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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1999 Commission File No. 0-10232
FIRST REGIONAL BANCORP
(Exact name of registrant as specified in its charter)
California 95-3582843
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1801 Century Park East
Los Angeles, California 90067
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 552-1776
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
--------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
-----
Aggregate market value of Common Stock held by non-affiliates as of March
21, 2000: $9,534,669
Number of shares of Common Stock outstanding at March 21, 2000: 2,810,997.
Documents incorporated by reference and parts of Form 10-K into which
incorporated:
Portions of Proxy Statement for 2000 Annual Meeting of Share- PART III
holders (to be filed within 120 days of fiscal year end)
Annual Report on Form 10-K for the Years Ended December 31, PART IV
1982, 1987, 1988, 1991, and 1993
Registration Statement on Form 10 as Filed with the Commission PART IV
in March, 1982
Registration Statement on Form S-14 Filed with the Commission PART IV
on December 2, 1981 (File Number 2-75140)
2
FORM 10-K
TABLE OF CONTENTS AND
CROSS REFERENCE SHEET
Page
in Incorporation
PART I 10-K by Reference
---- ------------
Item 1. Business........................... 4
-------
Item 2. Properties......................... 55
-------
Item 3. Legal Proceedings.................. 56
-------
Item 4. Submission of Matters to a Vote of
------- Securities Holders................. 56
PART II
Item 5. Market for Registrant's Common Stock
------ and Related Stockholder Matters.... 57
Item 6. Selected Financial Data............. 59
------
Item 7. Management's Discussion and Analysis
------ of Financial Condition and Results
Of Operations...................... 61
Item 8. Financial Statements and Supplement-
------ ary Data........................... 70
Item 9. Disagreements on Accounting and
------- Financial Disclosure............... 70
PART III
Item 10. Directors and Executive Officers of 2000 Proxy
-------- the Registrant..................... 71 Statement
Item 11. Executive Compensation............. 71 2000 Proxy
-------- Statement
Item 12. Security Ownership of Certain 2000 Proxy
-------- Beneficial Owners and Management... 71 Statement
3
Item 13. Certain Relationships and Related 2000 Proxy
------- Transactions.......................... 71 Statement
PART IV
Item 14. Exhibits, Financial Statement
------- Schedules, and Reports on Form 8-K.... 72
SIGNATURES.......................................... 73
INDEX TO FINANCIAL STATEMENTS....................... 74
INDEX TO EXHIBITS................................... 99
4
PART I
------
Item 1. Business
- -----------------
Business of First Regional Bancorp
- ----------------------------------
First Regional Bancorp (the Company) maintains its principal executive
offices at 1801 Century Park East, Los Angeles, California 90067. The Company
was incorporated in California as Great American Bancorp on February 18, 1981
for the purpose of becoming a bank holding company and acquiring all of the
outstanding common stock of First Regional Bank (the Bank), formerly Great
American Bank, a state-chartered bank headquartered in Los Angeles (Century
City), California. The reorganization of the Bank was accomplished on March 8,
1982, under the terms of a Plan of Reorganization and Merger Agreement dated
October 15, 1981, providing for the merger of a Company subsidiary with the
Bank, with the Bank being the surviving entity in the merger. As a result of the
Bank's reorganization, the Bank's outstanding shares were exchanged on a one-for
one basis for shares of the Company's Common Stock, and the Company became the
sole shareholder of the Bank. Prior to acquiring the Bank, the Company did not
conduct any ongoing business activities. The Company's principal asset is the
stock of the Bank and the Company's primary function is to coordinate the
general policies and activities of the Bank, as well as to consider from time to
time, other legally available investment opportunities. Both the Company and the
Bank changed their names from Great American to First Regional in 1987 as part
of an agreement with another financial institution.
Certain matters discussed in this Annual Report on Form 10-K may constitute
forward-looking statements within the meaning of the Private Securities Reform
Act of 1995 (the "Reform Act") and as such may involve risks and uncertainties.
These forward-looking statements relate to, among other things, expectations of
the business environment in which the Company and the Bank operate, projections
of future performance, perceived opportunities in the market, and statements
regarding the Company's and/or the Bank's mission and vision. The Company's
and/or the Bank's actual results, performance, or achievements may differ
significantly from the results, performance, or achievements expressed or
implied in such forward-looking statements. The following discusses certain
factors which may affect the Company's and/or the Bank's financial results and
operations and should be considered in evaluating the Company and/or the Bank.
The Company does not anticipate that its operations will be materially
affected as a result of compliance with Federal, State and local environmental
laws and regulations.
5
Business of First Regional Bank
- -------------------------------
The Bank was incorporated under the laws of the State of California on July
10, 1979, and has authorized capital of 5,000,000 shares of no par value Common
Stock. The Bank commenced operations as a California-chartered bank on December
31, 1979. The Bank conducts a business-oriented wholesale banking operation,
with services tailored to the needs of businesses and professionals in its
service area. The Bank's main office is located in the Century City office
complex in Los Angeles, California. The Bank also has Regional Offices located
in the California cities of Irvine, Glendale, Santa Monica, Gardena and Encino.
The Irvine and Santa Monica offices are full branch offices and the other
offices are presently established as loan production offices, but it is the
intent of the Bank to convert these facilities to full branch offices as soon as
sufficient business has been obtained to make this conversion advisable. The
Bank also has a Merchant Services division located in Agoura Hills, California.
The Bank's customers include professionals working in the primary service areas
as well as many business accounts located throughout both the counties of Los
Angeles and Orange. In distinction from many other independent banks in
California, the Bank's deposit business is generated by a relatively small
number of accounts, although most accounts have a very high average balance.
The Bank offers a full range of lending services including commercial, real
estate, and real estate construction loans. The Bank has developed a
substantial portfolio of short and medium-term "mini-perm" first trust deed
loans for income properties as well as specializing in construction lending for
moderate-size commercial and residential projects. The Bank also offers
commercial loans for commercial and industrial borrowers, which includes
equipment financing as well as short-term loans. The Bank also offers standard
banking services for its customers, including telephone transfers, wire
transfers, and travelers checks. The Bank accepts all types of demand, savings,
and time certificates of deposit. The Bank's Merchant Services division offers
credit card deposit and clearing services for retailers and other businesses
that accept credit cards. The Bank does not currently offer trust services, but
it does make trust services available to its customers through a correspondent
bank. At March 23, 2000 the Bank had 76 equivalent full-time employees.
Competition
- -----------
The banking business in California generally, and in the Los Angeles County
area where the Bank is located, is highly competitive with respect to both loans
and deposits and is dominated by a relatively small number of major banks which
have many offices operating over wide geographic areas. The Bank competes for
deposits and loans principally with these major banks,
6
but also with small independent banks located in its service areas. Among the
advantages which the major banks have over the Bank are their ability to finance
extensive advertising campaigns and to allocate their investment assets to
regions of highest yield and demand. Many of the major commercial banks
operating in the Bank's service area offer certain services (such as trust and
cash management services) which are not offered directly by the Bank and, by
virtue of their greater total capitalization, such banks have substantially
higher lending limits than the Bank.
Moreover, banks generally, and the Bank in particular, face increasing
competition for loans and deposits from non-bank financial intermediaries such
as savings and loan associations, thrift and loan associations, credit unions,
mortgage companies, insurance companies, and other lending institutions. Money
market funds offer rates competitive with banks, and an increasingly
sophisticated financial services industry continually develops new products for
consumers that compete with banks for investment dollars. In addition, other
entities (both public and private) seeking to raise capital through the issuance
and sale of debt or equity securities compete with banks in the acquisition of
deposits.
Interstate Competition
- ----------------------
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act"), enacted on September 29, 1994, provides that interstate
branching and merging of existing banks is permitted beginning June 1, 1997,
provided that the banks are at least adequately capitalized and demonstrate good
management. Interstate mergers and branch acquisitions are permitted at an
earlier time if a state chooses to enact a law allowing such activity. The
states are also authorized to enact a law to permit interstate banks to branch
de novo.
On August 9, 1989, the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") was signed into law. Among other things,
FIRREA allows the acquisition of healthy and failed savings associations by bank
holding companies, and imposes no interstate barriers on such bank holding
company acquisitions. With certain qualifications, FIRREA also allows bank
holding companies to merge acquired savings associations into their existing
commercial bank subsidiaries; however, for a period of five years from the date
of enactment, the acquired savings association must continue as a member of, and
continue to pay premiums to, the Savings Association Insurance Fund, which was
created by FIRREA to replace the Federal Savings and Loan Insurance Corporation
deposit insurance fund, which FIRREA abolished.
Recent legislation and economic developments have favored increased
competition between different types of financial institutions for both
7
deposits and loans, resulting in increased cost of funds to banks generally and
to the Bank in particular. In order to compete with the other financial
institutions in its service area, the Bank relies principally upon personal
contacts by its officers, directors, founders, employees and shareholders; local
promotional activity including direct mail, advertising in local newspapers and
business journals; and specialized services. The Bank's promotional activities
emphasize the advantages of dealing with a locally-owned and headquartered
institution attuned to the particular needs of the community. In the event that
a customer's loan demands exceed the Bank's lending limits, the Bank attempts to
arrange for such loans on a participation basis with its correspondent banks.
The Bank also assists customers requiring services not offered by the Bank to
obtain these services from its correspondent banks.
SUPERVISION AND REGULATION
- --------------------------
Introduction
- ------------
Banking is a complex, highly regulated industry. The primary goals of the
regulatory scheme are to maintain a safe and sound banking system, protect
depositors and the Federal Deposit Insurance Corporation's insurance fund, and
facilitate the conduct of sound monetary policy. In furtherance of these goals,
Congress and the states have created several largely autonomous regulatory
agencies and enacted numerous laws that govern banks, bank holding companies and
the banking industry. Consequently, the growth and earnings performance of the
Company and the Bank can be affected not only by management decisions and
general economic conditions, but also by the requirements of applicable state
and federal statutes, regulations and the policies of various governmental
regulatory authorities, including:
. the Federal Deposit Insurance Corporation (the ("FDIC"); and
. the California Department of Financial Institutions (the "DFI")
and
. the Board of Governors of the Federal Reserve System (the "FRB").
The system of supervision and regulation applicable to the Company and the
Bank establishes a comprehensive framework for their respective operations.
Federal and state laws and regulations generally applicable to financial
institutions, such as the Company and the Bank, regulate, among other things:
. the scope of business that they may conduct;
8
. investments that they can make;
. reserves that must be maintained against deposits;
. capital levels that must be maintained relative to the amount and
risks associated with assets;
. the nature and amount of collateral that may be taken to secure
loans;
. the establishment of new branches;
. mergers and consolidations with other financial institutions; and
. the amount of dividends that the Company and the Bank may pay.
The following summarizes the material elements of the regulatory framework
that applies to the Company and any subsidiaries, including the Bank. It does
not describe all of the statutes, regulations and regulatory policies that are
applicable. Also, it does not restate all of the requirements of the statutes,
regulations and regulatory policies that are described. Consequently, the
following summary is qualified in its entirety by reference to the applicable
statutes, regulations and regulatory policies. Any change in applicable laws,
regulations or regulatory policies may have a material effect on the business of
the Company and the Bank.
Supervision and Regulation - The Company
- ----------------------------------------
General. The Company, as a bank holding company registered under the Bank
-------
Holding Company Act of 1956 (the "BHCA"), is subject to regulation by the FRB.
According to FRB policy, the Company is expected to act as a source of financial
strength for the Bank and to commit resources to support them in circumstances
where the Company might not otherwise do so. Under the BHCA, the Company and
its subsidiaries are subject to periodic examination by the FRB. The Company is
also required to file periodic reports of its operations and any additional
information regarding its activities and those of its subsidiaries with the FRB,
as may be required.
The Company is also a bank holding company within the meaning of Section
3700 of the California Financial Code. As such, the Company and its
subsidiaries are subject to examination by, and may be required to file reports
with, the Commissioner of the California Department of Financial
9
Institutions (the "Commissioner"). Regulations have not yet been proposed or
adopted or steps otherwise taken to implement the Commissioner's powers under
this statute.
Bank Holding Company Liquidity. The Company is a legal entity, separate
------------------------------
and distinct from the Bank. Although there exists the ability to raise capital
on its own behalf or borrow from external sources, it may also obtain additional
funds through dividends paid by, and fees for services provided to, the Bank.
However, regulatory constraints may restrict or totally preclude the Bank from
paying dividends to the Company.
The Company is entitled to receive dividends, when and as declared by the
Bank's Board of Directors, out of funds legally available therefore, as
specified and limited by the California Financial Code. Under the California
Financial Code, funds available for cash dividend payments by a bank are
restricted to the lesser of: (i) a bank's retained earnings; or (ii) a bank's
net income for its last three fiscal years (less any distributions to
shareholders made during such period). With the prior approval of the
Commissioner, cash dividends may also be paid out of the greater of: (i) a
bank's retained earnings; (ii) net income for a bank's last preceding fiscal
year; or (iii) net income for a bank's current fiscal year. If the Commissioner
finds that the shareholders' equity of the bank is not adequate or that the
payment of a dividend would be unsafe or unsound for the bank, the Commissioner
may order the bank not to pay a dividend to the bank's shareholders.
Since the Bank is an FDIC insured institution, it is therefore possible,
depending upon its financial condition and other factors, that the FDIC could
assert that the payment of dividends or other payments might, under some
circumstances, constitute an unsafe or unsound practice and thereby prohibit
such payments.
Transactions With Affiliates. The Company and any subsidiaries it may
----------------------------
purchase or organize are deemed to be affiliates of the Bank within the meaning
of Sections 23A and 23B of the Federal Reserve Act. Pursuant thereto, loans by
the Bank to affiliates, investments by the Bank in affiliates' stock, and taking
affiliates' stock by the Bank as collateral for loans to any borrower will be
limited to 10% of the Bank's capital, in the case of any one affiliate, and will
be limited to 20% of the Bank' capital in the case of all affiliates. In
addition, such transactions must be on terms and conditions that are consistent
with safe and sound banking practices; in particular, a bank and its
subsidiaries generally may not purchase from an affiliate a low-quality asset,
as defined in the Federal Reserve Act. Such restrictions also prevent a bank
holding company and its other affiliates from borrowing from a banking
subsidiary of the bank holding company unless the loans are secured by
marketable collateral of
10
designated amounts. The Company and the Bank is also subject to certain
restrictions with respect to engaging in the underwriting, public sale and
distribution of securities. (See "Supervision and Regulation -The Banking
Subsidiaries - Recent Legislation and Regulatory Developments - 1. Gramm-Leach-
Bliley Act - Facilitating Affiliations and Expansion of Financial Activities"
herein.)
Limitations on Businesses and Investment Activities. Under the BHCA, a
---------------------------------------------------
bank holding company must obtain the FRB's approval before:
. directly or indirectly acquiring more than 5% ownership or control
of any voting shares of another bank or bank holding company;
. acquiring all or substantially all of the assets of another bank;
or
. merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any
state of the United States without regard to whether the acquisition is
prohibited by the law of the state in which the target bank is located. In
approving interstate acquisitions, however, the FRB must give effect to
applicable state laws limiting the aggregate amount of deposits that may be held
by the acquiring bank holding company and its insured depository institutions in
the state in which the target bank is located, provided that those limits do not
discriminate against out-of-state depository institutions or their holding
companies, and state laws which require that the target bank have been in
existence for a minimum period of time, not to exceed five years, before being
acquired by an out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own
subsidiaries engaged in certain businesses that the FRB has determined to be "so
closely related to banking as to be a proper incident thereto." The Company,
therefore is permitted to engage in a variety of banking-related businesses.
Some of the activities that the FRB has determined, pursuant to its Regulation
Y, to be related to banking are:
. making or acquiring loans or other extensions of credit for its
own account or for the account of others;
. servicing loans and other extensions of credit;
. operating a trust company in the manner authorized by federal or
state law under certain circumstances;
11
. leasing personal and real property or acting as agent, broker,
or adviser in leasing such property in accordance with various
restrictions imposed by FRB regulations;
. providing financial, banking, or economic data processing and
data transmission services;
. owning, controlling, or operating a savings association under
certain circumstances;
. selling money orders, travelers' checks and U.S. Savings Bonds;
. providing securities brokerage services, related securities
credit activities pursuant to Regulation T, and other incidental
activities; and
. underwriting and dealing in obligations of the U.S., general
obligations of states and their political subdivisions, and other
obligations authorized for state member banks under federal law.
Federal law prohibits a bank holding company and any subsidiary banks from
engaging in certain tie-in arrangements in connection with the extension of
credit. Thus, for example, the Banking Subsidiaries may not extend credit,
lease or sell property, or furnish any services, or fix or vary the
consideration for any of the foregoing on the condition that:
. the customer must obtain or provide some additional credit,
property or services from or to the Banking Subsidiaries other than
a loan, discount, deposit or trust service;
. the customer must obtain or provide some additional credit,
property or service from or to the Company or any of the Banking
Subsidiaries; or
. the customer may not obtain some other credit, property or
services from competitors, except reasonable requirements to assure
soundness of credit extended.
Generally, the BHCA does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
On November 12, 1999, the President signed into law the Gramm-Leach-Bliley
Act (the "GLB Act" or the "Financial Modernization Act"). The GLB Act
significantly changed the regulatory structure and oversight of the
12
financial services industry. The GLB Act permits banks and bank holding
companies to engage in previously prohibited activities under certain
conditions. Also, banks and bank holding companies may affiliate with other
financial service providers such as insurance companies and securities firms
under certain conditions. Consequently, a qualifying bank holding company,
called a financial holding company ("FHC"), can engage in a full range of
financial activities, including banking, insurance, and securities activities,
as well as merchant banking and additional activities that are beyond those
permitted for traditional bank holding companies. Moreover, various non-bank
financial services providers which were previously prohibited from engaging in
banking can now acquire banks while also offering services such as securities
underwriting and underwriting and brokering insurance products. The GLB Act also
expands passive investment activities by FHCs, permitting them to indirectly
invest in any type of company, financial or nonfinancial, through merchant
banking activities and insurance company affiliations. (See "Supervision and
Regulation- The Bank - Recent Legislation and Regulatory Developments - 1. Gramm
Leach-Bliley Act" herein.)
Capital Adequacy. Bank holding companies must maintain minimum levels of
----------------
capital under the FRB's risk based capital adequacy guidelines. If capital
falls below minimum guideline levels, a bank holding company, among other
things, may be denied approval to acquire or establish additional banks or non-
bank businesses.
The FRB's risk-based capital adequacy guidelines for bank holding companies
and state member banks, discussed in more detail below (see "Supervision and
Regulation - The Banking Subsidiaries - Recent Legislation and Regulatory
Developments - 4. Risk-Based Capital Guidelines" herein), assign various risk
percentages to different categories of assets, and capital is measured as a
percentage of risk assets. Under the terms of the guidelines, bank holding
companies are expected to meet capital adequacy guidelines based both on total
risk assets and on total assets, without regard to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels
will be required if warranted by the particular circumstances or risk profiles
of individual organizations. For example, the FRB's capital guidelines
contemplate that additional capital may be required to take adequate account of,
among other things, interest rate risk, or the risks posed by concentrations of
credit, nontraditional activities or securities trading activities. Moreover,
any banking organization experiencing or anticipating significant growth or
expansion into new activities, particularly under the expanded powers pursuant
to the GLB Act, would be expected to maintain capital ratios, including
tangible capital positions, well above the minimum levels.
13
Limitations on Dividend Payments. California Corporations Code Section 500
--------------------------------
allows the Company to pay a dividend to its shareholders only to the extent that
the Company has retained earnings and, after the dividend, the Company's assets
(exclusive of goodwill and other intangible assets) would be 1.25 times its
liabilities (exclusive of deferred taxes, deferred income and other deferred
credits), and the Company's current assets would be at least equal to its
current liabilities.
Additionally, the FRB's policy regarding dividends provides that a bank
holding company should not pay cash dividends exceeding its net income or which
can only be funded in ways that weaken the bank holding company's financial
health, such as by borrowing. The FRB also possesses enforcement powers over
bank holding companies and their non-bank subsidiaries to prevent or remedy
actions that represent unsafe or unsound practices or violations of applicable
statutes and regulations.
Supervision and Regulation - The Bank
General. The Bank, as a state-chartered nonmember bank, is subject to
-------
regulation, supervision, and regular examination by the DFI and the FDIC. The
Bank's deposits are insured by the FDIC up to the maximum extent provided by
law. The regulations of these agencies govern most aspects of the Bank's
business and establish a comprehensive framework governing its operations.
California law exempts all banks from usury limitations on interest rates.
Supervision, regulation, and examination of the Bank by the regulatory agencies
are generally intended to protect depositors and are not intended to protect the
shareholders of the Company.
