ITEM 1 - BUSINESS
The Company and the Bank
The San Francisco Company (the "Company"), a Delaware corporation, is a one-bank holding company registered under the Bank Holding Company Act of 1956, for Bank of San Francisco (the "Bank"), a California state chartered bank organized in 1978 whose deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC"), subject to applicable limits. The Bank is the only direct subsidiary of the Company and accounts for over 99% of the consolidated assets of the Company. The Bank delivers its services from its headquarters building, Bank of San Francisco Building, at 550 Montgomery Street (at Clay Street), San Francisco, California 94111, and its phone number is (415) 781-7810. The Bank's web-site on the Internet is www.banksf.com.
The Company's Class A Common Stock, par value $0.01 per share (the "Common Stock" or "Common Shares"), is not traded on an exchange. The sole market maker of the Common Stock is First Security Van Kasper. The Bank specializes in providing private banking as well as business banking for individuals, their businesses and other businesses, primarily in the Northern California banking market. See "-- Private and Business Banking." In addition, the Bank provides specialized services related to homeowners associations (see "-- Association Bank Services"), brokerage services (see "-- Stock Option Services") and escrow services (see "--Escrow Services").
The Bank's primary market area, Northern California, has a highly diversified economic base, including high technology electronic manufacturing, scientific research, real estate construction, retail and wholesale trade and transportation. Much of the diversity in the economic base is attributable to the service sector, including finance, accounting, insurance, communications, law, consulting and tourism. While many of the Bank's loans have been and continue to be collateralized by real estate, the Bank's deposit and lending relationships are not concentrated among borrowers within a specific trade, service or industrial activity.
Private and Business Banking
Private and Business Banking combines highly personalized service with an array of products to meet the complex needs of its primary clients -- executives, professionals and high net worth or high income individuals, and the private and closely held businesses with which those individuals are associated. The Bank has specialized in private banking since it began operations in 1979.
The Bank's marketing strategy focuses on establishing banking relationships with privately and closely held businesses, and their owners and operators whose financial needs require customized banking programs. At December 31, 1999 and 1998, Private and Business Banking customers deposits totaled $60.7 million and $41.2 million, representing 43.7% and 43.1% of the Bank's total deposits, respectively. At December 31, 1999 and 1998, Private and Business Banking customers loans totaled $93.4 million and $72.2 million, representing 98.7% and 97.6% of the Bank's total loans, respectively.
Association Bank Services
Established in 1987, Association Bank Services (the "ABS") provides deposit and financial management services to homeowner and community associations throughout California. The Bank offers its ABS customers deposit accounts for operating funds and reserves, loans, assessment collection services and investment services. In addition, the Bank offers lockbox services, courier services, expedited deposit processing and special handling of accounts. Deposits from homeowner and community associations are a key component of the Bank's core deposit base. At December 31, 1999 and 1998, ABS customers' deposits totaled $28.2 million and $19.2 million, representing 20.3% and 20.0% of the Bank's total deposits, respectively. At December 31, 1999 and 1998, ABS customers loans totaled $1.1 million and $1.5 million, representing 1.2% and 2.0% of the Bank's total loans, respectively.
The Bank also offers to ABS and other customers a certificate of deposit placement service (the "CD Placement") designed to invest a customer's funds in other insured financial institutions up to a maximum of $100,000 per institution (for which the Bank is paid a fee based on the average CD Placement investments outstanding).
Although a substantial portion of the individual ABS deposit accounts are fully insured and, therefore, could generally be considered stable, a small number of ABS customer account managers control significant numbers of such individual accounts, thus concentrating control of such deposits in the discretionary authority of a few individuals. Accordingly, a decision by several such account managers to withdraw their business from the Bank could have a significant impact on the Bank's core deposits. As of December 31, 1999, one account manager controlled less than 3% of total deposits.
Stock Option Services
Begun in 1984, Stock Option Services provides a range of discount brokerage services, combined with a program to facilitate the exercise of stock options by employees of publicly held companies.
The stock option exercise program offers employees the means to exercise, hold or sell their option shares at a minimum cost. In this program, the Bank makes loans to holders of stock options of publicly traded companies for the purpose of enabling them to exercise their options and sell all or a portion of the stock acquired. The Bank works with stock transfer and employee benefits officers to coordinate the payment of the option exercise price, the provision for the payment of taxes related to the exercise of such options, the issuance and subsequent sale of the underlying stock and the distribution of the net sale proceeds. At December 31, 1999 and 1998, the Bank had total stock option loans outstanding of $99,600 and $253,000, respectively. Such amounts can vary substantially based upon the timing of the exercise of stock options as well as market conditions.
Approximately 17% of Stock Option Services' clients have generated over 85% of the fee income from stock option transactions. These transactions accounted for 60% of total commission revenue in 1999. These clients are the focus of Stock Option Services' customer service activities; however, this concentration of clients exposes the Bank to the possibility of losing significant non-interest income if it loses some of these clients. Total commission revenue generated by Stock Option Services was $1.9 million, $1.1 million and $1.4 million for 1999, 1998 and 1997, respectively, representing 12.4%, 11.3%, and 12.4% of the Company's gross revenue for the same periods, respectively. The earnings generated by Stock Option Services is highly dependent on the trading prices of the stock underlying the stock options of its clients and the overall condition of the stock markets in which they trade. Management considers the fee income produced by Stock Option Services to be volatile, and there can be no guarantee that income levels from this activity can be maintained at current levels.
Historically, Stock Option Services has been a substantially self-funding activity with associated deposit balances closely tracking outstanding loan balances. Because Stock Option Services' deposits are primarily non-interest bearing demand deposit accounts, the Bank benefits from them by reducing its cost of funds. Management believes that most of these clients are in industries that continue to present growth opportunities. Accordingly, stock option programs should represent a continuing component of such clients' overall compensation programs. In addition, the Bank is expanding its marketing efforts to diversify its client base to increase revenue and reduce volatility. The Bank also markets its discount brokerage services to those clients presently using stock option services.
Escrow Services
Begun in 1989, the Corporate Escrow Services Department (the "Escrow") primarily provides non-real estate escrow services, including the temporary deposit and investment of funds, deposit of securities, personal property and other assets by attorneys, business brokers and clients for business transactions, disputes, life care facilities, and court actions. Escrow services has always made a modest contribution to operating profit and provided deposits to fund other business activities. At December 31, 1999 and 1998, Escrow deposits totaled $25.7 million and $19.2 million, representing 18.5% and 20.1% of the Bank's total deposits, respectively.
Trust Services
The Bank was granted trust powers in late 1989. The Bank suspended its trust activities in 1996 because the trust activities never achieved the size necessary to generate the revenues required to cover direct costs. The Bank will consider the resumption of trust activities in the future.
Financial Information Regarding the Operations of the Company
Financial information regarding the operations of the Company and the Bank is disclosed in the Company's consolidated financial statements.
Competition
The banking business in California, and specifically in the market area served by the Bank, is highly competitive. The Bank competes for loans and deposits with other commercial banks, including some of the country's and the world's largest banks, savings and loan associations, finance companies, money market funds, brokerage houses, credit unions, insurance companies, and non-financial institutions. By virtue of their larger amounts of capital, many of the financial institutions with which the Bank competes have significantly greater lending limits than the Bank and perform certain functions, including corporate trust services and international banking services, which are not presently offered directly by the Bank (although such functions may be offered indirectly by the Bank through correspondent institutions).
The Bank's strategy for meeting its competition has been to concentrate on discrete segments of the market for financial services, particularly small to medium-sized businesses and their owners, professionals, corporate executives, affluent individuals, and homeowner and community associations, by offering specialized and personalized banking and brokerage services to such clients.
Competitive conditions continue to intensify as legislation is enacted which has the effect of dissolving historical barriers that limit participation in certain markets, increasing the cost of doing business for banks, or affecting the competitive balance between banks and other financial institutions. Technological and economic factors can also be expected to have an ongoing impact on competitive conditions. It is difficult to predict the impact that these and other changes may have in the future on commercial banking in general or on the business of the Bank in particular.
Correspondent Banks
The Bank has correspondent relationships with twelve banks for the purposes of check clearing, selling federal funds, buying and selling investment securities, safekeeping of investment securities and related record keeping, stock registration and stock transfer services, and issuance of letters of credit.
Employees
At December 31, 1999, the Company and the Bank employed 60 persons, consisting of 58 full-time and 2 part-time employees compared to 56 employees consisting of 54 full-time and 2 part-time at December 31, 1998.
Regulation and Supervision
On December 4, 1998, the Federal Reserve Board announced that on November 30, 1998, Mr. Putra Masagung and PT Gunung Agung, the beneficial owners of a majority of the Company's Common Stock entered into a Voting Trust Agreement (the "Agreement"). Mr. Masagung and PT Gunung Agung retained their respective beneficial interests but collectively transferred voting control of the Company's Common Stock to a Trustee under the terms of the Agreement effective January 4, 1999 which has been filed with the Securities and Exchange Commission (the "SEC"). Under the terms of the Agreement, the Trustee shall dispose of the shares upon instructions from Mr. Masagung and PT Gunung Agung on or before July 4, 2001.
Bank holding companies and banks are subject to extensive supervision and regulation. The following summaries of certain statutes and regulations affecting banks and bank holding companies do not purport to be complete. Such summaries are qualified in their entirety by reference to the statutes and regulations.
Financial Modernization
In late 1999, legislation was approved that is designed to modernize the U. S. financial services industry by reducing existing regulatory restrictions on the combination within the same corporate group of commercial banking, investment banking and insurance activities. Activities eligible for combinations include all commercial banking products and services; underwriting, brokering and dealing in most types of securities; passive investments in any type of company via merchant banking and insurance company investments; investment advice; and insurance underwriting, agency, and brokerage. Additional activities may become approved as permissible "financial activities" if incidental to financial activities, if necessary or appropriate to respond to existing or expected changes in financial services markets or delivery technology or to compete effectively with other financial services companies, if usual in connection with financial operations aboard, or if complementary to financial activities and not a danger to the safety of a depository institution or its deposit insurance fund.
Other major changes made by this new legislation, officially known as the Gramm-Leach-Bliley Act of 1999 (the "GLB Act"), include:
. creation of a new category of "financial services holding company" ("FHC") to hold the newly-combined activities;
. adoption of "functional regulation" by which the SEC and state insurance regulators would regulate activities under their jurisdiction even if those functions are carried out within banking organizations, thus ending most of the traditional bank exemptions from federal securities regulation;
. enhancement of corporate organizational flexibility to allow many current and newly authorized financial services activities to be conducted by non-bank "financial subsidiaries" of either a bank or a FHC; and
. establishment of a minimum federal law standard of individual financial privacy, while expressly allowing state governments and the U. S. Congress to add additional protections. In an effort to avoid a competitive imbalance between large financial conglomerates and smaller community institutions, banks may disclose non-public customer financial information to a third party under a joint marketing arrangement if specific protective conditions are observed.
To avail itself of new powers and enhanced corporate organizational flexibility made available under the GLB Act by becoming a FHC, a banking organization must certify that all of its insured depository institutions are well-managed, well-capitalized, and rated satisfactory or higher under CRA. The Bank presently meets these standards.
The precise impact of the GLB Act on the Company and the Bank will not be fully known until the last of the GLB Act's phased effective dates occur on November 12, 2004 and until regulatory agencies complete the promulgation of administrative regulations implementing many portions of the GLB Act. It is clear, however, that the changes made by the GLB Act will increase competition in commercial banking business by allowing securities and insurance organizations to own and operate insured depository institutions and thereby compete with the Bank and the Company. Should we choose to do so, the Bank and the Company will, in turn, be able to compete more fully for the securities and insurance business of its existing and future customers.
The Company
The Company, as a bank holding company, is subject to regulation under the U.S. Federal Bank Holding Company Act of 1956 (the "Holding Company Act"), as amended by among other statutes, the GLB Act, and is registered with the Federal Reserve Board and subject to the supervision of the Federal Reserve Bank of San Francisco (collectively, the "FRB"). It is the policy of the FRB that each bank holding company serve as a source of financial and managerial strength to its subsidiary bank(s) and conduct its operations in a safe or sound manner.
The Holding Company Act requires prior FRB approval for the acquisition of control over another bank, and prior to the GLB Act the Holding Company Act generally restricted the Company from engaging in any business other than managing or controlling banks or furnishing services to its subsidiaries. Among the exceptions to such restrictions are certain activities which, in the opinion of the FRB, are so closely related to banking or to
managing or controlling banks as to be a proper incident to banking. Under the GLB Act, as a FHC the Company could directly and/or indirectly engage in a much broader range of financial services including, for example, insurance sales or underwriting, investment banking, merchant banking, and real estate development. The Company and the Bank are monitoring the promulgation of regulations under the GLB Act, presently meet the GLB Act criteria, and may consider exercising the GLB Act's self-certification option to be come a FHC and/or create permissible financial subsidiaries of the Bank.
The Company and its subsidiaries are, with certain exceptions, prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or provision of services. In recent years, the FRB has, however, allowed pricing discounts conditioned upon the Bank customer purchasing bundled groups of services. The GLB Act has strengthened consumer protections against a bank's attempt to tie the receipt of bank products and services to the consumer's agreement to purchase insurance, brokerage or other services from affiliated companies.
In addition, applicable federal law imposes certain restrictions on transactions between the Bank and its affiliates. As an affiliate of the Bank, the Company is subject, with certain exceptions, to the provisions of federal law imposing limitations on, and requiring collateral for, loans by the Bank to any affiliate. The GLB Act calls for enhanced regulation of affiliate transactions and creates certain new "firewalls" designed to safeguard insured depository institutions within a financial services holding company organization from risks arising from new activities.
The Bank
The Bank is a California state-chartered bank and is subject to regulation, supervision and periodic examination by the California Department of Financial Institutions (the "DFI") and the FDIC. The Bank is not a member of the Federal Reserve System, but is nevertheless subject to certain regulations of the FRB. The Bank's deposits are insured by the FDIC to the maximum amount permitted by law, which is currently $100,000 per depositor in most cases.
The regulations of state and federal bank regulatory agencies govern many aspects of the Bank's business and operations, including but not limited to, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds, the payment of dividends, and potential expansion. As noted, the GLB Act allows for expansion of the Bank's scope of operations but may subject some of the Bank's existing securities and other activities to functional regulation by the SEC and other agencies.
The California banking laws, among other matters, regulate: (a) the conduct of the banking business; (b) accounts, including types of deposit accounts and claims made thereon; (c) loans, including limitations on obligations to the bank by borrowers in general and by the bank's insiders; and (d) mergers, consolidations and conversions of banks, including changes in control of banks. California interstate banking and branching law allows the interstate acquisition of whole banks which have been in existence for more than five years and authorizes expanded correspondent bank agency relationships among affiliated and unaffiliated insured banks. It can be expected that the DFI, and possibly also the California state legislature, will act in response to the GLB Act to authorize, among other things, engagement in expanded activities by financial subsidiaries of California bank-chartered banks under existing wild card parity statutes and/or amendment of the California Financial Code. The GLB Act allows new financial activities to be exercised through financial subsidiaries jointly owned with other banks; this power may allow smaller banks to compete with larger institutions.
The privacy provisions of the GLB Act require, among other things, that any institution offering any financial activity authorized to a FHC annually disclose its policies on the sharing of non-public financial information, and that it allow its customers to opt to prohibit that institution from sharing their non-public data with unaffiliated third parties for marketing purposes. As noted, these federal privacy protections do not prohibit state governments from imposing more protective rules, and a variety of such bills are currently pend in the California state legislature. The Bank vigorously safeguards the financial privacy of its customers, and neither the Bank nor the Company have ever shared or sold non-public individual financial information with or to unaffiliated third parties for marketing purposes; the Bank and the Company thus do not anticipate that existing or future privacy rules will adversely impact profitability or operations.
The Federal Reserve Act and FRB regulations, some of which are applicable to state nonmember banks under regulations of the FDIC, place limitations and conditions on loans or other extensions of credit to: a bank's or bank holding company's executive officers, directors and principal shareholders ("insiders"); any company controlled by any such insiders; or any political or campaign committee controlled by such insiders.
Effective January 1, 1999, the FDIC's rules limiting the non- agency activities of state-chartered insured banks and their subsidiaries to those activities permissible to national banks were revised and liberalized. and these rules will undergo additional changes under the GLB Act. Such activities, including real estate investment and securities activities, are and will continue to be subject to a variety of general and specific safety and soundness restrictions.
