................ 70,082 7,619 10.87% 81,923 8,633 10.54% 99,095 10,559 10.66% -------- ------- ----- -------- ------- ----- -------- ------- ----- Total Earning Assets......... 115,372 10,385 9.02% 127,747 11,500 9.00% 144,817 13,205 9.12% Total Non-earning Assets..... 11,014 10,928 11,929 -------- -------- -------- Total Assets................. $126,386 $138,675 $156,746 ======== ======== ======== LIABILITIES & SHAREHOLDERS' EQUITY Demand deposits...................... $ 22,607 $ 27,019 $ 31,371 Interest-bearing transaction accounts........................... 70,533 2,902 4.11% 78,521 3,219 4.10% 88,255 3,472 3.93% Time deposits, $100,000 or more...... 9,023 496 5.50% 10,214 554 5.42% 12,493 664 5.31% Savings and other time............... 12,372 587 4.74% 10,009 452 4.52% 10,039 450 4.48% -------- ------- ----- -------- ------- ----- -------- ------- ----- Total interest-bearing deposits................... 91,928 3,985 4.33% 98,744 4,225 4.28% 110,787 4,586 4.14% -------- ------- ----- -------- ------- ----- -------- ------- ----- Other borrowings..................... 729 33 4.53% 591 28 4.74% 495 24 4.85% -------- ------- ----- -------- ------- ----- -------- ------- ----- Total interest-bearing liabilities................ 92,657 4,018 4.34% 99,335 4,253 4.28% 111,282 4,610 4.14% Other liabilities.................... 1,723 1,278 1,243 Shareholders' equity................. 9,399 11,043 12,850 -------- -------- -------- Total Liabilities and Shareholders' Equity....... $126,386 $138,675 $156,746 ======== ======== ======== ------- ------- ------- Net interest income.................. $ 6,367 $ 7,247 $ 8,595 ======= ======= ======= Net interest margin.................. 5.52% 5.68% 5.94%
The Company's net interest margin (net interest income divided by average earning assets) increased to 5.94% during 1998. This compared to 5.68% in 1997 and 5.52% in 1996. The increases were primarily attributable to growth in average loans as a percentage of earning assets. The increase in average loans was largely due to the improved economic conditions in the Company's market areas. 14 17 The following table presents the dollar amount of changes in interest earned and interest paid for each major category of interest-earning asset and interest-bearing liability and the amount of change attributable to average balances (volume) fluctuations and average rate fluctuations. The variance attributable to both balance and rate fluctuations is allocated to a combined rate/volume variance (dollar amounts in thousands):
1997 COMPARED TO 1996 1998 COMPARED TO 1997 INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO -------------------------------- -------------------------------- RATE/ RATE/ VOLUME RATE VOLUME TOTAL VOLUME RATE VOLUME TOTAL ------ ----- ------ ------ ------ ----- ------ ------ INTEREST INCOME: Federal funds sold.................. $ 112 $ 7 $ 4 $ 123 $ 129 $ (9) $ (3) $ 117 Interest-bearing deposits with banks............................. (20) (1) 1 (20) (4) 0 0 (4) Investment securities............... 4 106 0 110 (152) (188) 11 (329) Mortgage loans held for sale........ (112) (8) 8 (112) (5) (5) 5 (5) Loans............................... 1,284 (231) (39) 1,014 1,807 98 21 1,926 ------ ----- ---- ------ ------ ----- ---- ------ Total Interest Income........ 1,268 (127) (26) 1,115 1,775 (104) 34 1,705 ------ ----- ---- ------ ------ ----- ---- ------ INTEREST EXPENSE: Interest-bearing transaction accounts.......................... 325 (7) (1) 317 403 (133) (17) 253 Time deposits, $100,000 or more..... 66 (7) (1) 58 124 (11) (3) 110 Savings and other time.............. (113) (27) 5 (135) 1 (3) 0 (2) Other borrowings.................... (6) 2 (1) (5) (5) 1 0 (4) ------ ----- ---- ------ ------ ----- ---- ------ Total Interest Expense....... 272 (39) 2 235 523 (146) (20) 357 ------ ----- ---- ------ ------ ----- ---- ------ NET INTEREST INCOME................... $ 996 $ (88) $(28) $ 880 $1,252 $ 42 $ 54 $1,348 ====== ===== ==== ====== ====== ===== ==== ======
PROVISION FOR POSSIBLE CREDIT LOSSES. The Company provided $153,000 to the APCL during 1998 compared to $120,000 in 1997 and $220,000 in 1996. The provisions during those periods were recorded primarily due to growth in the loan portfolio. Net credit losses were $43,000 in 1998, $57,000 in 1997 and $28,000 in 1996. NONINTEREST INCOME. The following table summarizes noninterest income for the years 1996, 1997 and 1998 and expresses these amounts as a percentage of average assets (dollar amounts in thousands):
YEARS ENDED DECEMBER 31, ------------------------ 1996 1997 1998 COMPONENTS OF NONINTEREST INCOME ------ ---- ------ Gain on sale of mortgage loans............................. $ 351 $ 13 Gain on sale of SBA loans.................................. 47 133 $ 151 Service fees on deposit accounts........................... 390 494 522 Loan servicing fees........................................ 21 34 45 Gain on sale of investment securities available for sale... 53 Recovery of litigation expenses............................ 1,824 Other income............................................... 135 165 238 ------ ---- ------ Total............................................ $2,768 $839 $1,009 ====== ==== ====== AS A PERCENTAGE OF AVERAGE ASSETS Gain on sale of mortgage loans............................. 0.28% 0.01% Gain on sale of SBA loans.................................. 0.04 0.10 0.10% Service fees on deposit accounts........................... 0.31 0.36 0.33 Loan servicing fees........................................ 0.02 0.02 0.03 Gain on sale of investment securities available for sale... 0.03 Recovery of litigation expenses............................ 1.44 Other income............................................... 0.11 0.12 0.15 ------ ---- ------ Total............................................ 2.20% 0.61% 0.64% ====== ==== ======
During the first quarter of 1996, the Company recovered approximately $1.8 million in litigation expenses in conjunction with the complete settlement and release of its outstanding litigation. Gains from the sale of 15 18 mortgage loans decreased in 1997 due to the Company's decision to wind down its wholesale Mortgage Banking operations. NONINTEREST EXPENSES. The following table summarizes noninterest expenses and the associated ratios to average assets for the years 1996, 1997 and 1998 (dollar amounts in thousands):
YEARS ENDED DECEMBER 31, -------------------------- 1996 1997 1998 COMPONENTS OF NONINTEREST EXPENSE ------ ------ ------ Salaries and employee benefits.............................. $3,120 $3,011 $3,646 Occupancy expense........................................... 724 774 864 Furniture and equipment expense............................. 388 322 414 Professional services....................................... 202 365 310 Supplies.................................................... 236 212 294 Promotional................................................. 233 202 361 Data processing............................................. 276 354 323 Regulatory assessments...................................... 46 61 58 Other....................................................... 340 372 433 ------ ------ ------ Total............................................. $5,565 $5,673 $6,703 ====== ====== ====== Average full-time equivalent staff.......................... 50 49 55 AS A PERCENTAGE OF AVERAGE ASSETS Salaries and employee benefits.............................. 2.47% 2.17% 2.32% Occupancy expense........................................... 0.57 0.56 0.55 Furniture and equipment expense............................. 0.31 0.23 0.26 Professional services....................................... 0.16 0.26 0.20 Supplies.................................................... 0.19 0.15 0.19 Promotional................................................. 0.18 0.15 0.23 Data processing............................................. 0.22 0.26 0.21 Regulatory assessments...................................... 0.04 0.04 0.04 Other....................................................... 0.27 0.27 0.28 ------ ------ ------ Total............................................. 4.40% 4.09% 4.28% ====== ====== ======
Noninterest expense increased to $6.7 million during 1998 compared to $5.7 million during 1997. In January, 1998, the Company opened a branch office in San Francisco which contributed to the increase in noninterest expense during 1998. YEAR 2000. The Year 2000 creates challenges with respect to the automated systems used by financial institutions and other companies. Many software programs are not able to recognize the year 2000, since most programs and systems were designed to store calendar years in the 1900's by assuming the "19" and storing only the last two digits of the year. For example, these automated systems would recognize a year stored as "00" as the year "1900", rather than as the year "2000". If these automated systems are not appropriately re-coded, updated or replaced before the year 2000, they will likely crash or fail in some manner. In addition, many software programs and automated systems will fail to recognize the year 2000 as a leap year. The problem is not limited to computer systems. Year 2000 issues will potentially affect every system that has an embedded microchip, such as automated teller machines, elevators and vaults. The year 2000 challenge is especially problematic for financial institutions, since many transactions such as interest accruals and payments are date sensitive. It also may affect the operations of third parties with whom the Company does business, including the Company's vendors, suppliers, utility companies and customers. The Company's State of Readiness. The Company is committed to addressing these year 2000 challenges in a prompt and responsible manner and has dedicated resources to do so. Management has completed an assessment of its automated systems and has implemented a plan to resolve these issues, 16 19 including purchasing appropriate computer technology. The Company's year 2000 compliance plan ("Plan") has five phases. These phases are (1) project management, (2) awareness, (3) assessment, (4) testing, and (5) renovation and implementation. The Company has substantially completed phases one through four, although appropriate follow-up activities are continuing to occur. The Company is currently involved in the renovation and implementation phase of the Plan. Project Management. The Company's senior management provides periodic reports to its board of directors in order to assist them in overseeing the Company's year 2000 readiness. Awareness. The Company has completed several projects designed to promote awareness of year 2000 issues throughout the Company and the Company's customer base. These projects include mailing information to deposit and loan customers, providing training for lending officers and other staff, and responding to vendor, customer, and shareholder inquiries. Assessment. Assessment is the process of identifying all mission-critical applications that could potentially be negatively affected by dates in the year 2000 and beyond. The Company's assessment phase is substantially complete. Systems examined during this phase included telecommunications systems, account- processing applications, and other software and hardware used in connection with customer accounts. The Company's operations, like those of many other companies, are intertwined with the operations of certain of its business partners. Accordingly, the Company's operations could be materially affected if the operations of those companies who provide the Company with mission critical applications, systems, and services are materially affected. For example, the Company depends upon vendors who provide equipment, technology, and software to it in connection with its business operations. Failure of these software vendors to achieve year 2000 readiness could substantially affect the operations of the Company. In addition, lawsuits and other financial challenges materially affecting the financial viability of these vendors could materially affect the Company. In response to this concern, the Company has identified and contacted those vendors who provide our mission-critical applications. The Company has assessed their year 2000 compliance efforts and will continue to monitor their progress as the year 2000 approaches. Testing. Updating and testing of the Company's mission-critical automated systems is substantially complete. Testing of modified or new systems will continue throughout 1999. Renovation and Implementation. This phase involves obtaining and implementing renovated software applications provided by our vendors. As these applications are received and implemented, the Company will test them for year 2000 compliance. This phase also involves upgrading and replacing automated systems where appropriate and will continue throughout 1999. Although this phase will be substantially complete before the end of 1999, additional follow-up activities may take place in the year 2000 and beyond. The Costs to Address the Company's Year 2000 Issues. The total financial effect of these year 2000 challenges on the Company cannot be predicted with certainty at this time. In fact, in spite of all efforts being made to rectify these problems, the success of these efforts cannot be predicted until the year 2000 actually arrives. The Company upgraded and replaced its data processing and network system in 1997. The Company spent a total of approximately $500,000 on this conversion. The Company will continue to upgrade or replace certain automated systems before the year 2000; however some of these systems would have been replaced before the year 2000 without regard to year 2000 compliance issues, due to technology updates and Company expansion. Management does not believe that future expenses related to meeting the Company's year 2000 challenges will have a material effect on the operations or financial performance of the Company. However, factors beyond the control of management, such as the effects on vendors of our mission-critical software and systems, the effects of year 2000 issues on the economy, and the development of the risks identified below under "The Risks of the Company's Year 2000 Issues," among other things, could have a material effect on the operations or financial performance of the Company. The Risks of the Company's Year 2000 Issues. The year 2000 presents certain risks to the Company and its operations. Some of these risks are present because the Company purchases technology applications from other parties who face year 2000 challenges. Other of these risks are inherent in the business of banking or are risks faced by many other companies in other industries. Although it is impossible to identify every possible 17 20 risk that the Company may face moving into the new millennium, management has to date identified the following potential risks: 1. Commercial banks may experience a contraction in their deposit base if a significant amount of deposited funds are withdrawn by customers prior to the year 2000. Also, interest rates may increase in the latter part of 1999. This potential deposit contraction could make it necessary for the Company to change its sources of funding and could materially impact future earnings. The Company is currently developing a contingency plan for addressing this situation, should it occur. 2. The Company lends significant amounts to businesses in its market area. If these businesses are adversely affected by year 2000 issues, their ability to repay loans could be impaired. This increased credit risk could affect the Company's financial performance. As part of the Company's Plan, its primary borrowers were identified and the assessment of their year 2000 readiness and risk to the Company is in progress. 3. The Company's operations, like those of many other companies, can be affected by the year 2000 triggered failures of other companies upon whom the Company depends for the functioning of its automated systems. Accordingly, the Company's operations could be materially affected if the operations of those companies who provide the Company with mission critical systems and services are materially affected. As described above, the Company has identified its mission-critical vendors and is monitoring their year 2000 compliance progress. 4. All companies with publicly traded stock, including the Company, could experience a drop in stock price as investors change their investment portfolios or sell stock prior to the new millennium. At this time, it is impossible to predict whether or not this will in fact be the case with respect to the stock of the MCB Financial Corporation or any other company. 5. The Company's ability to operate effectively in the year 2000 could be affected by communications abilities and access to utilities, such as electricity, water and telephone. To the extent access is interrupted due to the effects of year 2000 issues on these and other utilities, the operations of the Company will be disrupted. The Company's Contingency Plans. The Company is currently developing a contingency plan to handle the most reasonably likely worst case scenarios related to year 2000 issues. This plan will range from obtaining mission-critical system back-up capabilities to funds management contingencies. INCOME TAXES. The Company's effective tax rate was 41.0% in 1998 compared to 41.1% in 1997 and 41.2% in 1996. Note 6 to the consolidated financial statements provides a reconciliation of the statutory tax rates to the effective tax rate for each period. LIQUIDITY AND ASSET/LIABILITY MANAGEMENT. Liquidity is the Company's ability to absorb fluctuations in deposits while simultaneously providing for the credit needs of its borrowers. The objective in liquidity management is to balance the sources and uses of funds. Primary sources of liquidity include payments of principal and interest on loans and investments, proceeds from the sale or maturity of loans and investments, growth in deposits, and increases in other borrowings. The Company holds overnight federal funds as a cushion for temporary liquidity needs. During 1998, federal funds sold averaged $9.0 million, or 5.7% of total assets. In addition to its federal funds, the Company maintains various lines of credit with correspondent banks, the Federal Reserve Bank, and the Federal Home Loan Bank. As of December 31, 1998, the Company had cash, time deposits with banks, federal funds sold, and unpledged investment securities of approximately $50.0 million, or 29.5% of total assets. This represented the total amount of liquid assets available for sale and/or available to secure the Company's lines of credit. Several methods are used to measure liquidity. One method is to measure the balance between loans and deposits (gross loans divided by total deposits). In general, the closer this ratio is to 100%, the more reliant an institution becomes on its illiquid loan portfolio to absorb temporary fluctuations in deposit levels. As of December 31, 1998, the loan-to-deposit ratio was 71.7% compared to 69.9% a year earlier. 18 21 Another frequently used method is the relationship between short-term liquid assets (federal funds sold and investments maturing within one year) and short-term liabilities (total deposits and other borrowings) as measured by the liquidity ratio. As of December 31, 1998, this ratio was 3.1% as compared 6.3% a year earlier. As of December 31, 1998, the Company had no material commitments that were expected to adversely impact liquidity. Net interest income and the net interest margin are largely dependent on the Company's ability to closely match interest-earning assets with interest-bearing liabilities. As interest rates change, the Company must constantly balance maturing and repricing liabilities with maturing and repricing assets. This process is called asset/liability management and is commonly measured by the maturity/repricing gap. The maturity/repricing gap is the dollar difference between maturing or repricing assets and maturing or repricing liabilities at different intervals of time. The following table sets forth rate sensitive interest-earning assets and interest-bearing liabilities as of December 31, 1998, the interest rate sensitivity gap (i.e. interest sensitive assets minus interest sensitive liabilities), the cumulative interest rate sensitivity gap, the interest rate sensitivity gap ratio (interest sensitive assets divided by interest sensitive liabilities) and the cumulative interest rate sensitivity gap ratio. For the purposes of the following table, an asset or liability is considered rate sensitive within a specified period when it matures or can be repriced within that period pursuant to its original contractual terms (dollar amounts in thousands):
OVER 90 OVER 180 AFTER ONE AFTER 90 DAYS DAYS TO DAYS TO YEAR TO FIVE OR LESS 180 DAYS 365 DAYS FIVE YEARS YEARS TOTAL DECEMBER 31, 1998 ------- -------- -------- ---------- ------- -------- EARNING ASSETS (RATE SENSITIVE): Federal funds sold.............. $ 3,200 $ 3,200 Interest-bearing deposits with other banks.................. 90 $ 196 286 Investment securities........... 96 $ 297 878 $32,267 $ 8,213 41,751 Loans, gross of allowance for possible losses.............. 48,928 2,167 4,735 38,154 17,124 111,108 ------- ------- -------- ------- ------- -------- Total................... 52,314 2,464 5,809 70,421 25,337 156,345 ------- ------- -------- ------- ------- -------- INTEREST-BEARING LIABILITIES (RATE SENSITIVE): Interest-bearing transaction deposits..................... 41,182 51,309 92,491 Time deposits, $100,000 or more......................... 4,682 3,620 3,620 700 12,622 Savings and other time deposits..................... 3,187 483 4,585 2,748 11,003 Other borrowings................ 356 356 ------- ------- -------- ------- ------- -------- Total................... 8,225 4,103 49,387 54,757 116,472 ------- ------- -------- ------- ------- -------- Period GAP........................ $44,089 $(1,639) $(43,578) $15,664 $25,337 ======= ======= ======== ======= ======= Cumulative GAP.................... $44,089 $42,450 $ (1,128) $14,536 $39,873 ======= ======= ======== ======= ======= Interest Sensitivity GAP Ratio.... 84.28% (66.52)% (750.18)% 22.24% 100.00% ======= ======= ======== ======= ======= Cumulative Interest Sensitivity... 84.28% 77.49% (1.86)% 11.10% 25.50% ======= ======= ======== ======= =======
