-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B5IuH+J2WraSgtdfu/P+wCO+vC7P71Xkujt7pVJcVEftXV2Z5fVpkP1HjmQDCiiH 7b1+JIUYB7hG6039gWBNeA== 0001047469-99-012275.txt : 19990331 0001047469-99-012275.hdr.sgml : 19990331 ACCESSION NUMBER: 0001047469-99-012275 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BYL BANCORP CENTRAL INDEX KEY: 0001039311 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 330755794 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-23257 FILM NUMBER: 99577676 BUSINESS ADDRESS: STREET 1: 1875 NORTH TUSTIN AVENUE CITY: ORANGE STATE: CA ZIP: 92865 BUSINESS PHONE: 7146851317 MAIL ADDRESS: STREET 1: 1875 NORTH TUSTIN AVENUE CITY: ORANGE STATE: CA ZIP: 92865 10-K405 1 FORM 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 Commission File Number 000-23257 BYL BANCORP CALIFORNIA 33-0755794 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1875 NORTH TUSTIN AVENUE, ORANGE, CALIFORNIA 92865 (Address of principalexecutive offices) (Zip Code) Issuer's telephone number: (714) 685-1317 SECURITIES REGISTERED UNDER SECTION 12(b)OF EXCHANGE ACT: NONE SECURITIES REGISTERED UNDER SECTION 12(g)OF EXCHANGE ACT: Common Stock, no par value -------------------------- (Title of Class) Check whether the issuer (1) filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90days. Yes [X] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] There were 2,533,835 shares of Common Stock outstanding at March 15, 1999. The aggregate market value of Common Stock held by non-affiliates at March 15, 1999 was approximately $30.3 million based upon the last known trade of $14.38 per share on March 15, 1999. Documents incorporated by reference: The proxy statement for the Annual Meeting of Shareholders of the registrant to be held in the second quarter of 1999. Certain information therein is incorporated by reference in Part III hereof. BYL BANCORP TABLE OF CONTENTS
PAGE ---- Part I Item 1. Business.................................................. 3 Item 2. Properties................................................ 15 Item 3. Legal Proceedings......................................... 15 Item 4. Submission of Matters to a Vote of Security Holders..... 15 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............................... 16 Item 6. Selected Financial Data................................... 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation........... 18 Item 8. Financial Statements and Supplementary Data............... 35 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................... 69 Part III Item 10. Directors and Executive Officers of the Registrant........ 69 Item 11. Executive Compensation.................................... 69 Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 69 Item 13. Certain Relationships and Related Transaction....................................... 69 Part IV Item 14. Exhibits Financial Statement Schedules, and Reports on Form 8-K ............................... 70
2 PART I ITEM 1: BUSINESS GENERAL BYL Bancorp (hereinafter the "Company") was incorporated under the laws of the State of California in 1997 and commenced operations in November 1997 as a bank holding company of Bank of Yorba Linda (the "Bank"), which changed its name to BYL Bank Group in June 1998. Other than its investment in the Bank, the Company currently conducts no other significant business activities, although it is authorized to engage in a variety of activities which are deemed closely related to the business of banking upon prior approval of the Federal Reserve's Board of Governors, the Company's primary regulator. As of December 31, 1998, the Company had total assets of approximately $318 million, total deposits of $287 million and total shareholders' equity of $26.9 million. The Bank was incorporated under the laws of the State of California in 1979 and was licensed by the California State Banking Department, now known as of the California Department of Financial Institutions ("DFI")and commenced operations as a California state chartered bank on March 3, 1980. The Bank's accounts are insured by the Federal Deposit Insurance Corporation ("FDIC"), but like most banks of its size in California, is not a member of the Federal Reserve Bank. The Bank is a California commercial bank that operates from its main office in Orange, California and operates full service branch offices located in Yorba Linda (formerly the head office of the Bank), Costa Mesa, Huntington Beach, Westminster, Riverside (2). and Mira Loma, California. The Bank's principal office is located at 1875 North Tustin Avenue, Orange, California. The Bank's Mortgage Divisions are currently located in Tustin and Diamond Bar, California. The Bank's SBA Loan Division is currently located in Mission Viejo, California. On March 26, 1999, the Bank closed its Laguna Hills office and relocated the branch's assets and liabilities to its Costa Mesa office. The Bank has notified its regulatory agencies of its intent to close one of its Riverside offices, which is anticipated to occur in May, 1999. The primary focus of the Bank is to provide personalized quality banking products and services to small- and medium-size businesses, including professionals, to originate primarily conforming and nonconforming mortgages in California and various other states and selling such loans in the secondary market, and to originate and sell SBA guaranteed loans, with the objective of building a balanced community loan and investment portfolio mix. Management believes that a local market focus, accompanied by strategic placement of bank branches and personnel, enables the Bank to attract and retain low cost core deposits which provide substantially all of the Bank's funding requirements. Historically, the Bank engaged in traditional community banking activities, including originating commercial, consumer and real estate construction loans, and gathering local deposits to fund these activities. With the employment of Mr. Robert Ucciferri as the Bank's President and Chief Executive Officer in late 1990 and other senior officers in early 1991, the Bank's operating strategy changed to emphasize the origination and sale of nonconforming residential mortgage loans and SBA loans. In part, because of the portfolio turnover and resultant gains on sales of such loans, such activities typically provide greater returns than more traditional community bank activities. 3 The Bank's operating strategy emphasizes: (i) expansion of its programs for originating and selling mortgage loans and SBA guaranteed loans; (ii) continued focus upon providing personalized quality banking products to small to medium-size businesses, professionals, general retail clients and the local community; and (iii) continued expansion of the Bank, primarily in Orange County and Riverside County, California, through internal growth and, when favorable, through selective acquisitions of, or mergers with, healthy, distressed or failed institutions or the selective acquisition of branches of such institutions; however, the Bank has no written or oral agreements regarding any such activities at this time. COMPLETION OF ACQUISITION OF BANK OF WESTMINSTER Following the receipt of all necessary regulatory approvals, the Bank completed the acquisition of Bank of Westminster ("BOW") on June 14, 1996 pursuant to the terms of the Agreement and Plan of Reorganization dated January 12, 1996 in which the Bank organized and established BYL Merger Corporation as a wholly-owned subsidiary of the Bank for the sole purpose of facilitating the merger of BOW with the Bank. BYL Merger Corporation was consolidated with BOW under the name and charter of BOW (the "Consolidation"), and, immediately thereafter, the consolidated corporation was merged with and into the Bank (the "Merger"). The aggregate purchase price of BOW was $6.17 million or $6.52 per share. The Bank acquired 100% of the outstanding common stock of BOW for $6,174,000 in cash. BOW had total assets of approximately $54,923,000. The acquisition was accounted for using the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16 "Business Combinations". Under this method of accounting, the purchase price was allocated to the assets acquired and deposits and liabilities assumed based on their fair values as of the acquisition date. The financial statements include the operations of BOW from the date of the acquisition. Goodwill arising from the transaction totaled approximately $1,717,000 and is being amortized over fifteen years on a straight-line basis. SECONDARY STOCK OFFERING During 1996, the Bank completed a secondary stock offering underwritten on a firm commitment basis by Ryan, Beck & Co. In connection with this offering, the Bank issued 805,000 shares of common stock generating $7.8 million in additional capital (net of underwriting discounts and transaction costs of $1.1 million). Proceeds from this offering were used, in part, to fund the acquisition of BOW. COMPLETION OF THE ACQUISITION OF DNB FINANCIAL Following the receipt of all necessary regulatory approvals, the Company completed the acquisition of DNB Financial ("DNBF") on May 29, 1998 pursuant to the terms of the Agreement and Plan of Reorganization dated January 29, 1998 in which DNBF was merged with and into the Company, and De Anza National Bank, the wholly-owned subsidiary of DNBF, was merged with and into the Bank. The transaction was structured as a pooling of interests through a tax-free exchange of the Company's shares of common stock for all outstanding shares of DNBF's common stock. As a result of the calculations required by the Agreement, each share of DNBF common stock was converted into the right to receive 4.1162 shares of the Company common stock, resulting in the issuance of 956,641 shares of Company common stock to the shareholders of DNBF. The acquisition of DNBF by the Company increased the total assets of the Company and its subsidiaries to approximately $270 million and total shareholders' equity to approximately $23 million as of the consummation of the transaction. 4 SALE OF UNGUARANTEED INTERESTS IN SBA LOANS On December 10, 1998, the Bank entered into a Pooling and Servicing Agreement dated as of October 1, 1998 (the "Pooling Agreement") between the Bank, as Servicer and Master Servicer, and Marine Midland Bank, as Trustee (the "Trustee") whereby the Bank transferred certain unguaranteed interests (the "Unguaranteed Interests") in loans (the "SBA Loans") partially guaranteed by the U.S. Small Business Administration ("SBA") to a newly-created trust (the "Trust") for the benefit of the SBA and the holders of certificate representing interests in such Trust. The Trust consists of the Unguaranteed Interests in such SBA Loans that are subject to the Pooling Agreement, and the Trust has issued three (3) classes of certificates representing certain fractional undivided ownership interests in the Trust. The Aggregate principal amount of the Unguaranteed Interests delivered to the Trust on October 31, 1998 equaled approximately $38.1 million. Pursuant to the Pooling Agreement, the Trust issued $34.4 million aggregate principal amount of BYL Bank Group SBA Loan-Backed Adjustable Rate Certificate, Series 1998-1, Class A ("Class A Certificate"), $6.02 million aggregate principal amount of BYL Bank Group SBA Loan-Backed Adjustable Rate Certificate, Series 1998-1, Class M. ("Class M Certificate") and $2.58 million aggregate principal amount of BYL Bank Group SBA Loan-Back Adjustable Rate Certificates, Series 198-1, Class B ("Class B Certificate"). The Class A and Class M Certificates were sold to a limited number of "Qualified Institutional Buyers" as defined in Rule 144A under the Securities Act of 1933, and institutional "Accredited Investors" as defined in Rule 501 under the Securities Act. Pursuant to the requirements of the SBA, the Class B Certificate were retained by the Bank and are subordinate to the Class A and Class M Certificates. The Class M Certificates are subordinate to the Class A Certificates. SUPERVISION AND REGULATION THE COMPANY The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is registered as such with, and subject to the supervision of, the Federal Reserve Board. The Company is required to file with the Federal Reserve Board quarterly and annual reports and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may conduct examinations of bank holding companies and their subsidiaries. The Company will be required to obtain the approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of the voting shares of any bank if, after giving effect to such acquisition of shares, the Company would own or control more than 5% of the voting shares of such bank. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company. The Company is prohibited by the Bank Holding Company Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging, directly or indirectly, in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company may, subject to the prior approval of the Federal Reserve Board, engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. 5 The Company, and any subsidiaries which it may acquire or organize, are deemed to be "affiliates" of the Company within the meaning of that term as defined in the Federal Reserve Act. This means, for example, that there are limitations (a) on loans by it subsidiaries to affiliates, and (b) on investments by its subsidiaries in affiliates' stock as collateral for loans to any borrower. The Company and its subsidiary are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. The Company and its subsidiary are prohibited from engaging in certain tie-in arrangements in connection with an extension of credit, sale or lease of property or furnishing of services. Section 106(b) of the Bank Holding Company Act Amendments of 1970 generally prohibits a bank from tying a product or service to another product or service offered by its subsidiaries, or by any of its affiliates. Further, the Company and its subsidiary is required to maintain certain levels of capital. See, "Effect of Governmental Policies and Recent Legislation - Capital Standards." The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest subsidiaries or affiliates when the Federal Reserve Board determines that the activity or the control or the subsidiary or affiliates constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company is required to file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the Federal Reserve Board's regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe and unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. THE BANK The Bank is extensively regulated under both federal and state law. Set forth below is a summary description of certain laws which relate to the regulation of the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. The Bank is chartered under the laws of the State of California and its deposits are insured by the FDIC to the extent provided by law. The Bank is subject to the supervision of, and is regularly examined by, the DFI and the FDIC. Such supervision and regulation include comprehensive reviews of all major aspects of the Bank's business and condition. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes relate to many aspects of the Bank's operations, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. Further, the Bank is required to maintain certain levels of capital. 6 California law and regulations of the DFI authorize California licensed banks, subject to applicable limitations and approvals of the DFI to (1) provide real estate appraisal services, management consulting and advice services, and electronic data processing services; (2) engage directly in real property investment or acquire and hold voting stock of one or more corporations, the primary activities of which are engaging in real property investment; (3) organize, sponsor, operate or render investment advice to an investment company or to underwrite, distribute or sell securities in California; and (4) invest in the capital stock, obligations or other securities of corporations not acting as insurance companies, insurance agents or insurance brokers. In November 1988, Proposition 103 was adopted by California voters. The DFI has established certain procedures to be followed by banks desiring to engage in certain insurance activities. CAPITAL STANDARDS The Federal Reserve Board and FDIC have adopted risk-based minimum capital guidelines (for bank holding companies and insured non-member state banks, respectively) intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which includes off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists primarily of common stock, retained earnings, noncumulative perpetual preferred stock (cumulative perpetual preferred stock for bank holding companies) and minority interests in certain subsidiaries, less most intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses, cumulative preferred stock, long-term preferred stock, eligible term subordinated debt and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banking organizations not rated in the highest category, the minimum leverage ratio must be at least 100 to 200 basis points above the 3% minimum, or 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. In June 1996, the federal banking agencies adopted a joint agency policy statement to provide guidance on managing interest rate risk. These agencies indicated that the adequacy and effectiveness of a bank's interest rate risk management process and the level of its interest rate exposures are critical factors in the agencies' evaluation of the Bank's capital adequacy. A bank with material weaknesses in its risk management process or high levels of exposure relative to its capital will be directed by the agencies to take corrective action. Such actions will include recommendations or directions to raise additional capital, strengthen management expertise, improve management information and measurement systems, reduce levels of exposure, or some combination thereof depending upon the individual institution's circumstances. 7 The federal banking agencies issued an interagency policy statement on the allowance for loan and lease losses which, among other things, establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by such policy statement is the sum of (a) assets classified loss; (b) 50 percent of assets classified doubtful; (c) 15 percent of assets classified substandard; and (d) estimated credit losses on other assets over the upcoming 12 months. Federally supervised banks and savings associations are currently required to report deferred tax assets in accordance with SFAS No. 109. The federal banking agencies recently issued final rules governing banks and bank holding companies, which became effective April 1, 1995, which limit the amount of deferred tax assets that are allowable in computing an institutions regulatory capital. The standard has been in effect on an interim basis since March 1993. Deferred tax assets that can be realized for taxes paid in prior carryback years and from future reversals of existing taxable temporary differences are generally not limited. Deferred tax assets that can only be realized through future taxable earnings are limited for regulatory capital purposes to the lesser of (i) the amount that can be realized within one year of the quarter-end report date, or (ii) 10% of Tier 1 Capital. The amount of any deferred tax in excess of this limit would be excluded from Tier 1 Capital and total assets and regulatory capital calculations. Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends. Under applicable regulatory guidelines, the Bank is considered "Well Capitalized" at December 31, 1998. On January 1, 1998, new legislation became effective which, among other things, gave the power to the DFI to take possession of the business and properties of a bank in the event that the tangible shareholders' equity of the bank is less than the greater of (i) 3% of the bank's total assets or (ii) $1,000,000. PROMPT CORRECTIVE ACTION Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An insured depository institution generally will be classified in the following categories based on capital measures indicated below: "Well capitalized" "Adequately capitalized" ------------------ ------------------------ Total risk-based capital of 10%; Total risk-based capital of 8%; Tier 1 risk-based capital of 6%; and Tier 1 risk-based capital of 4%; and Leverage ratio of 5%. Leverage ratio of 4%. "Undercapitalized" "Significantly undercapitalized" ----------------- -------------------------------- Total risk-based capital less than 8%; Total risk-based capital less than 6%; Tier 1 risk-based capital Tier 1 risk-based capital less than 4%; or less than 3%; or Leverage ratio less than 4%. Leverage ratio less than 3%. "Critically undercapitalized" - ----------------------------- Tangible equity to total assets less than 2%. 8 An institution that, based upon its capital levels, is classified as "well capitalized," "adequately capitalized" or undercapitalized" may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat an institution as "critically undercapitalized" unless its capital ratio actually warrants such treatment. The law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institution's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt correction action provisions. An insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (i) a forced sale of voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced acquisition; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or senior executive officers; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency. Although the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized. 9 Further restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 90 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. SAFETY AND SOUNDNESS STANDARDS Effective in 1995 the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by the Federal Deposit Insurance Corporation Improvement Act of 1991 (AFDICIA). These standards are designed to identify potential safety and soundness concerns and ensure that action is taken to address those concerns before they pose a risk to the deposit insurance fund. The standards relate to (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits. If a federal banking agency determines that an institution fails to meet any of these standards, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. In the event the institution fails to submit an acceptable plan within the time allowed by the agency or fails in any material respect to implement an accepted plan, the agency must, by order, require the institution to correct the deficiency. Effective October 1, 1996, the federal banking agencies promulgated safety and soundness regulations and accompanying interagency compliance guidelines on asset quality and earnings standards. These new guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. The institution should (i) conduct periodic asset quality reviews to identify problem assets; (ii) estimate the inherent losses in those assets and establish reserves that are sufficient to absorb estimated losses; (iii) compare problem asset totals to capital; (iv) take appropriate corrective action to resolve problems assets; (v) consider the size and potential risks of material asset concentrations; and (vi) provide periodic asset reports with adequate information for management and the board of directors to assess the level of risk. These new guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action. PREMIUMS FOR DEPOSIT INSURANCE Federal law has established several mechanisms to increase funds to protect deposits insured by Bank Insurance Fund ("BIF") administered by the FDIC. The FDIC is authorized to borrow up to $30 billion from the United States Treasury; up to 90% of the fair market value of assets of institutions acquired by the FDIC as receiver from the Federal Financing Bank; and from depository institutions that are members of the BIF. Any borrowings not repaid by asset sales are to be repaid through insurance premiums assessed to member institutions. Such premiums must be sufficient to repay any borrowed funds within 15 years and provide insurance fund reserves of $1.25 for each $100 of insured deposits. The FDIC also has authority to impose special assessments against insured deposits. 10 The FDIC has adopted final regulations implementing a risk-based premium system required by federal law. Under the regulations, which cover the assessment periods commencing on and after January 1, 1994, insured depository institutions are required to pay insurance premiums within a range of 23 cents per $100 of deposits to 31 cents per $100 of deposits depending on their risk classification. The FDIC, effective September 15, 1995, lowered assessments from their rates of $.23 to $.31 per $100 of insured deposits to rates of $.04 to $.31, depending on the health of the bank, as a result of the recapitalization of the BIF. On November 15, 1995, the FDIC voted to drop its premiums for well capitalized banks to zero effective January 1, 1996 Other banks will be charged risk-based premiums up to $.27 per $100 of deposits. The Bank pays no premiums as a result of its "well capitalized" status. Congress passed in 1996 and the President signed into law, provisions to strengthen the Savings and Loan Insurance Fund ("SAIF") and to repay outstanding bonds that were issued to recapitalize the SAIF as a result of payments made due to the insolvency of savings and loan associations and other federally insured savings institutions in the late 1980s and early 1990s. The new law requires saving and loan associations to be bear the cost of recapitalizing the SAIF and, after January 1, 1997, banks will contribute towards paying off the financing bonds, including interest. Effective January 1, 1997, SAIF-insured institutions pay 3.2 cents per $100 in domestic deposits, and BIF-insured institutions, like the Bank, pay 0.64 cents per $100 in domestics deposits. In 2000, the banking industry will share on a more equal basis in the bulk of the payments. FINANCIAL MODERNIZATION LEGISLATION Various proposals to adopt comprehensive financial modernization legislation have been introduced in Congress which include, among other things, elimination of the federal thrift charter, creation of a uniform financial institutions charter, expansion of bank powers, and integration of banking, commerce, securities activities and insurance. Under the proposed legislation, bank holding companies would be allowed to control both a commercial bank and a securities affiliate, which could engage in the full range of investment banking activities, including corporate underwriting. In May 1998, the House passed legislation that would overhaul the financial service industry and allow mergers among banking, securities and insurance firms. Congress adjourned without the passage of similar legislation by the Senate. It is anticipated that substantially similar legislation will be considered in the current session of Congress. INTERSTATE BANKING AND BRANCHING On September 29, 1994, the President signed into law the Rieglel Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act"). Under the Interstate Act, beginning one year after the date of enactment, a bank holding company that is adequately capitalized and managed may obtain approval under Bank Holding Company Act to acquire an existing bank located in another state without regard to state law. A bank holding company would not be permitted to make such an acquisition if, upon consummation, it would control (a) more than 10% of the total amount of deposits of insured depository institutions in the United States or (b) 30% or more of the deposits in the state in which it is located. A state may limit the percentage of total deposits that may be held in that state by any one bank or bank holding company if application of such limitation does not discriminate against out-of-state banks. An out-of-state bank holding company may not acquire a state bank in existence for less than a minimum length of time that may be prescribed by state law except that a state may not impose more than a five-year existence requirement. The Interstate Act also permits, beginning June 1, 1997, mergers of insured banks located in different states and conversion of the branches of the acquired bank into branches of the resulting bank. Each state may permit such combinations earlier than June 1, 1997, and may adopt legislation to prohibit interstate mergers after that date in that state or in other states by that state's banks. The same concentration limits discussed in the preceding paragraph apply. The Interstate Act also permits a national or state bank to establish branches in a state other than its home state if permitted by the laws of that state, subject to the same requirements and conditions as for a merger transaction. 11 In 1995, California adopted "opt in" legislation under the Interstate Act that permits out-of-state banks to acquire California banks that satisfy a five-year minimum age requirement (subject to exceptions for supervisory transactions) by means of merger or purchases of assets, although entry through acquisition of individual branches of California institutions and de novo branching into California are not permitted. The Interstate Act and the California branching statute will likely increase competition from out-of-state banks in the markets in which the Company intends to operate, although it is difficult to assess the impact that such increased competition may have on the Company's operations. The Interstate Act may increase competition in the Company's market areas especially from larger financial institutions and their holding companies. It is difficult to assess the impact such likely increased competition may have on the Company's operations. COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate-income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. In 1995 the federal banking agencies issued final regulations which change the manner in which they measure a bank's compliance with CRA obligations. The final regulations adopt a performance-based evaluation system which bases CRA ratings on an institution's actual lending, service and investment performance, rather than the extent to which the institution conducts needs assessments, documents community outreach activities or complies with other procedural requirements. In 1994 the federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate impact. In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of "outstanding," "satisfactory," "needs to improve" or "substantial noncompliance." The Bank has consistently been rate "satisfactory" and was examined most recently during the fourth quarter of 1998. Although the final report of examination has not yet been received, the Bank expects to retain its "satisfactory" rating. POTENTIAL ENFORCEMENT ACTIONS Commercial banking organizations and bank holding companies, such as the Bank and the Company, may be subject to potential enforcement actions by federal and state bank regulatory officials for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease and desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. Neither the Company nor the Bank are parties to any such enforcement action. 12 HAZARDOUS WASTE CLEAN-UP COSTS Management is aware of recent legislation and cases relating to hazardous waste clean-up costs and potential liability. Based on a general survey of the loan portfolios of the Bank, conversations with local authorities and appraisers, and the type of lending currently and historically done by the Bank (the Bank has generally not made the types of loans generally associated with hazardous waste contamination problems), management is not aware of any potential liability for hazardous waste contamination. OTHER REGULATIONS AND POLICIES The federal regulatory agencies have adopted regulations that implement Section 304 of FDICIA which requires federal banking agencies to adopt uniform regulations prescribing standards for real estate lending. Each insured depository institution must adopt and maintain a comprehensive written real estate lending policy, developed in conformance with prescribed guidelines, and each agency has specified loan-to-value limits in guidelines concerning various categories of real estate loans. Various requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal regulations include requirements to maintain non-interest bearing reserves against deposits, limitations on the nature and amount of loans which may be made, and restrictions on payment of dividends. The California Commissioner of Financial Institutions approves the number and locations of the branch offices of a bank. California law exempts banks from the usury laws. BUSINESS CONCENTRATIONS As of December 31, 1998, the Company had approximately $318 million in assets and $287 million in deposits. No individual or single group of related accounts is considered material in relation to the Company's totals, or in relation to its overall business. MONETARY POLICY Banking is a business which depends on rate differentials. In general, the difference between the interest paid by the Bank on its deposits and its other borrowings and the interest rate received by the Bank on loans extended to its clients and securities held in the Bank investment portfolios will comprise a major portion of the Bank's earnings. The earnings and growth of the Bank will be affected not only by general economic conditions, both domestic and international, but also by the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve Board. The Federal Reserve Board can and does implement national monetary policy, such as seeking to curb inflation and combat recession, by its open market operations in U.S. Government securities, limitations upon savings and time deposit interest rates, and adjustments to the discount rates applicable to borrowings by banks which are members of the Federal Reserve System. The actions of the Federal Reserve Board influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact that future changes in fiscal or monetary policies or economic controls may have on the Bank's businesses and earnings cannot be predicted. 13 COMPETITION The banking business in California generally, and in the Bank's primary service areas specifically, is highly competitive with respect to both loans and deposits, and is dominated by a relatively small number of major banks with many offices and operations over a wide geographic area. Among the advantages such major banks have over the Bank are their ability to finance and wide-ranging advertising campaigns and to allocate their investment assets to regions of higher yield and demand. Such banks offer certain services such as trust services and international banking which are not offered directly by the Bank (but which can be offered indirectly by the Bank through correspondent institutions). In addition, by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank. (Legal lending limits to an individual client are based upon a percentage of a bank's total capital accounts.) Other entities, both governmental and in private industry, seeking to raise capital through the issuance and sale of debt or equity securities also provide competition for the Bank in the acquisition of deposits. Banks also compete with money market funds and other money market instruments which are not subject to interest rate ceilings. In order to compete with other competitors in their primary service areas, the Bank attempts to use to the fullest extent the flexibility which their independent status permits. This includes an emphasis on specialized services, local promotional activity, and personal contacts by their respective officers, directors and employees. In particular, each of the banks offers highly personalized banking services. EMPLOYEES At December 31, 1998, the Bank had a total of 339 full-time employees and 27 part-time employees. The Bank believes that its employee relations are satisfactory. 14 ITEM 2. PROPERTIES The Company currently maintains an administrative facility in Orange, California, which is utilized by the Company and the Bank. The Bank also maintains nine full service branches, one regional loan center and six loan production offices. The Bank owns three of its branch locations and leases all of its other facilities. For additional information regarding the Bank's lease obligations, see Note K to the Consolidated Financial Statements, included in Item 8 hereof. The Company believes that all of its properties are appropriately maintained and suitable for their respective present needs and operations. ITEM 3. LEGAL PROCEEDINGS To the best of the Company's knowledge, there are no pending legal proceedings to which the Company is a party and which may have a materially adverse effect upon the Company's property or business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of securities holders during the fourth quarter of 1998. 15 PART II ITEM 5. MARKET FOR THE BANK'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The equity securities of BYL Bancorp consist of one class of common stock, of which there were 2,531,302 shares outstanding, held by approximately 800 shareholders of record at year-end 1998. Holders of the common stock are entitled to receive dividends, when, as and if declared by the Board of Directors out of funds legally available therefor, as specified by the California Financial Code. During 1998 and 1997, the Company paid quarterly cash dividends of $0.05 per share During the first quarter of 1999 the Company paid a cash dividend of $0.075 per share. On June 30, 1997, the Company completed a four-for-three stock split of the issued and outstanding shares. Management of the Company is aware of five (5) securities dealers who maintain an inventory and make a market in its Common Stock. The market makers are Ryan, Beck & Co., Wedbush Morgan Securities Inc., Herzog, Heine & Geduld, Sutro & Co. and Sandler, O'Neill & Partners. The information set forth in the table below summarizes, for the periods indicated, the bid and ask prices of the Company Common Stock. These quotes do not necessarily include retail markups, markdowns, or commissions and may not necessarily represent actual transactions. Additionally, there may have been transactions at prices other than those shown below (these amounts have been adjusted to reflect the four-for-three stock split effective June 30, 1997.)
1997 Bid Ask - --------------------- ------ ------ First Quarter 13.667 10.375 Second Quarter 15.938 12.375 Third Quarter 16.500 16.000 Fourth Quarter 21.250 16.000 1998 - --------------------- First Quarter 21.875 23.125 Second Quarter 23.250 23.500 Third Quarter 21.500 21.500 Fourth Quarter 18.000 18.500
16 ITEM 6. SELECTED FINANCIAL DATA The following table reflects selected financial data relating to the past five years of the Company's operations.