In response to various business failures in the savings and loan and commercial banking industries, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "FDICIA"). Among other things, FDICIA requires prompt corrective action by the federal bank regulatory agencies for troubled institutions. FDICIA also places restrictions on the activities of state-chartered institutions and on institutions failing to meet minimum capital standards and provides enhanced enforcement authority for the federal banking agencies.
FDICIA restricts the acceptance of brokered deposits by insured depository institutions that are not well capitalized. It also places restrictions on the interest rate payable on brokered deposits and the solicitation of such deposits.
Under FDICIA, the FDIC has adopted a revised risk-based assessment system for deposit insurance, under which depository institutions are charged between 0 and 27 basis points for every $100 in insured domestic deposits depending on such institution's capital level and supervisory rating. The Bank's present assessment is zero. The Bank is assessed a surcharge for the Financing Corporations (the "FICO") bonds which were issued to help fund the cost associated with the savings and loan crisis. The Bank is presently assessed an annual FICO surcharge of approximately 0.012% of average deposits through 1999 and 0.0243% of average deposits from 2000 through 2017. A marked increase in the number of bank failures in 1999 has led the FDIC to review its deposit insurance assessment system, and this review has and will result in increased assessments for some insured depository institutions.
Compliance of the Bank and the Company with Year 2000 data processing matters is discussed elsewhere in this document. The Bank is monitoring the promulgation by the federal bank regulatory agencies of "know your customer" guidelines.
Capital Adequacy Requirements
FDICIA establishes five capital categories for insured depository institutions: (a) Well Capitalized; (b) Adequately Capitalized; (c) Undercapitalized; (d) Significantly Undercapitalized; and (e) Critically Undercapitalized. All insured institutions (i.e., the Bank) are barred from making capital distributions or paying management fees to a controlling person (i.e., the Company) if to do so would cause the institution to fall into any of the three undercapitalized categories.
FDICIA also provides that if a well or adequately capitalized or undercapitalized institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, its capital category may be downgraded to achieve a higher level of regulatory scrutiny and prompt corrective action.
Minimum Leverage Ratio. The FRB and the FDIC have established a minimum leverage ratio of 3.0% Tier 1 capital to total quarterly average assets for companies that have received the highest composite regulatory rating (a regulatory measurement of capital, assets, management, earnings and liquidity) and that are not anticipating or experiencing any significant growth. All other institutions may be required to maintain a leverage ratio of at least 100 to 200 basis points above the 3.0% minimum.
Risk-based Capital Ratio. The FRB and the FDIC have established regulations that require companies to maintain a minimum ratio of qualifying total capital to risk-weighted assets of 8.0%. The risk-based capital ratio is calculated with reference to risk-weighted assets, including both on and off-balance sheet exposures, which are
multiplied by certain risk weights as defined by regulation. At least one-half of the qualifying capital must be in the form of Tier 1 capital.
In certain circumstances, the agencies which regulate financial institutions may determine that the capital ratios for a financial institution must be maintained at levels which are higher than the minimum levels required by the guidelines. A financial institution that does not achieve and maintain the required capital levels may be issued a capital directive by the regulatory authorities to ensure the maintenance of required capital levels. The FDIC has recently announced that it may require significantly higher capital requirements of institutions whose quantity of "subprime" loans is large. The Bank would not be affected by the proposal as initially announced by the FDIC.
The Company and the Bank are in compliance with these capital adequacy requirements. See "Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital" for a discussion regarding the Company's and Bank's present capital condition.
Prompt Corrective Action. As noted above, FDICIA amended the Federal Deposit Insurance Act (the "FDIA") to establish closer monitoring of insured depository institutions and to enable prompt corrective action by regulators when an institution begins to experience difficulty. The general thrust of these provisions is to impose greater and earlier scrutiny and more restrictions on institutions as their requirements for additional capitalization increases. Affected institutions may, for example, be required to: sell additional capital, including voting shares; restrict transactions with affiliates; restrict interest rates paid on deposits; restrict asset growth or reduce total assets; terminate, reduce or alter any risky activities; elect new directors and install new management; cease accepting deposits from correspondent depository institutions; or divest or liquidate certain subsidiaries. A parent holding company of an undercapitalized bank is expected to guarantee that the bank will comply with the bank's capital restoration plan until the bank has been adequately capitalized, on the average, for four (4) consecutive quarters. A bank holding company may be required to divest itself of any affiliate of the institution (other than another insured depository institution) under certain conditions.
ITEM 2
ITEM 2 - PROPERTIES
The following table sets forth certain information concerning the Bank's sole real property lease commitment:
Rentable Square Expiration of Renewal Banking Offices Footage Current Lease Period(s)
550 Montgomery Street 89,000 2010 One option for an additional San Francisco, CA 25 years
The Bank's headquarters at 550 Montgomery Street is an 89,000 square foot historically significant office building on Clay and Montgomery Streets in San Francisco's Financial District. The building serves as the administrative and banking headquarters of the Company and the Bank. The Bank currently subleases 57,000 square feet.
As of December 31, 1999, the Company's premises and equipment, net of accumulated amortization and depreciation, is comprised of leasehold improvements totaling $4.8 million, lease interests totaling $1.9 million, and furniture and equipment totaling $462,000. Depreciation on furniture, fixtures and equipment is computed on the straight-line method over the estimated useful life of each type of asset. Estimated useful lives are from three to seven years. Leasehold improvements are amortized over the term of the applicable lease, including lease extensions, or their estimated useful lives, whichever is shorter.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
Litigation
Because of the nature of its business, the Company and its subsidiaries, including the Bank, are from time-to-time a party to legal actions. Based upon information available to the Company and the Bank, and its review of such outstanding claims to date, management believes the ultimate liability relating to these actions, if any, will not have a material adverse effect on the Company's liquidity, consolidated financial condition or results of operations.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its 1999 Annual Meeting on May 19, 1999 at 10:00 am, at the Company's headquarters, 550 Montgomery Street, 11th floor, San Francisco, California. The 2000 Annual Meeting has been set for May 24, 2000 at 10:00 am, at the Company's headquarters, 550 Montgomery Street, 11th floor, San Francisco, California.
PART II
ITEM 5
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information
The Company's Common Stock is not listed on any exchange or the National Association of Securities Dealers' Automated Quotation System. First Security Van Kasper of San Francisco, California is the sole market maker in the Company's Common Stock. The following table sets forth the high and low bid prices for the Common Stock based upon information provided by First Security Van Kasper market from January 1, 1998 to December 31, 1999. The last known trade of the Common Stock occurred on December 17, 1999 for 800 shares at a price of $0.70 per share.
1999 1998 Quarter High Low High Low
First $0.45 $0.45 $0.60 $0.45 Second 0.70 0.45 0.60 0.45 Third 0.70 0.70 0.60 0.45 Fourth 0.71 0.70 0.45 0.35
The Company's preferred stock is not listed on any exchange or traded in any other public market.
On November 22, 1999, the Company redeemed and retired 2,802,769 shares or 8.7% of total Common Stock outstanding. The redeemed shares were from the Trustee, Mr. Robb Evans, for the benefit of PT Gunung Agung. The redemption price was $0.71 per share totaling $2.0 million
Holders
As of December 31, 1999, the number of holders of record of the Company's Common Stock and Series B Preferred Shares was 370 and nine (9), respectively, which management believes is in each case less than the number of actual beneficial owners because of the number of shares held by known nominees. Dividends
The Bank is subject to certain regulatory restrictions regarding payment of dividends to the Company as set forth in the California Financial Code. In 1999, the Bank paid a dividend to its majority shareholder, the Company, totaling $2.0 million.
The Company is subject to dividend restrictions under the Delaware General Corporation Law and Federal regulations. The Company's Series B Preferred Shares participate equally, share for share, in cash dividends paid on the Common Shares in addition to receiving the cash dividends to which they are entitled. The Board of Directors declared a cash dividend on the Series B Preferred Stock for stockholders of record on July 1, 1998 that was paid on July 15, 1998 totaling $3.92 per share, for stockholders of record on December 31, 1998 that was paid on February 26, 1999 totaling $0.28 per share, for stockholders of record on June 30, 1999 that was paid on July 15, 1999 totaling $0.28 per share, and for stockholders of record on December 31, 1999 that was paid on January 21, 2000 totaling $0.28 per share.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data of the Company at and for the years ended December 31:
1999 1998 1997 1996 1995 (Dollars in Thousands except for per share data)
FINANCIAL CONDITION DATA: Total assets $184,473 $140,136 $116,617 $104,001 $114,862 Total loans 94,612 73,980 51,924 43,762 53,208 Total securities held-to-maturity 1,953 3,846 5,864 6,943 -- Total securities available-for-sale 32,236 34,235 32,669 28,348 6,536 Total deposits 138,911 95,688 86,519 91,166 105,673 Other borrowings 20,000 20,000 10,000 -- -- Shareholders' equity 23,501 22,704 17,570 11,064 6,880
OPERATING DATA: Total interest income $10,636 $8,782 $8,026 $7,242 $10,691 Total interest expense 3,986 3,411 2,890 3,127 4,415 Net interest income 6,650 5,371 5,136 4,115 6,276 Provision (adjustment) for loan losses 100 (1,627) (2,820) -- 500 Net interest income after provision (adjustment) for loan losses 6,550 6,998 7,956 4,115 5,776 Total non-interest income 5,331 3,891 3,502 3,327 5,014 Total non-interest exp. 8,748 6,907 7,509 6,998 10,301 Income before taxes 3,133 3,982 3,949 444 489 (Benefit) provision for income taxes (732) (1,060) (1,494) (258) 153 Net income $3,865 $5,042 $5,443 $702 $336
OTHER DATA: Return on average assets 2.5% 4.0% 5.0% 0.7% 0.3% Return on average equity 16.4 26.7 45.2 7.9 6.8 Average equity to average assets 15.1 15.0 11.0 8.3 3.7 Equity to assets 12.7 16.2 15.1 10.6 6.0 Interest rate spread 3.8 3.7 4.0 3.7 4.3 Net interest margin 4.7 4.7 5.1 4.4 5.0 Non-performing assets to total assets 0.0 0.0 0.5 8.2 13.1 Average interest-earning assets to average interest- bearing liabilities 134.2 133.7 138.2 119.3 121.5 Non-interest expenses to average assets 5.5 5.5 6.8 5.0 6.0 Net interest income, after provision (adjustment) for loan losses, to non-interest expense 74.9 101.3 105.9 58.8 56.1 Loan charge-offs net of (recoveries) as a percent of average loans 0.2 (0.1) (0.8) 0.6 1.4 Allowance for loan losses as a percent of loans 1.6 2.2 6.2 12.9 11.1
PER SHARE DATA: Common shares outstanding, end of period 29,317,558 31,728,782 31,723,782 28,775,995 5,765,978 Preferred shares outstanding, end of period 15,869 15,869 15,869 15,869 231,291
Common Shares: Book value per common share $0.80 $0.71 $0.55 $0.38 $0.43 Income per weighted average common share Basic 0.12 0.16 0.18 0.12 0.05 Diluted 0.12 0.15 0.17 0.03 0.03
ITEM 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This document contains forward-looking statements that are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. Such statements involve risks and uncertainties, including, but not limited to, the Company's and Bank's ability to implement their respective long-term business plans, manage interest rate and operational risks, and utilize the tax benefit of the net operating loss carryforwards. Other factors involving risks and uncertainties include the economy in general, the real estate market in California, the condition of stock markets upon which the Company's stock brokerage business and fee income is dependent, the impact of the enactment of the GLB Act on operations and competition, the retention of key executives and managers, and other factors beyond the Company's and Bank's control. Such risks, uncertainties and factors, including those discussed herein, could cause actual results to differ materially from those indicated. Readers should not place undue reliance on forward-looking statements, which reflect management's views only as of the date hereof. The Company and the Bank undertake no obligation to revise these forward-looking statements to reflect subsequent events or circumstances. Readers are also encouraged to review the Company's publicly available filings with the SEC.
Overview
The following discussion relates to information about the financial condition and results of operations of the Company and the Bank that might not otherwise be apparent from a review of the financial statements contained under ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. In addition to historical information, this discussion and analysis includes certain forward-looking statements regarding events and trends which may affect the Company's future results. Such statements are subject to risks and uncertainties including, but not limited to, those described in this discussion and analysis, as well as those described in ITEM 1 - - BUSINESS section of this report that could cause actual results to differ.
The Company recorded net income of $3.9 million for the year ended December 31, 1999, following net income of $5.0 million in 1998 and $5.4 million in 1997. The net income in 1999 was comprised primarily from two sources; core operating earnings and the recognition of the tax benefit of certain deferred tax assets. The net income in 1998 and 1997 was comprised primarily from four sources; 1) core operating earnings, 2) gain on sale of assets, 3) adjustments for loan loss provisions, and 4) the recognition of the tax benefit of certain deferred tax assets.
Results of Operations - Years Ended December 31, 1999, 1998 and
Net Interest Income
One of the fundamental measures of the Bank's results of operations is net interest income. Net interest income is the difference between the combined yield earned on interest earning assets and the combined rate paid on interest bearing liabilities.
The following table presents the consolidated average balance sheets of the Company, together with the total dollar amounts of interest income and expense, and weighted average interest rates for each of the years in the three year period ended December 31, 1999. Where possible, the average balances are calculated on a daily average basis. When this information is not available, average balances are calculated on a monthly basis.
1999 1998 1997 (Dollars in Thou- Average Income/ Yield/ Average Income/Yield/ Average Income/ Yield/ sands) Balance Expense Rate Balance Expense Rate Balance Expense Rate
Assets Interest- earning assets: Federal funds and time deposits $21,207 $1,064 5.0% $21,038 $1,133 5.4% $19,914 $1,114 5.6% Investment securities 33,196 1,958 5.9 37,404 2,262 6.0 38,434 2,345 6.1 Loans, net (1) 85,660 7,614 8.9 56,225 5,387 9.6 42,389 4,567 10.8 Total interest- earning assets 140,063 10,636 7.6 114,667 8,782 7.7 100,737 8,026 8.0%
Non-interest earning assets 16,690 10,956 9,134 Total assets $156,753 $125,623 $109,871
Liabilities and Equity Interest- bearing liabilities: Interest- bearing deposits $84,471 2,875 3.4% $75,146 $2,778 3.7 $72,299 2,798 3.9 Other borrowings 19,912 1,111 5.6 10,644 633 6.0 575 34 6.0 Total interest- bearing liab- ilities 104,383 3,986 3.8 85,790 3,411 4.0 72,874 2,832 4.0 Series B Preferred Stock -- -- -- -- -- -- 111 58 52.3
Non-interest bearing lia- bilities 28,771 20,982 24,959 Stock- holders' equity 23,599 18,851 11,927 Total liab- ilities and stock- holders' equity $156,753 $125,623 $109,871 Net interest income $6,650 $5,371 $5,136
Primary interest spread 3.8% 3.7% 4.0%
Margin as a percent of earning assets: Interest income 7.6% 7.7% 8.0% Interest expense 2.8 3.0 2.9 Net interest margin 4.7% 4.7% 5.1%
(1) Non-performing loans have been included in the average loan balances. Interest income is included on non-accrual loans only to the extent to which cash payments have been received and full principal repayment is probable.
Net interest income is dependent on the average balances of interest earning assets and interest bearing liabilities and on the rates earned on interest sensitive assets and the rates paid on interest sensitive liabilities. See "Asset Liability Management" for more discussion of the management of net interest income.
The dollar amount of interest income and interest expense fluctuates depending on changes in the respective interest rates and on changes in the respective amounts (volume) of the Bank's earning assets and interest bearing liabilities. For each category of interest earning asset and interest bearing liability, information is provided in the following table for changes attributable to (i) changes due to volume (change in average balance multiplied by prior
year's rate), and (ii) changes in rate (changes in rates multiplied by prior year's average balances). Changes attributable to the combined impact of volumes and rates have been allocated pro-rata to each category.
1999 versus 1998 1998 versus 1997 (Dollars in Thousands) Rate Volume Net Rate Volume Net
Interest-earning assets: Federal funds and time deposits $(78) 9 (69) $(42) $61 $19 Investment securities (56) (248) (304) (21) (62) (83) Loans, net (412) 2,639 2,227 (550) 1,370 820 Total interest-earning assets (546) 2,400 1,854 (613) 1,369 756
Interest-bearing liabilities: Interest-bearing deposits (269) 366 97 (59) 39 (20) Other borrowings (42) 520 478 (83) 624 541 Total interest bearing lia- bilities (311) 886 575 (142) 663 521 Change in net interest income $(235) $1,514 $1,279 $(471) $706 $235
The Company's interest income increased during 1999 from 1998 and during 1998 from 1997 primarily as a result of the increase in loans outstanding. Interest income and dividends on Federal funds sold and investment securities was $3.0 million in 1999, $3.4 million in 1998 compared to $3.4 million in 1997. Average portfolio balances were $54.4 million in 1999, $58.4 million in 1998 compared to $58.3 million in 1997, and average portfolio yields were 5.6%, 5.8%, and 5.9% in 1999, 1998, and 1997, respectively.