The Company classifies its interest-bearing transaction accounts and savings accounts into the over 180 days to 365 days time period as well as the after one year to five years time period. This is done to adjust for the relative insensitivity of these accounts to changes in interest rates. Although rates on these accounts can be contractually reset at the Company's discretion, historically these accounts have not demonstrated strong correlations to changes in the prime rate. Generally, a positive gap at one year indicates that net interest income and the net interest margin will increase if interest rates rise in the future. A negative gap at one year indicates that net interest income and the net interest margin will decrease if interest rates rise in the future. The Company neither currently utilizes financial derivatives to hedge its asset/liability position nor has any plans to employ such strategies in the near future. 19 22 The maturities and weighted average yields of investment securities are presented in the following table: MATURITIES OF INVESTMENT SECURITIES AT DECEMBER 31, 1998 (AT BOOK VALUE)
AFTER 5 YEARS AFTER 1 YEAR WITHIN WITHIN 1 YEAR WITHIN 5 YEARS 10 YEARS TOTAL -------------- --------------- -------------- --------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD ------ ----- ------- ----- ------ ----- ------- ----- (DOLLARS IN THOUSANDS) Mortgage-backed securities(1)...... $1,172 5.76% $ 1,172 5.76% U.S. Treasury and other U.S. government agencies.............. $30,296 5.47% $8,212 5.43% 38,508 5.46 Corporate securities............... 1,971 6.32 1,971 6.32 States and municipalities(2)....... 100 6.48 100 6.48 ------ ---- ------- ---- ------ ---- ------- ---- Total.................... $1,272 5.82% $32,267 5.52% $8,212 5.43% $41,751 5.51% ====== ==== ======= ==== ====== ==== ======= ====
- --------------- (1) Mortgage securities are shown at stated maturities; however, these securities are subject to substantial prepayments which will accelerate actual maturities. (2) Weighted-average yield calculated on a tax equivalent basis using statutory rates. TIME CERTIFICATES, $100,000 AND OVER The following table sets forth the time remaining to maturity of the Company's time deposits in amounts of $100,000 or more (dollar amounts in thousands):
DECEMBER 31, 1998 TIME REMAINING TO MATURITY ----------------- Three months or less................................. $ 4,682 After three months to six months..................... 3,620 After six months to one year......................... 3,620 After twelve months.................................. 700 ------- Total...................................... $12,622 =======
MATURITIES OF LOANS AT DECEMBER 31, 1998
FIXED RATE ADJUSTABLE RATE TOTAL TIME REMAINING TO MATURITY ---------- --------------- -------- One year or less..................................... $ 8,601 $21,273 $ 29,874 After one year to five years......................... 38,500 8,742 47,242 After five years..................................... 16,817 17,175 33,992 ------- ------- -------- Total...................................... $63,918 $47,190 $111,108 ======= ======= ========
As of December 31, 1998, the percentage of loans held for investment with fixed and floating interest rates was 58% and 42%, respectively. The following table provides typical terms of maturity ranges offered by the Company for each loan category indicated:
TYPICAL TERM IN YEARS LOAN CATEGORY --------------------- Commercial Loans.................................. 1 to 3 Real Estate Loans: Commercial...................................... 5 Construction.................................... 1 Land............................................ 1 Home Equity....................................... 5 Loans to Consumers and Individuals................ 1 to 5
20 23 CAPITAL RESOURCES. The principal source of capital for the Company is and will continue to be the retention of operating profits. Total shareholders' equity was $13.1 million as of December 31, 1998 compared to $12.0 million a year earlier. During 1994, the Board of Directors approved a stock repurchase program authorizing open market and private purchases of up to $500,000 of the Company's common stock in order to enhance long term stockholder value. The 1994 repurchase program was completed during 1998 with 45,492 shares repurchased for a total purchase price of $395,000. In October, 1998, the Board of Directors authorized the Company to repurchase an additional $500,000 of the Company's common stock in addition to the $500,000 authorized pursuant to the repurchase program announced in 1994. As of December 31, 1998, 46,664 shares had been repurchased under this additional repurchase program for a total purchase price of $452,000. Regulatory authorities have established minimum capital adequacy guidelines requiring that qualifying capital be 8% of risk-based assets, of which at least 4% must be tier 1 capital (primarily shareholders' equity). As of December 31, 1998, the Company's qualifying capital was 11.1%, of which the tier 1 capital ratio was 10.2%. In addition, the Company, under the guidelines established for adequately capitalized institutions, must also maintain a minimum leverage ratio (tier 1 capital divided by total assets) of 4%. As of December 31, 1998, the Company's leverage ratio was 7.3%. 21 24 ITEM 7. FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1998
1997 1998 -------- -------- (DOLLAR AMOUNTS IN THOUSANDS) ASSETS Cash and due from banks..................................... $ 6,557 $ 8,804 Federal funds sold.......................................... 4,900 3,200 -------- -------- Total cash and cash equivalents................... 11,457 12,004 Interest-bearing deposits with banks........................ 286 286 Investment securities available for sale at fair value...... 10,314 36,023 Investment securities held to maturity; fair values of $25,197 in 1997 and $6,081 in 1998........................ 25,242 6,055 Loans held for investment (net of allowance for possible credit losses of $1,007 in 1997 and $1,117 in 1998) (Notes 3 and 7).................................................. 87,179 109,958 Premises and equipment -- net (Note 4)...................... 2,586 2,431 Accrued interest receivable................................. 1,070 1,152 Deferred income taxes....................................... 568 547 Other assets................................................ 1,175 1,040 -------- -------- Total assets...................................... $139,877 $169,496 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits: Noninterest-bearing.................................... $ 29,151 $ 38,788 Interest-bearing: Transaction accounts................................. 75,488 92,491 Time certificates, $100,000 and over................. 11,565 12,622 Savings and other time deposits...................... 9,928 11,003 -------- -------- Total interest-bearing deposits................... 96,981 116,116 -------- -------- Total deposits.................................... 126,132 154,904 Other borrowings.......................................... 750 356 Accrued interest payable and other liabilities (Note 9)... 1,028 1,154 -------- -------- Total liabilities................................. 127,910 156,414 -------- -------- Commitments and contingencies (Notes 9 and 10) Shareholders' equity: Preferred stock, no par value: authorized 20,000,000 shares; none issued or outstanding Common stock, no par value: authorized 20,000,000 shares; issued 2,054,715 shares in 1997 and 1,994,316 shares in 1998 outstanding 2,054,715 shares in 1997 and 1,989,016 shares in 1998......................................... 10,310 9,578 Accumulated other comprehensive income, net of income taxes.................................................. 1 191 Retained earnings......................................... 1,656 3,313 -------- -------- Total shareholders' equity........................ 11,967 13,082 -------- -------- Total liabilities and shareholders' equity........ $139,877 $169,496 ======== ========
See notes to consolidated financial statements. 22 25 CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
1996 1997 1998 ---------- ---------- ---------- IN THOUSANDS, EXCEPT PER SHARE AMOUNTS Interest Income: Loans, including fees..................................... $ 7,736 $ 8,638 $10,559 Federal funds sold........................................ 233 356 473 Investment securities..................................... 2,416 2,506 2,173 ------- ------- ------- Total interest income............................. 10,385 11,500 13,205 ------- ------- ------- Interest Expense: Interest-bearing transaction, savings and other time deposits............................................... 3,489 3,671 3,922 Time certificates, $100,000 and over...................... 496 554 664 Other interest............................................ 33 28 24 ------- ------- ------- Total interest expense............................ 4,018 4,253 4,610 ------- ------- ------- Net Interest Income......................................... 6,367 7,247 8,595 Provision for Possible Credit Losses (Note 3)............... 220 120 153 ------- ------- ------- Net Interest Income After Provision for Possible Credit Losses.................................................... 6,147 7,127 8,442 Other Income: Gain on sale of loans..................................... 398 146 151 Service fees on deposit accounts.......................... 390 494 522 Loan servicing fees....................................... 21 34 45 Gain on sale of investment securities available for sale................................................... 53 Recovery of litigation expenses (Note 9).................. 1,824 Other..................................................... 135 165 238 ------- ------- ------- Total other income................................ 2,768 839 1,009 ------- ------- ------- Other Expenses: Salaries and employee benefits............................ 3,120 3,011 3,646 Occupancy expense......................................... 724 774 864 Furniture and equipment expense........................... 388 322 414 Professional services..................................... 202 365 310 Supplies.................................................. 236 212 294 Promotional expenses...................................... 233 202 361 Data processing fees...................................... 276 354 323 Regulatory assessments.................................... 46 61 58 Other..................................................... 340 372 433 ------- ------- ------- Total other expenses.............................. 5,565 5,673 6,703 ------- ------- ------- Income Before Income Taxes.................................. 3,350 2,293 2,748 Income Tax Provision (Note 6)............................... 1,379 943 1,127 ------- ------- ------- Net Income.................................................. $ 1,971 $ 1,350 $ 1,621 ======= ======= ======= Basic Earnings Per Share (Note 14).......................... $ 1.00 $ 0.67 $ 0.79 ======= ======= ======= Diluted Earnings Per Share (Note 14)........................ $ 0.99 $ 0.64 $ 0.74 ======= ======= =======
See notes to consolidated financial statements. 23 26 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
1996 1997 1998 ------ ------ ------ (IN THOUSANDS) Net Income.................................................. $1,971 $1,350 $1,621 Other comprehensive income Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period, net of tax................................... (55) 46 159 Less: reclassification adjustment for gains included in net income, net of tax............................... 31 ------ ------ ------ Other comprehensive income (loss)......................... (55) 46 190 ------ ------ ------ Comprehensive income...................................... $1,916 $1,396 $1,811 ====== ====== ======
See notes to consolidated financial statements. 24 27 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
ACCUMULATED OTHER RETAINED COMMON STOCK COMPREHENSIVE EARNINGS ------------------- INCOME (ACCUMULATED SHARES AMOUNT (LOSS) DEFICIT) TOTAL --------- ------- ------------- ------------ ------- (DOLLAR AMOUNTS IN THOUSANDS) Balance, December 31, 1995............... 1,796,283 8,909 10 (648) 8,271 Net income............................. 1,971 1,971 Other comprehensive loss, net of taxes............................... (55) (55) Dividends on common stock (5%) Cash payment........................ (2) (2) Stock issued........................ 89,036... 489 (489) --------- ------- ---- ------ ------- Balance, December 31, 1996............... 1,885,319.. 9,398 (45) 832 10,185 Net income............................. 1,350 1,350 Other comprehensive income, net of taxes............................... 46 46 Dividends on common stock (5%) Cash payment........................ (2) (2) Stock issued........................ 95,428... 591 (591) Common stock issued upon exercise of stock options....................... 73,968 321 321 Tax benefit of stock options exercised... 67 67 --------- ------- ---- ------ ------- Balance, December 31, 1997............... 2,054,715 $10,310 $ 1 $1,656 $11,967 Net income............................. 1,621 1,621 Other comprehensive income, net of taxes............................... 190 190 Common stock issued upon exercise of stock options....................... 26,457 115 115 Purchases of common stock.............. (92,156) (847) (847) Tax benefit of stock options exercised... 36 36 --------- ------- ---- ------ ------- Balance, December 31, 1998............... 1,989,016 $ 9,578 $191 $3,313 $13,082 ========= ======= ==== ====== =======
See notes to consolidated financial statements. 25 28 CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
1996 1997 1998 -------- -------- -------- (DOLLAR AMOUNTS IN THOUSANDS) Cash Flows From Operating Activities: Net income................................................ $ 1,971 $ 1,350 $ 1,621 Adjustments to reconcile net income to net cash provided by operating activities: Originations of loans for sale.......................... (29,865) Settlement of mortgage loans sold....................... 32,733 648 Provision for possible credit losses.................... 220 120 153 Depreciation and amortization........................... 498 318 479 Gain on sale of investment securities................... (53) Recovery of litigation expenses......................... (1,800) Change in deferred income taxes......................... 902 28 (32) (Increase) in accrued interest receivable............... (20) (67) (82) Decrease (increase) in other assets..................... 2,334 (199) 124 (Decrease) increase in accrued interest payable and other liabilities..................................... (1,972) 90 96 -------- -------- -------- Net cash provided by operating activities.......... 5,001 2,288 2,306 -------- -------- -------- Cash Flows From Investing Activities: Held to maturity securities: Maturities.............................................. 3,000 Calls................................................... 8,000 7,500 21,250 Purchases............................................... (19,239) (7,000) (2,055) Available for sale securities: Maturities.............................................. 13,171 5,127 3,046 Calls................................................... 4,000 1,000 Purchases............................................... (1,000) (10,012) (30,642) Sales................................................... 1,206 Decrease in interest-bearing deposits with banks.......... 885 98 Net (increase) in loans held for investment............... (21,730) (7,178) (22,932) Purchases of premises and equipment....................... (102) (641) (278) -------- -------- -------- Net cash used by investing activities.............. (17,015) (8,106) (29,405) -------- -------- -------- Cash Flows From Financing Activities: Net increase in noninterest-bearing demand deposits....... 4,507 2,885 9,637 Net increase in interest-bearing transaction, savings and other time deposits..................................... 5,088 3,389 19,135 Net increase (decrease) in other borrowings............... 234 303 (394) Cash dividends paid....................................... (2) (2) Proceeds from the exercise of stock options............... 321 115 Purchases of common stock................................. (847) -------- -------- -------- Net cash provided by financing activities.......... 9,827 6,896 27,646 -------- -------- -------- Net (Decrease) Increase in Cash and Cash Equivalents........ (2,187) 1,078 547 -------- -------- -------- Cash and Cash Equivalents: Beginning of year......................................... 12,566 10,379 11,457 -------- -------- -------- End of year............................................... $ 10,379 $ 11,457 $ 12,004 ======== ======== ======== Cash Paid During the Year for: Interest on deposits and other borrowings................. $ 4,134 $ 4,217 $ 4,648 ======== ======== ======== Income taxes.............................................. $ 250 $ 1,111 $ 976 ======== ======== ======== Noncash Investing and Financing Activities: Stock dividends paid on common stock...................... $ 489 $ 591 ======== ========
See notes to consolidated financial statements. 26 29 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of MCB Financial Corporation (the "Company" on a consolidated basis) and its wholly owned subsidiary, Metro Commerce Bank (the "Bank"), conform to generally accepted accounting principles and general practice in the banking industry. The Company was incorporated in California on January 20, 1993 for the purpose of becoming a bank holding company registered under the Bank Holding Company Act of 1956. The following is a summary of the significant accounting policies and reporting methods used by the Company: NATURE OF OPERATIONS The Company operates four branches in the San Francisco Bay Area and one branch in Upland, California. The Company's primary source of revenue is providing loans to small and middle-market businesses. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. BASIS OF CONSOLIDATION The accompanying consolidated financial statements include the Company and its wholly owned subsidiary, the Bank. All intercompany amounts are eliminated in consolidation. CASH AND DUE FROM BANKS Cash and due from banks include balances with the Federal Reserve Bank. The Company is required by federal regulations to maintain certain minimum average balances with the Federal Reserve, based primarily on the Company's average daily deposit balances. At December 31, 1998, the Company had required balances and compensating balances with the Federal Reserve of $320,000. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. INVESTMENT SECURITIES The Company classifies its qualifying investments as trading, available for sale or held to maturity. Management has reviewed the securities portfolio and classified securities as either held to maturity or available for sale. The Company's policy of classifying investments as held to maturity is based upon its ability and management's intent to hold such securities to maturity. Securities expected to be held to maturity are carried at amortized historical cost. All other securities are classified as available for sale and are carried at fair value. Fair value is determined based upon quoted market prices . Unrealized gains and losses on securities available for sale are included in shareholders' equity on an after-tax basis. Gains and losses on dispositions of 27 30 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 investment securities are included in noninterest income and are determined using the specific identification method. LOANS Loans which are held for investment are stated at the principal amount outstanding, net of deferred loan origination fees and costs and the allowance for possible credit losses. Interest income is recognized using methods which approximate a level yield on principal amounts outstanding. The accrual of interest on loans is discontinued when the payment of principal or interest is considered to be in doubt, or when a loan becomes contractually past due by 90 days or more with respect to principal or interest, except for loans that are well secured and in the process of collection. Loan origination fees, net of certain related direct loan origination costs, are deferred and amortized as yield adjustments over the contractual lives of the underlying loans. SALE 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 the majority of the loans to an investor and retains the unguaranteed portion and servicing rights in its own portfolio. Funding for the SBA programs depend on annual appropriations by the U.S. Congress. 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. ALLOWANCE FOR POSSIBLE CREDIT LOSSES The allowance for possible credit losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in the loan portfolio and commitments to extend credit. The allowance is based upon management's continuing assessment of various factors affecting the collectibility of loans and commitments to extend credit, including current and projected economic conditions, past credit experience, the value of the underlying collateral, and such other factors as in management's judgment deserve current recognition in estimating potential credit losses. Loans deemed uncollectible are charged-off and deducted from the allowance, while subsequent recoveries are credited to the allowance. A loan is considered impaired when management determines that it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan agreement. Impaired loans are carried at the estimated present value of total expected future cash flows, discounted at the loan's effective rate, or the fair value of the collateral, if the loan is collateral dependent, if less than the recorded investment in the loan (including accrued interest, net deferred loan fees or costs and unamortized premium or discount). An impairment is recognized by adjusting an allocation of the existing allowance for credit losses. PREMISES AND EQUIPMENT Premises and equipment consist of leasehold improvements, furniture and equipment, and automobiles which are stated at cost, less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, primarily from three to thirty years. Leasehold improvements are amortized over the terms of the lease or their estimated useful lives, whichever is shorter. 28 31 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 STOCK-BASED COMPENSATION The Company accounts for stock-based awards to employees using the intrinsic value method as allowed under the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." INCOME TAXES The Company and its subsidiary file consolidated income tax returns. The Company provides a deferred tax expense or benefit equal to the net change in deferred tax assets and liabilities during the year. 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 amounts used for income tax purposes. STOCK SPLITS In February 1998, the Company's outstanding shares of common stock were split four-for-three. In August 1998, the Company's outstanding shares of common stock were split three-for-two. All shares and per share amounts reported have been restated to reflect the splits. COMPREHENSIVE INCOME The Company has adopted SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for all entities for reporting comprehensive income and its components in financial statements. This statement requires that all items which are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income is equal to net income plus the change in "other comprehensive income," as defined by SFAS No. 130. The only component of other comprehensive income currently applicable to the Company is the net unrealized gain or loss on available for sale investments. SFAS No. 130 requires that an entity: (a) classify items of other comprehensive income by their nature in a financial statement, and (b) report the accumulated balance of other comprehensive income separately from common stock and retained earnings in the equity section of the balance sheet. This statement is effective for financial statements issued for fiscal years beginning after December 15, 1997. NET INCOME PER COMMON SHARE Net income per common share is stated in accordance with SFAS No. 128, "Earnings per Share." Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the year. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares plus common equivalent shares outstanding including dilutive stock options. SEGMENT INFORMATION In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the company's reportable segments. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of SFAS No. 131 did not affect the results of operations, financial position or the disclosure of segment information. 29 32 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 DERIVATIVES AND HEDGING ACTIVITIES In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company formally document, designate and assess the effectiveness of transactions that receive hedge accounting. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after 6/15/99. Initial application of SFAS No. 133 would be as of the beginning of an entity's fiscal quarter. On that date, hedging relationships must be designated anew and documented pursuant to the provisions of SFAS No. 133. Earlier application of all of the provisions of SFAS No. 133 is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after issuance. SFAS No. 133 should not be applied retroactively to financial statements of prior periods. The Company has no derivative or hedged instruments and therefore the implementation of this statement is not expected to have a material impact on the Company's financial position or results of operations. RECLASSIFICATIONS Certain 1996 and 1997 amounts were reclassified to conform to the 1998 presentation. 30 33 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 2. INVESTMENT SECURITIES The amortized cost and approximate market value of investment securities at December 31 were as follows (dollar amounts in thousands):