Recent Legislation and Regulatory Developments. From time to time
----------------------------------------------
legislation is proposed or enacted which has the effect of increasing the cost
of doing business and changing the competitive balance between banks and other
financial and non-financial institutions. Various federal laws enacted over the
past several years have provided, among other things, for the maintenance of
mandatory reserves with the FRB on deposits by depository institutions (state
reserve requirements have been eliminated); the phasing-out of the restrictions
on the amount of interest which financial institutions may pay on certain of
their customers' accounts. Federal regulators have been given increased
authority and means for providing financial assistance to insured depository
institutions and for effecting interstate and cross-industry mergers and
acquisitions of failing institutions. These laws have generally had the effect
of altering competitive relationships existing among financial institutions,
reducing the historical distinctions between the services offered by banks,
savings and loan associations and other financial service providers, and
increasing the cost of funds to banks and other depository institutions.
14
1. Gramm-Leach-Bliley Act
----------------------
General. The Gramm-Leach-Bliley Act was signed into law on November 12,
-------
1999. The GLB Act represents the most significant revision of the banking and
financial services industry laws since the Depression Era by revising the BHCA
and permitting full affiliations with other financial service providers. The
GLB Act permits a qualified bank holding company, called a financial holding
company, to engage in a full range of financial activities including banking,
insurance, securities activities, as well as merchant banking and other
activities that are financial in nature. The following discusses the more
significant elements of the GLB Act.
Facilitating Affiliations and Expansion of Financial Activities. The GLB
---------------------------------------------------------------
Act:
. eliminates many federal and state barriers to affiliations among
banks and securities firms, insurance companies, and other financial
service providers;
. establishes a statutory framework for permitting full affiliations
to occur;
. provides financial organizations with flexibility in structuring
new financial affiliations through the FHC structure or through a
bank financial subsidiary, with certain safeguards and limitations;
. preserves the role of the FRB as the umbrella supervisory
authority for those FHCs, while incorporating a system of functional
regulation designed to utilize the strengths of various federal and
state regulatory authorities; and
. establishes a mechanism for coordination between the FRB and the
Secretary of the Treasury (the "Secretary") regarding the approval
of new financial activities for both holding companies and financial
subsidiaries of national banks.
Safety and soundness is also emphasized by requiring that banks and holding
companies be "well capitalized" and "well managed" in order to engage in the new
activities and affiliations contemplated by the GLB Act, with the appropriate
regulators given authority to address any failure to maintain safety and
soundness standards in a prompt manner.
Financial Affiliations and Activities. The GLB Act repeals previous
-------------------------------------
statutory prohibitions by permitting bank holding companies and FRB member banks
to engage in previously prohibited activities and affiliations.
15
Specifically, the GLB Act adds Section 6 to the BHCA, designating qualifying
bank holding companies engaging in the new, permissible financial activities and
affiliations as FHCs. In order for a bank holding company to qualify as an FHC,
its subsidiary depository institutions must be "well managed," "well
capitalized," and have at least a "satisfactory" Community Reinvestment Act
("CRA") rating as of their last examination.
On January 19, 2000, the FRB adopted interim regulations under Subpart I of
Regulation Y implementing the FHC provisions of the GLB Act. The interim
regulations, subject to revision, became effective March 11, 2000. Under the
interim regulations, a bank holding company must submit a declaration to the FRB
stating that the company elects to become an FHC and a certification that all
depository institutions controlled by the company are "well capitalized" and
"well managed." Providing that those requirements are met and that the
depository institutions have at least a "satisfactory" CRA rating, the election
to become an FHC is effective on the 31st day after the FRB receives the
election.
If any of an FHC's subsidiary depository institutions fails to retain a
"well managed" or "well capitalized" status, the FHC must execute an agreement
with the FRB within 45 days after notice of the deficiency, agreeing to
implement specific corrective measures to return the FHC to compliance. After
the agreement is executed, the FHC will have 180 days to correct any management
or capital deficiencies. Until the FRB has determined that the deficiencies
have been corrected, the FRB may impose any conditions or limitations on the
conduct or activities of an FHC or on any of its affiliates that the FRB deems
appropriate and consistent with the BHCA and the FHC and its affiliates may not
engage in any additional activities permitted by the GLB Act without the FRB's
prior approval.
If the FHC fails to correct the capital and management deficiencies within
180 days, the FRB may require the FHC to divest itself of any insured depository
institutions or the FRB may require the FHC to cease engaging (both directly and
through any subsidiary that is not a depository institution or a subsidiary of a
depository institution) in all activities that are not otherwise permissible for
a traditional bank holding company under the FRB's Regulation Y.
If any one of an FHC's depository institutions falls out of compliance with
the "satisfactory" CRA rating requirement, the FHC may continue existing
activities permitted by the GLB Act. However, the FHC may not commence any
additional GLB Act activities, or acquire direct or indirect control of any
entity engaged in such activities.
The GLB Act permits FHCs to engage in non-banking activities beyond those
permitted for traditional bank holding companies. Rather than
16
requiring that the non-banking activities be "closely related to banking," FHCs
may engage in those activities that the FRB determines to be financial in
nature, incidental to activities that are financial in nature, or complimentary
to financial activities. The GLB Act enumerates certain permissible activities
that the FRB considers financial in nature. FHCs, however, may only engage in
complimentary financial activities if the FRB determines that the complimentary
activities do not pose a substantial risk to the safety and soundness of the
FHC's depository institutions or the financial system in general.
For those expanded financial activities that are not specifically
enumerated in the GLB Act, the FRB has the primary authority to determine which
activities are financial in nature, incidental or complimentary, and may act by
regulation or order. However, the FRB may not act unilaterally. Pursuant to
the GLB Act, a consultive process between the FRB and the Secretary is required.
The Secretary may also make similar proposals to the FRB with respect to
determining whether proposed activities are financial in nature or incidental to
financial activities regarding financial subsidiaries of national banks. Such a
process is intended to bring a balance to the determinations regarding the type
of activities that are financial and limit so-called "regulatory shopping" by
financial service providers.
A qualifying FHC may engage in any new activity enumerated in the GLB Act
without receiving prior approval from the FRB. Rather, the FHC is only required
to file a notice with the FRB within 30 days after the activity is commenced or
a company is acquired. The new activities enumerated in the GLB Act which are
specifically considered financial in nature include:
. underwriting insurance or annuities, or acting as an insurance or
annuity principal, agent or broker;
. providing financial or investment advice;
. issuing or selling interests in pools of assets that a bank could
hold;
. all underwriting, dealing in or making markets in securities
without any revenue limitation;
. engaging within the United States in any activity that a bank
holding company could engage in outside of the country, if the
FRB determined,before the GLB Act, that the activity was usual in
connection with banking or other financial operations internationally;
17
. sponsoring and distributing all types of mutual funds;
. investment company activities;
. merchant banking equity investment activities;
. insurance company equity investments; and
. engaging in any activity that the FRB determined before the
GLB Act to be permitted for a bank holding company that is not an FHC.
The most significant of the new activities authorized by the GLB Act are
merchant banking and insurance company portfolio investment powers. Before
enactment of the GLB Act, bank holding companies had to limit their non-bank
equity investments, including controlling equity investments, to entities that
were engaged in activities that were closely related to the business of banking.
At the same time securities and insurance companies were free to make merchant
banking and insurance company portfolio investments in virtually any kind of
financial or non-financial company. Recognizing that such investments are
financial in nature, the GLB Act substantially expands the authority of an FHC
to make controlling equity investments in any kind of entity, including those
engaged in non-financial activities.
Merchant Banking. The GLB Act permits FHC's to make controlling equity
----------------
investments in virtually any business entity (including those that engage in
non-financial activities) by permitting the FHC to engage in merchant banking
activities. In order to engage in merchant banking activities:
. the investment must not be made by a depository institution
subsidiary of the FHC, or by a subsidiary of a depository institution;
. the FHC must own a securities affiliate;
. the investment must be made as part of a bona fide underwriting or
merchant or investment banking activity, including investment
activities engaged in for the purpose of appreciation and ultimate
resale or disposition of the investment;
. the investment must be held for a period of time to enable the
sale or disposition thereof on a reasonable basis consistent with
the financial viability of the bona fide underwriting or merchant
or investment banking activity; and
18
. the FHC must not routinely manage or operate the entity in which
the investment is made, except as may be required to obtain a
reasonable return on investment upon sale or disposition.
Insurance Company Portfolio Investments. The GLB Act permits FHCs to
---------------------------------------
affiliate with insurance companies. The GLB Act recognizes that, as part of
their ordinary business, insurance companies frequently invest funds received
from policy holders in most or all of the shares of stock of a company that may
not be engaged in a financial activity. New Section 4(k)(4)(I) of the BHCA
permits an insurance company that is affiliated with a depository institution to
continue insurance company portfolio investment activities, provided that
certain requirements are met. Specifically, the investments held by an
insurance company affiliate of a depository institution must:
. be acquired and held by an insurance company that is predominantly
engaged in underwriting life, accident and health, or property and
casualty insurance, or in providing and issuing annuities;
. represent investments made in the ordinary course of the insurance
company's business, according to relevant state insurance laws
governing such investments; and
. not be routinely managed or operated by the FHC, except as may be
necessary or required to obtain a reasonable return.
To the extent that an FHC does participate in management of the portfolio,
participation would be limited to safeguarding the investments under the
applicable requirements of state insurance laws.
The GLB Act imposes other restrictions on equity investment activities of
FHCs. First, a depository institution controlled by an FHC may not cross market
the products or services of a company in which the FHC has made a merchant
banking or insurance company portfolio investment (a "portfolio company"), and
vice versa. However, the GLB Act does not prevent a nonbank affiliate of an FHC
and a portfolio company from cross marketing each other's products.
Second, a controlling investment made pursuant to the GLB Act's merchant
banking or insurance company portfolio investment authority would make the
portfolio company an "affiliate" of the FHC's depository institution for
purposes of Sections 23A and 23B of the Federal Reserve Act. Moreover, the GLB
Act establishes a presumption that an investment of 15% or more in the equity of
a portfolio company will make the portfolio
19
company an affiliate. Thus, an affiliated depository institution's credit and
asset purchase transactions will be subject to the "covered transaction"
restrictions of Sections 23A and 23B of the Federal Reserve Act, including
quantitative limits, collateral requirements, and the "arms'-length" transaction
standard.
The Riegle-Neal Act was also amended to apply its prohibitions against
establishment of deposit production offices to interstate branches acquired or
established under the GLB Act, including all branches of a bank owned by an out-
of-state bank holding company.
Preemption of State Law. The GLB Act affirms that the states are the
-----------------------
primary legal authority to regulate the insurance business and related
activities. However, in their regulation of insurance activities, state laws
are pre-empted to the extent that they prohibit the affiliations permitted under
the GLB Act. States may not prevent or restrict depository institutions or
their affiliates from engaging in any activity permitted under the GLB Act, such
as insurance sales, solicitations and cross-marketing. States, however are
allowed to continue regulating other insurance activities such as licensing and
requiring that insurance companies maintain certain levels of capital.
Additionally, state regulation of other activities is not pre-empted, even
if they do prevent or restrict an activity permitted under the GLB Act, so long
as they do not discriminate. Consequently, state securities regulations are not
pre-empted with respect to a state's ability to investigate and enforce certain
unlawful transactions or require licensing. Similarly, state corporation and
antitrust laws are not pre-empted so long as such laws are consistent with the
intent of the Financial Modernization Act permitting affiliations.
Streamlining Supervision of Bank Holding Companies. The GLB Act authorizes
--------------------------------------------------
the FRB to examine each holding company and its subsidiaries. The legislation
provides that the FRB may require a bank holding company or any subsidiary to
submit reports regarding: financial condition; monitoring of financial and
operating risks; transactions with depository institutions; and compliance with
the BHCA and other laws that the FRB has jurisdiction to enforce. The FRB,
however, is directed to use existing examination reports prepared by functional
regulators of the particular activity, publicly reported information and reports
filed with other agencies to the fullest extent possible.
The FRB may only directly examine subsidiaries that are functionally
regulated by other federal or state agencies if it:
. has a reasonable basis to believe that the subsidiary is engaged in
activities that pose a material risk to an affiliated
20
depository institution;
. reasonably believes, after reviewing the relevant reports, that
examining the subsidiary is necessary to adequately provide
information regarding its risk monitoring systems; or
. has a reasonable basis to believe that the subsidiary is not in
compliance with the BHCA or other federal law that the FRB has
specific authority to enforce, and the FRB cannot make the
determination through an examination of an affiliated depository
institution or the holding company.
The FRB is not authorized to mandate capital requirements for any
subsidiary that is functionally regulated by another agency and which is in
compliance with the capital requirements prescribed by another federal or state
regulatory authority. Insurance and securities activities conducted in
regulated entities are subject to functional regulation by relevant state
insurance authorities and the Securities and Exchange Commission (the "SEC"),
respectively.
Also, the FRB cannot force a broker-dealer or insurance company that is a
bank holding company to contribute additional capital to a depository
institution, if the company's functional regulator determines, in writing, that
the contribution would have a material adverse effect on the broker-dealer or
insurance holding company. If a functional regulator, however, makes such a
determination, the FRB has authority to require the bank holding company to
divest its interests in the depository institution. The limitations on the FRB
also apply to all federal banking agencies. Thus, the Office of the Comptroller
of the Currency (the "OCC") which regulates national banks, the Office of Thrift
Supervision (the "OTS") which regulates federal savings banks, and the FDIC will
not be able to assume and duplicate the function of being the general
supervisory authority over functionally regulated subsidiaries of banks.
However, the GLB Act specifically preserves the FDIC's authority to examine a
functionally regulated affiliate of an insured depository institution, if it is
necessary to protect the deposit insurance fund.
The GLB Act also specifically limits the FRB's ability to take indirect
action against functionally regulated affiliates. Consequently, the FRB may not
promulgate rules, adopt restrictions, safeguards or any other requirement
affecting a functionally regulated affiliate unless:
. the action is necessary to address a "material risk" to the safety
and soundness of a depository institution affiliate or to the
domestic or international payments system; and
. it is not possible to guard against that material risk through
21
requirements imposed upon the depository institution directly.
Financial Subsidiaries of National Banks. In addition to the permissible
----------------------------------------
statutory subsidiaries (agricultural credit corporations, bank service
companies and community development corporations, etc.) and operating
subsidiaries (subsidiaries engaged in activities that a national bank itself can
perform), the GLB Act permits national banks to establish and operate a third
class of subsidiary known as a financial subsidiary. A financial subsidiary is
a subsidiary that performs financial activities that a national bank either
cannot otherwise perform itself, or that a national bank cannot otherwise own if
not for the enabling provisions of GLB Act.
Activities of national banks' financial subsidiaries are essentially the
same as those for FHCs. Thus, national banks, through financial subsidiaries,
are permitted to engage in the enumerated financial activities authorized by the
GLB Act. However, the following activities, although permissible for FHCs, are
prohibited for financial subsidiaries of national banks and can only be
performed in nonbank subsidiaries of FHCs. These prohibited activities are:
. insurance or annuity underwriting, except that underwriting title
insurance is permitted for national banks in those states where
state-chartered banks may do so;
. insurance company portfolio investments;
. merchant banking; and
. real estate investment and development activities beyond those
directly authorized by law.
The Secretary, in concert with the FRB, may jointly adopt rules lifting the
insurance underwriting, insurance company portfolio investment, and merchant
banking prohibitions beginning November 12, 2004. Additionally, the Secretary,
in conjunction with the FRB, has the authority to determine whether additional
activities are financial in nature and must follow the same evaluation criteria
that the FRB uses in determining additional financial activities for FHC
purposes.
On January 19, 2000, the OCC issued a proposal to amend Part 5 of its
regulations to provide that a national bank may establish a financial subsidiary
if:
. the national bank and its depository institution affiliates meet
the same "well capitalized," "well managed" and
22
"satisfactory" CRA rating standards for banking subsidiaries of FHCs;
. the aggregate consolidated financial assets of all of the national
bank's financial subsidiaries does not exceed the lesser of 45% of the
consolidated net assets of the parent bank or $50 billion; and
. a national bank that is one of the nation's 100 largest insured
banks, determined on the basis of consolidated total assets, has
at least one issue of outstanding eligible debt that is rated in
one of the three highest investment grade categories.
The proposed regulations provide for a filing and notification process.
Once expanded activities have commenced in a financial subsidiary, the proposed
regulations require a national bank to comply with certain conditions in order
to ensure that proper safeguards are implemented. These conditions include, but
are not limited to:
. requiring the national bank to deduct the total amount of its
investment in the financial subsidiary from its assets and equity
for purposes of determining regulatory capital, and presenting the
information separately in any published financial statements for the
bank;
. prohibiting the consolidation of the financial subsidiary's assets
and liabilities with those of the bank;
. requiring the national bank to establish adequate policies and
procedures to maintain the separate corporate identities of the bank
and its financial subsidiaries; and
. requiring adoption and implementation of policies and procedures
to identify and manage financial and operational risks associated
with the financial subsidiary.
Financial Subsidiaries of State-Chartered Nonmember Banks. The GLB Act
---------------------------------------------------------
added Section 46 to the Federal Deposit Insurance Act (the "FDI Act") which
permits state nonmember banks to hold interests in a subsidiary that are
essentially equivalent to a national bank's financial subsidiary. Additionally,
the state nonmember bank must comply with substantially all of the requirements
and conditions imposed on national banks in order to qualify and maintain their
investments in financial subsidiaries established under the GLB Act, except that
there is no requirement that the state nonmember bank be "well managed."
However, the FDI Act requires the FDIC's consent to an investment in any
financial subsidiary of a state-
23
chartered institution. (See - 5. Expanded Enforcement Powers - Activities of
State Banks herein.)
Broker-Dealer Activities. The GLB Act provides for the functional
------------------------
regulation of bank securities activities by the SEC. The GLB Act replaces the
broad bank exemption from broker-dealer regulation under the Securities Exchange
Act of 1934 (the "'34 Act"). The amendments include certain previously excluded
activities within the definition of "broker" and "dealer," thereby subjecting
those activities to the registration requirements and regulation of the '34 Act,
with an exception for certain activities in which banks have traditionally
engaged. These exemptions relate to:
. third-party networking arrangements;
. trustee and fiduciary activities if the bank: (i) is chiefly
compensated by means of administration and certain other fees; and
(ii) does not publicly solicit brokerage deposits; and
. identified banking products such as commercial paper, bankers'
acceptances, employee and shareholder benefit plans, sweep
accounts, affiliatetransactions, private placements, safekeeping
and custody services, asset-backed securities, derivatives and
other identified banking products.
The GLB Act also amends the Investment Company Act and the Investment
Advisers Act, subjecting banks that advise mutual funds to the same regulatory
scheme as other advisers to mutual funds. It also requires banks to make
additional disclosures when a fund is sold or advised by a bank.
Insurance Activities. In addition to affirming that states are the
--------------------
functional regulators of insurance activities, the GLB Act prohibits federally-
chartered banks from engaging in any activity involving the underwriting and
sale of title insurance. National banks may, however, sell title insurance
products in any state in which state-chartered banks are permitted to do so, so
long as those activities are undertaken in the same manner, to the same extent,
and under the same restrictions that apply to state-chartered banks.
The GLB Act requires the federal bank regulatory agencies and state
insurance regulators to coordinate efforts to supervise companies that control
both depository institutions and entities engaged in the insurance business, and
to share supervisory information including financial condition and affiliate
transactions on a confidential basis. Federal agencies are further directed to
provide notice to and consult with state
24
regulators before taking actions which affect any affiliates engaging in
insurance activities.
Unitary Savings and Loan Holding Company Provisions. The GLB Act amends
---------------------------------------------------
the Home Owners' Loan Act (the "HOLA") to prohibit unitary savings and loan
holding companies from engaging in non-financial activities or affiliations with
non-financial organizations. The prohibition applies to applications to form
unitary savings and loan holding companies filed with the OTS after May 4, 1999.
Unitary savings and loan holding companies existing or whose applications were
pending on or before May 4, 1999, retain their authority to engage in
nonfinancial activities and affiliations.
The prohibition on non-financial affiliations, however, does not prevent
transactions that involve corporate reorganizations. Specifically, it does not
prohibit transactions that solely involve an acquisition, merger, consolidation
or other type of business combination of a savings and loan holding company (or
any savings association subsidiary) with another company, where both are under
common control.
Consumer Privacy Protection. The GLB Act enhances financial privacy laws
---------------------------
by imposing an affirmative and continuing obligation to respect the privacy and
protect the confidentiality of nonpublic personal customer information provided
by a consumer to a financial institution, or otherwise obtained by the financial
institution. For purposes of the privacy provisions of the GLB Act, a financial
institution means any entity engaging in the financial activities that are
listed in the new Section 4(k) of the of the BHCA. Thus, the privacy
protections extend to all entities engaged in financial activities defined in
the GLB Act, whether or not they are affiliated with banks or bank holding
companies, FHCs or banks.