AT OR FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- SUMMARY OF OPERATIONS: Interest Income $ 24,016 $ 18,455 $ 12,642 $ 9,746 $ 9,148 Interest Expense 8,406 6,057 3,840 2,757 2,583 -------- -------- -------- -------- -------- Net Interest Income 15,610 12,398 8,802 6,989 6,565 Provision for Loan Losses 755 778 364 262 614 -------- -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses 14,855 11,620 8,438 6,727 5,951 Noninterest Income 23,408 15,920 8,752 6,726 4,794 Noninterest Expense 30,870 22,717 14,045 11,211 9,384 -------- -------- -------- -------- -------- Income Before Income Taxes 7,393 4,823 3,145 2,242 1,361 Income Taxes 3,277 1,968 1,229 872 509 -------- -------- -------- -------- -------- Net Income $ 4,116 $ 2,855 $ 1,916 $ 1,370 $ 852 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Dividends on Common Stock $ 467 $ 502 $ 168 $ 89 $ 187 PER SHARE DATA: Net Income - Basic $ 1.63 $ 1.19 $ 0.98 $ 0.88 $ 0.58 Net Income - Diluted $ 1.55 $ 1.12 $ 0.96 $ 0.75 $ 0.50 Book Value $ 10.62 $ 9.01 $ 8.10 $ 9.26 $ 8.08 STATEMENTS OF FINANCIAL CONDITION SUMMARY: Total Assets $318,013 $238,086 $183,755 $125,872 $117,376 Total Deposits 287,206 207,935 162,058 113,295 104,307 Loans Held for Sale 74,598 47,150 24,363 10,186 9,969 Total Loans 165,199 139,002 106,019 67,979 68,125 Allowance for Loan Losses (ALLL) 2,300 1,923 1,616 1,047 960 Total Shareholders' Equity 26,882 22,550 19,434 11,273 10,543 SELECTED RATIOS: Return on Average Assets 1.49% 1.31% 1.23% 1.17% 0.70% Return on Average Equity 17.03% 13.80% 12.81% 12.56% 8.20% Net Interest Margin 6.40% 6.46% 6.47% 6.68% 6.11% Dividend Payout Ratio - Common Stock 11.35% 17.59% 8.82% 6.50% 21.95% Non-performing Loans to Total Loans 1.23% 0.92% 1.15% 1.98% 1.66% Non-performing Assets to Total Assets 0.94% 0.93% 1.57% 1.81% 2.44% ALLL to Non-performing Loans 113.30% 150.35% 132.68% 77.90% 85.11% Average Shareholder's Equity to Average Assets 8.75% 9.49% 9.63% 9.28% 8.56%
17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS ORGANIZATION BYL Bancorp ("the Company") is a California corporation formed to act as the holding company of BYL Bank Group, formerly Bank of Yorba Linda ("the Bank"), a state-chartered commercial bank headquartered in Orange, California. Other than its investment in the Bank, the Company currently conducts no other significant business activities, although it is authorized to engage in a variety of activities which are deemed closely related to the business of banking upon prior approval of the Federal Reserve's Board of Governors, the Company's primary regulator. The Bank engages in the general business of banking throughout its primary market area of Orange and Riverside Counties in Southern California by offering a wide range of banking products and services, including (i) originating and selling Conforming and Nonconforming Mortgages and SBA guaranteed loans; (ii) providing many types of business and personal savings, money market and demand accounts, and other consumer banking services; and (iii) originating several other types of loans, and commercial and residential construction loans. The Bank maintains its main office in Orange, and presently operates nine (9) full service branches. Each banking office concentrates on servicing the local community in which it is located. The Bank also maintains mortgage banking offices in Tustin and Diamond Bar, California and a SBA loan office in Mission Viejo, California. At the close of business on May 29, 1998, the Company consummated a merger with DNB Financial and its wholly-owned subsidiary, De Anza National Bank. This merger was accounted for by the pooling of interest method, whereby the Company's Financial Statements and the following discussions have been restated as if the two companies were historically one unit. A total of 956,641 common shares were issued to the shareholders of DNB Financial in connection with this merger. During November 1998, the Company acquired the human resources, the marketing network, certain existing property and equipment leases and the mortgage loan pipeline of All Source Financial, LLC ("ASF") a subsidiary of Assurance Mortgage Corporation of America. ASF specialized in originating, selling and purchasing residential mortgage loans secured by first and second trust mortgages on single family residences. During 1998, ASF's average monthly fundings were approximately $45 million. On December 10, 1998, the Company securitized approximately $38.1 million of unguaranteed interests in SBA loans. The Company intends to securitize additional unguaranteed portions of its SBA loans, as well as other compatible loan products, as it is able to accumulate sufficient loans to provide for an economically viable transaction. The following sections set forth a discussion of the significant operating changes, business trends, financial condition, earnings, capital position, and liquidity that have occurred in the two-year period ended December 31, 1998, together with an assessment, when considered appropriate, of external factors that may affect the Company in the future. This discussion should be read in conjunction with the Company's consolidated financial statements and notes included herein. 18 OVERVIEW Net income in 1998 was $4.1 million, an increase of $1.2 million or 44.2%, compared to $2.9 million in 1997. Diluted earnings per share in 1998 were $1.55 compared to $1.12 in 1997. The increase in earnings in 1998 was due primarily to strong asset growth and increased profitability of the SBA and Mortgage Loan Divisions. The Company's net income for 1997 was $2.9 million, a $1.0 million or 49.0% increase over the 1996 net income of $1.9 million. On a diluted per share basis, 1997 net income was $1.12 compared to $0.95 in 1996. The increase in net income in 1997 was also due primarily to the growth in assets and the increased profitability of its SBA and Mortgage Loan Divisions. Shareholders' equity increased $4.3 million or 19.2%, in 1998 to $26.9 million at December 31, 1998 compared to $22.6 million at December 31, 1997. This increase was primarily from the retention of earnings. The following table sets forth several key operating ratios for 1998, 1997 and 1996:
For the Year Ended December 31, ---------------------------- 1998 1997 1996 ------ ------ ------ Return on Average Assets 1.49% 1.31% 1.23% Return on Average Equity 17.03% 13.80% 12.81% Average Shareholder's Equity to Average Total Assets 8.75% 9.49% 9.63%
19 DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY The following table presents, for the years indicated, the distribution of average assets, liabilities and shareholders' equity, as well as the total dollar amounts of interest income from average interest-earning assets and the resultant yields, and the dollar amounts of interest expense and average interest-bearing liabilities, expressed both in dollars and in rates. Nonaccrual loans are included in the calculation of the average balances of loans, and interest not accrued is excluded (dollar amounts in thousands).
For the Year Ended December 31, ---------------------------------------------------------------------------------------------- 1998 1997 1996 ----------------------------- ----------------------------- ------------------------------ Average Average Average Yield Yield Yield Interest or Interest or Interest or Average Earned Rate Average Earned Rate Average Earned Rate Balance or Paid Paid Balance or Paid Paid Balance or Paid Paid -------- -------- ------- -------- -------- ------- -------- -------- ------- ASSETS Interest-Earning Assets: Investment Securities $ 18,564 $ 1,119 6.03% $ 25,110 $ 1,535 6.11% $ 24,508 $1,449 5.91% Federal Funds Sold 13,322 669 5.02% 7,329 394 5.38% 4,339 228 5.25% Other Earning Assets 2,935 171 5.83% 3,882 227 5.85% 5,087 302 5.94% Loans 209,080 22,057 10.55% 155,588 16,299 10.48% 102,145 10,663 10.44% -------- -------- -------- -------- -------- -------- Total Interest-Earning Assets 243,901 24,016 9.85% 191,909 18,455 9.62% 136,079 12,642 9.29% Cash and Due From Banks 15,756 13,334 11,110 Premises and Equipment 5,299 4,830 2,967 Other Real Estate Owned 1,067 908 776 Accrued Interest and Other Assets 12,641 8,496 5,775 Allowance for Loan Losses (2,281) (1,552) (1,426) -------- -------- -------- Total Assets $276,383 $217,925 $155,281 -------- -------- -------- -------- -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Liabilities: Money Market and NOW $ 53,640 1,613 3.01% $ 48,414 1,321 2.73% $ 43,596 1,216 2.79% Savings 39,308 1,622 4.13% 26,164 920 3.52% 19,927 648 3.25% Time Deposits under $100,000 51,997 2,823 5.43% 37,866 2,080 5.49% 20,590 1,073 5.21% Time Deposits of $100,000 or More 38,120 2,258 5.92% 28,923 1,661 5.74% 13,443 792 5.89% Other 1,623 90 5.55% 908 75 8.26% 1,576 111 7.04% -------- -------- -------- -------- -------- -------- Total Interest-Bearing Liabilities 184,688 8,406 4.55% 142,275 6,057 4.26% 99,132 3,840 3.87% -------- -------- -------- Noninterest-Bearing Liabilities: Demand Deposits 62,771 51,664 39,813 Other Liabilities 4,753 3,306 1,381 Shareholders' Equity 24,171 20,680 14,955 -------- -------- -------- Total Liabilities and Shareholders' Equity $276,383 $217,925 $155,281 -------- -------- -------- -------- -------- -------- Net Interest Income $ 15,610 $ 12,398 $ 8,802 -------- -------- -------- -------- -------- -------- Net Yield on Interest-Earning Assets 6.40% 6.46% 6.47%
20 EARNINGS ANALYSIS NET INTEREST INCOME Net interest income refers to the difference between the interest paid on deposits and borrowings, and the interest earned on loans and investments. It is the primary component of the earnings of a financial institution. The primary factors that impact net interest income are the composition and volume of interest-earning assets and interest-bearing liabilities, the amount of noninterest-bearing liabilities and nonaccrual loans, and changes in market interest rates. Net interest income for 1998 was $15.6 million, an increase of 25.9% compared to the $12.4 million reported in 1997. This increase was primarily due to the significant increase in average interest-earning assets which increased $52.0 million or 27.1% to $243.9 million in 1998 compared to $191.9 million in 1997. Interest income in 1998 was $24.0 million, a $5.5 million or a 30.1% increase over the $18.5 million recorded in 1997. Increased loan totals accounted for the majority of this increase as the average loans outstanding increased 34.4% to $209.0 million in 1998 compared to $155.6 million in 1997. The significant increase in shareholders' equity in 1998 and 1997 has allowed the Company to aggressively grow its loan portfolio and other interest-earning assets. Interest expense also rose significantly in 1998 as the Company increased deposits and other borrowings to fund the loan growth discussed above. Interest expense was $8.4 million in 1998, compared to $6.0 million in 1997. Interest rates played a minor role in the changes in net interest income in 1998. The Company was able to increase its yield on interest-earning assets by 23 basis points, however, the rates paid on interest-bearing liabilities increased 29 basis points. The net yield on interest-earning assets in 1998 declined 6 basis points to 6.40% compared to 6.46% in 1997. Net interest income in 1997 was $12.4 million, an increase of $3.6 million or 40.9% from $8.8 million in 1996. This increase was also primarily attributable to the substantial increase in average total interest-earning assets which increased from $136.1 million in 1996 to $191.9 million in 1997. Changing interest rates had a very minor impact as the net yield on interest-earning assets decreased only 1 basis points from 6.47% in 1996 to 6.46% in 1997. Total interest income in 1997 was $18.5 million compared to $12.6 million in 1996. Increased loan volume was accountable for 97% of the increase in total interest income. The total yield on interest-earning assets also increased 33 basis points contributing slightly to the increase in interest income. Total interest expense also increased dramatically in 1997, rising to $6.0 million from $3.8 million in 1996. Again this increase was primarily attributable to increased volume in deposits which accounted for $2.1 million of the total increase. The average rate paid on deposits also increased 39 basis points increasing interest expense slightly. 21 NET INTEREST INCOME - CONTINUED The following table sets forth changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the years indicated. Changes not solely attributable to rate or volume have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each (dollar amounts in thousands).
Year Ended December 31, 1998 Year Ended December 31, 1997 versus versus Year Ended December 31, 1997 Year Ended December 31, 1996 ---------------------------- ----------------------------- Increase (Decrease) Due Increase (Decrease) Due To Change in To Change in ---------------------------- ----------------------------- Volume Rate Total Volume Rate Total ------ ------ ------- ------ ------ ------- INTEREST-EARNING ASSETS: Investment Securities $ (395) $ (21) $ (416) $ 36 $ 50 $ 86 Federal Funds Sold 302 (27) 275 161 5 166 Other Earning Assets (55) (1) (56) (70) (5) (75) Loans 5,642 116 5,758 5,599 37 5,636 ------ ----- ------ ------ ----- ------ TOTAL INTEREST INCOME 5,494 67 5,561 5,726 87 5,813 INTEREST-BEARING LIABILITIES: Money Market and NOW 150 142 292 131 (26) 105 Savings 521 181 702 216 56 272 Time Deposits under $100,000 767 (24) 743 946 61 1,007 Time Deposits $100,000 or More 543 54 597 889 (20) 869 Other 46 (31) 15 (53) 17 (36) ------ ----- ------ ------ ----- ------ TOTAL INTEREST EXPENSE 2,027 322 2,349 2,129 88 2,217 ------ ----- ------ ------ ----- ------ NET INTEREST INCOME $3,467 $(255) $3,212 $3,597 $ (1) $3,596 ------ ----- ------ ------ ----- ------ ------ ----- ------ ------ ----- ------
NONINTEREST INCOME The Bank receives noninterest income from three primary sources: service charges and fees on accounts and banking services, fees and premiums generated by the Mortgage Loan Division, and fees, premiums, and servicing income generated by the SBA Loan Division. In 1998, noninterest income was $23.4 million, an increase of $7.5 million or 47.0% compared to the 1997 amount of $15.9 million. The majority of this increase ($6.5 million) was generated by the Company's SBA and Mortgage Loan Divisions who continued to expand their operations in 1998. Included in the increase was a gain of $3.6 million from the securitization of the unguranteed portion SBA loans totaling approximately $38.1 million. By the end of 1998, these divisions had developed networks of referring brokers throughout most pacific coast states. Service charges, fees and other income increased almost $1.0 million in 1998 from a combination of increased deposit activity and income from loan referral programs 22 NONINTEREST INCOME - CONTINUED During 1997, noninterest income increased $7.1 million to $15.9 million compared to $8.8 million in 1996. The majority of this increase ($6.6 million) was again generated by the Bank's SBA and Mortgage Loan Divisions. NONINTEREST EXPENSE Noninterest expense reflects the costs of products and services related to systems, facilities and personnel for the Company. The major components of noninterest expense stated as a percentage of average assets are as follows:
1998 1997 1996 ------ ------ ------ Salaries and Employee Benefits 7.11% 6.46% 4.95% Occupancy Expenses .60 .62 .74 Furniture and Equipment .74 .64 .53 Professional Fees and Outside Services .65 .65 .77 OREO Expenses .10 .08 .24 Commission and Loan Expenses .38 .29 .29 Office Expenses .55 .60 .59 Other 1.04 1.08 .93 ----- ----- ---- 11.17% 10.42% 9.04% ----- ----- ---- ----- ----- ----
Noninterest expense was $30.9 million in 1998, an increase of $8.1 million or 35.9% over the $22.8 reported in 1997. The majority of this increase ($5.6 million) was created by increased salaries and benefits generated by the SBA and Mortgage Loan Divisions. Compensation in these divisions are primarily incentive-based, therefore, significant increases in volume of loan originations, and resulting gains, result in significant increases in salaries and incentive payments. Other expense categories increased in total amount but were consistent as a percentage of total assets. Included in other in 1998 was $542,000 of acquisition related expenses. Noninterest expenses in 1997 totaled $22.7 million, or a 61.7% increase over the 1996 amount of $14.0 million. The majority of this increase ($6.4 million) was created by increased salaries and employee benefits generated by and the Mortgage and the SBA Loan Divisions. Increases in furniture and equipment were primarily related to the costs incurred in converting to a new in-house data processing system. INCOME TAXES Income tax expense was $3.3, $2.9, and $1.9 million for the years ended December 31, 1998, December 31, 1997, and December 31, 1996, respectively. These expenses resulted in an effective tax rate of 44.3% in 1998, 40.8% in 1997 and 39.1% in 1996. The increase in effective rate in 1998 was due primarily to non-deductible merger expenses. BALANCE SHEET ANALYSIS Total assets of the Company at December 31, 1998 were $318.0 million, a $79.9 million or 33.6% increase from $238.1 million at December 31, 1997. Average assets for 1998 were $276.4 million compared to $217.9 million for 1997. The increases in shareholders' equity in 1998 and 1997 allowed the Company to aggressively expand its asset base. During 1997, the Bank's total assets increased $54.3 million from $183.8 million at December 31, 1996 to $238.1 million at December 31, 1997. 23 INVESTMENT PORTFOLIO The following table summarizes the amounts and distribution of the Company's investment securities held as of the dates indicated, and the weighted average yields as of December 31, 1998 (dollar amounts in thousands.)
