-----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, Qhvc64eUke/HYyaJjcTcYnVD7c3Cre7DjlXcb4xbAUISgdBqu7TA7iaY6BiS7exk E8IDLoNv6/UKYbyJtonGMA== 0000950148-97-000772.txt : 19970401 0000950148-97-000772.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950148-97-000772 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HERITAGE OAKS BANCORP CENTRAL INDEX KEY: 0000921547 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 953763629 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-25020 FILM NUMBER: 97568808 BUSINESS ADDRESS: STREET 1: 545 12TH ST CITY: PASO ROBLES STATE: CA ZIP: 93446 BUSINESS PHONE: 8052395200 MAIL ADDRESS: STREET 2: 545 12TH ST CITY: PASO ROBLES STATE: CA ZIP: 93446 10KSB 1 10KSB 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to ________________ Commission file number 0-25020 HERITAGE OAKS BANCORP ------------------------------------------------------ (Exact name of registrant as specified in its charter) State of California 77-0388249 - ------------------- ---------- (State or other jurisdiction of (I.R.S. Identification No.) employee incorporation or organization) 545 12th Street, Paso Robles, California 93446 - ---------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (805) 239-5200 ----------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Title of each class Name of each exchange on which registered - ------------------- ----------------------------------------- Common Stock, (no par value) None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB [X]. Registrant's revenues for 1996 were $8,480,287. The aggregate market value of the voting stock held by non-affiliates of the Registrant at March 1st, 1997 was $6,097,950. As of March 1st, 1997, the Registrant had 675,296 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE The following documents are incorporated by reference into this Form 10-KSB: Part III, Items 9 through 12 of Registrant's definitive proxy statement for the 1997 annual meeting of shareholders. Transitional Small Business Disclosure Format (check one) Yes [ ] No[X] 2 INDEX TO FORM 10-KSB ________________________________________________________________________________ PART I ________________________________________________________________________________ Item 1. Description of Business Item 2. Description of Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders ________________________________________________________________________________ PART II ________________________________________________________________________________ Item 5. Market for Common Equity and Related Stockholders Matters Item 6. Management's Discussion and Analysis or Plan of Operations Item 7. Financial Statements Item 8. Changes and Disagreements with Accountants on Accounting and Financial Disclosure ________________________________________________________________________________ PART III ________________________________________________________________________________ Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act Item 10. Executive Compensation Item 11. Security Ownership of Certain Beneficial Owners and Management Item 12. Certain Relationships and Related Transactions Item 13. Exhibits and Reports on Form 8-K ________________________________________________________________________________ 3 PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL Heritage Oaks Bancorp (the "Company") is a California corporation organized in 1994 to act as the bank holding company of Heritage Oaks Bank (the "Bank"). In 1994, the Company acquired all of the outstanding common stock of the Bank in a holding company formation transaction. Other than holding the shares of the Bank, the Company conducts no significant activities, although it is authorized, with the prior approval of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), the Company's principal regulator, to engage in a variety of activities which are deemed closely related to the business of banking. The Bank commenced operations in January 1983. It is headquartered in Paso Robles with a branch office in Paso Robles, two branches in San Luis Obispo and a branch office in Cambria. The Bank conducts a commercial banking business in San Luis Obispo County including accepting demand, savings and time deposits, and making commercial, real estate, SBA, agricultural, credit card, and consumer loans. It also offers installment note collection, provides POS terminals and processing, issues cashiers checks and money orders, sells travelers checks, and provides bank-by-mail, night depository, safe deposit boxes, and other customary banking services. The Bank's deposits are insured by the Federal Deposit Insurance Corporation ("FDIC") to the maximum extent permitted by law. The Bank does not offer trust services or international banking services and does not plan to do so in the near future. The Bank's operating policy since its inception has emphasized retail banking. Most of the Bank's customers are retail customers, farmers and small to medium-sized businesses. The Bank takes real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery and equipment as collateral for loans. The areas in which the Bank has directed virtually all of its lending activities are (i) commercial and agricultural loans, (ii) installment loans, (iii) construction loans, and (iv) other real estate loans or commercial loans secured by real estate. As of December 31, 1996, these four categories accounted for approximately 41.0%, 10.7%, 14.2% and 33.9% respectively, of the Bank's loan portfolio. As of December 31, 1996, $24,333,014 of the Bank's $50,570,564 in loans consisted of interim construction and real estate loans, primarily for single family residences or for commercial development. Additionally, commercial and agricultural loans grew $10.3 million (approximately 99%) between year end 1995 and year end 1996. See "Item 6 - Managements Discussion and Analysis of Financial Condition and Results of Operations." Most of the Bank's deposits are attracted by local promotional activities and advertising in the local media. A material portion of the Bank's deposits have not been obtained from a single person or a few persons, the loss of any one or more of which would have a materially adverse effect on the business of the Bank. As of December 31, 1996, the Bank had approximately 13,317 deposit accounts, representing approximately 3,523 non-interest bearing (demand) accounts with balances totaling approximately $13,230,117 for an average balance per account of approximately $3,755; 4 6,826 savings, interest-bearing demand and money market accounts with balances totaling approximately $36,200,319 for an average balance per account of approximately $5,303; and 1,484 time certificate of deposit accounts with balances totaling approximately $22,560,862, for an average balance per account of approximately $15,203. The principal sources of the Bank's revenues are (i) interest and fees on loans, (ii) interest on investments, (iii) service charges on deposit accounts and other charges and fees, and (iv) ATM transaction fees and interchange income (v) bankcard merchant fees. For the year ended December 31, 1996, these sources comprised 54.0%,11.9%, 4.4%, 22.5% and 4.3%, respectively, of the Bank's total operating income. The Bank has arranged to install 72 cash dispensing machines for the purpose of dispensing cash at 46 sites on Native American lands where bingo games and other gaming operations are conducted, at other commercial locations, and at the Bank's 5 offices. The Bank receives a transaction fee for each completed transaction on the cash dispensing machines at the gaming sites. The Bank shares a portion of the fee with the individuals who had helped to make these arrangements and with the tribes on whose lands the cash dispensing machines are installed. In connection with this program, the Bank has been named in a lawsuit seeking monetary damages and an injunction against certain of the Bank's activities under the program. See, "Item 3 - Legal Proceedings." The Bank's portion of the transaction fees related to such services were $1,349,949 in 1996 compared to $1,498,678 in 1995. Competition for these services has increased in recent years and no assurance can be given that the Bank will be able to continue to provide these services at as many locations and with the same degree of profitability as in the past. On February 21, 1997, the Bank established, through the acquisition of certain assets and liabilities from Wells Fargo Bank, a branch in Cambria, California. The total assets acquired were $5,255,161, including $217,000 of leasehold improvements and $99,610 in fixed assets. The Bank acquired only approximately $15,000 in loan assets. The Bank assumed approximately $5,237,000 of deposit liabilities, $17,908 of accrued liabilities and Wells Fargo's liability under the lease for the premise. The Bank paid a premium of $92,007 for the deposits which will be included in "Other Assets" in the Company's consolidated financial statements. The premium will be amortized over a five year period. The branch acquisition and its effects have not been included within the Company consolidated financial statements for the year ended December 31, 1996. See, Note 23 to the financial statements included at "Item 7 - Financial Statements." The Company has also caused to be incorporated a proposed subsidiary, CCMS Systems, Inc. which is currently inactive and has not been capitalized. The Company has no present plans to activate the proposed subsidiary. The Bank has not engaged in any material research activities relating to the development of new services or the improvement of existing bank services. There has been no significant change in the types of services offered by the Bank since its inception. The Bank has no present plans regarding "a new line of business" requiring the investment of a material amount of total assets. Most of the Bank's business originates from Paso Robles and San Luis Obispo and there is no emphasis on foreign sources and application of funds. The Bank's business, based upon 5 performance to date, does not appear to be seasonal. 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 regulations. The Bank holds no patents, licenses (other than licenses obtained from bank regulatory authorities), franchises or concessions. EMPLOYEES As of February 1, 1997, the Bank had a total of 47 full-time employees and 18 part-time employees. The management of the Bank believes that its employee relations are satisfactory. The Company's has only one salaried employee (the internal auditor). The Company's officers all hold similar positions at the Bank and receive compensation from the Bank. COMPETITION The banking and financial services business in California generally, and in the Bank's market area specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. The Bank's business is concentrated in its service area, which encompasses northern and central San Luis Obispo County. The economy of San Luis Obispo County is moderately dependent upon the agricultural industry. Consequently, the Bank competes with other financial institutions in northern and central San Luis Obispo County for deposits from and loans to individuals and companies who are also dependent upon the agricultural industry. In order to compete with other financial institutions in its service area, the Bank relies principally upon local advertising programs; direct personal contact by officers, directors, employees, and shareholders; and specialized services such as courier pick-up and delivery of non-cash banking items. The Bank emphasizes to its customers the advantages of dealing with a locally owned and community oriented institution. The Bank also seeks to provide special services and programs for individuals in its primary service area who are employed in the agricultural, professional and business fields, such as loans for equipment, furniture, tools of the trade or expansion of practices or businesses. Larger banks may have a competitive advantage because of higher lending limits and major advertising and marketing campaigns. They also perform services, such as trust services, international banking, discount brokerage and insurance services which the Bank is not authorized or prepared to offer currently. The Bank has made arrangements with its correspondent banks and with others to provide such services for its customers. For borrowers requiring loans in excess of the Bank's legal lending limits, the Bank has offered, and intends to offer in the future, such loans on a participating basis with its correspondent banks and with other independent banks, retaining the portion of such loans which is within its lending limits. As of December 31, 1996, the Bank's legal lending limits to a single borrower and such borrower's related 6 parties were $1,122,953 on an unsecured basis and $1,871,588 on a fully secured basis based on regulatory capital of $7,486,352. Commercial banks compete with savings and loan associations, credit unions, other financial institutions and other entities for funds. For instance, yields on corporate and government debt securities and other commercial paper affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for loans with savings and loan associations, credit unions, consumer finance companies, mortgage companies and other lending institutions. In recent years competition for cash dispensing machines on Native American lands in connection with gaming operations has increased and no assurance can be given that the Bank will be able to continue to provide these services at as many locations and with the same degree of profitability as in the past. SUPERVISION AND REGULATION The Company and the Bank are extensively regulated under both federal and state laws, as discussed below. THE COMPANY The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is registered as such with, and subject to the supervision of, the Federal Reserve Board. The Company is required to file with the Federal Reserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may conduct examinations of bank holding companies and their subsidiaries. The Company is required to obtain the approval of the Federal Reserve Board 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. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company. The Company is prohibited by the Bank Holding Company Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging, directly or indirectly, in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company may, subject to the prior approval of the Federal Reserve Board, engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Company, and any subsidiaries which it may acquire or organize, are deemed to be "affiliates" of the Bank within the meaning of that term as defined in the Federal Reserve Act. This 7 means, for example, that there are limitations (a) on loans by the Bank to affiliates, and (b) on investments by the Bank in affiliates' stock as collateral for loans to any borrower. 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 an extension of credit, sale or lease of property or furnishing of services. Section 106(b) of the Bank Holding Company Act Amendments of 1970 generally prohibits a bank from tying a product or service to another product or service offered by the bank, or by any of its affiliates. Further, the Company and the Bank are required to maintain certain levels of capital. See, "Effect of Governmental Policies and Recent Legislation - Capital Standards." The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest subsidiaries or affiliates when the Federal Reserve Board determines that the activity or the control or the subsidiary or affiliates constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the Federal Reserve Board's regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe and unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. THE BANK The Bank is chartered under the laws of the State of California and its deposits are insured by the FDIC to the extent provided by law. The Bank is subject to the supervision of, and is regularly examined by, the California Superintendent of Bank (the "Superintendent") and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Bank's business and condition. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes relate to many aspects of the Bank's operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. Further, the Bank is required to maintain certain levels of capital. See "Effect of Governmental 8 Policies and Recent Legislation - Capital Standards." California law and regulations of the Superintendent authorize California licensed banks, subject to applicable limitations and approvals of the Superintendent to (1) provide real estate appraisal services, management consulting and advice services, and electronic data processing services; (2) engage directly in real property investment or acquire and hold voting stock of one or more corporations, the primary activities of which are engaging in real property investment; (3) organize, sponsor, operate or render investment advice to an investment company or to underwrite, distribute or sell securities in California; and (4) invest in the capital stock, obligations or other securities of corporations not acting as insurance companies, insurance agents or insurance brokers. In November 1988, Proposition 103 was adopted by California voters. The Superintendent has established certain procedures to be followed by banks desiring to engage in insurance activities which include filing a report describing (1) a proposed business plan and information regarding the types of insurance products intended to be offered; (2) insurance companies with which the banks intend to conduct business; (3) organization plans; (4) locations at which activities will be conducted; and (5) proposed operational and compliance procedures and policies. EFFECT OF GOVERNMENTAL POLICIES AND RECENT LEGISLATION Banking is a business that depends 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 the 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 are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment. 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 Federal Reserve Board. The Federal Reserve Board 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 subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board 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. From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, in the California legislature and before various bank regulatory and other professional agencies. For example, legislation has been introduced in Congress that would repeal the current statutory restrictions on affiliations between commercial banks and securities 9 firms. Under the proposed legislation, bank holding companies would be allowed to control both a commercial bank and a securities affiliate, which could engage in the full range of investment banking activities, including corporate underwriting. The likelihood of any major legislative changes and the impact such changes might have on the Bank are impossible to predict. See, "Supervision and Regulation." CAPITAL STANDARDS The Federal Reserve Board 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 relatively high credit risk, such as business loans. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, noncumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. 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 is 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. In August 1995, the federal banking agencies adopted final regulations specifying that the agencies will include, in their evaluations of a bank's capital adequacy, an assessment of the exposure to declines in the economic value of the bank's capital due to changes in interest rates. The final regulations, however, do not include a measurement framework for assessing the level of a 10 bank's exposure to interest rate risk, which is the subject of a proposed policy statement issued by the federal banking agencies concurrently with the final regulations. The proposal would measure interest rate risk in relation to the effect of a 200 basis point change in market interest rates on the economic value of a bank. Banks with high levels of measured exposure or weak management systems generally will be required to hold additional capital for interest rate risk. The specific amount of capital that may be needed would be determined on a case-by-case basis by the examiner and the appropriate federal banking agency. Because this proposal has only recently been issued, the Bank currently is unable to predict the impact of the proposal on the Bank if the policy statement is adopted as proposed. Effective January 17, 1995, the federal banking agencies issued a final rule relating to capital standards and the risks arising from the concentration of credit and nontraditional activities. Institutions which have significant amounts of their assets concentrated in high risk loans or nontraditional banking activities and who fail to adequately manage these risks, will be required to set aside capital in excess of the regulatory minimums. The federal banking agencies have not imposed any quantitative assessment for determining when these risks are significant, but have identified these issues as important factors they will review in assessing an individual bank's capital adequacy. In December 1993, the federal banking agencies issued an interagency policy statement on the allowance for loan and lease losses which, among other things, establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by such policy statement is the sum of (A) assets classified loss; (B) 50 percent of assets classified doubtful; (C) 15 percent of assets classified substandard; and (D) estimated credit losses on other assets over the upcoming 12 months. Federally supervised banks and savings associations are currently required to report deferred tax assets in accordance with SFAS No. 109. The federal banking agencies issued final rules governing banks and bank holding companies, which became effective April 1, 1995, which limit the amount of deferred tax assets that are allowable in computing an institutions regulatory capital. The standard has been in effect on an interim basis since March 1993. Deferred tax assets that can be realized for taxes paid in prior carryback years and from future reversals of existing taxable temporary differences are generally not limited. Deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of (i) the amount that can be realized within one year of the quarter-end report date, or (ii) 10% of Tier 1 Capital. The amount of any deferred tax in excess of this limit would be excluded from Tier 1 Capital and total assets and regulatory capital calculations. Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends. 11 The following table presents the amounts of regulatory capital and the capital ratios for the Bank, compared to its minimum regulatory capital requirements as of December 31, 1996.
DECEMBER 31, 1996 -------------------------- Actual Minimum ----------- Capital Requirement ----------- Leverage ratio . . . . . . . . . . . . . . . . . . . 8.41% 4.0% Tier 1 risk-based ratio . . . . . . . . . . . . . . . 12.67% 4.0 Total risk-based ratio . . . . . . . . . . . . . . . 13.94% 8.0
PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS Federal law requires each federal banking agency 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. The law required each federal banking agency to promulgate 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. In September 1992, the federal banking agencies issued uniform final regulations implementing the prompt corrective action provisions of federal law. An insured depository institution generally will be classified in the following categories based on capital measures indicated below: "Well capitalized" "Adequately capitalized" ---------------- ---------------------- Total risk-based capital of 10%; Total risk-based capital of 8%; Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and Leverage ratio of 5%. Leverage ratio of 4%. "Undercapitalized" "Significantly undercapitalized" ---------------- ------------------------------ Total risk-based capital less than 8%; Total risk-based capital less than 6%; Tier 1 risk-based capital less than 4%; or Tier 1 risk-based capital less than 3%; or Leverage ratio less than 4%. Leverage ratio less than 3%. "Critically undercapitalized" --------------------------- Tangible equity to total assets less than 2%.