The GLB Act also makes it a federal crime to obtain, attempt to obtain,
disclose, cause to be disclosed or attempt to cause to be disclosed customer
information of a financial institution through fraudulent or deceptive means.
These include misrepresenting the identity of the person requesting the
information and misleading an institution or customer into making unwitting
disclosures of confidential information. In addition to criminal sanctions, the
legislation provides for a private right of action and enforcement by state
attorneys general.
Federal Home Loan Bank System Modernization. The Federal Home Loan Bank
-------------------------------------------
System Modernization Act of 1999 (the "FHLBSMA") was enacted as part of the GLB
Act. The FHLBSMA reforms the Federal Home Loan Bank System (the "FHLBS") in
several ways. The more significant changes include:
25
. voluntary rather than mandatory membership of federal savings
associations in the FHLBS;
. permitting all community financial institutions (i.e. institutions
whose deposits are insured by the FDIC and have less than
$500 million in average total assets) to obtain advances from
Federal Home Loan Banks; and
. permitting any community financial institution greater access to
FHLBS credit facilities by expanding the types of assets that may
be pledged ascollateral, including small business, agricultural,
rural development, or low-income community development loans.
In addition, a number of restrictions that had applied to FHLBS member
institutions which did not comply with the Qualified Thrift Lender ("QTL")
requirements under the HOLA were abolished, including: the Federal Home Loan
Bank stock purchase requirements; the requirement that advances only be given
for housing related purposes; the 30% limit on total advances for non-QTL
members; and certain restrictions that applied to non-QTL thrift institutions.
Community Reinvestment Act Provisions. In addition to the maintenance of
-------------------------------------
at least a "satisfactory" CRA rating in order to qualify for expanded
activities, the GLB Act amends the FDIA to require full disclosure of agreements
entered into between an insured depository institution or its affiliates and non
governmental entities or persons made under or in connection with fulfillment of
the CRA. These agreements are to be made available to the public and federal
regulatory agencies. Annually, the parties to each CRA agreement are required to
report the use of resources provided to the participating bank's primary federal
regulator.
Other provisions affecting the CRA include:
. reducing the frequency of CRA examinations for banks with less
than $250 million in assets to once every five years if they
have "outstanding" CRA ratings, and once every four years if they
have "satisfactory" ratings;
. requiring an FRB study of the default rates, delinquency rates
and profitability of CRA loans; and
. requiring a Treasury study of whether adequate services are
being provided under the CRA.
26
Other Provisions. Other provisions of the GLB Act include, but are not
----------------
limited to:
. requiring ATM operators who impose a fee for use of an ATM by a
non-customer to post notice on the ATM and on the screen that a fee
will be charged, the amount of the fee and that no fee will be imposed
unless such notices are made and the customer elects to proceed with
the transaction;
. requiring a General Accounting Office study of possible revisions
to the Internal Revenue Code's Subchapter S corporation rules to
permit greater access by community banks to Subchapter S tax
treatment; and
. requiring a General Accounting Office study analyzing the conflict
of interest faced by the FRB between its role as a primary regulator
of the banking industry and its role as a vendor of services to the
banking and financial services industry.
Conclusion. The provisions of the GLB Act are numerous and become
----------
effective at various times between the date of enactment and the middle of 2001
and beyond. Additionally, various federal regulatory authorities including the
FRB, OCC, FDIC, OTS and SEC have only started to promulgate the regulations and
interpretations required by the GLB Act. Furthermore, procedures for the
coordination of information among regulators, both state and federal, have yet
to be formulated. Management of the Company and the Bank, therefore, cannot
estimate with any degree of certainty the effect that the GLB Act, future
regulations and future regulatory information sharing will have on the financial
condition, results of operations or future prospects of the Company or the Bank.
Finally, the provisions of the GLB Act, particularly those permitting
affiliations and expansion of activities, may prompt mergers, joint ventures,
partnerships and other affiliations among providers of banking, insurance and
securities services, both domestically and internationally. The extent and
magnitude of these affiliations and their impact on the Company, the Bank or on
the banking industry in general cannot be predicted.
2. Interstate Banking
------------------
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act") allows banks to open branches across state lines and
also amended the BHCA to make it possible for bank holding
27
companies to buy out-of-state banks in any state and convert them into
interstate branches.
The amendment to the Bank Holding Company Act permits bank holding
companies to acquire banks in other states provided that the acquisition does
not result in the bank holding company controlling more than 10 percent of the
deposits in the United States, or 30 percent of the deposits in the state in
which the bank to be acquired is located. However, the Riegle-Neal Act also
provides that states have the authority to waive the state concentration limit.
Individual states may also require that the bank being acquired be in existence
for up to five years before an out-of-state bank or bank holding company may
acquire it.
The Riegle-Neal Act permits interstate branching through merging of
existing banks, provided that the banks are at least adequately capitalized and
demonstrate good management. The states were also authorized to enact laws to
permit interstate banks to branch de novo. All banks, however, are prohibited
from using the interstate branching authority of the Riegle-Neal Act for the
primary purpose of deposit production or the establishment of deposit production
offices. (See "- 1. Gramm-Leach-Bliley Act - Facilitating Affiliations and
Expansion of Financial Activities" herein.)
The California Interstate Banking and Branching Act of 1995 ("CIBBA")
authorized out-of-state banks to enter California by the acquisition of or
merger with a California bank that has been in existence for at least five
years, unless the California bank is in danger of failing or in certain other
emergency situations, but limits interstate branching into California to
branching by acquisition of an existing bank. CIBBA allows a California state
bank to have agency relationships with affiliated and unaffiliated insured
depository institutions and allows a bank subsidiary of a bank holding company
to act as an agent to receive deposits, renew time deposits, service loans and
receive payments for a depository institution affiliate.
3. Federal Deposit Insurance
-------------------------
General. The Financial Institutions Reform, Recovery, and Enforcement Act
-------
of 1989 ("FIRREA") has resulted in major changes in the regulation of insured
financial institutions, including significant changes in the authority of
government agencies to regulate insured financial institutions.
Under FIRREA, virtually all federal deposit insurance activities were
consolidated under the FDIC, including insuring deposits of federal savings
associations, state chartered savings and loans and other depository
institutions determined to be operated in substantially the same manner as
28
a savings association. FIRREA established two deposit insurance funds to be
administered by the FDIC. The money in these two funds is separately maintained
and not commingled. The Bank Insurance Fund (the "BIF") insures deposits of
commercial banking institutions and the Savings Association Insurance Fund (the
"SAIF") replaced the deposit insurance fund administered by the Federal Savings
and Loan Insurance Corporation. Insurance of deposits may be terminated by the
FDIC upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the
FDIC or the institution's primary regulator.
Deposit Insurance Assessments. Under FIRREA, the premium assessments made
-----------------------------
on banks and savings associations for deposit insurance were initially
increased, with rates set separately for banks and savings associations, subject
to statutory restrictions.
Since 1994, the FDIC has assessed deposit insurance premiums pursuant to a
risk-based assessment system, under which an institution's premium assessment is
based on the probability that the deposit insurance fund will incur a loss with
respect to the institution, the likely amount of such loss, and the revenue
needs of the deposit insurance fund. Under the risk-based assessment system,
BIF member institutions such as the Bank are categorized into one of three
capital categories (well capitalized, adequately capitalized, and
undercapitalized) and one of three categories based on supervisory evaluations
by its primary federal regulator (in the Bank's case, the FDIC). The three
supervisory categories are: financially sound with only a few minor weaknesses
(Group A), demonstrates weaknesses that could result in significant
deterioration (Group B), and poses a substantial probability of loss (Group C).
The capital and supervisory group ratings for SAIF institutions are the same as
for BIF institutions. The capital ratios used by the FDIC to define well-
capitalized, adequately capitalized and undercapitalized are the same as in the
prompt corrective action regulations (discussed below). The BIF and SAIF
assessment rates since January 1, 1997 are summarized below; assessment figures
are expressed in terms of cents per $100 in insured deposits.
Assessment Rates Effective January 1, 1997
------------------------------------------
Supervisory Group
---------------------------------------------------------
Capital Group Group A Group B Group C
- ------------------------------- ----------------- ----------------- -----------------
Well Capitalized............... 0 3 17
Adequately
Capitalized.................. 3 10 24
Undercapitalized............... 10 24 27
29
Commencing the first quarter of 1997, banks were required to share in the
payment of interest on the Financing Corporation Bonds (the "FICO Bonds") issued
in the 1980s to assist in the recovery of the savings and loan industry.
Previously, the FICO debt was paid solely out of the SAIF assessment base.
Prior to January 1, 2000, the FICO assessments imposed on BIF insured
institutions were assessed at a rate equal to 1/5 of the rate of the assessments
imposed on SAIF insured depository institutions. Between the first quarter of
1997 and the fourth quarter of 1999, the quarterly FICO assessment rates for
SAIF insured institutions ranged from a high of $.0650 to a low of $.0582 per
$100 in insured deposits. The BIF assessment rate for the same period ranged
from a high of $.0130 to a low of $.01164 per $100 in insured deposits. The
rates equalized effective January 1, 2000 at $.0212 per $100 in insured
deposits. Although the FICO assessment rates are annual rates, they are subject
to change quarterly. Since the FICO bonds do not mature until the year 2019, it
is conceivable that banks and savings associations will continue to share in the
payment of the interest on the bonds until then.
With certain limited exceptions, FIRREA prohibits a bank from changing
its status as an insured depository institution with the BIF to the SAIF and
prohibits a savings association from changing its status as an insured
depository institution with the SAIF to the BIF, without the prior approval of
the FDIC.
FDIC Receiverships. Pursuant to FIRREA, the FDIC may be appointed
------------------
conservator or receiver of any insured bank or savings association. In
addition, FIRREA authorized the FDIC to appoint itself as sole conservator or
receiver of any insured state bank or savings association for any, among others,
of the following reasons:
. insolvency of such institution;
. substantial dissipation of assets or earnings due to any violation
of law or regulation or any unsafe or unsound practice;
. an unsafe or unsound condition to transact business, including
substantially insufficient capital or otherwise;
. any willful violation of a cease and desist order which has become
final;
. any concealment of books, papers, records or assets of the
institution;
. the likelihood that the institution will not be able to meet the
demands of its depositors or pay its obligations in the
30
normal course of business;
. the incurrence or likely incurrence of losses by the institution
that will deplete all or substantially all of its capital with no
reasonable prospect for the replenishment of the capital without
federal assistance; or
. any violation of any law or regulation, or an unsafe or unsound
practice or condition which is likely to cause insolvency or
substantial dissipation of assets or earnings, or is likely to weaken
the condition of the institution or otherwise seriously prejudice the
interest of its depositors.
As a receiver of any insured depository institution, the FDIC may liquidate
such institution. The liquidation must be done in an orderly manner. The FDIC
may also dispose of any matter concerning the institution that the FDIC
determines to be in the institution's, its depositors' and the FDIC's best
interests. Additionally, the FDIC, as the conservator or receiver, succeeds to
all rights, titles, powers and privileges of the insured institution.
Consequently, the FDIC may take over the assets of and operate an institution
with all the powers of its members, shareholders, directors or officers, and
conduct all business of the institution, collect all obligations and money due
to the institution, and preserve and conserve the assets and property of the
institution.
Enforcement Powers. Some of the most significant provisions of FIRREA were
------------------
the expansion of regulatory enforcement powers. FIRREA has given the federal
regulatory agencies broader and stronger enforcement authorities reaching a
wider range of persons and entities. Some of those provisions included those
which:
. expanded the category of persons subject to enforcement under the
Federal Deposit Insurance Act;
. expanded the scope of cease and desist orders and provided for the
issuance of temporary cease and desist orders;
. provided for the suspension and removal of wrongdoers on an
expanded basis and on an industry-wide basis;
. prohibited the participation of persons suspended or removed or
convicted of a crime involving dishonesty or breach of trust from
serving in another insured institution;
. required the regulators to publicize all final enforcement orders;
and
31
. provided for extensive increases in the amounts and circumstances
for assessment of civil money penalties, civil and criminal forfeiture
and other civil and criminal fines and penalties.
Crime Control Act of 1990. The Crime Control Act of 1990 further
-------------------------
strengthened the authority of federal regulators to enforce capital
requirements, increased civil and criminal penalties for financial fraud, and
enacted provisions allowing the FDIC to regulate or prohibit certain forms of
golden parachute benefits and indemnification payments to officers and directors
of financial institutions.
4. Risk-Based Capital Guidelines
-----------------------------
General. The federal banking agencies have established minimum capital
-------
standards known as risk-based capital guidelines. The risk-based capital
guidelines include both a new definition of capital and a framework for
calculating the amount of capital that must be maintained against a bank's
assets and off balance sheet items. The amount of capital required to be
maintained is based upon the credit risks associated with a bank's types of
assets and off-balance sheet items. A bank's assets and off balance sheet items
are classified under several risk categories, with each category assigned a
particular risk weighting from 0% to 100%. A bank's risk-based capital ratio is
calculated by dividing its qualifying capital which is the numerator of the
ratio, by the combined risk weights of its assets and off balance sheet items
which is the denominator of the ratio.
Qualifying Capital. A bank's qualifying total capital consists of two
------------------
types of capital components: "core capital elements," known as Tier 1 capital
and "supplementary capital elements," known as Tier 2 capital. The Tier 1
component of a bank's qualifying capital must represent at least 50% of
qualifying total capital and may consist of the following items that are defined
as core capital elements:
. common stockholders' equity;
. qualifying noncumulative perpetual preferred stock (including
related surplus); and
. minority interests in the equity accounts of consolidated
subsidiaries.
The Tier 2 component of a bank's qualifying total capital may consist of the
following items:
. a portion of allowance for loan and lease losses;
32
. certain types of perpetual preferred stock and related surplus;
. certain types of hybrid capital instruments and mandatory
convertible debt securities; and
. a portion of term subordinated debt and intermediate-term
preferred stock, including related surplus.
Risk Weighted Assets and Off Balance Sheet Items. Assets and credit
------------------------------------------------
equivalent amounts of off-balance sheet items are assigned to one of several
broad risk classifications, according to the obligor or, if relevant, the
guarantor or the nature of collateral. The aggregate dollar value of the amount
in each risk classification is then multiplied by the risk weight associated
with that classification. The resulting weighted values from each of the risk
classification are added together. This total is the bank's total risk weighted
assets comprising the denominator of the risk-based capital ratio.
Risk weights for off-balance sheet items, such as unfunded loan
commitments, letters of credit and recourse arrangements, are determined by a
two-step process. First, the "credit equivalent amount" of the off-balance
sheet items is determined, in most cases by multiplying the off-balance sheet
item by a credit conversion factor. Second, the credit equivalent amount is
treated like any balance sheet asset and is assigned to the appropriate risk
category according to the obligor or, if relevant, the guarantor or the nature
of the collateral.
Minimum Capital Standards. The supervisory standards set forth below
-------------------------
specify minimum capital ratios based primarily on broad risk considerations.
The risk-based ratios do not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For
this reason, banks are generally expected to operate with capital positions
above the minimum ratios.
All banks are required to meet a minimum ratio of qualifying total capital
to risk weighted assets of 8%. At least 4% must be in the form of Tier 1
capital, net of goodwill, and a minimum ratio of Tier 1 capital to risk weighted
assets of 4%. The maximum amount of supplementary capital elements that
qualifies as Tier 2 capital is limited to 100% of Tier 1 capital net of
goodwill. In addition, the combined maximum amount of subordinated debt and
intermediate-term preferred stock that qualifies as Tier 2 capital is limited to
50% of Tier 1 capital. The maximum amount of the allowance for loan and lease
losses that qualifies as Tier 2 capital is limited to 1.25% of gross risk
weighted assets. The allowance for loan and
33
lease losses in excess of this limit may, of course, be maintained, but would
not be included in a bank's risk-based capital calculation.
Federal banking agencies also require all banks to maintain a minimum
amount of Tier 1 capital to total assets, referred to as the leverage ratio.
For a bank rated in the highest of the five categories used by regulators to
rate banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%.
For all banks not rated in the highest category, the minimum leverage ratio must
be at least 4% to 5%. These uniform risk-based capital guidelines and leverage
ratios apply across the industry. Regulators, however, have the discretion to
set minimum capital requirements for individual institutions which may be
significantly above the minimum guidelines and ratios.
Other Factors Affecting Minimum Capital Standards. The federal banking
-------------------------------------------------
agencies have established certain benchmark ratios of loan loss reserves to be
held against classified assets. The benchmark set forth by the policy statement
is the sum of:
. 100% of assets classified loss;
. 50% of assets classified doubtful;
. 15% of assets classified substandard; and
. estimated credit losses on other assets over the upcoming twelve
months.
The federal banking agencies have recently revised their risk-based capital
rules to take account of concentrations of credit and the risks of non-
traditional activities. Concentrations of credit refers to situations where a
lender has a relatively large proportion of loans involving a single borrower,
industry, geographic location, collateral or loan type. Non-traditional
activities are considered those that have not customarily been part of the
banking business, but are conducted by a bank as a result of developments in,
for example, technology, financial markets or other additional activities
permitted by law or regulation. The regulations require institutions with high
or inordinate levels of risk to operate with higher minimum capital standards.
The federal banking agencies also are authorized to review an institution's
management of concentrations of credit risk for adequacy and consistency with
safety and soundness standards regarding internal controls, credit underwriting
or other operational and managerial areas.
Further, the banking agencies recently have adopted modifications to the
risk-based capital rules to include standards for interest rate risk
34
exposure. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital to adverse movements in interest rates. While
interest rate risk is inherent in a bank's role as financial intermediary, it
introduces volatility to bank earnings and to the economic value of the bank.
The banking agencies have addressed this problem by implementing changes to the
capital standards to include a bank's exposure to declines in the economic value
of its capital due to changes in interest rates as a factor that they will
consider in evaluating an institution's capital adequacy. A bank's interest rate
risk exposure is assessed by its primary federal regulator on an individualized
basis, and it may be required by the regulator to hold additional capital if it
has a significant exposure to interest rate risk or a weak interest rate risk
management process.
The federal banking agencies also limit the amount of deferred tax assets
that are allowable in computing a bank's regulatory capital. 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. However, deferred tax assets that can only be realized through future
taxable earnings are limited for regulatory capital purposes to the lesser of:
. the amount that can be realized within one year of the quarter-end
report date; or
. 10% of Tier 1 capital.
The amount of any deferred tax in excess of this limit would be excluded from
Tier 1 capital, total assets and regulatory capital calculations.
5. Expanded Enforcement Powers
---------------------------
General. The Federal Deposit Insurance Corporation Improvement Act of 1991
-------
("FDICIA") recapitalized the FDIC's Bank Insurance Fund, granted broad
authorization to the FDIC to increase deposit insurance premium assessments and
to borrow from other sources, and continued the expansion of regulatory
enforcement powers, along with many other significant changes.
Prompt Corrective Action. FDICIA established five categories of bank
------------------------
capitalization: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized" and mandated the establishment of a system of "prompt
corrective action" for institutions falling into the lower capital categories.
Under the regulations, a bank shall be deemed to be:
. "well capitalized" if it has a total risk-based capital ratio
35
of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or
more, has a leverage capital ratio of 5.0% or more and is not subject
to specified requirements to meet and maintain a specific capital
level for any capital measure;
. "adequately capitalized" if it has a total risk-based capital
ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or
more and a leverage capital ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized";
. "undercapitalized" if it has a total risk-based capital ratio that
is less than 8.0%, a Tier 1 risk-based capital ratio that is less than
4.0%, or a leverage capital ratio that is less than 4.0% (3.0% under
certain circumstances);
. "significantly undercapitalized" if it has a total risk-based
capital ratio that is less than 6.0%, a Tier 1 risk-based capital
ratio that is less than 3.0% or a leverage capital ratio that is less
than 3.0%; and
. "critically undercapitalized" if it has a ratio of tangible equity
to total assets that is equal to or less than 2.0%.
Banks are prohibited from paying dividends or management fees to
controlling persons or entities if, after making the payment the bank would be
undercapitalized, that is, the bank fails to meet the required minimum level for
any relevant capital measure. Asset growth and branching restrictions apply to
undercapitalized banks, which are required to submit acceptable capital plans
guaranteed by its holding company, if any. Broad regulatory authority was
granted with respect to significantly undercapitalized banks, including forced
mergers, growth restrictions, ordering new elections for directors, forcing
divestiture by its holding company, if any, requiring management changes, and
prohibiting the payment of bonuses to senior management. Even more severe
restrictions are applicable to critically undercapitalized banks, those with
capital at or less than 2%, including the appointment of a receiver or
conservator after 90 days, even if the bank is still solvent. All of the
federal banking agencies have promulgated substantially similar regulations to
implement this system of prompt corrective action.