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING COST GAINS LOSSES VALUE VALUE --------- ---------- ---------- --------- -------- 1998: Held to maturity securities: U.S. Government agencies......... $ 6,055 $ 26 $ $ 6,081 $ 6,055 ------- ---- ----- ------- ------- Total held to maturity...... 6,055 26 6,081 6,055 ------- ---- ----- ------- ------- Available for sale securities: U.S. Treasury.................... 15,206 214 (6) 15,414 15,414 U.S. Government agencies......... 17,247 137 (60) 17,324 17,324 Mortgage-backed securities....... 1,172 5 1,177 1,177 Corporate securities............. 1,971 36 2,007 2,007 Municipal bonds.................. 100 1 101 101 ------- ---- ----- ------- ------- Total available for sale.... 35,696 393 (66) 36,023 36,023 ------- ---- ----- ------- ------- Total investment securities................ $41,751 $419 $ (66) $42,104 $42,078 ======= ==== ===== ======= ======= 1997: Held to maturity securities: U.S. Government agencies......... $25,242 $ 44 $ (89) $25,197 $25,242 ------- ---- ----- ------- ------- Total held to maturity...... 25,242 44 (89) 25,197 25,242 Available for sale securities: U.S. Treasury.................... 5,004 29 5,033 5,033 U.S. Government agencies......... 1,000 (2) 998 998 Mortgage-backed securities....... 2,176 (30) 2,146 2,146 Corporate securities............. 1,992 5 (1) 1,996 1,996 Municipal bonds.................. 140 1 141 141 ------- ---- ----- ------- ------- Total available for sale.... 10,312 35 (33) 10,314 10,314 ------- ---- ----- ------- ------- Total investment securities................ $35,554 $ 79 $(122) $35,511 $35,556 ======= ==== ===== ======= =======
The following table shows the amortized cost and approximate fair value of investment securities by contractual maturity at December 31, 1998:
HELD TO MATURITY AVAILABLE FOR SALE ------------------- -------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------- ------ --------- ------- Within one year............................. $ 1,272 $ 1,278 After one but within five years............. $6,055 $6,081 26,212 26,356 Over five years............................. 8,212 8,389 ------ ------ ------- ------- Total............................. $6,055 $6,081 $35,696 $36,023 ====== ====== ======= =======
The Bank carries its Federal Reserve Bank stock and Federal Home Loan Bank stock as other assets. These securities are not covered by the provisions of SFAS No. 115 and are recorded at historical cost. The total carrying value at December 31, 1998 and 1997 was $709,000 and $678,000, respectively. 31 34 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 Mortgage-backed securities are classified, in the table above, based on final maturity dates. These securities are issued by the Federal National Mortgage Association, $849,000, ($1,284,000 in 1997), and the Federal Home Loan Mortgage Corporation, $328,000 ($862,000 in 1997), and may be prepaid at the option of the issuer. The Bank has purchased U.S. government agency securities totaling $6,055,000 that contain certain issuer call option features. These securities have a weighted average yield of 6.45% and may be called if interest rates fall below certain levels. If these securities are called the Company may not be able to reinvest the proceeds to obtain the same weighted average yield. Securities with an amortized cost of approximately $3,345,000 as of December 31, 1998, and $3,866,000 as of December 31, 1997, were pledged to secure other borrowings. In 1998, proceeds from the sale of investment securities available for sale totaled $1,206,000. Realized gains on these sales totaled $53,000. No sales of investment securities occurred during 1997 or 1996. 3. LOANS AND ALLOWANCE FOR POSSIBLE CREDIT LOSSES Loans at December 31, consisted of the following:
1997 1998 ------- -------- Commercial.............................................. $21,217 $ 22,504 Real estate: Commercial............................................ 57,385 72,603 Construction.......................................... 3,757 9,619 Land.................................................. 1,307 2,592 Home equity............................................. 2,314 1,703 Loans to consumers and individuals...................... 2,331 2,085 ------- -------- Total......................................... 88,311 111,108 Deferred loan fees...................................... (125) (33) Allowance for possible credit losses.................... (1,007) (1,117) ------- -------- Total......................................... $87,179 $109,958 ======= ========
The Company is principally engaged in commercial banking in the San Francisco Bay Area of California and Upland, California. The Company primarily grants commercial loans, the majority of which are secured by commercial properties. Although the Company has a diversified portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic sector of Northern California, including the real estate markets of the San Francisco Bay Area. Approximately 42% of the Company's loans have interest rates that are variable and tied to the prime rate, whereas the remaining are fixed rate loans. Following is a schedule of the activity in the allowance for possible credit losses on loans for the years ended December 31:
1996 1997 1998 ---- ------ ------ Balances, January 1................................ $752 $ 944 $1,007 Provision for possible credit losses............... 220 120 153 Loans charged-off.................................. (47) (108) (53) Recoveries......................................... 19 51 10 ---- ------ ------ Total.................................... $944 $1,007 $1,117 ==== ====== ======
32 35 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 At December 31, 1998 and 1997, the Company had nonperforming loans in the amounts of $967,000 and $109,000, respectively. Had these loans performed under their contractual terms, $34,000 and $6,000, respectively, in additional interest income would have been recognized during the year. At December 31, 1998, the nonperforming loans included three nonaccrual loans totaling $563,000 and two loans 90 days or more past due and still accruing totaling $404,000. These loans are well secured and in the process of collection. At December 31, 1998 and 1997, the Company had loans identified as impaired, in the aggregate amounts of $967,000 and $109,000, respectively. The Company provided no specific allowance for possible credit losses at December 31, 1998 and 1997 for these impaired loans since they were adequately collateralized. 4. PREMISES AND EQUIPMENT The components of premises and equipment at December 31, are as follows (dollar amounts in thousands):
1997 1998 ------- ------- Leasehold improvements................................... $ 2,071 $ 2,074 Furniture and equipment.................................. 2,025 2,293 Automobiles.............................................. 180 196 Construction in progress................................. 50 1 ------- ------- Total.......................................... 4,326 4,564 Less accumulated depreciation and amortization........... (1,740) (2,133) ------- ------- Premises and equipment, net.............................. $ 2,586 $ 2,431 ======= =======
The amount of depreciation and amortization was $433,000 in 1998, $333,000 in 1997 and $375,000 in 1996. 5. DEPOSITS The aggregate amount of short-term jumbo CD's, each with a minimum denomination of $100,000, was approximately $11,922,000 and $11,265,000 in 1998 and 1997, respectively. At December 31, 1998, the scheduled maturities of CDs are as follows: 1999....................................................... $20,064 2000....................................................... 549 2001....................................................... 549 2002....................................................... 60 2003....................................................... 213 ------- Total............................................ $21,435 =======
33 36 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 6. INCOME TAXES The components of the provision for income taxes for the years ended December 31 are as follows (dollar amounts in thousands):
1996 1997 1998 ------ ---- ------ Current payable: Federal.......................................... $ 362 $672 $ 867 State............................................ 115 243 292 ------ ---- ------ Total current payable.................... 477 915 1,159 Deferred: Federal.......................................... 634 17 (37) State............................................ 268 11 5 ------ ---- ------ Total deferred........................... 902 28 (32) ------ ---- ------ Total.................................... $1,379 $943 $1,127 ====== ==== ======
A reconciliation of the statutory federal income tax rates with the Company's effective income tax rates is as follows:
1996 1997 1998 ---- ---- ---- Statutory federal tax rate......................... 34.0% 34.0% 34.0% State income taxes, net of federal income tax benefit.......................................... 7.5 7.1 7.1 Municipal interest................................. (0.1) (0.1) (0.1) Other.............................................. (0.2) 0.1 ---- ---- ---- Effective tax rate................................. 41.2% 41.1% 41.0% ==== ==== ====
Deferred income taxes reflect the impact of "temporary differences" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. Temporary differences and carryforwards which give rise to deferred tax assets and liabilities are as follows (dollar amounts in thousands):
DECEMBER 31, ------------ 1997 1998 ---- ---- Deferred tax assets: Net operating loss carryforwards.......................... $329 $294 Reserves not currently deductible......................... 384 397 Unrealized loss on securities available for sale.......... 1 State income taxes........................................ 45 72 Other..................................................... 102 ---- ---- Total............................................. 759 865 Deferred tax liabilities: Tax over book depreciation................................ 158 182 Unrealized gain on securities available for sale.......... 136 Other..................................................... 33 ---- ---- Total............................................. 191 318 ---- ---- Net deferred tax asset...................................... $568 $547 ==== ====
34 37 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 The Company has acquired net operating loss carryforwards ("NOL") in connection with the acquisition of the Bank of Hayward in 1994. The utilization of NOLs acquired through acquisition is limited by certain state and federal tax laws. The Company has determined that the annual limitation on its ability to utilize NOLs is $78,130 for the fifteen-year period. The following table presents the NOLs (after limitation) at December 31, 1998, by expiration date:
EXPIRATION DATE FEDERAL AMOUNT STATE AMOUNT --------------- -------------- ------------ December 31, 2004................................ $354 December 31, 2005................................ 126 December 31, 2006................................ 11 December 31, 2007................................ 180 $ 28 December 31, 2008................................ 78 5 December 31, 2009................................ 329
The Company reduced its 1998 federal and state current tax liability by approximately $27,000 and $9,000 by utilizing $78,130 in net operating loss carryforwards. 7. RELATED PARTY TRANSACTIONS In the ordinary course of business, the Company has made loans and advances under lines of credit to directors and their related interests. All such loans and advances were made under terms that are consistent with the Company's normal lending policies. At December 31, 1998, loans outstanding to related parties were $2,547,000 and loan commitments to related parties amounted to $3,010,000. 8. STOCK OPTION PLAN The Company has a Stock Option Plan (the "Plan") for certain of its directors, organizers and key employees under which up to 475,508 shares of common stock have been authorized to be granted. Up to 10% of the number of outstanding shares of the Company's common stock is available for granting solely to the directors and organizers of the Company, provided, however, that the sum of all shares granted to directors, organizers and key employees of the Company does not exceed the maximum number of options that may be granted by the Plan. Under the Plan, options may not be granted at a price less than the fair market value at the date of grant. Options for key employees are exercisable as determined at the sole discretion of the Stock Option Plan Committee (the "Committee"), but not exceeding 10 years from the date of grant. All options granted to nonemployee directors of the Company are nonstatutory options that have a term of 10 years. Furthermore, 20% of the nonstatutory options granted to a director are immediately vested and exercisable, and the remainder of the options vest at 20% annually for each of the four years from the date of grant. Each option granted to an organizer is exercisable as determined at the sole discretion of the Committee, but not exceeding five years from the date of grant. 35 38 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 The following is a summary of changes in options outstanding:
WEIGHTED NUMBER AVERAGE OF EXERCISE SHARES PRICE ------- -------- Outstanding at January 1, 1996 (243,628 exercisable at a weighted average price of $4.32).............................................. 337,475 $ 4.31 Granted (weighted average fair value of $1.65)........... 23,151 3.73 Canceled................................................. (30,871) 4.08 ------- ------ Outstanding at December 31, 1996 (278,342 exercisable at a weighted average price of $4.33).............................................. 329,755 4.29 Granted (weighted average fair value of $3.11)........... 21,255 7.16 Exercised................................................ (75,107) 4.27 Canceled................................................. (4,407) 4.99 ------- ------ Outstanding at December 31, 1997 (223,636 exercisable at a weighted average price of $4.39).............................................. 271,496 4.51 Granted (weighted average fair value of $4.61)........... 10,250 10.21 Exercised................................................ (26,457) 4.38 ------- ------ Outstanding at December 31, 1998......................... 255,289 $ 4.75 ======= ======
Additional information regarding options outstanding as of December 31, 1998 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ----------------------------------------------------------------- ---------------------------- REMAINING WEIGHTED WEIGHTED RANGE OF NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING LIFE(YRS.) EXERCISE PRICE EXERCISABLE EXERCISE PRICE - --------------------- ----------- ----------- -------------- ----------- -------------- $3.40 -- $ 4.31 146,638 4.2 $ 4.08 128,998 $ 4.11 4.53 -- 5.71 76,889 1.5 4.61 73,739 4.56 5.89 -- 7.63 21,512 7.9 7.18 11,912 6.82 9.50 -- 12.08 10,250 9.6 10.21 2,050 10.21 ------- ------- $3.40 -- $12.08 255,289 3.9 $ 4.75 216,699 $ 4.47 ======= =======
At December 31, 1998, 87,299 options were available for future grants under the Plan. ADDITIONAL STOCK OPTION PLAN INFORMATION The Company continues to account for its stock-based awards using the intrinsic value method in accordance with Accounting Principles Board No. 25, Accounting for Stock Issued to Employees and its related interpretations. Accordingly, no compensation expense has been recognized in the financial statements for employee stock arrangements. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (SFAS 123) requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, 36 months following full vesting; stock 36 39 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 volatility, 34% in 1998, 25% in 1997 and 26% in 1996; risk free interest rates, 4.7% in 1998, 6.5% in 1997 and 6.5% in 1996; and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the 1995 -- 1998 awards had been amortized to expense over the vesting period of the awards, pro forma net income would have been as follows (dollar amounts in thousands, except per share amounts):
YEARS ENDED DECEMBER 31, -------------------------- 1996 1997 1998 ------ ------ ------ Net Income: As reported.................................... $1,971 $1,350 $1,621 Pro forma...................................... 1,958 1,329 1,594 Basic earnings per share: As reported.................................... $ 1.00 $ 0.67 $ 0.79 Pro forma...................................... 0.99 0.66 0.78 Diluted earnings per share: As reported.................................... $ 0.99 $ 0.64 $ 0.74 Pro forma...................................... 0.98 0.63 0.73
9. COMMITMENTS AND CONTINGENCIES The Bank leases its premises under noncancelable operating leases expiring through June 30, 2014 with options to extend the leases for two additional five-year terms. Future minimum lease commitments are $653,000 in 1999, $634,000 in 2000, $433,000 in 2001, $430,000 in 2002, $442,000 in 2003 and $3,033,000, thereafter. Rental expense for premises under operating leases included in occupancy expense was $583,000, $506,000 and $464,000 in 1998, 1997 and 1996, respectively. There are various legal actions pending against the Company arising from the normal course of business. Management, upon the advice of legal counsel handling such actions, believes that the ultimate resolution of these actions will not have a material effect on the financial position or results of operations of the Company. In September 1992, Chino Valley Bank filed a lawsuit against Metro Commerce alleging that Metro Commerce and its Chief Executive Officer, John Cavallucci, had engaged in unfair competition with Chino Valley Bank. In June 1995, a jury rendered a verdict in favor of Chino Valley Bank and against Metro Commerce and Mr. Cavallucci in the amount of $795,000. Subsequently during 1995 Metro Commerce established a legal contingency reserve of $2.8 million, based on the amount of the jury verdict, the legal costs expected to be incurred by Metro Commerce, and the possibility of an award of attorneys' fees to the plaintiff. In addition, Metro Commerce agreed to indemnify Mr. Cavallucci for the amount of his personal liability to Chino Valley Bank, and Metro Commerce and Mr. Cavallucci reached an agreement with Metro Commerce's directors and officers liability insurance carrier pursuant to which the carrier agreed to pay $1.2 million of the amounts awarded to Chino Valley Bank. In February 1996, the trial court awarded Chino Valley Bank costs and attorneys' fees in the amount of $1,327,438. Subsequently, in March 1996 Metro Commerce and Mr. Cavallucci entered into a settlement agreement with Chino Valley Bank pursuant to which the parties agreed to settle all claims upon the payment of $2,100,000 to Chino Valley Bank. As a result of the settlement agreement with Chino Valley Bank and the separate settlement with Metro Commerce's insurance carrier, Metro Commerce recovered and reversed approximately $1.8 million from the legal contingency reserve during the first quarter of 1996. This recovery reflects the final settlement of this matter. 37 40 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Bank is a party to various financial instruments with on-balance sheet and off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Financial instruments include commitments to extend credit, standby letters-of-credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters-of-credit and financial guarantees is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Bank controls the credit risk of these transactions through credit approvals, credit limits and monitoring procedures. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies, but may include marketable securities, accounts receivable, inventory, property, plant and equipment. Standby letters-of-credit and financial guarantees are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. Most guarantees extend for less than five years and expire in decreasing amounts. The credit risk involved in issuing letters-of-credit is essentially the same as that involved in extending loan facilities to customers. The following table summarizes these financial instruments and other commitments and contingent liabilities at December 31 (dollar amounts in thousands):