December 31, --------------------------------------------------------------------------- 1998 1997 1996 ------------------------------- ------------------ ------------------ Weighted Book Market Average Book Market Book Market Value Value Yield Value Value Value Value ------- ------- --------- ------- ------- ------- ------- AVAILABLE-FOR-SALE SECURITIES U.S. GOVERNMENT AND AGENCY SECURITIES: Within One Year $ -- $ -- $ 1,022 $ 1,025 $ 638 $ 635 One to Five Years -- -- 233 232 3,081 3,071 After Ten Years -- -- 1,297 1,307 1,678 1,665 ------- ------- ------- ------- ------- ------- Total U.S. Government and Agency Securities -- -- 2,552 2,564 5,397 5,371 MUNICIPAL SECURITIES - FIVE TO TEN YEARS -- -- 1,018 1,032 MUTUAL FUNDS 3,000 3,000 5.44% 6,059 6,016 3,622 3,524 MORTGAGE BACKED SECURITIES 2,305 2,570 8.00% -- -- -- -- OTHER 830 830 6.00% 802 802 324 324 ------- ------- ------- ------- ------- ------- TOTAL AVAILABLE-FOR-SALE SECURITIES $ 6,135 $ 6,400 6.45% $10,431 $10,414 $ 9,343 $ 9,219 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- HELD-TO-MATURITY SECURITIES U.S. TREASURIES: Within One Year $ 2,001 $ 2,015 5.66% $ 1,999 $ 1,998 $ 500 $ 504 One to Five Years 498 511 6.36% 2,499 2,505 2,797 2,789 ------- ------- ------- ------- ------- ------- Total U.S. Treasuries Securities 2,499 2,526 5.80% 4,498 4,503 3,297 3,293 U.S. GOVERNMENT AND AGENCY SECURITIES: Within One Year 994 1,001 6.45% -- -- 999 987 One to Five Years 7,035 7,029 5.53% 998 999 2,935 2,957 Five to Ten Years 3,968 3,990 4,197 4,191 After Ten Years -- -- 1,500 1,502 -- -- ------- ------- ------- ------- ------- ------- Total U.S. Government and Agency Securities 8,029 8,030 5.65% 6,466 6,491 8,131 8,135 MUNICIPAL SECURITIES: One to Five Years -- -- 1,074 1,079 844 836 Five to Ten Years -- -- 852 867 1,088 1,089 ------- ------- ------- ------- ------- ------- Total Municipal Securities -- -- 1,926 1,946 1,932 1,925 MORTGAGE BACKED SECURITIES 316 318 5.50% 60 56 62 59 ------- ------- ------- ------- ------- ------- TOTAL HELD-TO-MATURITY SECURITIES $10,844 $10,874 5.67% $12,950 $12,996 $13,422 $13,412 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
24 INVESTMENT PORTFOLIO - CONTINUED Securities may be pledged to meet security requirements imposed as a condition to receipt of deposits of public funds and other purposes. At December 31, 1998 and 1997, the carrying values of securities pledged to secure public deposits and other purposes were $10.8 million and $5.0 million, respectively. LOANS HELD FOR SALE The Company originates mortgage loans and SBA loans for sale to institutional investors. Loans held for sale increased from $24.4 million at December 31, 1996, to $47.2 million at December 31, 1997 and $74.6 million at December 31, 1998. Historically, the Company sold these loans within sixty (60) days of origination, but during 1998 began to warehouse and accumulate pools of loans to take advantage of short-term fluctuations in the market. At December 31, 1998 and 1997, the Bank was servicing approximately $164.8 million and $76.1 million, respectively, in SBA loans previously sold. In connection with a portion of these loans, the Company has capitalized approximately $2.5 million and $1.9 million in servicing assets at December 31, 1998 and 1997, respectively. Servicing assets are amortized over the estimated life of the serviced loan using a method that approximates the interest method. The Company evaluates the carrying value of the excess servicing receivables by estimating the excess future servicing income, based on management's best estimate of the remaining loan lives. The Company has also recorded interest-only strips receivable in connection with its loan sales and securitizations. These totaled $5.9 million at December 31, 1998 and $644,000 at December 31, 1997. See also Note C in the Consolidated Financial Statements for additional information on loans held for sale. LOAN PORTFOLIO The following table sets forth the components of total net loans outstanding in each category at the date indicated (dollar amounts in thousands):
December 31, 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- LOANS Commercial $ 56,244 $ 36,359 $ 24,512 $ 13,706 $ 15,341 Real Estate - Construction 4,411 2,867 4,149 3,478 4,700 Real Estate - Other 82,235 84,792 71,799 46,885 44,134 Consumer 22,309 14,984 5,559 3,910 3,950 -------- -------- -------- -------- -------- Total Loans 165,199 139,002 106,019 67,979 68,125 Net Deferred Loan Costs (Fees) 1,255 471 173 (102) (159) Allowance for Loan Losses (2,300) (1,923) (1,616) (1,047) (960) -------- -------- -------- -------- -------- Net Loans $164,154 $137,550 $104,576 $ 66,830 $ 67,006 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- COMMITMENTS Standby Letters of Credit $ 360 $ 371 $ 203 $ 398 $ 474 Undisbursed Loans and Commitments to Grant Loans 21,627 18,521 14,843 10,014 9,445 -------- -------- -------- -------- -------- Total Commitments $ 21,987 $ 18,892 $ 15,046 $ 10,412 $ 9,919 -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
25 RISK ELEMENTS The Company assesses and manages credit risk on an ongoing basis through lending policies. Management strives to continue the historically low level of credit losses by continuing its emphasis on credit quality in the loan approval process, active credit administration and regular monitoring. In extending credit and commitments to borrowers, The Company generally requires collateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceeds from the sale of selected assets of the borrower. The Company's requirement for collateral and/or guarantees is determined on a case-by-case basis in connection with management's evaluation of the credit worthiness of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, income-producing properties, residences and other real property. The Company secures its collateral by perfecting its interest in business assets, obtaining deeds of trust, or outright possession among other means. Management believes that its lending policies and underwriting standards will tend to minimize losses in an economic downturn, however, there is no assurance that losses will not occur under such circumstances. The following table shows the maturity distribution of the fixed rate portion of the loan portfolio and the repricing distribution of the variable rate portion of the loan portfolio, including loans held for sale, at December 31, 1998
Over 3 Months Due after Due after 3 Months through one year to three years to Due after or Less 12 months three years five years five years Total - ---------- --------- ----------- -------------- ---------- --------- $ 101,637 $ 52,839 $ 15,364 $ 27,476 $ 40,674 $ 237,990 --------- -------- -------- -------- -------- --------- -------- -------- -------- -------- Loans on Non-Accrual 1,807 --------- Total Loans, including Loans Held for Sale $ 239,797 --------- ---------
26 NONPERFORMING ASSETS The following table provides information with respect to the components of the Company's nonperforming assets at the dates indicated (dollar amounts in thousands):
For the Year Ended December 31, ---------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- Loans 90 Days Past Due and Still Accruing $ 223 $ -- $ 122 $ 149 $ -- Nonaccrual Loans 1,807 1,279 1,096 1,195 1,128 -------- -------- -------- -------- -------- Total Nonperforming Loans 2,030 1,279 1,218 1,344 1,128 Other Real Estate Owned 971 924 1,661 930 1,734 -------- -------- -------- -------- -------- Total Nonperforming Assets $ 3,001 $ 2,203 $ 2,879 $ 2,274 $ 2,862 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Nonperforming Loans as a Percentage of Total Loans 1.23% 0.92% 1.15% 1.98% 1.66% Allowance for Loan Loss as a Percentage of Nonperforming Loans 113.30% 150.35% 132.68% 77.90% 85.11% Nonperforming Assets as a Percentage of Total Assets 0.94% 0.93% 1.57% 1.81% 2.44%
Nonaccrual loans are generally past due 90 days or are loans that management believes the interest on which may not be collectible. Loans past due 90 days will continue to accrue interest only when management believes the loan is both well-secured and in the process of collection. Other real estate owned is acquired through foreclosure or other means. These properties are recorded on an individual asset basis at the estimated fair value less selling expenses. Management believes these properties can be liquidated at or near their current fair value. PROVISION AND ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level that is considered adequate to provide for the loan losses inherent in Company's loans. The provision for loan losses was $755,000 in 1998 compared to $778,000 in 1997 and $364,000 in 1996. 27 PROVISION AND ALLOWANCE FOR LOAN LOSSES - CONTINUED The following table summarizes, for the years indicated, changes in the allowances for loan losses arising from loans charged-off, recoveries on loans previously charged-off, and additions to the allowance which have been charged to operating expenses and certain ratios relating to the allowance for loan losses (dollar amounts in thousands):
For the Year Ended December 31, ------------------------------------------------------------ 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- OUTSTANDING LOANS: Average for the Year $209,080 $155,588 $102,145 $ 68,052 $ 74,101 End of the Year $165,199 $139,002 $106,019 $ 67,979 $ 68,125 ALLOWANCE FOR LOAN LOSSES: Balance at Beginning of Year $ 1,923 $ 1,616 $ 1,047 $ 960 $ 1,233 Actual Charge-Offs: Commercial 175 486 318 133 426 Consumer 252 29 21 24 45 Real Estate 101 20 192 162 503 -------- -------- -------- -------- -------- Total Charge-Offs 528 535 531 319 974 Less Recoveries: Commercial 140 33 19 18 80 Consumer 7 7 11 3 6 Real Estate 3 24 6 123 1 -------- -------- -------- -------- -------- Total Recoveries 150 64 36 144 87 -------- -------- -------- -------- -------- Net Loans Charged-Off 378 471 495 175 887 Provision for Loan Losses 755 778 364 262 614 Allowance on Loans Acquired from BOW -- -- 700 -- -- -------- -------- -------- -------- -------- Balance at End of Year $ 2,300 $ 1,923 $ 1,616 $ 1,047 $ 960 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- RATIOS: Net Loans Charged-Off to Average Loans 0.18% 0.30% 0.48% 0.26% 1.20% Allowance for Loan Losses to Total Loans 1.39% 1.38% 1.87% 1.54% 1.41% Net Loans Charged-Off to Beginning Allowance for Loan Losses 19.66% 29.15% 47.28% 18.23% 71.94% Net Loans Charged-Off to Provision for Loan Losses 50.07% 60.54% 135.99% 66.79% 144.46% Allowance for Loan Losses to Nonperforming Loans 113.30% 150.35% 132.68% 77.90% 85.11%
Management believes that the allowance for loan losses is adequate. Quarterly detailed reviews are performed to identify the risks inherent in the loan portfolio, assess the overall quality of the loan portfolio and to determine the adequacy of the allowance for loan losses and the related provision for loan losses to be charged to expense. These systematic reviews follow the methodology set forth by the FDIC in its 1993 policy statement on the allowance for loan losses. 28 PROVISION AND ALLOWANCE FOR LOAN LOSSES - CONTINUED A key element of our methodology is the credit classification process. Loans identified as less than "acceptable" are reviewed individually to estimate the amount of probable losses that need to be included in the allowance. These reviews include analysis of financial information as well as evaluation of collateral securing the credit. Additionally, management considers the inherent risk present in the "acceptable" portion of the loan portfolio taking into consideration historical losses on pools of similar loans, adjusted for trends, conditions and other relevant factors that may affect repayment of the loans in these pools. The following table summarizes the allocation of the allowance for loan losses by loan type for the years indicated and the percent of loans in each category to total loans (dollar amounts in thousands):
December 31, 1998 December 31, 1997 December 31, 1996 December 31, 1995 December 31, 1994 ----------------- ----------------- ----------------- ----------------- ----------------- Loan Loan Loan Loan Loan Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- Commercial $ 854 34.1% $ 657 26.2% $ 806 23.1% $ 522 20.2% $ 479 22.5% Construction 100 2.7% 33 2.1% 65 3.9% 42 5.1% 39 6.9% Real Estate 1,049 49.8% 873 61.0% 569 67.7% 368 69.0% 337 64.8% Consumer 55 13.5% 139 10.8% 50 5.2% 32 5.8% 29 5.8% Unallocated 242 n/a 221 n/a 126 n/a 83 n/a 76 n/a ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- $2,300 100.0% $1,923 100.0% $1,616 100.0% $1,047 100.0% $ 960 100.0% ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ -------
FUNDING Deposits are the Company's primary source of funds. At December 31, 1998, the Company had a deposit mix of 55.3% in time and savings deposits, 20.4% in money market and NOW deposits, and 24.3% in noninterest-bearing demand deposits. The Company's net interest income is enhanced by its percentage of noninterest-bearing deposits. 29 FUNDING - CONTINUED The following table summarizes the distribution of average deposits and the average rates paid for the years indicated (dollar amounts in thousands):
December 31, ------------------------------------------------------------------------- 1998 1997 1996 --------------------- --------------------- --------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate --------- ------- --------- ------- --------- ------- Money Market and NOW Accounts $ 53,640 3.01% $ 48,414 2.73% $ 43,596 2.51% Savings Deposits 39,308 4.13% 26,164 3.52% 19,927 3.25% TCD Less than $100,000 51,997 5.43% 37,866 5.49% 20,590 5.21% TCD $100,000 or More 38,120 5.92% 28,923 5.74% 13,443 5.89% --------- --------- --------- Total Interest-Bearing Deposits 183,065 4.54% 141,367 4.23% 97,556 100.00% Noninterest-Bearing Demand Deposits 62,771 n/a 51,664 n/a 39,813 n/a --------- --------- --------- Total Average Deposits $ 245,836 3.38% $ 193,031 3.10% $ 137,369 2.71% --------- --------- --------- --------- --------- ---------
The scheduled maturity distribution of the Bank's time deposits of $100,000 or greater, as of December 31, 1998, were as follows (dollar amounts in thousands): Three Months or Less $ 15,896 Over Three Months to One Year 16,655 Over One Year to Five Years 6,685 -------- $ 39,236 -------- --------
30 LIQUIDITY AND INTEREST RATE SENSITIVITY The objective of the Company's asset/liability strategy is to manage liquidity and interest rate risks to ensure the safety and soundness of the Bank and its capital base, while maintaining adequate net interest margins and spreads to provide an appropriate return to the Company's shareholders. The Company manages its interest rate risk exposure by limiting the amount of long-term fixed rate loans it holds for investment, by originating mortgage and SBA loans for sale to the secondary market, increasing emphasis on shorter-term, higher yield loans for portfolio, increasing or decreasing the relative amounts of long-term and short-term borrowings and deposits and/or purchasing commitments to sell loans. The table below sets forth the interest rate sensitivity of the Company's interest-earning assets and interest-bearing liabilities as of December 31, 1998, using the interest rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered rate-sensitive within a specified period when it can be repriced or matures within its contractual terms, except for loans held for sale which the Company classifies as highly liquid based on historical sale patterns (dollar amounts in thousands):
After After One Within Three Months Year But Three But Within Within After Months One Year Five Years Five Years Total -------- ------------ ---------- ---------- --------- INTEREST-EARNING ASSETS: Federal Funds Sold $ 18,700 $ -- $ -- $ -- $ 18,700 Investment Securities 3,830 2,995 7,533 2,886 17,244 Gross Loans 103,444 52,839 42,840 40,674 239,797 -------- -------- -------- -------- -------- $125,974 $ 55,834 $ 50,373 $ 43,560 $275,741 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- INTEREST-BEARING LIABILITIES: Money Market and NOW Deposits $ 58,740 $ -- $ -- $ -- $ 58,740 Savings 70,838 70,838 Time Deposits 37,743 39,909 10,383 -- 88,035 Other Borrowings -- -- -- -- -- -------- -------- -------- -------- -------- $167,321 $ 39,909 $ 10,383 $ -- $217,613 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Interest Rate Sensitivity Gap $(41,347) $ 15,925 $ 39,990 $ 43,560 $ 58,128 Cumulative Interest Rate Sensitivity Gap $(41,347) $(25,422) $ 14,568 $ 58,128 Ratios Based on Total Assets: Interest Rate Sensitivity Gap (13.00%) 5.01% 12.57% 13.70% 18.28% Cumulative Interest Rate Sensitivity Gap (13.00%) (7.99%) 4.58% 18.28%
31 LIQUIDITY AND INTEREST RATE SENSITIVITY - CONTINUED Liquidity refers to the Company's ability to maintain a cash flow adequate to fund both on-balance sheet and off-balance sheet requirements on a timely and cost-effective basis. Potentially significant liquidity requirements include funding of commitments to loan clients and withdrawals from deposit accounts. CAPITAL RESOURCES Shareholders' equity at December 31, 1998 was $26.9, an increase of $4.3 million or 19.2% over $22.6 million at December 31, 1997. Average shareholders' equity for 1998 was $24.2 million compared to $20.7 million in 1997. Shareholders' equity averaged $20.7 million in 1997, an increase of $5.7 million or 383% compared to 1996. At December 31, 1997, shareholders' equity amounted to $22.6 million, an increase of $3.2 million or 16.0% over the prior year. In 1990, the banking industry began to phase in new regulatory capital adequacy requirements based on risk-adjusted assets. These requirements take into consideration the risk inherent in investments, loans, and other assets for both on-balance sheet and off-balance sheet items. Under these requirements, the regulatory agencies have set minimum thresholds for Tier 1 capital, total capital and leverage ratios. At December 31, 1998, the Bank's capital exceeded all minimum regulatory requirements and the Bank was considered to be "well capitalized" as defined in the regulations issued by the FDIC. The Bank's risk-based capital ratios, shown below as of December 31, 1998, have been computed in accordance with regulatory accounting policies (The Company's capital ratios are comparable to the Bank's).