Information concerning the Bank's capital adequacy at December 31, 1999 is
as follows (the Company's ratios and amounts are substantially the same):
36
Amount to be
Minimum "Well
Amount for Capitalized"
Capital Minimum Under Prompt
Actual Adequacy Regulatory Corrective Action
Amount Ratio Purposes Ratio Provisions Ratio
The Bank: (Dollars in thousands)
Total Capital (To Risk-
Weighted Assets)...................... $23,013 11.7% $15,748 8.0% $19,684 10.0%
Tier 1 Capital (To Risk-
Weighted Assets)...................... 20,713 10.5 7,874 4 .0 11,811 6.0
Leverage Ratio (Tier 1 Capital 9,356
To Average Assets).................... 20,713 8.9 4 .0 11,695 5.0
FDICIA and the implementing regulations also provide that a federal banking
agency may, after notice and an opportunity for a hearing, reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category if the institution
is in an unsafe or unsound condition or engaging in an unsafe or unsound
practice. The FDIC may not, however, reclassify a significantly
undercapitalized institution as critically undercapitalized.
Operational Standards. FDICIA also granted the regulatory agencies
---------------------
authority to prescribe standards relating to internal controls, credit
underwriting, asset growth and compensation, among others, and required the
regulatory agencies to promulgate regulations prohibiting excessive compensation
or fees. Many regulations have been adopted by the regulatory agencies to
implement these provisions and subsequent legislation (see -"6. Riegle Community
Development and Regulatory Improvement Act of 1994" herein) gave the regulatory
agencies the option of prescribing the safety and soundness standards as
guidelines rather than regulations.
Brokered Deposits. Effective June 16, 1992, FDICIA placed restrictions on
-----------------
the ability of banks to obtain brokered deposits or to solicit and pay interest
rates on deposits that are significantly higher than prevailing rates. FDICIA
provides that a bank may not accept, renew or roll over brokered deposits
unless: (i) it is "well capitalized"; or (ii) it is adequately capitalized and
receives a waiver from the FDIC permitting it to accept brokered deposits paying
an interest rate not in excess of 75 basis points over certain prevailing market
rates. FDIC regulations define brokered deposits to include any deposit
obtained, directly or indirectly, from any person engaged in the business of
placing deposits with, or selling interests in deposits of, an insured
depository
37
institution, as well as any deposit obtained by a depository institution that is
not "well capitalized" for regulatory purposes by offering rates significantly
higher (generally more than 75 basis points) than the prevailing interest rates
offered by depository institutions in such institution's normal market area. In
addition to these restrictions on acceptance of brokered deposits, FDICIA
provides that no pass-through deposit insurance will be provided to employee
benefit plan deposits accepted by an institution which is ineligible to accept
brokered deposits under applicable law and regulations.
Lending. New regulations were issued in the area of real estate lending,
-------
prescribing standards for extensions of credit that are secured by real property
or made for the purpose of the construction of a building or other improvement
to real estate. In addition, the aggregate of all loans to executive officers,
directors and principal shareholders and related interests may now not exceed
100% (200% in some circumstances) of the depository institution's capital.
Activities of State Banks. FDICIA imposed restrictions on the activities
-------------------------
of state-chartered banks which are otherwise authorized under state law.
Generally, FDICIA restricts investments and activities of state banks, either
directly or through subsidiaries, to those permissible for national banks,
unless the FDIC has determined that such activities would not pose a risk to the
insurance find of which the bank is a member and the bank is also in compliance
with applicable capital requirements. This restriction effectively eliminated
real estate investments authorized under California law.
6. Riegle Community Development and Regulatory Improvement Act of 1994
-------------------------------------------------------------------
The Riegle Community Development and Regulatory Improvement Act of 1994
(the "1994 Act") provides for funding for the establishment of a Community
Development Financial Institutions Fund (the "Fund"), which provides assistance
to new and existing community development lenders to help to meet the needs of
low- and moderate-income communities and groups. The 1994 Act also mandated
changes to a wide range of banking regulations. These changes included:
. less frequent regulatory examination schedules for small
institutions;
. amendments to the money laundering and currency transaction
reporting requirements of the Bank Secrecy Act; and
38
. amendments to the Truth in Lending Act to provide greater
protection for consumers by reducing discrimination against the
disadvantaged.
The "Paperwork Reduction and Regulatory Improvement Act," Title III of the
1994 Act, required the federal banking agencies to consider the administrative
burdens that new regulations will impose before their adoption and required a
transition period in order to provide adequate time for compliance. This Act
also required the federal banking agencies to work together to establish uniform
regulations and guidelines as well as to work together to eliminate duplicative
or unnecessary requests for information in connection with applications or
notices. The Paperwork Reduction and Regulatory Improvement Act also amended
the BHCA and Securities Act of 1933 to simplify the formation of bank holding
companies.
7. Safety and Soundness Standards
------------------------------
The federal banking agencies have also adopted uniform guidelines
establishing standards for safety and soundness. 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 and
asset quality and earnings. 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.
The federal banking agencies issued regulations prescribing uniform
guidelines for real estate lending. The regulations 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 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,
39
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.
8. Consumer Protection Laws and Regulations
----------------------------------------
The bank regulatory agencies are focusing greater attention on compliance
with consumer protection laws and their implementing regulations. Examination
and enforcement have become more intense in nature, and insured institutions
have been advised to monitor carefully compliance with various consumer
protection laws and their implementing regulations. In addition to the consumer
privacy protections enacted pursuant to the GLB Act, banks are subject to many
other federal consumer protection laws and their regulations including, but not
limited to, the Community Reinvestment Act, the Truth in Lending Act (the
"TILA"), the Fair Housing Act (the "FH Act"), the Equal Credit Opportunity Act
(the "ECOA"), the Home Mortgage Disclosure Act ("HMDA"), and the Real Estate
Settlement Procedures Act ("RESPA").
The CRA is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their
communities. The CRA specifically directs the federal bank regulatory agencies,
in examining insured depository institutions, to assess their record of helping
to meet the credit needs of their entire community, including low- and moderate-
income neighborhoods, consistent with safe and sound banking practices. The CRA
further requires the agencies to take a financial institution's record of
meeting its community credit needs into account when evaluating applications
for, among other things, domestic branches, consummating mergers or
acquisitions, or holding company formations.
The federal banking agencies have adopted regulations which measure a
bank's compliance with its CRA obligations on a performance-based evaluation
system. This system bases CRA ratings on an institution's actual lending
service and investment performance rather than the extent to which the
institution conducts needs assessments, documents community outreach or complies
with other procedural requirements. The ratings range from a high of
"outstanding" to a low of "substantial noncompliance."
The ECOA prohibits discrimination in any credit transaction, whether for
consumer or business purposes, on the basis of race, color, religion,
40
national origin, sex, marital status, age (except in limited circumstances),
receipt of income from public assistance programs, or good faith exercise of any
rights under the Consumer Credit Protection Act. In March, 1994, the Federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in lending. The policy statement describes the three methods that
federal agencies will use to prove discrimination: overt evidence of
discrimination, evidence of disparate treatment and evidence of disparate
impact. This means that if a creditor's actions have had the effect of
discriminating, the creditor may be held liable -- even when there is no intent
to discriminate.
The FH Act regulates may practices, including making it unlawful for any
lender to discriminate in its housing-related lending activities against any
person because of race, color, religion, national origin, sex, handicap, or
familial status. The FH Act is broadly written and has been broadly interpreted
by the courts. A number of lending practices have been found to be, or may be
considered illegal under the FH Act, including some that are not specifically
mentioned in the FH Act itself. Among those practices that have been found to
be, or may be considered illegal under the FH Act are: declining a loan for the
purposes of racial discrimination; making excessively low appraisals of property
based on racial considerations; pressuring, discouraging, or denying
applications for credit on a prohibited basis; using excessively burdensome
qualifications standards for the purpose or with the effect of denying housing
to minority applicants; imposing on minority loan applicants more onerous
interest rates or other terms, conditions or requirements; and; racial steering,
or deliberately guiding potential purchasers to or away from certain areas
because of race.
The TILA is designed to ensure that credit terms are disclosed in a
meaningful way so that consumers may compare credit terms more readily and
knowledgeably. As a result of the TILA, all creditors must use the same credit
terminology and expressions of rates, the annual percentage rate, the finance
charge, the amount financed, the total payments and the payment schedule.
HMDA grew out of public concern over credit shortages in certain urban
neighborhoods. One purpose of HMDA is to provide public information that will
help show whether financial institutions are serving the housing credit needs of
the neighborhoods and communities in which they are located. HMDA also includes
a "fair lending" aspect that requires the collection and disclosure of data
about applicant and borrower characteristics as a way of identifying possible
discriminatory lending patterns and enforcing anti-discrimination statutes.
HMDA requires institutions to report data regarding applications for one-to-four
family loans, home improvement loans, and multifamily loans, as well as
41
information concerning originations and purchases of such types of loans.
Federal bank regulators rely, in part, upon data provided under HMDA to
determine whether depository institutions engage in discriminatory lending
practices.
RESPA requires lenders to provide borrowers with disclosures regarding the
nature and costs of real estate settlements. Also, RESPA prohibits certain
abusive practices, such as kickbacks, and places limitations on the amount of
escrow accounts.
Violations of these various consumer protection laws and regulations can
result in civil liability to the aggrieved party, regulatory enforcement
including civil money penalties, and even punitive damages.
9. Recent California Developments
------------------------------
Effective January 1, 1998, California legislation eliminated the provisions
regarding impairment of contributed capital and the assessment of shares when
there is an impairment in capital and added as additional grounds to close a
bank, if the Commissioner finds that the bank's tangible shareholders' equity is
less than the greater of 3% of the bank's total assets or $1 million.
In addition, California law provides the Commissioner with certain
additional enforcement powers. For example, if it appears to the Commissioner
that a bank is violating its articles of incorporation or state law, or is
engaging in unsafe or unsound business practices, the Commissioner can order the
bank to comply with the law or to cease the unsafe or injurious practices or the
Commissioner can close the bank. The Commissioner also has the power to suspend
or remove the bank's officers, directors and employees who: (i) violate any law,
regulation or fiduciary duty to the bank; (ii) engage in any unsafe or unsound
practices related to the business of the bank; or (iii) are charged with or
convicted of a crime involving dishonesty or breach of trust.
10. Conclusion
----------
As a result of the recent federal and California legislation, including the
GLB Act, there has been a competitive impact on commercial banking in general
and the business of the Company and the Bank in particular. There has been a
lessening of the historical distinction between the services offered by banks,
savings and loan associations, credit unions, securities dealers, insurance
companies, and other financial institutions. Banks have also experienced
increased competition for deposits and loans which may result in increases in
their cost of funds,
42
and banks have experienced increased overall costs. Further, the federal banking
agencies have increased enforcement authority over bank holding companies, banks
and their directors and officers.
Future legislation is also likely to impact the Company's business.
Consumer legislation has been proposed in Congress which may require banks to
offer basic, low-cost, financial services to meet minimum consumer needs.
Further, the regulatory agencies have proposed and may propose a wide range of
regulatory changes, including the calculation of capital adequacy and limiting
business dealings with affiliates. These and other legislative and regulatory
changes may have the impact of increasing the cost of doing business or
otherwise impacting the earnings of financial institutions. However, the
degree, timing and full extent of the impact of these proposals cannot be
predicted. Management of the Company and the Bank cannot predict what other
legislation might be enacted or what other regulations might be adopted or the
effects thereof.
The foregoing summary of the relevant laws, rules and regulations governing
banks and bank holding companies do not purport to be a complete summary of all
applicable laws, rules and regulations governing banks and bank holding
companies.
Impact of Monetary Policies
- ---------------------------
Banking is a business which 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 earned by the Bank on loans, securities
and other interest-earning assets will comprise the major source of the
Company's earnings. These rates are highly sensitive to many factors which are
beyond the Company's and the Bank's control and, accordingly, the earnings and
growth of the Bank are subject to the influence of economic conditions
generally, both domestic and foreign, including inflation, recession, and
unemployment; and also to the influence of monetary and fiscal policies of the
United States and its agencies, particularly the FRB. The FRB implements
national monetary policy, such as seeking to curb inflation and combat
recession, by its open-market dealings in United States government securities,
by adjusting the required level of reserves for financial institutions subject
to reserve requirements, by placing limitations upon savings and time deposit
interest rates, and through adjustments to the discount rate applicable to
borrowings by banks which are members of the Federal Reserve System. The
actions of the FRB in these areas influence the growth of bank loans,
investments, and deposits and also affect interest rates. The nature and timing
of any future changes in such policies and their impact on the Company or the
Bank cannot be predicted; however, depending on the degree to which the Bank's
interest-earning assets and interest-bearing liabilities are rate
43
sensitive, increases in rates would have the temporary effect of increasing
their net interest margin, while decreases in interest rates would have the
opposite effect.
In addition, adverse economic conditions could make a higher provision for
loan losses more prudent and could cause higher loan charge-offs, thus adversely
affecting the Company's net income.
Product Development Research
- ----------------------------
The Company has not engaged in any material research activities relating to
the development of new services or the improvement of existing banking services
during the last three fiscal years. The officers and employees of the Bank are
continually engaged in marketing activities, however, including the evaluation
and development of new services, to enable the Bank to retain a competitive
position in the service area.
Distribution of Assets, Liabilities and Shareholders' Equity
- ------------------------------------------------------------
The following table shows the average balances of the Bank's assets,
liabilities, and shareholders' equity for the past two years:
For Period Ended
December 31,
1999 1998
-------- -------
(Dollars in Thousands)
Assets
Cash and Due From Banks.... $ 12,354 $ 8,351
Time Deposits with Other
Financial Institutions..... 7,571 9,145
Investment Securities...... 68,976 32,090
Funds Sold................. 29,579 34,163
Net Loans.................. 100,303 79,964
Other Assets............... 4,022 2,528
-------- --------
Total................. $222,805 $166,241
======== ========
44
Liabilities & Shareholders' Equity
Deposits:
Demand (non-interest
bearing)................. $ 63,470 $ 43,087
Savings.................. 1,809 1,522
Money Market Accounts.... 85,120 66,056
Time..................... 47,269 35,763
-------- --------
Total Deposits...... 197,668 146,428
Securities Sold Under
Agreements to Repurchase...... 579 104
Other Liabilities............. 2,356 2,117
-------- --------
Total Liabilities........ 200,603 148,649
-------- --------
Shareholders' Equity.......... 22,202 17,592
-------- --------
Total.................... $222,805 $166,241
======== ========
Interest Rates and Interest Differential
- ----------------------------------------
The following table sets forth the average balances outstanding for major
categories of interest earning assets and interest bearing liabilities and the
average interest rates earned and paid thereon:
45
For Period Ended December 31,
1999 1998
--------------------------- -------------------------
Interest Average Interest Average
Average Income(2)/ Yield/ Average Income(2)/ Yield/
Balance Expense Rate % Balance Expense Rate %
------- --------- ------ ------- --------- ------
(Dollars in Thousands)
Interest
Earning
Assets:
Loans(1) $102,633 $ 9,910 9.7% $ 82,387 $ 8,517 10.3%
Investment
Securities 68,976 3,455 5.0% 32,090 1,766 5.5%
Funds Sold 29,579 1,486 5.0% 34,163 1,808 5.3%
Time Deposits
With Other
Financial
Institutions 7,571 406 5.4% 9,145 521 5.7%
-------- ------- -------- -------
Total
Interest
Earning
Assets $208,759 $15,257 7.3% $157,785 $12,612 8.0%
======== ======= ======== =======
1999 1998
-------------------------- --------------------------
Interest Average Interest Average
Average Income(2)/ Yield/ Average Income(2)/ Yield/
Balance Expense Rate % Balance Expense Rate %
------- --------- ------ ------- --------- ------
(Dollars in Thousands)
Interest
Bearing
Liabilities:
Savings
deposits $ 1,809 $ 50 2.8% $ 1,522 $ 37 2.4%
Money
Market
Accounts 85,120 2,156 2.5% 66,056 1,544 2.3%
46
Time 47,269 2,238 4.7% 35,763 1,856 5.2%
Securities
sold under
agreements
to repur-
chase $ 579 $ 17 2.9% $ 104 $ 3 2.9%
-------- ------ -------- -------
Total
interest
bearing
liabili-
ties $134,777 $4,461 3.3% $103,445 $ 3,440 3.3%
======== ====== ======== =======
__________
(1) This figure reflects total loans, including non-accrual loans, and is not
net of the allowance for possible losses, which had an average balance of
$2,330,000 in 1999 and $2,423,000 in 1998.
(2) Includes loan fees of $803,000 in 1999 and $655,000 in 1998.
The following table shows the net interest earnings and the net yield on
average interest earning assets:
1999 1998
--------- ---------
(Dollars in Thousands)
Total interest income (1)................. $ 15,257 $ 12,612
Total interest expense.................... 4,461 3,440
-------- --------
Net interest earnings..................... $ 10,796 $ 9,172
======== ========
Average interest earning assets............ $208,759 $157,785
Net yield on average interest earning
assets..................................... 5.2% 5.8%
__________
(1) Includes loan fees of $803,000 in 1999 and $655,000 in 1998.
47
The following table sets forth changes in interest income and interest
expense. The net change as shown in the column "Net Increase (Decrease)" is
segmented into the change attributable to variations in volume and the change
attributable to variations in interest rates. Non-performing loans are included
in average loans.
Increase (Decrease) Increase (Decrease)
1999 over 1998 1998 over 1997
------------------------- ------------------------
Volume Rate Net Volume Rate Net
(Dollars in Thousands)
Interest Income(1)
- ------------------
Loans (2) $1,904 $(511) $1,393 $(852) $ 627 $(225)
Investment
securities 1,832 (143) 1,689 563 (74) 489
Funds sold (234) (88) (322) 284 (45) 239
Interest on time
deposits with
other financial
institutions (86) (29) (115) 251 (10) 241
------ ----- ------ ----- ----- -----
Total
Interest
Earning
Assets $3,416 $(771) $2,645 $ 246 $ 498 $ 744
====== ===== ====== ===== ===== =====
Interest Expense (1)
- --------------------
Savings $ 8 $ 5 $ 13 $ 6 $ 1 $ 7
Money market 474 138 612 (524) (160) (684)
Time 525 (143) 382 798 31 829
Securities
sold under
agreements to
repurchase 14 0 14 0 3 3
------ ----- ------ ----- ----- -----
Total interest
bearing liab-
ilities $1,021 $ 0 $1,021 $ 280 $(125) $ 155
====== ===== ====== ===== ===== =====
48
__________
(1) The change in interest due to both rate and volume has been allocated to
the change due to volume and the change due to rate in proportion to the
relationship of the absolute dollar amounts of the change in each.
(2) Includes loan fees of $803,000 in 1999 and $655,000 in 1998.
Investment Securities
- ---------------------
The following table shows fair value of the investment securities portfolio
at December 31, 1999 and 1998:
December 31,
1999 1998
----------- -------
(Dollars in Thousands)
U.S. Treasury Securities................... $ 5,007 $ 0
Obligations of U.S. Government
Agencies and Corporations.................. 3,447 5,999
Commercial Paper........................... 44,335 41,861
------- -------
Total.................................... $52,789 $47,860
======= =======
The maturity schedule and weighted average yields of investment securities
at December 31, 1999 is as follows:
Average
Amount Yield
------ -------
(Dollars in Thousands)
U.S. Treasury Securities
- ------------------------
One year or less................... $ 5,007 4.94%
Over one year...................... 0 0.00%
-------
Category total................. $ 5,007 4.94%
49
U.S. Agency Securities
- ----------------------
One year or less................... $ 3,447 5.62%
Over one year...................... 0 0.00%
-------
Category total................. $ 3,447 5.62%
Commercial Paper
- ----------------
One year or less................... $44,335 5.99%
Over one year...................... 0 0.00%
-------
Category total................. $44,335 5.99%
Total Investment Portfolio
- --------------------------
One year or less................... $52,789 5.86%
Over one year through five years... 0 0.00%
Over five years.................... 0 0.00%
-------
Total.......................... $52,789 5.86%
=======
Loan Portfolio
- --------------
The loan portfolio consisted of the following at December 31, 1999 and 1998:
1999 1998
-------- -------
(Dollars in Thousands)
Commercial loans.................................... $42,789 $24,811
Real estate construction loans...................... 19,267 15,702
Real estate loans................................... 56,741 46,251
Bankers acceptances................................. 0 6,681
Other loans......................................... 961 797
------- -------
50
Total loans.................................... $119,758 $94,242
Less - Allowances for loan losses................... 2,300 2,500
- Deferred loan fees........................... 726 562
-------- -------
Net loans...................................... $116,732 $91,180
======== =======
Government guaranteed loans held for sale........... $ 5,084 $ 521
======== =======
Loan Maturities and Interest Rates
- ----------------------------------
The following table shows the amounts of total loans outstanding as of
December 31, 1999, which, based on remaining scheduled payments of principal,
are due in one year or less, more than one year but less than five years, more
than five years but less than ten years, and ten years or more. The amount due
for each interval is classified according to whether the interest rate floats in
response to changes in interest rates or is fixed.