1997 1998 ------- ------- Financial instruments whose credit risk is represented by contract amounts: Commitments to extend credit -- loans.................. $21,417 $26,612 Standby letters-of-credit and financial guarantees..... 800 621 ------- ------- Total.......................................... $22,217 $27,233 ======= =======
38 41 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value amounts of financial instruments have been determined using the available market information and appropriate valuation methodologies consistent with the requirements of SFAS No. 107, Disclosures about Fair Value of Financial Instruments. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Bank could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
DECEMBER 31, 1998 ---------------------- CARRYING ESTIMATED AMOUNT FAIR VALUE -------- ---------- Financial assets: Cash and due from banks.............................. $ 8,804 $ 8,804 Federal funds sold................................... 3,200 3,200 Interest-bearing deposits with banks................. 286 286 Available for sale securities........................ 36,023 36,023 Held to maturity securities.......................... 6,055 6,081 Loans, net........................................... 109,958 109,029 Financial liabilities: Noninterest-bearing deposits......................... 38,788 38,788 Interest-bearing deposits............................ 116,116 116,326 Other borrowings..................................... 356 356
DECEMBER 31, 1997 ---------------------- CARRYING ESTIMATED AMOUNT FAIR VALUE -------- ---------- Financial assets: Cash and due from banks............................... $ 6,557 $ 6,557 Federal funds sold.................................... 4,900 4,900 Interest-bearing deposits with banks.................. 286 286 Available for sale securities......................... 10,314 10,314 Held to maturity securities........................... 25,242 25,197 Loans, net............................................ 87,179 86,862 Financial liabilities: Noninterest-bearing deposits.......................... 29,151 29,151 Interest-bearing deposits............................. 96,981 97,004 Other borrowings...................................... 750.... 750
The following methods and assumptions were used to estimate the fair value of each class of financial instrument: SHORT-TERM FINANCIAL ASSETS -- This category includes cash and due from banks, federal funds sold and interest-bearing deposits with banks. Because of their relatively short maturities, the fair value of these financial instruments is considered to be equal to book value. AVAILABLE-FOR-SALE AND HELD-TO-MATURITY SECURITIES -- Fair value is quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar instruments. 39 42 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 LOANS -- The fair value of floating rate loans is deemed to approximate book value. The fair value of all other performing loans is determined by discounting expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. In addition to the above, the allowance for credit losses is considered a reasonable adjustment for credit risk relating to the entire credit portfolio, including obligations to extent credit and other off-balance-sheet transactions. DEPOSITS -- The fair value of demand, savings and money market deposits is equal to the amount payable on demand at the reporting date. For other types of deposits with fixed maturities, fair value is estimated by discounting contractual cash flows at interest rates currently being offered on deposits with similar characteristics and maturities. A fair value for the deposits base intangible has not been estimated. OTHER BORROWINGS -- The fair value of the other borrowings is determined by discounting contractual cash flows at current market interest rates for similar instruments. OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS -- The Company has not estimated the fair value of off-balance-sheet commitments to extend credit, standby letters of credit and financial guarantees. Because of the uncertainty involved in attempting to assess the likelihood and timing of a commitment being drawn upon, coupled with the lack of an established market and the wide diversity of fee structures, the Company does not believe it is practicable to provide a meaningful estimate of fair value. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1998. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. Management does not intend to dispose of a significant portion of its financial instruments. 12. REGULATORY MATTERS The Company and Bank are subject to various regulations issued by Federal banking agencies, including minimum capital requirements. Failure to meet minimum regulatory capital requirements could result in regulators requiring prompt corrective action to be taken which could have a material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company's and Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and Bank's capital amounts and classifications are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total and tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of tier 1 capital (as defined) to average assets (as defined). As of December 31, 1998 and 1997, the most recent notification from the regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, tier 1 risk-based, and tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institutions's category. 40 43 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 The Company and Bank's actual capital amounts and ratios are also presented below (dollar amounts in thousands):
1998 FOR CAPITAL REQUIRED TO BE ACTUAL ADEQUACY PURPOSES WELL CAPITALIZED ---------------- ------------------ ------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------- ----- ------- ------ --------- ------ Total Capital (to risk weighted assets) Company................ $13,728 11.1% $9,918 8.0% n/a Bank........................... 13,359 10.8% 9,911 8.0% *=$12,388 *=10.0% Tier 1 Capital (to risk weighted assets) Company................ 12,611 10.2% 4,959 4.0% n/a Bank........................... 12,242 9.9% 4,955 4.0% *=7,433 *=6.0% Tier 1 Capital (to average assets) Company................ 12,611 7.3% 6,870 4.0% n/a Bank........................... 12,242 7.1% 6,866 4.0% *=8,583 *=5.0%
1997 FOR CAPITAL REQUIRED TO BE ACTUAL ADEQUACY PURPOSES WELL CAPITALIZED ---------------- ------------------ ------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------- ----- ------- ------ --------- ------ Total Capital (to risk weighted assets) Company................ $12,691 12.4% $8,160 8.0% n/a Bank........................... 12,072 11.8% 8,160 8.0% *=$10,200 *=10.0% Tier 1 Capital (to risk weighted assets) Company................ 11,684 11.5% 4,080 4.0% n/a Bank........................... 11,065 10.9% 4,080 4.0% *=6,120 *=6.0% Tier 1 Capital (to average assets) Company................ 11,684 8.1% 5,795 4.0% n/a Bank........................... 11,065 7.6% 5,795 4.0% *=7,243 *=5.0%
Management believes, as of December 31, 1998, that the Bank meets all capital requirements to which it is subject. The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 1998, the Bank had available $3,461,000 for the payment of dividends. The Bank paid $500,000 in dividends during 1998. The Bank is subject to certain restrictions under the Federal Reserve Act, including restrictions on the extension of credit to affiliates. In particular, the Company is prohibited from borrowing from the Bank 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 on a per affiliate basis. There were no such extensions of credit by the Bank in 1998 and 1997. 13. EMPLOYEE BENEFIT PLAN In 1991 the Company approved a defined contribution plan covering all eligible salaried employees. Employees may, up to prescribed limits, contribute to the plan. The Company may also elect to make discretionary contributions to the plan based on the Company's earnings. No contributions were made by the Company in 1998 or 1997. 41 44 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 In 1994 the Company established a Deferred Compensation Plan for Executives. Participation in the Plan is limited to a select group of management and other employees as determined by the Board of Directors. Under the terms of the Plan, participants may defer a portion of their cash compensation and receive minimum 50% matching contributions from the Company, which vest over the employee's remaining years of employment to retirement. The Company has guaranteed participants a certain minimum return on their contributions and on the Bank's matching contributions. Contributions made by the Company for the years ended December 31, 1998, 1997 and 1996 were $39,000, $12,000 and $15,000, respectively. 14. EARNINGS PER SHARE The following table reconciles the numerators and the denominators of the basic and diluted per share computations in accordance with SFAS No. 128 (in thousands, except per share amounts):
YEARS ENDED DECEMBER 31, ----------------------------------------------------------------------------------------------- 1996 1997 1998 --------------------------------------- --------------------------------------- ----------- INCOME SHARES PER SHARE INCOME SHARES PER SHARE INCOME (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) ----------- ------------- --------- ----------- ------------- --------- ----------- BASIC EPS Income available to common shareholders............... $1,971 1,980 $1.00 $1,350 2,013 $0.67 $1,621 EFFECT OF DILUTIVE SECURITES Stock options............... 10 91 ------ ----- ----- ------ ----- ----- ------ DILUTED EPS Income available to common shareholders plus assumed conversions................ $1,971 1,990 $0.99 $1,350 2,104 $0.64 $1,621 ====== ===== ===== ====== ===== ===== ====== YEARS ENDED DECEMBER 31, ------------------------- 1998 ------------------------- SHARES PER SHARE (DENOMINATOR) AMOUNT ------------- --------- BASIC EPS Income available to common shareholders............... 2,055 $0.79 EFFECT OF DILUTIVE SECURITES Stock options............... 139 ----- ----- DILUTED EPS Income available to common shareholders plus assumed conversions................ 2,194 $0.74 ===== =====
42 45 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 15. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION The condensed financial information for MCB Financial Corporation (parent company only) at December 31, 1997 and 1998, and the results of its operations and cash flows for the years then ended, is summarized as follows (dollar amounts in thousands):
1997 1998 ------- ------- FINANCIAL CONDITION: Assets: Cash and due from banks............................. $ 603 $ 264 Investment in the Bank.............................. 11,348 12,713 Other............................................... 17 105 ------- ------- Total.......................................... $11,968 $13,082 ======= ======= Liabilities and shareholders' equity: Other liabilities...................................... $ 1 Shareholders' equity: Common stock........................................ 10,310 $ 9,578 Unrealized gain on investment securities available for sale -- net................................... 1 191 Retained earnings................................... 1,656 3,313 ------- ------- Total shareholders' equity..................... 11,967 13,082 ------- ------- Total.......................................... $11,968 $13,082 ======= ======= RESULTS OF OPERATIONS: Dividend income from Bank................................ $ 138 $ 500 Income -- interest from loans............................ 5 Income -- interest from investments...................... 14 26 Income -- miscellaneous.................................. 1 Expenses -- general and administrative................... 62 140 ------- ------- Income (loss) before equity in net income of the Bank.... 90 392 Equity in undistributed net income of the Bank........... 1,236 1,176 ------- ------- Income before income tax provision....................... 1,326 1,568 Income tax benefit....................................... 24 53 ------- ------- Net income............................................... $ 1,350 $ 1,621 ======= ======= CASH FLOWS: Cash flows from operating activities: Net income............................................. $ 1,350 $ 1,621 Reconciliation to cash used in operating activities: (Increase) in equity in undistributed net income of Bank.............................................. (1,375) (1,675) Amortization........................................ 14 11 Decrease in other assets............................ 86 29 Decrease in accrued interest payable and other liabilities....................................... (1) ------- ------- Cash provided (used in) operating activities........ 75 (15) Cash flows from investing activities: Dividend received from Bank............................ 138 500 Net (increase) in loans held for investment............ (92) ------- ------- Cash provided by investing activities.................. 138 408
43 46 MCB FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
1997 1998 ------- ------- Cash flows from financing activities: Proceeds from the exercise of stock options............ 321 115 Cash dividends paid.................................... (2) Purchases of common stock.............................. (847) ------- ------- Cash provided (used in) financing activities........... 319 (732) Net increase in cash and equivalents..................... 532 (339) Cash and equivalents: Beginning of period.................................... 71 603 End of period.......................................... $ 603 $ 264
16. SUBSEQUENT EVENT In January, 1999 the Company adopted a shareholder rights plan designed to maximize the long-term value of the Company and to protect the Company's shareholders from improper takeover tactics and takeover bids that are not fair to all shareholders. In accordance with the plan, preferred share purchase rights were distributed as a dividend at the rate of one right for each common share held of record as of the close of business on February 8, 1999. The rights, which are not immediately exercisable, entitle the holders to purchase one one-hundredth of a share of the Company's Series A Junior Participating Preferred Stock at a price of $37.00 subject to adjustment (the "Purchase Price") upon the occurrence of certain triggering events. In the event of an acquisition not approved by the Board of Directors, each right enables its holder (other than the acquirer) to purchase at the Purchase Price the number of shares of common stock (or, preferred stock if there is insufficient common stock) having a market value equal to two times the Purchase Price. Further, in the event the Company is acquired in an unwanted merger or business combination, each right enables the holder to purchase shares of the acquiring entity at a similar discount. Under certain circumstances, the rights may be exchanged for common shares of the Company. The Board may, in its sole discretion, redeem the rights at any time prior to any of the triggering events. The rights can be exercised and separate rights certificates distributed only if either of the following events occur: (i) acquisition by a person of 10% or more of the Company's common shares (other than a person holding 10% or more at the time the plan was adopted, who may purchase an additional 1%) or (ii) a tender offer for 10% or more of the Company's common shares. The rights will initially trade automatically with the common shares. The rights are not deemed by the Board of Directors to be presently exercisable. In February, 1999 the Board of Directors authorized the Company to repurchase an additional $2,000,000 of the Company's common stock in addition to the $1,000,000 authorized pursuant to the repurchase programs announced in 1994 and 1998. The 1994 repurchase program was completed in 1998 and the 1998 repurchase program was completed in February, 1999 with the repurchase of 5,635 shares for a total purchase price of $48,000. The 1999 repurchase program authorizes the Company to repurchase shares in open market and private transactions during the next five years. 44 47 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of MCB Financial Corporation: We have audited the accompanying consolidated balance sheets of MCB Financial Corporation and subsidiary (the "Company") as of December 31, 1997 and 1998, and the related consolidated statements of operations, comprehensive income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of MCB Financial Corporation and its subsidiary as of December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP Deloitte & Touche LLP San Francisco, California January 12, 1999 (February 8, 1999 as to Note 16 of the consolidated financial statements) 45 48 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The information required to be furnished pursuant to this item will be set forth under the captions "Election of Directors" and "Executive Officers" in the registrant's proxy statement (the "Proxy Statement") to be furnished to stockholders in connection with the solicitation of proxies by The Company's Board of Directors for use at the 1999 Annual Meeting of Shareholders to be held on May 19, 1999, and is incorporated herein by reference. ITEM 10. EXECUTIVE COMPENSATION The information required to be furnished pursuant to this item will be set forth under the caption "Executive Compensation of The Company and The Bank" of the Proxy Statement, and is incorporated herein by reference. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required to be furnished pursuant to this item will be set forth under the captions "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" of the Proxy Statement, and is incorporated herein by reference. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required to be furnished pursuant to this item will be set forth under the caption "Certain Relationships and Related Transactions Regarding The Company and The Bank" of the Proxy Statement, and is incorporated herein by reference. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) List of Exhibits:
EXHIBITS: --------- (2) -- Plan of acquisition, reorganization (incorporated by reference to the registrant's registration statement on Form S-4 (File No. 33-76832). (3)(a) -- Restated articles of incorporation (incorporated by reference from Exhibit (3)(a) to the registrant's Quarterly Report on Form 10-QSB for its quarter ended September 30, 1998). (3)(b) -- By-laws (incorporated by reference to the registrant's registration statement on Form S-4 (File No. 33-76832). (4) -- Rights Agreement (incorporated by reference from the registrant's Form 8-A12G filed with the SEC on January 25, 1999). (10)(a)(1) -- Stock Option Plan (incorporated by reference to the registrant's registration statement on Form S-4 (File No. 33-76832). (10)(a)(2) -- Deferred Compensation Plan for Executives (incorporated by reference to Exhibit (10)(a)(2) to the registrant's Annual Report on Form 10-KSB for its fiscal year ended December 31, 1994). (10)(b) -- Leases
46 49
EXHIBITS: --------- (10)(b)(1) -- San Rafael Office Lease (incorporated by reference to Exhibit (10)(b)(1) to the registrant's Annual Report on Form 10-KSB for its fiscal year ended December 31, 1994). (10)(b)(2) -- South San Francisco Office Lease (incorporated by reference to Exhibit (10)(b)(2) to the registrant's Annual Report on Form 10-KSB for its fiscal year ended December 31, 1994). (10)(b)(3) -- Hayward Office Lease (incorporated by reference to Exhibit (10)(b)(3) to the registrant's Annual Report on Form 10-KSB for its fiscal year ended December 31, 1994). (10)(b)(4) -- Upland Office Lease (incorporated by reference to Exhibit (10)(b)(4) to the registrant's Annual Report on Form 10-KSB for its fiscal year ended December 31, 1994). (10)(b)(5) -- San Francisco Office Lease (incorporated by reference to Exhibit (10)(b)(5) to the registrant's Annual Report on Form 10-KSB for its fiscal year ended December 31, 1997). (10)(b)(6) -- Petaluma Office Lease (11) -- Statement re: computation of per share earnings (the information required to be furnished pursuant to this exhibit is contained in the Consolidated Financial Statements and the Notes to Consolidated Financial Statements) (21) -- Subsidiaries of the small business issuer (the information required to be furnished pursuant to this exhibit is contained in the Notes to Consolidated Financial Statements) (27) -- Financial Data Schedule
(b) Reports on Form 8-K. The Company filed the following Current Reports on Form 8-K: (i) A Current Report on Form 8-K dated October 20, 1998, pertaining to an additional Common Stock Repurchase Program. (ii) A Current Report on Form 8-K filed January 25, 1999, pertaining to the adoption of a Shareholder Rights Plan. (iii) A Current Report on Form 8-K filed January 26, 1999, pertaining to a press release regarding the appointment of Charles O. Hall to President and Chief Executive Officer. 47 50 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, on the 19th day of March, 1999. By /s/ CHARLES O. HALL ------------------------------------ Charles O. Hall President and Chief Executive Officer (Principal Executive Officer); Director By /s/ PATRICK E. PHELAN ------------------------------------ Patrick E. Phelan Chief Financial Officer (Principal Financial Officer) (Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 19th day of March, 1999.