Interest expense for 1999 was $4.0 million compared to $3.4 million in 1998 and $2.9 million for 1997. The 1999 increase compared to 1998 was primarily attributable to an increase in average interest bearing deposits to $84.5 million from $75.1 million. The increase in interest expense in 1998 compared to 1997 was primarily attributable to an increase in average other borrowings to $20.0 million at the end of 1998 from $10.0 million at the end of 1997. The average cost of deposits and borrowings for 1999 was 3.8% as compared to 4.0% for both 1998 and 1997.
Provision (Adjustment) for Loan and Lease Losses
During 1999, the Bank increased to the allowance for loan and lease losses by $100,000 based on an estimate of loan and lease losses. As of December 31, 1999, the allowance for loan and lease losses totaled $1.5 million, or 1.6% of total loans and leases compared to $1.6 million, or 2.2% of total loans and leases at December 31, 1998. During 1998 and 1997, the Bank reduced the allowance for loan and lease losses by $1.6 million and $2.8 million, respectively. The adjustment in 1998 reduced the total allowance for loan and lease losses as a percent of total loans to 2.2% at the end of 1998 from 6.2% at the end of 1997. The 1998 and 1997 reductions in the Company's allowance for loan and lease losses to a level that management believes is adequate was based on many factors that are more fully discussed under "Loans -- Allowance for Loan and Lease Losses".
Non-Interest Income
Non-interest income increased $1.4 million, or 37.0%, in 1999 as compared to 1998, primarily as a result of an increase in brokerage commissions and fees, and revenue from operating leases. Brokerage commissions and fees were higher due to higher stock option exercise and trading volume. Operating lease income totaling $1.0 million was received in 1999 compared to none in 1998. Income from real estate rental income increased in 1999 compared to 1998 as a result of higher rental rates on the sublease of certain office space in the Bank's headquarter building. In addition, other services charges and fees increased as a result of higher transaction volumes.
Non-interest income increased $389,000 or 11.1% in 1998 as compared to 1997, primarily as a result of the reinstatement as other income of a note receivable related to a loan previously charged-off. Income from real estate rental income increased in 1998 compared to 1997 as a result of the increase in the rental rates on available space in the Bank's headquarter building. In addition, other services charges and fees increased as a result of higher volumes transaction volumes. The net increase in non- interest income in 1998 compared to 1997 included a decline
in brokerage commissions as a result of a decline in transaction volumes due primarily to the decline in stock values during the second half of 1998.
The following table provides a detail of non-interest income for the years ended December 31:
(Dollars in Thousands) 1999 1998 1997
Stock option commissions and brokerage fees $1,860 $1,051 $1,416 Real estate rental income 1,241 1,114 896 Operating lease income 1,022 -- -- Service charges and fees 870 683 603 Other income 268 563 116 Loss on sale of investment securities, net -- -- (6) Gain on sale of other assets, net 70 480 477 Total non-interest income $5,331 $3,891 $3,502
Non-Interest Expense
For the year ended December 31, 1999, non-interest expenses increased $1.8 million, or 26.7%, from the year ended December 31, 1998. The increase was primarily attributed to the incremental cost of increasing loan and deposit activities, and depreciation related to equipment under operating leases.
For the year ended December 31, 1998, non-interest expenses decreased $602,000, or 8.0%, from the year ended December 31, 1997. The reduction was primarily attributed to an adjustment to the accrual for legal related costs that reduced other operating expenses, lower professional fees, and lower costs related to problem assets.
The following table provides a detail of non-interest expense for the years ended December 31:
(Dollars in Thousands) 1999 1998 1997
Salaries and related benefits $5,017 $4,272 $4,203 Occupancy expense 1,190 1,142 1,192 Depreciation - operating lease equipment 595 -- -- Data processing 482 403 431 Professional fees 304 398 530 Insurance premiums 251 218 228 Equipment expense 190 176 198 FDIC insurance premiums 11 24 98 Other operating expenses 708 274 629 Total non-interest expense $8,748 $6,907 $7,509
The increase in salaries and related expenses in 1999 of $745,000 compared to 1998 was primarily the result of an increase in staffing levels including temporary personnel and incentive compensation accruals. The incentive compensation accruals increased based on the Company's strong financial performance in 1999. The increase in salaries and related expenses in 1998 of $69,000 compared to 1997 was primarily the result of an increase in staffing levels. The compensation expense included incentives costs of $1,325,000, $960,000, and $970,000 for 1999, 1998 and 1997, respectively.
The increase in depreciation expense from equipment under operating leases of $595,000 compared to none in 1998 was the result of the purchase and lease of equipment from December 31, 1998 to March 31, 1999 totaling $4.9 million. The equipment is depreciated over 68 months using the straight-line method.
The Company's expenses for professional services were $304,000 in 1999 compared to $398,000 in 1998, and $530,000 in 1997. The Company includes in professional fees the costs of legal, accounting, and management consulting services. Professional service expenses declined in 1999, 1998 and 1997 primarily as a result of a lower
level of professional services required to manage problem assets, the reduction in litigation matters, and the reduction in activities related to regulatory matters.
Other operating costs were higher in 1999 than 1998 by $434,000 primarily related to a one-time reduction of accruals for legal and non-performing assets costs in 1998. The decline in other operating costs of $355,000 in 1998 compared to 1997 resulted primarily from the reduction of $225,000 in an accrual for legal related costs and a reduction in costs related to non-performing assets by $248,000 due primarily to a write-down of certain other real estate owned (the "OREO") properties in 1997.
Provision (Benefit) for Income Taxes
The net income tax benefit was $732,000 for 1999 compared to $1.1 million for 1998 and to $1.5 million in 1997. The 1999, 1998 and 1997 income tax benefit related primarily to the Company's recognition of additional net deferred tax assets and a 1998 and 1997 income tax refund for taxes paid in prior periods.
As required by SFAS No. 109, the realizability of the deferred tax assets is reevaluated periodically and the valuation allowance is adjusted so that the resulting level of deferred tax asset is, more likely than not, to be realized. As of December 31, 1999, the total net deferred tax asset was $2.1 million. The resulting decrease in the amount of realizable deferred tax assets of $800,000 in 1999, $600,000 in 1998, and $1.5 million in 1997 were made based on a determination that the Company is, more likely than not, able to utilize deferred tax assets that had previously been reserved.
In 1999, the Company had current Federal income tax expense based on the alternative minimum tax calculation. The Company did not have any current Federal income tax expense in 1998 and 1997 as a result of tax operating losses in those years. The effective tax rates for the years ended December 31, 1999, 1998 and 1997, were (23.3)%, (26.6)% and (37.8)%, respectively. For each of the years ended December 31, 1999, 1998 and 1997, the federal statutory tax rate applicable to the Company was 34%.
As of December 31, 1999, the Company had temporary differences and net operating loss carryforwards for federal tax purposes of approximately $44.8 million which begin expiring in 2007, and for California franchise tax purposes of approximately $10.8 million, which began expiring in 2000. As of December 31, 1999, the Company had rehabilitation tax credit carryforwards for federal tax purposes of approximately $213,000, which expire in 2004 and 2005, and other tax credits of approximately $276,000, which have no expiration. Utilization of the net operating loss carryforwards, and rehabilitation and minimum tax credit carryforwards may be limited on an annual basis under current tax law due to possible changes in ownership in future years.
Financial Condition
Total Assets
The Company's total assets were $184.5 million as of December 31, 1999 an increase of $44.4 million or 31.7% compared to $140.1 million at December 31, 1998. In 1999 and 1998, management continued its strategy to build the Bank's loan portfolio.
Liquidity
Liquidity is the Bank's ability to meet the present and future cash needs of its clients for loans and deposit withdrawals. The Bank's liquidity generally increases or decreases as a result of fluctuations in the Bank's loans and deposits. The Bank maintains liquid assets of cash and cash equivalents, such as federal funds sold, at levels management believes are sufficient to meet the liquidity needs of its deposit customers. At December 31, 1999, the Company's cash and cash equivalents were $39.5 million or 28.4% of total deposits and 120.9% of non-interest bearing deposits. At December 31, 1998, the Company's cash and cash equivalents were $14.9 million or 15.6% of total deposits and 81.7% of non-interest bearing deposits.
In 1999, the Company's principal source of liquidity was from repayment of loans, maturity or sale of investment securities, new core deposits, long and short-term secured borrowing, and earnings. The Bank's access to some of these sources of liquidity may be limited for various reasons including some contractual maturities of
more than two years, the inability of borrowers to repay loans according to the contractual terms, and limited borrowing capacity under existing borrowing arrangements.
Investment Activities
All securities are classified, at acquisition, into one of three categories: held-to-maturity securities, trading securities, and available-for-sale securities. The Bank determines the classification of all securities at the time of acquisition. In classifying securities as being held-to-maturity, trading, or available-for-sale, the Bank considers its collateral needs, asset/liability management strategies, liquidity needs, interest rate sensitivity and other factors in determining its intent and ability to hold the securities to maturity.
Investment securities held-to-maturity may include United States Treasury and Federal agency securities, investments in certificates of deposit, and mortgage-backed securities. The objectives of these investments are to increase portfolio yield, and to provide collateral to pledge for federal, state and local government deposits and other borrowing facilities. The investments held-to-maturity have an average term to maturity of 7 and 19 months at December 31, 1999 and 1998, respectively, and are carried at amortized cost. At December 31, 1999 and 1998, the investment securities held-to-maturity portfolio includes $2.0 million and $3.8 million, respectively, in fixed rate balloon mortgage-backed security investments.
Investment securities available-for-sale may include United States Treasury and Federal agency securities, mutual funds, mortgage-backed securities, and collateralized mortgage obligations. These securities are typically used to supplement the Bank's liquidity portfolio with the objective of increasing yield. Investment securities available-for-sale are accounted for at fair value. Unrealized gains and losses are recorded as a component of accumulated other comprehensive income under shareholders' equity and are not reflected in the current earnings of the Bank. If the security is sold any gain or loss is recorded as a charge to earnings and reclassified from other accumulated comprehensive income. At December 31, 1999 and 1998, the Bank held $32.2 million and $34.2 million as investments available-for-sale, respectively. In 1999, the charge against other accumulated comprehensive income to reflect the market value adjustment net of taxes to the securities available-for-sale was $1.2 million.
The tables below sets forth certain information regarding the carrying value and the weighted average yields of the Bank's investment securities portfolio at December 31, 1999 by final contractual maturity:
Available for Sale Total Within One to More than- Investment One Year Five Years Five years Securities (Dollars in Thousands) U.S. Treasury $300 -- -- $300 Average yield 5.1% -- -- 5.1%
Agency securities -- $13,499 $4,789 $18,288 Average yield -- 6.0% 6.1% 6.0%
Mortgage-backed securities $940 $9,159 $3,549 $13,648 Average yield 5.8% 6.2% 7.0% 6.4% Total $1,240 $22,658 $8,338 $32,236 Average yield 5.6% 6.1% 6.5% 6.2%
Held to Maturity Total One to Investment Five Years Securities (Dollars in Thousands) Mortgage-backed securities $1,953 $1,953 Average yield 5.8% 5.8%
Expected maturities of mortgage-backed securities can differ from final contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties, and the expected maturity of agency securities can differ from final contractual maturity because the issuer may have the right to prepay the obligation prior to final contractual maturity.
As of December 31, 1999 and 1998, the Bank held 20,770 and 19,710 shares, respectively, of stock in the Federal Home Loan Bank of San Francisco (the "FHLB") as a membership requirement with a carrying and market value of $2.1 million and $2.0 million, respectively. The FHLB stock has no term to maturity. As of December 31, 1999 and 1998, the Company and the Bank had no derivative financial instruments.
Loans
The Bank's primary lending activities are in commercial and financial loans made primarily to individuals and businesses in the nine counties surrounding the San Francisco Bay Area and, to some extent, in the Sacramento metropolitan area. The Bank purchases whole loans and enters into loan participation agreements with other banks in Northern California. In addition, the Bank also provides financing for the exercise of employee stock options. The Bank offers credit ranging from $25,000 to $4.0 million depending on loan characteristics such as type, collateral, and terms.
At December 31, 1999 and 1998, the Bank had net loans out- standing of $94.6 million and $72.7 million, respectively, which represented 68.1% and 75.5% of the Bank's total deposits at those dates and 51.3% and 51.5% of the total assets of the Company. During 1999, the Bank originated, purchased and participated in loans outstanding totaling $29.4 million, compared with $35.0 million during 1998. The interest rates charged on the Bank's loans vary with the degree of risk, maturity, market interest rates, funds availability, and governmental regulations, and have been subject to competitive pressures. Approximately 35.0% of the Bank's loans have interest rates that either adjust quarterly, or more frequently, based on the Bank's prime rate, the FHLB eleventh district cost of funds ("Cofi"), or the one-year treasury constant maturity, or mature within 90 days.
At December 31, 1999, the Bank had no direct loans to foreign borrowers.
Real Estate Secured Loans The Bank's real estate mortgage loans typically are secured by first or second deeds of trust on either commercial or residential property, and have original maturities of three years or more. Such loans have been non- revolving and generally have had maturities that do not exceed ten years. Repayment terms generally include principal amortization over a negotiated term, with balloon principal payments due upon maturity. The typical purpose of these loans is the acquisition or re-financing of real property securing the loan. The primary sources of repayment have been the properties' cash flow in the case of commercial real estate loans and the borrowers' cash flow in the case of residential real estate. The secondary source of repayment is the sale of the real property securing the loan. The Bank's real estate secured loans typically bear a floating rate of interest based on either the prime rate, Cofi, or a treasury constant maturity index. The Bank has made and will continue to consider fixed rate loans.
Loans collateralized by real estate represent the Bank's largest loan concentration. As of December 31, 1999 and 1998, 71.8% and 68.7%, respectively, of the Bank's total outstanding loan portfolio was secured by real estate. The Bank mitigates concentration risk by diversifying the type of real estate and the geographic location of the collateral. The largest concentration of real estate loans is collateralized by commercial real estate which is 54.9% of total outstanding loans. The largest concentration of commercial real estate loans by type of underlying collateral are in retail properties which total $16.2 million or 8.9% of total assets. The largest geographic concentration in San Francisco totals $25.2 million, or 13.7% of total assets. The largest real estate secured loan was 2.1% of total assets as of December 31, 1999. As of December 31, 1999, the Bank's real estate loan portfolio consists primarily of loans with principal amounts of between $100,000 and $4.0 million which generally have terms of maturities of between one and fifteen years.
Secured Commercial and Financial Loans The Bank offers a variety of commercial and financial lending services including revolving lines of credit, working capital loans, homeowners' association loans, and letters of credit. In addition, the Bank may purchase participations in agricultural and other types of loans. These loans are typically secured by cash deposits, accounts receivable, homeowners' association dues assessments, equipment, inventories, agricultural crop production, investments, and securities. In underwriting commercial and financial loans, the Bank focuses on the net worth, income, liquidity and cash flows of the borrower or borrowers and the value of the collateral. The Bank's commercial and financial loans typically have a floating rate of interest based on the prime rate. The Bank's commercial and financial loans are primarily in principal amounts of at least $100,000 and generally have terms of one year or less.
As of December 31, 1999 and 1998, the Bank had secured commercial and financial loans outstanding of $9.4 million and $10.1 million constituting 9.9% and 13.6% of the Bank's total outstanding loan portfolio, respectively. As of December 31, 1999, 68.0% of the Bank's gross secured commercial and financial loan commitments were scheduled to mature within one year. As of December 31, 1999, the largest secured commercial and financial loan commitment accounted for less than 2% of the Bank's total assets.
Unsecured Loans The Bank offers a variety of unsecured loans including commercial and financial loans and loans to individuals. The purpose of unsecured loans includes revolving lines of credit for personal investing or cash flow management, home or business improvements, working capital loans, and letters of credit. In underwriting unsecured loans, the Bank focuses on the net worth, income, liquidity and cash flows of the borrower. The Bank's unsecured loans typically have a floating rate of interest based on the prime rate. The Bank's unsecured loans are primarily in prin- cipal amounts of at least $100,000 and generally have terms of one year or less. In addition, the Bank will extend unsecured credit under a credit card arrangement as an accommodation for qualifying borrowers. As of December 31, 1999, the Bank had credit card commitments totaling $654,000 with outstanding balances of $170,000.