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 12 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 an institution as "critically undercapitalized" unless its capital ratio actually warrants such treatment. The law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt correction action provisions. An insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or senior executive officers; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any 13 of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized. Further restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator. 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. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. SAFETY AND SOUNDNESS STANDARDS In July 1995, the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by FDICIA. The guidelines set forth operational and managerial standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. Guidelines for asset quality and earnings standards will be adopted in the future. The guidelines establish the safety and soundness standards that the agencies will use to identify and address problems at insured depository institutions before capital becomes impaired. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action. In December 1992, the federal banking agencies issued final regulations prescribing uniform guidelines for real estate lending. The regulations, which became effective on March 19, 1993, require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must 14 address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations. Appraisals for "real estate related financial transactions" must be conducted by either state certified or state licensed appraisers for transactions in excess of certain amounts. State certified appraisers are required for all transactions with a transaction value of $1,000,000 or more; for all nonresidential transactions valued at $250,000 or more; and for "complex" 1-4 family residential properties of $250,000 or more. A state licensed appraiser is required for all other appraisals. However, appraisals performed in connection with "federally related transactions" must now comply with the agencies' appraisal standards. Federally related transactions include the sale, lease, purchase, investment in, or exchange of, real property or interests in real property, the financing or refinancing of real property, and the use of real property or interests in real property as security for a loan or investment, including mortgage-backed securities. PREMIUMS FOR DEPOSIT INSURANCE Federal law has established several mechanisms to increase funds to protect deposits insured by the Bank Insurance Fund ("BIF") administered by the FDIC. The FDIC is authorized to borrow up to $30 billion from the United States Treasury; up to 90% of the fair market value of assets of institutions acquired by the FDIC as receiver from the Federal Financing Bank; and from depository institutions that are members of the BIF. Any borrowings not repaid by asset sales are to be repaid through insurance premiums assessed to member institutions. Such premiums must be sufficient to repay any borrowed funds within 15 years and provide insurance fund reserves of $1.25 for each $100 of insured deposits. The FDIC also has authority to impose special assessments against insured deposits. The FDIC has adopted final regulations implementing a risk-based premium system required by federal law. Under the regulations, which cover the assessment periods commencing on and after January 1, 1994, insured depository institutions are required to pay insurance premiums within a range of 23 cents per $100 of deposits to 31 cents per $100 of deposits depending on their risk classification. The FDIC, effective September 15, 1995, lowered assessments from their rates of $.23 to $.31 per $100 of insured deposits to rates of $.04 to $.31, depending on the health of the bank, as a result of the recapitalization of the BIF. On November 15, 1995, the FDIC voted to drop its premiums for well capitalized banks to zero effective January 1, 1996. Other banks will be charged risk-based premiums up to $.27 per $100 of deposits. The Bank's premium for 1997 is nominal. In 1994 the Bank acquired a branch of a savings and loan association and the Bank pays an additional premium related to these deposits to the FDIC's Savings Association Insurance Fund ("SAIF"). The premium related to theses deposits is $.06 per $100. At the current rate the Bank's premiums will be approximately $4,584 per quarter for 1997. Congress has in 1996 passed and the President has signed into law, provisions to strengthen the SAIF and to repay outstanding bonds that were issued to recapitalize the SAIF as a result of payments made due to the insolvency of savings and loan association and other federally insured 15 savings institutions in the late 1980s and early 1990s. The new law will require saving and loan associations to be bear the cost of recapitalizing the SAIF and, after January 1, 1997, banks will contribute towards paying off the financing bonds, including interest. In 2000, the banking industry will assume the bulk of the payments. The new law also aims to merge the BIF and SAIF by 1999 but not until the bank and savings and loan charters are combined. The Treasury department has until March 31, 1997 to deliver a report to Congress on combining the charters. Additionally, the new law provides "regulatory relief" for the banking industry by effecting approximately 30 laws and regulations. The cost and benefits of the new law to the Bank can not currently be predicted accurately; however, because of the acquisition of SAIF insured deposits through the branch acquisition in 1994, the Bank was assessed a payment of $99,985. INTERSTATE BANKING AND BRANCHING On September 29, 1994, the President signed into law the Riegel-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act"). Under the Interstate Act, beginning one year after the date of enactment, a bank holding company that is adequately capitalized and managed may obtain approval under the Bank Holding Company Act to acquire an existing bank located in another state without regard to state law. A bank holding company would not be permitted to make such an acquisition if, upon consummation, it would control (a) more than 10% of the total amount of deposits of insured depository institutions in the United States or (b) 30% or more of the deposits in the state in which the bank is located. A state may limit the percentage of total deposits that may be held in that state by any one bank or bank holding company if application of such limitation does not discriminate against out-of-state banks. An out-of-state bank holding company may not acquire a state bank in existence for less than a minimum length of time that may be prescribed by state law except that a state may not impose more than a five year existence requirement. The Interstate Act also permits, beginning June 1, 1997, mergers of insured banks located in different states and conversion of the branches of the acquired bank into branches of the resulting bank. Each state may permit such combinations earlier than June 1, 1997, and may adopt legislation to prohibit interstate mergers after that date in that state or in other states by that state's banks. The same concentration limits discussed in the preceding paragraph apply. The Interstate Act also permits a national or state bank to establish branches in a state other than its home state if permitted by the laws of that state, subject to the same requirements and conditions as for a merger transaction. In 1995, California adopted "opt in" legislation under the Interstate Act that permits out-of-state banks to acquire California banks that satisfy a five-year minimum age requirement (subject to exceptions for supervisory transactions) by means of merger or purchases of assets, although entry through acquisition of individual branches of California institutions and de novo branching into California are not permitted. The Interstate Act and the California branching statute will likely increase competition from out-of-state banks in the markets in which the Company operates, although it is difficult to assess the impact that such increased competition may have on the Company's operations. 16 COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. At its last examination by the FDIC, the Bank received a CRA rating of "Satisfactory." The banking regulators have recently substantially overhauled the implementing CRA regulations. Under the new regulations, banks will have the option of being assessed for CRA compliance under one of several methods. Small banks will be evaluated differently than larger banks and technically are not subject to some date collection requirements. The focus of the new regulations is on the volume and distribution of a bank's loans, with particular emphasis on lending activity in low and moderate income areas and to low and moderate income persons. The new regulations place added importance on a bank's product delivery system, particularly branch localities. The new regulation will require banks, other than small banks, to comply with significantly increased date collection requirements. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required for any bank which has applied to, among other things, establish a new branch office that will accept deposits, relocate an existing office, or merge, consolidate with or acquire the assets or assume the liabilities of a federally regulated financial institution. It is likely that banks' compliance with the CRA, as well as other so-called fair lending laws, will face heightened government scrutiny and that costs associated with compliance will increase. ACCOUNTING CHANGES In February 1992, the Financial Accounting Standards Board ("FASB") issued SFAS No. 109, "Accounting for Income Taxes," which superseded SFAS No. 96 of the same title. SFAS No. 109, which became effective for fiscal years beginning after December 31, 1992, employs an asset and liability approach in accounting for income taxes payable or refundable at the date of the financial statements as a result of all events that have been recognized in the financial statements and as measured by the provisions of enacted tax laws. Adoption by the Company of SFAS No. 109 did not have a material impact on the Company's results of operations. In December 1991, the FASB issued SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," which is effective for fiscal years ending after December 15, 1992 (December 15, 1995 in the case of entities with less than $150 million in total assets). SFAS No. 107 requires financial intermediaries to disclose, either in the body of their financial statements or in the accompanying notes, the "fair value" of financial instruments for which it is "practicable to estimate that value." SFAS No. 107 defines "fair value" as the amount at which 17 a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Quoted market prices, if available, are deemed the best evidence of the fair value of such instruments. Most deposit and loan instruments issued by financial intermediaries are subject to SFAS No. 107, and its effect will be to require financial statement disclosure of the fair value of most of the assets and liabilities of financial intermediaries such as the Company. Management is unable to predict what effect, if any, such disclosure requirements could have on the market price of the Company's Common Stock or its ability to raise funds in the financial markets. In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan". SFAS No. 114 prescribes the recognition criterion for loan impairment and the measurement methods for certain impaired loans and loans whose terms are modified in troubled debt restructurings. SFAS No. 114 states that a loan is impaired when it is probable that a creditor will be unable to collect all principal and interest amounts due according to the contracted terms of the loan agreement. A creditor is required to measure impairment by discounting expected future cash flows at the loan's effective interest rate, or by reference to an observable market price, or by determining that foreclosure is probable. SFAS No. 114 also clarifies the existing accounting for in-substance foreclosures by stating that a collateral-dependent real estate loan would be reported as real estate owned only if the lender had taken possession of collateral. SFAS No. 118 amended SFAS No. 114, to allow a creditor to use existing methods for recognizing interest income on an impaired loan. To accomplish that, it eliminated the provisions in SFAS No. 114 that described how a creditor should report income on an impaired loan. SFAS No. 118 did not change the provisions in SFAS No. 114 that require a creditor to measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, or as a practical expedient, at the observable market price of the loan or the fair value of the collateral if the loan is collateral dependent. SFAS No. 118 amends the disclosure requirements in SFAS No. 114 to require information about the recorded investments in certain impaired loans and about how a creditor recognizes interest income related to those impaired loans. SFAS No. 114 is effective for financial statements issued for fiscal years beginning after December 15, 1994. In May 1993, the FASB issued SFAS No. 115 "Accounting For Certain Investments in Debt and Equity Securities" addressing the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. These investments would be classified in three categories and accounted for as follows: (i) debt and equity securities that the entity has the positive intent and ability to hold to maturity would be classified as "held to maturity" and reported at amortized cost; (ii) debt and equity securities that are held for current resale would be classified as trading securities and reported at fair value, with unrealized gains and losses included in operations; and (iii) debt and equity securities not classified as either securities held to maturity or trading securities would be classified as securities available for sale, and reported at fair value, with unrealized gains and losses excluded from operations and reported as a separate component of shareholders' equity. The statement is effective for financial statements for calendar year 1994, but may be applied to an earlier fiscal year for which annual financial statements have not been issued. The Company adopted SFAS No. 115 effective January 18 1, 1994. The cumulative effect of the change in accounting was not material. During the fourth quarter of 1995, the Bank was permitted under applicable accounting standards to make a one time transfer of securities between investments held to maturity and investments available for sale. The Bank elected not to make any transfers between its investment portfolios during 1995. In March of 1995, the FASB issued SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of. SFAS No. 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. The statement does not apply to financial instruments, long-term customer relationships of a financial institution (core deposits), mortgage and other servicing rights, and deferred tax assets. SFAS No. 121 requires the review of long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances include, for example, a significant decrease in market value of an asset, a significant change in use of an asset, or an adverse change in a legal factor that could affect the value of an asset. If such an event occurs and it is determined that the carrying value of the asset may not be recoverable, an impairment loss should be recognized as measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value can be determined by a current transaction, quoted market prices, or present value of estimated expected future cash flows discounted at the appropriate rate. The statement is effective for fiscal years beginning after December 15, 1995. The Company does not anticipate that implementation of SFAS No. 121 will have a material impact on its results of operations or financial position. In May of 1995, the FASB issued SFAS No. 122, Accounting for Mortgage Servicing Rights. SFAS No. 122 eliminate distinctions between servicing rights that were purchased and those that were retained upon the sale of loans. The statement requires mortgage servicers to recognize as separate assets rights to service loans, no matter how the rights were acquired. Institutions who sell loans and retain the servicing rights will be required to allocate the total cost of the loans to servicing rights and loans based on their relative fair values if the value can be estimated. SFAS No. 122 is effective for fiscal years beginning after December 15, 1995. Further, SFAS No. 122 requires that all capitalized mortgage servicing rights be periodically evaluated for impairment based upon the current fair value of these rights. Management believes the implementation of this statement will not have a material effect on the Company's financial condition and results of operations since it does not retain servicing on its sold mortgage loans. In October of 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation, establishing financial accounting and reporting standards for stock-based employee compensation plans. This statement encourages all entities to adopt a new method of accounting to measure compensation cost of all employee stock compensation plans based on the estimated fair value of the award at the date it is granted. Companies are, however, allowed to continue to measure compensation cost for those plans using the intrinsic value based method of accounting, which generally does not result in compensation expense recognition for most plans. Companies that elect to remain with the existing accounting are required to disclose in a footnote to the financial statements pro forma net income and, if presented, earnings per share, as if this statement had been 19 adopted. The accounting requirements of this statement are effective for transactions entered into in fiscal years that begin after December 15, 1995; however, companies are required to disclose information for awards granted in their first fiscal year beginning after December 15, 1994. Management believes the implementation of this statement will not have a material effect on the Company's financial condition and results of operations. In June of 1996, the FASB issued SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, establishing accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities based on the consistent application of the financial-components approach. This approach requires the recognition of financial assets and servicing assets that are controlled by the reporting entity, the derecognition of financial assets when control is surrendered, and the derecognition of liabilities when they are extinguished. Specific criteria are established for determining when control has been surrendered in the transfer of financial assets. Liabilities and derivatives incurred or obtained by transferors in conjunction with the transfer of financial assets are required to be measured at fair value, if practicable. Servicing assets and other retained interests in transferred assets are required to be measured by allocating the previous carrying amount between the assets sold, if any, and the interest that is retained, if any, based on the relative fair values of the assets at the date of the transfer. Servicing assets retained are subsequently subject to amortization and assessment for impairment. Management believes the implementation of this statement will not have a material effect on the Company's financial condition and results of operations. ITEM 2. DESCRIPTION OF PROPERTIES The Bank and the Company occupy a permanent headquarters facility which is located at 545 Twelfth Street, Paso Robles, California. The purchase price for the headquarters, was approximately $1,000,000 for the building and land. This building has approximately 9,000 square feet of space and off-street parking. The Bank has remodeled this building at an approximate cost of $300,000. The Bank has a non-banking office, located at 600 Twelfth Street, Paso Robles (directly across from its present headquarters) which was purchased by the Bank on December 23, 1986, for approximately $400,000 from an unaffiliated party. In June of 1994, the Bank opened a branch at 171 Niblick Rd. Paso Robles, California. The Bank leases this 1,400 square foot branch for $2,135 per month. The lease will expire July 19, 1997 at which time the Bank has an option to renew the lease for an additional 3 years. On September 2, 1994, the Bank acquired the San Luis Obispo branch of La Cumbre Savings and Loan. The Bank leases this 2,124 square foot branch for approximately $3,712 per month. The lease will expire December 28, 1997 at which time the Bank has an option to renew the lease for an additional 5 years. 20 The Bank opened a branch office at 1135 Santa Rosa Street in downtown San Luis Obispo, California in April 1996. The Bank is leasing a building containing approximately 5,618 square feet for $5,050 per month for the first year. The lease payment will increase by approximately $500 per month during the next 4 years. The lease will expire on February 28, 2001 at which time the Bank has an option to renew the lease for an additional 5 years. On February 21, 1997, the Bank acquired the Cambria branch of Wells Fargo Bank located at 1276 Tamson Drive, Cambria. The Bank leases this 2,916 square foot branch for approximately $38,491 in yearly base rent subject to adjustments for cost of living increases and certain pass-throughs. The lease will expire in 2004 at which time the Bank has an option to renew the lease for two additional five year terms. ITEM 3. LEGAL PROCEEDINGS The Bank is, from time to time, subject to various pending and threatened legal actions which arise out of the normal course of its business. Except as described below, neither the Company nor the Bank is a party to any pending legal or administrative proceedings (other than ordinary routine litigation incidental to the Company's or the Bank's business) and no such proceedings are known to be contemplated, The Bank is a defendant in a suit brought in January 1996 in Santa Clara County, California, Superior Court by Mescom Enterprises, Inc. ("Mescom"). The action alleges that the Bank has breached a contract with Mescom in connection with the Bank's providing automatic teller machines and related services on Indian lands pursuant to contracts between Mescom and certain Native American tribes (the "Mescom Agreement"). Among other causes of action, the suit alleges certain purported breaches of the Mescom Agreement. Mescom is seeking, among other things, a permanent injunction against the Bank entering into contracts directly with Native American tribes and assigning to Mescom all contracts for automatic teller machine services that the Bank has entered into directly with Native American tribes, declaratory relief, damages according to proof, and punitive damages. During March 1996, the court issued an injunction requiring the Bank to continue to make its payments under the Mescom Agreement for the next 30 days or so long as it takes the parties to settle the action or resolve it through arbitration. The action has been moved to San Luis Obispo County Court. Mediation hearings are scheduled for April 2, 1997. Management of the Bank, based upon the opinion of its legal counsel, is of the opinion that the potential liability represented by the Mescom litigation will not have a material adverse effect upon the financial condition or results of operations of the Bank. There are no material proceedings adverse to the Company or the Bank to which any director, officer, affiliate of the Company or 5% shareholder of the Company or the Bank, or any associate of any such director, officer, affiliate or 5% shareholder of the Company or Bank is a party, and none of the above persons has a material interest adverse to the Company or the Bank. 21 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1996. 22 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION There is a limited over-the-counter market for the Company's Common Stock. The Company's Common Stock is not listed on any exchange or market. However, Maguire Investments, Inc., Hoefer & Arnett, Inc. and Sutro & Co. make a market in the Company's Common Stock. The information in the following table indicates the high and low bid prices of the Company's Common Stock for each quarterly period during the last two years based upon information provided by Maguire Investments, Inc., Hoefer & Arnett and Sutro & Co. These prices do not include retail mark-ups, mark-downs or commission.
Quarter Ended Bid Prices - ------------- ------------------------ 1996 Low High - ---- --- ---- March 31 $ 9.25 $ 9.75 June 30 9.75 10.63 September 30 10.00 10.75 December 31 10.50 12.75
1995 Low High - ---- --- ---- March 31 $ 6.50 $ 7.25 June 30 7.00 7.25 September 30 8.00 8.50 December 31 8.88 9.25
HOLDERS As of February 1, 1997, there were approximately 530 holders of the Company's Common Stock. There are no other classes of common equity outstanding. 23 DIVIDENDS The Company is a legal entity separate and distinct from the Bank. The Company's shareholders are entitled to receive dividends when and as declared by its Board of Directors, out of funds legally available therefor, subject to the restrictions set forth in the California General Corporation Law (the "Corporation Law"). The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Corporation Law also provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets two conditions, which generally stated are as follows: (i) the corporation's assets equal at least 1-1/4 times its liabilities, and (ii) the corporation's current assets equal at least its current liabilities or, if the average of the corporation's earnings before taxes on income and before interest expenses for the two preceding fiscal years was less than the average of the corporation's interest expenses for such fiscal years, then the corporation's current assets must equal at least 1-1/4 times its current liabilities. The ability of the Company to pay a cash dividend depends largely on the Bank's ability to pay a cash dividend to the Company. The payment of cash dividends by the Bank is subject to restrictions set forth in the California Financial Code (the "Financial Code"). The Financial Code provides that a bank may not make a cash distribution to its shareholders in excess of the lesser of (a) the bank's retained earnings; or (b) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank may, with the approval of the Superintendent, make a distribution to its shareholders in an amount not exceeding the greater of (x) its retained earnings; (y) its net income for its last fiscal year; or (z) its net income for its current fiscal year. In the event that the Superintendent determines that the shareholders' equity of a bank is inadequate or that the making of a distribution by the bank would be unsafe or unsound, the Superintendent may order the bank to refrain from making a proposed distribution. The FDIC may also restrict the payment of dividends if such payment would be deemed unsafe or unsound or if after the payment of such dividends, the Bank would be included in one of the "undercapitalized" categories for capital adequacy purposes pursuant to federal law. See, "Item 1 - - Description of Business - Effect of Governmental Policies and Recent Legislation - Prompt Corrective Action and Other Enforcement Mechanisms." Additionally, while the Federal Reserve Board has no general restriction with respect to the payment of cash dividends by an adequately capitalized bank to its parent holding company, the Federal Reserve Board might, under certain circumstances, place restrictions on the ability of a particular bank to pay dividends based upon peer group averages and the performance and maturity of the particular bank, or object to management fees to be paid by a subsidiary bank to its holding company on the basis that such fees cannot be supported by the value of the services rendered or are not the result of an arm's length transaction. Under these provisions and considering minimum regulatory capital requirements, the amount available for distribution from the Bank to the Company was approximately $2,136,012 at December 31, 1996. Prior to the formation of the Company, the Bank declared cash dividends of $0.10 per share to shareholders of record on January 29, 1993 (paid on or about March 1, 1993) and February 4, 1994 (paid on or about February 15, 1994). The Company declared cash dividends to 24 shareholders of record on December 21, 1994 (paid on or about January 11, 1995) of $0.27 per share, on February 6, 1996 (paid on or about February 20, 1996) of $0.32 per share, and on January 3, 1997 (paid on or about February 26, 1997) of $0.50 per share. The Company intends to pay cash dividends in the future subject to various factors including regulatory restrictions described above. Whether or not stock dividends or any cash dividends will be paid in the future will be determined by the Board of Directors after consideration of various factors. The Company's profitability and regulatory capital ratios in addition to other financial conditions will be key factors considered by the Board of Directors in making such determinations regarding the payment of dividends by the Company. 25 ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is an analysis of the financial condition and results of operations of the Company for the two years ended December 31, 1996. The analysis should be read in connection with the consolidated financial statements and notes thereto appearing elsewhere in this report. On November 15, 1994, the Company acquired all of the assets and assumed all of the liabilities of the Bank. Each shareholder of the Bank received one share of stock in the Company in exchange for one share of Bank stock. The Bank became a wholly owned subsidiary of the Company. The Bank is the only active subsidiary owned by the Company. EARNINGS OVERVIEW The Company reported net income for 1996 of $913,831. This was a 7.6% decrease from the $988,568 reported in 1995. Net income reported for 1995 represented an increase of $80,740 or 8.9% more than 1994 net income of $907,828. Per share earnings, on a primary and fully diluted basis were $1.30 in 1996 compared to $1.47 in 1995 and $1.58 per share in 1994.