Minimum Requirements Bank ------------- ------ Tier 1 Capital 4.0% 10.00% Total Capital 8.0% 10.94% Leverage Ratio 4.0% 7.95%
EFFECTS OF INFLATION The financial statements and related financial information presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or same magnitude as the price of goods and services. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES". This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard is effective for 2000 and is not expected to have a material impact on the Bank's financial statements. 32 YEAR 2000 ISSUES OVERVIEW The Year 2000 issue is the result of computer programs being written using two digits rather that four to define the applicable year. As a result, date-sensitive software and/or hardware may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or other disruption of operations and impede normal business activities. In June 1996, the Federal Financial Institutions Examination Council ("FFIEC") alerted the banking industry of the serious challenges that would be encountered with Year 2000 issues. The FDIC has also implemented a plan to require compliance with Year 2000 issues and regularly examines out progress. STATE OF READINESS In accordance with FDIC guidelines, the Company developed a comprehensive plan which management believes will result in timely and adequate modifications of Company's systems and technology to address Year 2000 issues, which contemplates all system conversions and testing to be substantially completed by December 31, 1999. Management has completed a top-down assessment of all mission-critical and other systems for Year 2000 compliance and are currently in the third and fourth of the five phases for compliance, "renovation and validation", as defined by the FFIEC. Management has also tested non-information technology systems, such as microprocessors controlling environmental and alarm systems, and found them to be Year 2000 compliant. To determine the readiness of the Company's clients, management sent a questionnaire to, and received responses from, significant borrowers and depositors to determine the extent of risk created by any failure by them to remediate their own Year 2000 issues. Each borrower and depositor is categorized according to their state of readiness based on their response to the questionnaire and a review of the client. The Company has also taken steps to ensure liquidity for depositors with high Year 2000 risks. Re-assessment of each client's risk will be made on a regular basis. To determine the readiness of the Company's vendors, letters were sent to each vendor inquiring about their compliance with Year 2000. For those vendors that have responded that they are Year 2000 compliant and that were determined to not have a material impact on the Bank's operations, no further work is performed. For those vendors that have responded they are working towards Year 2000 compliance and that are determined to be significant, including mission critical vendors, the Company will follow up on a regular basis through 1999. These vendors have advised the Company that they expect to be Year 2000 compliant prior to December 31, 1999. If those vendors do not demonstrate compliance by a certain date, the Company will seek other alternatives in accordance with its contingency plan, which may include seeking replacement vendors. COSTS AND RISKS A few computer hardware and software applications were modified or replaced in order to maintain their functionality as the year 2000 approaches. The Company has spent approximately $20,000 as of December 31, 1998 to address Year 2000 issues and estimate total costs over the two year period 1999-2000 to be approximately $119,000, which will come from general funds. None of these costs, however, are expected to materially impact the Company's result of operations in any one reporting period. 33 COSTS AND RISKS - CONTINUED Ultimately, the potential impact of the Year 2000 issue will depend not only on the corrective measures the Company undertakes, but also on the way in which the Year 2000 issue is addressed by governmental agencies, businesses, and other entities who provide data, receive data, or whose financial condition or operational capability is important to the Company, such as suppliers or clients. At worst, clients and vendors will face severe Year 2000 issues, which may cause borrowers to become unable to service their loans. The Company may also be required to replace non-compliant vendors with more expensive Year 2000-compliant vendors. At this time management cannot determine the financial effect if significant client and/or vendor remediation efforts are not resolved in a timely manner. 34 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report 36 Consolidated Balance Sheets at December 31, 1998 and 1997 37 and 38 Consolidated Statements of Income for each of the Years in the Three-Year Period Ended December 31, 1998 39 Consolidated Statements of Shareholders' Equity for each of the Years in the Three-Year Period Ended December 31, 1998 40 Consolidated Statements of Cash Flows for each of the Years in the Three-Year Period Ended December 31, 1998 41 Notes to Financial Statements 42 through 68
All supplemental schedules are omitted as inapplicable or because the required information is included in the financial statements or notes hereto. 35 To the Board of Directors and Shareholders of BYL Bancorp and Subsidiary INDEPENDENT AUDITORS' REPORT We have audited the accompanying consolidated balance sheets of BYL Bancorp and Subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger of BYL Bancorp and DNB Financial on May 29,1998, in a transaction accounted for as a pooling of interest, as discussed in Note Q. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of BYL Bancorp and Subsidiary as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. VAVRINEK, TRINE, DAY & CO., LLP January 21, 1999 Laguna Hills, California 36 BYL BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 (DOLLAR AMOUNTS IN THOUSANDS)
1998 1997 -------- -------- ASSETS Cash and Due from Banks $ 14,214 $ 11,893 Federal Funds Sold 18,700 -- -------- -------- TOTAL CASH AND CASH EQUIVALENTS 32,914 11,893 Interest-Bearing Deposits -- 3,419 Investment Securities Available for Sale 6,400 10,414 Held to Maturity 10,844 12,950 -------- -------- TOTAL INVESTMENT SECURITIES 17,244 23,364 Loans Held for Sale 74,598 47,150 Loans Commercial 56,244 36,359 Real Estate 86,646 87,659 Consumer 22,309 14,984 -------- -------- TOTAL LOANS 165,199 139,002 Net Deferred Loan Costs 1,255 471 Allowance for Credit Losses (2,300) (1,923) -------- -------- NET LOANS 164,154 137,550 Premises and Equipment 6,082 5,205 Other Real Estate Owned 971 924 Cash Surrender Value of Life Insurance 1,374 906 Deferred Tax Assets 1,843 1,762 Goodwill 1,445 1,545 Interest-Only Strips Receivable and Servicing Assets 9,025 2,564 Accrued Interest and Other Assets 8,363 1,804 -------- -------- $318,013 $238,086 -------- -------- -------- --------
The accompanying notes are an integral part of these consolidated financial statements. 37 BYL BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 (DOLLAR AMOUNTS IN THOUSANDS)
1998 1997 ---------------- --------------- LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-Bearing Demand $ 69,863 $ 56,143 Money Market and NOW 58,470 48,174 Savings 70,838 27,403 Time Deposits Under $100,000 48,799 42,494 Time Deposits $100,000 and Over 39,236 33,721 ---------------- --------------- TOTAL DEPOSITS 287,206 207,935 Federal Funds Purchased - 1,000 Federal Home Loan Bank Advances - 3,000 Accrued Interest and Other Liabilities 3,925 3,601 ---------------- --------------- TOTAL LIABILITIES 291,131 215,536 Commitments and Contingencies - Note K Shareholders' Equity Preferred Shares - Authorized 25,000,000 Shares; None Outstanding Common Shares - Authorized 50,000,000 Shares; Issued and Outstanding 2,531,302 Shares in 1998 and 2,503,171 Shares in 1997 12,760 12,622 Retained Earnings 13,602 9,955 Accumulated Other Comprehensive Income 520 (27) ---------------- --------------- TOTAL SHAREHOLDERS' EQUITY 26,882 22,550 ---------------- --------------- $ 318,013 $ 238,086 ---------------- --------------- ---------------- ---------------
The accompanying notes are an integral part of these consolidated financial statements. 38 BYL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
1998 1997 1996 --------------- -------------- -------------- INTEREST INCOME Interest and Fees on Loans $ 22,057 $ 16,299 $ 10,663 Interest on Investment Securities 1,119 1,535 1,449 Other Interest Income 840 621 530 --------------- -------------- -------------- TOTAL INTEREST INCOME 24,016 18,455 12,642 INTEREST EXPENSE Interest on Money Market and NOW 1,613 1,321 1,216 Interest on Savings Deposits 1,622 920 648 Interest on Time Deposits 5,081 3,741 1,865 Interest on Other Borrowings 90 75 111 --------------- -------------- -------------- TOTAL INTEREST EXPENSE 8,406 6,057 3,840 --------------- -------------- -------------- NET INTEREST INCOME 15,610 12,398 8,802 Provision for Credit Losses 755 778 364 --------------- -------------- -------------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 14,855 11,620 8,438 NONINTEREST INCOME Net Servicing and Interest-Only Strip Income 662 689 350 Net Gain on Sale and Securitization of Loans 19,724 13,150 6,510 Service Charges, Fees, and Other Income 3,022 2,081 1,892 --------------- -------------- -------------- 23,408 15,920 8,752 --------------- -------------- -------------- 38,263 27,540 17,190 NONINTEREST EXPENSE Salaries and Employee Benefits 19,662 14,073 7,682 Occupancy Expenses 1,645 1,342 1,152 Furniture and Equipment 2,032 1,388 826 Other Expenses 7,531 5,914 4,385 --------------- -------------- -------------- 30,870 22,717 14,045 --------------- -------------- -------------- INCOME BEFORE INCOME TAXES 7,393 4,823 3,145 Income Taxes 3,277 1,968 1,229 --------------- -------------- -------------- NET INCOME $ 4,116 $ 2,855 $ 1,916 --------------- -------------- -------------- --------------- -------------- -------------- Per Share Data Net Income - Basic $ 1.63 $ 1.19 $ 0.98 Net Income - Diluted $ 1.55 $ 1.12 $ 0.95
The accompanying notes are an integral part of these consolidated financial statements. 39 BYL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS)
Common Shares Accumulated ---------------------- Other Number of Comprehensive Retained Comprehensive Shares Amount Income Earnings Income --------- -------- ------------- -------- ------------- BALANCE AT JANUARY 1, 1996 1,332,040 $ 4,218 $ 6,033 $ 20 COMPREHENSIVE INCOME: Net Income $ 1,916 1,916 Other Comprehensive Income - Unrealized Loss on Available-for-Sale Securities, Net of Taxes of $24 (133) (133) -------- TOTAL COMPREHENSIVE INCOME $ 1,783 -------- -------- Preferred Dividends (159) Redemption of Preferred Stock (20) Issuance of Common Shares, Net of Expenses of $1,096,145 1,073,333 7,759 Dividends on Common (168) Common Stock Retired (9,570) (55) Exercise of Stock Options 4,116 23 --------- -------- -------- ------ BALANCE AT DECEMBER 31, 1996 2,399,919 11,945 7,602 (113) COMPREHENSIVE INCOME: Net Income $ 2,855 2,855 Other Comprehensive Income - Unrealized Gain on Available-for-Sale Securities, Net of Taxes of $21 86 86 -------- TOTAL COMPREHENSIVE INCOME $ 2,941 -------- -------- Dividends on Common (502) Common Stock Retired (823) (6) Exercise of Stock Options, Including Tax Benefit of $91 104,075 683 --------- -------- -------- ------ BALANCE AT DECEMBER 31, 1997 2,503,171 12,622 9,955 (27) COMPREHENSIVE INCOME: Net Income $ 4,116 4,116 Other Comprehensive Income - Unrealized Gain on Available-for-Sale Securities, Net of Taxes of $116 183 183 Unrealized Gain on Interest-Only Strips Net of Taxes of $256 364 364 -------- TOTAL COMPREHENSIVE INCOME $ 4,663 -------- -------- Fractional Shares from Merger with DNB (2) Cash Dividends (467) Exercise of Stock Options 28,131 138 --------- -------- -------- ------ BALANCE AT DECEMBER 31, 1998 2,531,302 $ 12,760 $ 13,602 $ 520 --------- -------- -------- ------ --------- -------- -------- ------
The accompanying notes are an integral part of these consolidated financial statements. 40 BYL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS)
1998 1997 1996 ---------- ---------- ---------- OPERATING ACTIVITIES Net Income $ 4,116 $ 2,855 $ 1,916 Adjustments to Reconcile Net Income to Net Cash Provided (Used) by Operating Activities: Depreciation and Amortization 1,920 1,013 517 Deferred Income Taxes (496) (911) (237) Loans Originated for Sale (336,685) (225,800) (114,260) Proceeds from Loan Sales 319,630 216,434 106,082 Gain on Sale of Loans (19,724) (13,150) (6,510) Provision for Credit Losses 755 778 364 Other Real Estate Owned Losses 220 53 220 Other Items - Net (5,784) 2,616 917 ---------- ---------- ---------- NET CASH USED BY OPERATING ACTIVITIES (36,048) (16,112) (10,991) INVESTING ACTIVITIES Net Change in Interest-Bearing Deposits 3,419 685 1,769 Purchases of Available-for-Sale Securities (1,894) (5,864) (26,314) Purchases of Held-to-Maturity Securities (10,551) 97,902) (3,391) Proceeds from Maturities and Sale of Available-for-Sale Securities 18,683 4,787 29,400 Proceeds from Maturities of Held-to-Maturity Securities 2,663 8,407 6,647 Net Change in Loans (28,838) (35,866) (5,879) Proceeds from Sales of Other Real Estate Owned 1,212 885 321 Net Cash Received from Purchase of Bank of Westminster -- -- 4,618 Purchases of Premises and Equipment (2,184) (1,885) (579) Proceeds from Sale of Premises and Equipment 82 3 35 ---------- ---------- ---------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (17,408) (36,750) 6,627 FINANCING ACTIVITIES Net Change in Demand Deposits and Savings Accounts 67,451 14,568 (6,340) Net Change in Time Deposits 11,820 31,310 5,382 Net Change Short-Term Borrowings (4,000) 3,500 500 Reductions in Long-Term Debt (465) (58) (58) Proceeds from Exercise of Stock Options 138 592 23 Proceeds from Stock Offering -- -- 7,759 Redemption of Common and Preferred Stock -- (1,075) (6) Dividends Paid (467) (502) (327) ---------- ---------- ---------- NET CASH PROVIDED BY FINANCING ACTIVITIES 74,477 49,404 5,864 INCREASE (DECREASE) IN ---------- ---------- ---------- CASH AND CASH EQUIVALENTS 21,021 (3,458) 1,500 Cash and Cash Equivalents at Beginning of Year 11,893 15,351 13,851 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 32,914 $ 11,893 $ 15,351 ---------- ---------- ---------- ---------- ---------- ---------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest Paid $ 8,338 $ 5,895 $ 3,749 Income Taxes Paid $ 4,237 $ 2,352 $ 1,567