As of December 31, 1999 and 1998, the Bank's unsecured loan commitments totaled $28.2 million and $22.7 million and had outstanding balances totaling $13.3 million and $11.8 million and were 14.6% and 15.9%, respectively, of the Bank's total outstanding loan portfolio. The Bank's largest unsecured loan accounted for less than 2.0% of total assets as of December 31, 1999.
Other Loans and Leases The Bank offers a variety of other loans and leases including stock option loans and lease financing. The stock option loans typically have a floating rate of interest based on the prime rate and have a term of less than 30 days. See "Stock Option Services." As of December 31, 1999 and 1998, stock option
loans totaled $99,000 and $253,000 and were 0.1% and 0.4%, respectively, of the Bank's total loan portfolio. The lease financing receivables totaled $3,530,000 and $893,000 at December 31, 1999 and 1998, respectively.
Lending Policies and Procedures The Bank's lending policies are established by the Bank's senior management and approved by the Board of Directors of the Bank and its Loan and Investment Committee. The Bank is required by regulation to limit its maximum outstanding balance to any one borrower to 25% of capital and reserves on secured loans and to 15% of capital and reserves on unsecured loans. Secured loans are defined as loans secured by a first deed of trust or possessory collateral. As of December 31, 1999, thirty-two customers each had total commitments from the Bank that exceeded $1.0 million. The commitments to these customers totaled $64.8 million, or 54.0%, of total commitments outstanding, and had outstanding balances of $50.3 million, or 53.2% of total loans outstanding. Generally, any new or renewing loan where the Bank's total borrower credit exposure is over $1.0 million requires the approval of the Loan and Investment Committee of the Board. All other loans where the total borrower exposure is $1.0 million and less can be approved by executive management.
The Bank assesses the lending risks, economic conditions and other relevant factors related to the quality of the Bank's loan portfolio in order to identify possible credit quality risks. The Bank has engaged a third party professional firm to perform certain agreed upon procedures relating to credit quality and loan classification. These credit review consultants review a sample of loans periodically and report the results of their findings to the Audit Committee of the Bank's Board of Directors. Results of reviews by the credit review consultants as well as examination of the loan portfolio by state and federal regulators are also considered by management and the Board in determining the level of the allowance for loan and lease losses.
The Bank may restructure loans as a result of a borrower's inability to service the obligation under the original terms of the loan agreement. Restructures are executed only when the Bank expects to realize more from a restructured loan than from allowing the loan to be foreclosed or pursuing other forms of collection.
When a borrower fails to make a required payment on a loan, the loan is categorized as delinquent. If the delinquency is not cured, workout procedures are generally commenced. If workout proceedings are not successful, collection procedures, which may include collection demands, negotiated restructures, foreclosures and suits for collection, are initiated. In general, loans are placed on non-accrual status after being contractually delinquent for more than 90 days, or earlier if management believes full collection of future principal and interest on a timely basis is unlikely. When a loan is placed on non-accrual status, all interest accrued but not received is charged against interest income. When the ability to fully collect non-accrual loan principal is in doubt, cash payments received are applied against the principal balance of the loan until such time as full collection of the remaining recorded balance is expected. Generally, loans with temporarily impaired values and loans to borrowers experiencing financial difficulties are placed on non-accrual status even though the borrowers continue to repay the loans as scheduled. Such loans are categorized as performing non-accrual loans and are reflected in non-performing assets. Interest received on such loans is recognized as interest income when received. A non-accrual loan is restored to an accrual basis when principal and interest payments are paid current and full payment of principal and interest is probable. Loans that are well secured and in the process of collection remain on accrual status.
Composition of Loan and Lease Portfolio The composition of the Bank's loan portfolio at December 31, is summarized as follows:
(Dollars in Thousands) 1999 1998 1997 1996 1995
Real estate mortgage $67,914 $50,845 $37,826 $28,022$ 37,049 Secured commercial and financial 9,386 10,054 4,912 6,229 7,379 Unsecured 13,344 11,771 8,633 7,800 7,604 Other loans and leases 3,968 1,310 553 1,711 1,176 94,612 73,980 51,924 43,762 53,208 Deferred fees, net (140) (144) (61) (190) (180) Allowance for possible loan and lease losses (1,525) (1,625) (3,200) (5,663) (5,912) Total loans and leases, net $92,947 $72,211 $48,663 $37,909 $47,116
The following table presents the loan portfolio at December 31, 1999 based upon the final contractual maturity date allocated into maturity categories. This table does not reflect anticipated prepayment of loans.
One to After Within Five Five (Dollars in Thousands) One Year Years Years Total
Real estate mortgage $2,201 $18,328 $47,385 $67,914 Secured commercial and financial 4,360 4,916 110 9,386 Unsecured 6,813 4,318 2,213 13,344 Other 201 3,300 568 3,968 Total loans $13,575 $30,761 $50,276 $94,612
Adjustable rate loans total $61.3 million, or 64.8% of total loans, including $25.4 million with rates that adjust immediately based on prime rate. Fixed rate loans and loans with next adjustment dates beyond two years total $33.3 million, or 35.2% of the Bank's total loan portfolio, have a weighted average yield of 8.5% and an average final maturity date of within 10 years. As of December 31, 1999, fixed rate loans with pre-payment penalties totaled $19.2 million. Generally, the prepayment penalty provisions are effective for the first one to three years from the date of origination.
As of December 31, 1999, there were $10.0 million in loans, or 10.6% of total loans, that adjust at least annually based on Cofi which have a weighted average yield of 8.2% and a weighted average term to final maturity of approximately 9 years, as of December 31, 1999. Generally, these loans have a weighted average annual interest rate change limit of 2.00% and a life-time interest rate floor and cap of 6.5% and 14.4%, respectively. The Bank also held $21.6 million in loans, or 22.8% of total loans, that have an initial fixed term of two years and then adjust quarterly based on the one-year treasury constant maturity index. As of December 31, 1999, the yield on these loans was 8.4% and the average term to final maturity was approximately 8 years.
Non-performing Assets
A loan is considered impaired when, based on certain events and information, it is "probable" that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. At December 31, 1999 and 1998, the Bank had no impaired loans. For the year ended December 31, 1999 and 1998, the weighted average impaired loans outstanding was $35,000 and $34,000, respectively. Total interest recognized on impaired loans during 1999 was zero compared to $3,000 in 1998.
OREO is recorded at fair value at the time of acquisition. The Bank periodically obtains either an appraisal or market valuation analysis on all OREO. If the valuation analysis indicates a decline in the market value of the property, a specific loss allowance is established. The Bank provides a charge against current earnings for estimated losses on foreclosed property when the carrying value of the property exceeds its fair value net of estimated selling expenses. Fair value is based on current market conditions, appraisals, and estimated sales values of similar properties, net of an estimated discount for selling and other expenses.
In 1999, the Bank reduced its non-performing asset portfolio by $51,000, or 100% at December 31, 1998 through asset sales. Based upon information presently available, management believes that the Bank has made sufficient provision to its allowance for possible loan losses and specific reserves to absorb possible losses.
The table below outlines the Bank's non-performing assets as of December 31:
(Dollars in Thousands) 1999 1998 1997 1996 1995
Non-accrual loans -- -- $171 $3,400 $7,511 Other real estate owned, net -- $51 410 5,133 7,514 Real estate investment, net -- -- -- -- 236 Total non-performing assets -- $51 $581 $8,533 $15,261
Non-performing assets as a percentage of total loans, OREO outstanding -- 0.1% 1.1% 17.4% 24.7%
Loans past due 90 days or more and accrual -- -- -- -- --
Loans restructured and in compliance with modified terms -- -- -- 4,109 4,126
At December 31, 1999, the Bank had no loans that were delinquent 31 days or more. For each of the years ended December 31, 1999, 1998, and 1997, interest income foregone on restructured loans was zero. The amount of gross interest income that would have been collected for non-accrual loans if all such loans had been performing in accordance with their original terms was zero, zero,and $2,000, in 1999, 1998 and 1997, respectively.
Allowance for Loan and Lease Losses Generally, the Bank's method of analyzing the adequacy of its allowance for loan and lease losses is based on the evaluation of fair value of the underlying collateral, known risks, trends, and other factors. The fair value of the underlying collateral is based on current market conditions, appraisals, and estimated sales values of similar properties. In addition, the Bank establishes a specific loss allowance based on the asset classification and credit quality grade. This specific loss allowance is utilized to ensure that allowances are allocated based on the credit quality grading to capture inherent risks. In addition, the Bank carries an "unallocated" allowance for loan and lease losses to provide for losses that may occur in the future in loans that are not presently classified, based on present economic conditions, trends, and related uncertainties. The Bank continues to refine the allowance methodology to ensure that all known risks, trends, and facts are utilized in determining the adequacy of the allowance for loan and lease losses.
Generally, the Bank charges current earnings with provisions for estimated losses on loans receivable. However, the Bank will record an allowance for loan and lease loss adjustment if the total allowance for loan and lease losses exceeds the amount of estimated losses. The provision or adjustment takes into consideration the adequacy of the total allowance for loan and lease losses giving due consideration to specifically identified problem loans, the financial condition of the borrowers, the fair value of the collateral, recourse to guarantors, and other factors. See "Provision (Adjustment) for Loan and Lease Losses" for additional discussion on allowance for loan and lease losses.
The following table summarizes the loan and lease loss experience of the Bank for the years ended December 31:
(Dollars in Thousands) 1999 1998 1997 1996 1995
Balance of allowance for loan and lease losses at beginning of period $1,625 $3,200 $5,663 $5,912 $6,576
Loans charged off: Commercial, financial and unsecured (200) -- (5) (4) (427) Real estate -- -- (35) (642) (2,444) Sale of loans -- -- -- -- -- Subtotal (200) -- (40) (646) (2,871) Recoveries of previous losses: Commercial and financial -- -- 320 397 1,565 Real estate -- 52 77 -- 142 Net lease financing -- -- -- -- -- Subtotal -- -- 397 397 1,707 Net loans recovery/(charged off) (200) 52 357 (249) (1,164)
Provision (adjustment) for loan and lease losses 100 (1,627) (2,820) -- 500 Balance of allowance for loan and lease losses at end of period 1,525 $1,625 $3,200 $5,663 $5,912
Ratio of the allowance to total loans and leases 1.6% 2.2% 6.2% 12.9% 11.1%
Ratio of the allowance to non-accrual loans -- -- 1,871.3 166.6 78.7
Ratio of net (recoveries)/charge-offs to average loans 0.2 (0.1) (0.8) 0.6 1.4
Allocation of the allowance for loan and lease losses by collateral type as of December 31 is as follows:
1999 1998 1997 (Dollars in Balance Percent(1) Balance Percent(1) Balance Percent(1) Thousands) Real estate mortgage $839 71.8% $939 68.7% $1,460 72.8% Secured commercial and financial 113 9.9 129 13.6 97 9.6 Unsecured 177 14.1 137 15.9 214 16.6 Other loans and leases 38 4.2 11 1.8 2 1.0 Unallocated 358 -- 409 -- 1,427 -- Total $1,525 100.0% $1,625 100.0% $3,200 100.00%
1996 1995 Balance Percent(1) Balance Percent(1)
Real estate mortgage $2,456 64.0% $1,613 69.6% Secured commercial and financial 250 14.2 1,207 13.9 Unsecured 483 17.8 1,872 14.3 Other loans and leases 36 4.0 -- 2.2 Unallocated 2,438 -- 1,220 -- Total $5,663 100.0% $5,912 100.0%
(1) Percent refers to the percent of loans and leases in each category to total loans.
Deposits
The Bank had total deposits of $138.9 million and $95.7 million at December 31, 1999 and 1998, respectively. As of December 31, 1999, deposits consisted of demand deposits totaling $32.7 million, money
market and savings accounts totaling $38.4 million, NOW accounts totaling $27.6 million and time deposits totaling $40.2 million. As of December 31, 1999, the Bank had a total of 2,576 deposit accounts consisting of 685 demand deposit accounts with an average balance of approximately $48,000 each, 600 savings and money market accounts with an average balance of approximately $64,000 each, 906 NOW accounts with an average balance of approximately $30,000 each and 385 time accounts with an average balance of approximately $105,000. The Bank's deposits and, correspondingly, its liquidity, are largely dependent upon four sources of funds: deposits acquired through its ABS function, Private and Business Banking, Escrow Services, and deposits solicited through the Bank's money desk.
Certificates of deposit, including $2.9 million of money desk deposits discussed below, having a balance of at least $100,000 represented approximately 17.4% of the Bank's total deposits as of December 31, 1999 compared to 22.0% as of December 31, 1998. As of December 31, 1999, $19.1 million of the Bank's certificates of deposit of at least $100,000 mature in 90 days or less and $6.0 million mature between 91 days and one year. The aggregate average maturity of all of the Bank's certificates of deposit of at least $100,000 was three months as of December 31, 1999, and the aggre- gate amount of all such certificates of deposit as of December 31, 1999 was $25.5 million with a weighted average stated rate of 4.29%.
The Bank solicits money desk certificates of deposit with balances between $90,000 and $2.0 million principally from other financial institutions and municipalities outside of the Bank's market area. As of December 31, 1999 and 1998, the Bank had outstanding money desk deposits of $9.7 million or 6.9% of total Bank's total deposits and $12.3 million or 12.8% of Bank's total deposits, respectively. During 1999, the money desk deposits averaged $12.0 million, with a high balance of $13.1 million. As of December 31, 1999, money desk deposits had a remaining weighted average maturity of approximately eight months.
The following table sets forth the maturities, as of December 31, 1999, of the Bank's interest-bearing deposits and other interest-bearing liabilities:
Over 3 Over 3 Months Months to 6 Months 1 Year to (Dollars in Thousands) or Less 6 Months to 1 Year 5 Years Total
Interest-bearing liabilities: Now accounts $27,555 -- -- -- $27,555 Money market and savings accounts 38,354 -- -- -- 38,354 Time deposits including money desk deposits 24,578 $3,104 $10,809 $1,835 40,326 Total interest-bearing liabilities $90,487 $3,104 $10,809 $1,835 $106,235
Other Borrowings
The Bank has other borrowing facilities which include advances from the FHLB and access to the discount window at the FRB. During 1999 and 1998, the Bank borrowed $20.0 million from the FHLB under this borrowing facility. The following table sets forth the maturities, as of December 31, 1999, of the borrowings:
Over More Than Less than 1 Year 4 Years to (Dollars in Thousands) 1 year to 3 Years 5 Years Total
Fixed rate borrowing $5,000 $5,000 $5,000 $ 15,000 Adjustable rate borrowing -- -- 5,000 5,000 Total interest-bearing liabilities $5,000 $5,000 $10,000 $20,000
The Bank's short term line of credit with the FRB of up to $2.8 million is available upon the pledge of securities. The borrowing from the FHLB of $20.0 million is secured by pledged securities and loans totaling $55.5 million. As of December 31, 1999, the Bank had $2.4 million available under its line of credit with the FHLB. During 1999 and 1998, the Bank did not borrow at the discount window at the Federal Reserve Bank.
Capital
Shareholders' equity totaled $23.5 million at December 31, 1999, an increase of $797,000 from $22.7 million at December 31, 1998. The increase in equity in 1999 was primarily from earnings of $3.9 million partially offset by the redemption of Common Stock totaling $2.0 million and the comprehensive loss on investment securities totaling $1.1 million.
The Company and the Bank are subject to general regulations issued by the FRB, FDIC, and DFI which require maintenance of a certain level of capital. As of December 31, 1999, the Company and the Bank were in compliance with all minimum capital requirements.
The following table reflects both the Company's and the Bank's capital ratios with respect to the minimum capital requirements in effect as of December 31, 1999.
Minimum Capital Company Bank Requirement
Leverage ratio 13.9% 13.8% 4.0% Tier 1 risk-based capital 18.1 18.0 4.0 Total risk-based capital 19.3 19.1 8.0
Year 2000 Disclosure
The Bank implemented a plan to identify, assess, and address issues related to the Year 2000 problem (the "Y2K Plan"). The Y2K problem was a computer programming issue that occurred as a result of many computer systems being programmed to use a two digit code to identify the year. For example, the year 1998 would be signified as "98", and, therefore, the year 2000 may be mis- recognized as 1900. This could have resulted in the miscalculation of financial data and/or result in processing errors in transactions or functions that are date sensitive.