RETURN ON EQUITY AND ASSETS DECEMBER 31, 1996 1995 ---- ---- RETURN ON AVERAGE ASSETS 1.21% 1.36% RETURN ON AVERAGE EQUITY 13.76% 17.93% DIVIDEND PAYOUT RATIO 38.38% 21.72% AVERAGE EQUITY TO AVERAGE ASSETS RATIO 8.76% 7.59% RETURN ON AVERAGE INTEREST BEARING LIABILITIES 1.55% 1.68% AVERAGE LOANS TO AVERAGE DEPOSITS 64.27% 59.67%
NET INTEREST INCOME AND INTEREST MARGIN Net interest income, the primary component of the net earnings of a financial institution, refers to the difference between the interest paid on deposits and borrowings, and the interest earned on loans and investments. The net interest margin is the amount of net interest income expressed as a percentage of average earning assets. Factors considered in the analysis of net interest income are the composition and volume of earning assets and interest-bearing liabilities, the amount of non-interest bearing liabilities and nonaccrual loans, and changes in market interest rates. 26 Net interest income before provision for possible loan losses for 1996 was $3,609,586, an increase of $378,823 or 11.7% more than the $3,231,303 in 1995. Net interest income for 1994 was $3,030,321. The increase in net interest income for 1996 compared to 1995 was attributable to a $1,613,000 increase in average earning assets at an average rate of 8.99%. The average interest-bearing liabilities for 1996 declined by $74,000. The increase in net interest income resulted primarily from increased interest earning assets and a decrease in the volume and rate of interest-bearing liabilities. The average rate paid on interest bearing liabilities in 1996 was 3.37% compared to 3.86%. The average non-interest bearing demand deposits increased by $2,177,000 over 1995. Other low cost deposits such as savings, now and money market accounts grew an average $4,399,000 with a weighted average rate of 2.11%. The higher cost time deposits decreased $3,920,000. These changes reflect a major effort by the Bank to adjust its liability mix to increase its level of demand deposits and savings accounts. Total income on the loan portfolio increased from $4,232,288 in 1995 to $4,578,552 in 1996. This was due to an average increase in the loan portfolio of $4,693,000. During 1995, interest income for loans had increased $691,646 as a result of an increase in loans and higher interest rates. The average yield on earning assets was 8.99% and 9.09% for 1996 and 1995, respectively. The average yield on interest bearing liabilities was 3.37% for 1996, compared to 3.86% for 1995. The net interest margin was 5.80% in 1996 compared to 5.33% in 1995. The following tables set forth average balance sheet information, interest income and expense, average yields and rates and net interest income and margin for the years ended December 31, 1996 and 1995. The average balance of nonaccruing loans has been included in loan totals. 27
AVERAGE BALANCE SHEET INFORMATION (dollars in thousands) 1996 1995 Avg. Yield Interest Avg. Yield Interest Average Interest Earning Assets: Balance Rate paid Amount Balance Rate paid Amount ------- --------- ------ ------- --------- ------ Time deposits with other Banks $ 100 5.00% $ 5 $ 100 8.00% $ 8 Investment securities taxable 13,820 5.10% 761 18,384 5.86% 1,078 Investment securities non-taxable 2,785 4.96% 138 1,935 5.37% 104 Federal funds sold 2,094 5.16% 108 1,460 5.62% 82 Loans (1)(2) 43,400 10.55% 4,580 38,707 10.94% 4,233 --------- --------- --------- --------- Total interest earning assets $ 62,199 8.99% 5,592 60,586 9.09% 5,505 Allowance for possible loan losses (773) (854) Non-earning assets: Cash and due from banks 9,822 8,467 Property, premises, & equipment 1,720 1,619 Other assets 2,791 2,824 --------- --------- TOTAL ASSETS $ 75,759 $ 72,642 ========= ========= Interest-bearing liabilities: Savings, now, & money market $ 33,407 2.11% $ 704 $ 29,008 2.35% $ 683 Time deposits 24,882 5.02% 1,248 28,802 5.28% 1,520 Other borrowings 526 5.70% 30 1,079 6.58% 71 --------- --------- --------- --------- Total interest-bearing liabilities 58,815 3.37% 1,982 58,889 3.86% 2,274 --------- --------- Non-interest-bearing liabilities: Demand deposits 9,237 7.060 Other liabilities 1,479 1,176 -------- --------- Total liabilities 69,531 67,125 Stockholders' equity: Common stock 4,032 4,032 Retained earnings 2,678 2,150 Valuation allowance investments (482) (665) --------- --------- Total stockholders' equity 6,228 5,517 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 75,759 $ 72,642 ========= ========= Net interest income $ 3,610 $ 3,231 ========= ========= Net interest margin(3) 5.80% 5.33%
(1) Nonaccruing loans have been included in total loans. (2) Loan fees of $252 and $269 for 1996 and 1995, respectively have been included in the interest income computation. (3) Net interest margin has been calculated by dividing the net interest Income by total earning assets. Note: All average balances have been computing using daily balances. 28 RATE/VOLUME ANALYSIS
1996 1995 Average Average Average Average Increase (decrease) in: Bal/Vol Rate Total Bal/Vol Rate Total Interest income: Loans (1) $ 499 $(152) $ 347 $ 394 $ 298 $ 692 Investment securities taxable (255) (62) (317) 142 41 183 Investment Sec. (Non-taxable)(2) 66 (15) 51 70 (3) 67 Taxable equivalent adjustment (2) (23) 6 (17) (24) 1 (23) Interest bearing deposits 0 (3) (3) 0 1 1 Federal funds sold 33 (7) 26 40 2 42 ----- ----- ----- ----- ----- ----- Total 320 (233) 87 622 340 962 Interest expense: Savings, now, money market 97 (76) 21 64 72 136 Time deposits (199) (73) (272) 391 342 733 Subordinated debt 0 0 0 (48) 0 (48) Other borrowings (33) (8) (41) (104) 44 (60) ----- ----- ----- ----- ----- ----- Total (135) (157) (292) 303 458 761 ----- ----- ----- ----- ----- ----- Increase (decrease) in net Interest income $ 455 $ (77) $ 379 $ 319 $ 118 $ 201 ===== ===== ===== ===== ===== =====
(1) Loan fees of $252 and $269 for 1996 and 1995, respectively have been included in the interest income computation. (2) Adjusted to a fully taxable equivalent basis using a tax rate of 34%. Note A: Average balances of all categories in each period were included in the volume computations. Note B: Average yield rates in each period were used in rate computations. Any change attributable to changes in both volume and rate which cannot be segregated has been allocated. 29 NON-INTEREST INCOME Non-interest income consists of Bankcard merchant, automatic teller machines ("ATM") transactions, and other fees, service charges, and gains on other real estate owned. Non-interest income for 1996 was $2,888,823 compared to $2,794,742 for 1995. The primary increase in non-interest income is attributable to ATM transaction fees and ATM interchange income. These fees increased by $94,081 from 1995. ATM transaction fees and interchange income were $1,906,075 for 1996 compared to $1,498,664 for 1995. The Bank had lost some gaming sites in 1996 but this loss was offset by an expansion in the Company's retail ATM network. The Bank receives income for each transaction and as the volume increases so does the related income. Approximately half of the ATMs are located at gaming sites on Native American lands. The competition related to the installation of ATM machines has been increasing and the increased competition could reduce future income from existing machines. To offset this lost revenue the Bank is actively seeking new locations. Bankcard merchant fees were $363,247 in 1996 compared to $591,658 in 1995. The decrease in merchant fees was caused by the Bank selling off about half of these accounts during 1996. NON-INTEREST EXPENSES Non-interest expenses have increased as a result of the Banks growth in its branches and ATM network. The Bank opened a new branch located in downtown San Luis Obispo during May 1996. This brought the total number of branches to four at the end of the year. The Bank had also entered into an agreement to purchase Wells Fargo Bank's Cambria branch. This purchase was completed on February 21, 1997. The branch purchase increased deposits by $5,255,161 and provided the Bank the opportunity to move into a new market area in the county that we serve. Salaries and employee benefit expenses were $1,873,389 and $1,751,751 for 1996 and 1995 respectively. Full time equivalent employees were 56 for 1996 and 49 for 1995. The increase in salary and benefit expense is attributable to increase staffing for the new branch that was added in May of 1996. The ratio of "assets per employee," one of the measures of operational efficiency, was $1,520,041 and $1,476,427 for 1996, and 1995 respectively. Occupancy, furniture and equipment expenses were $770,283 during 1996, compared to $442,437 incurred in 1995. The increase was a result of the growth in branches that occurred during May of 1996 and a $145,055 increase in costs related to our ATM network. Other expenses increased to $2,297,563 in 1996 as compared to $2,149,591 in 1995. The increase in other expenses reflects costs associated with growth of the Bank and a $227,482 increase in cost associated with the growth of the ATM network. Bankcard Merchant expenses were $290,236 for 1996, compared to $530,182 for 1995 the decline resulted from the sell of half of the accounts during 1996. 30 PROVISION FOR TAXES ON INCOME The provision for income taxes was $553,343 for 1996 compared to $633,698 in 1995. The decrease in the provision is the result of the decrease in the Company's earnings before the provision for taxes. The Bank's effective tax rate was 37.7% and 39.1% in 1996 and 1995, respectively. PROVISION AND ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is based upon management's evaluation of the adequacy of the existing allowance for outstanding loans. This allowance is increased by provisions charged to expense and reduced by loan charge-offs net of recoveries. Management determines an appropriate provision based upon loan growth during the period, a comprehensive grading and review formula for loans outstanding and historical loss experience. In addition, management periodically reviews the condition of the loan portfolio including the value of security interest related to portfolio loans and the economic circumstances which may affect the value of portfolio loans to determine the adequacy of the allowance. The evaluation of the allowance is reviewed by management and reported on an ongoing basis to the Company's Loan Committee, Audit Committee and Board of Directors. A provision for credit losses of $90,000 was expended in 1996 as compared to $60,000 in 1995. Net loan charge-offs (loans charged off, net of loans recovered) were $84,337 in 1996. Net charge-offs were $169,450 during 1995. The allowance for credit losses as a percent of total gross loans at year-end 1996 and 1995 was 1.53% and 1.88%, respectively. Monitoring of all credits enables management to analyze any inherent risks in the portfolio which may result from changes in economic conditions. The following table summarizes the analysis of the allowance for loan losses as of December 31, 1996 and 1995. 31 Analysis of Allowance for Loan Losses
1996 1995 --------------------------------- Balance at Beginning of Period $ 766,262 $ 875,712 Charge-Offs: Commercial, financial and agricultural 38,475 65,000 Real estate-construction 10,032 947 Installment loans to individuals: Money Plus 3,910 4,247 Credit Cards 40,375 92,385 Other installment loans 14,339 18,531 --------------------------------- Total charge-offs 107,131 181,110 --------------------------------- Recoveries: Commercial, financial and agricultural 4,822 3,412 Real estate-construction 0 0 Installment loans to individuals: Money Plus 0 0 Credit Cards 4,780 7,498 Other installment loans 13,192 750 --------------------------------- 22,794 11,660 --------------------------------- Net Charge-offs 84,337 169,450 Additions Charged to Operations 90,000 60,000 --------------------------------- Balance at End of Period $ 771,925 $ 766,262 ================================= Gross Loans at End of Period $ 50,570,564 $ 40,813,458 Ratio of net Charge-offs (Recoveries) During The Year to Average Loans Outstanding 0.19% 0.44% Ratio of Reserve/Gross Loans 1.53% 1.88% Ratio of Non-Performing Loans to The Allowance for Credit losses 124.55% 98.94%
The Bank adopted SFAS No. 114 (as amended by SFAS No. 118), "Accounting by Creditors for Impairment of a Loan" on January 1, 1996. The statement generally requires those loans identified as "impaired" to be measured on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable that the creditor will not be able to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Included in non performing loans for the last three years is a loan for $758,115. This loan is secured 32 by real estate with an appraised value of approximately $1,500,000. Even though this loan is on a nonaccrual status, management doesn't believe that there will be any loss of the principal due. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
1996 1995 %OF LOANS % OF LOANS IN EACH CATEGORY IN EACH CATEGORY TO TOTAL LOANS TO TOTAL LOANS AMOUNT LOANS AMOUNT LOANS -------- --------- -------- --------- Commercial, Financial and Agricultural $136,610 40.99% $210,333 25.51% Real Estate - Construction 150,000 14.22% 150,000 17.79% Real Estate - Mortgage 11,700 33.90% 11,700 39.00% Installment Loans to individuals $ 48,988 10.71% 44,163 17.38% All Other Loans (Including overdrafts) 424,627 .18% 350,066 .32% -------- --------- -------- --------- $771,925 100.00% $766,262 100.00% ======== ========= ======== =========
In evaluating the allowance for the credit losses, management takes into consideration the composition of its loan portfolio, loan growth during the period, risk and collectibility of loans, and economic conditions. The allowance is maintained at a sufficient level to cover all potential loan charge-offs in addition to a cumulative, annual amount based upon the factors outlined above. Management utilizes an internal loan classification system to grade portfolio loans as a part of its analysis of the adequacy of the allowance. In addition, management periodically reviews the condition of the loan portfolio including the value of security interests related to the portfolio loan to determine the adequacy of the allowance. The evaluation of the adequacy of the allowance is reviewed by management and reported on an ongoing basis to the Bank's Loan Committee, Audit Committee and Board of Directors. LOCAL ECONOMY The California economy is expected to continue to grow at a modest rate during 1997, with the local economy in the Bank's primary service area anticipated to show higher rates of growth than the State as a whole. During 1997 a few large retail stores are under construction and are expected 33 to open during the later part of 1997. The bank has a branch in Paso Robles which is located across the street from this shopping center. Several mergers in our market area have opened a unique window of opportunity for the Bank to increase its market share. 34 FINANCIAL CONDITION ANALYSIS Total assets of the Company were $85,122,317 at December 31, 1996 compared to $72,344,925 in 1995. A major portion of the Banks's loans are adjustable. Approximately 62.9% of the loans are adjustable. The majority of those loans that reprice is tied to changes in the prime rate. If interest rates change the yield on these loans will also change. A 1.00% increase in the prime rate would increase net interest income approximately $180,000 and a 1.00% decrease in the prime rate would decrease net interest income by $180,000. The following table summarizes the composition of the loan portfolio as of December 31, 1996 and 1995.
COMPOSITION OF THE LOAN PORTFOLIO 1996 1995 Loan Category Amount Percent Amount Percent --------------------------------------------------------- Commercial, financial and agricultural $ 20,729,098 40.99% $ 10,410,604 25.51% Real estate-construction 7,190,680 14.22% 7,261,097 17.79% Real estate-mortgage 17,142,334 33.90% 15,917,437 39.00% Installment loans to individuals 5,416,061 10.71% 7,093,480 17.38% All other (including overdrafts) 92,391 0.18% 130,840 0.32% --------------------------------------------------------- Total Loans, Gross 50,570,564 100.00% 40,813,458 100.00% ====== ====== Deferred Loan Fees (218,786) (127,550) Reserve For Possible Loan Losses (771,925) (766,262) ------------ ------------ Total Loans, Net $ 49,579,853 $ 39,919,646 ============ ============
Net loans totaled $49,579,853 at December 31, 1996, compared to $39,919,646 at December 31, 1995. Loans increased during the year as the result of our new branch and moderate growth at the head office. The primary growth was approximately $2,707,000 in commercial loans for business purposes, commercial real estate of $4,953,000 and $2,658,000 in agricultural loans. 35 The following are the approximate maturities and sensitivity to change in interest rates for the loans at December 31, 1996.
AFTER ONE DUE WITHIN YEAR BUT AFTER Loan Category ONE YEAR WITHIN FIVE FIVE YEARS TOTALS - ------------- (Dollars in thousands) Commercial, Financial and Agricultural $11,781 $ 7,303 $ 1,645 $20,729 Real Estate - Construction 1,701 3,950 1,540 7,191 Real Estate - Mortgage 1,839 8,359 6,944 17,142 Installment Loans to individuals 1,161 4,181 74 5,416 All Other loans (including overdrafts) 93 0 0 93 ------- ------- ------- ------- TOTALS $16,575 $23,793 $10,203 $50,571 ======= ======= ======= =======
AFTER ONE DUE WITHIN YEAR BUT AFTER Loan Category ONE YEAR WITHIN FIVE FIVE YEARS TOTALS Interest Rate Provision - ----------------------- Predetermined rates $ 2,595 $ 7,969 $ 8,189 $18,753 Floating or adjustable rates 13,980 15,824 2,014 31,818 ------- ------- ------- ------- TOTALS $16,575 $23,793 $10,203 $50,571 ======= ======= ======= =======
RISK ELEMENTS Risk elements on loans are presented in the following table for December 31:
1996 1995 Nonaccrual Loans (impaired loans) $803,280 $758,115 Accruing Loans Past Due 90 days $160,729 $ 16,634 Restructured Loans $514,999 $149,740 Interest Excluded on Nonaccrual Loans $ 97,382 $ 92,412 Interest Recognized on Nonaccrual and Troubled Debt Restructured Loans $ 42,432 $ 21,839
36 At December 31, 1996, the Bank had no foreign loans outstanding. The Bank did not have any concentrations of loans except as disclosed above. The Bank's management is responsible for monitoring loan performance which is done through various methods, including a review of loan delinquencies and personal knowledge of customers. Additionally, the Bank, maintains both a "watch" list of loans which, for a variety of reasons, management believes require regular review as well as an internal loan classification process. Yearly, the loan portfolio is also reviewed by an experienced, outside loan reviewer not affiliated with the Bank. A list of delinquencies, the watch list, loan grades and the outside loan review are reviewed regularly by the Board of Directors. Except as set forth in the preceding table, there are no loans which management has serious doubts as to the borrower's ability to comply with present loan repayment terms. The Bank has a nonaccrual policy which requires a loan greater than 90 days past due to be placed on nonaccrual status unless such loan is well-collateralized and in the process of collection. When loans are placed on nonaccrual status, all uncollected interest accrued is reversed from earnings. Once on nonaccrual status, interest on a loan is only recognized on a cash basis. Loans may be returned to accrual status if management believes that all remaining principal and interest is full collectible and there has been at least six months of sustained repayment performance since the loan was placed on nonaccrual. If a loan's credit quality deteriorates to the point that collection of principal is believed by management to be doubtful and the value of collateral securing the obligation is sufficient the Bank generally takes steps to protect and liquidate the collateral. Any loss resulting from the difference between the loan balance and the fair market value of the property is recognized by a charge to the reserve for loan losses. When the property is held for sale after foreclosure, it is subject to a periodic appraisal. If the appraisal indicates that the property will sell for less than its recorded value, the Bank recognizes the loss by a charge to non-interest expense. TOTAL CASH AND DUE FROM BANKS Total cash and due from banks increased from $9,047,414 at December 31, 1995 to $13,575,653 at December 31, 1995. This increase was a result of the cash needed to fund the Bank's ATM networks. Other earning assets are comprised of Federal Funds sold (funds lent on a short term basis to other banks), investment securities and short term certificates of deposit at other financial institutions. These assets are maintained for short term liquidity needs of the Bank, collateralization of public deposits, and diversification of the earning asset mix. Other earning assets declined to $17,597,726 at December 31, 1996 compared to $19,392,692 at December 31, 1995. The large decrease in 1996 represents a shift in asset allocation to increase the loan portfolio. Other earning assets represented 26.2% of the earning asset portfolio at December 31, 1996, compared to 32.7% in 1995. 37 The following table summarizes the composition of other earning assets at December 31: COMPOSITION OF OTHER EARNING ASSETS
1996 1995 Amount Percent Amount Percent ----------------------------------------------------------------------- Held to Maturity investments $11,080,726 62.97% $12,314,492 63.50% Available for Sale investments 5,317,000 30.21% 5,228,200 26.96% Federal Funds Sold 1,100,000 6.25% 1,750,000 9.02% Certificate of Deposits 100,000 0.57% 100,000 0.52% ----------------------------------------------------------------------- Total other earning assets $17,597,726 100.00% $19,392,692 100.00% =======================================================================
THE AMORTIZED COST, FAIR VALUE, AND MATURITIES AT DECEMBER 31, 1996 ARE AS FOLLOWS:
SECURITIES AVAILABLE SECURITIES HELD FOR SALE TO MATURITY AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ----------- ----------- ----------- ----------- Due in one year or less $ 0 $ 0 $ 1,132,981 $ 1,142,037 Due after one year through five years 5,500,842 5,315,000 4,472,384 4,506,072 Due after five years through ten years 0 0 399,371 393,088 Due after ten years 2,000 2,000 0 0 Mortgage-backed securities 0 0 5,075,990 4,965,231 ----------- ----------- ----------- ----------- TOTAL $ 5,502,842 $ 5,317,000 $11,080,726 $11,006,428 =========== =========== =========== ===========
DEPOSITS Total deposits increased to $71,991,298 at December 31, 1996. Total deposits at December 31, 1995 were $64,714,097. 38 The following table sets forth information for the last two fiscal years regarding the composition of deposits at December 31, and the average rates paid on each of these categories.
COMPOSITION OF DEPOSITS 1996 1995 Average Average Deposit Type Balance Rate Paid Balance Rate Paid --------------------------------------------------------------------------- Non-Interest Bearing Demand $13,230,117 0.00% $ 7,495,670 0.00% Interest Bearing Demand 20,750,267 1.75% 16,844,583 1.95% Savings 8,923,709 2.53% 7,646,206 2.53% Money Market 6,526,343 2.73% 4,141,487 3.44% Time Deposits 22,560,862 5.02% 28,586,151 5.28% ----------------- ----------------- Total Deposits $71,991,298 2.89% $64,714,097 3.36% ================= =================
Set forth below is a maturity schedule of domestic time certificates of deposits of $100,000.00 or more at December 31, 1996. TIME DEPOSITS $100,000 AND MORE: (Dollars in thousands) Less than 3 months $3,567 3-6 months 204 6-12 months 200 ------ TOTAL $3,971 ------
CAPITAL The Company's total stockholders equity was $7,053,148 as of December 31, 1996 compared to $6,225,463 as of December 31, 1995. The increase in capital during 1996 was due to net income of $913,831 and an increase in the valuation allowance for investments of $71,429. The valuation allowance was a result of the company's adoption of SFAS No. 115 "Accounting for Certain Investment in Debt and Equity Securities." Capital ratios for commercial banks in the United States are generally calculated using 3 different formulas. These calculations are referred to as the "Leverage Ratio" and two "risk based" calculations known as: "Tier One Risk Based Capital Ratio" and the "Total Risk Based Capital Ratio." These standards were developed through joint efforts of banking authorities from 12 different countries around the world. The standards essentially take into account the fact that different types of assets have different levels of risk associated with them. Furthermore, they take 39 into account the off-balance sheet exposures of banks when assessing capital adequacy. The Leverage Ratio calculation simply divides common stockholders' equity (reduced by any Goodwill a bank may have) by the total assets of the bank. In the Tier One Risk Based Capital Ratio, the numerator is the same as the leverage ratio, but the denominator is the total "risk-weighted assets" of the bank. Risk weighted assets are determined by segregating all the assets and off balance sheet exposures into different risk categories and weighting them by a percentage ranging from 0% (lowest risk) to 100% (highest risk). The Total Risk Based Capital Ratio again uses "risk-weighted assets" in the denominator, but expands the numerator to include other capital items besides equity such as a limited amount of the loan loss reserve, long-term capital debt, preferred stock and other instruments. Summarized below are the bank's capital ratios at December 31, 1996. Additionally, the standards for a well-capitalized institution are displayed below.