Aggregate maturities of loan balances
which are due:
In one year or less:
Interest rates are floating or
adjustable....................... $56,772
Interest rates are fixed or
predetermined.................... 1,653
After one year but within five years:
Interest rates are floating or
adjustable....................... 48,303
Interest rates are fixed or
predetermined.................... 75
After five years but within ten years:
Interest rates are floating or
adjustable....................... 17,746
Interest rates are fixed or
predetermined.................... 0
51
After ten years or more:
Interest rates are floating or
adjustable....................... 293
Interest rates are fixed or
predetermined.................... 0
--------
Total.................................... $124,842
========
Non-Performing Loans
- --------------------
The current policy is to cease accruing interest on commercial, real estate
and installment loans which are past due as to principal or interest 90 days or
more, except that in certain circumstances interest accruals are continued on
loans deemed by management to be fully collectible.
The following table shows the principal amount of nonperforming loans as of
December 31, 1999 and 1998:
December 31,
1999 1998
---- ----
(Dollars in Thousands)
Non-accrual loans
Commercial.................... $ 129 $ 85
Real estate loans............. 0 158
Government guaranteed loans... 0 0
Bankers acceptances........... 0 0
Other loans................... 0 0
----- -----
Total..................... $ 129 $ 243
===== =====
Accruing loans past due more than 90 days
Commercial.................... $ 0 $ 0
Real estate loans............. 0 0
52
Government guaranteed loans... 0 220
Bankers acceptances........... 0 0
Other loans................... 0 0
---- ----
Total...................... $ 0 $220
==== ====
Except as may have been included in the above table, at December 31, 1999,
there were no loans, the terms of which had been renegotiated to provide a
reduction or deferral of interest or principal because of a deterioration of the
financial position of the borrower or which would be classified as restructured
debt in a troubled loan situation. In addition, at December 31, 1999, there
were no loans then current as to which there were serious doubts as to the
ability of the borrower to comply with the then-present loan repayment terms.
For the non-accrual loans listed in the above table, the Bank would have
realized additional gross interest income of $21,000 in 1999 had the loans been
current in accordance with their original terms.
Summary of Loan Loss Experience
- -------------------------------
The following table provides information concerning changes in the
allowance for possible loan losses and loans charged off and recovered for 1999
and 1998:
1999 1998
---- ----
(Dollars in Thousands)
Amount of loans outstanding at end of
period..................................... $124,842 $ 94,763
======== ========
Average amount of loans outstanding
before allowance for loan losses........... $102,633 $ 82,393
======== ========
Balance of allowance for loan losses at
beginning of period........................ $ 2,500 $ 2,400
Loans charged off:
Commercial............................ 0 19
Real estate........................... 46 0
53
Government guaranteed loans........... 0 0
Bankers acceptances................... 0 0
Other................................. 0 0
------ ------
Total loans charged off........... 46 19
Recoveries of loans previously charged off:
Commercial............................ 10 47
Real estate........................... 42 0
Government guaranteed loans........... 0 0
Bankers acceptances................... 0 0
Other................................. 0 0
------ ------
Total loan recoveries............. 52 47
------ ------
Net loans (recovered) charged off.......... 6 (28)
------ ------
Provisions charged to operating expense.... (206) 72
------ ------
Balance of allowance for possible loan
losses at end of period.................... $2,300 $2,500
====== ======
The ratio of net loans charged off to average loans outstanding was
(0.006)% and (0.03)% for the two years ended December 31, 1999 and 1998,
respectively.
The Bank has historically evaluated the adequacy of its allowance for
possible loan losses on an overall basis rather than by specific categories of
loans. In determining the adequacy of the allowance for possible loan losses,
management considers such factors as historical loan loss experience, known
problem loans, evaluations made by bank regulatory authorities, assessment of
economic conditions and other appropriate data to identify the risks in the loan
portfolio.
For the purposes of this report, the allowance for possible loan losses has
been allocated to the major categories of loans as set forth in the following
table. The allocations are estimates based upon historical loss experience and
management judgment. The allowance for possible loan losses should not be
interpreted as an indication that charge-offs will occur in these amounts or
proportions, or that the allocation indicates future charge-off trends.
Furthermore, the portion allocated to each loan category is not the total amount
available for future losses that might occur within such categories, since even
in this allocation is an unallocated portion, and, as previously stated, the
total allowance is applicable to the entire portfolio.
54
1999 1998
---- ----
Allowance Ratio of Allowance Ratio of
for loans to for loans to
possible total possible total
loan losses loans loan losses loans
----------- -------- ----------- --------
Commercial loans........................ $ 714 34% $ 472 26%
Real estate loans....................... 1,397 61% 1,009 65%
Gov't guaranteed........................ 0 4% 0 1%
Bankers acceptances..................... 0 0% 0 7%
Other loans............................. 4 1% 4 1%
Unallocated............................. 185 0% 1,015 0%
------ ---- ------ ---
Total.............................. $2,300 100% $2,500 100%
====== ==== ====== ===
Deposits
- --------
The average amounts of deposits for the periods indicated are summarized
below.
1999 1998
---- ----
(Dollars in Thousands)
Demand Deposits.............................................. $ 63,470 $ 43,087
Savings deposits, money market and
time certificates of deposit of less
than $100,000................................................ 103,645 85,895
Time certificates of deposit of
$100,000 or more............................................. 30,553 17,446
-------- --------
Total................................................... $197,668 $146,428
======== ========
The maturity schedule of time certificates of deposit of $100,000 or more at
December 31, 1999 is as follows:
55
December 31, 1999
-----------------
(Dollars in Thousands)
3 months or less.................. $24,867
Over 3 through 6 months........... 2,652
Over 6 through 12 months.......... 4,778
Over 12 months.................... 0
-------
Total..................... $32,297
=======
Selected Financial Ratios
- -------------------------
The following table sets forth the ratios of net income to average total
assets and to average shareholders' equity, and average shareholders' equity to
average total assets.
1999 1998
----- -----
Return on assets......... 0.8% 1.0%
Return on equity......... 7.8% 9.7%
Dividend payment ratio... 0.0% 0.0%
Equity to assets ratio... 10.0% 10.6%
Item 2. Properties
- -------------------
The Bank's head office is located on the ground and eighth floors of an
office building located at 1801 Century Park East, Los Angeles, California. The
Bank has leased approximately 3,735 square feet of ground floor office space and
approximately 8,256 square feet of eighth floor office space under a lease which
expires on February 28, 2003. The Bank has an option to extend the term of the
lease for an additional five years. The total monthly rental for the premises is
$29,400 for the period from March, 1993 through February, 1998, and $35,280 for
the period from March, 1998 through February, 2003, subject to annual
adjustments for increases in
56
property taxes and other operating costs. At the end of 1994, the Bank elected
to apply the unused tenant improvement allowance of $224,000 against its future
lease payments. Payment of the allowance was made to the Bank over a 15-month
period beginning February 1, 1995. The Bank is deferring recognition of this
amount and amortizing it evenly over the lease term.
The Bank's Merchant Services division is located at 28310 Roadside Drive,
Suite 250, Agoura Hills, California. The premises consist of approximately 2,010
square feet which are provided under a lease which expires on October 31, 2002.
The total monthly rental is $2,754, subject to annual adjustments of 4% and
various operating costs.
The Bank also subleases an office in an executive suite facility to house
its Orange County Regional Office. The office is located at 2030 Main Street,
Irvine, California, and consists of approximately 1440 square feet. The premises
are provided under a lease which expires November 3, 2001 at a monthly rental of
$4,464 plus a proportionate share of the building's operating costs.
The Bank also leases an office located at 501 Santa Monica Boulevard, Suite
403, Santa Monica, California to house its Santa Monica Regional Office. The
premises consisting of approximately 1,984 square feet are provided under a
lease which expires July 31, 2004 at a rental of $4,602 per month.
Item 3. Legal Proceedings
- --------------------------
Litigation
- ----------
In the normal course of business, the Company and the Bank are involved in
litigation. Management does not expect the ultimate outcome of any pending
litigation to have a material effect on the Company's financial position or
results of operations.
During 1999, the Company settled a suit filed by a former director of the
Company. The effect on the Company's financial results was not material.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
During the fourth quarter of 1999, no matters were submitted to a vote of
the Company's shareholders.
57
PART II
-------
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
- -----------------------------------------------------------------------------
Securities Activity
- -------------------
The common stock of First Regional Bancorp is traded on The Nasdaq Stock Market
under the trading symbol FRGB. Quotations are carried either daily or weekly by
newspapers throughout the nation including The Wall Street Journal and the Los
Angeles Times. The following table summarizes the quotations reported by Nasdaq
of First Regional Bancorp's common stock.
1999 1998
---- ----
High Low High Low
---- --- ---- ---
1st Quarter 8 3/4 7 1/2 9 3/4 8 1/4
2nd Quarter 8 3/4 6 1/8 10 7 3/4
3rd Quarter 9 1/4 7 3/8 10 1/8 8 1/2
4th Quarter 8 7 8 7/8 7
Dividends
- ---------
The Company has not paid any cash dividends and it is the Company's Board
of Directors' intention that no cash dividends be declared by the Company during
this stage of the Company's development. The Board of Directors intends to
increase the Company's capital and to pay cash dividends only when it is prudent
to do so and the Company's performance justifies such action.
The Company is a legal entity separate and distinct from its subsidiaries,
and has not engaged in any activities other than acting as a holding company.
Accordingly, the Company's principal source of funds, including funds available
for payment of cash dividends to its shareholders, have and will consist of
dividends paid and other funds advanced to the Company by its subsidiaries. As
described below, statutory and regulatory requirements impose limitations on the
amounts of dividends payable by the Bank to the Company and on extensions of
credit by the Bank to the Company.
Holders of the Company's Common Stock are entitled to receive dividends as
and when declared by the Board of Directors out of funds legally available
therefore under the laws of the State of California. Under California law, the
Company would be prohibited from paying dividends
58
unless: (1) its retained earnings immediately prior to the dividend payment
equals or exceeds the amount of the dividend; or (2) immediately after giving
effect to the dividend (i) the sum of the Company's assets would be at least
equal to 125% of its liabilities, and (ii) the current assets of the Company
would be at least equal to its current liabilities, or, if the average of its
earnings before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of its interest expense for the
two preceding fiscal years, at least 125% of its current liabilities.
Prior to the consummation of the reorganization of the Bank, the Bank did
not pay any cash dividends to its shareholders. It is the Bank's Board of
Directors' current intention to retain most of the Bank's earnings to increase
its capital, although the Bank may pay cash dividends to the Company as its
current sole shareholder subject to regulation and when deemed prudent. The Bank
paid dividends to the Company of $2,000,000, $100,000 and $230,000 in 1999, 1998
and 1997.
Restrictions on Transfer of Funds to the Company by the Bank
- ------------------------------------------------------------
The Company is a legal entity separate and distinct from the Bank. It is
anticipated that the Company may eventually receive sufficient income to fund
its operating expenses through the payment of management fees by its
subsidiaries. However, if the Company requires significant amounts of cash,
including funds available for the payment of dividends and extraordinary
operating expenses, such funds initially will be received as dividends paid by
the Bank. Subject to the regulatory restrictions described below, future cash
dividends by the Bank to the Company also will depend upon Management's
assessment of the Bank's future capital requirements, contractual restrictions
and other factors.
In addition, there are statutory and regulatory limitations on the amount
of dividends which may be paid to the Company by the Bank. Under California law,
funds available for cash dividend payments by a bank are restricted to the
lesser of: (i) retained earnings or (ii) the bank's net income for its last
three fiscal years (less any distributions to shareholders made during such
period). Cash dividends may also be paid out of net income for a bank's last
preceding fiscal year upon the prior approval of the California Commissioner of
Financial Institutions, without regard to retained earnings or net income for
its last three fiscal years. If the Commissioner of Financial Institutions finds
that the shareholders' equity of a bank is not adequate or that the payment of a
dividend would be unsafe or unsound for the bank, the Commissioner may order the
bank not to pay any dividend to its shareholders.
59
Moreover, in a policy statement adopted in November, 1985, the Federal
Reserve Board advised banks and bank holding companies that payment of cash
dividends in excess of current earnings from operations is inappropriate and may
be cause for supervisory action. As a result of this new policy, banks and their
holding companies may find it difficult to pay dividends out of retained
earnings from historical periods prior to the most recent fiscal year or to take
advantage of earnings generated by extraordinary items such as sales of
buildings, other large assets, or business segments in order to generate profits
to enable payment of future dividends.
Under the Financial Institutions Supervisory Act, the FDIC also has
authority to prohibit a bank from engaging in business practices which the FDIC
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of the bank in question and other factors, that the FDIC could assert
that the payment of dividends or other payments might under some circumstances
be such an unsafe or unsound practice.
In addition, the Bank is subject to certain restrictions imposed by federal
law on any extensions of credit to the Company or other affiliates, investments
in stock or other securities thereof, and taking of such securities as
collateral for loans. Such restrictions prevent the Company and such other
affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts.
Item 6. Selected Financial Data
- --------------------------------
The balances of selected balance sheet components as of December 31 of each
of the past five years were as follows:
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
Total assets $233,033 $193,884 $162,445 $152,449 $137,810
Net loans 121,816 91,701 78,720 87,602 85,327
Investment securities 59,712 58,003 33,057 32,059 22,003
Funds sold 37,090 31,900 38,390 22,780 20,690
Total deposits 205,732 170,423 145,096 136,755 124,724
Shareholders' equity 20,703 20,470 15,423 14,316 12,259
Book value per share $ 7.73 $ 7.22 $ 6.38 $ 5.95 $ 5.11
outstanding
60
The Company's operating results are summarized as follows for the twelve-
month periods ending December 31 of each of the following years:
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in Thousands except for per share)
Interest income $15,257 $12,612 $11,868 $11,463 $10,920
Interest expense 4,461 3,440 3,285 2,974 2,764
------- ------- ------- ------- -------
Net interest income 10,796 9,172 8,583 8,489 8,156
Provision for loan losses (206) 72 540 0 678
------- ------- ------- ------- -------
Net interest income after
provision for loan losses 11,002 9,100 8,043 8,489 7,478
Other income 1,796 858 695 700 447
Other expense 9,859 7,052 6,645 6,320 5,644
------- ------- ------- ------- -------
Income (loss) before taxes and
effects of accounting change 2,939 2,906 2,093 2,869 2,281
Provision (credit) for income
taxes 1,213 1,197 885 833 254
------- ------- ------- ------- -------
Net income (loss) $ 1,726 $ 1,709 $ 1,208 $ 2,036 $ 2,027
Basic earnings (loss) per
common share outstanding $ 0.61 $ 0.66 $ 0.50 $ 0.85 $ 0.85
Cash dividends declared per
share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00
The number of shares outstanding (net of unearned ESOP shares) was
2,677,000 in 1999, 2,837,000 in 1998, 2,416,000 in 1997, 2,406,000 in 1996, and
2,398,800 for 1995.
The summary information presented above should be read in conjunction with
the Notes to Consolidated Financial Statements, which accompany the Company's
financial statements as described below.
61
Item 7. Management's Discussion and Analysis of Financial
- ----------------------------------------------------------
Condition and Results of Operations
-----------------------------------
Summary
First Regional Bancorp (the "Company") has not conducted any significant
business activities independent of First Regional Bank (the "Bank") since the
reorganization of the Bank on March 8, 1982. Therefore, the following discussion
and analysis relates primarily to the Bank and its two reportable business
segments consisting of core bank operations and the administration and custodial
services in relation to the formation of Trust Administration Services Corp.
(TASC) during the current year. For segment reporting financial information see
Note 17 of the Consolidated Financial Statements.
Core Bank Operations - The principal business activities of this segment
are attracting funds from the general public and originating commercial and
real estate loans for small and midsize businesses in Southern California.
This segment's primary sources of revenue are interest income from loans
and investment securities, and fees earned in connection with loans and
deposits. This segment's principal expenses consist of interest paid on
deposits, personnel, and other general and administrative expenses.
Administration and Custodial Services - The principal business activity of
this segment is providing administrative and custodial services for self-
directed retirement plans. The primary source of revenue for this segment
is fee income from self-directed accounts. The segment's principal expenses
consist of personnel, rent, data processing, and other general and
administrative expenses.
The Company achieved continued profitability in 1999, with significant
increases in assets, deposits and loans. The Company continues to benefit from
strategic decisions made in 1995, when the Company initiated a program of
prudent, managed growth; this program resulted in higher levels of earning
assets and interest revenue in 1997, 1998 and 1999. The Company's profitability
was also in part a reflection of the continued low levels of nonperforming
loans, other real estate owned, and other nonearning assets. The low levels of
problem assets continue to result in higher revenues due to additional funds
being available for investment, and also eliminated the need for large loan loss
provisions or real estate writedowns.
62
Average assets in 1999 were $222,805,000 compared to $166,241,000 in 1998
and $152,151,000 in 1997. As was the case in 1998 and 1997, the Company's asset
growth in 1999 was funded by an increase in deposits, as well as by the
retention of earnings for the year. The Company generated net income of
$1,726,000 in 1999 compared to a profit of $1,709,000 in 1998 and a profit of
$1,208,000 in 1997.
Net Interest Income
-------------------
Net interest income is the excess of interest income earned on interest-
earning assets over interest expense incurred on interest-bearing liabilities.
Interest income or expense are determined by the average volume of interest-
bearing assets or liabilities, and the average rate of interest earned or paid
on those assets or liabilities. As was the case during 1998, in 1999 the
Company's continued growth efforts resulted in an increase in interest earning
assets, including loans. The Bank's core loan portfolio increased significantly
during 1999. The 1999 asset growth reflects a corresponding increase in total
deposits. While the deposit growth was centered in money market deposits, there
was also significant growth in savings deposits and noninterest bearing
deposits, while time deposits experienced some decline. The increase in money
market deposits was due to both the deposits of Trust Administration Services
Corp. (TASC), a new wholly owned subsidiary that provides administrative and
custodial services to self-directed retirement plans and to a new program to
provide deposit services to Bankruptcy Trustees. Deposit interest rates
increased slightly in 1999 after remaining essentially stable during 1998 and
1997, the higher deposit levels led to significant increases in interest expense
in 1999 after remaining relatively stable the prior two years.
Other Operating Income
----------------------
Other operating income increased substantially in 1999 and 1998 after
remaining generally stable in 1997. Other operating income for 1999 was
$1,796,000, versus $858,000 in 1998 and $695,000 for the year 1997. The Bank's
new Trust Administration Services Corp. (TASC), a new wholly owned subsidiary
that provides administrative and custodial services to self-directed retirement
plans, had revenue that totaled $618,000 during 1999; there was no such revenue
in the prior years. The Bank's merchant services operation started in 1997,
which provides credit card deposit and clearing services to retailers and other
credit card accepting businesses, had revenue that totaled $513,000 in 1999,
$350,000 in 1998 and compared to $14,000 in 1997. The 1999 other operating
income figure included gains on sales of land of $138,000. The 1998 figure
included gains on sales of land of $86,000 while the 1997 figure includes gains
on sales of land of
63
$179,000 and gains on sales of loans of $136,000. Customer service fees
continued their decline of the past several years.
Loan Portfolio and Provision for Loan Losses
- --------------------------------------------
The loan portfolio consisted of the following at December 31, 1999 and
1998:
1999 1998
---- ----
(Dollars in Thousands)
Commercial loans.............................................. $ 42,789 24,811
Real estate construction loans................................ 19,267 15,702
Real estate loans............................................. 56,741 46,251
Bankers acceptances........................................... 0 6,681
Other loans................................................... 961 797
-------- ------
Total loans........................... $119,758 94,242
Less - Allowances for loan losses 2,300 2,500
- Deferred loan fees..................................... 726 562
-------- ------
Net loans............................. $116,732 91,180
======== =======
Government guaranteed loans held for sale..................... $ 5,084 $ 521
======== =======
The allowance for possible loan losses is intended to reflect the known and
unknown risks which are inherent in a loan portfolio. The adequacy of the
allowance for possible loan losses is continually evaluated in light of many
factors, including loan loss experience and current economic conditions. While
the recent economic recession in California appears to be giving way to full
recovery, its impact on the payment performance of the Bank's borrowers has not
been a significant factor in recent years. More important, the Company's
emphasis on maintaining high asset quality continued in 1999, and as a result,
non-performing assets (loans past due ninety days or more excluding government
guaranteed loans, loans on nonaccrual status, and other real estate owned)
totaled just $129,000 at the end of 1999, down from $243,000 on December 31,
1998, and compared to $338,000 at the end of 1997. Management believes the
allowance for possible loan losses as of December 31, 1999 was adequate in
relation to both existing and potential risks in the loan portfolio.
The Bank has historically evaluated the adequacy of its allowance for
possible loan losses on an overall basis rather than by specific categories of
loans. In determining the adequacy of the allowance for possible loan
64
losses, management considers such factors as historical loan loss experience,
known problem loans, evaluations made by bank regulatory authorities, assessment
of economic conditions and other appropriate data to identify the risks in the
loan portfolio.