Generally, the Bank's Y2K business risks could have come from internal sources such as the Bank's own computer systems and from external sources such as borrowers whose businesses might be adversely impacted by the Y2K problem, deposit customers whose transactions are transmitted electronically, and other third parties such as institutions, vendors, and governmental agencies whose computer systems may have a direct or indirect adverse impact on the Bank or the Bank's customers.
As of December 31, 1999, the Bank had implemented mission critical system upgrades for all of its core banking hardware and software including vendor supported hardware and software. The Bank, the Bank's third party vendors, and the Bank's customers have not experienced any material date sensitive systems failures.
The cost associated with executing the Y2K Plan and completing the Y2K modification and testing totaled $265,000 including approximately $175,000 for acquired hardware which is being amortized over its estimated useful life. The funds for the modification and testing were from general working capital. These costs, exclusive of the cost of replacement systems that are being capitalized and amortized in accordance with the Bank's policies, were expensed as incurred. No significant information technology projects have been deferred as a result of the Y2K efforts.
Item 7A
Item 7A - Quantitative and Qualitative Disclosure About Market Risk
Market Risk Management
Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, and other market changes that affect market sensitive instruments. The Company's primary market rate risk is interest rate risk. The Company does not have any significant direct risks related to foreign currency exchange rates, commodity prices, equity prices, or other market changes that affect market sensitive instruments.
Generally, interest rate risk occurs as a result of interest sensitive assets and liabilities not repricing at the same time and by the same amount. The Company's interest rate risk is a combination of several risk factors including interest, liquidity, price, and compliance. These risk factors are influenced by many circumstances including changes in the economic environment and competitive pressures.
The oversight responsibility for the Company's interest rate risk management is performed by the Bank's Asset Liability Committee (the "ALCO"). The interest rate risk management policies are approved by the Board of Directors. The Company's approach to managing interest rate risk is to periodically measure the amount of interest rate risk based on estimated cashflows assuming multiple interest rate scenarios. The results of the measurement are evaluated and alternate strategies, if needed, are implemented to reduce the interest rate risk exposure. The strategies the Company uses to manage interest rate risk include adjustments to the composition of the investment securities portfolio, and new loan and deposit product terms. The Company's policies permit the use of off-balance sheet derivative instruments to control interest rate risk. However, as of December 31, 1999, no such instruments were outstanding.
Using a simulation model, the Company measures interest rate sensitivity on a quarterly basis. The simulation model takes into consideration the potential volatility in projected results that can occur as the interest rate environment changes over time. Management believes that this provides a dynamic assessment of interest rate sensitivity. For example, callable agency securities have a final maturity but also have a call feature that could result in a security being repaid prior to final maturity in a declining interest rate environment, and, due to competitive pressures, a reduction in interest rates on deposits may not be possible without increasing liquidity risk. These and other factors may increase or decrease the amount of volatility in projected results.
A simplified method of measuring interest rate sensitivity is a "gap" analysis. A gap analysis assesses the difference between the amount of assets and the amount of liabilities which are subject to interest rate repricing at set intervals as of a specific date. If more assets than liabilities are interest rate sensitive at a given time in a rising interest rate environment, net interest income increases. In a declining interest rate environment with the same "gap", net interest income decreases. If more liabilities change rates than assets, the same scenarios produce the opposite effects. Gap analysis only partially depicts the Company's sensitivity to interest rate changes at a specific date. Such an analysis does not fully describe the complexity of relationships between product features and pricing, market rates and future management of the asset and liability mix.
The following table illustrates the repricing opportunities for the Company's interest-earning assets and interest-bearing liabilities at December 31, 1999:
Over 3 Over More Than No stated 3 Months Months to 6 Months 1 Year to and/or Over (Dollars in or Less 6 Months to 1 Year 5 Years 5 Years Total Thousands) Interest- Earning Assets: Investment securities and certain cash equivalents $35,595 -- $1,040 $20,792 $13,063 $70,490 Operating leases -- -- -- 4,406 -- 4,406 Loans and leases 34,525 $12,438 7,551 30,444 9,654 94,612 Total interest- earning assets 70,120 12,438 8,591 55,642 22,717 169,508
Liabilities and Equity: Interest- bearing deposits 91,194 3,024 10,440 1,577 -- 106,235 Other borrowings 7,000 -- -- 13,000 -- 20,000 Portion of non-interest bearing liabilities and equity -- -- -- -- 43,273 43,273 Portion of liabilities and equity 98,194 3,024 10,440 14,577 43,273 169,508
Interest bearing assets over (under) liabilities and equity $(28,074) $9,414 $(1,849) $41,065 $20,556 --
Cumulative primary gap $(28,074) $(18,660) $(20,509) $20,556 --
Gap as a percentage of total interest- earning assets (16.6)% (11.0)% (12.1)% 12.1% 0.0%
The Company's simulation model estimates the changes in earnings as a result of changes in interest rate sensitive assets and liabilities which would occur as a result of an instantaneous and sustained increase or decrease in interest rates of 200 basis points, and the resulting effect on the Company's net interest margin, net income and capital over a one and two year period. The Company has established policy guidelines regarding maximum negative variances in net interest margin of 15%, in net income of 50%, and in capital of 10% in the event of an instantaneous and sustained increase or decrease in market rates of 200 basis points. As of December 31, 1999, the Company's sensitivity to changes on interest rates was within policy guidelines.
The following table presents the Company's hypothetical changes in the Company's net interest income, net income and capital, measured for the one-year period beginning January 1, 2000, based on the December 31, 1999 ending balance sheet.
Change in Estimated Increase/(Decrease) in Interest Rates Net interest income Net income Capital (basis points) Amount Percent Amount Percent Amount Percent + 200 $ 576 7.2% $ 565 14.9% $(895) (3.3)% no change - - - - - - - 200 $(418) (5.2)% $(409) (10.8)% $441 1.6%
The table above illustrates that in an increasing interest rate environment, the Company's net interest income and earnings would be expected to increase slightly due to an increase in yield on loans and investments at a faster pace than the increase in the cost of deposits. However, capital would be expected to decline due to an estimated decline in the market value primarily related to investment securities. In a declining interest rate environment, the Company's net interest margin and earnings would be expected to decline primarily as a result
of lower interest income on loans and investments. Net interest income would decline due to lower reinvestment yields on the accelerated maturity of certain fixed rate callable securities, prepayment of fixed rate loans, and the decline of interest on adjustable rate loans and investments, and the lag in the decline of the cost of interest bearing deposits. Capital would be expected to increase due to a projected increase in the value of the investment portfolio.
The simulation model includes key assumptions regarding cashflows including projections of new and renewing loans and deposits, prepayment assumptions for certain investment securities and loans, and assumptions of estimated competitive pressures on the pricing of loan and deposit products.
The simulation model does not contemplate all interest rate scenarios or all of the actions the Company may undertake in response to changes in market interest rates. Also, the model does not capture the change in value for certain balance sheet assets, which may reduce the effect of changes in interest rates or the impact of stock market fluctuations on the Stock Option Services revenue. For example, in a 2% falling rate scenario, the model will not reflect additional interest income on certain loans that have reached annual or life-time floors and/or have pre-payment penalties; however, those floors and/or prepayment penalties may result in a significant increase in value.
The projections provided herein contain estimates that are based on certain assumption that may or may not occur, are subject to uncertainties that could cause actual results to differ materially, and any method of analyzing interest rate risk has certain inherent shortcomings. For example, although certain assets and liabilities have similar repricing characteristics, they may react in different degrees to changes in market interest rates, certain categories of assets and/or liabilities may precede, or lag behind, changes in market interest rates, and the shift in the slope of the yield curve could result in different estimates. Also, actual rates of prepayments on loans and investments could vary significantly from the estimates used in the projections. Accordingly, results in the preceding tables should not be relied upon as indicative of actual results in the event of changing market interest rates and are not intended to represent, and should not be construed to represent, the underlying value of the Company.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . 29
Consolidated Statements of Financial Condition, December 31, 1999 and 1998 . . . . . . . . . . . . . . . . . . . . . . 30
Consolidated Statements of Operations, . . . . . . . . . . . . . . . . . 31 Years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income,. . . . . . . . . . . . . . . . . . . . . . . . . . 32 Years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows, . . . . . . . . . . . . . . . . . 33 Years ended December 31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . 35
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of The San Francisco Company:
We have audited the accompanying consolidated statements of financial condition of The San Francisco Company and subsidiaries (the "Company") as of December 31, 1999 and 1998 and the related consolidated statements of operations, changes in shareholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The San Francisco Company and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999 in conformity with generally accepted accounting principles.
KPMG LLP
February 10, 2000 San Francisco, California
The San Francisco Company Consolidated Statements of Financial Condition December 31, 1999 and 1998
(Dollars in Thousands Except Per Share Data) Notes 1999 1998
Assets: Cash and due from banks $ 5,265 $ 5,908 Federal funds sold 34,224 9,000 Cash and cash equivalents 39,489 14,908
Investment securities available-for-sale 2 32,236 34,235 Investment securities held-to-maturity (Market value: 1999 - $1,904 and 1998 - $3,851) 2 1,953 3,846 Federal Home Loan Bank stock, at par 2 2,077 1,971
Loans and leases 3 94,612 73,980 Deferred fees, net 3 (140) (144) Allowance for loan and lease losses 4 (1,525) (1,625) Loans, net 92,947 72,211
Other real estate owned 5 -- 51 Premises and equipment, net 6 7,151 7,546 Operating lease equipment 7 4,306 2,000 Interest receivable 867 748 Other assets 3,447 2,620 Total assets $184,473 $140,136
Liabilities and Shareholders' Equity: Non-interest bearing deposits $ 32,676 $18,237 Interest bearing deposits 106,235 77,451 Total deposits 8 138,911 95,688
Other borrowings 9 20,000 20,000 Other liabilities and interest payable 2,061 1,744 Total liabilities 160,972 117,432
Commitments and contingencies 15
Shareholders' Equity: 11 Convertible preferred stock (par value $0.01 per share) Series B - Authorized - 437,500 shares Issued and outstanding - 1999 - 15,869 and 1998 - 15,869 shares 111 111 Common stock (par value $0.01 per share) Class A - Authorized - 100,000,000 shares Issued and outstanding - 1999 - 29,317,558 and 1998 - 31,728,782 shares 293 317 Additional paid in capital 76,963 78,816 Retained deficit (52,766) (56,619) Accumulated other comprehensive (loss) income (1,100) 79 Total shareholders' equity 23,501 22,704 Total liabilities and shareholders' equity $184,473 $140,136
The accompanying notes are an integral part of the consolidated financial statements.
The San Francisco Company Consolidated Statements of Operations Years Ended December 31, 1999, 1998 and 1997
(Dollars in Thousands Except Per Share Data) Notes 1999 1998 1997
Interest income: Loans $7,614 $5,387 $4,567 Federal funds sold 1,064 1,133 1,103 Investments 1,852 2,172 2,311 Dividends 106 90 45 Total interest income 10,636 8,782 8,026
Interest expense: Deposits 8 2,875 2,778 2,798 Other borrowings 1,111 633 92 Total interest expense 3,986 3,411 2,890
Net interest income 6,650 5,371 5,136 Provisions (adjustment) for loan and lease losses 4 100 (1,627) (2,820) Net interest income after provisions (adjustment) for loan and lease losses 6,550 6,998 7,956
Non-interest income: Stock option commissions and brokerage fees 1,860 1,051 1,416 Real estate rental income 6 1,241 1,114 896 Operating lease revenue 7 1,022 -- -- Service charges and fees 870 683 603 Other income 268 563 116 Loss on sale of investment securities, net -- -- (6) Gain on sale of other assets, net 70 480 477 Total non-interest income 5,331 3,891 3,502
Non-interest expense: Salaries and related benefits 5,017 4,272 4,203 Occupancy expense 6 1,190 1,142 1,192 Depreciation of operating lease equipment 7 595 -- -- Data processing 482 403 431 Professional fees 304 398 530 Insurance premiums 251 218 228 Equipment expense 190 176 198 FDIC insurance premiums 11 24 98 Other operating expenses 708 274 629 Total non-interest expense 8,748 6,907 7,509 Income before income taxes 3,133 3,982 3,949 Benefit for income taxes 10 (732) (1,060) (1,494) Net Income $3,865 $5,042 $5,443
Income per share: Basic: Weighted average shares outstanding 31,541,826 31,727,138 30,393,679 Net income $0.12 $0.16 $0.18 Diluted: Weighted average shares outstanding 33,185,999 33,062,713 30,644,487 Net income $0.12 $0.15 $0.17
The accompanying notes are an integral part of the consolidated financial statements.
The San Francisco Company and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income Years Ended December 31, 1999, 1998 and 1997
Accum- ulated Other (Dollars in Addit- Other Compre- Total Thousands) ional Compre- Retained hensive Share- Preferred Common Paid-in hensive Earnings Income/ holders' Stock Stock Capital Income (Deficit) (Loss) Equity Balances at January 1, 1997 $111 $288 $77,841 $(67,099) $(77) $11,064
Net proceeds from the sale of stock -- 29 971 -- -- 1,000 Net proceeds from the exercise of stock options -- -- 2 -- -- 2 Other comprehensive income Unrealized holding gains arising during the period, net Plus: reclassification adjustment for losses included in net income $6 Net unrealized income 55 Other compre- hensive income 61 -- 61 61 Net income 5,443 5,443 -- 5,443 Comprehensive income $5,504
Balances at December 31, 1997 111 317 78,814 (61,656) (16) 17,570
Net proceeds from the exercise of stock options -- -- 2 -- -- 2 Dividend on Preferred Stock -- -- -- (5) -- (5) Other comprehensive income Net unrealized gains $95 -- 95 95 Other comprehensive income 95 Net income 5,042 5,042 -- 5,042 Comprehensive income $5,137
Balances at December 31, 1998 111 317 78,816 (56,619) 79 22,704
Net proceeds from the exercise of stock options -- 4 128 -- -- 132 Redemption of Common Stock -- (28) (1,981) -- -- (2,009) Dividend on Preferred Stock -- -- -- (12) -- (12) Other comprehensive income Net unrealized losses $(1,179) -- (1,179) (1,179) Other comprehensive loss (1,179) Net income 3,865 3,865 -- 3,865 Comprehensive income $2,686
Balances at December 31, 1999 $111 $293 $76,963 $(52,766)$(1,100) $23,501
The accompanying notes are an integral part of the consolidated financial statements.
The San Francisco Company Consolidated Statements of Cash Flows For the Years Ended December 31, 1999, 1998 and 1997
(Dollars in Thousands 1999 1998 1997
Cash Flows from Operating Activities: Net income $3,865 $5,042 $5,442 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision (adjustment) for loan losses 100 (1,627) (2,820) Benefit for income taxes (800) (600) (1,500) Depreciation and amortization expense 1,161 533 535 Net gain on sale of real estate owned and other assets (70) (480) (477) Provision for other real estate owned and real estate investment -- -- 182 Loss on sale of investment securities available for sale -- -- 6 (Increase) decrease in interest receivable and other assets (46) (34) 79 Increase (decrease) in other liabilities and interest payable 317 (726) 757 Increase (decrease) in deferred loan fees (4) 83 (129) Net cash flows provided by operating activities 4,523 2,191 2,076
Cash Flows from Investing Activities: Purchase of Federal Home Loan Bank stock, net (106) (472) (829) Proceeds from maturities of investment securities held-to-maturity 1,893 2,018 1,079 Proceeds from sales of investment securities available-for-sale -- -- 9,120 Purchase of investment securities available-for-sale (12,671)(32,562)(18,600) Proceeds from maturities of investment securities available-for-sale 13,491 31,091 5,214 Capital expenditures for real estate owned -- -- 28 Net increase in loans (20,632)(22,056) (8,162) Net (charge-offs) recoveries of loans previously charged off (200) 52 397 Purchases of premises and equipment (173) (288) (267) Purchase of equipment under operating lease (2,901) (2,000) -- Proceeds from sales of real estate owned and investment, and other assets 23 839 4,952 Net cash used in investing activities (21,276)(23,378) (7,068)
Cash Flows from Financing Activities: Net increase (decrease) in deposits 43,223 9,169 (4,647) Net increase in other borrowings -- 10,000 10,000 Cash dividend on Series B Preferred Stock (12) (63) -- Redemption of Class A Common Stock (2,009) -- -- Net proceeds from sale of stock 132 2 1,000 Net cash provided by financing activities 41,334 19,108 6,353 Increase (decrease) in cash and cash equivalents 24,581 (2,079) 1,361 Cash and cash equivalents at beginning of year 14,908 16,987 15,626 Cash and cash equivalents at end of year $39,489 $14,908 $16,987
The accompanying notes are an integral part of the consolidated financial statements. (continued)
The San Francisco Company Consolidated Statements of Cash Flows For the Years Ended December 31, 1999, 1998 and 1997 (continued)
(Dollars in Thousands) 1999 1998 1997
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for: Interest $4,002 $3,386 $2,811 Income taxes 65 21 6
The accompanying notes are an integral part of the consolidated financial statements.