WELL-CAPITALIZED HERITAGE (REGULATORY STANDARD) OAKS BANK Leverage Ratio 5.00% 8.41% Tier One Risk Based Capital Ratio 6.00% 12.67% Total Risk Based Capital Ratio 10.00% 13.94%
It is the intent of Management to continue to maintain strong capital ratios. LIQUIDITY The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors, investors and borrowers. Asset liquidity is primarily derived from loan payments and the maturity of other earning assets. Liquidity from liabilities is obtained primarily from the receipt of new deposits. The Bank's Asset Liability Committee (ALCO) is responsible for managing the on-and off-balance sheet commitments to meet the needs of customers while achieving the Bank's financial objectives. ALCO meets regularly to assess the projected funding requirements by reviewing historical funding patterns, current and forecasted economic conditions and individual customer funding needs. Deposits generated from Bank customers serve as the primary source of liquidity. The Bank has credit arrangements with correspondent banks which serve as a secondary liquidity source in the amount of $2,500,000. The Bank has also established to borrowing lines with brokers whereby the Bank can pledge investment securities as collateral for short term borrowings. The Bank manages its liquidity by maintaining a majority of its investment portfolio in federal funds sold and other liquid investments. At December 31, 1996, the ratio of liquid assets not pledged for collateral and other purposes to deposits and other liabilities were 18.5% compared to 32.6% in 1995. The liquidity ratio for 1996 declined as a result of investment securities that were pledged for short tem borrowing at the end of the year to fund the loan growth. These borrowings were paid in full after the acquisition of the Cambria branch purchase that closed on February 21, 1997. The ratio of gross loans to deposits, another key liquidity ratio, was 70.3% at year end 1995 compared to 63.1% at December 31, 1995. INFLATION The assets and liabilities of a financial institution are primarily monetary in nature. As such 40 they represent obligations to pay or receive fixed and determinable amounts of money which are not affected by future changes in prices. Generally, the impact of inflation on a financial institution is reflected by fluctuations in interest rates, the ability of customers to repay debt and upward pressure on operating expenses. The effect on inflation during the three-year period ended December 31, 1996 has not been significant to the Bank's financial position or results of operations. 41 ITEM 7. FINANCIAL STATEMENTS HERITAGE OAKS BANCORP CONSOLIDATED BALANCE SHEETS
December 31, --------------------------- ASSETS 1996 1995 --------------------------- Cash and due from banks (Minimum Federal Reserve required at December 31, 1996 was $1,064,000) $ 13,575,653 $ 9,047,414 Federal funds sold 1,100,000 1,750,000 --------------------------- Total Cash and Cash Equivalents 14,675,653 10,797,414 Time deposits with other banks 100,000 100,000 Investment securities: Available-for-sale 5,317,000 5,228,200 held-to-maturity, fair value of $11,006,428 and $12,484,403, respectively 11,080,726 12,314,492 Loans (net of reserves for possible loan losses of $771,925 and $766,262 at December 31, 1996 and 1995, respectively) 49,579,853 39,919,646 Property, premises and equipment, net 1,756,099 1,666,243 Net deferred tax asset 573,154 624,152 Cash surrender value 729,920 692,424 Other assets 1,309,912 1,002,354 --------------------------- TOTAL ASSETS $ 85,122,317 $ 72,344,925 =========================== LIABILITIES and STOCKHOLDERS' EQUITY Deposits: Demand, non-interest bearing $ 13,230,117 $ 7,495,670 Savings, NOW, and money market deposits 36,200,319 28,632,276 Time deposits of $100,000 or more 3,971,092 3,051,959 Time deposits under $100,000 18,589,770 25,534,192 --------------------------- Total Deposits 71,991,298 64,714,097 Other borrowed money 4,730,000 0 Other liabilities 1,347,871 1,405,365 --------------------------- Total Liabilities 78,069,169 66,119,462 Stockholders' Equity: Common Stock, no par value; 20,000,000 authorized; 675,296 and 665,655 shares issued and outstanding, respectively 4,089,245 4,033,809 Retained earnings 3,405,995 2,705,175 Valuation allowance for investments (442,092) (513,521) --------------------------- Total Stockholders' Equity 7,053,148 6,225,463 --------------------------- TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 85,122,317 $ 72,344,925 ===========================
The accompanying notes are an integral part of these financial statements. 42 HERITAGE OAKS BANCORP CONSOLIDATED STATEMENTS OF INCOME
December 31, ---------------------------------- 1996 1995 1994 ---------------------------------- Interest income: Interest and fees on loans $4,578,552 $4,232,288 $3,540,642 Interest on investment securities: U.S. Treasury securities 51,666 75,792 128,557 Obligations of U.S. Government Agencies 684,716 981,589 750,489 Corporate Bonds, mutual funds, and commercial paper 24,838 21,101 16,116 Obligations of State and Political Subdivisions 138,345 104,141 60,102 Interest on time deposits with other banks 5,334 7,631 6,883 Interest on federal funds sold 108,013 82,132 40,206 ---------------------------------- Total interest income 5,591,464 5,504,674 4,542,995 Interest expense: Savings, NOW and money market deposits 703,580 682,640 546,475 Time deposits of $100,000 or more 110,221 155,539 121,353 Time deposits under $100,000 1,138,282 1,364,584 665,947 Other 29,795 70,608 178,899 ---------------------------------- Total interest expense 1,981,878 2,273,371 1,512,674 ---------------------------------- Net interest income before provision for possible loan losses 3,609,586 3,231,303 3,030,321 Provision for possible loan losses 90,000 60,000 45,000 ---------------------------------- 3,519,586 3,171,303 2,985,321 ---------------------------------- Non-interest Income: Service charges on deposit accounts 373,022 337,757 277,268 Insurance and brokerage commission fees 14,693 7,078 34,567 Investment securities gains, net 0 337 11,608 Other 2,501,108 2,449,570 1,785,227 ---------------------------------- Total Non-interest Income 2,888,823 2,794,742 2,108,670 ---------------------------------- Non-interest Expenses: Salaries and employee benefits 1,873,389 1,751,751 1,549,404 Equipment expenses 397,068 162,986 129,844 Occupancy expenses 373,215 279,451 203,422 Other 2,297,563 2,149,591 1,696,753 ---------------------------------- Total Non-interest Expenses 4,941,235 4,343,779 3,579,423 ---------------------------------- Income before provision for income taxes 1,467,174 1,622,266 1,514,568 Provision for income taxes 553,343 633,698 606,740 ---------------------------------- Net Income $ 913,831 $ 988,568 $ 907,828 ================================== Earnings per share: Primary and fully diluted earnings per share $ 1.30 $ 1.47 $ 1.58 ==================================
The accompanying notes are an integral part of these financial statements. 43 HERITAGE OAKS BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
VALUATION TOTAL SHARES COMMON RETAINED ALLOWANCE STOCKHOLDERS' OUTSTANDING STOCK EARNINGS FOR INVESTMENTS EQUITY ------------------------------------------------------------------- BALANCES, January 1, 1994 541,858 $ 3,291,102 $ 1,042,610 $ 0 $ 4,333,712 Cash dividends paid - $.10 per share 0 0 (54,186) 0 (54,186) Conversion of Convertible Debenture 123497 740982 0 0 740,982 Cash dividends declared - $.27 per share 0 0 (179,645) 0 (179,645) Net Income 0 0 907,828 0 907,828 Unrealized loss on investment securities 0 0 0 (782,579) (782,579) ------------------------------------------------------------------- BALANCES, December 31, 1994 665,355 4,032,084 1,716,607 (782,579) 4,966,112 Exercise of Stock Options 300 1,725 0 0 1,725 Net Income 0 0 988,568 0 988,568 Change in unrealized gain (loss) on investments securities 0 0 0 269,058 269,058 ------------------------------------------------------------------- BALANCES, December 31, 1995 665,655 4,033,809 2,705,175 (513,521) 6,225,463 Exercise of stock options 9,641 55,436 0 0 55,436 Cash dividends paid - $.32 per share 0 0 (213,011) 0 (213,011) Net Income 0 0 913,831 0 913,831 Change in unrealized gain (loss) on investments securities 0 0 0 71,429 71,429 ------------------------------------------------------------------- BALANCES, December 31, 1996 675,296 $ 4,089,245 $ 3,405,995 $ (442,092) $ 7,053,148 ===================================================================
The accompanying notes are an integral part of these financial statements. 44 HERITAGE OAKS BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS
December 31, --------------------------------------------- 1996 1995 1994 --------------------------------------------- Cash flows from operating activities: Net income $ 913,831 $ 988,568 $ 907,828 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 262,424 189,057 163,141 Provision for possible loan losses 90,000 60,000 45,000 (Decrease) increase in deferred loan fees 91,236 (15,951) (109,739) Net gain on sales of investment securities 0 (337) (11,608) Amortization of premiums/discounts on investment securities, net (63,468) (128,331) (185,531) Gain on sale of other real estate owned 0 (13,314) (79,277) Gain on sale of property, premises, and equipment 0 0 (785) Net (gain) loss on sale of POS equipment (2,269) 157 (4,415) (Increase) decrease in net deferred tax assets 0 189,073 (601,101) Decrease (increase) in other assets (305,289) (262,949) 130,678 Increase (decrease) in other liabilities (57,494) 467,245 (29,676) --------------------------------------------- Net cash provided by operating activities 928,971 1,473,218 224,515 --------------------------------------------- Cash flows from investing activities: Purchase of securities held-to-maturity (2,856,218) (3,492,874) (12,697,233) Purchase of mortgage-backed securities available-for-sale 0 0 (2,911,969) Purchase of mortgage-backed securities held-to-maturity Purchase of securities available-for-sale (500,000) 0 (8,339,894) Proceeds from sales of securities held-to-maturity 0 4,978,707 0 Proceeds from principal reductions and maturities of securities held-to-maturity 3,890,000 5,299,999 0 Proceeds from sales of mortgage-backed securities available-for-sale 0 0 1,895,890 Proceeds from principal reductions and maturities of mortgage-backed securities held-to-maturity 297,079 96,192 399,973 Proceeds from principal reductions and maturities of mortgage-backed securities available-for-sale 0 0 27,032 Proceeds from sales of securities available-for-sale 0 1,115,754 8,882,000 Proceeds from principal reductions and maturities of securities available-for-sale 500,000 0 0 Purchase of life insurance policies (37,496) (33,756) (658,668) Proceeds from sale of other real estate owned 0 258,978 451,771 Increase in loans, net (9,841,443) (4,164,382) (1,264,564) Purchase of property, premises & equipment, net (352,280) (367,842) (180,816) --------------------------------------------- Net cash provided by (used in) investing activities (8,900,358) 3,690,776 (14,396,478) --------------------------------------------- Cash flows from financing activities: Increase in deposits, net 7,277,201 2,108,969 16,570,439 Net increase in other borrowings 4,730,000 (4,727,500) 1,555,000 Proceeds from exercise of stock options 55,436 1,725 0 Cash dividends paid or declared (213,011) 0 (233,831) --------------------------------------------- Net cash provided by (used in) financing activities 11,849,626 (2,616,806) 17,891,608 --------------------------------------------- Net increase in cash and cash equivalents 3,878,239 2,547,188 3,719,645 Cash and cash equivalents at beginning of year 10,797,414 8,250,226 4,530,581 --------------------------------------------- Cash and cash equivalent at end of year $ 14,675,653 $ 10,797,414 $ 8,250,226 ============================================= Supplemental disclosures of cash flow information: Interest paid $ 2,120,014 $ 1,927,954 $ 1,498,212 Income taxes paid $ 537,000 $ 611,114 $ 876,922 Supplemental disclosures of noncash flow information: Change in unrealized gain (loss) on investment securities $ 71,429 $ 269,058 ($ 782,579)
The accompanying notes are an integral part of these financial statements. 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: Summary of Significant Accounting Policies: The accounting and reporting policies of Heritage Oaks Bancorp (the Company) and Subsidiary conform to generally accepted accounting principles and to general practices within the banking industry. A summary of the Company's significant accounting and reporting policies consistently applied in the preparation of the accompanying financial statements follows: Principles of Consolidation: The consolidated financial statements include the Company and its wholly owned subsidiaries, Heritage Oaks Bank and CCMS Systems, Inc. Intercompany balances and transactions have been eliminated. Use of Estimates: 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. Estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowances for losses on loans and foreclosed real estate. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowances for losses on loans and foreclosed real estate may change. Investment Securities and Mortgage-backed securities: The Company adopted SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" which addresses the accounting for investments in equity securities that have readily determinable fair values and for investments in all debt securities. Securities and mortgage-backed securities are classified in three categories and accounted for as follows: debt, equity, and mortgage-backed securities that the company has the positive intent and ability to hold to maturity are classified as held-to-maturity and are measured at amortized cost; debt and equity securities bought and held principally for the purpose of selling in the near term are classified as trading securities and are measured at fair value, with unrealized gains and losses included in earnings;, debt and equity securities not classified as either held-to-maturity or trading securities are deemed as available-for-sale and are measured at fair value, with unrealized gains and losses, net of applicable taxes, reported in a separate component of stockholders' equity. Gains or losses on sales of investment securities and mortgage-backed securities are determined on the specific identification method. Premiums and discounts are amortized or accreted using the interest method over the expected lives of the related securities. 46 Note 1: Summary of Significant Accounting Policies: (continued) Loans: Loans are stated at unpaid principal balances less the allowance for loan losses and net deferred loan fees and unearned discounts. The Bank recognizes loan origination fees to the extent they represent reimbursement for initial direct costs, as income at the time of loan boarding. The excess of fees over costs, if any, is deferred and credited to income over the term of the loan. The Company adopted SFAS No. 114 (as amended by SFAS No. 118), "Accounting by Creditors for Impairment of a Loan" on January 1, 1995. The statement generally requires those loans identified as "impaired" to be measured on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable the creditor will not be able to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Loans are placed on a nonaccrual when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. All loans on non accrual are measured for impairment. The Bank applies the measurement provision of SFAS No. 114 to all loans in its portfolio. All loans are generally charged off at such time the loan is classified a loss. Allowance for Loan Losses: The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related allowance may change in the near term. Property, Premises and Equipment: Property, premises and equipment are stated at cost, less accumulated depreciation and amortization. Equipment under capital leases is carried at the present value of future minimum lease payments less accumulated amortization over the term of the lease. Depreciation is computed on a straight-line basis over the estimated useful lives of each asset type. Other Real Estate Owned: Other real estate owned, which represents real estate acquired through foreclosure is stated at the lower of the carrying value of the loan or the estimated fair market value less estimated selling costs of the related real estate. Loan balances in excess of the fair market value of the real estate acquired at the date of acquisition are charged against the allowance for loan losses. Any subsequent declines in estimated fair value, operation income, and gains or losses on disposition of such properties are expensed or charged to current operations. 47 Note 1: Summary of Significant Accounting Policies: (continued) Income Taxes: Provisions for income taxes are based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and include deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred taxes are computed on the liability method as prescribed in SFAS No. 109, "Accounting for Income Taxes". Consolidated Statements of Cash Flows: The Company presents its cash flows using the indirect method and reports certain cash receipts and payments arising from customer loans, deposits and deposits placed with other financial institutions on a net basis. For the purpose of the Statements of Cash Flows, cash and cash equivalents include cash and due from banks, cash items in transit, and Federal funds sold balances as of the year end. Reclassifications: Certain amounts in the 1995 and 1994 financial statements have been reclassified to conform to the 1996 presentation. Earnings Per Share: Primary and fully diluted earnings per share are based on the weighted average number of shares outstanding including dilutive common stock equivalents during each year, which were 701,421, 671,093, and 574,418, for 1996, 1995, and 1994, respectively. New Accounting Pronouncements: In June of 1996, the FASB issued SFAS No. 125 "Accounting for Transfers and Servicing of Financial assets and Extinguishment's of Liabilities" as amended by SFAS No. 127 "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125, establishing accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of the financial-components approach. This approach requires the recognition of financial assets when control is surrendered for determining when control has been surrendered in the transfer of financial assets. Liabilities and derivatives incurred or obtained by transferors in conjunction with the transfer of financial assets are required to be measured at fair value, if practicable. Servicing assets and other retained interests in transferred assets are required to be measured by allocating the previous carrying amount between the assets sold, if any, and the interest that is retained, if any, based on the relative fair values of the assets on the date of the transfer. Servicing assets retained are subsequently subject to amortization and assessment for impairment. Management has not determined the potential impact this statement will have, however believes that there will be no material effect on the Bank's financial condition or results of operations. SFAS No. 125 is effective for transactions occurring after December 31, 1996. Note 2: Reorganization Heritage Oaks Bancorp was incorporated under the laws of the State of California on March 1, 1994 for the purpose of becoming a bank holding company for Heritage Oaks Bank. Under the reorganization agreement, one share of Heritage Oaks Bank stock was converted into one share of Heritage Oaks Bancorp stock. The reorganization was consummated on November 15, 1994. The accompanying consolidated financial statements include the activity of Heritage Oaks Bancorp from November 15, 1994 (commencement of operations) and Heritage Oaks Bank for all periods presented. 48 Note 3: Fair Values of Financial Instruments Statement of Financial Accounting Standard No. 107; "Disclosure about Fair Value of Financial Instruments," requires disclosure of fair value information about all financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets, and, in many cases, could not be realized in immediate settlement of the instruments. SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank. The following table presents the estimates of fair values of financial instruments at December 31, 1996:
Carrying Amount FairValue ----------------------------- Assets: Cash and cash equivalents $14,675,653 $14,675,653 Interest bearing deposits 100,000 100,000 Investment and mortgage-backed securities 16,397,726 16,323,428 Loans receivable 49,579,853 49,538,057 Accrued interest receivable 549,515 549,515 Liabilities: Non-interest bearing deposits 13,230,117 13,230,117 Interest bearing deposits 58,761,181 58,751,053 Other borrowed money 4,730,000 4,730,000 Accrued interest payable 503,724 503,724 -----------------------------
Notional Cost to Cede Amount Or Assume -------------------------- Off-balance sheet instruments: Commitments to extend credit and standby letters of credit 12,238,199 122,382
The following methods and assumptions were used by the Bank in estimating fair value disclosures: Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values due to the short-term nature of the assets. Interest Bearing Deposits: Fair values for time deposits are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. Investment and mortgage-backed securities: Fair values are based upon quoted market prices, where available. 49 Note 3: Fair Values of Financial Instruments (continued) Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other (for example, fixed rate commercial real estate and rental property mortgage loans and commercial and industrial loans) are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The carrying amount of accrued interest receivable approximates its fair value. Deposits: The fair values disclosed for demand deposits (for example, the interest-bearing checking accounts and passbook accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value. Short-term borrowing, Federal Funds purchased, and securities sold under agreements to repurchase agreements: The carrying values reported in the balance sheet approximate the fair values of those instruments due to their short-term nature. Off-balance sheet instruments: Fair values of loan commitments and Financial guarantees are based upon fees currently charged to enter similar agreements, taking into account the remaining terms of the agreement and the counterparties' credit standing. Note 4: Investment and Mortgage-backed Securities At December 31, 1996, the investment securities portfolio was comprised of securities classified as available-for-sale and held-to-maturity, in conjunction with the adoption of SFAS No. 115, resulting in investment securities available-for-sale being carried at fair value and investment securities held-to-maturity being carried at cost, adjusted for amortization of premiums and accretion of discounts, and fair market value adjustments for securities transferred from available-for-sale. The amortized cost and fair value and investment securities available-for-sale at December 31, 1996 were:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------- U.S. Treasury securities $1,000,842 $ 0 ($ 18,342) $ 982,500 Obligations of U.S. government agencies and corporations 4,500,000 0 (167,500) 4,332,500 Other securities 2,000 0 0 2,000 ----------------------------------------------- TOTAL $5,502,842 $ 0 ($ 185,842) $5,317,000 -----------------------------------------------
Available-for-Sale Securities in the amount of $3,739,082 were transferred to held-to-maturity during 1994. The unrealized loss of $640,927 net of tax of $266,138 was reflected in a separate component of stockholders' equity and is being amortized over the remaining life of the securities as a yield adjustment. At December 31, 1996 the remaining unrealized loss of $571,892 net of tax of $238,227 is included in the valuation allowance. 50 Note 4: Investment and mortgage-backed Securities (continued) The amortized cost and fair values of investment securities held-to-maturity at December 31, 1996 were:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------------------------------------------- U.S.Treasury securities $ 98,489 $ 0 ($ 932) $ 97,557 Obligations of U.S. government agencies and corporations 3,202,355 29,702 (375) 3,231,682 Mortgage-backed securities 5,075,990 110,810 (221,569) 4,965,231 Obligations of state and political subdivisions 2,703,892 20,279 (12,213) 2,711,958 --------------------------------------------------- TOTAL $11,080,726 $ 160,791 ($ 235,089) $11,006,428 ===================================================
The amortized cost and fair value and investment securities available-for-sale at December 31, 1995 were:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------ U.S. Treasury securities $1,001,388 $ 0 ($ 13,888) 987,500 Obligations of U.S. government agencies and corporations 4,500,984 0 (262,284) 4,238,700 Other securities 2,000 0 0 2,000 ------------------------------------------------ TOTAL $5,504,372 $ 0 ($ 276,172) $5,228,200 ================================================
The amortized cost and fair values of investment securities held-to-maturity at December 31, 1995 were:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------------------------------------------- U.S.Treasury securities $ 100,000 $ 0 ($ 1,500) $ 98,500 Obligations of U.S. government agencies and corporations 4,422,374 48,876 0 4,471,250 Mortgage-backed securities 5,263,938 162,334 (83,957) 5,342,315 Obligations of state and political subdivisions 2,528,180 45,753 (1,595) 2,572,338 --------------------------------------------------- TOTAL $12,314,492 $ 256,963 ($ 87,052) $12,484,403 ===================================================
The amortized cost and fair values of investment securities available-for-sale and held-to-maturity at December 31, 1996, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities Available Securities Held For Sale To Maturity Amortized Fair Amortized Fair Cost Value Cost Value ------------------------ ------------------------ Due in one year or less $ 0 $ 0 $ 1,132,981 $ 1,142,037 Due after one year through five years 5,500,842 5,315,000 4,472,384 4,506,072 Due after five years through ten years 0 0 399,371 393,088 Due after ten years 2,000 2,000 0 0 Mortgage-backed securities 0 0 5,075,990 4,965,231 ------------------------ ------------------------ Total $ 5,502,842 $ 5,317,000 $11,080,726 $11,006,428 ======================== ========================
Proceeds from sales and maturities of investment securities available-for-sale during 1996, 1995, and 1994 were $500,000, $1,115,754, and $8,882,000, respectively. There were no gross gains or losses during 1996 on those sales and maturities. Gross gains in 1995 and 1994 were $221 and $11,068, respectively. During 1994 there were $1,658 of gross losses on sales and maturities. Proceeds from maturities and sales of investment securities held-to-maturity during 1996 and 1995 were $3,890,000 and $10,278,706, respectively. There were no gross gains or losses during 1996 on those sales and maturities and gross gains in 1995 were $1,250 and gross losses in 1995 were $1,134. Proceeds from sales and maturities of mortgage-backed securities during 1996, 1995 and 1994 were $297,079, $1,211,946, $2,322,895, respectively. During 1994 there were gross gains of $2,197. Unrealized net losses on investment securities and mortgage-backed securities included in shareholders' equity net of tax at December 31, 1996, 1995, and 1994 is $442,092, $513,521, and $782,579, respectively. Securities having a carrying value of $8,982,122 and $4,841,511 and fair value of $8,257,217 and $4,878,251 at December 31, 1996 and 1995, respectively, were pledged to secure public deposits and for other purposes as required by law. 51 Note 5: Derivative Financial Instruments The Bank adopted Statement of Financial Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments". This statement requires disclosure about derivative financial instruments such as futures, swaps, option contracts, or other financial instruments with similar characteristics. As of December 31, 1996 and 1995 the Bank held derivatives for purposes other than trading for the purpose of asset-liability management. The principal objective of the Bank's asset-liability management activities is to assure maximum levels of net interest income while maintaining acceptable levels of interest-rate and liquidity risk and facilitating the funding needs of the Bank. At December 31 ,1996, the Bank's derivatives are comprised of three securities classified on the balance sheet under investments and included in the "held-to-maturity" category. The two securities maturing in 1998 were the only two derivatives owned at December 31, 1995. These securities are considered derivatives since each included a "step-up" feature which provides the issuer of the security the option of either increasing the interest rate or having the security called, effective on the call date. This option is always the issuers and is generally based on current or future interest rates of similar securities. At December 1995 the two securities that will mature in 1998 have increased to the maximum interest rates and there are no additional increases in rate between now and maturity. The issuer can still call the bonds prior to maturity. Additional information regarding each of the securities at December 31, 1996 and 1995 is outlined below:
Next Carrying Maturity Callable Current Step-up U.S. Government Sponsored Securities: Value Date After Rates Rates ---------- ----------- ---------- ------- ------- 1996: Federal National Mortgage Association $976,779 11/03/98 11/03/95 5.47% 5.47% Federal National Mortgage Association $975,576 11/02/98 11/02/95 5.42% 5.42% Federal Home Loan Bank $250,000 10/29/2001 10/29/97 6.25% 6.63% 1995: Federal National Mortgage Association $963,889 11/03/98 11/03/95 5.47% 5.47% Federal National Mortgage Association $962,099 11/02/98 11/02/95 5.42% 5.42%
Note 6: Loans and Reserve for Possible Loan Losses