The allowance for possible loan losses has been allocated to the major
categories of loans as set forth in the following table. The allocations are
estimates based upon historical loss experience and management judgment. The
allowance for possible loan losses should not be interpreted as an indication
that charge-offs will occur in these amounts or proportions, or that the
allocation indicates future charge-off trends. Furthermore, the portion
allocated to each loan category is not the total amount available for future
losses that might occur within such categories, since even in this allocation is
an unallocated portion, and, as previously stated, the total allowance is
applicable to the entire portfolio.
1999 1998
---- ----
Allowance Ratio of Allowance Ratio of
for loans to for loans
possible total possible total
loan losses loans loan losses loans
----------- -------- ----------- -------
Commercial loans...... $ 714 34% $ 472 26%
Real estate loans..... 1,397 61% 1,009 65%
Gov't guaranteed...... 0 4% 0 1%
Bankers acceptances 0 0% 0 7%
Other loans........... 4 1% 4 1%
Unallocated........... 185 0% 1,015 0%
------ ---- ------ ----
Total........... $2,300 100% $2,500 100%
====== ==== ====== ====
The allowance for possible loan losses is increased by provisions which are
charged to operating expense and is reduced by loan chargeoffs. Any subsequent
recoveries of charged off loans are added back into the allowance. Based on its
ongoing evaluation of loan risks, in 1999 provisions of $(206,000) were made to
the reserve for loan losses, $46,000 in loans were charged off, and $52,000 in
loans previously charged off were recovered. By way of comparison, in 1998
provisions of $72,000 were made to the reserve for loan losses, $19,000 in loans
were charged off, and $47,000 in loans previously charged off were recovered.
During 1997 provisions of $540,000 were made to the reserve for loan losses,
$719,000 in loans were charged off, and $279,000 in loans previously charged off
were recovered. These transactions brought the balance of the allowance for
possible loan losses at the end of 1999 to $2,300,000 (or 1.9% of total loans),
compared
65
to $2,500,000 (or 2.7% of total loans) at December 31, 1998, and compared to
$2,400,000 (or 2.9% of total loans) at the end of 1997.
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
114, "Accounting by Creditors for Impairment of a Loan," effective January 1,
1995. This Statement defines an impaired loan as one for which it is likely
that an institution will be unable to collect all amounts due (that is, all
principal and interest) according to the contractual terms of the loan. The
Statement generally requires impaired loans to be measured at the present value
of expected future cash flows discounted at the effective interest rate of the
loan, or, as an expedient, at the loan's observable market price, or the fair
value of the collateral if the loan is collateral dependent. In 1999, the
Company identified loans having an aggregate average balance of $243,000 which
it concluded were impaired under SFAS No. 114. During 1998, the Company had
identified loans having an aggregate average balance of $370,000 which it
concluded were impaired. In contrast, during 1997 the Company had identified
loans having an aggregate average balance of $1,783,000 which it concluded were
impaired under SFAS No. 114. The Company's policy is to discontinue the accrual
of interest income on impaired loans, and to recognize income on such loans only
after the loan principal has been repaid in full. Pursuant to this policy, the
Company had already ceased to accrue interest on the impaired loans, and had
established a general loss reserve for each of the loans.
Operating Expenses
------------------
Total operating expenses rose in 1999, to $9,859,000 from $7,052,000 in
1998 and $6,645,000 in 1997. While the total expense figures increased primarily
due to increases in overall bank growth, most components continue to be
moderated by the effects of an ongoing program of expense control.
Salaries and related benefits expense increased again in 1999, rising to
$5,344,000 from a 1998 total of $3,555,000 and from $2,915,000 in 1997. The
increase in this expense category principally reflects the increases in staffing
which took place due to the addition of the new TASC operation as well as
staffing in the new regional offices as part of the Company's growth initiative
and which have continued through 1999. Occupancy expense rose in 1999, to
$694,000 from $410,000 in 1998 and a 1997 total of $393,000; the increases
reflect the rent paid on the various facilities which house the Bank's new
regional offices and the TASC operation. Real estate expense from prior years
was reversed leaving income of $139,000 in 1999 and $33,000 in 1998 in contrast
to real estate expense of $3,000 in 1997. Custodial and other services to
customers declined again in 1999 as they did in both 1998 and 1997, standing at
$168,000 for the year after $553,000 for 1998 versus $987,000 in 1997. This
category typically fluctuates in conjunction with the deposit balances
maintained by customers, and this factor accounts for
66
the changes in this area over the past three years. Other expenses rose again in
1999 as they did in 1998 and 1997. Other expenses totaled $3,792,000 in 1999
compared to $2,567,000 in 1998, which was increased from $2,347,000 in 1997.
Other expenses in 1999 include professional services of $607,000 an increase
from the prior year when professional services were $330,000 for 1998, a
significant reduction after totaling $865,000 in 1997. Other expenses in 1997
include an increase in legal fees relating to collection of non-performing loans
and the termination of the Company's deposit relationship with Transcorp Pension
Services; data processing fees rose in 1999 to $545,000 compared to $365,000 in
1998 and $254,000 in 1997. A positive factor was the continued low level of
premiums for FDIC insurance, reflecting the banking industry's achievement of
full capitalization of the Bank Insurance Fund as defined by applicable statute.
General insurance increased to $212,000 during 1999 from $120,000 during 1998
and $108,000 for 1997. Most of the remaining categories of other expense
generally remained stable: directors fees rose to $73,000 in 1999, and 72,000 in
1998 due to an increase in outside directors during 1998 from $46,000 in 1997;
and other expenses, which rose to $1,573,000 in 1999 from $1,192,000 in 1998 and
$708,000 in 1997 principally due to higher costs of services provided to
customers.
Taxes
------
The combined effects of the activity described above resulted in Income
Before Taxes of $2,939,000 in 1999, up from $2,906,000 in 1998, and up sharply
from $2,093,000 in 1997. In 1999, the Company recorded tax provisions of
$1,213,000. During 1998, the Company recorded tax provisions of $1,197,000 and
during 1997, the company recorded tax provisions of $885,000. As a result, the
Company generated Net Income of $1,726,000 in 1999, compared to $1,709,000 in
1998, and versus Net Income of $1,208,000 in 1997.
Liquidity, Sources of Funds, and Capital Resources
--------------------------------------------------
The Bank continues to enjoy a liquid financial position. Total liquid
assets (cash and due from banks, investment securities, and federal funds sold)
totaled $106,876,000 and $99,180,000 (or 51.9% and 58.0% of total deposits) at
December 31, 1999 and 1998, respectively. The ratio of net loans to deposits was
56.7% and 53.5% at the end of 1999 and 1998, respectively.
In January 1999, the Bank established TASC, a wholly owned subsidiary that
provides administrative and custodial services to self-directed retirement
plans. Deposits held for TASC clients by the bank represent approximately 16%
of the Bank's total deposits as of December 31, 1999.
67
Prior to the commencement of the TASC operations, the bank had a long-term
relationship with Transcorp Pension Services, Inc. (Transcorp). The Bank's
deposit and service relationships with Transcorp ended in 1999. Deposits of
custodial clients of retirement plans administered by Transcorp Pension
Services, a corporate customer of the Bank, represented approximately 0% and 13%
of the Bank's total deposits as of December 31, 1999 and 1998, respectively.
The Bank's investment portfolio continues to be composed of high quality,
low risk securities, principally U.S. Agency securities and commercial paper. No
gains or losses were recorded on securities sales during 1999 or 1998. In 1997,
the Bank generated net gains of $23,000 on sales of securities. As of December
31, 1999 the Bank's investment portfolio contained no gross unrealized gains and
gross unrealized losses of $2,000, for net unrealized gains of $1,000; as of
December 31, 1998 the Bank's investment portfolio contained gross unrealized
gains of $3,000 and gross unrealized losses of $2,000, for net unrealized gains
of $1,000. The Company adopted SFAS No. 115 in 1994, with the result that the
net unrealized gains and losses gave rise to a $1,000 (net of taxes) decrease in
shareholders' equity as of December 31, 1999, and a $1,000 increase (net of
taxes) in the Company's shareholders' equity as of December 31, 1998. Because
the Company's holdings of securities are intended to serve as a source of
liquidity should conditions warrant, the securities have been classified by the
Company as "available for sale," and thus the unrealized gains and losses had no
effect on the Company's income statement.
The Bank's management has attempted to match the rates and maturities of
its interest-bearing assets and liabilities as part of its liquidity and
asset/liability management policy. The objective of this policy is to moderate
the fluctuations of net interest revenue which result from changes in the level
of interest rates. The table which follows indicates the repricing or maturity
characteristics of the major categories of the Bank's assets and liabilities,
and thus the relative sensitivity of the Bank's net interest income to changes
in the overall level of interest rates. A positive "gap" for a period indicates
that an upward or downward movement in the level of interest rates would have a
corresponding change in net interest income, while a negative "gap" implies that
an interest rate movement would result in an inverse change in net interest
income.
68
One month Six months
Floating Less than but less than but less than
Category Rate one month six months one year
=============================== ======== ========== ============= =============
Fed funds sold 37,090 0 0 0
Time deposits with 0 1,680 5,243 0
other banks
Investment securities 0 9,973 42,816 0
------- ------ ------ ------
Subtotal 37,090 11,653 48,059 0
Loans 120,088 160 208 1,285
------- ------ ------ ------
Total earning assets 157,178 11,813 48,267 1,285
Cash and due from banks 0 0 0 0
Premises and equipment 0 0 0 0
Other real estate owned 0 0 0 0
Other assets 0 0 0 0
------- ------ ------ ------
Total non-earning assets 0 0 0 0
------- ------ ------ ------
Total assets 157,178 11,813 48,267 1,285
Funds purchased 0 0 0 0
Repurchase agreements 0 0 0 0
------- ------ ------ ------
Subtotal 0 0 0 0
Savings deposits 8,605 0 0 0
Money market deposits 87,670 0 0 0
Time deposits 0 21,095 15,809 6,845
------- ------ ------ ------
Total bearing liabilities 96,275 21,095 15,809 6,845
Demand deposits 0 0 0 0
Other liabilities 0 0 0 0
Equity capital 0 0 0 0
------- ------ ------ ------
Total non-bearing liabilities 0 0 0 0
------- ------ ------ ------
Total liabilities 96,275 21,095 15,809 6,845
GAP 60,903 (9,282) 32,458 (5,560)
Cumulative GAP 60,903 51,621 84,079 78,519
One year Non-interest
but less than Five years earning
Category five years or more or bearing Total
=============================== ============= ========== ============ =======
Fed funds sold 0 0 0 37,090
Time deposits with 0 0 0 6,923
other banks
Investment securities 0 0 0 52,789
------ ------ ------- -------
Subtotal 0 0 0 96,802
Loans 75 0 0 121,816
------ ------ ------- -------
Total earning assets 75 0 0 218,618
Cash and due from banks 0 0 10,074 10,074
Premises and equipment 0 0 1,172 1,172
Other real estate owned 0 0 0 0
Other assets 0 0 3,169 3,169
------ ------ ------- -------
Total non-earning assets 0 0 14,415 14,415
------ ------ ------- -------
Total assets 75 0 14,415 233,033
Funds purchased 0 0 0 0
Repurchase agreements 0 0 0 0
------ ------ ------- -------
Subtotal 0 0 0 0
Savings deposits 0 0 0 8,605
Money market deposits 0 0 0 87,670
Time deposits 303 0 0 44,052
------ ------ ------- -------
Total bearing liabilities 303 0 0 140,327
Demand deposits 0 0 65,405 65,405
Other liabilities 0 0 6,598 6,598
Equity capital 0 0 20,703 20,703
------ ------ ------- -------
Total non-bearing liabilities 0 0 92,706 92,706
------ ------ ------- -------
Total liabilities 303 0 92,706 233,033
GAP (228) 0 (78,291) 0
Cumulative GAP 78,291 78,291 0 0
As the table indicates, the vast majority of the Company's assets are
either floating rate or, if fixed rate, have extremely short maturities. Since
the yields on these assets quickly adjust to reflect changes in the overall
level of interest rates, there are no significant unrealized gains or losses
with respect to the Company's assets, nor is there much likelihood of large
realized or unrealized gains or losses developing in the future. For this
reason, realized or unrealized gains or losses are not expected to have any
significant impact on the Company's future operating results or liquidity.
69
The Company continues to maintain a strong and prudent capital position.
Total shareholders' equity was $20,703,000 and $20,470,000 as of December 31,
1999 and 1998, respectively. The Company's capital ratios for those dates in
comparison with regulatory capital requirements were as follows:
12-31-99 12-31-98
-------- --------
Leverage Ratio (Tier I Capital
to Assets):
First Regional Bancorp 8.90% 11.17%
Regulatory requirement 4.00% 4.00%
The "regulatory requirement" listed represents the level of capital
required for Adequately Capitalized status.
In addition, bank regulators have issued new risk-adjusted capital
guidelines which assign risk weighting to assets and off-balance sheet items and
place increased emphasis on common equity. The Company's risk adjusted capital
ratios for the dates listed in comparison with the risk adjusted capital
requirements were as follows:
12-31-99 12-31-98
-------- --------
Tier I Capital to Assets:
First Regional Bancorp 10.50% 14.35%
Regulatory requirement 4.00% 4.00%
Tier I + Tier II Capital to Assets:
First Regional Bancorp 11.70% 15.60%
Regulatory requirement 8.00% 8.00%
The Company believes that it will continue to meet all applicable capital
standards.
During 1998, First Regional's capital was substantially increased through a
private placement offering of common shares at a price of $9.00 per share. This
transaction strengthens the Company's already solid financial foundation, and
thus provides the basis for additional future growth.
During that year the company also established an Employee Stock Ownership
Plan consisting of 150,000 shares of First Regional common stock acquired in
market transactions or directly from First Regional Bancorp at
70
an average price of $9.48 per share. This new Plan will build the capital base
of First Regional Bank and provide its employees with a powerful incentive to
achieve further improvements in First Regional's operating performance.
During 1999, the company repurchased 275,800 shares of its outstanding
common stock at a total cost of $2,059,000. As the average price paid for the
repurchased shares was less than the book value per share outstanding, these
purchases resulted in an increase in book value per share of the remaining
outstanding shares, thus benefiting existing shareholders.
Inflation
- ---------
The impact of inflation on the Company differs significantly from other
industries, since virtually all of its assets and liabilities are monetary.
During periods of inflation, companies with net monetary assets will always
experience a reduction in purchasing power. Inflation continues to have an
impact on salary, supply, and occupancy expenses, but the rate of inflation in
general and its impact on these expenses in particular has remained moderate in
recent years.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
See "Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K" below for financial statements filed as part of this report.
Item 9. Disagreements on Accounting and Financial Disclosure
- -------------------------------------------------------------
The Company has not reported a disagreement with its existing or previous
accountants on any matter of accounting principle or practice on financial
statement disclosure.
71
PART III
--------
Item 10. Directors and Executive Officers of Registrant
- --------------------------------------------------------
The information pertaining to directors which is required by this item
will be included in the definitive proxy statement to be filed by the Company
within 120 days of fiscal year end pursuant to Section 14 of the Act. Such
information is hereby incorporated by reference in accordance with Rule G of
the General Instructions to the Annual Report on Form 10-K.
Item 11. Executive Compensation
- --------------------------------
The information required by this item will be included in the definitive
proxy statement to be filed by the Company within 120 days of fiscal year end
pursuant to Section 14 of the Act. Such information is hereby incorporated by
reference in accordance with Rule G of the General Instructions to the Annual
Report on Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
The information required by this item will be included in the definitive
proxy statement to be filed by the Company within 120 days of fiscal year end
pursuant to Section 14 of the Act. Such information is hereby incorporated by
reference in accordance with Rule G of the General Instructions to the Annual
Report on Form 10-K.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item will be included in the definitive
proxy statement to be filed by the Company within 120 days of fiscal year end
pursuant to Section 14 of the Act. Such information is hereby incorporated by
reference in accordance with Rule G of the General Instructions to the Annual
Report on Form 10-K.
72
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules, and Reports
- --------------------------------------------------------------
on Form 8-K
-----------
List of Documents filed as a part of this report:
(a) Financial Statements and Financial Statement Schedules
See Index to Financial Statements which is part of this Form 10-K.
(b) Exhibits
See Index to Exhibits which is part of this Form 10-K.
(Exhibits are listed by numbers corresponding to the Exhibit Table in
Item 601 of Regulation S-K)
(c) Reports on Form 8-K
A Form 8-K report was filed by the Company on December 8, 1999 relating to
both 1) the settlement of the Rubin lawsuit and the pursuant resignation
from the Board of Directors and 2) the stock repurchase from an unrelated
party pursuant to the Company's previously announced repurchase program.
73
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
First Regional Bancorp
By: /s/ Jack A. Sweeney
--------------------------------------
Jack A. Sweeney, Chairman of the Board
Chief Executive Officer
Date: March 23, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
/s/ Jack A. Sweeney Director, Chairman March 23, 2000
- ----------------------- of the Board and Chief
Jack A. Sweeney Executive Officer
/s/ Lawrence J. Sherman Director, Vice Chairman March 23, 2000
- ------------------------ of the Board
Lawrence J. Sherman
/s/ H. Anthony Gartshore Director and President March 23, 2000
- ------------------------
H. Anthony Gartshore
/s/ Thomas McCullough Director, Chief March 23, 2000
- ------------------------ Financial Officer and
Thomas E. McCullough Chief Accounting
Officer
/s/ Gary Horgan Director March 23, 2000
- ---------------------
Gary Horgan
/s/ Fred M. Edwards Director March 23, 2000
- ------------------------
Fred M. Edwards
74
INDEX TO FINANCIAL STATEMENTS
-----------------------------
Financial Statements Page in Form 10-K
- -------------------- -----------------
First Regional Bancorp and Subsidiary:
Report of Independent Auditors.................. 76
Consolidated Balance Sheets as of
December 31, 1999 and 1998...................... 77
Consolidated Statements of Earnings for
the years ended December 31, 1999, 1998,
1997............................................ 78
Consolidated Statements of Shareholders'
Equity for the years ended December 31, 1999,
1998, and 1997.................................. 80
Consolidated Statements of Cash Flows for
the years ended December 31, 1999, 1998,
and 1997........................................ 81
Notes to Consolidated Financial Statements...... 83
First Regional Bancorp (Parent Company):
Note 16 to Consolidated Financial
Statements...................................... 97
All other financial statement schedules are omitted because they are not
applicable, not material or because the information is included in the financial
statements or the notes.
-------------------------------------------
First Regional Bancorp
and Subsidiary
Consolidated Financial Statements as of
December 31, 1999 and 1998 and for
Each of the Three Years in the Period
Ended December 31, 1999 and
Independent Auditors' Report
76
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
First Regional Bancorp and Subsidiary
Century City, California:
We have audited the accompanying consolidated balance sheets of First Regional
Bancorp and subsidiary (the "Company") as of December 31, 1999 and 1998, and the
related consolidated statements of earnings, changes in shareholders' equity,
and cash flows for each of the three years in the period ended December 31,
1999. These 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of First Regional Bancorp and its
subsidiary as of December 31, 1999 and 1998, and the results of their earnings
and their cash flows for each of the three years in the period ended December
31, 1999, in conformity with accounting principles generally accepted in the
United States of America.