The accompanying notes are an integral part of these consolidated financial statements. 41 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The financial statements include the accounts of BYL Bancorp and its subsidiary, BYL Bank Group ("the Bank"), collectively referred to herein as the "Company". NATURE OF OPERATIONS The Bank operates nine retail branches in Orange and Riverside County, California. It also operates a Small Business Administration (SBA) loan department and a mortgage loan department. The Bank's primary source of revenue is providing loans to clients for both retention in the Bank's loan portfolio as well as sales to other institutional investors. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND DUE FROM BANKS Banking regulations require that all banks maintain a percentage of their deposits as reserves in cash or on deposit with the federal reserve bank. The Company maintains amounts due from banks which exceed federally insured limits. The Company has not experienced any losses in such accounts. INVESTMENT SECURITIES Bonds, notes, and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Investments not classified as trading securities nor as held to maturity securities are classified as available-for-sale securities and recorded at fair value. Unrealized gains or losses on available-for-sale securities are excluded from net income and reported as an amount net of taxes as a separate component of other comprehensive income included in shareholders' equity. Premiums or discounts on held-to-maturity and available-for-sale securities are amortized or accreted into income using the interest method. Realized gains or losses on sales of held-to-maturity or available-for-sale securities are recorded using the specific identification method. 42 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED LOANS HELD FOR SALE Mortgage, SBA loans and other loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. LOANS Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances reduced by any charge-offs or specific valuation accounts and net of any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. For impairment recognized in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 114, "ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN" (SFAS No. 114), amended by SFAS No. 118, the entire change in the present value of expected cash flows is reported as either provision for loan losses in the same manner in which impairment initially was recognized, or as a reduction in the amount of provision for loan losses that otherwise would be reported. On January 1, 1997, the Company adopted SFAS No. 125 "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES". The statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Under this statement, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered, and dercognizes liabilities when extinguished. 43 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED LOANS - CONTINUED To calculate the gain (loss) on sale of loans, the Company's investment in the loan is allocated among the retained portion of the loan, the servicing retained, the interest-only strip and the sold portion of the loan, based on the relative fair market value of each portion. The gain (loss) on the sold portion of the loan is recognized at the time of sale based on the difference between the sale proceeds and the allocated investment. As a result of the relative fair value allocation, the carrying value of the retained portion is discounted, with the discount accreted to interest income over the life of the loan. That portion of the excess servicing fees that represent contractually specified servicing fees (contractual servicing) are reflected as a servicing asset which is amortized over an estimated life using a method approximating the level yield method; in the event future prepayments exceed Management's estimates and future expected cash flows are inadequate to cover the unamortized servicing asset, additional amortization would be recognized. The portion of excess servicing fees in excess of the contractual servicing fees is reflected as interest-only (I/O) strips receivable which are classified as interest-only strips receivable available for sale and are carried at fair value. ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is increased by charges to income and decreased by charge-offs (net of recoveries). The company performs quarterly detailed reviews to identify the risks inherent in the loan portfolio, assess the overall quality of the loan portfolio and to determine the adequacy of the allowance for loan losses and the related provision for loan losses to be charged to expense. This systematic reviews follow the methodology set forth by the FDIC in its 1993 policy statement on the allowance for loan losses. Loans identified as less than "acceptable" are reviewed individually to estimate the amount of probable losses that need to be included in the allowance. These reviews include analysis of financial information as well as evaluation of collateral securing the credit. Additionally, management considers the inherent risk present in the "acceptable" portion of the loan portfolio taking into consideration historical losses on pools of similar loans, adjusted for trends, conditions and other relevant factors that may affect repayment of the loans in these pools. MORTGAGE BANKING ACTIVITIES The Company originates and sells residential mortgage loans to a variety of secondary market investors, including the Federal Home Loan Mortgage Corporation (FHLMC), the Federal National Mortgage Association (FNMA) and others. Gains and losses on the sale of mortgage loans are recognized upon delivery based on the difference between the selling price and the carrying value of the related mortgage loans sold. Deferred origination fees and expenses are recognized at the time of sale in the determination of the gain or loss. The Company sells the servicing for such loans to the purchaser of the loans. The Company recognizes the gain or loss on servicing sold when all risks and rewards of ownership have transferred. 44 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED MORTGAGE BANKING ACTIVITIES - CONTINUED Mortgage loans held for sale are stated at the lower of cost or market as determined by the outstanding commitments from investors or current investor yield requirements calculated on an aggregate loan basis. Valuation adjustments are charged against noninterest income. Forward commitments to sell, and put options on mortgage-backed securities are used to reduce interest rate risk on a portion of loans held for sale and anticipated loan fundings. The resulting gains and losses on forward commitments are deferred and included in the carrying values of loans held for sale. Premiums on put options are capitalized and amortized over the option period. Gains and losses on forward commitments and put options deferred against loans held for sale approximately offset equivalent amounts of unrecognized gains and losses on the related loans. Forward commitments to sell and put options on mortgage-backed securities that hedge anticipated loan funding are not reflected in the consolidated statement of financial condition. Gains and losses on these instruments are not recognized until the actual sale of the loans held for sale. Loans generally fund in 10 to 30 days from the date of commitment. PREMISES AND EQUIPMENT Land is carried at cost. Bank premises, furniture and equipment, and leasehold improvements are carried at cost less accumulated depreciation and amortization. OTHER REAL ESTATE OWNED Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of cost or fair value minus estimated costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses. GOODWILL AND OTHER INTANGIBLES Goodwill represents the excess of the purchase price over the estimated fair value of net assets associated with acquisition transactions of the Company accounted for as purchases and is amortized over fifteen years. Core deposit intangibles represent the intangible value of depositor relationships resulting from deposit liabilities assumed in acquisitions and are amortized over seven years. Goodwill and other intangibles are evaluated periodically for other than temporary impairment. Should such an assessment indicate that the undiscounted value of an intangible may be impaired, the net book value of the intangible would be written down to net estimated recoverable value. 45 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED INCOME TAXES Deferred income taxes are computed using the asset and liability method, which recognizes a liability or asset representing the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the consolidated financial statements. A valuation allowance is established to reduce the deferred tax asset to the level at which it is "more likely than not" that the tax asset or benefits will be realized. Realization of tax benefits of deductible temporary differences and operating loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryforward periods. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107 specifies the disclosure of the estimated fair value of financial instruments. The Bank's estimated fair value amounts have been determined by the Bank using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates are not necessarily indicative of the amounts the Company could have realized 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. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since the balance sheet date and, therefore, current estimates of fair value may differ significantly from the amounts presented in the accompanying Notes. EARNINGS PER SHARES (EPS) Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. 46 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED STOCK-BASED COMPENSATION Statement of Financial Accounting Standards ("SFAS") No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION," encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. The pro forma effects of adoption are disclosed in Note I. CURRENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES". This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This new standard is effective for 2000 and is not expected to have a material impact on the Bank' s financial statements. RECLASSIFICATIONS Certain reclassifications were made to prior years' presentations to conform to the current year. These classifications are of a normal recurring nature. 47 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE B - INVESTMENT SECURITIES Debt and equity securities have been classified in the consolidated balance sheets according to management's intent. The carrying amount of securities and their approximate fair values at December 31 were as follows:
Gross Gross Amortized Unrealized Unrealized Cost Gains (Losses) Fair Value --------- ---------- ----------- ---------- AVAILABLE-FOR-SALE SECURITIES: DECEMBER 31, 1998: Investment in Mutual funds $ 3,000 $ -- $ -- $ 3,000 Mortgage-Backed Securities 2,305 265 2,570 Other 830 -- -- 830 -------- ----- ----- -------- $ 6,135 $ 265 $ -- $ 6,400 -------- ----- ----- -------- -------- ----- ----- -------- DECEMBER 31, 1997: U.S. Government and Agency Securities $ 2,552 $ 14 $ (2) $ 2,564 Municipal Securities 1,018 14 -- 1,032 Investment in Mutual funds 6,059 -- (43) 6,016 Other 802 -- -- 802 -------- ----- ----- -------- $ 10,431 $ 28 $ (45) $ 10,414 -------- ----- ----- -------- -------- ----- ----- -------- HELD-TO-MATURITY SECURITIES: DECEMBER 31, 1998: U.S. Treasury $ 2,499 $ 27 $ -- $ 2,526 U.S. Government and Agency Securities 8,029 7 (6) 8,030 Mortgage-Backed Securities 316 2 -- 318 -------- ----- ----- -------- $ 10,844 $ 36 $ (6) $ 10,874 -------- ----- ----- -------- -------- ----- ----- -------- DECEMBER 31, 1997: U.S. Treasury $ 4,498 $ 7 $ (2) $ 4,503 U.S. Government and Agency Securities 6,466 25 -- 6,491 Municipal Securities 1,926 20 -- 1,946 Mortgage-Backed Securities 60 -- (6) 56 -------- ----- ----- -------- $ 12,950 $ 52 $ (8) $ 12,996 -------- ----- ----- -------- -------- ----- ----- --------
The gross unrealized gain of $265 on available-for-sale securities is included in accumulated other comprehensive income at December 31, 1998, net of taxes of $109. 48 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE B - INVESTMENT SECURITIES - CONTINUED During 1998, the Company received $1,504 in proceeds and recorded a loss of $39 from the sale of investment securities. The Company did not sell any investment securities for the years ended December 31, 1997, and 1996. Investment securities carried at approximately $10,843 and $5,007 at December 31, 1998 and 1997, respectively, were pledged to secure public deposits and other purposes as required by law. The scheduled maturities of securities available for sale and securities held to maturity at December 31, 1998, were as follows:
AVAILABLE-FOR-SALE HELD-TO-MATURITY --------------------- --------------------- Amortized Fair Amortized Fair Cost Value Cost Value --------- ------- --------- -------- Due In One Year or Less $ 3,000 $ 3,000 $ 2,995 $ 3,016 Due from One to Five Years -- -- 7,533 7,540 Mortgage-Backed Securities 2,305 2,570 316 318 Other 830 830 -- -- --------- ------- -------- -------- $ 6,135 $ 6,400 $ 10,844 $ 10,874 --------- ------- -------- -------- --------- ------- -------- --------
NOTE C - LOANS HELD FOR SALE The Bank originates auto, mortgage and SBA loans for sale to institutional investors. A substantial portion of the Bank's revenues are from origination of loans guaranteed by the Small Business Administration under its Section 7 program and sale of the guaranteed portions of those loans. Funding for the Section 7 program depends on annual appropriations by the U.S. Congress. At December 31, 1998 and 1997, the Bank was servicing approximately $164,764 and $76,085, respectively, in SBA loans previously sold. Prior to January 1, 1997, the Company's excess servicing fees were recorded as excess servicing assets which were amortized over the estimated life of the related loans. Effective January 1, 1997, under provisions of SFAS 125, excess servicing assets on loans sold prior to January 1, 1997 were reclassified to interest-only strips receivable and to servicing assets. These assets are amortized as an offset to loan servicing income and I/O strip income over the estimated life of the related loans. 49 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE C - LOANS HELD FOR SALE - CONTINUED A summary of the changes in the servicing assets and interest-only strips receivable was as follows:
Servicing Assets -------------------------------- 1998 1997 1996 -------- -------- -------- Balance at Beginning of Year $ 1,920 $ 1,249 $ 632 Transfer to Interest-Only Strips Receivable -- (312) -- Increase from Loan Sales 968 1,057 844 Amortization and Prepayments Charged to Income (409) (74) (227) -------- -------- -------- Balance at End of Year $ 2,479 $ 1,920 $ 1,249 -------- -------- -------- -------- -------- --------
Interest-Only Strips Receivable -------------------------------- 1998 1997 1996 -------- -------- -------- Balance at Beginning of Year $ 644 $ -- $ -- Transfer from Servicing Assets -- 312 -- Increase from Loan Sales 5,437 353 -- Amortization and Prepayments Charged to Income (155) (21) -- -------- -------- -------- Balance at End of Year $ 5,926 $ 644 $ -- -------- -------- -------- -------- -------- -------- Unrecognized Gain at End of Year $ 620 $ -- $ --
The unrecognized gain on interest-only strips receivable of $620 is included in accumulated other comprehensive income at December 31, 1998, net of taxes of $256. The estimated fair value of the servicing assets was approximately $2,500 at December 31, 1998. Fair value is estimated by discounting estimated future cash flows from the servicing assets using discount rates that approximate current market rates over the expected lives of the loans being serviced. For purposes of measuring impairment, the Bank has identified each servicing asset with the underlying loan being serviced. A direct write down is recorded where the fair value is below the carrying amount of a specific servicing asset. 50 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE D - LOANS The Bank's loan portfolio consists primarily of loans to borrowers within Orange and Riverside County in Southern California. Although the Bank seeks to avoid concentrations of loans to a single industry or based upon a single class of collateral, real estate and real estate associated businesses are among the principal industries in the Bank's market area and, as a result, the Bank's loan and collateral portfolios are, to some degree, concentrated in those industries. A summary of the changes in the allowance for credit losses as of December 31 follows:
1998 1997 1996 -------- -------- -------- Balance at Beginning of Year $ 1,923 $ 1,616 $ 1,047 Additions to the Allowance Charged to Expense 755 778 364 Recoveries on Loans Charged Off 150 64 36 Allowance on Loans Acquired from Bank of Westminster -- -- 700 -------- -------- -------- 2,828 2,458 2,147 Less Loans Charged Off (528) (535) (531) -------- -------- -------- $ 2,300 $ 1,923 $ 1,616 -------- -------- -------- -------- -------- --------