Major classifications of loans were: December 31, ---------------------------- 1996 1995 Commercial, financial, and agricultural $ 20,729,098 $ 10,410,604 Real estate-construction 7,190,680 7,261,097 Real estate-mortgage 17,142,334 15,917,437 Installment loans to individuals 5,416,061 7,093,480 All other loans (including overdrafts) 92,391 130,840 ---------------------------- 50,570,564 40,813,458 ---------------------------- Less - deferred loan fees (218,786) (127,550) Less - reserve for possible loan losses (771,925) (766,262) ---------------------------- $ 49,579,853 $ 39,919,646 ============================
52 Note 6: Loans and Reserve for Possible Loan Losses (continued) Concentration of Credit Risk At December 31, 1996, approximately $24,333,014 of the Bank's loan portfolio was collateralized by various forms of real estate. Such loans are generally made to borrowers located in Northern San Luis Obispo County. The Bank attempts to reduce its concentration of credit risk by making loans which are diversified by project type. While management believes that the collateral presently securing this portfolio is adequate, there can be no assurances that significant deterioration in the California real estate market would not expose the Bank to significantly greater credit risk. An analysis of the changes in the reserve for possible loan losses is as follows:
December 31, --------------------------------- 1996 1995 1994 --------------------------------- Balance at beginning of year $ 766,262 $ 875,712 $ 796,805 Additions charged to operating expense 90,000 60,000 45,000 Loans charged off (107,130) (181,110) (62,199) Recoveries of loans previously charged off 22,793 11,660 96,106 --------------------------------- Balance at end of year $ 771,925 $ 766,262 $ 875,712 =================================
The following is a summary of the investment in impaired loans, the related allowance for loan losses, and income recognized theron as of December 31:
1996 1995 ------------------ Recorded investment in impaired loans $965,008 $758,115 Related allowance for loan losses 193,109 150,000 Average recorded investment in impaired loans 812,252 758,115 Interest income recognized for cash payments 0 0 Cash receipts applied to reduce principal balance 0 0
The provisions of SFAS No. 114 and SFAS No. 118 permit the valuation allowance reported above to be determined a loan-by-loan basis or by aggregating loans with similar risk characteristics. Because, the loans currently identified as impaired have unique risk characteristics, the valuation allowance was determined on a loan-by-loan basis. Nonaccruing loans totaled $803,280 and $758,115 at December 31, 1996 and 1995, respectively. As of December 31, 1996 and 1995, all loans on nonaccrual were classified as impaired. if interest had been recognized at the original interest rates, interest income would have increased $97,382, $92,412, $86,125 in 1996,1995, and 1994, respectively. At December 31, 1996 and 1995, the Bank had $160,729 and $16,634, respectively in loans past due 90 days or more in interest or principal and still accruing interest. These are well secured and in the process of collection, or are secured by 1-4 single family residences. At December 31, 1996, loans totaling $514,999 were classified as trouble debt restructurings. 53 Note 7: Property, Premises and Equipment Property, premises and equipment consisted of the following:
December 31 ------------------------ 1996 1995 ------------------------ Land $ 400,000 $ 400,000 Building and improvements 1,903,593 1,713,077 Furniture and equipment 2,083,349 1,922,013 ------------------------ 4,386,942 4,035,090 Less - accumulated depreciation 2,630,843 2,368,847 ------------------------ Total property, premises and equipment $1,756,099 $1,666,243 ========================
Depreciation included in other expenses was $262,424, $189,057, and, 159,058 in 1996, 1995, and 1994, respectively, and are based on estimated lives of 20 years for buildings and 3 to 7 years for furniture, fixtures, and equipment. Note 8: Time Deposits Liabilities At December 31, 1996 the Bank had time certificate of deposits with maturity distributions as follows:
1997 $21,212,120 1998 1,115,220 1999 88,693 2000 109,764 2001 10,065 2002 25,000 ----------- $22,560,862 ===========
Note 9: 401(k) Pension Plan During 1994, the Bank established a savings plan for employees which allows participants to make contributions by salary deduction equal to 15% or less of their salary pursuant to section 401(k) of the Internal Revenue Code. Employee contributions are matched up to 25% of the employee's contribution. Employees vest immediately in their own contributions and they vest in the Bank's Contribution based on years of service. Expenses of the savings plan were $16,651, $12,904, and $11,729 for the years ended December 31, 1996, 1995, and 1994, respectively. Note 10: Salary Continuation Plan During 1994, the Bank established a salary continuation plan agreement with the President, Chief Financial Officer, and Chief Administrative Officer, as authorized by the Board of Directors. This agreement provides for annual cash payments for a period not to exceed 15 years, beginning at retirement age 60. In the event of death prior to retirement age, annual cash payments would be made to the beneficiaries for a determined number of years. The present value of the Company's liability under this Agreement were $92,947 and $55,866 at December 31, 1996 and 1995, respectively and are included in other liabilities in the Company's Consolidated Financial Statements. The Company maintains life insurance policies, which are intended to fund all costs of the plan. The cash surrender values of these life insurance policies totaled $729,920 and $692,424 at December 31, 1996 and December 31, 1995, respectively. 54 Note 11: Acquisitions of Assets and Liabilities On September 2, 1994 the Bank acquired certain assets and liabilities of the La Cumbre Savings Bank branch located in San Luis Obispo, California. The total assets acquired were $18,849,913, which consisted of $31,150 of leasehold improvements and fixed assets, $18,802,691 of cash and $16,072 of other prepaid expenses. In addition, the Bank also assumed $19,023,015 of deposits. The Bank paid a premium of $173,102 for the deposits which is included in other assets on the consolidated balance sheet. The premium is being amortized over a five year period. Amortization of the premium for 1996, 1995, and 1994 were $34,620, $34,620, $11,540. This acquisition has been accounted for as a purchase and, accordingly, the results of the branch's operations from the date of acquisition are included in the consolidated statements of income. The remaining unamortized premium at December 31, 1996 was $92,321. Note 12: Taxes on Income The current and deferred amounts of the provision, (benefit) for income taxes were:
December 31, --------------------------------- 1996 1995 1994 --------------------------------- Federal Current $ 396,443 $ 448,359 $ 446,347 Deferred (9,105) (2,669) (11,877) --------------------------------- Total Federal Taxes 387,338 445,690 434,470 --------------------------------- State Current 166,433 180,700 171,844 Deferred (428) 7,308 426 --------------------------------- Total State Taxes 166,005 188,008 172,270 --------------------------------- Total Federal and State Taxes $ 553,343 $ 633,698 $ 606,740 ================================= The principal items giving rise to deferred taxes were: Use of different depreciation for tax purposes $ 2,300 $ (1,240) $ (7,015) Difference in loan loss provision for tax purposes 37,400 38,911 (20,461) Differences arising from changes in accruals (62,400) (68,486) 12,431 Other, net 13,167 35,454 3,594 --------------------------------- Total Deferred Taxes $ (9,533) $ 4,639 $ (11,451) =================================
The provision for taxes on income differed from the amounts computed using the federal statutory tax rate of 34 percent are as follows:
1996 1995 1994 --------------------------------- Tax provision at federal statutory tax rate $ 498,839 $ 551,570 $ 514,953 State income taxes, net of federal income tax benefit 109,563 124,085 113,698 Other, net (55,059) (41,957) (21,911) --------------------------------- Total Tax Provision $ 553,343 $ 633,698 $ 606,740 =================================
55 Note 12: Taxes on Income (continued) The net deferred tax asset is determined as follows:
1996 1995 1994 --------------------------------- Deferred tax assets arising from cumulative timing differences $ 676,154 $ 727,152 $ 916,225 Valuation Allowance * (103,000) (103,000) (103,000) --------------------------------- Net deferred tax asset $ 573,154 $ 624,152 $ 813,225 =================================
* The valuation allowance is estimated based upon amounts less than likely of future realization. There was no change in the valuation allowance during the year. Note 13. Subordinated Notes On July 27, 1989, the Bank offered $1,500,000 in floating rate mandatory convertible subordinated notes (convertible notes) maturing September 30, 1994. On September 30, 1994, the convertible notes converted to 123,497 shares of the Bank's common stock at $6 per share. Interest payments on subordinated notes was approximately $48,000 for the year ended December 31, 1994. Note 14: Other Borrowed Money Other borrowed money consisted of the following:
1996 1996 1995 1995 Current Average Current Average Balance Balance (1) Balance Balance (1) Securities sold under agreements to repurchase $4,730,000 $ 486,704 $ 0 $1,049,755 Federal funds sold 0 39,675 0 29,699 -------------------------------------------------------------- $4,730,000 $ 526,379 $ 0 $1,079,454 ============================================================== The maximum outstanding balance at any month end during the $4,730,000.00 $3,884,500
(1) Average balances are computed using the daily balances outstanding during the year. At December 31, 1996, the book value including accrued interest receivable on securities sold under agreements to repurchase were $4,899,438. The securities dealer that has lent the Bank the money has possession of the securities during the term of the loan. Interest expense on federal funds purchased was $2,360 $5,332, and $4,476 and interest expense on securities sold under agreements to repurchase was $27,434, $65,276 and $126,060 for the years ended December 31, 1996, 1995, and 1994, respectively. 56 Note 15. Stock Options At December 31, 1996, the Company had a stock option plan, which is described below. The Company applies APB Opinion 25 and related interpretations in accounting for its plan. Accordingly, no compensation costs has been recognized for its stock option plan. Had compensation costs for this plan been determined on the fair value at the grant dates consistent with the method of SFAS No. 123, the impact would not have materially affected net income. The Company adopted the Bank's 1990 stock option plan, which is a tandem stock option plan permitting options to be granted either as "Incentive Stock Options" or as non-qualified stock options under the Internal Revenue Code. All outstanding options were granted at prices which equal the fair market value on the day of grant. Options granted vest at a rate of 25 percent per year for four years, and expire no later than ten years from the date of grant. The plan provides for issuance of up to 92,310 shares of common stock and is subject to the specific approval of the Board of Directors. The shares are exercisable at prices ranging from $5.75 to $6.50 per share. At December 31, 1996, 60,700 shares were exercisable.
1996 1995 1994 ---------------------------------------------------------------------------- Weighted Average Weighted Average Weighted Average Shares Exercise Price Shares Exercise Price Shares Exercise Price --------------------------------------------------------------------------- Options outstanding, beginning of year 89,274 $ 5.87 92,310 $ 5.86 92,310 $ 5.86 Granted 0 0 0 Canceled 0 2,736 $ 5.75 0 Exercised 9,641 $ 5.75 300 $ 5.75 0 --------- --------- --------- Options outstanding, end of year 79,633 $ 5.88 89,274 $ 5.87 92,310 $ 5.86 ========= ========= ========= Options available for grant, end of year 2,736 2,736 $ 5.75 0
Options Outstanding and Exercisable
Number Weighted-Average Range of Outstanding Remaining Weighted-Average Exercise Prices at 12/31/96 Contractual Life Exercise Price $5.75-$6.50 79,633 5.5 years $5.88
Note 16. Restriction on Transfers of Funds to Parent There are legal limitations on the ability of the Bank to provide funds to the Company. Dividends declared by the Bank may not exceed, in any calendar year, without approval of the State Banking Department, net income for the year and the retained net income for the preceding two years. Section 23A of the Federal Reserve Act restricts the Bank from extending credit to the Company and other affiliates amounting to more than 20% of its contributed capital and retained earnings. During 1996, the Bank paid the parent $499,016 in dividends. 57 Note 17. Commitments and Contingencies The Company leases land, buildings, and equipment under noncancelable operating leases expiring at various dates through 2001. The following is a schedule of future minimum lease payments based upon obligations at year end, lease payments based upon obligations at year end.
Year Ending December 31, 1997 $344,296 1998 191,015 1999 82,173 2000 88,233 2001 23,664 -------- Total $729,381 ========
Total expenditures charged for leases for the reporting period ended December 31, 1996, 1995, and 1994 were $250,736, $62,989, $22,368, respectively. The Company is involved in various litigation. In the opinion of management and the Company's legal counsel, the disposition of all such litigation pending will not have a material effect on the Company's financial statements. At December 31, 1996 and 1995, the Bank was contingently liable for letters of credit accommodations made to its customers totaling $235,955 and $74,000, respectively. At December 31, 1996 and 1995 the Bank had undisbursed loan commitments in the amount of $12,238,199 and $8,516,466, respectively. The Bank makes commitments to extend credit in the normal course of business to meet the financing needs of its customers. 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 outstanding commitment amount does not necessarily represent future cash requirements. Standby letters of credit written are confidential commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank anticipates no losses as a result of such transactions. Note 18. Related Party Transactions An analysis of loans to directors and executive officers is as follows:
1996 1995 1994 -------------------------------------- Balance at beginning of year $510,990 $592,108 $203,378 Additional loans made 158,000 18,000 414,577 Payments received (383,979) (99,118) (25,847) ----------------------------------- Balance at end of year $285,011 $510,990 $592,108 ===================================
The Bank has entered into loan and deposit transactions with certain directors and executive officers of the Company. These loans were made and deposits were taken in the ordinary course of the Bank's business and, in management's opinion, were made at prevailing rates and terms. 58 Note 19. Regulatory Matters The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the 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 Tier 1 capital (as defined) to average assets (as defined). Management believes, as December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 1996, the most recent notification from the California State Banking Department categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action (there are no conditions or events since that notification that Management believes have changed the Bank's category). To be categorized as well-capitalized, the Bank must maintain minimum capital ratios set forth in the table below. The following table also sets forth the Bank's actual regulatory capital and ratios (dollars in thousands):
For Capital To be Well-Capitalized under Actual regulatory Adequacy Purposes Prompt Corrective action provisions ------------------------ --------------------- ----------------------------------- Capital amount Ratio Capital amount Ratio Capital amount Ratio -------------- ----- -------------- ----- -------------- ----- As of December 31, 1996 Total Capital to Risk-Weighted Assets $7,761 13.94% $4,454 8.00% $5,568 10.00% Tier 1 Capital to Risk-Weighted Assets $7,064 12.67% $2,230 4.00% $3,345 6.00% Tier 1 Capital to Average Assets $7,064 8.41% $3,360 4.00% $3,360 4.00% As of December 31, 1995 Total Capital to Risk-Weighted Assets $7,171 15.21% $3,772 8.00% $4,715 10.00% Tier 1 Capital to Risk-Weighted Assets $6,579 13.90% $1,893 4.00% $2,840 6.00% Tier 1 Capital to Average Assets $6,579 9.27% $2,839 4.00% $2,839 4.00%
On September 30, 1996, Congress passed the Budget Act which capitalized the Savings Association Insurance Fund. ("SAIF") through a special assessment on SAIF-insured deposits and required banks to share in part of the interest payments on the Financial Corporation ("FICO") bonds which were issued to help fund the federal government's costs associated with the savings and loan crisis of the late 1980's. The special thrift SAIF assessment was set at 65.7 cents per $100 insured by the thrift funds as of March 31, 1995. The Bank was assessed these fees in connection with the 1994 purchase of the deposits of La Cumbre Savings Bank. Based upon the provisions of the act, Heritage Oaks Bank's assessment was $99,985 using a deposit base of $15,359,756. 59 Note 20: Other Non-interest Income The major items included in other non-interest income were:
December 31, -------------------------------------- 1996 1995 1994 -------------------------------------- ATM transaction fees $1,024,017 $978,335 $637,344 ATM interchange income 882,058 779,678 509,779 Bankcard merchant fees 363,247 591,658 461,818 Gain on sale of other real estate owned 0 13,314 79,277 Other 231,786 86,585 97,009 -------------------------------------- $2,501,108 $2,449,570 $1,785,227 ======================================
Note 21: Other Non-interest Expenses The major items included in other non-interest expenses were:
December 31, -------------------------------------------- 1996 1995 1994 -------------------------------------------- Data processing $481,844 $477,384 $466,450 Advertising and promotional 123,240 79,412 89,463 Regulatory fees 159,324 118,087 122,077 Other professional fees and outside services 54,376 82,358 58,717 Legal fees and other litigation expense 118,071 121,143 48,895 Stationery and supplies 98,386 78,254 100,801 Bankcard merchant expense 290,236 530,182 400,173 Director fees 88,675 94,455 86,750 ATM costs for retail sites 486,831 259,349 2,621 Miscellaneous 396,580 308,967 320,806 -------------------------------------------- $2,297,563 $2,149,591 $1,696,753 ============================================
60 NOTE 22: Condensed Financial Information of Heritage Oaks Bancorp (Parent Company) BALANCE SHEETS
1996 1995 --------------------------- Cash $314,388 $48,669 Prepaid 57,807 29,373 Investment in Subsidiary 6,714,428 6,191,958 --------------------------- TOTAL ASSETS $7,086,623 $6,270,000 =========================== LIABILITIES and STOCKHOLDERS' EQUITY Other Liabilities $33,475 $44,537 --------------------------- Total Liabilities 33,475 44,537 Stockholders' Equity: Common Stock 4,089,245 4,033,809 Retained earnings 2,963,903 2,191,654 --------------------------- Total Stockholders' Equity 7,053,148 6,225,463 --------------------------- $7,086,623 $6,270,000 ===========================
STATEMENTS OF INCOME
1996 1995 1994 ---------------------------------------- Income Equity in undistributed income of subsidiary $950,057 $1,008,268 $84,716 Management Fee from Bank 0 100,321 0 ---------------------------------------- Total income 950,057 1,108,589 84,716 ---------------------------------------- Expense Salary expense 31,987 22,158 0 Equipment Expense 182 424 0 Other Professional Fees and Outside Services 13,781 95,843 947 Other 16,141 11,745 0 ---------------------------------------- Total expense 62,091 130,170 947 ---------------------------------------- Total Operating Income 887,966 978,419 83,769 Tax expense (benefit) of parent (25,865) (10,149) 800 ---------------------------------------- $913,831 $988,568 $82,969 ========================================
61 STATEMENTS OF CASH FLOWS Statements of Cash Flows for the years ended December 31, 1996, 1995, and from the commencement of operations November 15, 1994 through December 31, 1994.
1996 1995 1994 ------------------------------------ Cash flows from operating activities: Net income $913,831 $988,568 $82,969 Adjustments to reconcile net income to net cash provided by operating activities: (Increase) decrease in other assets (28,434) 7,581 (36,956) Increase (decrease) in other liabilities (11,062) 43,737 800 Increase (decrease) in dividends payable 0 (179,645) 179,645 Undistributed income of subsidiary (950,057) (1,008,268) (84,716) ------------------------------------ Net cash provided by (used in) operating activities (75,722) (148,027) 141,742 Cash flows from financing activities: Cash dividends declared (213,011) 0 (179,645) Cash dividends received 499,016 0 232,874 Proceeds from the exercise of options 55,436 1,725 0 ------------------------------------ Net cash provided by financing activities 341,441 1,725 53,229 ------------------------------------ Net increase (decrease) in cash 265,719 (146,302) 194,971 Cash at beginning of year 48,669 194,971 0 ------------------------------------ Cash at end of year $314,388 $48,669 $194,971 ====================================
Note 23. Subsequent Events On January 23, 1997, the Board of Directors declared a dividend of $.50 per share to stockholders' of record on February 7, 1997. The dividend paid was $337,787. On February 21, 1997 the Bank acquired certain assets and liabilities of the Wells Fargo Branch located in Cambria, California. The total assets acquired were $5,255,161, which consisted of $217,000 of leasehold improvements, $86,461 of fixed assets, $4,837,458 in cash, and $15,217 of loans and accrued interest. The Bank assumed $5,237,253 of deposits and accrued liabilities of $17,908. The Bank paid a premium of $86,461 for the deposits which is included in other assets on the consolidated balance sheet. The premium will be amortized over a five year period. This branch will be operated from a leased facility consisting of approximately 2,916 square feet. The term of the lease will be through July 1, 2004. The lease has two consecutive options to extend the lease for an additional five years each. Note: This statement has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation. 62 Selected Quarterly Financial Data The selected quarterly data for 1996 and 1995 is based on the unaudited financial statements of the Company as presented by Management.
Quarter ended -------------------------------------------------- (Dollars in thousands, except per share data) March 31 June 30 September 30 December 31 -------- ------- ------------ ----------- 1996 Net interest income $822 $848 $915 $1,025 Provision for possible loan losses 23 22 23 22 Non-interst income 725 733 703 728 Non-interest expenses 1,135 1,176 1,265 1,366 ------- ------- ------- ------- Income before provision for income taxes 389 383 330 365 Provision for income taxes 150 146 123 134 ------- ------- ------- ------- Net income $239 $237 $207 $231 ======= ======= ======= ======= Earnings per share: Primary $0.36 $0.34 $0.27 $0.33 Fully diluted 0.36 0.34 0.27 0.24 Dividends declared per share 0.32 0.00 0.00 0.00 Total assets 71,203 76,508 77,353 85,122 Total Deposits 63,327 66,658 69,250 71,991 Loans, net 40,453 43,903 43,594 49,580 Stockholders' equity 6,283 6,529 6,827 7,053 1995 Net interest income $746 $763 $844 $878 Provision for possible loan losses 15 15 15 15 Non-interst income 608 619 647 661 Non-interest expenses 866 942 1,099 1,177 ------- ------- ------- ------- Income before provision for income taxes and cumulative effect of accounting change 473 425 377 347 Provision for income taxes 188 166 147 133 ------- ------- ------- ------- Net income $285 $259 $230 $214 ======= ======= ======= ======= Earnings per share: Primary $0.43 $0.39 $0.41 $0.24 Fully diluted 0.43 0.39 0.41 0.24 Dividends declared per share 0.00 0.00 0.00 0.00 Total assets 71,182 73,085 73,150 72,345 Total Deposits 64,947 65,483 66,177 64,714 Loans, net 35,565 39,177 39,770 39,920 Stockholders' equity 5,377 5,613 5,962 6,225
63 SELECTED FINANCIAL DATA (unaudited) (Dollars in thousands, except per share and ratio data)
Year Ended December 31, 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- Results of Operations: Total interest income $5,591 $5,505 $4,543 $4,367 $4,757 Total interest expense 1,982 2,273 1,513 1,519 2,295 -------- -------- -------- -------- -------- Net Interest Income 3,609 3,232 3,030 2,848 2,462 Provision for possible loan losses 90 60 45 30 53 -------- -------- -------- -------- -------- Net interest income after provision for possible loan losses 3,519 3,172 2,985 2,818 2,409 Total non-interest income 2,889 2,535 2,106 1,625 1,017 Total non-interest expenses 4,941 4,084 3,576 3,288 2,900 -------- -------- -------- -------- -------- Income before provision for income taxes and cumulative effect of accounting change 1,467 1,623 1,515 1,155 526 Provision for income taxes 553 634 607 467 202 Cumulative effect of change in accounting for income taxes -- -- -- 99 -- -------- -------- -------- -------- -------- NET INCOME $914 $989 $908 $787 $324 ======== ======== ======== ======== ======== Selected Financial Ratios: Return on average assets 1.21% 1.36% 1.48% 1.41% 0.56% Return on average equity 13.76% 17.93% 22.40% 19.84% 9.36% Average equity to average assets 8.76% 7.59% 6.60% 7.10% 6.01% Dividend payout ratio (1) 38.38% 21.72% 23.42% 6.90% 0.00% Earnings per share - Primary earnings per share: Income before effect of accounting change $1.30 $1.47 $1.58 $1.27 $0.60 Effect of change in accounting for taxes -- -- -- $0.18 -- -------- -------- -------- -------- -------- NET INCOME $1.30 $1.47 $1.58 $1.45 $0.60 ======== ======== ======== ======== ======== Fully diluted earnings per share: Income before effect of accounting change $1.30 $1.47 $1.58 $1.07 $0.54 Effect of change in accounting for taxes -- -- -- $0.15 -- -------- -------- -------- -------- -------- NET INCOME $1.30 $1.47 $1.58 $1.22 $0.54 ======== ======== ======== ======== ======== Dividends declared per share (1) $0.50 $0.32 $0.37 $0.10 $0.00 Weighted average common and common equivalent shares outstanding: Primary 665,355 671,075 574,418 541,858 541,858 Fully diluted 665,355 671,075 574,418 676,585 670,728 Total Assets $85,122 $72,345 $73,237 $55,247 $58,832 Subordinated debt $0 $0 $0 $737 $731
(1) The 1996 dividend of $.50 was declared on January 23, 1997. The 1995 dividend of $.32 was declared on January 20, 1996. 64 [VAVRINEK, TRINE, DAY & CO. LETTERHEAD] INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders Heritage Oaks Bancorp Paso Robles, California We have audited the accompanying consolidated balance sheets of Heritage Oaks Bancorp as of December 31, 1996 and 1995, and the related consolidated statements of income and changes in stockholders' equity and statements of cash flows for each of the three years in the period ended December 31, 1996. 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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Heritage Oaks Bancorp as of December 31, 1996 and 1995, the results of their operations and changes in their stockholders' equity and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. VAVRINEK, TRINE, DAY & CO. Rancho Cucamonga, California February 7, 1997 65 ITEM 8. CHANGES 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 by Item 9 of Form 10-KSB is incorporated by reference from the information contained in the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 10. EXECUTIVE COMPENSATION The information required by Item 10 of Form 10-KSB is incorporated by reference from the information contained in the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 11 of Form 10-KSB is incorporated by reference from the information contained in the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 12 of Form 10-K is incorporated by reference from the information contained in the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A. 66 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS: (2.1) Plan of Reorganization and Merger Agreement dated as of March 22, 1994, incorporated by reference from Exhibit 2 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. (3.1) Articles of Incorporation incorporated by reference from Exhibit 3.1 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April, 1994. (3.2) Bylaws incorporated by reference from Exhibit 3.2 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. (4.1) Specimen form of Heritage Oaks Bancorp stock certificate incorporated by reference from Exhibit 4.1 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. (10.1) Agreement to Purchase Assets and Assume Liabilities between Heritage Oaks Bank and La Cumbre Savings Bank, dated March 28, 1994, incorporated by reference from Exhibit 10.1 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. *(10.2) 1990 Stock Option Plan incorporated by reference from Exhibit 10.2 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. *(10.3) Form of Stock Option Agreement incorporated by reference from Exhibit 4.2 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. *(10.4) Lawrence P. Ward Employment Letter Agreement, dated November 17, 1992, incorporated by reference from Exhibit 10.3 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. (10.5) Service Agreement, dated November 10, 1992, between Heritage Oaks Bank and Mescom Enterprises, Inc. dba Native American Network System, incorporated by reference from Exhibit 10.4 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. (10.6) Letter Agreement, dated October 23, 1992, between Heritage Oaks Bank and Peter Gheorghiu, incorporated by reference from Exhibit 10.5 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994.