NAME TITLE ---- ----- /s/ JOHN CAVALLUCCI Chairman; Director - ----------------------------------------------------------- John Cavallucci /s/ CHARLES O. HALL Director - ----------------------------------------------------------- Charles O. Hall /s/ TIMOTHY J. JORSTAD Director - ----------------------------------------------------------- Timothy J. Jorstad /s/ CATHERINE H. MUNSON Director - ----------------------------------------------------------- Catherine H. Munson /s/ GARY T. RAGGHIANTI Vice Chairman; Director - ----------------------------------------------------------- Gary T. Ragghianti /s/ MICHAEL J. SMITH Director - ----------------------------------------------------------- Michael J. Smith /s/ EDWARD P. TARRANT Director - ----------------------------------------------------------- Edward P. Tarrant /s/ RANDALL J. VERRUE Director - ----------------------------------------------------------- Randall J. Verrue
48 EX-10.(B)(6) 2 PETALUMA OFFICE LEASE 1 EXHIBIT 10(B)(6) PETALUMA OFFICE LEASE REDWOOD BUSINESS PARK NET LEASE THIS LEASE, dated December 9, 1998, is made and entered into by and between G & W/Copley Redwood Business Park, L.P. ("Landlord"), and Metro Commerce Bank, Inc., a California corporation ("Tenant"). 1. Premises. Landlord leases to Tenant, and Tenant hereby leases from Landlord for the term of this Lease ("Term") and at the rent and upon the conditions set forth below, the Premises described in the Basic Lease Information and identified on the floor plan attached hereto as Exhibit A. The Premises are located within the Building described in the Basic Lease Information, and constitute part of the Project described in the Basic Lease Information and as shown in Exhibit A-1 attached hereto, at the Redwood Business Park, located in Petaluma, California. All areas and facilities outside the Buildings and within the exterior boundaries of the Project that are provided and designated by Landlord from time to time for the general nonexclusive use and convenience of the tenants of the Project shall be known as "Common Areas". 2. Term. (a) The Term shall commence March 1, 1999. A "Lease Year" is a period of twelve (12) consecutive calendar months. A "Lease Month" is a calendar month. The initial Term of this Lease shall be determined as follows: (1) If the Commencement Date of this Lease occurs on the first calendar day of a calendar month, the Term shall be for a period of Lease Years and Months as specified in the Basic Lease Information, unless terminated sooner as provided in this Lease. (2) If the Commencement Date of this Lease occurs on other than the first calendar day of a calendar month, the Term shall be for a period of Lease Years and Months as specified in the Basic Lease Information, plus the number of days remaining in the calendar month in which the Commencement Date occurs, unless terminated sooner as provided in this Lease. 3. Rent. (a) For purposes of this Lease, the term "Rent" shall mean the Base Rent, Advanced Base Rent, all additional rent, and all of the other monetary obligations of Tenant under this Lease. Upon execution of this Lease, Tenant shall pay to Landlord the Advanced Base Rent set forth in the Basic Lease Information. Tenant shall pay to Landlord the Base Rent specified in the Basic Lease Information, payable on or before the first day of each and every successive calendar month following the Commencement Date. If the Term commences on other than the first day of a calendar month, the first payment of Base Rent shall be appropriately prorated, on the basis of a 30-day month. Tenant's payment of any Advanced Base Rent (excluding that portion attributable to last month's rent, if any) shall be credited against Tenant's obligation to pay Base Rent beginning as of the Commencement Date. (b) Tenant shall pay, as additional rent, all amounts of money required to be paid to Landlord by Tenant under this Lease in addition to monthly Base Rent, whether or not the same be designated "additional rent." If such amounts are not paid at the time provided in this Lease, they shall nevertheless be collectable as additional rent with the next installment of monthly Base Rent thereafter falling due, but nothing herein contained shall be deemed to suspend or delay the payment of any amount of money at the time the same becomes due and payable hereunder, or limit any other remedy of Landlord. -1- 2 (c) Tenant acknowledges that late payment by Tenant to Landlord of Rent after the expiration of the grace period set forth in Paragraph 14(a)(1) belowwill cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any trust deed covering the Premises. Accordingly, if any installment of Rent or any other sums due from Tenant shall not be received by Landlord when due, Tenant shall pay to Landlord a late charge equal to six percent (6%) of such overdue amount. The parties agree that such late charge represents a fair and reasonable estimate of the costs Landlord will incur by reason of late payment by Tenant. Acceptance of such late charge by Landlord shall in no event constitute a waiver of Tenant's default with respect to such overdue amount, nor prevent Landlord from exercising any of the other rights and remedies granted hereunder. (d) Any amount due to Landlord, if not paid when due, shall bear interest from the date due until paid at the rate of ten percent (10%) per annum. Payment of interest shall not excuse or cure any default hereunder by Tenant. (e) All payments due from Tenant to Landlord hereunder shall be made to Landlord without deduction or offset, in lawful money of the United States of America at Landlord's address for notices hereunder, or to such other person or at such other place as Landlord may from time to time designate in writing to Tenant. 4. Taxes and Operating Expenses. (a) In addition to the Base Rent, Tenant shall pay (i) Tenant's Percentage Share of Property Taxes (according to the percentage set forth in the Basic Lease Information) relating to those Property Taxes (as the term is defined under Paragraph 4(a)(1) below) which are assessed during the Term, and (ii) Tenant's Percentage Share of Operating Expenses (according to the percentage set forth in the Basic Lease Information) relating to those Operating Expenses (as the term is defined under Paragraph 4(a)(2) below) which are paid or incurred by Landlord during the Term. (1) "Property Taxes" shall mean all real property taxes, bonds and assessments and governmentally imposed fees or charges (and any tax levied wholly or partly in lieu thereof) levied, assessed, confirmed, imposed or which have become a lien against the Building (which for the purposes of defining "Property Taxes" shall include the tax parcel of which the Building is a part) and Common Areas. (2) "Operating Expenses" shall mean the following: (A) all costs of management, operation, maintenance and repair of the Building and Common Areas, including, without limitation, property management expenses, maintenance and repair materials, supplies and equipment; (B) all costs of water, power, electricity, refuse collection, parking lot sweeping, landscaping, and other services relating to the Common Areas; (C) all costs of alterations or improvements to the Building or Common Areas made to achieve compliance with federal, state and local law including, without limitation, the Americans with Disabilities Act (42 U.S.C. Section 12101 et seq.), which costs will be amortized over the useful life of each alteration or improvement; (D) all costs of public liability and casualty insurance maintained by Landlord with respect to the Building and Common Areas; (E) all costs incurred by Landlord for making any capital improvements, structural repairs or modifications to the Building or Common Areas or making any improvements or modifications to reduce the operating expenses, which costs will be amortized over the useful life of each capital improvement, structural repair or modification; (F) all costs of maintaining machinery, equipment and directional signage or other markers; and G) the share allocable to the Building of dues and assessments payable under any reciprocal easement or common area maintenance agreements or declarations or by any owners' associations affecting the Building. That portion of the Operating Expenses relating to the property management expenses for the Building and Common Areas which shall be charged to Tenant shall be four percent (4%) of both Tenant's annual Base Rent and the subtotal of Tenant's share of Operating Expenses of the Building. In the event that Landlord calculates the Operating Expenses based upon the Project instead of the Building, as indicated on the Basic Lease Information, then the term "Project" shall be substituted in the place of all references to the term "Building" in this paragraph. -2- 3 (b) The Property Taxes to be paid by Tenant shall be determined by multiplying the total amount of the Property Taxes by Tenant's Percentage Share of Property Taxes (which percentage is determined by multiplying 100% by a fraction, the numerator of which is the rentable area of the Premises and the denominator of which is the total rentable area of all improvements located within the tax parcel of which the Premises are a part). Landlord may cause the Common Areas of the Project to be separately assessed from other areas and buildings of the Project. In such case, Tenant's Percentage Share of Property Taxes attributable to the Common Areas shall be determined by the ratio that the total rentable square feet in the Premises bears to the total number of square feet of rentable area which is included in the property subject to the assessment. (c) Operating Expenses for each calendar year shall be adjusted to equal Landlord's reasonable estimate of Operating Expenses as though ninety-five percent (95%) of the total rentable area of the Building had been occupied. When the Building is one hundred percent (100%) occupied, the Operating Expenses shall be adjusted to reflect a 100% occupied building. The Operating Expenses to be paid by Tenant shall be determined by multiplying the total amount of the Operating Expenses as adjusted above by Tenant's Percentage Share of Operating Expenses (which percentage is determined by multiplying 100% by a fraction, the numerator of which is the rentable area of the Premises and the denominator of which is the total rentable area located within the Building, if the Operating Expenses are calculated for the Building, or within the Project, if the Operating Expenses are calculated for the Project). (d) Tenant shall pay to Landlord each month at the same time and in the same manner as monthly Base Rent one-twelfth (l/12th) of Landlord's estimate of the amount of Property Taxes and one- twelfth (1/12th) of Landlord's estimate of Operating Expenses payable by Tenant for the then-current calendar year. The initial monthly amount shall be as set forth in the Basic Lease Information. Within (120) one hundred eighty (180) days after the close of each calendar year, Landlord shall deliver to Tenant a statement in reasonable detail of the actual amount of Property Taxes and Operating Expenses payable by Tenant in accordance with this Paragraph 4 for such calendar year; Landlord 's failure to provide such statement to Tenant within the 180-day period shall act as a waiver against Landlord later delivering a statement to Tenant for such calendar year and recovering additional amounts from Tenant based Upon the actual expenses for such calendar year. Tenant may request further information if desired. Landlord's failure to provide such statement to Tenant within the 180-day period shall not act as a waiver and shall not excuse Tenant or Landlord from making the adjustments to reflect actual costs as provided herein. If on the basis of such statement Tenant owes an amount that is less than the estimated payments for such calendar year previously made by Tenant, Landlord shall credit such excess to Tenant against future additional rent due under this Paragraph 4. If on the basis of such statement Tenant owes an amount that is more than the estimated payments for such calendar year previously made by Tenant, Tenant shall pay the deficiency to Landlord within fifteen (15) days after delivery of the statement. The obligations of Landlord and Tenant under this Paragraph 4(d) with respect to the reconciliation between the estimated and actual amounts of Property Taxes and Operating Expenses payable by Tenant for the last year of the Term shall survive the termination of the Lease. When the final determination is made of the actual amounts of Property Taxes and Operating Expenses payable by Tenant for the year in which this Lease terminates, Tenant shall immediately pay any increase due over the estimated payments and, conversely, any overpayment made by Tenant shall be immediately reimbursed to Tenant by Landlord. 5. Other Taxes. In addition to Tenant's obligations under Paragraph 4 above, Tenant shall pay or reimburse Landlord for (i) any taxes upon, measured by or reasonably attributable to the cost or value of Tenant's equipment, furniture, fixtures, and other personal property located in the Premises or leasehold improvements made in or to the Premises at Tenant's expense, (ii) for taxes, if any, measured by or reasonably attributable to tenant improvements paid for by Tenant and (iii) for any taxes, assessments, fees, or charges imposed by any public authority or private community maintenance association upon or by reason of the development, possession, use or occupancy of the Premises or the parking facilities used by Tenant in connection with the Premises. On -3- 4 request by Landlord, Tenant shall furnish Landlord with satisfactory evidence of payment of Tenant's business personal property taxes and deliver copies of such business personal property tax bills to Landlord. 6. Use. 6.1 Prohibited Uses. (a) The Premises shall be used and occupied by Tenant solely for the use set forth in the Basic Lease Information. Tenant shall, at Tenant's expense, comply promptly with all applicable federal, state and local laws, regulations, ordinances, rules, orders, and requirements in effect during the Term relating to the condition, use or occupancy of the Premises. Tenant shall not use or permit the use of the Premises in any manner that will tend to create waste or a nuisance, or that unreasonably disturbs other tenants of the Building or Project, nor shall Tenant place or maintain any signs, antennas, awnings, lighting or plumbing fixtures, loudspeakers, exterior decoration or similar devises on or visible from the exterior of the Premises, without Landlord's prior written consent, which may be withheld in Landlord's sole discretion. Tenant shall not use any corridors, sidewalks, stairs, elevators, or other areas outside of the Premises for storage or any purpose other than access to the Premises. Tenant shall not use, keep, or permit to be used or kept on the Premises any foul or noxious gas or substance, nor shall Tenant do or permit to be done anything in and about the Premises, either in connection with activities hereunder expressly permitted or otherwise, which would cause an increase in premiums for or a cancellation of any policy of insurance (including fire insurance) maintained by Landlord in connection with the Premises or the Building or which would violate the terms of any covenants, conditions, or restrictions, or the design guidelines, or the sign guidelines affecting the Building or the land on which it is located, or the Rules (as the term is defined under Paragraph 6.3(b) below). (b) Tenant shall be permitted to attach signage to the facia using standard individual plexiglass letters painted dark bronze and a double sided non-illuminated monument sight up to five (5) feet tall and four (4) feet wide on the landscape berm at Tenant's sole cost and expense, subject to Landlord's prior approval of the placement of such signage. Any signage so permitted shall be subject to prior approval of and conformance with the requirements of the design review committee of the Project and the design review agency of the City of Petaluma. At Tenant's expense, Tenant shall (i) maintain all permitted signage, and (ii) upon the expiration or termination of this Lease, remove such signage and repair any damage caused by their removal. If Tenant fails to do so, Landlord may maintain, repair or remove such signage without notice to Tenant and at Tenant's expense, the cost of which shall be payable by Tenant as additional rent in accordance with Paragraph 14(b)(2) below. 6.2 Suitability. Tenant acknowledges that neither Landlord nor any agent of Landlord has made any representation or warranty with respect to the Premises or the Building or with respect to the suitability or fitness of either for the conduct of Tenant's business or for any other purpose. Nor has Landlord agreed to undertake any modification, alteration or improvement to the Premises except as provided in this Lease. Tenant acknowledges that the Premises are located in a 100-year flood zone and that the finished floor elevations of the Building are designed to be at least one (1) foot above the federal government's estimate of the 100-year flood level at the time of initial construction. 6.3 Use of Common Areas. (a) Landlord gives Tenant and its authorized employees, agents, customers, representatives, and invitees the nonexclusive right to use the Common Areas, with others who are entitled to use the Common Areas, subject to Landlord's rights as set forth in this Paragraph 6.3. (b) All Common Areas shall be subject to the exclusive control and management of Landlord and Landlord shall have the right to establish, modify, amend, and enforce reasonable rules and regulations with respect to the Common Areas. Tenant acknowledges receipt of a copy of the current rules and regulations, attached hereto as Exhibit C, and agrees that they may, from time to time, be modified or amended by Landlord in a commercially reasonable manner (the "Rules"). Tenant agrees to abide by and conform with such Rules; to cause its concessionaires and its and their employees and agents to abide -4- 5 by such Rules; and to use its best efforts to cause its customers, invitees, and licensees to abide by such Rules. (c) Landlord shall have the right to close temporarily any portion of the Common Areas for the purpose of discouraging use by parties who are not tenants or customers of tenants; to use portions of the Common Areas while engaged in making additional improvements or repairs or alterations to the Property; to use or permit the use of the Common Areas by others to whom Landlord may grant or have granted such rights; and to do and perform such acts in, to, and with respect to, the Common Areas as in the use of good business judgment Landlord shall determine to be appropriate for the Project. However, except in emergencies, Landlord shall provide reasonable access to the Premises over the Common Areas for the customers of Tenant. (d) Landlord shall have the unqualified right to increase or reduce the Common Areas, provided the Project meets the parking requirement under Paragraph 6.5 below. (e) Tenant shall cooperate with Landlord and other tenants in the Project in recycling waste paper, cardboard, or such other materials identified under any trash recycling program that may be established in order to reduce trash collection costs. (f) Upon commencement of the Lease, Landlord warrants that it has no knowledge of violations or pending actions by any governmental authority with respect to the Common Areas regarding ADA or other laws. 6.4 Environmental Matters. (a) (1) The term "Hazardous Materials" as used herein means any petroleum products, asbestos, polychlorinated biphenyls, P.C.B.'s, chemicals, compounds, materials, mixtures or substances that are now or hereafter defined or listed in, or otherwise classified as a "hazardous substance", "hazardous material", "hazardous waste", "extremely hazardous waste", "infectious waste", "toxic substance", "toxic pollutant" or any other formulation intended to define, list or classify substances by reason of deleterious properties such as ignitability, corrosivity, reactivity, carcinogenicity or toxicity pursuant to any federal, state or local environmental law, regulation, ordinance, resolution, order or decree relating to industrial hygiene, environmental protection or the use, analysis, generation, manufacture, storage, release, disposal or transportation of the same ("Hazardous Materials Laws"). (2) Except for ordinary office supplies and janitorial cleaning materials which in common business practice are customarily and lawfully used, stored and disposed of in small quantities, and except for those Hazardous Materials listed on Exhibit D attached hereto, Tenant shall not use, manufacture, store, release, dispose or transport any Hazardous Materials in, on, under or about the Premises, the Building or the Project without giving prior written notice to Landlord and obtaining Landlord's prior written consent, which consent Landlord may withhold in its sole discretion. Subject to Landlord's prior written consent, Hazardous Materials may be added to Exhibit D on an annual review basis, any such amendments to Exhibit D shall be signed by each party and attached hereto. Tenant shall at its own expense procure, maintain in effect, and comply with all conditions of any and all permits, licenses, and other governmental and regulatory approvals required in connection with Tenant's generation, use, storage, disposal and transportation of Hazardous Materials. Except as discharged into the sanitary sewer in strict accordance and conformity with all applicable Hazardous Materials Laws, Tenant shall cause any and all Hazardous Materials removed from the Premises to be removed and transported solely by duly licensed haulers to duly licensed facilities for final disposal of such materials and wastes. Regardless whether permitted under the Hazardous Materials Laws, Tenant shall not maintain in, on, under, or about the Premises, the Building or the Project any above or below ground storage tanks, clarifiers, or sumps, nor shall any wells for the monitoring of ground water, soils, or subsoils be allowed. (3) Tenant shall immediately notify Landlord in writing of: (a) any enforcement, cleanup, removal or other governmental or regulatory action instituted, completed or threatened pursuant to any Hazardous Materials Law; (b) any claim made or threatened by any person or entity against Tenant or the Premises relating to damage, contribution, cost, recovery, compensation, loss or injury resulting from or claimed to -5- 6 result from any Hazardous Materials; and (c) any reports, information, inquiries or demands made, ordered, or received by or on behalf of Tenant which arise out of or in connection with the existence or potential existence of any Hazardous Materials in, on, under or about the Premises, the Building, or the Project, including, without limitation, any complaints, notices, warnings, asserted violations, or mandatory or voluntary informational filings with any governmental agency in connection therewith, and immediately supply Landlord with copies thereof. (b) Tenant shall indemnify, defend (by counsel reasonably acceptable to Landlord), protect, and hold Landlord, and each of Landlord's partners, officers, directors, partners, employees, affiliates, joint venturers, members, trustees, owners, shareholders, principals, agents, representatives, attorneys, successors and assigns, free and harmless from and against any and all claims, liabilities, damages, fines, penalties, forfeitures, losses, cleanup and remediation costs or expenses (including attorneys' fees) or death of or injury to any person or damage to any property whatsoever, arising from or caused in whole or in part, directly or indirectly, by (i) Tenant's use, analysis, generation, manufacture, storage, release, disposal, or transportation of Hazardous Materials by Tenant, Tenant's agents, employees, contractors, licensees or invitees to, in, on, under, about or from the Premises, the Building, or the Project, or (ii) Tenant's failure to comply with any Hazardous Materials Law. Tenant's obligations hereunder shall include, without limitation, and whether foreseeable or unforeseeable, all costs of any required or necessary repair, cleanup, detoxification or decontamination of the Premises, the Building, or the Project and the preparation and implementation of any closure, remedial action or other required plans in connection therewith, and shall survive the expiration or earlier termination of this Lease. (c) Landlord shall have the right to enter the Premises during regular business hours upon reasonable prior notice at all times for the purposes of ascertaining compliance by Tenant with all applicable Hazardous Materials Laws, provided, however, that in the instance of an emergency Landlord's entry onto the Premises shall not be restricted to regular business hours nor shall notice be required. (d) Landlord shall have the option to declare a default of this Lease for the release or discharge of Hazardous Materials by Tenant, Tenant's employees, agents, contractors, or invitees on the Premises, Building or Project or in violation of law or in deviation from prescribed procedures in Tenant's use or storage of Hazardous Materials. If Tenant fails to comply with any of the provisions under this Paragraph 6.4, Landlord shall have the right (but not the obligation) to remove or otherwise cleanup any Hazardous Materials from the Premises, the Building or the Project. In such case, the costs of any Hazardous Materials investigation, removal or other cleanup (including, without limitation, transportation, storage, disposal and attorneys' fees and costs) will be additional rent due under this Lease, whether or not a court has ordered the cleanup, and will become due and payable on demand by Landlord. 