The following is a summary of the investment in impaired loans, the related allowance for credit losses, and income recognized thereon as of December 31:
1998 1997 1996 -------- -------- -------- Recorded Investment in Impaired Loans $ 1,806 $ 2,325 $ 2,508 Related Allowance for Impaired Losses $ 289 $ 341 $ 538 Average Recorded Investment in Impaired Loans $ 2,102 $ 2,324 $ 2,039 Interest Income Recognized from Cash Payments $ -- $ 103 $ 19
Loans having carrying values of $1,479, $336 and $995 were transferred to other real estate owned in 1998, 1997 and 1996, respectively. 51 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE E - PREMISES AND EQUIPMENT A summary of premises and equipment follows:
1998 1997 -------- -------- Land $ 943 $ 943 Buildings 2,039 2,068 Leasehold Improvements 1,380 1,130 Furniture, Fixtures, and Equipment 5,739 5,214 -------- -------- 10,101 9,355 Less Accumulated Depreciation and Amortization (4,019) (4,150) -------- -------- $ 6,082 $ 5,205 -------- -------- -------- --------
NOTE F - DEPOSITS At December 31, 1998, the scheduled maturities of time deposits are as follows: 1999 $ 77,652 2000 through 2002 10,331 After 2002 52 -------- $ 88,035 -------- --------
52 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE G - OTHER EXPENSES A summary of other expenses for the years ended December 31 is as follows:
1998 1997 1996 -------- -------- -------- Regulatory Assessments $ 58 $ 79 $ 59 Other Real Estate Owned 288 185 375 Commissions 13 278 200 Professional Fees and Outside Services 1,792 1,406 1,198 Loan Expenses 1,047 511 247 Office Expenses 1,527 1,303 910 Merger Related Expenses 542 -- -- Other 2,264 2,152 1,396 ------- ------- ------- $ 7,531 $ 5,914 $ 4,385 ------- ------- ------- ------- ------- -------
NOTE H - INCOME TAXES The provisions for income taxes included in the statements of income consist of the following:
1998 1997 1996 -------- -------- -------- Current: Federal $ 2,723 $ 2,176 $ 1,072 State 1,050 704 394 -------- -------- -------- 3,773 2,880 1,466 Deferred (496) (912) (237) -------- -------- -------- $ 3,277 $ 1,968 $ 1,229 -------- -------- -------- -------- -------- --------
Deferred taxes are a result of differences between income tax accounting and generally accepted accounting principles with respect to income and expense recognition. The Company's principal differences are from loan loss provision accounting, loan sales, and depreciation differences. 53 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE H - INCOME TAXES - CONTINUED The following is a summary of the components of the deferred tax asset account recognized in the accompanying consolidated balance sheets:
1998 1997 -------- -------- Deferred Tax Assets: Allowance for Loan Losses $ 510 $ 395 Other Real Estate Writedowns 222 155 Gain on Sale of Loans 1,196 1,169 California Franchise Tax 312 211 Other Assets/Liabilities 401 271 ------- ------- 2,641 2,201 Deferred Tax Liabilities: Unrealized Gains on Securities and Other Assets (365) -- Premises and Equipment (433) (439) ------- ------- (798) (439) ------- ------- $ 1,843 $ 1,762 ------- ------- ------- -------
A comparison of the federal statutory income tax rates to the Company's effective income tax rates for the years ended December 31 follows:
1998 1997 1996 --------------- ------------------ ------------------ Amount Rate Amount Rate Amount Rate ------- ------ ------- ------ ------- ------ Federal Tax Rate $ 2,514 34.0% $ 1,640 34.0% $ 1,069 34.0% California Franchise Taxes, Net of Federal Tax Benefit 536 7.3 330 6.8 222 7.1 Tax Savings from Exempt Interest (44) (0.6) (79) (1.6) (93) (3.0) Merger Expenses 222 3.0 -- -- -- - Other Items - Net 49 0.6 77 1.6 31 1.0 ------- ------ ------- ------ ------- ------ Bank's Effective Rate $ 3,277 44.3% $ 1,968 40.8% $ 1,229 39.1% ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------
54 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE I - EARNINGS PER SHARE (EPS) The following is a reconciliation of net income and shares outstanding to the income and number of share used to compute EPS:
1998 1997 1996 ------------------- ---------------------- ---------------------- Income Shares Income Shares Income Shares ------- ---------- ------- ---------- ------- ---------- Net Income as Reported $ 4,116 $ 2,855 $ 1,916 Current Period Preferred Dividends -- -- (29) Weighted Average Shares Outstanding During the Year 2,520,828 2,403,103 1,918,438 ------- ---------- ------- ---------- ------- ---------- USED IN BASIC EPS 4,116 2,520,828 2,855 2,403,103 1,887 1,918,438 Dilutive Effect of: Outstanding Stock Options 135,410 134,084 74,104 ------- ---------- ------- ---------- ------- ---------- USED IN DILUTIVE EPS $ 4,116 2,656,238 $ 2,855 2,537,187 $ 1,887 1,992,542 ------- ---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- ------- ----------
NOTE J - EMPLOYEE BENEFITS The Company has a salary deferral 401(k) Plan that covers substantially all employees. The Bank contributed matching funds at its option, which amounted to $302 and $34 in 1998 and 1997, respectively. No contribution for matching funds was made in 1996. The Bank has entered into retirement benefit agreements with certain officers providing for future benefits aggregating approximately $3,180, payable in equal annual installments for fifteen years from the death or retirement dates of each participating officer. The obligations for these agreements are funded by single premium life insurance policies, with cash surrender values aggregating approximately $1,374, $906 and $862 at December 31, 1998, 1997 and 1996, respectively. As of December 31, 1998, 1997 and 1996, approximately $152, $97, and $48, respectively, has been accrued in conjunction with these agreements. 55 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE K - COMMITMENTS AND CONTINGENCIES The Bank has entered into various operating lease agreements, primarily covering its branch locations. These agreements expire at various times through the year 2003. The approximate future minimum annual payments for these leases by year are as follows: 1999 $ 1,288 2000 889 2001 687 2002 500 2003 191 Thereafter 355 ------- $ 3,910 ------- -------
The minimum rental payments shown above are given for the existing lease obligations, are not a forecast of future rental expense, and do not include sublease income. Total rental expense included in occupancy expense and furniture and equipment expense was approximately $987 in 1998, $768 in 1997 and $772 in 1996. The Company is involved in various litigation which has arisen in the ordinary course of its business. In the opinion of management, based upon representation of legal counsel, the disposition of such pending litigation will not have a material effect on the Bank's financial statements. In the ordinary course of business, the Bank enters into financial commitments to meet the financing needs of its clients. These financial commitments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the statement of financial position. The Bank's exposure to loan loss in the event of nonperformance on commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it does for loans reflected in the financial statements. 56 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE K - COMMITMENTS AND CONTINGENCIES - CONTINUED As of December 31, 1998, the Bank had the following outstanding financial commitments whose contractual amount represents credit risk: Commitments to Extend Credit $ 21,627 Standby Letter of Credit 360 -------- $ 21,987 -------- --------
Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments to guarantee the performance of a Bank client to a third party. Since many of the commitments and standby letters of credit are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. The Bank evaluates each client's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, is based on management's credit evaluation of the client. The majority of the Bank's commitments to extend credit and standby letters of credit are secured by real estate. NOTE L - RELATED PARTY TRANSACTIONS In the ordinary course of business, the Bank has granted loans to certain officers and directors and the companies with which they are associated. In the Bank's opinion, all loans and loan commitments to such parties are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. The balance of these loans outstanding at December 31, 1998 was approximately $2,241 and approximately $1,486 at December 31, 1997. The Bank leases its Main Riverside facility from a partnership comprised of two of its directors. The initial term of the lease started in 1982 and expires in 2002, with two successive ten year options. Monthly rental expense, currently at $14, is adjusted for cost of living increases every three years. The Bank also pays its pro-rata share of taxes and common operating expenses. NOTE M - PREFERRED STOCK The Bank is authorized to issue 1,000,000 shares of its preferred stock in series. The rights, preferences, privileges and restrictions of each series of preferred stock are determined upon issuance. On July 16, 1986, the Bank issued 10,000 shares of its Series A preferred stock at a price of $100 per share for a total consideration of $1,000 to members of the Board of Directors. During 1996 the Bank redeemed all outstanding preferred stock for $1,020. 57 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE N - STOCK OPTION PLAN At December 31, 1998, the Bank has an option plan which is described below. The Bank applies APB Opinion 25 and related interpretations in accounting for its plan. Accordingly, no compensation cost has been recognized for its fixed stock option plan. In 1997, the Company adopted an incentive stock option plan under which up to 460,519 shares of the Company's common shares may be issued to directors, officers, and key employees at not less than 100% of the fair market value at the date the options are granted. The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions; risk-free rates of 4.5% in 1998 and 5.8% in 1997, volatility of 28% in 1998 and 19% in 1997 and expected lives of five years. The weighted-average fair value of options granted during 1998 was $5.22 and $3.87 for 1997. A summary of the status of the Company's fixed stock option plan as of December 31, 1998, 1997, and 1996, and changes during the years ending on those dates is presented below:
1998 1997 1996 ---------------------- ---------------------- ---------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price -------- --------- -------- --------- -------- --------- Outstanding at Beginning of Year 288,700 $ 9.56 125,865 $ 4.88 130,397 $ 4.88 Options Granted 152,533 17.47 179,368 12.70 -- Options Exercised (28,131) 4.88 (11,466) 6.40 -- Options Forfeited -- (5,067) 11.79 4,532 4.88 -------- -------- -------- Outstanding at End of Year 413,102 12.80 288,700 9.56 134,929 4.88 -------- -------- -------- -------- -------- -------- Options Exercisable at Year-End 203,052 9.31 171,783 7.41 129,542 4.88 Weighted-Average Fair Value of Options Granted During the Year $ 5.22 $ 3.87 N/A
58 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE N - STOCK OPTION PLAN - CONTINUED The following table summarizes information about fixed options outstanding at December 31, 1998:
Options Outstanding Options Exercisable ---------------------------------------------- -------------------------- Weighted- Weighted Weighted- Average Average Average Exercise Number Remaining Exercise Number Exercise Price Outstanding Contractual Life Price Exercisable Price - ---------------- ----------- ---------------- --------- ------------ --------- $4.48 88,001 3.8 years $4.48 88,001 $4.48 $12.00 to $13.00 172,568 8.3 years 12.71 115,051 12.71 $17.00 to $21.00 152,533 10.0 years 17.47 -- ------- ------- 413,102 7.9 years 12.80 203,052 9.31 ------- ------- ------- -------
Had the Bank determined compensation cost based on the fair value at the grant date for its stock options under No. 123, the Bank's net income would have been reduced to the following pro forma amount:
1998 1997 1996 ------- ------- ------- Net Income: As Reported $ 4,116 $ 2,855 $ 1,916 Pro Forma $ 3,888 $ 2,640 $ 1,916 Per Share Data: Net Income - Basic As Reported 1.63 1.19 0.98 Pro Forma 1.54 1.10 0.98 Net Income - Diluted As Reported 1.55 1.12 0.96 Pro Forma 1.46 1.04 0.96
The information above does not include options from DNB Financial which was acquired in 1998 (see Note Q). DNB Financial had no options granted in 1998, 1997 and 1996 and therefore did not impact the pro forma data presented above. During 1997 and 1996, options previously granted equal to 92,609 shares and 4,116 shares, respectively, were exercised. 59 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates. The following methods and assumptions were used to estimate the fair value of significant financial instruments: FINANCIAL ASSETS The carrying amounts of cash, short term investments, due from clients on acceptances, and Bank acceptances outstanding are considered to approximate fair value. Short term investments include federal funds sold, securities purchased under agreements to resell, and interest bearing deposits with Banks. The fair values of investment securities, including available-for-sale, are generally based on quoted market prices. The fair value of loans are estimated using a combination of techniques, including discounting estimated future cash flows and quoted market prices of similar instruments where available. FINANCIAL LIABILITIES The carrying amounts of deposit liabilities payable on demand, commercial paper, and other borrowed funds are considered to approximate fair value. For fixed maturity deposits, fair value is estimated by discounting estimated future cash flows using currently offered rates for deposits of similar remaining maturities. The fair value of long term debt is based on rates currently available to the Bank for debt with similar terms and remaining maturities. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. The fair value of these financial instruments is not material. 60 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - CONTINUED Forward Commitments to Sell Mortgage-Backed Securities - Fair value is based on quoted prices for financial instruments with identical or similar terms. The fair value of forward commitments to sell mortgage-backed securities is not material. Put Options to Sell Mortgage-Backed Securities - Fair value is derived from active exchange quotations. The fair value of put options to sell mortgage-backed securities is not material. The estimated fair value of financial instruments at December 31, 1998 and 1997 is summarized as follows:
December 31, ----------------------------------------------- 1998 1997 --------------------- --------------------- Carrying Fair Carrying Fair Value Value Value Value -------- -------- -------- -------- FINANCIAL ASSETS: Cash and Due From Banks $ 14,214 $ 14,214 $ 11,893 $ 11,893 Federal Funds Sold 18,700 18,700 -- -- Interest-Bearing Deposits -- -- 3,419 3,419 Investment Securities 17,244 17,274 23,364 23,410 Loans Held for Sale 74,598 76,836 47,150 49,290 Loans 164,154 164,138 137,550 136,650 I/O Strips Receivable and Servicing Assets 9,025 9,025 2,564 2,564 Cash Surrender Value - Life Insurance 1,374 1,374 906 906 FINANCIAL LIABILITIES: Deposits 287,206 287,394 207,935 207,944 Federal Funds Purchased -- -- 1,000 1,000 Federal Home Loan Bank Advances -- -- 3,000 3,000
61 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE P - REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1998, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action (there are no conditions or events since that notification that management believes have changed the Bank's category). To be categorized as well-capitalized, the Bank must maintain minimum ratios as set forth in the table below.