67 (10.7) Item Processing and Back Offices Servicing Agreement, dated August 11, 1993, between Heritage Oaks Bank and Systematics Financial Services, Inc., incorporated by reference from Exhibit 10.6 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1995. (10.8) Data Processing Agreement, dated October 1, 1992, between Heritage Oaks Bank and City National Information Systems, incorporated by reference from Exhibit 10.7 to Registration Statement on Form S-4 No. 33-77504, filed with the Commission on April 8, 1994. *(10.9) 401(k) Pension and Profit Sharing Plan, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. *(10.10) Heritage Oaks Bancorp 1995 Bonus Plan, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. *(10.11) Salary Continuation Plan of Heritage Oaks Bank, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. *(10.12) Salary Continuation Agreement with Lawrence P. Ward, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. *(10.13) Salary Continuation Agreement with Gwen R. Pelfrey, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. *(10.14) Salary Continuation Agreement with Robert E. Bloch, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. (10.15) Woodland Shopping Center Lease, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. (10.16) Laguna Village Sublease, filed with the Commission in the Company's 10K Report for the year ended December 31, 1994. *(10.17) Lawrence P. Ward Employment Letter Agreement, dated February 27, 1996, filed with the Commission in the Company's 10KSB Report for the year ended December 31, 1995. (10.18) 1135 Santa Rosa Street Lease, filed with the Commission in the Company's 10KSB Report for the year ended December 31, 1995. (10.19) Purchase and Assumption between Wells Fargo Bank, N.A. and Heritage Oaks Bank, dated as of October 15, 1996, filed with the Commission in the Company's 8-K Report, dated December 2, 1996.
68 (10.20) Lease Agreement for Cambria Branch Office (21) Subsidiaries of Heritage Oaks Bancorp. (23) Consent of Independent Accountants (27) Financial Schedule
*Denotes management contracts, compensatory plans or arrangements. REPORTS ON FORM 8-K: During the fourth quarter of 1996, the Company filed one Report on Form 8-K, dated December 2, 1996, reporting under "Item 5 - Other Event" in connection with the Bank entering into a purchase and assumption agreement to acquire the Wells Fargo Bank branch office in Cambria, California. No financial statements were included within the Report. An Annual Report for the fiscal year ended December 31, 1996, and Notice of Annual Meeting and Proxy Statement for the Company's 1997 Annual Meeting will be mailed to security holders subsequent to the date of filing of this Report. Copies of said materials will be furnished to the Commission in accordance with the Commission's Rules and Regulations. 69 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HERITAGE OAKS BANCORP By: /S/ LAWRENCE P. WARD ------------------------------------------------------- LAWRENCE P. WARD President and Chief Executive officer Dated: March 20, 1997 By: /S/ ROBERT E. BLOCH ------------------------------------------------------- ROBERT E. BLOCH Executive Vice President and Chief Financial Officer Dated: March 20, 1997 70 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Dated: /S/ B.R.Brant Chairman of the March 20, 1997 - ------------------------------ Board of B.R. BRYANT Directors /S/ Donald H. Campbell Vice Chairman March 20, 1997 - ------------------------------- of the Board DONALD H. CAMPBELL of Directors /S/ Elizabeth A. Cousins Director March 20, 1997 - ------------------------------ ELIZABETH A. COUSINS Director March 20, 1997 - ------------------------------ DOLORES T. LACEY /S/ Merle F. Miller Director March 20, 1997 - ------------------------------ MERLE F. MILLER /S/ John Palla Director March 20, 1997 - ------------------------------ JOHN PALLA /S/ J. Russell Roy Director March 20, 1997 - ------------------------------ J. RUSSELL ROY /S/ Ole K. Viborg Director March 20, 1997 - ------------------------------ OLE K. VIBORG /S/ Lawrence P. Ward Director March 20, 1997 - ------------------------------ LAWRENCE P. WARD
71 EXHIBIT INDEX
Exhibit Sequential Number Description Page Number - ------ ----------- ----------- 10.20 Lease Agreement for Cambria Branch Office 10.21 Subsidiaries of Heritage Oaks Bancorp 10.23 Consent of Independent Accountants 10.27 Financial Schedule
EX-10.20 2 EXHIBIT 10.20 1 EXHIBIT 10.20 LEASE AGREEMENT LANDLORD: CAMBRIA VILLAGE SQUARE TENANT: WELLS FARGO BANK, NATIONAL ASSOCIATION PREMISES: Building J 1276 Tamson Drive Cambria, California 2 TABLE OF CONTENTS
Article Page ------- ---- 1. BASIC LEASE INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 . LEASE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.1 Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.2 Construction of Tenant Improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.2.1 Plans and Specifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.2.2 Permits and Approvals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.2.3 Representations and Warranties Re: Improvements . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . 4 2.3 Common Areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.4 Parking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3 . TERM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . 5 3.1 Commencement of Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3.2 Options to Extend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . 5 3.2.1 Exercise of options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3.2.2 Market Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3.2.3 Negotiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3.2.4 Arbitration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3.3 Option to Terminate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 4 . RENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4.1 Base Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4.2 CPI Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 5. ADDITIONAL CHARGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 5.1 Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 5.2 Exclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 5.3 Collection; Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 5.4 Proration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 5.5 Survival . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 5.6 Estimated Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 5.7 Statements and Invoices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6. INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.1 All Risk Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.1.1 Landlord's Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.1.2 Tenant's Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
i 3 6.2 Comprehensive General Liability Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.3 Course of Construction Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.4 Insurance Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.5 Waiver of Subrogation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 7. TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 7.1 Impositions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 7.2 Personal Property Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 8. SERVICES AND UTILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 9. REPAIRS AND MAINTENANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 9.1 Landlord's Repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 9.2 Tenant's Repairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 9.3 Inspection of Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 10. ALTERATIONS AND SIGNAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 10.1 Alterations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 10.2 Signage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 10.3 Alterations by Other Tenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 11. USE AND COMPLIANCE WITH LAWS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 11.1 Use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 11.2 Exclusive Use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 11.3 Compliance with Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 11.4 Use by Other Tenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 12. DAMAGE AND DESTRUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 12.1 Reconstruction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 12.2 Rent Abatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 12.3 Excessive Damage or Destruction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 13. EMINENT DOMAIN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 13.1 Total Condemnation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 13.2 Partial Condemnation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 13.3 Landlord's Award . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 13.4 Tenant's Award . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 14. DEFAULT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 14.1 Events of Tenant Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 14.1.1 Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 14.1.2 Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 14.2 Landlord'S Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 14.2.1 Election of Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 14.2.2 Acceleration Prohibited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
ii 4 14.3 Landlord's Default; Tenant's Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 15. ASSIGNMENT AND SUBLETTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 16. OFFSET STATEMENT, ATTORNMENT AND SUBORDINATION; QUIET ENJOYMENT . . . . . . . . . . . . . . . . . . . . . . . . . . 21 16.1 Offset Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 16.2 Attornment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 16.3 Quiet Enjoyment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 17. ENVIRONMENTAL MATTERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 17.1 Landlord's Indemnification of Tenant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 17.2 Exclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 17.3 Survivability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 18. GENERAL PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 18.1 Holding Over . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 18.2 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 18.3 Successors Bound . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 18.4 Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 18.5 Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 18.6 Attorneys' Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 18.7 Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 18.8 Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 18.9 Applicable Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 18.10 Additional Conditions to Lease . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 18.11 Recording . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 18.12 Consent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 18.13 Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 18.14 Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Exhibit A -- Site Plan Exhibit B -- Tenant Improvements Exhibit C -- Parking Plan
iii 5 LEASE AGREEMENT THIS LEASE AGREEMENT (the "Lease") is, for reference purposes only, entered into this _________ day of May, 1994, by and between WELLS FARGO BANK, NATIONAL ASSOCIATION, a national banking association, as tenant ("Tenant") and CAMBRIA VILLAGE SQUARE, as landlord ("Landlord"). RECITALS A. Landlord is the fee owner of that certain shopping center commonly known as Cambria Village Square Shopping Center (the "Center") located at 1145-1201 Main Street, Cambria, California, consisting of several buildings (the "Buildings") as shown on the site map attached hereto as Exhibit A and by this reference incorporated herein, together with the parking lots, common areas and other improvements thereon (the "Common Areas"). B. Landlord desires to lease the building commonly known as Building J located at 1276 Tamson Drive, Cambria, California, as depicted on the site map attached hereto as Exhibit A (the "Premises") which shall contain approximately 2,916 rentable square feet to Tenant, and Tenant desires to lease the Premises from Landlord pursuant to the terms, covenants and conditions set forth below. C. Except as expressly set forth below, all capitalized terms used in this Lease without definition shall be as defined in the Basic Lease Information section. AGREEMENT NOW, THEREFORE, FOR GOOD AND VALUABLE CONSIDERATION, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows: 1. BASIC LEASE INFORMATION. The information set forth in this Section (the "Basic Lease Information") is intended to supplement or summarize the provisions set forth in the balance of this Lease. Each reference in this Lease to any of the terms set forth below shall mean the respective information set forth next to such term as amplified, construed, or supplemented by the particular section of the Lease pertaining to such information. In the event of a conflict between the provisions of this Section and the balance of the Lease, the balance of the Lease shall control. Landlord: Cambria Village Square 1 6 Landlord's 307 Bryant Street Address: Ojai, California 93023 Tenant: Wells Fargo Bank, National Association, a national banking association Tenant's Address: Wells Fargo Bank, N.A. Corporate Properties Group 111 Sutter Street, 22nd Floor San Francisco, California 94163 Attn: Lease Administration With copy to:. Wells Fargo Bank, N.A. Corporate Properties Group 333 So. Grand Avenue, Suite 840 Los Angeles, California 90071 Attn: Manager Center: The shopping center commonly known as Cambria Village Square Shopping Center located at 1145-1201 Main Street, Cambria, California Premises: Approximately 2,916 rentable square feet of Building J commonly known as 1267 Tamson Drive, Cambria, California, as depicted in the site map attached hereto as Exhibit A, subject to verification by Tenant's architect Improvements: The tenant improvements to be constructed by Tenant in conformance with the specifications set forth in Exhibit B Tenant's Share: ______% Commencement Date: Upon full execution of this Lease Rent Commencement Date: Upon Tenant's opening for business, but in no event later than July 1, 1994 Expiration Date: Ten (10) years following the Rent Commencement Date 2 7 Base Rent: Period Rent ------ ---- Years 1-5 $1.10/sq.ft. Years 6-10 $1.10/sq.ft. plus CPI increase with maximum cap of 24% effective at the beginning of the 6th lease year for the balance of the Initial Term Options to Renew: Two (2) consecutive options to extend the Initial Term for an additional five (5) years each at 90% of Market Rent. Option to Terminate: Tenant has the option to terminate the Lease effective after the fifth (5th) lease year 2. LEASE. 2.1 PREMISES. Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, the Premises, consisting of approximately 2,916 square feet of Building J as depicted on the site plan attached hereto as Exhibit A, upon all of the terms, covenants and conditions in this Lease. 2.2 CONSTRUCTION OF TENANT IMPROVEMENTS. Landlord and Tenant shall cooperate in the construction of the tenant improvements (the "Improvements") as provided in Exhibit B. Promptly following the Commencement Date, the Improvements shall be constructed by Tenant, at Tenant's sole cost and expense, in a good and workmanlike manner with due diligence and in accordance with all applicable laws and in accordance with the Approved Space Plans (as defined in Section 2.2.1 below), provided, however, that Landlord shall promptly reimburse Tenant the sum of Forty-Three Thousand Seven Hundred Forty Dollars ($43,740) upon Tenant's submission of paid invoices or other evidence of payment by Tenant to contractors, suppliers, or materialmen for construction of the Improvements. Tenant agrees to use a licensed contractor to construct the Improvements. 2.2.1 PLANS AND SPECIFICATIONS. Tenant shall retain an architect of its choice to prepare the plans and specifications for the Improvements. Tenant shall cause its architect to furnish to Landlord for Landlord's approval, space plans sufficient to convey the architectural design of the Premises, including, without limitation, the location of doors, partitions, extraordinary electrical and telephone outlets, a 3 8 typical office electrical and telephone plan, plumbing fixtures, heavy floor loads and other special requirements, together with ceiling plans (collectively the "Space Plans"). If Landlord shall disapprove of any portion of the Space Plans, Landlord shall advise Tenant of such disapproval, together with a detailed description of the basis for Landlord's disapproval, in writing. Landlord shall have a period of fifteen (15) days after the date of receipt of the Space Plans within which to approve or reject such plans. Any changes in the Space Plans, pursuant to rejection by Landlord of previously submitted Space Plans or otherwise, shall be submitted to Landlord for approval in the manner set forth above. Failure by Landlord to disapprove any portion of the proposed Space Plans submitted pursuant to this section within the specified fifteen (15) day time period shall be deemed to constitute Landlord's approval thereof as submitted. The Space Plans as approved from time to time by Landlord pursuant to this Section shall constitute the "Approved Space Plans". Tenant shall have the right, without further approval of Landlord, to construct the Improvements consistent with the Approved Space Plans, together with such changes thereto as may be requested or required by any applicable governmental authority. 2.2.2 PERMITS AND APPROVALS. Tenant shall be responsible for obtaining all permits and approvals necessary for the construction of the Improvements. From time to time, upon request by Tenant, Landlord shall execute such reasonable documents, petitions, applications and authorizations as may be necessary or appropriate, and shall, at no additional cost to Tenant, appear at or participate in such public hearings, staff meetings and similar gatherings, as are, in the good faith opinion of Tenant, necessary or appropriate for the purposes of obtaining such permits and approvals. 2.2.3 REPRESENTATION AND WARRANTY RE: IMPROVEMENTS. Tenant represents and warrants to Landlord that as of the Commencement Date, the Improvements shall be in full compliance with all applicable municipal, county, state and federal statutes, laws, ordinances, including, without limitation, the Americans with Disabilities Act (and all regulations promulgated thereunder). 2.3 COMMON AREAS. Tenant, its employees, licensees, invitees, successors, assignees and subtenants shall have, as appurtenant to the Premises, the non-exclusive right in common with other tenants of the Center to use the common walkways, sidewalks, and driveways located on the Center and necessary for ingress and egress to the Premises and the parking area described in Section 2.4 below (collectively the "Common Areas") 4 9 2.4 PARKING. During the Term of this Lease (as it may be extended from time to time) Tenant shall have, at no additional cost to Tenant, (i) the non-exclusive right to use short term parking stalls in the parking area appurtenant to the Premises (all of which shall be located in front of the Premises), as depicted on the Parking Plan attached hereto as Exhibit C; and (ii) the right to use, in common with other tenants of the Center, such additional parking stalls on a non-exclusive basis in the parking area appurtenant to the Premises. 3. TERM. 3.1 COMMENCEMENT OF TERM. The term of this Lease shall commence upon the Commencement Date which shall be the date when all of Tenant's obligations hereunder commence, except for payment of Base Rent and Additional Charges. For purposes of this Lease, "open for business" means a date no later than thirty (30) days after the Improvements have been substantially completed in accordance with the Approved Space Plans and a certificate of occupancy has been issued by the governmental authority having jurisdiction thereof. The term of this Lease shall expire ten (10) years after the Rent Commencement Date (the "Initial Term"). Notwithstanding any provision to the contrary, if there is any existing ground lease, deed of trust, mortgage or other security instrument or agreement affecting the Premises in place as of the date this Lease is executed by Tenant, then the Commencement Date shall not occur until Landlord shall have obtained for Tenant a non-disturbance agreement in form satisfactory to Tenant assuring Tenant that neither Tenant's right to occupy the Premises nor any of Tenant's other rights and remedies under this Lease (including, without limitation, Tenant's rights upon a default by Landlord), shall be affected by the exercise of any rights which such party may have. 3.2 OPTIONS TO EXTEND. 3.2.1 EXERCISE OF OPTIONS. Tenant shall have the options of extending the Initial Term for two (2) consecutive periods of five (5) years (each an "Extension Term") by giving written notice of Tenant's exercise to Landlord at least three (3) months prior to the expiration of the Initial Term or Extension Term, as the case may be. Upon exercise of such option by Tenant, this Lease shall automatically be extended for the duration of the Extension Term upon the same terms, covenants and conditions of this Lease except that Base Rent during each Extension Term shall be ninety percent (90%) of the Market Rent (defined in Section 3.2.2 below). 3.2.2 MARKET RENT. The term "Market Rent" shall mean the going market rental as of the date of the commencement of the 5 10 Extension Term for similar space in the area where the Premises is located, taking into consideration location, size, condition, permitted uses, and improvements (but excluding any alterations or personal property of Tenant installed in the Premises by Tenant at Tenant's expense) for a tenant proposing to sign a lease equal to the Extension Term, and passing on to Tenant (in the form of reduced Market Rent) of any cost-savings which would be realized by Landlord in extending the Lease, including, without limitation, any customary brokerage commissions which would have been paid relative to a nonrenewal tenant, and any free rent, tenant improvement allowance, or other tenant concessions that may then be customarily granted to prospective tenants. 3.2.3 NEGOTIATION. Commencing from the date that notice of Tenant's exercise of the option to extend the Initial Term or Extension Term is delivered to Landlord, and continuing thereafter for thirty (30) days ("Negotiation Period"), the parties shall negotiate in good faith the Market Rent. If the parties are unable to agree on the Market Rent prior to the expiration of the Negotiation Period, the matter shall be submitted into arbitration pursuant to terms and conditions set forth in Section 3.2.4 below. 3.2.4 ARBITRATION. (a) TWO APPRAISERS. Within fifteen (15) days after the expiration of the Negotiation Period and if the parties are still unable to agree on Market Rent, each party, at its own cost and by giving written notice to the other party, shall appoint a real estate appraiser, with a membership in the American Institute of Real Estate Appraisers ("MAI") and at least five (5) years' full-time commercial appraisal experience in the area where the Premises is located, to appraise and determine the Market Rent. If, in the time provided, only one (1) party shall give written notice of appointment of an appraiser, the single appraiser appointed shall determine the Market Rent. If two (2) appraisers are appointed by the parties, the two (2) appraisers shall independently, and without consultation, prepare an appraisal of the Market Rent within thirty (30) days after their appointment. Each appraiser shall deliver its respective appraisal after completion to the appointing party. The resulting appraisals of the Market Rent shall be opened by the parties and compared. If the value of the appraisals differ by no more than ten percent (10%) of the value of the higher appraisal, then the Market Rent shall be the average of the two (2) appraisals. (b) THREE APPRAISERS. If the values of the appraisals differ by more than ten percent (10%) of the value of 6 11 the higher appraisal and the parties still cannot agree on Market Rent, then within ten (10) days after the date the appraisals are compared, the two (2) appraisers selected by the parties shall appoint a third similarly qualified MAI appraiser. If the two (2) appraisers fail to so select a third appraiser, a third similarly qualified MAI appraiser shall be appointed at the request of either Landlord or Tenant by the then Presiding Judge of the Superior Court of the State of California of the County in which the Premises is located. The two (2) appraisers shall each then submit his or her independent appraisal in simple letter form to the third appraiser stating his or her determination of the Market Rent (which determination may not be changed from that which was set forth in such appraiser's appraisal delivered to the appointing party). The sole responsibility of the third appraiser shall be to determine which of the determinations made by the first two (2) appraisers is most accurate. The third appraiser shall have no right to propose a middle ground or any modification of either of the determinations made by the first two (2) appraisers. The third appraiser's choice shall be submitted to Landlord and Tenant within fifteen (15) days after the third appraiser has received the written determination from each of the first two (2) appraisers. The Market Rent shall be determined by the selection made by the third appraiser from the determination submitted by the first two (2) appraisers. (c) COSTS. Each party shall pay the fees and expenses of their own appraiser, and fifty percent (50%) of the fees and expenses of, and the cost of appointing, the third appraiser. (d) CRITERIA. Subject to the criteria set forth in Section 3.2.2 above, the Market Rent shall be determined using the "market comparison approach". The appraisers shall use their best efforts to fairly and reasonably appraise and determine the Market Rent in accordance with the terms of the Lease, and shall not act as advocates for either Landlord or Tenant. (e) LIMITATION ON APPRAISERS' AUTHORITY. The appraisers shall have no power to modify the provisions of this Lease, and their sole function shall be to determine the Market Rent in accordance with Section 3.2.4. 