The San Francisco Company Notes to Consolidated Financial Statements December 31, 1999 and 1998
Note 1: Statement of Accounting Policies
The accounting and reporting policies of The San Francisco Company (the "Company") and its subsidiaries are in accordance with generally accepted accounting principles and practices within the banking industry.
Organization
The Company is a Delaware corporation and a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was organized in 1981 under the laws of the State of California, and in July, 1988, the Company reincorporated in Delaware. Bank of San Francisco (the "Bank"), a state chartered bank, was organized as a California banking corporation in 1978 and became a wholly owned subsidiary of the Company through a reorganization in 1982. The Bank specializes in providing private banking and business banking for professional individuals, their business and other businesses primarily in the Northern California banking market. The Bank's wholly owned subsidiary, Bank of San Francisco Realty Investors (the "BSFRI"), invested in real estate investment properties from 1985 to 1996. During 1996, BSFRI disposed of all of its real estate investment properties.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company, the Bank, and the Bank's wholly owned subsidiary, BSFRI. BSFRI is no longer active in real estate investment activities. All material intercompany transactions have been eliminated in consolidation.
Cash and Cash Equivalents and Statements of Cash Flows
Cash equivalents are defined as short-term, highly liquid investments both readily convertible to known amounts of cash and so near maturity that there is insignificant risk of change in value because of changes in interest rates. Generally, only investments with maturities of three months or less at the time of purchase qualify as cash equivalents. Cash and cash equivalents include cash and due from banks, time deposits with other financial institutions, and Federal funds sold.
The Bank is required to maintain non-interest bearing cash reserves equal to a percentage of certain deposits. In 1999 and 1998, the average reserve balances outstanding were $1,103,000 and $879,000, respectively. Generally, the Bank does not maintain compensating balance arrangements.
Investment Securities
The Company classifies its investment securities into one of two categories: held-to-maturity or available-for-sale. The investments classified as held-to-maturity are carried at amortized cost because management has both the intent and ability to hold these investments to maturity. Investments classified as available-for-sale are carried at fair value with any unrealized gains and losses included as a component of accumulated other comprehensive income in shareholders' equity.
Investment securities include debt securities and Federal Home Loan Bank (the "FHLB") Stock. Any discounts or premiums are accreted or amortized to income over the expected term of the investment considering prepayment assumptions, if applicable. Discounts or premiums are adjusted periodically to reflect actual prepayment experience. The gain or loss on all investment securities sold is determined based on the specific identification
method. The estimated fair value is based on quoted market prices and/or third party dealer quotes. FHLB stock is recorded at cost and is redeemable at par value.
Loans and Leases
Loans are stated at the principal amount outstanding, net of the allowance for loan and lease losses, deferred fees and unearned discount, if any. The Bank holds loans receivable primarily for investment purposes. A significant portion of the Bank's loan portfolio is comprised of adjustable rate loans.
Interest on loans is calculated using the simple interest method on the daily balances of the principal amount outstanding. The accrual of interest is discontinued and any accrued and unpaid interest is charged against current income when the payment of principal or interest is 90 days past due, unless the loan is well-secured and in the process of collection. When the ability to fully collect non-accrual loan principal is in doubt, cash payments received are applied against the principal balance of the loan until such time as full collection of the remaining recorded balance is expected. Generally, loans with temporarily impaired values and loans to borrowers experiencing financial difficulties are placed on non-accrual status even though the borrowers continue to repay the loans as scheduled. Interest received on such loans is recognized as interest income when received. A non-accrual loan is restored to an accrual basis when principal and interest payments are being paid currently and full payment of principal and interest is probable.
Lease financing receivables, net of unearned income, are included in loans. Unearned income related to lease financing receivables is recognized in income over the life of the lease under a method that yields an approximately level rate of return on the unrecovered lease investment.
Loan Fees
The Bank charges nonrefundable fees for originating loans. Loan origination fees, net of the direct costs of underwriting and closing the loans, are deferred and amortized to interest income using the interest method. Unamortized net fees and costs on loans sold or paid in full are recognized as income. Other loan fees and charges, which represent income from delinquent payment charges, and miscellaneous loan services, are recognized as interest income when collected.
Allowance for Loan and Lease Losses
Generally, the Bank charges current earnings with provisions for estimated losses on loans receivable. However, the Bank will record an allowance for loan and lease loss adjustment if the total allowance for loan and lease losses exceeds the amount of estimated losses. The provision or adjustment takes into consideration the adequacy of the total allowance for loan and lease losses giving due consideration to specifically identified problem loans, the financial condition of the borrowers, the fair value of the collateral, recourse to guarantors, and other factors. At December 31, 1999 and 1998, the management believes the allowance for loan and lease losses adequately reflects the credit risks in the loan and lease portfolio.
The allowance for loan and lease losses takes into consideration numerous factors including the financial condition of the borrowers, the fair value of the collateral prior to the anticipated date of sale, collateral concentrations and past loss experience. These allowances are subjective and may be adjusted in the future depending on economic conditions. In addition, regulatory examiners may require the Company to provide additional allowances based on their judgements of the information regarding problem loans and credit risks available to them at the time of their examinations.
Losses are recognized as charges to the allowance when the loan or a portion of the loan is considered uncollectible or at the time of foreclosure. Recoveries on loans receivable previously charged off are credited to allowance for loan and lease losses.
Premises and Equipment
Premises and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation on furniture, fixtures and equipment is computed on the straight-line method over the estimated useful life of each type of asset. Estimated useful lives are from three to seven years. Leasehold improvements are amortized over the term of the applicable lease, including lease extensions, or their estimated useful lives, whichever is shorter.
Operating Lease Equipment
Equipment is stated at cost net of accumulated depreciation and is leased to third parties under lease agreements. The equipment has an estimated useful life of 68 months and is depreciated using a straight-line method. Lease payments are recognized as non-interest income and the depreciation expense is recognized as non-interest expense.
Other Real Estate Owned
Other real estate owned (the "OREO") includes loans receivable that have been repossessed in settlement of debt (foreclosures). At the date of transfer, OREO is recorded at fair value net of estimated selling costs.
The Company provides a charge against current earnings for estimated losses on foreclosed property when the carrying value of the property exceeds its fair value net of estimated selling expenses. The Bank obtains an appraisal or market valuation analysis on all other real estate owned. If the periodic valuation indicates a decline in the fair value below recorded carrying value, an allowance for OREO losses is established. Fair value is based on current market conditions, appraisals, and estimated sales values of similar properties.
Impairment of Long-lived Assets
Long-lived assets and certain identifiable intangibles held and used by the Company are reviewed for impairment whenever events or changes indicate that the carrying value of the asset may not be recoverable. Recoverability of long-lived assets is measured by a comparison of the carrying value of the asset to future net undiscounted cash flows expected to be generated by that asset. As of December 31, 1999, the Company determined that no events or changes occurred during 1999 that would indicate that the carrying value of any long-lived assets may not be recoverable.
Other Assets
Other assets included operating lease equipment owned by the Bank and deferred tax assets discussed below.
Income Taxes
The Company uses the asset and liability method to account for income taxes. Under such method, deferred tax assets and liabilities are recognized for the future tax consequences of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases (temporary differences). Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period of enactment.
A valuation allowance is established to the extent that it is not more likely than not that the benefits associated with the deferred tax assets will be realized.
Stock-based Compensation
The Company has elected to use the intrinsic value based method of accounting under APB No. 25 for its stock-based compensation and to provide supplemental disclosure of its stock- based compensation.
Non-Interest Income
Fees for other customer services represent fees earned for the brokerage of certificates of deposit and escrow services, and commissions earned in connection with the Bank's stock option lending program and other banking services. Fees for services are recorded as income when the services are performed.
Earnings per Share (the "EPS")
Basic EPS is calculated dividing net income by the weighted average number of common shares outstanding. The dilutive EPS is calculated giving effect to all potentially dilutive common shares, such as certain stock options, that were outstanding during the period.
The following tables present a reconciliation of the amounts used in calculating basic and diluted EPS for each of the periods shown.
(dollars in thousands except Per-share amounts) Per-share 1999 Income Shares amount
Basic EPS $3,857 31,541,826 $0.12 Effect of dilutive securities: Series B Preferred Stock 8 793 Stock options -- 1,643,380 Diluted EPS $3,865 33,185,999 $0.12
Per-share 1998 Income Shares amount
Basic EPS $5,034 31,727,138 $0.16 Effect of dilutive securities: Series B Preferred Stock 8 793
Stock options -- 1,334,782 Diluted EPS $5,042 33,062,713 $0.15
Per-share 1997 Income Shares amount
Basic EPS $5,443 30,393,679 $0.18 Effect of dilutive securities: Series B Preferred Stock 58 793
Stock options -- 250,015 Diluted EPS $5,501 30,644,487 $0.17
Use of Estimates
The preparation of these financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of recognized and contingent assets and liabilities at the date of the financial statements and the reporting amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. Recently, SFAS No. 137 was issued amending the effective date of SFAS No. 133 as the fiscal year beginning January 1, 2001. As of December 31, 1999, the Company did not have any derivative instruments or engage in hedging activities.
The Company has evaluated its business activities in accordance with the provisions of SFAS No. 131 "Disclosure about Segments of an Enterprise and Related Information" and determined that its operating segments have similar economic characteristics such as products and services, production process, customers, methods used to distribute products and services, and regulatory environment resulting in their aggregation. The adoption of this statement effective for year-end 1998 financial statements did not have a material impact on the Company's financial statements.
Regulatory
On December 4, 1998, the Federal Reserve Board announced that Mr. Putra Masagung and PT Gunung Agung, the beneficial owners of 97.8% of the Company's outstanding Common Stock entered into a Voting Trust Agreement (the "Agreement"). Mr. Masagung and PT Gunung Agung retained their individual beneficial interest but collectively transferred voting control the Company's Common Stock to a Trustee under the terms of the Agreement effective January 4, 1999 which has been filed with the Securities and Exchange Commission. Under the terms of the Agreement, the Trustee shall dispose of the shares upon instructions from Mr. Masagung and PT Gunung Agung by July 4, 2001.
Reclassifications
Certain reclassifications have been made in the prior years' consolidated financial statements to conform to the current year presentation.
Note 2: Investment Securities
The amortized cost and estimated market values of investment securities held-to-maturity at December 31, are as follows:
Amortized Unrealized Unrealized Market (Dollars in Thousands) Cost Gains Losses Value
1999: Mortgage-backed securities $1,953 -- $(49) $1,904 Total $1,953 -- $(49) $1,904
1998: Mortgage-backed securities $3,846 $6 $(1) $3,851 Total $3,846 $6 $(1) $3,851
The amortized cost and estimated market values of investment securities available-for-sale at December 31 are as follows:
Amortized Unrealized Unrealized Market (Dollars in Thousands) Cost Gains Losses Value 1999: Fixed rate mortgage- backed securities $13,972 -- $(324) $13,648 U.S. Treasury and agency securities 19,364 -- (776) 18,588 Total $33,336 -- $(1,100) $32,236
1998: Fixed rate mortgage- backed securities $12,810 $67 $(4) $12,873 U.S. Treasury and agency securities 21,346 26 (10) 21,362 Total $34,156 $93 $(14) $34,235
For 1999 and 1998, the Company included a net unrealized loss of $1,100,000 and a net unrealized gain of $79,000, respectively, as a component of accumulated other comprehensive income under shareholders' equity. The Company recorded no gains or losses on sale of investment securities during 1999 and 1998.
As of December 31, 1999 and 1998, the Bank's investment in FHLB stock totaled $2.1 million and $2.0 million and is stated at par.
The amortized cost and estimated market value of securities at December 31, 1999 by contractual final maturity, are shown below:
Securities Available Securities for Sale Held to Maturity Amortized Estimated Amortized Estimated (Dollars in Thousands) Cost Market Value Cost Market Value
1 to 5 years $14,268 $13,799 -- -- More than 5 years 5,096 4,789 -- -- Subtotal 19,364 18,588 -- -- Mortgage-backed securities 13,972 13,648 $1,953 $1,904 Total $33,336 $32,236 $1,953 $1,904
The average yield on investments securities was 6.0% during 1999 and 1998. The investment securities held by the Company had weighted average maturities of less than three years. Weighted average maturities of mortgage-backed securities can differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties. Factors such as prepayments and interest rates may affect the yield and carrying value of mortgage-backed and callable agency securities. As of December 31, 1999 and 1998, the Company had no derivative financial instruments.
At December 31, 1999 and 1998, $600,000 of securities were pledged as collateral for treasury, tax, loan deposits, public agency, bankruptcy and trust deposits. At December 31, 1999, $23.9 million of investment securities and $31.6 million of loans were pledged as collateral for the $20.0 million FHLB borrowing.
Note 3: Loans and Leases
The Bank's loan and lease portfolio at December 31, is summarized as follows:
(Dollars in Thousands) 1999 1998
Real estate mortgage $67,914 $50,845 Secured commercial and financial 9,386 10,054 Unsecured 13,344 11,771 Other loans and leases 3,968 1,310 Total loans and leases 94,612 73,980 Deferred fees (140) (144) Allowance for loan and lease losses (1,525) (1,625) Total loans and leases, net $92,947 $72,211
At December 31, 1999 and 1998, non-accrual loans totaled zero, and there were no loans past due 90 days or more and still accruing. For the years ended December 31, 1999, 1998 and 1997 interest income foregone on non-accrual loans was $8,000, zero, and $2,000, respectively. Restructured loans totaled zero at December 31, 1999 and 1998. For the years ended December 31, 1999, 1998 and 1997, no interest income was foregone on restructured loans.
A loan is considered impaired when, based on certain events and information, it is "probable" that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. At December 31, 1999 and 1998, there were no impaired loans outstanding. For the year ended December 31, 1999 and 1998, the weighted average impaired loans outstanding was $35,000 and $34,000, respectively. Total interest income recognized on impaired loans during 1999 and 1998 was zero and $3,000, respectively.
The Company's business activities are with clients in Northern California primarily the greater San Francisco Bay Area. As of December 31, 1999, the Company had $73.3 million in loans secured by real estate located in Northern California including 34.4% located in San Francisco. The primary source of repayment of real estate loans is the borrower's or property's debt service capacity while the secondary source of repayment is the underlying real estate collateral. As of December 31, 1999, the Company had $28.2 million in commitments on unsecured loans of which 47.3% were outstanding. The primary source of repayment on the unsecured loans is the borrowers net worth and cash flow.
Note 4. Allowance for Loan and Lease Losses
Changes in the Company's allowance for loan and lease losses for the years ended December 31, were as follows:
(Dollars in Thousands) 1999 1998 1997
Balances at beginning of the year $1,625 $3,200 $5,663 Provision (adjustment) for loan and lease losses 100 (1,627) (2,820) Loans charged off (200) -- (40) Recoveries of loans charged off -- 52 397 Balances at end of the year $1,525 $1,625 $3,200
Note 5: Other Real Estate Owned
Other real estate owned at December 31, consist of the following:
(Dollars in Thousands) 1999 1998
Real Estate: Residential development -- $217 Commercial development -- -- Raw land -- -- Subtotal -- 217 Allowance for losses -- (166) Total -- $51
In 1999, the Company sold OREO that had an original book value of $217,000 and a net book value, at December 31, 1998, totaling $51,000. In 1999 and 1998, the Company recorded net gains on sale totaling $71,000 and $480,000, respectively.
The following table summarizes the changes in the allowance for losses related to OREO for the periods shown:
(Dollars in Thousands) 1999 1998 1997
Balance of allowance for losses - beginning of the year $166 $3,242 $9,111 Charge-offs (166) (3,076) (6,051) Provision -- -- 182 Balance of allowance for losses - end of the year -- $166 $3,242
Note 6: Premises and Equipment, net
Premises and equipment at December 31, consist of the following:
(Dollars in Thousands) 1999 1998
Leasehold $3,616 $3,616 Leasehold improvements 8,784 8,700 Furniture and equipment 1,806 1,747 Subtotal 14,206 14,063 Less: Accumulated depreciation and amortization (7,055) (6,517) Total $7,151 $7,546
The amount of depreciation and amortization included in non-interest expense was $566,000, $533,000, and $535,000 in 1999, 1998 and 1997, respectively. Total rental and other occupancy expenses net of sublease income for the Company's premises were $67,000, $154,000 and $326,000 in 1999, 1998 and 1997.