6.5 Parking. Landlord grants to Tenant and Tenant's customers, suppliers, employees and invitees a nonexclusive license to use unassigned and unreserved parking spaces in the Common Areas for the use of motor vehicles during the Term subject to rights reserved to Landlord as specified in this Paragraph 6.5. Landlord reserves the right to grant similar nonexclusive and unassigned and unreserved use to other tenants; to promulgate rules and regulations relating to the use of the Common Areas including parking by tenants and employees of tenants; to make changes in the parking layout from time to time; and to do and perform any other acts in and to these areas and improvements as Landlord determines to be advisable. Tenant agrees not to overburden the parking facilities and to abide by and conform with the rules and regulations and to cause its employees and agents to abide by and conform to the rules and regulations. Upon request, Tenant shall provide Landlord with license plate numbers of all vehicles driven by its employees and to cause Tenant's employees to park only in spaces specifically designated for tenant parking. Landlord shall have the unqualified right to rearrange or reduce the number of parking spaces; provided, however, the ratio of the number of parking spaces available to Tenant will be no less than three point five (3.5) spaces per 1,000 usable square feet of the Premises. -6- 7 7. Services. (a) Tenant shall pay for all water, sewer, gas, electricity, heat, cooling, telephone, refuse collection, and other utility-type services furnished to Tenant or the Premises, together with all related installation or connection charges or deposits. Wherever it is practical to do so such services shall be separately metered or charged to Tenant by the provider thereof and paid for directly by Tenant. To the extent any of the foregoing services are provided by Landlord, Tenant shall reimburse Landlord for all costs incurred by Landlord in connection with the provision of such services based on Landlord's reasonable estimate of the level of Tenant's use or consumption of such services. Landlord shall bill Tenant on a monthly or other periodic basis for such services and payment shall be made by Tenant within ten (10) days after submittal of Landlord's statement. (b) Landlord shall not be in default hereunder or be liable for any damages or personal injuries to any person directly or indirectly resulting from, nor shall there be any Rent abatement by reason of, any interruption or curtailment whatsoever in utility services. 8. Maintenance' Repairs and Alterations. (a) Excluding repairs that occur in the Premises, but to facilities that are actually for the use of all Building Tenants, in which case shall be deemed an Operating Expense, Tenant shall, at Tenant's expense, maintain every part of the Premises in good order, condition and repair, including without limitation, (i) all interior surfaces, ceilings, walls, door frames, window frames, floors, carpets, draperies, window coverings and fixtures, (ii) all windows, doors, locks and closing devices, entrances, plate glass, and signs, (iii) all plumbing and sewage pipes, fixtures and fittings, (iv) all phone lines, electrical wiring, equipment, switches, outlets, and light bulbs, (v) any fire detection, fire sprinkler or extinguisher equipment, (vi) all of Tenant's personal property, improvements and alterations, and (vii) all other fixtures and special items installed by or for the benefit of, or at the expense of Tenant. Tenant shall, at its expense, cause to be maintained in good operating condition and repair, all heating, ventilating, and air conditioning equipment installed in, or on the roof of the Premises. Tenant shall keep in force a preventive maintenance contract with a qualified maintenance company covering all heating, ventilating and air conditioning equipment and shall annually provide Landlord with a copy of this contract. Tenant shall not enter onto the roof area of the Building, except for the purpose of maintaining the heating, ventilating, and air conditioning equipment and provided that Tenant shall repair any damage to the roof area caused by its entry. Tenant shall be responsible for its own janitorial service. Landlord shall incur no expense (nor have any obligation) of any kind whatsoever in connection with the maintenance of the Premises. (b) Landlord shall keep in good condition and repair the foundation, roof structure, exterior walls and other structural parts of the Building, and all other portions of the Building not the obligation of Tenant or any other tenant in the Building. Tenant expressly waives the right to make repairs at Landlord's expense or to terminate this Lease due to the Landlord's failure to keep the Building in good order, condition and repair. Landlord shall have no liability to Tenant for any damage, inconvenience, or interference with the use of the Premises by Tenant as the result of Landlord performing any such maintenance and repair work. (c) In the event Tenant fails to perform Tenant's obligations under this Paragraph 8, Landlord may, but shall not be required to, give Tenant notice to do such acts as are reasonably required to so maintain the Premises. If Tenant shall fail to commence such work and diligently prosecute it to completion, then Landlord shall have the right (but not the obligation) to do such acts and expend such funds at the expense of Tenant as are reasonably required to perform such work. Any amounts so expended by Landlord will be additional rent due under this Lease, and such amounts will become due and payable on demand by Landlord. Landlord shall have no liability to Tenant for any such damages, inconvenience, or interference with the use of the Premises by Tenant as a result of performing such work. (d) Upon the expiration or earlier termination of this Lease, Tenant shall surrender the Premises in good condition and repair, only ordinary wear and tear excepted. Tenant, at its sole cost and expense, agrees to repair any damages to the Premises caused by or in connection with the removal of any articles of personal property, business or trade fixtures, signs, machinery, equipment, cabinetwork, furniture, moveable partitions, or permanent improvements or additions, including without limitation thereto, repairing the floor and patching -7- 8 and painting the walls where required by Landlord, to Landlord's reasonable satisfaction. Tenant shall indemnify Landlord against any loss or liability resulting from delay by Tenant in so surrendering the Premises, including without limitation, any claims made by any succeeding tenant resulting from such delay. (e) Upon commencement of the Lease, Tenant shall not make any alterations, improvements, or additions in, on, or about the Premises without Landlord's prior written consent, said consent will not be unreasonably withheld by Landlord, except that Tenant may make alterations, improvements, or additions without Landlord's prior written consent where (i) the reasonably estimated cost does not exceed $2,500, and (ii) such alterations, improvements, or additions do not affect or involve the structural integrity, roof membrane, exterior areas, building systems, or water-tight nature of the Premises, the Building or the Project. In requesting Landlord's consent, Tenant shall, at Tenant's sole cost, submit to Landlord complete drawings and specifications describing such work and the identity of the proposed contractor at least ten (10) business days prior to the commencement of any work. With respect to any alterations, improvements or additions made to the Premises by Tenant: (1) Before commencing any work relating to alterations, additions, or improvements affecting the Premises, Tenant shall notify Landlord of the expected date of commencement thereof and of the anticipated cost thereof. Landlord shall then have the right at any time and from time to time to post and maintain on the Premises such notices as Landlord reasonably deems necessary to protect the Premises and Landlord from mechanics' liens or any other liens. (2) Tenant shall pay when due all claims for labor or materials furnished to Tenant for use in the Premises. Tenant shall not permit any mechanics' liens or any other liens to be levied against the Premises for any labor or materials furnished to Tenant in connection with work performed on the Premises by or at the direction of Tenant. Tenant shall indemnify, hold harmless and defend Landlord (by counsel reasonably satisfactory to Landlord) from any liens and encumbrances arising out of any work performed or materials furnished by, or at the direction of Tenant. In the event that Tenant shall not, within twenty (20) days following the imposition of any such lien, cause such lien to be released of record by payment or posting of a proper bond, Landlord shall have, in addition to all other remedies provided herein by law, the right, but not the obligation, to cause the same to be released by such means as it shall deem proper, including payment of the claim giving rise to such lien. All such sums paid by Landlord and all expenses incurred by it in connection therewith, including attorneys' fees and costs, shall be payable to Landlord by Tenant on demand with interest at the rate of ten percent (10%) per annum. (3) All alterations, improvements or additions in or about the Premises performed by or on behalf of Tenant shall be done in a first-class, workmanlike manner, shall not unreasonably lessen the value of leasehold improvements in the Premises, and shall be completed in compliance with all applicable laws, ordinances, regulations and orders of any governmental authority having jurisdiction thereover, as well as the requirements of insurers of the Premises and the Building. (4) Upon Landlord's request, Tenant shall remove any contractor, subcontractor or material supplier from the Premises and the Building if the work or presence of such person or entity results in labor disputes in or about the Building or Project or damage to the Premises, Building or Project. (5) Landlord, at Landlord's sole discretion, may refuse to grant Tenant permission for alterations, improvements or additions which require, because of application of Americans with Disabilities Act or other laws, substantial improvements or alterations to be made to the Common Areas. (6) Landlord may, up to sixty (60) days prior to the expiration of the Term, require that Tenant, at Tenant's expense, remove any such alterations, improvements or additions prior to or upon the expiration of this Lease, and restore the Premises to their condition prior to such alterations, improvements or additions. (7) Unless Landlord requires their removal, as set forth above, all alterations, improvements, or additions made to the Premises shall become the property of Landlord and remain upon and be surrendered with the Premises upon the expiration of this Lease; provided, however, that Tenant's -8- 9 machinery, equipment, and trade fixtures, other than any which may be affixed to the Premises so that they cannot be removed without material damage to the Premises, shall remain the property of Tenant and may be removed by Tenant subject to the provisions of Paragraph 8(d) above. 9. Construction of Tenant Improvements. Tenant shall be responsible for constructing within the Premises the tenant improvements ("Tenant Improvements") described in the preliminary space plan attached hereto as Exhibit B-l ("Preliminary Space Plan"). The Tenant Improvements for the Premises will be more particularly described in the plans and construction' drawings ("Construction Drawings") as provided below. Landlord and Tenant reviewed and approved the attached Preliminary Space Plan for construction of the Tenant Improvements so that Tenant can provide Landlord with the Construction Drawings. The Construction Drawings shall indicate the specific requirements of Tenant's lease space, outlining in detail interior partitions, floor coverings, a reflected ceiling plait, plumbing fixtures, and electrical plans (setting forth the electrical requirements of Tenant), all in conformity with the Preliminary Space Plan. The Construction Drawings shall include full energy calculations as required by the State of California and the city agencies. Tenant shall, at Tenant's sole cost, submit to Landlord, for Landlord's approval, the construction drawings and the identity of the proposed contractor at least five (5) business days prior to the commencement of ally work. Landlord shall approve or return the Construction Drawings within five (5) business days for further modification or such Construction Drawings are deemed approved. Landlord shall contribute a Tenant Improvement Allowance of $22.00/useable sq. ft., payable to Tenant upon Landlord's receipt of an invoice for the Tenant Improvements constructed. (1) Before commencing any work relating to improvements affecting the Premises, Tenant shall notify Landlord of the expected date of commencement thereof and of the anticipated cost thereof Landlord shall then have the right at any time and from time to time to post and maintain on the Premises such notices as Landlord reasonably deems necessary to protect the Premises and Landlord from mechanics' liens or any other liens. (2) Tenant shall pay when due all claims for labor or materials furnished to Tenant for use in the Premises. Tenant shall not permit any mechanic liens or any other liens to be levied against the Premises for any labor or materials furnished to Tenant in connection with work performed on the Premises by or at the direction of Tenant. Tenant shall indemnify, hold harmless and defend Landlord (by counsel reasonably satisfactory to Landlord) from any liens and encumbrances arising out of any work performed or materials furnished by, or at the direction of Tenant. In the event that Tenant shall not, within twenty (20) days following the imposition of any such lien, cause such lien to be released of record by payment or posting of a proper bond, Landlord shall have, addition to all other remedies provided herein by law, the right, but not the obligation, to cause the same to be released by such means as it shall deem proper, including payment of the claim giving rise to such lien. All such sums paid by Landlord and all expenses incurred by it in connection therewith, including attorneys fees and costs, shall be payable to Landlord by Tenant or demand with interest at the rate of ten percent (10%) per annum. (3) All Improvements in or about the Premises performed by or on behalf of Tenant shall be done in a first-class, workmanlike manner, and shall be completed in compliance with all applicable laws, ordinances, regulations alp orders of any governmental authority having jurisdiction thereover, as well as the requirements of insurers of the Premises and the Building. (4) Upon Landlord's request, Tenant stall remove any contractor, subcontractor or material supplier from the Premises and the Building if the work or presence of such person or entity results in labor disputes in or about the Building or Project or damage to the Premises, Building or Project. -9- 10 10. Insurance and Indemnity. 10.1 Insurance. (a) Tenant shall obtain and maintain during the Term commercial general liability insurance with a combined single limit for personal injury and property damage in an amount of not less than $2,000,000 (in a form, with a deductible amount, and with carriers reasonably acceptable to Landlord) and employer's liability and workers' compensation insurance as required by law. The insurance carrier shall be authorized to do business in the State of California, with a policyholders and financial rating of at least A:IX Class status as rated in the most recent edition of Best's Key-Rating guide. Tenant's comprehensive general liability insurance policy shall be endorsed to provide that (i) it may not be canceled or altered in such a manner as to adversely affect the coverage afforded thereby without thirty (30) days' prior written notice to Landlord, (ii) Landlord is designated as an additional insured, (iii) the insurer acknowledges acceptance of the mutual waiver of claims by Landlord and Tenant pursuant to Paragraph 10.2(b) below, and (iv) such insurance is primary with respect to Landlord and that any other insurance maintained by Landlord is excess and noncontributing with such insurance. If, in the opinion of Landlord's lender or in the commercially reasonable opinion of Landlord's insurance adviser, the specified amounts of coverage are no longer adequate, such coverage shall, within 30 days written notice to Tenant, be appropriately increased. Prior to the commencement of the Term, Tenant shall deliver to Landlord a duplicate of such policy or a certificate thereof to Landlord for retention by it, with endorsements. At least thirty (30) days prior to the expiration of such policy or any renewal or modification thereof, Tenant shall deliver to Landlord a replacement or renewal binder, followed by a duplicate policy or certificate within a reasonable time thereafter. If Tenant fails to obtain such insurance or to furnish Landlord any such duplicate policy or certificate as herein required, Landlord may, at its election, without notice to Tenant and without any obligation to do so, procure and maintain such coverage and Tenant shall reimburse Landlord on demand as additional rent for any premium so paid by Landlord. (b) Landlord waives all claims against Tenant, and Tenant's officers, directors, partners, employees, agents and representatives for loss or damage to the extent that such loss or damage is insured against under any valid and collectable insurance policy insuring Landlord or would have been insured against but for any deductible amount under any such policy. Tenant waives all claims against Landlord, and Landlord's officers, directors, partners, employees, affiliates, joint venturers, members, trustees, owners, shareholders, principals, agents, representatives, successors and assigns, for loss or damage to the extent such loss or damage is insured against under any valid and collectable insurance policy insuring Tenant or required to be maintained by Tenant under this Lease, or would have been insured against but for any deductible amount under any such policy. The insuring party shall, upon obtaining the policies of insurance required under this Lease, give notice to the insurance carrier or carriers that the foregoing mutual waiver of subrogation is contained in this Lease. Tenant agrees that in the event of a sale, assignment or transfer of the Premises by Landlord, this waiver of subrogation shall continue in favor of the original Landlord and any subsequent Landlord. (c) Tenant shall at its own cost maintain on all its personal property Tenant's improvements, and alterations, in, on, or about the Premises, a policy of standard fire and extended coverage insurance, with vandalism and malicious mischief endorsements, to the extent of at least one hundred percent (100%) of their full replacement value. The proceeds from any such policy shall be used by Tenant for the replacement of personal property and the restoration of Tenant's improvements or alterations. Notwithstanding any other provisions of the Lease, Landlord shall have no liability for damage to or destruction of Tenant's personal property, except if the damage or destruction results from the gross negligent acts or omissions of Landlord. (d) During the Term, Landlord shall keep the Building, and improvements within which the Premises are located, insured against loss or damage by (i) fire, with extended coverage and vandalism, malicious mischief and special extended perils (all risk) endorsements or their equivalents, in amounts not less than one hundred percent (100%) of the replacement cost of the Building and structures insured, and (ii) flood, in the maximum amount provided for by FEMA under its flood loss insurance program, -10- 11 with loss payable thereunder to Landlord and to any authorized encumbrances of Landlord (with standard mortgagee loss payable clause) in accordance with their respective interests. Landlord may maintain rent insurance, for the benefit of Landlord, equal to at least one year's Base Rent hereunder. If the Lease is terminated as a result of