January 28, 2000
77
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
ASSETS 1999 1998
Cash and due from banks (Note 6) $ 10,074,000 $ 9,277,000
Federal funds sold 37,090,000 31,900,000
------------ ------------
Cash and cash equivalents 47,164,000 41,177,000
Investment securities available for sale, amortized cost $52,791,000
and $47,859,000 (Note 2) 52,789,000 47,860,000
Interest-bearing deposits in financial institutions 6,923,000 10,143,000
Loans, net (Note 3) 116,732,000 91,180,000
Government guaranteed loans, held for sale, at lower of cost or
market (Note 3) 5,084,000 521,000
Premises and equipment, net (Note 4) 1,172,000 790,000
Accrued interest receivable and other assets (Note 14) 2,468,000 1,287,000
Income tax assets (Note 5) 701,000 926,000
------------ ------------
TOTAL $233,033,000 $193,884,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits (Notes 12, 14, and 15):
Noninterest bearing $ 65,405,000 $ 61,964,000
Interest bearing:
Time deposits 44,052,000 51,154,000
Money market deposits 87,670,000 49,991,000
Other 8,605,000 7,314,000
------------ ------------
Total deposits 205,732,000 170,423,000
Note payable (Note 10) 1,313,000 1,463,000
Accrued interest payable and other liabilities 5,285,000 1,528,000
------------ ------------
Total liabilities 212,330,000 173,414,000
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 4 and 6)
SHAREHOLDERS' EQUITY (Notes 7, 8, 9, and 10):
Common stock, no par value; authorized, 50,000,000 shares;
outstanding, 2,809,000 (1999) and 2,983,000 (1998) shares 14,410,000 16,034,000
Unearned ESOP shares; 132,000 in 1999 and 146,000 in 1998 (1,244,000) (1,386,000)
------------ ------------
Total common stock, no par value; outstanding
2,677,000 (1999) and 2,837,000 (1998) shares 13,166,000 14,648,000
Retained earnings 7,538,000 5,821,000
Accumulated other comprehensive (loss) income (1,000) 1,000
------------ ------------
Total shareholders' equity 20,703,000 20,470,000
------------ ------------
TOTAL $233,033,000 $193,884,000
============ ============
78
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
- --------------------------------------------------------------------------------
1999 1998 1997
INTEREST INCOME:
Interest on loans $ 9,910,000 $ 8,517,000 $ 8,742,000
Interest on deposits in financial institutions 406,000 521,000 280,000
Interest on federal funds sold 1,486,000 1,808,000 1,569,000
Interest on investment securities 3,455,000 1,766,000 1,277,000
----------- ----------- -----------
Total interest income 15,257,000 12,612,000 11,868,000
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits (Notes 12 and 14) 4,444,000 3,437,000 3,285,000
Interest on other borrowings 17,000 3,000
----------- ----------- -----------
Total interest expense 4,461,000 3,440,000 3,285,000
----------- ----------- -----------
NET INTEREST INCOME 10,796,000 9,172,000 8,583,000
PROVISION FOR LOAN LOSSES (Note 3) (206,000) 72,000 540,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 11,002,000 9,100,000 8,043,000
----------- ----------- -----------
OTHER OPERATING INCOME:
Customer service fees (Note 14) 1,468,000 680,000 291,000
Other 328,000 178,000 404,000
----------- ----------- -----------
Total other operating income 1,796,000 858,000 695,000
----------- ----------- -----------
OTHER OPERATING EXPENSES:
Salaries and related benefits (Notes 6 and 10) 5,344,000 3,555,000 2,915,000
Occupancy expenses (Note 4) 694,000 410,000 393,000
Custodial and other service (Note 14) 168,000 553,000 987,000
Real estate (income) expense, net (139,000) (33,000) 3,000
Other expenses (Note 13) 3,792,000 2,567,000 2,347,000
----------- ----------- -----------
Total other operating expenses 9,859,000 7,052,000 6,645,000
----------- ----------- -----------
See notes to consolidated financial statements.
(Continued)
79
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
- --------------------------------------------------------------------------------
1999 1998 1997
INCOME BEFORE PROVISION FOR INCOME TAXES $2,939,000 $2,906,000 $2,093,000
PROVISION FOR INCOME TAXES (Note 5) 1,213,000 1,197,000 885,000
---------- ---------- ----------
NET INCOME $1,726,000 $1,709,000 $1,208,000
========== ========== ==========
BASIC EARNINGS PER COMMON SHARE (Note 8) $ 0.61 $ 0.66 $ 0.50
========== ========== ==========
DILUTED EARNINGS PER COMMON SHARE (Note 8) $ 0.59 $ 0.62 $ 0.46
========== ========== ==========
See notes to consolidated financial statements.
(Concluded)
80
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
- --------------------------------------------------------------------------------
Common Stock Accumulated
--------------------------- Other
Shares Retained Comprehensive Comprehensive
Outstanding Amount Earnings Income (Loss) Income
BALANCE, JANUARY 1, 1997 2,406,000 $11,332,000 $2,958,000 $ 26,000
Options exercised, including
tax benefit 40,000 102,000
Common stock repurchased and
retired (30,000) (148,000) (38,000)
Comprehensive income:
Net income 1,208,000 $1,208,000
Other comprehensive income -
Net change in unrealized gain
(loss) on securities available
for sale, net of tax (17,000) (17,000)
----------
Comprehensive income $1,191,000
---------- ----------- ---------- ---------- ==========
BALANCE, DECEMBER 31, 1997 2,416,000 11,286,000 4,128,000 9,000
Common stock repurchased
and retired (4,000) (20,000) (16,000)
Common stock issued in private
placement and for ESOP 503,000 4,574,000
Unearned ESOP shares (146,000) (1,386,000)
Options exercised, including
tax benefit 68,000 194,000
Comprehensive income:
Net income 1,709,000 $1,709,000
Other comprehensive income -
Net change in unrealized gain
(loss) on securities available
for sale, net of tax (8,000) (8,000)
----------
Comprehensive income $1,701,000
---------- ----------- ---------- ---------- ==========
BALANCE, DECEMBER 31, 1998 2,837,000 14,648,000 5,821,000 1,000
Common stock repurchased
and retired (276,000) (2,050,000) (9,000)
Common stock issued in private
placement 23,000 205,000
Earned ESOP shares 15,000 142,000
Options exercised, including
tax benefit 78,000 221,000
Comprehensive income:
Net income 1,726,000 $1,726,000
Other comprehensive income -
Net change in unrealized gain
(loss) on securities available
for sale, net of tax (2,000) (2,000)
----------
Comprehensive income $1,724,000
---------- ----------- ---------- ---------- ==========
BALANCE, DECEMBER 31, 1999 2,677,000 $13,166,000 $7,538,000 $ (1,000)
========== =========== ========== ==========
See notes to consolidated financial statements.
81
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
- --------------------------------------------------------------------------------
1999 1998 1997
OPERATING ACTIVITIES:
Net income $ 1,726,000 $ 1,709,000 $ 1,208,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for losses on loans (206,000) 72,000 540,000
Provision for depreciation 193,000 136,000 88,000
Gain on sale of investment securities, net (23,000)
Gain on sale of real estate (138,000) (86,000) (179,000)
Amortization of investment securities premiums
and discounts, net (228,000) (287,000) (261,000)
Gain on sale of loans (9,000) (103,000)
(Gain) loss on sale of premises and equipment (1,000) 4,000 (15,000)
Amortization of loan premiums and discounts, net (308,000) (464,000) (977,000)
(Increase) decrease in interest receivable
and other assets (1,181,000) (181,000) 1,418,000
Increase (decrease) in interest payable
and other liabilities 3,757,000 (398,000) 659,000
Deferred income tax provision (benefit) 86,000 (212,000) (4,000)
Deferred compensation expense 142,000
------------- ------------ ------------
Net cash provided by operating activities 3,842,000 284,000 2,351,000
------------- ------------ ------------
INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing
deposits in financial institutions 3,220,000 (3,517,000) (1,384,000)
Net increase in loans (29,378,000) (13,017,000) (263,000)
Proceeds from sale of loans 452,000 7,275,000
Purchases of investment securities (199,162,000) (88,500,000) (39,158,000)
Proceeds from maturities of investment securities 194,287,000 67,346,000 22,474,000
Proceeds from sales of investment securities 17,328,000
Purchases of premises and equipment (574,000) (352,000) (425,000)
Proceeds from sale of premises and equipment 120,000 16,000
Proceeds from sale of real estate 138,000 86,000 2,589,000
------------- ------------ ------------
Net cash (used in) provided by investing
activities (31,469,000) (37,382,000) 8,452,000
------------- ------------ ------------
See notes to consolidated financial statements.
(Continued)
82
FIRST REGIONAL BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
- --------------------------------------------------------------------------------
1999 1998 1997
FINANCING ACTIVITIES:
Net (decrease) increase in time deposits $(7,102,000) $19,785,000 $ 5,367,000
Net increase in noninterest-bearing deposits
and other interest-bearing deposits 42,411,000 5,542,000 2,974,000
Decrease in note payable (150,000) (37,000)
Sales of common stock 205,000 4,688,000
Stock options exercised 309,000 96,000
Common stock repurchased and retired (2,059,000) (36,000) (186,000)
----------- ----------- -----------
Net cash provided by financing activities 33,614,000 30,038,000 8,155,000
----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,987,000 (7,060,000) 18,958,000
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR $41,177,000 48,237,000 29,279,000
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $47,164,000 $41,177,000 $48,237,000
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Issuance of debt for ESOP shares $ 1,500,000
Acquisition of other real estate owned through
foreclosure $ 2,410,000
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 4,002,000 $ 3,354,000 $ 3,272,000
Income taxes paid $ 853,000 $ 1,397,000 $ 625,000
See notes to consolidated financial statements. (Concluded)
83
FIRST REGIONAL BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
- ------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
First Regional Bancorp, a bank holding company (the "Company"), and its
subsidiary, First Regional Bank, a California state-chartered bank (the
"Bank"), primarily serve Southern California through their branches and loan
production offices. The Company's primary source of revenue is providing
loans to customers, which are predominantly small and midsize businesses.
The Company has two operating segments as discussed in Note 17. The
accounting and reporting policies of the Company conform to generally
accepted accounting principles and general practices within the banking
industry. The following are descriptions of the more significant of these
policies.
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company and the Bank. All significant intercompany
transactions and accounts have been eliminated.
Use of Estimates in the Preparation of the Financial Statements - The
preparation of the consolidated 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 consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
Investment Securities - Investment securities available for sale are reported
in the accompanying consolidated balance sheets at fair value, and the net
unrealized gain or loss on such securities (unless other than temporary) is
reported as a separate component of shareholders' equity. Premiums and
discounts on debt securities are amortized or accreted as adjustments to
interest income using the level-yield method. Realized gains and losses on
sales of securities are determined on a specific-identification basis and
reported in earnings.
Loans - Loans are carried at face amount less payments collected, deferred
fees, and allowances for loan losses. Interest on loans is accrued monthly
on a simple-interest basis. Loan origination fees and commitment fees, net
of related costs, are deferred and recognized over the contractual lives of
the loans as a yield adjustment.
Government guaranteed loans represent loans for which the repayment of
principal and interest is guaranteed by the U.S. government. Those loans are
secured by real estate and are due in amortizing installments over periods of
up to 40 years. The loans bear contractual interest at various rates above
national prime lending rates and were generally purchased at premiums.
Premiums on purchases of government guaranteed loans are amortized on a
level-yield method over the estimated lives of the loans, considering
estimated prepayments.
When a decision to sell a loan is made, the loan is classified as held for
sale and carried at the lower of cost or market value. Government guaranteed
loans are generally classified as held for sale. Gains or losses on the sale
of loans are determined on a specific-identification basis and reported in
earnings.
The allowance for loan losses is maintained at a level considered adequate by
management to provide for losses that might be reasonably anticipated. The
allowance is increased by provisions charged to earnings and reduced by
charge-offs, net of recoveries. Management's periodic estimates of the
allowance for loan losses are inherently uncertain and depend on the outcome
of future events. Such estimates are based on previous loan loss experience;
84
current economic conditions; volume, growth, and composition of the loan
portfolio; the value of collateral; and other relevant factors.
Loans are considered to be impaired when it is not probable that they will be
collected in accordance with their original terms. Impaired loans are
carried at the lower of their contractual balances or estimated fair values.
Specific reserves necessary to reduce their carrying amounts to fair value
are included in the allowance for loan losses.
All loans on nonaccrual are considered to be impaired; however, not all
impaired loans are on nonaccrual status. Impaired loans on accrual status
must be such that the loan underwriting supports the debt service
requirements. Factors that contribute to a performing loan being classified
as impaired include: a below-market interest rate, delinquent taxes, and
debts to other lenders that cannot be serviced out of existing cash flow.
Nonaccrual loans are those which are past due 90 days as to either principal
or interest, or earlier when payment in full of principal or interest is not
expected. When a loan is placed on nonaccrual status, interest accrued but
not received is reversed against interest income. Thereafter, interest
income is no longer recognized, and the full amount of all payments received,
whether principal or interest, is applied to the principal balance of the
loan. A nonaccrual loan may be restored to an accrual basis when principal
and interest payments are current, and full payment of principal and interest
is expected.
Other Real Estate Owned - Other real estate owned is recognized when a
property collateralizing a loan is foreclosed upon or otherwise acquired by
the Bank in satisfaction of the loan. Upon foreclosure, other real estate
owned is recorded at estimated fair value. Reductions in value at the time
of foreclosure are charged against the allowance for loan losses. Allowances
are recorded to provide for estimated declines in fair value and costs to
sell subsequent to the date of acquisition. The Bank has no other real
estate owned as of December 31, 1999.
Premises and Equipment - Premises and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets, which
range from 5 to 15 years. Amortization is computed using the straight-line
method over the estimated useful lives of the leasehold improvements or the
term of the lease, whichever is shorter.
Income Taxes - Deferred income taxes are recognized for the tax consequences
in future years of differences between the tax bases of assets and
liabilities and their financial reporting amounts at each year-end based on
enacted tax laws and statutory tax rates applicable to the periods in which
the differences are expected to affect taxable income. A deferred tax asset
is recorded to the extent that management believes it is more likely than not
to be realized. A valuation allowance is recognized for the remaining
portion of the deferred tax asset.
Cash and Cash Equivalents - Cash and cash equivalents include cash and due
from banks and federal funds sold. Generally, federal funds are sold for
one-day periods.
Earnings per Common Share - Basic earnings per share ("EPS") are computed by
dividing income available to common shareholders by the weighted-average
number of common shares outstanding during each year. The computation of
diluted EPS also considers the number of shares issuable upon the assumed
exercise of outstanding common stock options. All earnings per common share
amounts presented have been restated in accordance with the provisions of
this statement. A reconciliation of the numerator and the denominator used
in the computation of basic and diluted earnings per common share is included
in Note 8.
Administrative and Custodial Services - Trust Administrative Services Corp.
("TASC"), a wholly owned subsidiary of the Bank, maintains funds as a
custodian for customers. The amount of these funds and the related liability
have not been recorded in the accompanying consolidated balance sheets,
because they are not assets or liabilities of the
85
Bank or the Company, with the exception of any funds held on deposit with the
Bank. Administrative and custodial fees are recorded on an accrual basis.
Stock Compensation Plans - The Company grants stock options to key executives
under its stock option plans. The options are accounted for using the
intrinsic value method. Because the options have exercise prices no less
than the fair market value of the stock at the grant dates, intrinsic value
of the options is zero and no compensation expense is recorded for the
options.
Employee Stock Ownership Plan and Trust - The debt of the Employee Stock
Ownership Plan and Trust ("ESOP") is recorded as debt of the Company, and the
shares pledged as collateral are reported as unearned ESOP shares in the
balance sheet. As shares are released from collateral, the Company reports
compensation expense equal to the current market price of the shares, and the
shares become outstanding for EPS computations.
Current Accounting Pronouncements - Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended, is effective for financial statements for
periods beginning after June 15, 2000. This statement establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to
as derivatives), and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. Adoption of
this statement is not expected to have a material impact on the Company's
consolidated financial statements.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities available for sale
as of December 31, 1999 and 1998 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
1999 Cost Gains Losses Value
U.S. Treasury securities $ 5,009,000 $ - $(2,000) $ 5,007,000
U.S. agency securities 3,447,000 3,447,000
Commercial paper 44,335,000 44,335,000
----------- ------ ------- -----------
$52,791,000 $ - $(2,000) $52,789,000
=========== ====== ======= ===========
1998
U.S. agency securities $ 5,998,000 $1,000 $ - $ 5,999,000
Commercial paper 41,861,000 41,861,000
----------- ------ ------- -----------
$47,859,000 $1,000 $ - $47,860,000
=========== ====== ======= ===========
All securities held at December 31, 1999 are scheduled to mature in 2000.
The Bank's investments in commercial paper are subject to credit risk. The
Bank's policy is to purchase commercial paper rated "A1" by Moody's or "P1"
by Standard & Poor's. All purchases are reviewed and approved by the
Investment Committee.
86
Securities carried at $8,000,000 and $6,000,000 were pledged as of December
31, 1999 and 1998, respectively, to secure current or future public deposits
and for other purposes required or permitted by law.
3. LOANS
The loan portfolio consisted of the following at December 31, 1999 and 1998:
1999 1998
Real estate loans $ 56,741,000 $46,251,000
Commercial loans 42,789,000 24,811,000
Real estate construction loans 19,267,000 15,702,000
Bankers' acceptances 6,681,000
Other loans 961,000 797,000
------------ -----------
119,758,000 94,242,000
Allowance for loan losses (2,300,000) (2,500,000)
Deferred loan fees, net (726,000) (562,000)
------------ -----------
Loans, net $116,732,000 $91,180,000
============ ===========
Government guaranteed loans held for sale $ 5,084,000 $ 521,000
============ ===========
The Bank's lending is concentrated in real estate and businesses in Southern
California. From time to time, this area has experienced adverse economic
conditions. Future declines in the local economy or in real estate values
may result in increased losses that cannot reasonably be predicted at this
date. No industry constitutes a concentration in the Bank's portfolio,
except the real estate construction industry.
An analysis of the activity in the allowance for loan losses for the years
ended December 31, 1999, 1998, and 1997 is as follows:
1999 1998 1997
Balance, beginning of year $2,500,000 $2,400,000 $2,300,000
Provision for loan losses (reversal) (206,000) 72,000 540,000
Loans charged off (46,000) (19,000) (719,000)
Recoveries on loans previously charged off 52,000 47,000 279,000
---------- ---------- ----------
Balance, end of year $2,300,000 $2,500,000 $2,400,000
========== ========== ==========
Management believes the allowance for loan losses as of December 31, 1999 is
adequate to absorb losses inherent in the loan portfolio. Management's
estimates of the allowance are subject to potential adjustment by the Federal
Deposit Insurance Corporation ("FDIC") and the California Department of
Financial Institutions upon examination of the Bank by such authorities.
At December 31, 1999 and 1998, the recorded investment in loans for which
impairment had been recognized was $129,000 and $463,000, with specific
reserves of $65,000 and $121,000, respectively. The average recorded
investment in impaired loans during 1999 and 1998 was $243,000 and $370,000,
respectively. Interest income on
87
impaired loans of $0, $43,000, and $45,000 was recognized for cash payments
received in 1999, 1998, and 1997, respectively.
In the ordinary course of business, the Bank may grant loans to its directors
and executive officers. The Bank had no loans outstanding to directors and
executive officers at December 31, 1999 or 1998.
4. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following as of December 31, 1999 and
1998:
1999 1998
Furniture, fixtures, and equipment $ 2,559,000 $ 2,020,000
Leasehold improvements 591,000 555,000
----------- -----------
3,150,000 2,575,000
Accumulated depreciation and amortization (1,978,000) (1,785,000)
----------- -----------
Premises and equipment, net $ 1,172,000 $ 790,000
=========== ===========
Rental expense for premises included in occupancy expenses for 1999, 1998,
and 1997 was approximately $664,000, $385,000, and $366,000, respectively.
The future minimum rental commitments, primarily representing noncancelable
operating leases for premises, were as follows at December 31, 1999,
excluding the effect of future cost-of-living increases provided for in the
leases, and net of sublease income:
Minimum
Year Ended Rental
December 31, Commitments
2000 $ 637,000
2001 556,000
2002 506,000
2003 126,000
2004 30,000
----------
Total $1,855,000
==========
At the end of 1994, the Company elected to apply the unused tenant
improvement allowance of $224,000 against its future lease payments for the
Century City Office. Payment of the allowance was made to the Company over a
15-month period beginning February 1, 1995. The Company is deferring
recognition of the amount and amortizing it evenly over the lease term, which
expires in February 2003.