At December 31, 1999, the approximate future minimum rental expense payments under a non-cancelable operating lease, with a remaining term of eleven years, for the Company's premise are as follows:
(Dollars in Thousands) Amount
2000 $134 2001 134 2002 134 2003 134 2004 134 Thereafter 782 Total $1,452
The lease payment is fixed until the expiration of the lease on October 31, 2010.
During 1999, 1998 and 1997, the Company received $1,241,000, $1,114,000 and $864,000 of sublease income, respectively. The sublease income payments in the following table are not reflected in the table above. At December 31, 1999, the approximate future minimum rental income payments under non-cancelable subleases, with remaining terms over the next five years, of the Company's premise are as follows:
(Dollars in Thousands) Amount
2000 $1,192 2001 1,056 2002 765 2003 257 2004 66 Thereafter -- Total $3,336
Note 7: Operating Lease Equipment
The following schedule provides an analysis of the Company's investment in property on operating leases by major classes as of December 31,:
(Dollars in Thousands) 1999 1998 Test equipment $4,901 $2,000 Less: Accumulated Depreciation (595) - Total $4,306 $2,000
The test equipment has an estimated useful life of 68 months and is leased under short-term rental agreements for periods ranging from one week to six months. Rental revenue received in 1999 and 1998 totaled $1.0 million and zero, respectively.
Note 8: Deposits
Deposit balances and average interest rates paid by the Bank at December 31, are as follows:
1999 1998 Average Average (Dollars in Thousands) Balance Rate Balance Rate
Demand deposit accounts $32,676 0.0% $18,237 0.0% Money market and savings accounts 38,354 2.9 19,998 1.9 NOW accounts 27,555 1.9 17,838 2.2 Time accounts 40,326 4.6 39,615 4.8 Total $138,911 2.5% $95,688 2.8%
Total deposit balances averaged $108.6 million and $94.0 million during 1999 and 1998, respectively, with average interest rates of 2.5% and 2.8%, respectively. The weighted average stated rates on deposits as of December 31, 1999 and 1998 were 2.5% and 2.8%, respectively.
Domestic time deposits in amounts of $100,000 or more by time remaining to maturity at December 31, are as follows:
(Dollars in Thousands) 1999 1998
Three months or less $19,091 $15,774 Three months to six months 631 953 Six months to one year 5,364 2,015 Between one and two years 421 2,500 Total $25,507 $21,242
Interest expense on time deposits in amounts of $100,000 or more was $900,000, $809,000 and $589,000 in 1999, 1998, and 1997, respectively. Time deposit accounts in amounts of $100,000 or more averaged $21.7 million and $16.7 million during 1999 and 1998, respectively, with weighted average rates of 4.1% and 4.8%, respectively. The weighted average stated interest rate on such deposits at December 31, 1999 and 1998 was 4.3% and 4.4%, respectively.
Note 9: Other Borrowings
Other borrowings at December 31, are as follows:
Maximum Balance Stated Average Average Balance (Dollars in Thousands) Outstanding Rate Balance Rate Outstanding 1999: FHLB borrowings: Long-term $15,000 5.7% $17,910 5.7% $18,000 Short-term 5,000 6.3 2,003 4.2 2,000 Total $20,000 5.9% $19,913 5.6% $20,000
1998: FHLB borrowings: Long-term $18,000 5.6% $10,545 6.0% $18,000 Short-term 2,000 5.1 99 5.1 $2,000 Total $20,000 5.5% $10,644 6.0% $20,000
The following table sets forth the maturities of the FHLB borrowings, as of December 31, 1999, of the borrowings:
Over More Than Less than 1 Year 4 Years to (Dollars in Thousands) 1 Year to 3 Years 5 Years Total
Fixed rate borrowing $5,000 $5,000 $5,000 $ 15,000 Adjustable rate borrowing -- -- 5,000 5,000 Total other borrowings $5,000 $5,000 $10,000 $20,000
The Bank has a credit facility available with the FHLB for up to $22.4 million as of December 31, 1999. At December 31, 1999 and 1998, $55.5 million and $25.0 million of loans and securities were pledged as collateral against other borrowings. The Bank is required to hold FHLB stock as a condition for maintaining its membership in the FHLB.
The Bank has access to the discount window at the Federal Reserve Bank (the "FRB") for a total borrowing facility of $2.8 million upon the pledge of securities. At December 31, 1999, no securities are pledged as collateral for the FRB facility.
Note 10: Income Taxes
The (benefit) provision for income taxes for the years ended December 31, consists of:
(Dollars in Thousands) 1999 1998 1997
Current: Federal $49 $(472) -- State 19 12 $6 Total current 68 (460) 6
Deferred: Federal (464) (680) (1,065) State (336) 80 (435) Total deferred (800) (600) (1,500) Total benefit for income taxes $(732) $(1,060) $(1,494)
The provision for income taxes for 1999 consists of state tax minimum amounts due, alternative minimum tax, and recognition of the tax benefit of certain deferred tax assets including temporary differences and net operating loss carryforwards.
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1999 and 1998 are presented below:
(Dollars in Thousands) 1999 1998 Deferred Tax Assets: Net operating losses $15,982 $17,645 Tax credits 489 489 Unrealized loss on investment securities available for sale 453 -- Allowance for loan and lease losses 75 45 Other provisions 51 33 Provision for losses on real estate -- 68 Net tax value of premises in excess of book -- 124 Other 354 272 Total deferred tax assets 17,404 18,676 Valuation allowance (14,042) (16,107) Total deferred tax assets, net 3,362 2,569
Deferred Tax Liabilities: Net book value of premises in excess of tax (47) -- Loan origination costs (97) (101) Unrealized gain on investment securities available for sale -- (33) Taxable income in excess of book for rehabilitation credit (318) (335) Total deferred tax liabilities (462) (469) Net deferred taxes $2,900 $2,100
As required by SFAS No. 109, the realizability of the deferred tax assets is reevaluated and the valuation allowance is adjusted so that the resulting level of deferred tax asset will, more likely than not, be realized. During 1999 and 1998, an adjustment of $800,000 and $600,000, respectively, to the amount of realizable deferred tax assets was recorded based on a determination that the Company is more likely than not able to utilize deferred tax assets that had previously been reserved.
The total tax provision (benefit) rate differs from the statutory federal rate for the reasons shown in the following table:
1999 1998 1997
Tax expense at the statutory federal rate 34.0% 34.0% 34.0% Utilization of prior year taxable losses 0.0 0.0 (34.2) State income taxes (refund), net of federal tax benefit 7.3 8.5 0.2 Non-deductible expenditures and non-taxable income 3.4 0.5 0.0 Expiration of state net operating loss carryforwards 8.1 10.8 0.0 Realization of previously deferred tax benefits 0.0 (12.0) 0.0 Change in valuation allowance (76.1) (68.4) (38.0) Total effective tax benefit rate (23.3) %(26.6)% (38.0)%
As of December 31, 1999, the Company has net operating loss carryforwards for federal tax purposes of approximately $44.7 million which begin expiring in 2007, and for California tax purposes of approximately $10.8 million, which began expiring in 1999. As of December 31, 1999, the Company had rehabilitation tax credit carryforwards for federal tax purposes of approximately $213,000, which expire in 2004 and 2005, and minimum tax credits of approximately $276,000 which have no expiration.
Note 11: Shareholders' Equity
In 1997, the Company received capital contributions totaling $1.0 million resulting in the issuance of 2,947,787 shares of Class A Common Stock (the "Common Stock") at $0.34 per share. In 1999, the Company redeemed and retired 2,802,769 shares of Common Stock.
Description of Capital Stock
The authorized capital stock of the Company consists of 100,000,000 Common Shares, par value $0.01 per share and 5,000,000 shares of preferred stock, par value $0.01 per share, of which 437,500 are designated as Series B Preferred Shares. The remainder are not designated.
Description of Common Stock
As of December 31, 1999, there were 29,317,558 Common Shares outstanding out of a total of 100,000,000 shares authorized. The Series B Preferred Shares, which were convertible into shares of the Class B Common Stock at the option of the holders thereof are now convertible to Common Stock. The reclassification is not deemed by the Company to alter or change any of the relative powers, preferences or special rights of the holders of the Class B Preferred shares.
Dividends
After payment of dividends at the stated rate on all series of preferred stock that the Company may issue in the future and that are designated senior, each share of Common Stock is entitled to receive dividends if, as and when declared by the Board of Directors of the Company. Any dividend so declared and payable in cash, capital stock of the Company or other property will be paid equally, share for share, on the Common Stock, Series B Preferred Shares, and on any other participating series of preferred stock issued in the future; provided, however, that the Company may issue dividends consisting solely of its Common Shares on the Common Stock.
Liquidation Rights
In the event of the liquidation, dissolution or winding up of the Company, holders of the Common Stock are entitled to share equally, share for share, in the assets available for distribution, subject to the liquidation preferences of the Series B Preferred Shares and the rights of any other class or series of preferred stock then outstanding.
Voting Rights
Holders of Common Stock are entitled to one vote per share. Except as described below, holders of Common Stock vote together with holders of the Company's Series B Preferred Shares, on all matters including the election of directors. The Board of Directors is presently authorized to have nine (9) members. The Board of Directors is a classified Board with staggered terms providing for a maximum of three classes of directors, which are as nearly equal in number as possible, and with one class elected each year for a maximum term of three years. Holders of Common Stock are not entitled to vote cumulatively for the election of directors.
The holders of Common Stock are entitled to vote as separate classes on any modification to the rights of either class of stock and as otherwise required by law.
Description of Preferred Stock
The Board of Directors of the Company is authorized by the Certificate of Incorporation to provide for the issuance of one or more series of preferred stock. The Board of Directors has the power to fix various terms with respect to each such series, including voting powers, designations, preferences, dividend rates, conversion and exchange provisions, redemption provisions, and the amounts which holders are entitled to receive upon any liquidation, dissolution, or winding up of the Company. As of December 31, 1999, the Board of Directors authorized only the issuance of the Series B Preferred Shares. The Company's Certificate of Incorporation provides that additional securities, including additional shares of any class of preferred stock, can be issued only if unanimously approved by the Board of Directors or by stockholders holding a majority of the voting power of the Company.
Description of Series B Preferred Stock
The Company issued the Series B Preferred Shares during 1988. As of December 31, 1999, there were 15,869 Series B Preferred Shares outstanding.
Dividends
Holders of the Series B Preferred Shares are entitled to receive, when funds of the Company are legally available for payment, an annual cash dividend of 8% per annum or Fifty-Six Cents ($0.56) per share, payable semi-annually in January, and July of each year. Dividends on the Series B Preferred Shares are cumulative.
Payment of dividends on the Series B Preferred Shares shall be junior to payment of dividends at the stated rate of all other series of preferred stock that the Company may issue in the future and that are designated senior to the Series B Preferred Shares. Dividends on the Series B Preferred Shares will be declared and paid or set apart for payment in full for all previous dividend periods (i) before the payment or setting apart of any funds or assets for the payment of any dividends on the Common Stock or any other class of stock, except preferred stock ranking on a parity with or senior to the Series B Preferred Shares, and (ii) before any purchase or other acquisition for value of any Common Stock or any future class of stock except preferred stock ranking on a parity with or senior to the Series B Preferred Shares; provided, however, that the Company may issue dividends consisting of its Common Shares on the Common Shares.
After payment of dividends at the stated rate on all series of preferred stock that the Company may issue in the future and that are designated senior to the Series B Preferred Shares and on any other preferred stock of the Company that is on a parity with the Series B Preferred Shares, and payment of dividends at the stated rate on the
Series B Preferred Shares, holders of the Series B Preferred Shares will participate pro rata with the holders of Common Stock, on the basis of number of shares owned, in all other dividends by the Company to its stockholders, except that, as noted above, the Company may issue dividends consisting solely of its Common Shares on the Common Shares.
Liquidation Rights
In the event of any liquidation, dissolution, receivership, bankruptcy, or winding up of the Company, voluntarily or involuntarily, the holders of the Series B Preferred Shares are entitled to receive the sum of Seven Dollars ($7.00) per share, plus any accrued and unpaid dividends thereon, before any distributions will be made to the holders of the Common Stock or any other class of stock junior in preference upon liquidation, but after or concurrent with distributions to be made at the stated rate on preferred stock of any series ranking on a parity with or senior in preference upon liquidation to the Series B Preferred Shares, and will be entitled to no other distribution.
Conversion
The holders of Series B Preferred Shares are entitled at any time to convert their Series B Preferred Shares into Common Stock of the Company at the conversion ratio of one Series B Preferred Share convertible into one-tenth of one share of Common Stock, upon payment of a conversion fee of Seven Dollars ($7.00) per share, subject to adjustment under certain conditions.
Voting Rights
The holders of the Series B Preferred Shares are entitled to one vote per Series B Preferred Share on all matters on which shareholders are entitled to vote. Holders of the Series B Preferred Shares have full voting rights and powers equal to the voting rights and powers of the holders of the Common Stock. Holders of the Series B Preferred Shares are entitled to vote generally for the election of directors and vote with the holders of the Common Stock, except that the holders of the Series B Preferred Shares are entitled to vote as a class on any modification to the rights of the Series B Preferred Shares and otherwise as required by law.
Note 12: Stock Option Plan
During 1996, the Company's stockholders approved the Amended and Restated 1993 Stock Option Plan (the "Plan"). Pursuant to the Plan, options may be granted to directors and key employees of the Company and its subsidiaries. The shares of Common Stock reserved for the Plan total 4,325,069 shares. The number of shares granted may be subject to adjustment as determined by a Committee of the Board of Directors. The exercise price of options must be at least the fair market value of the shares of the Company's Common Stock as of the date the option is granted. The expiration date of the options is ten years from the effective date that the options were granted. As of December 31, 1999, 403,278 of the options granted have been exercised. The agreements for certain executive officers and former executive officers provide that options shall be granted to acquire shares of Common Stock under the Plan equal to 9% of the fully-diluted shares of the Company's Common Stock, with additional shares to be issued in the future to maintain the 9% ratio.
The following table provides the fair value of stock options granted in 1998 and 1997. There were no stock options granted in 1999. The fair value was calculated using the following assumptions in the Black Scholes option-pricing model:
1999 1998 1997 Expected dividend yield -- 0.0% 0.0% Risk-free interest rate -- 4.54% 5.35% Expected life -- 2.5 yrs 2.75 yrs Volatility factor -- 0.431 0.253 Fair value of options granted -- $0.08 $0.08
The Company has not recognized any compensation costs for the stock options in the financial statements. The proforma net income reflects only options vested in 1999, 1998, and 1997. Had the Company determined compensation cost based on fair value at the date of grant for its stock options, the Company's net income would have been the proforma amounts indicated below:
1999 1998 1997 Net income - as reported (dollars in thousands) $3,865 $5,042 $5,443 proforma 3,839 5,026 5,355
Earnings per share -Basic $0.12 $0.16 $0.18 Diluted 0.12 0.15 0.17
Proforma per share -Basic $0.12 $0.16 $0.18 Diluted 0.12 0.15 0.17
The following table provides the stock option activity for each period presented:
December 31, 1999 December 31, 1998 December 31, 1997 Weighted Average Weighted Average Weighted Average Number of Exercise Number of Exercise Number of Exercise Shares Price Shares Price Shares Price Balance at beginning of year 4,313,458 $0.99 3,672,033 $1.08 3,029,500 $1.24 Granted -- -- 646,425 0.45 668,971 0.34 Exercised 391,667 0.34 5,000 0.34 6,611 0.34 Expired 17,000 0.45 -- -- 19,827 0.34 Balance at end of year 3,904,791 $1.06 4,313,458 $0.99 3,672,033 $1.08
At December 31, 1999, the range of exercise prices and remaining contractual life of outstanding options was $0.34 and $5.68, respectively, and four (4) years and nine (9) years, respectively. Generally, the stock options vest within a three year period. The following table provides stock option information as of December 31, 1999:
Options Outstanding Options Exercisable Weighted- Weighted- Weighted- average Remain- average Number average Range of Number ing Contrac- Exercise Exer- Exercise Exercise price Outstanding tual life Price cisable Price $0.34 - $0.45 3,394,298 7.70 years $0.36 2,826,332 $0.34 $4.50 - $5.68 510,493 4.75 years $5.68 484,970 $5.68
Note 13: Regulatory Capital Requirements
The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by 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 judgements by the regulators regarding the Bank's capital components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios, as set forth below, of total and Tier I capital, as defined by regulations, to risk weighted assets, and Tier I capital to average assets.