3.3 OPTION TO TERMINATE. At any time after the fifth (5th) lease year, Tenant shall have the option to terminate this Lease, at no cost to Tenant, which option may only be exercised by Tenant delivering to Landlord written notice of Tenant's election to terminate this Lease ("Termination Notice") but in no event less than nine (9) months before expiration of the fifth (5th) lease year. If Tenant should exercise such option, the 7 12 Lease shall be deemed to terminate on the expiration of the fifth (5th) lease year of the Term. Upon such termination, this Lease shall become null and void and of no further force or effect except as to any obligations which by their express terms survive the termination of this Lease and any unperformed obligations of either party applicable to the period prior to the date of termination. Upon termination of this Lease, if requested by Landlord, Tenant shall remove the Improvements and its personal property, repair any damage to the Premises caused by such removal and leave the Premises in a broom clean condition. 4. RENT. 4.1 BASE RENT. The annual Base Rent for each of the first five (5) years of the Initial Term shall be Thirty-Eight Thousand Four Hundred Ninety-One and 20/100 Dollars ($38,491.20) based on the rate of One and 10/100 Dollars ($1.10) per square foot per month for approximately 2,916 square feet, subject to verification by Tenant's architect. If the actual square footage of the Premises differs from 2,916 square feet, then an appropriate adjustment to the annual Base Rent shall be made. Commencing on the Rent Commencement Date, the annual Base Rent shall be payable in equal monthly installments. Tenant shall pay the Base Rent to Landlord in advance upon the first day of each calendar month following the Rent Commencement Date, at Landlord's address or at such other place designated by Landlord in a written notice to Tenant, without any prior demand therefor. If the Initial Term shall commence or end on a day other than the first day of a calendar month, then Tenant shall pay, upon the Rent Commencement Date or the first day of the last calendar month of this Lease, a pro rata portion of the Base Rent, prorated on a per diem basis. 4.2 CPI ADJUSTMENT. Effective as of the beginning of the sixth (6th) year of the Initial Term (the "Adjustment Date"), the annual Base Rent for each of the last five (5) years of the Initial Term shall be determined by applying the cumulative percentage increases, if any, in the Consumer Price Index--Urban Consumers (Los Angeles-Long Beach, CA area; Base 1992-93 = 100), as published by the United States Department of Labor, Bureau of Labor Statistics (the "Index"), for the calendar month (the "Comparison Month") which is three (3) months prior to the Commencement Date as compared with the Index for the Comparison Month immediately preceding the Adjustment Date, but in no event shall the total cumulative percentage increase exceed twenty-four percent (24%) nor shall the annual Base Rent during each of the last five (5) years of the Lease be less than the annual Base Rent for the first five (5) years of the Lease. Landlord shall calculate and give Tenant written notice of any increase in the annual Base Rent prior to, and Tenant shall pay the adjusted 8 13 Annual Rent as of, the Adjustment Date for the remaining five (5) year period. Should the Bureau of Labor Statistics discontinue the publication of the Index, or publish the Index less frequently, or alter the Index in some other manner, Landlord and Tenant may adopt a substitute index or procedure which reasonably reflects and monitors increases in consumer prices. 5. ADDITIONAL CHARGES. Commencing on the Rent Commencement Date, Tenant shall, as additional charges hereunder (the "Additional Charges"), pay to Landlord the Tenant's pro rata share of the Operating Expenses, as defined and limited below, actually incurred by Landlord for maintaining and operating the Common Areas on the east side of Tamson Drive. 5.1 DEFINITION. Tenant's pro rata share of the Operating Expenses shall be determined by dividing the rentable square footage of the Premises by the total rentable square footage of the Buildings. Subject to the limitations set forth in section 5.2 below, "Operating Expenses" shall include only the following: (i) premiums paid by Landlord for insurance procured pursuant to Article 6 to insure the Buildings and the Common Areas appurtenant thereto (excluding the Improvements and Tenant's personal, property); (ii) all actual and direct costs of maintaining, repairing and servicing the Common Areas appurtenant to the Buildings and the roof covering the Premises; (iii) sums for amortization over the reasonable life of any capital improvements made to the Buildings and the Common Areas appurtenant thereto and required to meet new governmental regulations not in effect as of the Commencement Date; (iv) reasonable charges for heat, water, gas, electricity and other utilities used or consumed in the Common Areas appurtenant to the Buildings; (v) all direct and actual costs to supervise and administer the Buildings and the Common Areas appurtenant thereto; and (vi) all parking charges, utilities surcharges, or any similar costs levied, assessed or imposed by or at the direction of, or resulting from statutes or regulations, or interpretations thereof, promulgated by any governmental authority in connection with the use of the Common Areas appurtenant to the Buildings. 5.2 EXCLUSIONS. Operating Expenses shall not include the following: (i) legal fees, brokerage commissions, advertising costs, or other related expenses incurred in connection with the leasing of the Buildings of the Center; (ii) repairs, alterations, additions, improvements or replacements made to rectify or correct any defect in the design, materials or workmanship of the Center or Common Areas or to comply with any requirements of any governmental authority in effect as of the Commencement Date; (iii) any capital improvements, alterations or expenditures (including, without limitation, reroofing of the 9 14 roof or replacement of any heating, ventilation and air conditioning ("HVAC") units) except as may be required to meet new governmental regulations not in effect as of the Commencement Date; (iv) damage and repairs attributable to fire or other casualty; (v) damage and repairs covered under any insurance policy carried by Landlord in connection with the Center or Common Areas; (vi) damage and repairs necessitated by the negligence or willful misconduct of Landlord or Landlord's employees, contractors or agents; (vii) executive salaries or salaries of service personnel to the extent that such service personnel perform services not solely in connection with the management, operation, repair, or maintenance of the Center or Common Areas; (viii) Landlord's general overhead expenses not related to the Center; (ix) payments of principal or interest on any mortgage or other encumbrance affecting the Center; (x) legal fees, accountants' fees and other expenses incurred in connection with disputes with tenants or other occupants or associated with the enforcement of any leases or defense of Landlord's title to or interest in the Center or any part thereof; (xi) costs (including permit, license and inspection fees) incurred in renovating or otherwise improving, decorating, painting or altering space for other tenants or other occupants or vacant space in the Center; (xii) costs incurred due to violation by Landlord or any other tenant in the Center of the terms and conditions of any lease; (xiii) all costs that are reimbursable by insurance or chargeable to another tenant or other occupant of the Center; (xiv) the cost of any utilities unless such utilities were consumed solely in the Buildings; (xv) any management fees exceeding ten percent (10%) of the Operating Expenses; and (xvi) any other expense which, under generally accepted accounting principles and practice, would not be considered a normal maintenance and operating expense. 5.3 COLLECTION; AUDIT. Landlord shall not collect in excess of one hundred percent (100%) of operating Expenses, or any item of cost more than once. There shall not be included in Operating Expenses any costs in excess of those that would be reasonably incurred by prudent operators and managers of first-class shopping centers in the San Luis Obispo/Cambria area. All Operating Expenses shall be determined in accordance with generally accepted accounting principles and practices, consistently applied. Landlord's statement of Operating Expenses shall be certified by a Certified Public Accountant or signed and certified to be correct by Landlord. At any time Tenant shall have the right to challenge the accuracy of any Operating Expenses and if Tenant challenges any Operating Expenses, Landlord shall make Landlord's books and supporting documents available to Tenant and Tenant may inspect the same. Tenant shall pay the cost and expenses of such audit, unless such audit shows a discrepancy of at least two percent (2%) of Operating 10 15 Expenses, in which event Landlord shall pay the costs and expenses of such audit. 5.4 PRORATION. Any operating Expenses attributable to a period which falls only partially within the Initial Term or Extension Term shall be prorated between Landlord and Tenant based on the actual number of days elapsed so that Tenant shall pay only that proportion thereof which the part of such period within the Initial Term or Extension Term bears to the entire period. 5.5 SURVIVAL. Any such sum payable by Tenant which would not otherwise be due until after the date of the termination of this Lease, shall, if the exact amount is uncertain at the time that this Lease terminates, be paid by Tenant to Landlord upon final determination of the exact amount. Tenant shall have no obligation to pay Additional Charges or adjustments to Base Rent unless a notice of such obligation or adjustment is received by Tenant within three (3) months of the date such Additional Charge was to be billed or adjustment to Base Rent was to have been made. 5.6 ESTIMATED PAYMENTS. Prior to the commencement of each of Landlord's accounting years of the Initial Term, Landlord shall make a reasonable estimate of Tenant's Share of the Operating Expenses (exclusive of real estate taxes and insurance premiums which shall be paid by Tenant as and when they are paid by Landlord) and Tenant shall pay to Landlord on the first of each month in advance, one-twelfth (1/12) of Landlord's estimated amount. In no event shall Landlord's estimate of Operating Expenses payable by Tenant hereunder for any year subsequent to the first year of the Initial Term exceed the actual Operating Expenses paid by Landlord during the prior year by more than ten percent (10%). Within thirty (30) days of the end of each year Landlord shall forward to Tenant a statement of the actual Operating Expenses for such year which statement shall include a comparison of such year's Operating Expenses with the prior year showing charges in each category by percentage and dollar amount. There shall be an adjustment made to account for any difference between the actual and the estimated Operating Expenses for the previous year. If Tenant has overpaid the amount of Additional Charges owing pursuant to this provision, Tenant shall subtract the amount of such overpayment from the next payment of Base Rent and Additional Charges; provided, that in the case of an overpayment for the final lease year, Landlord shall refund such overpayment to Tenant within thirty (30) days after the end of the Initial Term or Extension Term. If Tenant has underpaid the amount owing pursuant to this provision, Tenant shall pay the amount of such underpayment to Landlord within thirty (30) days after receipt of Landlord's written demand accompanied by a 11 16 statement of Operating Expenses. Tenant shall not be obligated to pay such amount in the event that Tenant challenges Operating Expenses unless and until such challenge is complete and Tenant is satisfied that such Operating Expenses are payable to Landlord. 5.7 STATEMENTS AND INVOICES. Landlord shall maintain full and accurate books and records with regard to all Additional Charges for a period of not less than three (3) years. All statements, invoices and correspondence regarding Additional Charges shall be sent to Tenant at Tenant's address as set forth in the Basic Lease Information and shall contain thereon or therein, for reference purposes, the address of the Premises and the following number: "AU_______". 6. INSURANCE. 6.1 ALL RISK COVERAGE. 6.1.1 LANDLORD'S INSURANCE. Landlord shall procure and maintain during the Initial Term and any Extension Term "all risk" property insurance with respect to the Buildings (excluding the Improvements and Tenant's personal property) and the Common Areas appurtenant thereto, in amounts equal to one hundred percent (100%) of the full insurance replacement value (including debris removal and demolition), and so as to prevent the application of co-insurance provisions. 6.1.2 TENANT'S INSURANCE. Tenant shall procure and maintain during the Initial Term and any Extension Term, at its expense, insurance ("Personal Property Insurance") covering the Improvements, any other leasehold improvements paid for by Tenant, and Tenant's personal property from time to time in, on, or at the Premises, in an amount not less than eighty percent (80%) of the full replacement cost, and to provide protection against events protected under "Fire and Extended Coverage," as well as against sprinkler damage, vandalism, and malicious mischief. 6.2 COMPREHENSIVE GENERAL LIABILITY INSURANCE. Each party shall procure and maintain during the Initial Term or Extension Term, at its sole cost and expense, a policy or policies of comprehensive general liability insurance on an "occurrence" basis against claims for personal injury liability, including, without limitation, bodily injury, death, or property damage liability with a limit of not less than Three Million Dollars ($3,000,000.00) to cover personal injury to any number of persons or of damage to property arising out of any one occurrence. Nothing in this Lease shall prevent Tenant from carrying any of the insurance required of Tenant hereunder in the form of a 12 17 blanket insurance policy or policies which cover other properties owned or operated by Tenant in addition to the Premises, or to self-insure against such casualties or liabilities. 6.3 COURSE OF CONSTRUCTION INSURANCE. Tenant shall procure and maintain, during the period of construction for the Improvements, a Course of Construction insurance policy in an amount equal to the replacement cost of the Improvements. 6.4 INSURANCE CERTIFICATES. Each party shall furnish to the other prior to the Commencement Date, and thereafter within thirty (30) days prior to the expiration of each such policy, a certificate of insurance issued by the insurance carrier of each policy of insurance carried hereunder. The certificates shall expressly provide that such policies shall not be cancelable or subject to reduction of coverage or otherwise be subject to modification except after thirty (30) days' prior written notice to the other party required to be named as additional insureds in this Section 6.4. Each party and its successors and assigns, and any nominee of Landlord holding any interest in the Lot (but only if previously requested and named by Landlord to Tenant in writing), including, without limitation, any ground lessor and the holder of any fee or leasehold mortgage, shall be named as additional insureds under each such policy of insurance maintained by the other pursuant to this Lease. 6.5 WAIVER OF SUBROGATION. The parties hereby release each other, and their respective successors and assigns, from any claims for damage to any person, the Premises, the Building, or Common Areas, or to the fixtures, personal property, and alterations in the Premises, Building, or Common Areas that are caused by or result from risks insured against under any insurance policies carried by the parties and in force at the time of any such damages. Each party shall cause each insurance policy obtained by it to provide that the insurance company waives all right of recovery by way of subrogation against either party in connection with any damage covered by any policy carried with respect to the Building, Premises or Common Areas. If the insurance cannot be obtained without undue expense, the other party is relieved of the obligation to obtain a waiver of subrogation rights with respect to the particular insurance involved, provided such party gives written notice to the other of such inability to obtain the policy in question. 7. TAXES. 7.1 IMPOSITIONS. All ad valorem real estate taxes relating to the Center, Premises, or Common Areas shall collectively be referred to as "Impositions." Notwithstanding the foregoing, the following shall not constitute Impositions for 13 18 purposes of this Lease: (i) any state, local, federal, personal or corporate income tax measured by the income of Landlord; (ii) any estate, inheritance taxes, or gross rental receipts tax; (iii) any franchise, succession or transfer taxes; (iv) interest on taxes or penalties resulting from Landlord's failure to timely pay taxes; (v) two-third (2/3) of any increases in real property taxes attributable to the reassessment of the Center (or any portion thereof) upon the sale or other transfer of the Center (or any portion thereof) in the first twelve (12) months after any such reassessment; (vi) one-third (1/3) of any increases in real property taxes attributable to the reassessment of the Center (or any portion thereof) upon the sale or other transfer of the Center (or any portion thereof) in the second twelve (12) months after any such reassessment; or (vii) any taxes which are essentially payments to a governmental agency for the right to make improvements to the Center or surrounding area. Tenant shall pay or cause to be paid, prior to delinquency, the Impositions assessed directly to Tenant by the county assessor for the Premises, but if the county assessor does not directly assess the Impositions to Tenant, Tenant shall reimburse Landlord for a pro rata share of the Impositions paid by Landlord, such reimbursement being equal to the same percentage as Tenant's Share of the Operating Expenses. If the Impositions may be paid in annual or other periodic installments, Landlord shall elect to pay the Impositions in installments over the maximum period permitted by law. Such reimbursement shall be made by Tenant at such time as the subject Impositions are paid by Landlord but in no event later than thirty (30) days after Tenant's receipt of proof of payment of such Impositions from Landlord. 7.2 PERSONAL PROPERTY TAXES. Tenant shall pay or cause to be paid, prior to delinquency, any and all taxes and assessments levied upon all trade fixtures, inventories and other personal property placed in and upon the Premises by Tenant and owned by Tenant. 8. SERVICES AND UTILITIES. Landlord shall provide the Premises with separate meters for electricity, gas and water. Tenant shall directly contract for electricity, gas, water and janitorial services to the Premises. Landlord shall provide to the Common Areas appurtenant to Buildings J and F, such janitorial services, utilities, security, and maintenance as required for the comfortable use and occupancy of the Common Areas. Tenant shall also be permitted reasonable access to the roof of Building J to install, maintain and replace satellite dishes and/or other telecommunication equipment. If there is any interruption in the services or utilities required to be provided by Landlord, and such interruption substantially interferes with Tenant's use or enjoyment of the Premises or Tenant's conduct of business for more than two (2) continuous business days, Tenant 14 19 shall have the right to abate payments of Base Rent and Additional Charges otherwise payable under this Lease. 9. REPAIRS AND MAINTENANCE. 9.1 LANDLORDS REPAIRS. Landlord shall at all times operate and maintain the Center and all Common Areas in accordance with standards not less than those customarily followed in the operation and maintenance of first-class shopping centers in the San Luis Obispo/Cambria area. Such operation and maintenance shall be undertaken in the most efficient and cost effective manner so as to minimize Operating Expenses. Except for repairs specifically required to be made by Tenant under this Lease, Landlord shall at all times keep, replace and maintain in good condition, order and repair: (i) all portions of the Center which are not a part of the Premises; (ii) all portions of the roof, roof structures and supports (and including Tenant's interior ceiling damaged from leaking), of the Premises; (iii) all driveways, sidewalks, parking areas and all other Common Areas and facilities thereof; and (iv) any damage to the Premises caused by the willful act or the negligence of the Landlord or its agents. Notwithstanding the above, Tenant shall be responsible for the cost of repair of any damage caused by the willful misconduct or negligence of Tenant or its agents. Tenant shall give Landlord notice of any such repairs as may be required under the terms of this Lease and Landlord shall proceed forthwith to effect the same with reasonable diligence, but in no event later than thirty (30) days after having received such notice. If Landlord fails to repair or maintain the Premises within the thirty (30) day period provided herein, Tenant may perform the repairs or maintenance and deduct the reasonable cost thereof from the Base Rent next coming due, in addition to any other remedies Tenant may have at law or in equity. In the event of an emergency Tenant shall be empowered to undertake immediate repairs of such nature as would be Landlord's responsibility and notify Landlord promptly after such repairs have been undertaken. Tenant may deduct the cost thereof from the Base Rent next coming due. 9.2 TENANT'S REPAIRS. Tenant shall keep the exterior (excluding the roof, roof structures and supports) and the interior of the Premises in good condition, order and repair, excepting items to be maintained and repaired by Landlord as provided above, conditions covered under any warranties of Landlord's contractors, damage by fire and other casualties, acts of governmental authorities, acts of God and the elements, and ordinary wear and tear. Tenant, at Tenant's sole cost and expense, shall promptly replace all plate glass windows and other glass forming part of the Premises which may be damaged or broken 15 20 with glass of the same quality and strength. Notwithstanding the above, Landlord shall be responsible for the cost of repair of any damage caused by the willful misconduct or negligence of Landlord or its agents. 9.3 INSPECTION OF PREMISES. Subject to Tenant's reasonable security requirements, Landlord may, at reasonable times and with Tenant's prior written consent, which consent shall not be unreasonably withheld, enter the Premises to complete construction undertaken by Landlord on the Premises or the Center, to inspect, clean or repair the same, or to show the Premises to prospective purchasers, tenants and lenders. Landlord shall conduct such activities in a manner which will cause the least possible inconvenience, annoyance or disturbance to Tenant and Tenant's business. 10. ALTERATIONS AND SIGNAGE. 10.1 ALTERATIONS. Except for the Improvements (which shall be governed by Section 2.2 above) and any structural work affecting the Premises (with respect to which Landlord's consent shall be required), Tenant may, at any time during the Initial Term or Extension Term of this Lease at Tenant's own expense, make such improvements, alterations and additions and may install such fixtures and equipment (including, without limitation, a reasonable number of exterior automatic teller machines, night depository boxes and other customary banking fixtures) (collectively the "Alterations") upon or to the Premises including the interior or exterior thereof as Tenant deems desirable for the conduct of its business, without Landlord's consent. Tenant agrees that all Alterations shall be done in a good and workmanlike manner, in conformity with applicable building codes and without endangering the structural integrity of the Premises. The ownership interest in the Improvements, all Alterations and signs installed by Tenant (pursuant to Section 10.2 below) shall remain in Tenant whether or not affixed to or attached to the Premises, and Tenant shall have the right, but shall not be required during the Initial Term or Extension Term, to remove from the Premises at any time and from time to time, all or any part of such Improvements, Alterations or signs, provided such removal shall not cause structural injury to the Premises. 10.2 SIGNAGE. During the Initial Term or Extension Term of this Lease, Tenant shall have the maximum signage that may be installed on the Premises as permitted by local regulatory ordinances and the right to pursue and install a monument sign along Main Street near the Premises. All such signage shall be developed and approved by both Landlord and Tenant, and shall be 16 21 installed by Tenant, at Tenant's sole cost and expense, in accordance with all applicable codes and regulations. 10.3 ALTERATIONS BY OTHER TENANTS. If any one or more of the other tenant(s) of the Center should desire to make any alterations which may have a material impact on Tenant's use or enjoyment of the Premises, Landlord shall first notify Tenant in writing of such alteration (which notice shall include an adequate description of such alteration), and shall obtain Tenant's prior written approval of such alteration, which approval shall not be unreasonably withheld or delayed. 11. USE AND COMPLIANCE WITH LAWS. 11.1 USE. Tenant may use the Premises for Tenant or Tenant's affiliates to provide banking or any other financial services or any office or administrative services in support thereof, or both; provided that if Tenant desires to assign the Lease or sublet all or any portion of the Premises, then the Premises may be used for any legal use which is compatible with the applicable zoning and the overall nature, quality and tenant mix of the Center. 11.2 EXCLUSIVE USE. So long as Tenant operates a full service retail bank branch in the Premises, Tenant shall have the exclusive right in the Center to provide banking and other financial services, and Landlord shall not lease to, or permit any other space within the Center to be used (including, without limitation, use for automatic teller machines) by any financial institution, commercial or savings bank, savings and loan association, credit union, or any other entity offering the services of a financial institution (whether with or without federally insured deposits). 11.3 COMPLIANCE WITH LAWS. Tenant shall faithfully observe, in Tenant's use of the Premises, all municipal, county, state, federal and other applicable governmental entities' requirements which are now in force, or which may hereafter be in force. Subject to the foregoing, Landlord shall be solely responsible for complying with the requirements of all municipal, county, state, federal and other applicable governmental entities' requirements which are now in force, or which may hereafter be in force, pertaining to the Center and Common Areas. 11.4 USE BY OTHER TENANTS. Landlord shall not permit any other tenant, subtenant or licensee of the Center to use the Center (or any portion thereof) for A use which is not compatible with the applicable zoning and the overall nature, quality and tenant mix of the Center. 