damage by fire, casualty or earthquake as set forth in this Paragraph 10, all insurance proceeds shall be paid to and retained by Landlord, subject to the rights of any authorized encumbrances of Landlord. (e) Tenant acknowledges that Landlord does not, at the time of the signing of this Lease, insure the Building for earthquake damage. Landlord may, when Landlord deems the premiums to be reasonable, insure the Building fully or partially for earthquake damage. At such time, the premium for earthquake insurance will be added to the Operating Expenses for purposes of determining additional rent. l0.2 Indemnity. (a) Tenant waives all claims against Landlord for damage to any property or injury to or death of any person in, on, or about the Premises, the Building, or any other portion of the Project arising at any time and from any cause, unless caused by the active negligence or willful misconduct of Landlord, its agents, employees, or contractors. Tenant shall indemnify, defend (by counsel reasonably satisfactory to Landlord) and hold harmless Landlord, and Landlord's officers, directors, partners, employees, affiliates, joint venturers, members, trustees, owners, shareholders, principals, agents, representatives, successors and assigns, from and against all claims, costs, damages, actions, indebtedness and liabilities (except such as may arise from the active negligence or willful misconduct of Landlord, and Landlord's officers, directors, partners, employees, affiliates, joint venturers, members, trustees, owners, shareholders, principals, agents, representatives, successors and assigns) arising by reason of any death, bodily injury, personal injury, property damage or any other injury or damage in connection with (i) any condition or occurrence in or about or resulting from any condition or occurrence in or about the Premises during the Term, or (ii) any act or omission of Tenant, or Tenant's agents, representatives, officers, directors, shareholders, partners, employees, successors and assigns, wherever it occurs. The foregoing indemnity obligation of Tenant shall include reasonable attorneys' fees, and all other reasonable costs and expenses incurred by Landlord from the first notice that any claim or demand is to be made. The provisions of this Paragraph 10.2 shall survive the termination or expiration of this Lease with respect to any damage, injury, or death occurring prior to such expiration or termination. (b) Neither party shall be liable to the other for any unauthorized or criminal entry of third parties into the Premises, Building, Project, Common Areas, or parking facilities, or for any damage to person or property, or loss of property in and about the Premises, Building, Project, Common Areas, parking facilities and the approaches, entrances, streets, sidewalks, stairs, elevators, restrooms, or corridors thereto, by or from any unauthorized or criminal acts of third parties, regardless of any breakdown, malfunction or insufficiency of any security measures, practices or equipment provided by Landlord or Tenant. Tenant shall immediately notify Landlord in writing of any breakdown or malfunction of any security measures, practices or equipment provided by Landlord as to which Tenant has knowledge. (c) Any diminution or interference with light, air or view by any structure which may be erected on land adjacent to the Building or resulting from any other cause shall in no way alter this Lease or impose any liability on Landlord. (d) Tenant agrees that in no event shall Landlord be liable for consequential damages, including injury to Tenant's business or any loss of income therefrom. (e) In the event that Landlord or any successor owner of the Building sells or conveys the Building, then all liabilities and obligations of Landlord or the successor owner under this Lease accruing after the sale or conveyance shall terminate and become binding on the new owner, and Tenant shall release Landlord from all liability under this Lease (including, without limitation, the Security Deposit, as defined under Paragraph 16 below), except for acts or omissions of Landlord occurring prior to such sale or conveyance. -11- 12 (f) Tenant expressly agrees that so long as Landlord is a corporation, limited liability company, trust, partnership, joint venture, unincorporated association or other form of business entity, (i) the obligations of Landlord shall not constitute personal obligations of the officers, directors, partners, employees, affiliates, joint venturers, members, trustees, owners, shareholders, or other principals, agents or representatives of such business entity ("Member of Landlord"), and (ii) Tenant shall have recourse only to the interest of such business entity in the Building of which the Premises are a part for the satisfaction of such obligations and not against the assets of such Member of Landlord other than to the extent of their respective interests in the Building. In this regard, Tenant agrees that in the event of any actual or alleged failure, breach or default by Landlord of its obligations under this Lease, that (i) no Member of Landlord shall be sued or named as a party in any suit or action (except as may be necessary to secure jurisdiction of Landlord), (ii) no judgment will be taken against any Member of Landlord, and any judgment taken against any Member of The Landlord may be vacated and set aside at any time without hearing, (iii) no writ of execution will ever be levied against the assets of any Member of Landlord, and (iv) these agreements by Tenant are enforceable both by Landlord and by any Member of Landlord. 11. Damage or Destruction. (a) Subject to the provisions of Paragraphs 11(b) and 11(c) below, if, during the Term, the Premises are totally or partially destroyed from any insured casualty, Landlord shall, within SIXTY (60) DAYS after the destruction, commence to restore the Premises to substantially the same condition as they were in immediately before the destruction and prosecute the same diligently to completion. Such destruction shall not terminate this Lease. Landlord's obligation shall not include repair or replacement of Tenant's alterations or Tenant's equipment, furnishings, fixtures and personal property. If the existing laws do not permit the Premises to be restored to substantially the same condition as they were in immediately before destruction, and Landlord is unable to get a variance to such laws to permit the commencement of restoration of the Premises within the 60-day period, then either party may terminate this Lease by giving written notice to the other party within thirty (30) days after expiration of the 60-day period. (b) Despite the provisions of Paragraph 11 (a) above, Landlord may decide within SIXTY (60) days after such destruction to demolish the Building rather than rebuild it, in which case this Lease will terminate as of the date of the destruction. Landlord shall give Tenant written notice of its intention within SIXTY (60) days after the destruction. (c) If any destruction occurs to the Premises during the last six (6) months of the initial Term or during the last six (6) months of any extension period, regardless of the nature and extent of the destruction, either party can elect to terminate this Lease within thirty (30) days after the destruction occurs. If this Lease does not terminate pursuant to this Paragraph 11 (c), the provisions of Paragraph 11 (a) above shall apply. (d) If the Premises are damaged from any uninsured casualty to any extent whatsoever, Landlord may within SIXTY (60) days following the date of such damage: (i) commence to restore the Premises to substantially the same condition as they were in immediately before the destruction and prosecute the same diligently to completion, in which event this Lease shall continue in full force and effect; or (ii) within the 90-day period Landlord may elect not to so restore the Premises, in which event this Lease shall cease and terminate. In either such event, Landlord shall give Tenant written notice of its intention within the 90-day period. (e) In the event of destruction or damage to the Premises which materially interferes with Tenant's use of the Premises, if this Lease is not terminated as above provided, there shall be an abatement or reduction of Base Rent between the date of destruction and the date Landlord substantially completes its reconstruction obligations, based upon the extent to which the destruction materially interferes with Tenant's use of the Premises. All other obligations of Tenant under this Lease shall remain in full force and effect. Except for abatement of Base Rent, Tenant shall have no claim against Landlord for any loss suffered by Tenant due to damage or destruction of the Premises or any work of repair undertaken as herein provided. -12- 13 (f) The provisions of California Civil Code Sections 1932(2) and 1933(4), and any successor statutes, are inapplicable with respect to any destruction of the Premises, such sections providing that a lease terminates upon the destruction of the Premises unless otherwise agreed between the parties to the contrary. (g) Notwithstanding any other provisions of this Paragraph 11, if the Premises are more than 50% destroyed then, Tenant shall have the right to terminate this Lease lay giving Landlord written notice thereof; provided, however, Landlord does not substantially complete the restoration of the Premises prior to receipt of Tenant's written notice of termination. 12. Eminent Domain. (a) If all or any part of the Premises shall be taken as a result of the exercise of the power of eminent domain, this Lease shall terminate as to the part so taken as of the date of taking. In the case of a partial taking of greater than fifty percent (50%) of the rentable area of the Premises, either Landlord or Tenant shall have the right to terminate this Lease as to the balance of the Premises by notice to the other within thirty (30) days after the date of the taking. In the event of a partial taking of the Premises which does not result in a termination of this Lease, the monthly Base Rent thereafter to be paid shall be equitably reduced on a square footage basis. If the continued occupancy of Tenant is materially interfered with for any time during the partial taking notwithstanding the partial taking does not terminate this Lease as to the part not so taken, the Base Rent shall proportionately abate so long as Tenant is not able to continuously occupy the part remaining and not so taken. (b) All compensation awarded or paid upon a total or partial taking of the fee title shall belong to Landlord whether such compensation be awarded or paid as compensation for diminution in value of the leasehold or of the fee except Tenant shall retain and have a claim for the following, to the extent specifically designated by the condemning authority (i) the unamortized value over the Term of Tenant's leasehold improvements (to the extent Landlord has not contributed to the cost thereof); (ii) that portion (if any) of the award made to Landlord as a result of removing fixtures, removable by Tenant herein, under the terms of this Lease but which are required to be taken by the condemner or are so acquired by the condemner; and (iii) all relocation assistance, moving and relocation expenses to the extent (if any) provided by the condemning authority directly to Tenant. 13. Assignment and Subletting (a) Tenant shall not assign, sublet or hypothecate this Lease or any interest herein or sublet the Premises or any part thereof or permit the use of the Premises by any party other than Tenant without the prior written consent of Landlord, which consent shall not be unreasonably withheld Any of the foregoing acts without Landlord's consent shall be void and shall, at the option of Landlord, terminate this Lease In connection with each consent requested by Tenant, Tenant shall submit to Landlord the terms of the proposed transaction, the identity of the parties to the transaction, the proposed documentation for the transaction, current financial statements of any proposed assignee or sublessee and all other information reasonably requested by Landlord concerning the proposed transaction and the parties involved therein. (c) No sublessee shall have a right further to sublet, and any assignment by a sublessee of its sublease shall be subject to Landlord's prior written consent in the same manner as if Tenant were entering into a new sublease. (d) Regardless of Landlord's consent, no subletting or assignment shall release Tenant of Tenant's obligation, or alter the primary liability of Tenant to pay the Rent and to perform all other obligations to be performed by Tenant hereunder The acceptance of Rent by Landlord from any other person shall not be deemed to be a waiver by Landlord of any provisions hereof Consent to one assignment or subletting shall not be deemed consent to any subsequent assignment or subletting In the event of default by any assignee of Tenant or any successor of Tenant in the performance of any of the terms hereof, Landlord may proceed directly against Tenant without the necessity of exhausting remedies against such assignee or successor. -13- 14 (e) In the event Tenant shall assign or sublet the Premises or request the consent of Landlord to any assignment or subletting, then Tenant shall reimburse Landlord for reasonable costs and attorneys' fees incurred in connection therewith in an amount not to exceed $1,000.00. 14. Default by Tenant. (a) The following events shall constitute events of default under this Lease: (1) a failure by Tenant to pay any scheduled Rent where such failure continues for five (5) days after written notice by Landlord to Tenant. (2) a failure by Tenant to deliver any rent other than scheduled Rent where such failure continues for ten (10) days after written notice by Landlord to Tenant. (3) a failure by Tenant to deliver an estoppel certificate (as provided in Paragraph 17 below) where such failure continues for ten (10) days after written notice by Landlord to Tenant. (4) the bankruptcy or insolvency of Tenant, any transfer by Tenant to defraud creditors, any assignment by Tenant for the benefit of creditors, or the commencement of any proceedings of any kind by or against Tenant under any provision of the Federal Bankruptcy Act or under any other insolvency, bankruptcy or reorganization act unless, in the event any such proceedings are involuntary, Tenant is discharged from the same within sixty (60) days thereafter; the appointment of a receiver for a substantial part of the assets of Tenant; or the levy upon this Lease or any estate of Tenant hereunder by any attachment or execution; (5) the abandonment or vacation of the Premises; (6) the discovery by Landlord that any financial statement given to Landlord by Tenant, any assignee of Tenant, any subtenant of Tenant, any successor in interest of Tenant or any guarantor of Tenant's obligation hereunder, and any of them, was materially false; and (7) a failure by Tenant to perform any of the terms, covenants, agreements or conditions of this Lease to be observed or performed by Tenant (excluding any event of default under Paragraph 14(a)(1) through 14(a)(3) above), where such failure continues for thirty (30) days after written notice thereof by Landlord to Tenant; provided, however, that if the nature of the default is such that the same cannot reasonably be cured within the 30-day period, Tenant shall not be deemed to be in default if Tenant shall within such period commence such cure and thereafter diligently prosecute the same to completion. (b) In the event of any material default or breach by Tenant, Landlord may at any time thereafter, without limiting Landlord in the exercise of any right or remedy at law or in equity which Landlord may have by reason of such default or breach: (1) Pursue the remedy described in California Civil Code Section 1951.4 whereby Landlord may continue this Lease in full force and effect after Tenant's breach and abandonment and recover the Rent and any other monetary charges as they become due, without terminating Tenant's right to sublet or assign this Lease, subject only to reasonable limitations as herein provided. During the period Tenant is in default, Landlord shall have the right to do all acts necessary to preserve and maintain the Premises as Landlord deems reasonable and necessary, including removal of all persons and property from the Premises, and Landlord can enter the Premises and relet them, or any part of them, to third parties for Tenant's account. Tenant shall be liable immediately to Landlord for all costs Landlord incurs in reletting the Premises, including, without limitation, brokers' commissions, expenses of remodeling the Premises required by the reletting, and like costs. Reletting can be for a period shorter or longer than the remaining Term. (2) Pay or perform such obligation due (but shall not be obligated to do so), if Tenant fails to pay or perform any obligations when due under this Lease within the time permitted for their payment or performance. In such case, the costs incurred by Landlord in connection with the performance of any -14- 15 such obligation will be additional rent due under this Lease and will become due and payable on demand by Landlord. (3) Terminate Tenant's rights to possession by any lawful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the Premises to Landlord. In such event Landlord shall be entitled to recover from Tenant all damages incurred by Landlord by reason of Tenant's default, including, without limitation, the following: (A) the worth at the time of award of any unpaid Rent which had been earned at the time of such termination; plus (B) the worth at the time of award of the amount by which the unpaid Rent which would have been earned after termination until the time of award exceeds the amount of such Rent loss that is proved could have been reasonably avoided; plus (C) the worth at the time of award of the amount by which the unpaid Rent for the balance of the Term after the time of award exceeds the amount of such Rent loss that is proved could be reasonably avoided; plus (D) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of events would be likely to result therefrom; plus (E) at Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable State law. Upon any such termination of Tenant's possessory interest in and to the Premises, Tenant (and at Landlord's sole election, Tenant's sublessees) shall no longer have any interest in the Premises, and Landlord shall have the right to make any reasonable repairs, alterations or modifications to the Premises which Landlord in its sole discretion deems reasonable and necessary. The "worth at the time of award" of the amounts referred to in subparagraphs (A) and (B) above is computed by allowing interest at the maximum rate an individual is permitted by law to charge. The worth at the time of award of the amount referred to in subparagraph (C) above is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). (4) Pursue any other legal or equitable remedy available to Landlord. Unpaid installments of Rent and other unpaid monetary obligations of Tenant under the terms of this Lease shall bear interest from the date due at the rate of ten percent (10%) per annum. (c) In the event Tenant is evicted or Landlord takes possession of the Premises by reason of any default by Tenant hereunder, Tenant hereby waives any right of redemption or relief from forfeiture as provided by law. (d) Even though Tenant has breached this Lease and abandoned the Premises, this Lease shall continue in effect for so long as Landlord does not terminate Tenant's right to possession, and Landlord may enforce all its rights and remedies under this Lease, including the right to recover Rent as it becomes due under this Lease. Acts of maintenance or preservation, efforts to relet the Premises, or the appointment of a receiver upon initiative of Landlord to protect Landlord's interest under this Lease, shall not constitute a termination of Tenant's right to possession. (e) In the event Tenant is in material default under any provision of this Lease then, at Landlord's sole election: (i) Tenant shall not have the right to exercise any available right, option or election under this Lease ("Tenant's Exercise Rights") if at such time Tenant is in default hereunder, (ii) Tenant shall not have the right to consummate any transaction or event triggered by the exercise of any of Tenant's Exercise Rights if at such time Tenant is in default hereunder, and (iii) Landlord shall not be obligated to give Tenant any required notices or information relating to the exercise of any of Tenant's Exercise Rights hereunder. 15. Default by Landlord Notice to Mortgagee. Landlord shall not be in default unless Landlord, or the holder of any mortgage, deed of trust or ground lease covering the Premises, fails to perform obligations required of Landlord within a reasonable time, but in no event later than thirty (30) days after written notice by Tenant to Landlord certified mail, postage prepaid, and to the holder of any first mortgage, deed of trust or ground lease covering the Premises whose name and address shall have been furnished to Tenant in writing, specifying wherein Landlord has failed to perform such obligations; provided, however, that if the nature of Landlord's obligation is such that more than thirty (30) days are required for performance then Landlord shall not be in default if Landlord or the holder of any -15- 16 such mortgage, deed of trust or ground lease commences performance within such 30-day period and thereafter diligently prosecutes the same to completion. In no event shall Tenant be entitled to terminate this Lease by reason of Landlord's default, and Tenant's remedies shall be limited to an action for monetary damages at law. 16. Security Deposit. On execution of this Lease, Tenant shall deposit with Landlord the sum specified in the Basic Lease Information (the "Security Deposit"). The Security Deposit shall be held by Landlord as security for the performance by Tenant of all of the provisions of this Lease. If Tenant fails to pay Rent or other charges due hereunder, or otherwise defaults with respect to any provision of this Lease, Landlord may use, apply, or retain all or any portion of the Security Deposit for the payment of any Rent or other charge in default, or the payment of any other sum to which Landlord may become obligated by reason of Tenant's default, or to compensate Landlord for any loss or damage which Landlord may suffer thereby. If Landlord so uses or applies all or any portion of the Security Deposit, then within ten (10) days after demand therefor Tenant shall deposit cash with Landlord in an amount sufficient to restore the deposit to the full amount thereof, and Tenant's failure to do so shall be a material breach of this Lease. Landlord shall not be required to keep the Security Deposit separate from its general accounts. If Tenant performs all of Tenant's obligations hereunder, the Security Deposit, or so much thereof as has not theretofore been applied by Landlord, shall be returned, without payment of interest for its use, to Tenant (or, at Landlord's option to the last assignee, if any, of Tenant's interest hereunder) at the expiration of the Term, and after Tenant has vacated the Premises. No trust relationship is created herein between Landlord and Tenant with respect to the Security Deposit. 