As of December 31, 1999, the most recent notification from the FDIC categorized the Bank as Well Capitalized under the regulatory framework for prompt corrective action.
The following table sets forth the Bank's capital amounts and ratios as of December 31, for each of the periods shown:
To be Well (dollars in thousands) Capitalized Under For Capital Prompt Corrective Actual Adequacy purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio
1999: Total risk-based capital $24,506 19.1% $10,248 8.0% $12,810 10.0% Tier 1 capital 22,981 18.0 5,121 4.0 7,682 6.0 Leverage capital 22,981 13.8 6,674 4.0 8,343 5.0
1998: Total risk-based capital $22,620 22.8% $7,945 8.0% 9,931 10.0% Tier 1 capital 21,374 21.4 3,988 4.0 5,981 6.0 Leverage capital 21,374 16.1 5,296 4.0 6,621 5.0
Note 14: Employee Benefit Plans
Employee 401K Plan
The Company provides a 401k plan for its employees. The Company provides matching contributions up to 2% of the employees qualifying earnings. During 1999, 1998, and 1997, the Company contributed $49,000, $47,000 and $41,000, respectively, to the 401k Plan.
Note 15: Commitments and Contingencies
Lending and Letter of Credit Commitments
In the normal course of its business, the Bank has entered into various commitments to extend credit which are not reflected in the consolidated financial statements. Over 90% of such commitments consist of the undisbursed balance on personal and commercial lines of credit and of undisbursed funds on construction and development loans. At December 31, 1999 and 1998, the Bank had outstanding loan commitments, which had primarily adjustable rates, totaling approximately $25.3 million and $20.9 million, respectively. In addition, the Bank had outstanding letters of credit, which represent guarantees of obligations of Bank customers, totaling $790,000 and $1.1 million at December 31, 1999 and 1998, respectively. The actual liquidity needs or the credit risk that the Company will experience will be lower than the contractual amount of commitments to extend credit because a significant portion of these commitments are expected to expire without being drawn upon. The Bank's outstanding loan commitments are made using the same underwriting standards as comparable outstanding loans. The credit risk associated with these commitments is considered in management's determination of the allowance for loan losses.
Litigation
Because of the nature of its business, the Company and its subsidiaries, including the Bank, are from time-to-time a party to legal actions. Based upon information available to the Company and the Bank, and its review of such outstanding claims to date, management believes the ultimate liability relating to these actions, if any, will
not have a material adverse effect on the Company's liquidity, consolidated financial condition or results of operations.
Note 16: Related Party Transactions
Loans
In the ordinary course of business, the Bank may extend credit to directors, officers, shareholders and their associates on substantially the same terms, including interest rates and collateral, as in comparable loan transactions with unaffiliated persons, and such loans do not involve more than the normal risk of collection. As of December 31, 1999 and 1998, there were no loans outstanding to such individuals.
Note 17: Fair Value of Financial Instruments
The following disclosures of the estimated fair value of financial instruments are made in accordance with the requirements of SFAS No. 107. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgement is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount 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.
The carrying amount and estimated fair values of the Company's financial instruments at December 31, are as follows:
1999 1998 Carrying Fair Carrying Fair (Dollars in Thousands) Amount Value Amount Value
Financial Assets: Cash and cash equivalents $39,489 $39,489 $14,908 $14,908 Investment securities 36,266 36,217 40,052 40,057 Loans, net 92,947 92,600 72,211 72,783
Financial Liabilities: Deposits 138,911 138,900 95,688 95,877 Other borrowings 20,000 19,625 20,000 20,176
The following methods and assumptions were used to estimate the fair value of each major classification of financial instruments at December 31, 1999 and 1998:
Cash and Cash Equivalents: Current carrying amounts approximate estimated fair value. Due to the short term nature of time deposits with other financial institutions (original maturities of 90 days or less), current carrying amounts approximate market.
Investment Securities Held-to-Maturity and Available-for-Sale, and FHLB Stock: For securities held-to-maturity and available-for- sale, quoted market prices and/or third party dealer quotes were used to determine fair value. FHLB stock is included at par value which is fair value.
Loans Receivable: The carrying amount of loans is net of unearned fee income and allowance for loan losses. The fair value of loans was calculated by discounting cash flows expected to be received through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The
credit and interest rate risk inherent in the loans, was estimated by segmenting the portfolio into categories based on collateral type, fixed or adjustable interest rate, maturity, estimated credit risk, and accrual status. The estimate of maturity is based on final maturity for each loan classification, modified, as required, by an estimate of the effect of amortization, and estimated prepayment based on current economic and lending factors.
Deposit Liabilities: The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings and NOW accounts, and money market and checking accounts, is equal to the amount payable on demand as of each period end. The fair value of time deposits is based on the discounted value of contractual cash flows. The market rates are estimated using the rates currently offered for deposits of similar remaining maturities.
Other Borrowings: The fair value of other borrowings are determined based on the actual cost of funds compared to the market rate of similar borrowings published daily by the FHLB.
Off Balance Sheet Instruments: The estimated fair value of off balance sheet instruments, principally letters of credit and loan commitments, is approximately the amount of commitment fees collected.
Note 18: The San Francisco Company
Condensed statements of financial condition of the Company at December 31, are as follows:
Condensed Statements of Financial Condition
(Dollars in Thousands) 1999 1998
Assets: Cash and short term investments $181 $205 Investment in subsidiary 23,331 22,503 Other assets -- 5 Total assets $23,512 $22,713
Liabilities: Other liabilities $11 $9 Total liabilities 11 9
Stockholders' equity 23,501 22,704 Total liabilities and shareholders' equity $23,512 $22,713
Condensed statements of operations and cash flows of the Company for the period ended December 31, are as follows:
Condensed Statements of Operations
(Dollars in Thousands) 1999 1998 1997
Income: Dividend income from subsidiary $2,050 -- -- Interest earned 2 $5 $6 Other income -- -- 24 Total income 2,052 5 30
Expense: Other expense 177 3 67 Total expense 177 3 67 Franchise taxes 17 9 3 Income (loss) before equity in undistributed net income of subsidiary 1,858 (7) (40) Equity in undistributed net income of subsidiary 2,007 5,049 5,483 Net income $3,865 $5,042 $5,443
Condensed Statements of Cash Flows
(Dollars in Thousands) 1999 1998 1997
Cash Flows from Operating Activities: Net income $3,865 $5,042 $5,443 Adjustments to reconcile net income to net cash used in operating activities: Equity in undistributed net income of subsidiary (2,007)(5,049)(5,483) Net cash flows provided by (used in) operating activities 1,858 (7) (40)
Cash Flows (used in) investing activities: Investment in Bank -- -- (1,000) Net decrease (increase) in other assets 5 (5) 2 Net cash provided by (used in) investing activities 5 (5) (998)
Cash Flows (used in) provided by financing activities: Proceeds from sale of Common Stock 132 2 1,000 Preferred stock cash dividend (12) (63) -- Redemption and retirement of Common Stock (2,009) -- -- Net increase (decrease) in other liabilities 2 (29) 41 Net cash (used in) provided by financing activities (1,887) (90) 1,041
(Decrease) increase in cash and cash equivalents (24) (102) 3 Cash and cash equivalents at beginning of year 205 307 304 Cash and cash equivalents at end of year $181 $205 $307
Note 19: Quarterly Information (Unaudited)
The following table sets forth the condensed operating results of the Company for each quarter of the years ending December 31, 1999 and 1998, and is qualified in its entirety by the more detailed information and financial statements contained elsewhere in this report:
(Dollars in Thousands Except Per Share data)
1999 Quarters Ended March 31 June 30 Sept. 30 Dec. 31
Interest income $2,468 $2,506 $2,730 $2,932 Interest expense 924 968 1,004 1,090 Net interest income 1,544 1,538 1,726 1,842
Adjustment for loan losses -- 100 -- -- Non-interest income 1,076 1,349 1,397 1,452 Non-interest expense 2,060 2,050 2,193 2,388 Income before income taxes 560 737 930 906 Provision (benefit) for taxes 3 20 17 (772) Net income $557 $717 $913 $1,678
Earnings per common share: Basic $0.02 $0.02 $0.03 $0.05 Diluted 0.02 0.02 0.03 0.05
1998 Quarters Ended March 31 June 30 Sept. 30 Dec. 31
Interest income $2,060 $2,093 $2,315 $2,314 Interest expense 803 795 932 881 Net interest income 1,257 1,298 1,383 1,433
Adjustment for loan losses (94) (308) (1,075) (150) Non-interest income 697 776 731 1,687 Non-interest expense 1,746 1,795 1,678 1,688 Income before income taxes 302 587 1,511 1,582 Provision (benefit) for taxes -- 5 6 (1,071) Net income $302 $582 $1,505 $2,653
Earnings per common share: Basic $0.01 $0.02 $0.05 $0.08 Diluted 0.01 0.02 0.05 0.07
The realizability of the deferred tax assets is reevaluated and the valuation allowance is adjusted so that the resulting level of deferred tax asset will, more likely than not, be realized. During the fourth quarter of 1999 and 1998, an adjustment of $800,000 and $600,000, respectively, to the amount of realizable deferred tax assets was recorded based on a determination that the Company is more likely than not able to utilize deferred tax assets that had previously been reserved. See additional discussion under "Note 9: Income Taxes".
During 1998, the Bank provided an adjustment of $1.6 million to its allowance for loan losses. Based on the significant reduction in problem assets and the demonstrated performance on the existing loans, management determined that a reduction of total allowance for loan losses as a percent of total loans to 2.2% at the end of 1998
was appropriate. The adequacy of the allowance for loan losses gives consideration to specifically identified problem loans, the financial condition of the borrower, the fair value of the collateral, recourse to guarantors, and other factors that are discussed under "Note 1: Statement of Accounting Policies -- Allowance for Loan and Lease Losses".
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
Not applicable.
PART III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be furnished in the Company's definitive Proxy Statement, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after December 31, 1999, and is incorporated by reference.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item will be furnished in the Company's definitive Proxy Statement, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after December 31, 1999, and is incorporated by reference.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be furnished in the Company's definitive Proxy Statement, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after December 31, 1999, and is incorporated by reference.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be furnished in the Company's definitive Proxy Statement, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after December 31, 1999, and is incorporated by reference.
PART IV
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. All financial statements.
See Index to Financial Statements on page 27.
2. Financial Statement Schedules
All financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements or the notes thereto.
3. List of Exhibits (numbered in accordance with Item 601 of Regulation S-K):
Exhibit Number Exhibit
3.1 Certificate of Incorporation of Bank of San Francisco (Delaware) Holding Company, dated June 23, 1988 (1) 3.2 Agreement and Plan of Merger of Bank of San Francisco (Delaware) Holding Company, a Delaware corporation and Bank of San Francisco Company Holding Company, a California Corporation, dated June 24, 1988 (1) 3.3 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding Company, dated May 22, 1989 (1) 3.4 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding Company, dated September 21, 1989 (1) 3.5 Bylaws of Bank of San Francisco (Delaware) Holding Company, dated June 23, 1988 (1) 3.6 First Amendment to Bylaws of Bank of San Francisco Company Holding Company, dated July 19, 1989 (1) 3.7 Second Amendment to Bylaws of Bank of San Francisco Company Holding Company, dated June 6, 1990 (1) 3.8 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding Company, dated May 23, 1994 (4) 3.9 Amended and Restated Certificate of Incorporation of The San Francisco Company, dated May 23, 1994 (4) 3.10 Certificate of Amendment of Certificate of Incorporation or The San Francisco Company, dated December 18, 1996(7) 4.1 Certificate of Designations of Rights, Preferences, Privileges and Restrictions of 8% Series B Convertible Preferred Stock of Bank of San Francisco Company Holding Company, dated July 28, 1988 (1) 4.2 Amended Certificate of Designations of Rights, Preferences, Privileges and Restrictions of 7% Series B Convertible Preferred Stock of Bank of San Francisco Company Holding Company, dated October 7, 1988 (1) 4.3 Certificate of Correction of Certificate of Incorporation, dated June 18, 1990 (1) 10.2 Lease dated November 1, 1960 between The Lurie Company and Bank of America, with respect to premises at 550 Montgomery Street (2) 10.3 Consent to Assignment of Lease, dated October 8, 1986, between The Lurie Company and Bank of San Francisco and Bank of San Francisco Realty Investors, with respect to premises at 550 Montgomery Street (2) 10.4 Assignment of Lease, dated October 17, 1986, by Bank of America to Bank of San Francisco and Bank of San Francisco Realty Investors, with respect to premises at 550 Montgomery Street (2) 10.7 Letter Agreement with the Board of Governors of the Federal Reserve Board, dated April 21, 1989 (1) 10.9 Bank of San Francisco Company Holding Company 401(k) Profit Sharing Plan (3) 10.18 Employment Agreements dated October 1, 1994 between Mr. Gilleran and The San Francisco Company and the Bank of San Francisco. (5) 10.19 Employment Agreements dated November 27, 1995 between Mr. John McGrath and the Bank of San Francisco(6) 10.20 Subscription Agreement dated as of February 26, 1996 between The San Francisco Company and Putra Masagung (6) 10.21 Amended and Restated 1993 Stock Option Plan (7) 10.22 Employment Agreements dated April 22, 1998 between Mr. James E. Gilleran and The San Francisco Company and the Bank of San Francisco. (8) 10.23 Employment Agreements dated April 22, 1998 between Mr. John McGrath and the Bank of San Francisco(8) 10.24 Employment Agreements dated April 22, 1998 between Ms. Keary Colwell and The San Francisco Company and the Bank of San Francisco. (8) 10.25 Employment Agreements dated April 22, 1998 between Ms. Joanne Haakinson and the Bank of San Francisco(8) 21 Subsidiaries of registrant (3) 23.1* Consent of Independent Auditors ___________________________ Footnotes to List of Exhibits: * Indicates filed herewith. (1) Incorporated by reference from the Form S-2 (Registration No. 33- 34985). (2) Incorporated by reference from the Form 10-K for the year ended December 31, 1986. (3) Incorporated by reference from Form 10-K for the year ended December 31, 1990. (4) Incorporated by reference from Proxy Statement for the Special Meeting of Stockholders' held on May 23, 1994. (5) Incorporated by reference from Form 10-K for the year ended December 31, 1994. (6) Incorporated by reference from Form 10-K for the year ended December 31, 1995. (7) Incorporated by reference from Proxy Statement of the 1996 Annual Meeting of Stockholders' held on December 18, 1996. (8) Incorporated by reference from the Form 10-Q for the three and six months ended June 30, 1998.
(b) Reports on Form 8-K filed in the fourth quarter of 1999:
None. 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.
The San Francisco Company
/s/ James E. Gilleran Chairman of the Board and March 6, 2000 James E. Gilleran Chief Executive Officer (Principal Executive Officer)
/s/ Keary L. Colwell Executive Vice President March 6, 2000 Keary L. Colwell Chief Financial Officer (Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Signature Title Date
/s/ James E. Gilleran Chairman of the Board and March 6, 2000 James E. Gilleran Chief Executive Officer (Principal Executive Officer)
/s/ John McGrath President and March 6, 2000 John McGrath Director
/s/ Paul Erickson Director March 6, 2000 Paul Erickson
/s/ Peter Foo Director March 6, 2000 Peter Foo
/s/ Kent D. Price Director March 6, 2000 Kent D. Price
/s/ Willard D. Sharpe Director March 6, 2000 Willard D. Sharpe
/s/ Gordon B. Swanson Director March 6, 2000 Gordon B. Swanson
/s/ Nicholas C. Unkovic Director March 6, 2000 Nicholas C. Unkovic
/s/ Gary Williams Director March 6, 2000 Gary Williams
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors The San Francisco Company
We consent to the incorporation by reference in the registration statement on Form S-8 (No. 333-24993) of The San Francisco Company and subsidiaries (the "Company") of our report dated February 10, 2000, relating to the Consolidated Statements of Financial Condition of The San Francisco Company and subsidiaries as of December 31, 1999 and 1998, and the related consolidated Statements of Operations, Changes in Shareholders' Equity and Comprehensive Income, and Cash Flows for each of the years in the three-year period ended December 31, 1999, which report appears in the December 31, 1999 Form 10K of The San Francisco Company.
San Francisco, California March 6, 2000