17 22 12. DAMAGE AND DESTRUCTION. 12.1 RECONSTRUCTION. If the Premises is damaged or destroyed during the Initial Term or Extension Term, Tenant shall diligently repair or rebuild the damaged or destroyed areas to substantially the condition in which they existed immediately prior to such damage or destruction. 12.2 RENT ABATEMENT. Base Rent and Additional Charges due and payable hereunder shall be abated proportionately during any period in which, by reason of any such damage or destruction, Tenant reasonably determines that there is substantial interference with the operation of Tenant's business in the Premises. Such abatement shall continue for the period commencing with such damage or destruction and ending with the date the business may be fully resumed on the Premises, as reasonably determined by Tenant. If Tenant determines that continuation of business is not practical pending reconstruction, Base Rent and Additional Charges due and payable hereunder shall abate until business is fully resumed. 12.3 EXCESSIVE DAMAGE OR DESTRUCTION. If the Premises is damaged or destroyed to the extent that the Premises cannot, with reasonable diligence as determined by Tenant, be fully repaired or restored by Tenant within one hundred twenty (120) days after the date of the damage or destruction, Tenant may terminate this Lease, in which event Tenant shall assign to Landlord any and all rights to payment under insurance policies insuring the Premises as procured pursuant to Section 10 above. Tenant shall within thirty (30) days of such damage or destruction determine whether the Premises can be fully repaired or restored within the one hundred twenty (120) day period, and notify Landlord of such determination and, if Tenant has elected to terminate, of Tenant's election to terminate. 13. EMINENT DOMAIN. 13.1 TOTAL CONDEMNATION. If the whole of the Premises is acquired or condemned by eminent domain, inversely condemned or sold in lieu of condemnation, for any public or quasi-public use or purpose ("Condemned"), then this Lease shall terminate as of the date of title vesting in such proceeding, and Base Rent and Additional Charges shall be adjusted as of the date of such termination. Landlord shall immediately notify Tenant of any such occurrence. 13.2 PARTIAL CONDEMNATION. If any part of the Premises is partially Condemned, and such partial condemnation renders the Premises unusable for the business of the Tenant, as reasonably determined by Tenant, or in the event a substantial portion of 18 23 the Center is Condemned, as reasonably determined by Tenant, then this Lease shall terminate as of the date of title vesting in such proceeding and Base Rent and Additional Charges shall be adjusted to the date of termination. If such condemnation is not sufficiently extensive to render the Premises unusable for the business of Tenant as reasonably determined by Tenant, or less than a substantial portion of the Center is Condemned, then Landlord shall promptly restore the Premises to a condition comparable to its condition immediately prior to such condemnation less the portion thereof lost in such condemnation, and this Lease shall continue in full force and effect except that after the date of such title vesting the Base Rent shall be proportionately reduced. 13.3 LANDLORD'S AWARD. If the Premises are wholly or partially Condemned, then, subject to the provision of Section 13.4 below, Landlord shall be entitled to the entire award paid for such condemnation, and Tenant waives any right or claim to any part thereof from Landlord or the condemning authority, except as set forth in Article 13.4, below. 13.4 TENANT'S AWARD. Tenant shall be entitled to seek a separate award on its own behalf for (i) a sum equal to the value of Tenant's leasehold interest under this Lease; (ii) any and all costs or loss which Tenant may incur in removing or relocating Tenant's merchandise, furniture, fixtures, leasehold improvements and equipment to a new location; (iii) any loss of goodwill occasioned to Tenant's business; and (iv) the value of the Improvements and any other leasehold improvements made to the Premises by Tenant. 14. DEFAULT. 14.1 EVENTS OF TENANT DEFAULT. The occurrence of any of the following events shall constitute an "Event of Default" on the part of Tenant following written notice from Landlord: 14.1.1 PAYMENT. Failure to pay any installment of Base Rent, Operating Expense, Additional Charge or other monies due and payable hereunder ("Monetary Defaults") continuing for ten (10) days after Tenant's receipt of written notice that said payment is overdue from Landlord; or 14.1.2 PERFORMANCE. Material default in the performance of any of Tenant's covenants, agreements or obligations hereunder (except Monetary Defaults) continuing for thirty (30) days after Tenant's receipt of written notice thereof from Landlord. Notwithstanding the above, if the cure of any such default cannot reasonably be completed within such thirty (30) day period, there shall be no Event of Default so long as 19 24 Tenant shall have commenced to cure such default within said thirty (30) day period and diligently prosecutes said cure to completion. 14.2 LANDLORD'S REMEDIES. 14.2.1 ELECTION OF REMEDIES. Upon the occurrence of an Event of Default, Landlord, as its exclusive remedy against Tenant for the recovery of Base Rent due under this Lease, may do either of the following: (i) without re-entry into the Premises institute suit from time to time for the recovery of past due Base Rent, or (ii) re-enter the Premises pursuant to process of law and dispossess Tenant and all other occupants therefrom and remove and store all property therein in a public warehouse or elsewhere at the cost and for the account of Tenant; and in such event Landlord may make such alteration and repairs as may be necessary in order to relet the Premises, and may relet the Premises or any part thereof for such term or terms (which may be for a term extending beyond the term of this Lease) and at such rental or rentals and upon such other terms and conditions as Landlord may deem reasonably advisable. Upon each such reletting all rentals and other sums received by Landlord from such reletting shall be applied in the following order: (a) to the payment of any indebtedness other than Base Rent due hereunder from Tenant to Landlord; (b) to the payment of any costs and expenses of such reletting including reasonable brokerage fees and costs of such alterations and repairs (all of the aforementioned items in (a) and (b) being collectively referred to as "Other Damages"), and (c) to the payment of Base Rent due and unpaid hereunder; and the residue, if any, shall be held by Landlord and applied in payment of future Base Rent as the same may become due and payable by Tenant hereunder. If such rentals and other sums received from such reletting during any month are less than the Base Rent to be paid during that month by Tenant hereunder, Tenant shall pay such deficiency to Landlord; if such rentals and sums shall be more, Tenant shall have no right to the excess. Such deficiency shall be calculated and paid monthly. Landlord shall use reasonable efforts to mitigate damages and relet the Premises. 14.2.2 ACCELERATION PROHIBITED. There shall be no liability or obligation on the part of Tenant to pay any Base Rent prior to the date the same would otherwise have become due in the absence of any Event of Default, it being understood that Landlord shall not have the right to accelerate the payment of any Base Rent due in the future ("Future Rent"). In the event Landlord terminates this Lease, Tenant's liability for Future Rent (as well as any damages specifically in lieu of or representing such Future Rent) shall terminate, except to the extent and in the manner provided for in Section 14.2.1 above. Nothing 20 25 contained in this Section 14.2.2 shall affect or diminish Landlord's rights to recover Other Damages as defined in Section 14.2.1 above. 14.3 LANDLORD'S DEFAULT; TENANT'S REMEDIES. In the event that Landlord fails to perform any of its obligations under this Lease, Tenant may, at its option, and following notification of Landlord of such failure and provided Landlord has not commenced to cure such default, (i) perform Landlord's obligations and reduce Tenant's payment of Base Rent and Additional Charges to reimburse Tenant for such performance of Landlord's obligation, which amount may include attorneys' fees and reasonable administrative costs, (ii) reduce Tenant's payment of Base Rent and Additional Charges to the extent that Landlord's failure to perform its obligation affects Tenant's use of its Premises, or (iii) terminate this Lease. If Tenant elects to terminate this Lease, Landlord shall be liable for any and all of Tenant's relocation costs, including such rent which Tenant may be required to pay under another lease in excess of the rent Tenant is required to pay under this Lease. No failure by Tenant to insist upon the strict performance of any term hereof or to exercise any right or remedy upon a breach by Landlord thereof, shall constitute a waiver of any such breach or of any such term. Efforts by Tenant to mitigate the damages caused by Landlord's breach of this Lease shall not be construed to be a waiver of Tenant's right to recover damages. Tenant shall be under no obligation to observe or perform any covenant of this Lease on its part to be observed or performed which accrues after the date of any default by Landlord, and for so long as such default continues. 15. ASSIGNMENT AND SUBLETTING. Tenant may assign, sublet, or permit occupancy by any party other than Tenant of all or any part of the Premises for any legal use which is compatible with the applicable zoning and the overall nature, quality and tenant mix of the Center. 16. OFFSET STATEMENT, ATTORNMENT AND SUBORDINATION; QUIET ENJOYMENT. 16.1 OFFSET STATEMENT. within twenty (20) days after request therefor by either party, an offset statement may be required from the other party, at no cost or expense to the requesting party, provided the party furnishing such statement need only submit its standard form offset statement. If the requesting party requires other than the standard form offset, such statement shall be granted, provided (i) the party issuing such statement is reimbursed for its reasonable administrative and legal expenses in responding to such request; and (ii) the party delivering the statement need certify only that this Lease 21 26 is in full force and effect, the date of Tenant's most recent payment of Base Rent, and that to the best of its knowledge, it has no defenses or offsets outstanding to the enforcement of the Lease, or stating those claimed. 16.2 ATTORNMENT. In the event of any foreclosure or deed in lieu of foreclosure under any first mortgage or first deed of trust encumbering the Premises, or any part thereof, or in the event of a termination of a ground lease, if any, Tenant shall, if so requested, attorn to the purchaser, grantee or ground lessor (collectively, "Successor") , as the case may be, and recognize such Successor as the Landlord under this Lease; provided, however, that Tenant's obligation to so attorn to any Successor is expressly conditioned upon Tenant's prior receipt from such Successor of a satisfactory non-disturbance agreement and written assumption of Landlord's obligations (past, present and future) under this Lease. 16.3 QUIET ENJOYMENT. Landlord covenants with Tenant that so long as no Event of Default on the part of Tenant has occurred hereunder, Tenant shall and may peaceably and quietly have, hold and enjoy the Premises for the term of this Lease, and any renewals or extensions thereof, and that neither Landlord, nor any party claiming under or through Landlord, shall disturb the use or the occupancy of the Premises by Tenant and Landlord shall defend Tenant's right to such use and occupancy. 17. ENVIRONMENTAL MATTERS. 17.1 LANDLORD'S INDEMNIFICATION OF TENANT. Landlord shall indemnify and hold harmless (a) Tenant and any person or entity who acquires all or any portion of the leasehold interest hereunder in any manner and (b) the directors, officers, shareholders, employees, successors and assigns of Tenant, from and against any and all damages arising from the presence of hazardous materials upon, about, or beneath the Premises, or migrating to or from the Center to the Premises, whether foreseeable or unforeseeable, and, except as set forth in Section 17.2 below, regardless of when such damages occurred. For purposes of this Lease, "hazardous materials" means those materials included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," "extremely hazardous waste," "restricted hazardous waste" or "toxic substances" or words of similar import, including, but not limited to, Sections 66680-66685 of Title 22 of the California Administrative Code, Division 4, Chapter 30; the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601, et seq.; the Hazardous Materials Transportation Act, as amended, 249 U.S.C. Section 1801, et seq.; the Resource Conservation and Recovery Act, as amended, 42 U.S.C. Section 6901, et 22 27 seq.; the Federal Water Pollution Control Act, as amended, 33 U.S.C. Section 1251, et seq. 17.2 EXCLUSIONS. Notwithstanding the foregoing, Landlord's obligations hereunder shall not apply with respect to damages caused solely by Tenant after the date hereof unless such damages are of a continuous nature and commenced prior to the date hereof. 17.3 SURVIVABILITY. The obligation of the Landlord hereunder shall be continuing and shall survive the termination or expiration of this Lease and any transfer of title to the Center (whether by sale, foreclosure, deed in lieu of foreclosure or otherwise). 18. GENERAL PROVISIONS. 18.1 HOLDING OVER. If Tenant remains in possession of the Premises after the term of this Lease, or any extensions or renewals thereof, Tenant shall become a tenant from month to month at the Base Rent payable during the last month of the Initial Term or Extension Term of this Lease, or any extensions or renewals thereof and upon the other terms herein specified, and such tenancy shall continue until terminated by Landlord or Tenant giving the other at least thirty (30) days prior notice of its intention to terminate tenancy. 18.2 NOTICES. All notices required to be given hereunder shall be in writing and mailed postage prepaid by certified or registered mail, return receipt requested, or by personal delivery, to the appropriate address indicated in the Basic Lease Information, or at such other place or places as either Landlord or Tenant may, from time to time, designate in a written notice given to the other. Notices shall be deemed sufficiently served three (3) days after the date of mailing thereof, or upon personal delivery. 18.3 SUCCESSORS BOUND. This Lease and each of its covenants and conditions shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, successors and legal representatives and their respective assigns, subject to the provisions hereof. Whenever in this Lease a reference is made to the Landlord or Tenant, such reference shall be deemed to refer to the person in whom the interest of Landlord or Tenant shall be vested. Any successor or assignee of Landlord or Tenant who accepts an assignment or the benefit of this Lease and enters into possession or enjoyment hereunder shall thereby assume and agree to perform and be bound by the covenants and conditions thereof. 23 28 18.4 WAIVER. No waiver of any default or breach of any covenant by either party hereunder shall be implied from any omission by either party to take action on account of such default if such default persists or is repeated, and no express waiver shall affect any default other than the default specified in the waiver, and then said waiver shall be operative only for the time and to the extent therein stated. Waivers of any covenant, term or condition contained herein by either party shall not be construed as a waiver of any subsequent breach of the same covenant, term or condition. The consent or approval by either party to or of any act by either party requiring further consent or approval shall not be deemed to waive or render unnecessary their consent or approval to or of any subsequent similar acts. 18.5 TIME. Time is of the essence of every provision hereof. If any date set forth for the performance of any obligation or for the delivery of any instrument or notice should be on a Saturday, Sunday or legal holiday, compliance with such obligations or delivery shall be deemed acceptable on the next business day following such Saturday, Sunday or legal holiday. As used herein, the term "legal holiday" means any state or federal holiday for which financial institutions and post offices are generally closed in the State of California for observance thereof. Except as expressly provided to the contrary in this Lease, all references to days shall mean calendar days. 18.6 ATTORNEYS' FEES. In any action or proceeding which the Landlord or the Tenant may be required to prosecute to enforce its respective rights hereunder, the unsuccessful party therein agrees to pay all costs incurred by the prevailing party therein, including reasonable attorneys' fees, to be fixed by the court, and said costs and attorneys' fees shall be made a part of the judgment in said action. 18.7 CONSTRUCTION. This Lease shall not be construed more strictly against one party than against the other merely by virtue of the fact that it may have been prepared by counsel for one of the parties, it being recognized that both Landlord and Tenant have been independently represented and have contributed substantially and materially to the preparation of this Lease. The captions, article numbers and table of contents appearing in this Lease are inserted only as a matter of convenience and in no way define, limit, construe or describe the scope or intent of such sections or articles of this Lease nor in any way affect this Lease. 18.8 SEVERABILITY. If any term, covenant, condition or provision of this Lease, or the application thereof to any person or circumstance, shall to any extent be held by a court of 24 29 competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, covenants, conditions or provisions of this Lease, or the application thereof to any person or circumstance, shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 18.9 APPLICABLE LAW. This Lease, and the rights and obligations of the parties hereto, shall be construed and enforced in accordance with the laws of the State of California. 18.10 ADDITIONAL CONDITIONS TO LEASE. The submission of this document does not constitute a lease. This document shall become effective and binding upon Tenant only upon the satisfaction of each of the following conditions precedent: (i) the approval of the transaction contemplated by this Lease by senior management of Tenant; and (ii) Tenant's receipt, within one hundred twenty (120) days after the full execution of this Lease, of the approval of the transaction contemplated by this Lease by the Comptroller of the Currency. Promptly after the full execution of this Lease, Tenant shall apply for and diligently pursue such approval from the Comptroller of the Currency. No act or omission of any employee or agent of Tenant or of Tenant's broker or managing agent shall alter, change, or modify any of the provisions hereof. 18.11 RECORDING. This Lease may be recorded at either party's election and each party shall execute and deliver as necessary a short form hereof, in a recordable form. 18.12 CONSENT. Except as otherwise expressly provided in this Lease, whenever either parties' consent or approval is required under the terms of this Lease, such consent or approval shall not be unreasonably withheld and shall be delivered within ten (10) days of the date such approval or consent is requested. Failure to respond within such period shall be conclusive on the non-responding party that its consent or approval was given. If either party withholds its consent or approval, then such failure to consent or approve shall only be effective if accompanied by a detailed explanation of the reasons for failing to consent or approve. 18.13 ENTIRE AGREEMENT. This Lease sets forth all covenants, promises, agreements, conditions and understandings between Landlord and Tenant concerning the Premises, and there are no covenants, promises, agreements, conditions or understandings, either oral or written, between Landlord and Tenant other than as are herein set forth. Except as herein otherwise provided, no subsequent alteration, amendment, change or addition to this Lease shall be binding upon Landlord or Tenant unless reduced to writing and signed by Landlord and Tenant. 25 30 18.14 AUTHORITY. Each individual executing this Lease on behalf of Landlord or Tenant represents and warrants that he or she is duly authorized to execute and deliver this Lease on behalf of the party for whom he or she is signing, and that this Lease is binding upon the party for whom he or she is signing in accordance with its terms. IN WITNESS WHEREOF, the parties shall be deemed to have executed this Lease as of the date first set forth above. "Tenant" "Landlord" WELLS FARGO BANK, CAMBRIA VILLAGE SQUARE NATIONAL ASSOCIATION, a national banking association [SIG] [SIG] By:______________________________ By:______________________________ Its:_____________________________ Its:_____________________________ [SIG] By:______________________________ By:______________________________ Its:_____________________________ Its:_____________________________ 26 31 ASSIGNMENT OF LEASE AND ASSUMPTION KNOW THAT WELLS FARGO BANK, NATIONAL ASSOCIATION, a national bank, organized under the laws of the United States, having its principal office in San Francisco, California ("Assignor"), in consideration of One Dollar ($1.00) and other good and valuable consideration paid by HERITAGE OAKS BANK, with its principal office located in Paso Robles, California ("Assignee"), hereby assigns unto the Assignee all of Assignor's right, title and interest as tenant under a certain lease more particularly described on Attachment A hereto, covering premises described on such attachment and in such Lease (the "Lease"). TO HAVE AND TO HOLD the same unto Assignee, its successors and assigns from and after 11:59 P.M ., California time, the day prior to the date hereof (the "Effective Time"), subject to the terms, covenants, conditions and provisions set forth in the Lease. ASSIGNEE hereby assumes, effective as of the Effective Time, the performance of all terms, covenants and obligations of the Lease on the part of Assignor to be performed under the Lease. IN WITNESS WHEREOF, Assignor and Assignee have executed this Agreement as of the 21st of February, 1997. WELLS FARGO BANK, NATIONAL, ASSOCIATION By: /s/ DAVID NELSON ----------------------- Name: David Nelson Title: Senior Vice President By: /s/ ARTHUR BARBOUR ----------------------- Name: Arthur Barbour Title: Vice President HERITAGE OAKS BANK By: /s/ LAWRENCE P. WARD ----------------------- Name: Lawrence P. Ward Title: President 32 AMENDMENT TO LEASE AGREEMENT THIS AMENDMENT TO LEASE AGREEMENT (the "Amendment") is for reference purposes only, entered into this 20th day of January, 1995, by and between WELLS FARGO BANK, NATIONAL ASSOCIATION, a national banking association, as tenant ("Tenant") and CAMBRIA VILLAGE SQUARE, as landlord ("Landlord") , with reference to the following recitals: RECITALS A. Landlord and Tenant are parties to that certain Lease Agreement dated May 1, 1994 (the "Lease"), covering the premises (the "Premises") consisting of approximately 2,916 rentable square feet of Building J ("Building J") located at 1276 Tamson Drive, Cambria, California, in the shopping center commonly known as Cambria Village Square Shopping Center (the "Center") B. Landlord and Tenant desire to amend certain provisions of the Lease dealing with common area maintenance charges and real estate taxes pursuant to the terms, covenants and conditions set forth below. NOW, THEREFORE, in consideration of the mutual covenants herein contained, the parties agree as follows: 1. COMMON AREA MAINTENANCE CHARGES. Notwithstanding the provisions of Section 5.1 of the Lease to the contrary, Tenant's pro rata share of the Operating Expenses, as defined in the Lease but specifically excluding the insurance premiums paid by Landlord to insure the Center, shall be 8.38% based on the rentable square feet of the Premises (2,916 square feet) divided by the total rentable square feet of Buildings F, G, J, I and H (collectively 34,797 square feet) of the Center. 2. REAL PROPERTY TAXES AND INSURANCE. Notwithstanding the provisions of Section 7.1 of the Lease to the contrary, Tenant's pro rata share of the Impositions, as defined in the Lease and specifically including the insurance premiums paid by Landlord to insure the Center, shall be 4.743% based on the rentable square feet of the Premises (2,916 square feet) divided by the total rentable square feet of all buildings in the Center (collectively 61,480 square feet). 3. INCONSISTENT PROVISIONS. The provisions of the Lease are hereby ratified and continue in full force and effect, except to the extent inconsistent with this Amendment. -1- 33 IN WITNESS WHEREOF, the parties shall be deemed to have executed this Lease as of the date first set forth above. "Tenant" "Landlord" WELLS FARGO BANK, CAMBRIA VILLAGE SQUARE NATIONAL ASSOCIATION, a national banking association [SIG] [SIG] By:______________________________ By:______________________________ Its:_____________________________ Its:_____________________________ [SIG] By:______________________________ By:______________________________ Vice President Its:_____________________________ Its:_____________________________ -2- EX-21 3 EXHIBIT 21 1 EXHIBIT 21 SUBSIDIARIES OF HERITAGE OAKS BANCORP Heritage Oaks Bank, - a California banking corporation CCMS Systems, Inc., - inactive EX-23 4 EXHIBIT 23 1 EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To: Heritage Oaks Bancorp We consent to the incorporation of our report dated February 7, 1997, on the consolidated financial statements of Heritage Oaks Bancorp as of December 31, 1996 and 1995, and for each of the three years in the period ended December 31, 1996 included in its Annual Report on Form 1O-KSB for the year ended December 31, 1996. /s/ VAVRINEK, TRINE, DAY & CO. - ------------------------------ VAVRINEK, TRINE, DAY & CO. Certified Public Accountants Rancho Cucamonga, California March 21, 1997 EX-27 5 FINANCIAL DATA SCHEDULE
9 1 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 13,575,653 100,000 1,100,000 0 5,317,000 11,080,726 11,006,428 50,570,564 771,925 85,122,317 71,991,298 4,730,000 1,347,871 0 0 0 4,089,245 2,963,903 85,122,317 4,578,552 899,565 113,347 5,591,464 1,952,083 1,981,878 3,609,586 90,000 0 4,941,235 1,467,174 553,343 913,831 0 913,831 1.30 1.30 5.80 803,730 160,729 514,999 143,411 766,262 107,131 22,794 771,925 0 0 771,925
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