88
5. INCOME TAXES
Income tax expense (benefit) for the years ended December 31, 1999, 1998, and
1997, consists of the following:
1999 1998 1997
Current provision:
Federal $ 771,000 $1,068,000 $652,000
State 356,000 341,000 237,000
---------- ---------- --------
1,127,000 1,409,000 889,000
---------- ---------- --------
Deferred provision (benefit):
Federal 119,000 (190,000) (3,000)
State (33,000) (22,000) (1,000)
---------- ---------- --------
86,000 (212,000) (4,000)
---------- ---------- --------
Total $1,213,000 $1,197,000 $885,000
========== ========== ========
Income tax (liabilities) assets consisted of the following at December 31,
1999 and 1998:
1999 1998
Income taxes currently (payable) receivable:
Federal $(68,000) $ 34,000
State 18,000 57,000
-------- --------
(50,000) 91,000
-------- --------
Deferred income tax asset:
Federal 497,000 614,000
State 254,000 221,000
-------- --------
751,000 835,000
-------- --------
Total $701,000 $926,000
======== ========
89
The components of the net deferred income tax asset at December 31 are
summarized as follows:
Federal 1999 1998
Deferred tax liabilities:
Prepaid expenses $(118,000) $ (37,000)
State taxes (86,000) (75,000)
Depreciation (119,000) (119,000)
--------- ---------
Gross liabilities (323,000) (231,000)
--------- ---------
Deferred tax assets:
Loan and real estate loss allowances 227,000 311,000
Deferred compensation 446,000 328,000
State franchise tax 97,000 97,000
Goodwill 23,000
Contribution charge-off 3,000 77,000
Other 24,000 32,000
--------- ---------
Gross assets 820,000 845,000
--------- ---------
Net deferred tax asset - federal $ 497,000 $ 614,000
========= =========
State
Deferred tax liabilities:
Prepaid expenses $ (37,000) $ (12,000)
Depreciation (35,000) (35,000)
--------- ---------
Gross liabilities (72,000) (47,000)
--------- ---------
Deferred tax assets:
Loan and real estate loss allowances 169,000 153,000
Deferred compensation 142,000 105,000
Goodwill 7,000
Other 8,000 10,000
--------- ---------
Gross assets 326,000 268,000
--------- ---------
Net deferred tax asset - state 254,000 221,000
--------- ---------
Net deferred tax asset $ 751,000 $ 835,000
========= =========
90
The income tax provision (benefit) for the years ended December 31, 1999,
1998, and 1997 varied from the federal statutory tax rate for the following
reasons:
1999 1998 1997
---------------------- ---------------------- ----------------------
Amount Rate Amount Rate Amount Rate
Tax expense at
statutory rate $1,029,000 35.0% $1,017,000 35.0% $733,000 35.0%
State franchise taxes,
net of federal income
tax benefit 213,000 7.3 211,000 7.3 156,000 7.4
Other, net (29,000) (1.0) (31,000) (1.1) (4,000) (0.1)
---------- ---- ---------- ---- -------- ----
Total $1,213,000 41.3% $1,197,000 41.2% $885,000 42.3%
========== ==== ========== ==== ======== ====
6. COMMITMENTS AND CONTINGENCIES
As of December 31, 1999, the Company had the following commitments and
contingent liabilities:
Undisbursed loans $45,031,000
Standby letters of credit $ 1,142,000
The Bank uses the same standards of credit underwriting in entering into
these commitments to extend credit as it does for making loans and,
therefore, does not anticipate any losses as a result of these transactions.
Also, commitments may expire unused, and consequently, the above amounts do
not necessarily represent future cash requirements. The majority of the
commitments above carry variable interest rates.
The Company sponsors a defined contribution 401(k) plan benefiting
substantially all employees. At the discretion of the Board of Directors,
the Company matches employee contributions. Currently, the Company provides
50 percent matching up to the first 6 percent of wages contributed by an
employee. Company contributions are used to buy the Company's common stock
on the open market for allocation to the employees' accounts in the plan.
The Company contributed approximately $70,000, $47,000, and $42,000 for the
years ended December 31, 1999, 1998, and 1997, respectively.
As of December 31, 1999, the Bank had unused lines of credit with other
depository institutions of $6,500,000.
The Bank processes merchant credit card transactions for a fee. The Bank is
subject to off-balance-sheet credit risk in relation to these transactions.
To help mitigate this risk, the Bank requires participating merchants to have
deposits on hand at the Bank.
Regulations of the Federal Reserve Board require depository institutions to
maintain a portion of their deposits in the form of either cash or deposits
with the Federal Reserve Bank that are noninterest bearing and are not
available for investment purposes. The average Federal Reserve balances
required to be maintained to meet these requirements were approximately
$3,643,000 and $2,202,000 at December 31, 1999 and 1998, respectively.
In the normal course of business, the Company and the Bank are involved in
litigation. Management does not expect the ultimate outcome of any pending
litigation to have a material effect on the Company's financial position or
results of operations.
91
During 1999, the Company settled a suit filed in 1998 by a former director of
the Company. The effect on the Company's financial results was not material.
7. REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by the regulators that, if undertaken, could have a
direct, material effect on the Company's consolidated 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 I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes, as of December 31, 1999
and 1998, that the Bank meets all capital adequacy requirements to which it
is subject.
As of December 31, 1999 and 1998, the most recent notifications from the FDIC
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "well capitalized," the Bank
must maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the table. There are no conditions or events
since the most recent notification that management believes have changed the
Bank's category.
Following is a table showing the minimum capital ratios required for the Bank
and the Bank's actual capital ratios and actual capital amounts at December
31, 1999 and 1998 (the Company's ratios and amounts are substantially the
same):
To Be Well
Capitalized under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 1999:
Total capital
(to risk-weighted assets) $23,013,000 11.7% $15,748,000 > 8.0% $19,684,000 > 10.0%
Tier I capital
(to risk-weighted assets) $20,713,000 10.5% $ 7,874,000 > 4.0% $11,811,000 > 6.0%
Tier I capital
(to average assets) $20,713,000 8.9% $ 9,356,000 > 4.0% $11,695,000 > 5.0%
As of December 31, 1998:
Total capital
(to risk-weighted assets) $23,546,000 15.6% $12,075,000 > 8.0% $15,093,000 > 10.0%
Tier I capital
(to risk-weighted assets) $21,651,000 14.4% $ 6,035,000 > 4.0% $ 9,053,000 > 6.0%
Tier I capital
(to average assets) $21,651,000 11.2% $ 7,753,000 > 4.0% $ 9,692,000 > 5.0%
92
8. EARNINGS PER SHARE RECONCILIATION
December 31, 1999
---------------------------------------------------
Weighted-
Average
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income available to common shareholders $1,726,000 2,832,000 $ 0.61
Effect of Dilutive Securities
Incremental shares from assumed exercise
of outstanding options 94,000 (0.02)
---------- --------- ------
Diluted EPS
Income available to common shareholders $1,726,000 2,926,000 $ 0.59
========== ========= ======
December 31, 1998
---------------------------------------------------
Weighted-
Average
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income available to common shareholders $1,709,000 2,595,000 $ 0.66
Effect of Dilutive Securities
Incremental shares from assumed exercise
of outstanding options 169,000 (0.04)
---------- --------- ------
Diluted EPS
Income available to common shareholders $1,709,000 2,764,000 $ 0.62
========== ========= ======
December 31, 1997
---------------------------------------------------
Weighted-
Average
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income available to common shareholders $1,208,000 2,429,000 $ 0.50
Effect of Dilutive Securities
Incremental shares from assumed exercise
of outstanding options 194,000 (0.04)
---------- --------- ------
Diluted EPS
Income available to common shareholders $1,208,000 2,623,000 $ 0.46
========== ========= ======
93
9. STOCK COMPENSATION PLANS
In 1999 the Company adopted a new nonqualified employee stock option plan
that authorizes the issuance of up to 600,000 shares of its common stock and
expires in 2009. The Company also has a nonqualified employee stock option
plan that authorizes the issuance of up to 350,000 shares of its common stock
and expires in April 2001. Under both plans, options may be granted at a
price not less than the fair market value of the stock at the date of grant.
No options were granted in 1998 or 1997. In 1999, 335,000 options were
granted under the new plan at an exercise price of $7.75 per share, vesting
over a seven-year period and expiring on December 21, 2009.
At December 31, 1999, 1998, and 1997, the Company had options outstanding
granted under the plans as follows:
1999 1998 1997
-------------------------- ------------------------- --------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
Outstanding at
beginning of year 206,000 $2.36 280,000 $2.29 340,000 $2.24
Granted 335,000 7.75
Exercised (90,000) 2.08 (74,000) 2.10 (60,000) 2.00
Terminated (10,000) 2.00
------- ------- -------
Outstanding at
end of year 441,000 6.52 206,000 2.36 280,000 2.29
======= ======= =======
Options exercisable
at year-end 96,000 2.41 64,000 2.38 70,000 2.21
======= ======= =======
Information pertaining to options outstanding at December 31, 1999 is as
follows:
Options Outstanding Options Exercisable
-------------------------------------------------- ----------------------------
Weighted- Weighted-
Average Average Weighted-
Range of Number Remaining Exercise Average
Exercise Prices Outstanding Life Price Number Price
$2.00 - $5.75 106,000 .02 years $2.64 96,000 $2.41
$7.75 335,000 7 years 7.75
-------
441,000 6.52
=======
The estimated fair value of options granted during 1999 was $1.66 per share.
No compensation cost has been recognized for the stock option plan. Had
compensation cost for the Company's stock option plan been determined based
on the fair value at the grant dates for awards under the plan consistent
with the method of SFAS No. 123, the Company's net income and basic EPS for
the years ended December 31, 1999, 1998, and 1997 would have been reduced to
the pro forma amounts indicated below:
94
1999 1998 1997
Net income to common shareholders:
As reported $1,726,000 $1,709,000 $1,208,000
Pro forma $1,669,000 $1,672,000 $1,171,000
Basic earnings per share:
As reported $ 0.61 $ 0.66 $ 0.50
Pro forma $ 0.59 $ 0.64 $ 0.49
The fair values of options granted under the Company's stock option plan
during 1999 were estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used:
no dividend yield, expected volatility of 53 percent, risk-free interest
rate of 6.3 percent, and expected lives of seven years.
10. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
During 1998, the Company established for eligible employees an ESOP.
Eligible full-time and part-time employees employed with the Bank who have
been credited with at least 1,000 hours during a 12-month period and who
have attained age 21 are eligible to participate.
On September 30, 1998, the ESOP borrowed $1,500,000 from an unrelated bank
in order to fund the purchase of 150,000 shares of the Company's common
stock. This loan is scheduled to be repaid monthly on a straight-line basis
over five years, with the funds for repayment from the Company's
contributions to the ESOP. The ESOP shares were pledged as collateral for
its debt. The interest rate on this loan is variable, prime plus .5 percent,
with interest of 9 percent at December 31, 1999. The outstanding principal
balance of the ESOP loan at December 31, 1999 and 1998 was $1,313,000 and
$1,463,000, respectively.
Shares purchased by the ESOP are held in a trust account for allocation
among participants as the loan is repaid. The number of shares allocated
each plan year is dependent upon the ratio of that year's total loan payment
to the aggregate payments scheduled to occur throughout the term of the
loan. The annual allocation of shares is apportioned among participants on
the basis of compensation in the year of allocation. Unallocated ESOP shares
are excluded from EPS computations. ESOP benefits generally become 100
percent vested after an employee completes seven years of credited service.
Benefits are payable upon death, retirement, or disability. The number of
shares of common stock allocated to employee accounts was 19,000 shares at
December 31, 1999.
Periodic compensation expense associated with the ESOP is recognized based
upon both the number of shares pro-rata allocated and the periodic fair
market value of the common stock. The expense related to the ESOP for the
years ended December 31, 1999 and 1998 was $269,000 and $68,000,
respectively.
At December 31, 1999 and 1998, unearned compensation related to the ESOP
approximated $1,244,000 and $1,386,000, respectively, and is shown as a
reduction of shareholders' equity in the accompanying balance sheets. Based
upon the market price of the Company's stock at December 31, 1999, the
unearned shares of the ESOP have a cumulative fair value of $982,500.
11. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair value amounts have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret
market data to develop the estimates of fair value. Accordingly, the
estimates presented herein are not necessarily
95
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
December 31, 1999 December 31, 1998
--------------------------------- --------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
(In thousands) (In thousands)
Assets:
Cash and due from banks $ 10,074 $ 10,074 $ 9,277 $ 9,277
Federal funds sold 37,090 37,090 31,900 31,900
Interest-bearing deposits in
financial institutions 6,923 6,923 10,143 10,143
Investment securities available for sale 52,789 52,789 47,860 47,860
Loans 116,732 119,214 91,180 96,364
Government guaranteed loans 5,084 5,084 521 521
Accrued interest receivable 858 858 660 660
Liabilities:
Deposits:
Noninterest-bearing 65,405 65,405 61,964 61,964
Interest-bearing:
Time deposits 44,052 43,996 51,154 51,277
Money market and other deposits 96,275 96,275 57,305 57,305
Note payable 1,313 1,313 1,463 1,463
Accrued interest payable 241 241 220 220
Fair values of commitments to extend credit and standby letters of credit are
immaterial as of December 31, 1999 and 1998.
The fair values of cash and due from banks, federal funds sold, interest-
bearing deposits in financial institutions, noninterest-bearing deposits, and
money market and other deposits approximate their carrying value.
The fair value of investment securities available for sale is based on quoted
market prices, dealer quotes, and prices obtained from independent pricing
services. The fair value of loans and interest-bearing deposits is estimated
based on present values using applicable risk-adjusted spreads to the U.S.
Treasury curve to approximate current entry-value interest rates applicable
to each category of such financial instruments.
No adjustment was made to the entry-value interest rates for changes in
credit of performing loans for which there are no known credit concerns.
Management segregates loans in appropriate risk categories. Management
believes that the risk factor embedded in the entry-value interest rates,
along with the general reserves applicable to the performing loan portfolio
for which there are no known credit concerns, results in a fair valuation of
such loans on an entry-value basis. The fair value of nonperforming loans
with a recorded book value of $129,000 in 1999 and $463,000 in 1998 was not
estimated because it is not practicable to reasonably assess the credit
adjustment that would be applied in the marketplace for such loans.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1999 and 1998. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial
96
statements since that date, and therefore, current estimates of fair value
may differ significantly from the amounts presented herein.
12. DEPOSITS AND INTEREST EXPENSE
A summary of interest expense on deposits for the years ended December 31,
1999, 1998, and 1997 is as follows:
1999 1998 1997
Money market savings / NOW account deposits $2,156,000 $1,544,000 $2,228,000
Time deposits under $100,000 1,464,000 1,026,000 322,000
Time deposits of $100,000 or more 774,000 830,000 705,000
Savings deposits 50,000 37,000 30,000
---------- ---------- ----------
$4,444,000 $3,437,000 $3,285,000
========== ========== ==========
The maturities of time deposits as of December 31, 1999 are as follows:
2000 $43,749
2001 211
2002 3
2003 89
-------
$44,052
=======
The aggregate amount of time deposits in denominations of $100,000 or more
outstanding as of December 31, 1999 and 1998 was approximately $32,297,000
and $22,246,000, respectively. The aggregate amount of deposits from escrow-
related accounts was approximately $13,879,000 and $30,294,000 as of
December 31, 1999 and 1998, respectively.
13. OTHER OPERATING EXPENSES
Included in other operating expenses for the years ended December 31, 1999,
1998, and 1997 are the following items:
1999 1998 1997
Professional services $ 607,000 $ 330,000 $ 865,000
Data processing fees 545,000 365,000 254,000
Equipment expense 375,000 254,000 196,000
General insurance 212,000 120,000 108,000
Stationary and supplies 208,000 132,000 72,000
Customer courier service 272,000 174,000 144,000
Other 1,573,000 1,192,000 708,000
---------- ---------- ----------
Total $3,792,000 $2,567,000 $2,347,000
========== ========== ==========
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14. ADMINISTRATION OF SELF-DIRECTED RETIREMENT ACCOUNTS
In January 1999, the Bank established TASC, a wholly owned subsidiary that
provides administrative and custodial services to self-directed retirement
plans. In conjunction with the formation of TASC, the Bank acquired the
retirement plan division of another institution at a cost of approximately
$900,000, which was recorded as goodwill in the accompanying 1999 balance
sheet (included in other assets) and is being amortized over the expected
recoverable period of seven years on a straight-line basis. As of December
31, 1999, TASC was the custodian of approximately $303 million in retirement
assets.
Deposits held for TASC clients by the Bank represent approximately 16
percent of the Bank's total deposits as of December 31, 1999. The Bank paid
interest of $672,000 on deposits of TASC clients and received fees of
$587,000 from TASC clients during 1999. $128,000 of goodwill was amortized
into operating expenses during 1999.
Prior to the commencement of TASC operations, the Bank had a long-term
relationship with Transcorp Pension Services, Inc. ("Transcorp"), an
administrator of self-directed individual retirement accounts and simplified
employee pension retirement plans, pursuant to which the Bank provided
custodial and other services to IRA and pension plans for which Transcorp
served as administrator. The Bank's deposit and service relationships with
Transcorp ended in 1999. There were no deposits of custodial clients of the
plans Transcorp administers as of December 31, 1999.
Deposits of custodial clients of the plans Transcorp administers represented
approximately 13 percent of the Bank's total deposits as of December 31,
1998. For the years ended December 31, 1999, 1998, and 1997, the Bank paid
interest of $122,000, $782,000, and $1,780,000, respectively, on deposits of
Transcorp custodial clients, and paid $168,000, $553,000, and $987,000,
respectively, in administrative fees to Transcorp on behalf of its custodial
clients.
15. RELATED-PARTY TRANSACTIONS
As of December 31, 1999 and 1998, deposits from directors, officers, and
their affiliates amounted to $1,078,000 and $318,000, respectively.
16. FINANCIAL INFORMATION REGARDING FIRST REGIONAL BANCORP
As of December 31, 1999 and 1998, the Company's investment in the Bank was
recorded on the equity method at $21,429,000 and $21,619,000, respectively.
The Company's cash balance held in the Bank was $185,000 and $36,000 as of
December 31, 1999 and 1998, respectively. The only other significant asset
or liability recorded on the Company's balance sheets in 1999 and 1998 is a
tax benefit of $334,000 and $199,000, respectively, pertaining to the
exercise of stock options. The Company's significant operations consist
solely of the recognition of its equity in the income or loss of the Bank.
The Bank paid dividends of $2,000,000 and $100,000 to the Company in 1999
and 1998, respectively. No dividends were paid by the Bank to the Company in
1997.
Federal law restricts the Bank from extending credit to the Company; any
such extensions of credit are subject to strict collateral requirements.
17. SEGMENT REPORTING
Management has evaluated the Company's overall operation, and determined
that its business consists of two reportable business segments as of
December 31, 1999, core banking operations and the administration and
custodial
98
services in relation to the formation of TASC during the current year. The
following describes these two business segments:
Core Bank Operations - The principal business activities of this segment are
attracting funds from the general public and originating commercial and real
estate loans for small and midsize businesses in Southern California. This
segment's primary sources of revenue are interest income from loans and
investment securities, and fees earned in connection with loans and deposits.
This segment's principal expenses consist of interest paid on deposits,
personnel, and other general and administrative expenses.
Administration and Custodial Services - The principal business activity of
this segment is providing administrative and custodial services for self-
directed retirement plans. The primary source of revenue for this segment is
fee income from self-directed accounts. The segment's principal expenses
consist of personnel, rent, data processing, and other general and
administrative expenses.
The following table shows the net income (loss) for the core banking
operation and the administration and custodial services for the year ended
December 31, 1999.
Core Banking Administration and Year Ended
Operations Custodial Services December 31, 1999
Net interest income $11,002,000 $ - $11,002,000
Other operating income 1,178,000 618,000 1,796,000
Other operating expense 8,866,000 993,000 9,859,000
Provision for income taxes 1,213,000 1,213,000
----------- ---------- -----------
Net income $ 2,101,000 $(375,000) $ 1,726,000
=========== ========== ===========
The operations of the administration and custodial services positively affect
the results of core banking operations by providing a low-cost source of
deposits.
******
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INDEX TO EXHIBITS
-----------------
Exhibit No.
- -----------
3.1 Articles of Incorporation, as amended (filed as Exhibit 3.1 to the
Company's Registration Statement on Form S-14, File No. 2-75140 filed December
2, 1981 and incorporated herein). Certificate of Chairman and Chief Executive
Officer and Assistant Secretary evidencing amendment of Articles of
Incorporation by written consent of shareholders on November 24, 1987 and filed
with the Secretary of State of the State of California on December 7, 1987
(filed as Exhibit 3.1 to the Company's Annual Statement on Form 10-K for the
year ended December 31, 1987 and incorporated herein). Certificate of Chairman
and Chief Executive Officer and Assistant Secretary evidencing amendment of
Articles of Incorporation adopted at Annual Shareholders Meeting on May 19, 1988
and filed with the Secretary of State of the State of California (filed as
Exhibit 3.1 to the Company's Annual Statement on Form 10-K for the year ended
December 31, 1988 and incorporated herein).
3.2 Bylaws, as amended (filed as Exhibit 3(b) to the Company's Registration
Statement on Form 10, File No. 0-10232 filed in March, 1982 and incorporated
herein). Certificate of Assistant Secretary evidencing amendment adopted at
Annual Shareholders Meeting on May 16, 1985 (filed as Exhibit 3.2 to the
Company's Annual Statement on Form 10-K for the year ended December 31, 1985 and
incorporated herein).
10.1 1982 Stock Option Plan and Agreement, as amended (filed as Exhibit 10.1
to Company's Annual Statement on Form 10-K for the year ended December 31, 1982
and incorporated herein).
10.2 1991 Stock Option Plan and Agreement (filed as Exhibit 10.4 to Company's
Annual Statement on Form 10-K for the year ended December 31, 1991 and
incorporated herein).
10.3 Lease for ground and eighth floor premises at 1801 Century Park East,
Los Angeles, California (filed as Exhibit 10.3 to Company's Annual Statement on
Form 10-K for the year ended December 31, 1993 and incorporated herein). Lease
for office at 28310 Roadside Drive, Suite 152, Agoura Hills, California.
11 Statement regarding computation of per share earnings (see Note 1 of the
Notes to Consolidated Financial Statements at page 83 of this report on
Form 10-K)
21 Subsidiary of Registrant
27 Financial Data Schedule