17. Estoppel Certificate. (a) Tenant shall within ten (10) days of notice from Landlord execute, acknowledge and deliver to Landlord a statement certifying (i) that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect), (ii) the amount of the Security Deposit, (iii) the date to which the Rent has been paid, (iv) acknowledging that there are not, to Tenant's knowledge, any uncured defaults on the part of Landlord hereunder, or specifying such defaults, if any are claimed, and (v) such other matters as may reasonably be requested by Landlord. Any such statement may be conclusively relied upon by any prospective purchaser or encumbrances of the Building. (b) Tenant's failure to deliver such statement within such time shall be conclusive upon Tenant, (i) that this Lease is in full force and effect, without modification except as may be represented by Landlord, (ii) that there are no uncured defaults in Landlord's performance, and (iii) that not more than one month's Base Rent has been paid in advance. (c) If Landlord desires to finance or refinance the Building, Tenant agrees to deliver to any lender designated by Landlord such financial statements of Tenant as may be reasonably required by such lender. All such financial statements shall be received by Landlord in confidence and shall be used for the purposes herein set forth. 18. Subordination. This Lease, at Landlord's sole option, shall be subordinate to any ground lease, mortgage, deed of trust, or any other hypothecation for security now or hereafter placed upon the Building and to any and all advances made on the security thereof and to all renewals, modifications, consolidations, replacements, refinancing and extensions thereof. Notwithstanding such subordination, Tenant's right to quiet possession of the Premises shall not be disturbed if Tenant is not in default and so long as Tenant shall pay the Rent and observe and perform all of the provisions of this Lease, unless this Lease is otherwise terminated pursuant to its terms. If any mortgagee, trustee, or ground lessor shall elect to have this Lease prior to the lien of its mortgage, deed of trust or ground lease, and shall give notice thereof to Tenant, this Lease shall be deemed prior to such mortgage, deed of trust, or ground lease, whether this Lease is dated prior to or subsequent to the date of said -16- 17 mortgage, deed of trust or ground lease or the date of recording thereof. If any mortgage or deed of trust to which this Lease is subordinate is foreclosed or a deed in lieu of foreclosure is given to the mortgagee or beneficiary, Tenant shall attorn to the purchaser at the foreclosure sale or to the grantee under the deed in lieu of foreclosure; if any ground lease to which this Lease is subordinate is terminated, Tenant shall attorn to the ground lessor. Tenant agrees to execute any documents required to effectuate such subordination or to make this Lease prior to the lien of any mortgage, deed of trust or ground lease, as the case may be, or to evidence such attornment. Any such document of attornment shall also provide that the successor shall not disturb Tenant in its use of the Premises in accordance with this Lease. 19. Attorneys' Fees. In the event legal action is initiated by either party, the prevailing party shall be entitled to recover all costs and expenses incurred in such action, including, without limitation, reasonable attorneys' fees and costs, including attorneys' fees incurred at trial and on appeal, if any. 20. Notices. All notices, consents, demands, and other communications from one party to the other given pursuant to the terms of this Lease shall be in writing and shall be deemed to have been fully given when personally delivered, delivered by courier service, sent via facsimile (confirmation receipt required), or forty-eight (48) hours after the same is deposited in the United States mail, certified or registered, postage prepaid, and addressed as follows: To Tenant at the address specified in the Basic Lease Information or to such other place as Tenant may from time to time designate in a notice to Landlord; to Landlord at the address specified in the Basic Lease Information, or to such other place and to such other parties as Landlord may from time to time designate in a notice to Tenant. 21. General Provisions. (a) This Lease shall be governed by and construed in accordance with the internal laws of the State of California, notwithstanding any choice of law statutes, regulations, provisions or requirements to the contrary. (b) The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof. (c) This Lease including attached Exhibits, Addenda, and Basic Lease Information contains all agreements and understandings of the parties and supersedes and cancels any and all prior or contemporaneous written or oral agreements, instruments, understandings, and communications of the parties with respect to the subject matter herein. This Lease, including the attached Exhibits, Addenda, and Basic Lease Information, may be modified only in a writing signed by each of the parties. (d) No waiver of any provision hereof by either party shall be deemed by the other party to be a waiver of any other provision, or of any subsequent breach of the same provision. Landlord's or Tenant's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Landlord's or Tenant's consent to, or approval of, any subsequent act by the other party. (e) If Tenant remains in possession, with the expressed consent of Landlord, of all or any part of the Premises after the expiration of the Term, such tenancy shall be from month to month only, and not a renewal hereof or an extension for any further term, and in such case, Rent shall be payable in the amount of the last month's Base Rent and all other charges under the Lease and such month-to-month tenancy shall be subject to every other term, covenant and agreement contained herein. (f) Subject to the provisions of this Lease restricting assignment or subletting by Tenant, this Lease shall bind the parties, their personal representatives, successors, and assigns. (g) Upon reasonable prior notice to Tenant (which notice shall not be required in the event of an emergency), Landlord and Landlord's representatives and agents shall have the right to enter the Premises during regular business hours for the purpose of inspecting the same, showing the same to prospective -17- 18 purchasers or lenders, and making such alterations, repairs, improvements, or additions to the Premises, the Building or the Common Areas as Landlord may deem necessary or desirable. Landlord may at any time during the last one hundred twenty (120) days of the Term place on or about the Premises any ordinary "For Lease" sign. Landlord may at any time place on or about the Premises any ordinary "For Sale" sign. (h) The voluntary or other surrender of this Lease by Tenant, the mutual cancellation thereof or the termination of this Lease by Landlord as a result of Tenant's default shall, at the option of Landlord, terminate all or any existing subtenancies or may, at the option of Landlord, operate as an assignment to Landlord of any or all of such subtenancies. (i) If Tenant is a corporation, limited liability company or partnership, each individual executing this Lease on behalf of Tenant represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of the corporation, company or partnership in accordance with, where applicable, a duly adopted resolution of the board of directors of the corporation, the vote of the members of the limited liability company or the vote of the partners within the partnership, and that this Lease is binding upon the corporation, company or partnership in accordance with its respective articles of incorporation and bylaws, operating agreement or partnership agreement. (j) Time is expressly declared to be of the essence of this Lease and of each and every covenant, term, condition, and provision hereof, except as to the conditions relating to the delivery of possession of the Premises to Tenant. (k) If there is more than one party comprising Tenant, the obligations imposed on Tenant shall be joint and several. (l) The language in all parts of this Lease shall be in all cases construed as a whole according to its fair meaning and not strictly for nor against either Landlord or Tenant. (m) As used in this Lease and whenever required by the context thereof, each number, both singular and plural, shall include all numbers and in each gender shall include all genders. Landlord and Tenant, as used in this Lease or in any other instrument referred to in or made a part of this Lease, shall likewise include both the singular and the plural, a corporation, limited liability company, partnership, individual or person acting in any fiduciary capacity as executor, administrator, trustee or in any other representative capacity. (n) The Exhibits and Addendum, if any, specified in the Basic Lease Information are attached to this Lease and by this reference made a part hereof. 22. Force Majeure. Any delay in construction, repairs, or rebuilding any building, improvement or other structure herein shall be excused and the time limit extended to the extent that the delay is occasioned by reason of acts of God, labor troubles, laws or regulations of general applicability, acts of Tenant or other occurrences beyond the reasonable control of Landlord. Accordingly, Landlord's obligation to perform shall be excused for the period of the delay and the period for performance shall be extended for a period equal to the period of such delay. 23. Broker's Fee. Each party represents that it has not had dealings with any real estate broker, finder, or other person, with respect to this Lease in any manner, except the brokerage firm(s) specified in the Basic Lease Information. Each party shall hold harmless the other party from all damages resulting from any claim that may be asserted against the other party by any broker, finder, or other person with whom the other party has or purportedly has dealt. Landlord shall pay any commissions or fees that are payable to the broker or finder specified in the Basic Lease Information, with respect to this Lease in accordance with the provisions of a separate commission contract. -18- 19 24. Financial Statement. It is acknowledged by all parties hereto that the attached financial declaration of Tenant is incorporated as a part of this Lease as Exhibit E, that the information contained therein is true and correct in all material respects, and that the accuracy of the information is a significant fact upon which Landlord has relied in the granting of this Lease. IN WITNESS WHEREOF, the parties have executed this Lease on the date first mentioned above. TENANT: LANDLORD: Metro Commerce Bank, Inc. G & W/Copley Redwood Business Park, L.P. a California corporation a limited partnership By: /s/ CHARLES HALL By: G & W Management Co. Its President Its: Manager By: /s/ WILLIAM C. WHITE, President G & W Management Co. By: /s/ PATRICK E. PHELAN By: /s/ MATTHEW T. WHITE Its: SVP/Chief Financial Officer Chief Financial Officer G & W Management Co.
-19- 20 ADDENDUM NO. 1 1. Base Rent:
MONTHLY BLENDED NNN TOTAL MONTHLY LEASE YEAR BASE RENT PER SQ. FT. BASE RENT ---------- --------------------- ------------- 1 - 3 $1.15 $5,331 4 - 6 $1.20 $5,562 7 - 8 $1.25 $5,794 9 - 10 $1.30 $6,026
2. Option to Extend: (a) Tenant shall have the option to extend the term of this Lease for two (2) five (5) year terms ("Extended Term(s)") commencing upon the expiration of the Initial Term (and the Extended Term), provided that in each such case Tenant gives Landlord at least six (6) months prior written notice of the exercise of its option to extend the term of the Lease. However, (i) if Tenant is in default on the date of giving the Option Notice, then the notice shall be deemed ineffective and invalid, or (ii) if Tenant is in default on the commencement date of the Extended Term(s), then the Extended Term(s) and this Lease shall expire at the end of the Current Lease Term. Tenant shall have no other right to extend the term of the Lease beyond the Extended Terms. (b) The Base Rent for the Extended Term(s) shall be increased annually by three percent (3%) from the preceding Lease Year. (c) Tenant shall have no other right to extend the term beyond the Extended Term. 3. ATM Machine, Safe, Awning and Night Deposit Box: Tenant may install, at Tenant's sole expense, an ATM machine, night deposit box and an awning on the outside of the Premises and a safe inside the Premises. Tenant shall obtain all required governmental approvals for such installation, including without limitation, approval from the Redwood Business Park Architectural Review Committee and the City of Petaluma. Tenant agrees to assume full responsibility for any liability, damage action claim, injury (to person or property), cost or expense in conjunction with the installation, placement, maintenance and repair thereto or damage caused thereby. Upon vacating the premises at the end of the Lease Term or any extension thereof, Tenant shall be responsible for removing such ATM machine, night deposit box and safe, and repairing any damage occasioned by such removal at Tenant's sole expense. 4. Dedicated Parking Spaces: Four (4) parking spaces located in front of the ATM shall be marked by Landlord for Tenant's customers using the ATM. The four (4) dedicated spaces shall be included in the 3.5 per 1,000 square feet as detailed in Lease Paragraph 6.5. 5. Common Area Restrooms: Tenant shall have use of the common area restrooms as outlined on Exhibit A. -20- 21 EXHIBIT C RULES AND REGULATIONS It is further agreed that the following Rules and Regulations shall be and are hereby made a part of this Lease, and Tenant agrees that Tenant's employees and agents, or any others permitted by Tenant to occupy or enter the Premises, will at all times abide by said Rules and Regulations, unless otherwise specified or provided for in the Lease, to wit: 1. The driveways, entrances and exits to the Property, sidewalks, passages, building entries, lobbies, corridors, stairways, and elevators of the Building shall not be obstructed by Tenant, or Tenant's agents or employees, or used for any purpose other than ingress and egress to and from the Premises. Tenant or Tenant's agents or employees shall not loiter on the lawn areas or other common areas of the Property. (a) Furniture, freight equipment and supplies will be moved in or out of the Building in a reasonable manner In the event Tenant's movers damage any part of the Building or Property, Tenant shall forthwith pay to Landlord the amount required to repair said damage. (b) Except as outlined in tire Addendum, no article, the weight of which may in the opinion of Landlord constitute a hazard to or damage to the Building or the Building's equipment, shall be moved into the Premises without Landlord's prior written approval, but such consent or approval shall not be unreasonably withheld, conditioned or delayed. Landlord and Tenant shall mutually agree to the location of such articles in the Premises. All damage done to the Property, Building or Premises by putting in, taking out or maintaining extra heavy equipment shall be repaired at the expense of Tenant. (c) Landlord reserves the right to close and keep locked any and all entrances and exits of the Building and Property and gates or doors closing the parking areas thereof during such hours as Landlord may deem advisable for the adequate protection of the Property and all tenants therein. Subject to Paragraph 6.3 of the Lease, Landlord shall not close off parking areas during banking hours. 2. Except as otherwise provided for in the Lease, no sign, advertisement or notice shall be inscribed, painted or affixed on any part of the inside or outside of the Building unless of such color, size and style and in such place upon or in the Building as shall be first approved in writing by Landlord. No furniture or other materials shall be placed in front of the Building or in any lobby or corridor, without the prior written consent of Landlord. Landlord shall have the right to remove all non permitted signs and furniture, without notice to Tenant. 3. Tenant shall not employ any person or persons other than the janitor or cleaning contractor of Landlord for the purpose of cleaning or taking care of the Premises without the prior written consent of Landlord, which shall not be unreasonably withheld, conditioned or delayed. Except as otherwise provided in the Lease, Landlord shall in no way be responsible to Tenant for any loss of property from the Premises, however occurring. 4. Water closets and other water fixtures shall not be used for any purpose other than that for which the same are intended, and any damage resulting to the same from misuse on the part of Tenant or Tenant's agents or employees, shall be paid for by Tenant. No person shall waste water by tying back or wedging the faucets or in any other manner. 5. No animals except seeing-eye dogs or other animals necessary to the functioning of handicapped personnel shall be allowed on the lawns or sidewalks or in the offices, halls, and corridors of the Building. 6. No persons shall disturb the occupants of this or adjoining buildings or premises by the use of any radio, sound equipment or musical instrument or by the making of loud or improper noises, nor interfere in any way with the other tenants or those having business with them. Should sound mitigation C-1 22 measures be required due to sounds originating in the Premises, the costs of such measures shall be paid for by Tenant. 7. Bicycles or other vehicles, other than wheel chairs, shall not be permitted in the offices, halls, corridors and lobbies in the Building nor shall any obstruction of sidewalks or entrances of the Building by such be permitted. 8. Tenant shall not allow anything to be placed on the outside of the Building, nor shall anything be thrown by Tenant or Tenant's agents or employees, out of the windows or doors, or down the corridors, ventilation ducts or shafts of the Building. Tenant, except in case of fire or other emergency, shall not open any outside window. 9. N/A. 10. All garbage, including wet garbage, refuse or trash shall be placed by Tenant in the receptacles designated by Landlord for that purpose. Tenant shall not burn any trash or garbage at any time in or about the leased Premises or any area of the Property. Tenant and Tenant's of ricers, agents, and employees shall not throw cigar or cigarette butts or other substances or litter of any kind in or about the Property. 11. Tenant shall not install or operate any steam or gas engine or boiler, or other machinery or carry on any mechanical business, other than such mechanical business which normally is identified with general use in the Premises. Explosives or other articles of an extra hazardous nature shall not be brought into the Building complex. 12. Any painting or decorating as may be agreed to be done by and at the expense of Landlord shall be done during regular weekday working hours. Should Tenant desire such work on Saturdays, Sundays, holidays or outside of regular working hours, Tenant shall pay for the extra cost thereof, if any. 13. Tenant and Tenant's agents and employees shall park their vehicles in areas designated from time-to-time for employee parking. 14. Tenant shall not mark, drive nails, screw, bore, or drill into, paint or in any way deface the common area walls, exterior walls, roof, foundations, bearing walls, or pillars without the prior written consent of Landlord. The expense of repairing any breakage, stoppage or damage resulting from a violation of this rule shall be borne by Tenant. 15. No waiver of any rule or regulation by Landlord shall be effective unless expressed in writing and signed by Landlord or his authorized agent. 16. Tenant shall be responsible for cleaning up any trash blowing around their facility that may have been left by their customers or employees. 17. In the event of any conflict between these rules and regulations or any further or modified rules and regulations from time to time issued by Landlord, and the lease provisions, the lease provisions shall govern and control. 18. Landlord reserves the right at any time to change or rescind any one or more of these rules and regulations, or to make such other and further reasonable rules and regulations as in Landlord's judgment may from time to time be necessary for the management, safety, care and cleanliness of the Premises, and for the preservation of good order therein, as well as for the convenience of other tenants of the Property. Landlord shall not be responsible to Tenant or to any other person for the nonobservance or violation of the rules and regulations by any other tenant or person. Tenant shall be deemed to have read these rules and to have agreed to abide by them as a condition to its occupancy of the space herein leased, and Tenant shall abide by any additional rules and regulations which are ordered or requested by Landlord or by any governmental authority. C-2 23 EXHIBIT D
MATERIALS QUANTITIES --------- ----------
Tenant agrees that: (a) None of the above materials will be used, held or stored on or about the Premises in quantities of greater than one (1) gallon each, or twenty (20) pounds each in the case of non-liquid materials; provided, however, that used or excess materials may be stored together in a fifty-five (55) gallon drum while awaiting transport off the Premises for disposal. (b) The materials listed on Page 1 to this Exhibit D shall be stored in fire-proof lockers on the Premises in accordance with applicable laws, regulations and ordinances. No storage outside the Premises will be permitted. (c) No used or excess materials will be disposed of in, on, under or about the Premises or Redwood Business Park. Instead, such materials shall be transported off-site, no less often than every one hundred eighty (180) days, by a duly licensed hazardous materials transporter. While waiting for transport off-site for disposal, used or excess materials shall be stored in a safe location on the Premises in secure containers which are appropriately labeled. (d) No materials listed on Page 1 to this Exhibit D, regardless of whether they are water-soluble, shall be flushed down any sanitary sewer drains on or about the Premises or Redwood Business Park. D-1 EX-27 3 FINANCIAL DATA SCHEDULE (ARTICLE 9)
9 1,000 YEAR DEC-31-1998 DEC-31-1998 8,804 286 3,200 0 36,023 6,055 6,081 111,075 1,117 169,496 154,904 356 1,154 0 0 0 9,578 3,504 169,496 10,559 2,173 473 13,205 4,586 4,610 8,595 153 53 6,703 2,748 2,748 0 0 1,621 0.79 0.74 9.12 563 404 0 0 1,007 53 10 1,117 924 0 193
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