Minimum Required Capital --------------------------------------- To Be Well- Capitalized For Capital Under Prompt Adequacy Corrective Actual Purposes Provisions ------------------ ------------------ ------------------ Amount Ratio Amount Ratio Amount Ratio -------- ------- -------- ------- -------- ------- AS OF DECEMBER 31, 1998: Total Capital (to Risk-Weighted Assets) $ 26,782 10.9% $ 19,593 8.0% $ 24,491 10.0% Tier 1 Capital (to Risk-Weighted Assets) $ 24,483 10.0% $ 9,796 4.0% $ 14,694 6.0% Tier 1 Capital (to Average Assets) $ 24,483 7.9% $ 12,314 4.0% $ 15,392 5.0% AS OF DECEMBER 31, 1997: Total Capital (to Risk-Weighted Assets) $ 20,811 11.5% $ 14,475 8.0% $ 18,094 10.0% Tier 1 Capital (to Risk-Weighted Assets) $ 18,887 10.5% $ 7,238 4.0% $ 10,856 6.0% Tier 1 Capital (to Average Assets) $ 18,887 7.8% $ 9,727 4.0% $ 12,160 5.0%
62 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE Q - MERGERS AND ACQUISITIONS On November 19, 1997, BYL Bancorp acquired Bank of Yorba Linda by issuing 1,546,530 shares of Bancorp common stock in exchange for the surrender of all outstanding shares of the Bank's common stock. There was no cash involved in this transaction. The acquisition was accounted for as a pooling of interest and the consolidated financial statements contained herein have been restated to give full affect to this transaction. On June 13, 1996, the Bank acquired 100% of the outstanding common stock of Bank of Westminster (BOW) for $6,174 in cash. BOW had total assets of approximately $54,923. The acquisition was accounted for using the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16. "Business Combinations". Under this method of accounting, the purchase price was allocated to the assets acquired and deposits and liabilities assumed based on their fair values as of the acquisition date. The financial statements include the operations of BOW from the date of the acquisition. Goodwill arising from the transaction totaled approximately $1,717 and is being amortized over fifteen years on a straight-line basis. BOW's pre-acquisition income in 1996 was not material. At the close of business on May 29, 1998, the Company consummated a merger with DNB Financial and its wholly-owned subsidiary, De Anza National Bank. This merger was accounted for by the pooling of interest method, whereby the Company's Financial Statements have been restated as if the two companies were historically one unit. A total of 956,641 common shares were issued to the shareholders of DNB Financial in connection with this merger. The following table summarizes the separate revenue and net income of the Company and DNB Financial that have been reported in the restated financial statements included herein:
1998 1997 1996 -------- -------- -------- Interest and Noninterest Income: The Company $ 44,635 $ 27,818 $ 15,151 DNB Financial 2,789 6,557 6,243 -------- -------- -------- $ 47,424 $ 34,375 $ 21,394 -------- -------- -------- -------- -------- -------- Net Income: The Company $ 3,794 $ 2,110 $ 1,202 DNB Financial 322 745 714 -------- -------- -------- $ 4,116 $ 2,855 $ 1,916 -------- -------- -------- -------- -------- --------
63 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY BYL Bancorp operates Bank of Yorba Linda. BYL Bancorp commenced operations during 1997. The earnings of the subsidiary are recognized on the equity method of accounting. Condensed financial statements of the parent company only are presented below:
December 31, --------------------- 1998 1997 -------- -------- ASSETS: Cash $ 193 $ 50 Investment Securities -- 1,106 Investment in Subsidiary 26,689 21,092 Loans -- 555 Other Assets -- 216 -------- -------- $ 26,882 $ 23,019 -------- -------- -------- -------- LIABILITIES: Long-Term Debt $ -- $ 465 Other Liabilities -- 4 -------- -------- TOTAL LIABILITIES -- 469 SHAREHOLDER'S EQUITY 22,550 26,882 -------- -------- $ 26,882 $ 23,019 -------- -------- -------- --------
64 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY - CONTINUED CONDENSED STATEMENTS OF INCOME
Year Ended December 31, ----------------------- 1998 1997 -------- -------- INCOME: Cash Dividends from Subsidiary $ 531 $ 389 Interest Income 36 96 ------- ------- TOTAL INCOME 567 485 EXPENSES: Merger Related Expenses 542 -- Other 44 154 ------- ------- TOTAL EXPENSES 586 154 ------- ------- INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY (19) 331 EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 4,135 2,524 ------- ------- NET INCOME $ 4,116 $ 2,855 ------- ------- ------- -------
65 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY - CONTINUED CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31, ----------------------- 1998 1997 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 4,116 $ 2,855 Noncash Items Included in Net Income: Equity in Income of Subsidiary (4,666) (2,913) Change in Other Assets and Liabilities 212 (94) -------- -------- NET CASH USED IN OPERATING ACTIVITIES (338) (152) CASH FLOWS FROM INVESTING ACTIVITIES: Dividends Received from Subsidiary 531 389 Investment in Subsidiary (915) -- Change in Investments 1,106 (584) Change in Loans 555 131 -------- -------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 1,277 (64) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from Short-Term Debt -- 100 Repayment of Short-Term Debt -- (100) Repayments of Long-Term Debt (465) (58) Options Exercised and Shares Retired 138 604 Dividends Paid (469) (287) -------- -------- NET CASH PROVIDED (USED) IN FINANCING ACTIVITIES (796) 259 -------- -------- NET INCREASE IN CASH AND CASH EQUIVALENTS 143 43 CASH AND CASH EQUIVALENTS, AT BEGINNING OF YEAR 50 7 -------- -------- CASH AND CASH EQUIVALENTS AT ENDING OF YEAR $ 193 $ 50 -------- -------- -------- --------
66 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE S - SEGMENT INFORMATION The Company has two primary reportable segments; its wholesale lending operations and its retail banking operations. The wholesale lending segment originates loans for resale to institutional investors. The Company's SBA Loan Division and its Mortgage Loan Division are included in this segment. The retail banking segment accepts deposits, originates loans and provides other banking services to the communities in which its nine branch offices are located. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from operations before allocation of the provision for loan losses, administrative costs, amortization of goodwill and income taxes. The retail segment charges the wholesale segments for use of excess funds based on the estimated cost of outside financing The following tables summarize segment operations and asset allocations for the last three years:
1998 ------------------------------------------------- Wholesale Segments ---------------------- Retail Total Mortgage SBA Segment Company -------- --------- --------- --------- CONDENSED INCOME STATEMENT Net Interest Income $ 2,772 $ 3,382 $ 9,456 $ 15,610 Noninterest Income 13,487 6,899 3,022 23,408 Operating Expense (11,225) (4,405) (10,433) (26,063) -------- --------- --------- --------- OPERATIONAL PROFIT 5,876 5,034 2,045 12,955 Provision for Loan Losses (755) Administrative Costs (4,686) Goodwill Amortization (121) Income Taxes (3,277) --------- NET INCOME $ 4,116 --------- --------- Total Assets at December 31, 1998 $ 37,365 $ 74,720 $205,928 $318,013 Loans Originated for Sale during 1998 $245,000 $ 89,000 Loans Sold during 1998 $222,000 $ 94,000
67 BYL BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (DOLLAR AMOUNTS IN THOUSANDS) NOTE S - SEGMENT INFORMATION - CONTINUED
1997 ------------------------------------------------- Wholesale Segments ---------------------- Retail Total Mortgage SBA Segment Company -------- --------- --------- --------- CONDENSED INCOME STATEMENT Net Interest Income $ 2,733 $ 2,023 $ 7,642 $ 12,398 Noninterest Income 8,655 3,681 3,584 15,920 Operating Expense (7,513) (3,121) (9,017) (19,651) -------- --------- --------- --------- OPERATIONAL PROFIT 3,875 2,583 2,209 8,667 Provision for Loan Losses (778) Administrative Costs (2,952) Goodwill Amortization (114) Income Taxes (1,968) --------- NET INCOME $ 2,855 --------- --------- Total Assets at December 31, 1997 $ 46,957 $ 43,861 $147,268 $238,086 Loans Originated for Sale during 1997 $190,000 $ 62,000 Loans Sold during 1997 $163,000 $ 42,000
1996 ------------------------------------------------- Wholesale Segments ---------------------- Retail Total Mortgage SBA Segment Company -------- --------- --------- --------- CONDENSED INCOME STATEMENT Net Interest Income $ 684 $ 944 $ 7,174 $ 8,802 Noninterest Income 4,039 2,255 2,458 8,752 Operating Expense (3,345) (1,883) (6,760) (11,988) -------- --------- --------- --------- OPERATIONAL PROFIT 1,378 1,316 2,872 5,566 Provision for Loan Losses (364) Administrative Costs (2,000) Goodwill Amortization (57) Income Taxes (1,229) --------- NET INCOME $ 1,916 --------- --------- Total Assets at December 31, 1996 $ 20,278 $ 19,884 $143,593 $183,755 Loans Originated for Sale during 1996 $ 89,000 $ 38,000 Loans Sold during 1996 $ 76,000 $ 28,000
68 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information required by this Item is incorporated by reference from the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the second quarter, 1999. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference from the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the second quarter, 1999. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference from of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the second quarter, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference from of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held in the second quarter, 1999. 69 PART IV ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K a) EXHIBITS
EXHIBIT NO. ----------- 2.1 Plan of Reorganization and Merger Agreement - Annex I of Proxy Statement/Prospectus incorporated by reference (A) 3.1 Articles of Incorporation of the Registrant (A) 3.2 Amendment to Articles of Incorporation of Registrant (A) 3.3 Bylaws of the Registrant (A) 4.1 Specimen Certificate evidencing shares of Registrant's Common Stock (A) 4.2 Stockholder Agreement Covering Issuance and Compulsory Repurchase of Organizing Shares of Registrant - Annex II of Proxy Statement/Prospectus incorporated by reference (A) 10.1 Form of Indemnification Agreement (A) 10.2 BYL Bancorp 1997 Stock Option Plan, as amended in 1999 10.3 Form of Proxy 10.4 Employment Agreement - Mr. Robert Ucciferri (A) 10.5 Employment Agreement - Mr. Barry J. Moore (A) 10.6 Employment Agreement - Mr. Michael Mullarky (A) 10.7 Employment Agreement - Ms. Gloria Van Kampen 10.8 Salary Continuation Agreement - Mr. Robert Ucciferri (A) 10.9 Salary Continuation Agreement - Mr. Barry J. Moore (A) 10.11 Agreement and Plan of Reorganization with DNB Financial (B) 21.1 Subsidiary of BYL Bancorp (A) 23.1 Consent of Vavrinek, Trine, Day & Co.
- --------------------------------- (A) Filed as an Exhibit to the Registrants Registration Statement (File No. 333-34995) filed on September 5, 1997, which exhibit is incorporated herein by this reference. (B) Filed as an Exhibit to Form 8-K filed on January 29, 1998, which exhibit is incorporated herein by this reference. ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K - CONTINUED b) REPORTS ON FORM 8-K 1) BYL's Registration Statement on Form 8-K, dated December 24, 1998, announcing the completion of the securitization of a pool of unguaranteed interests in SBA loans. 70 SIGNATURES In accordance with 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. BYL BANCORP By: /s/ Robert Ucciferri ------------------------------------- Robert Ucciferri President and Chief Executive Officer In accordance with the Securities Exchange Act, this report has been signed by the following persons on behalf of the registrant and in the capacities on the dates indicated: Signature Title Date - --------- ----- ---- /s/ Barry J. Moore Senior Executive Vice President March 30, 1999 - ------------------------ and Chief Financial Officer Barry J. Moore /s/ Henry C. Cox II Director March 30, 1999 - ------------------------ Henry C. Cox II /s/ Eddie R. Fischer Director March 30, 1999 - ------------------------ Eddie R. Fischer /s/ Neil Hatcher Director March 30, 1999 - ------------------------ Neil Hatcher /s/ Leonard O. Lindborg Director March 30, 1999 - ------------------------ Leonard O. Lindborg /s/ H. Rhoads Martin, Jr. Chairman of the Board, Director March 30, 1999 - ------------------------ H. Rhoads Martin, Jr. /s/ John F. Myers Director March 30, 1999 - ------------------------ John F. Myers /s/ Brent W. Walberg Director March 30, 1999 - ------------------------ Brent W. Walberg 71 EX-10.2 2 EXHIBIT 10.2 BYL BANCORP 1997 STOCK OPTION PLAN Adopted April 23, 1997 Amended July 23, 1997 Amended February 18, 1998 Amended March 24, 1999 1. PURPOSE The purpose of the BYL Bancorp 1997 Stock Option Plan (the "Plan") is to strengthen BYL Bancorp (the "Corporation") and those corporations which are or hereafter become subsidiary corporations by providing additional means of attracting and retaining competent managerial personnel and by providing to participating directors, officers, key employees, consultants and others with significant and material business relationships added incentives for high levels of performance and for unusual efforts to increase the earnings of the Corporation and any Subsidiary corporations; and to allow such individuals the opportunity to participate in the ownership of the Corporation and thereby have an interest in the success and increased value of the Corporation. The Plan seeks to accomplish these purposes and achieve these results by providing a means whereby such directors, officers, key employees, consultants and others with significant and material business relationships may purchase shares of Common Stock of the Corporation pursuant to Stock Options granted in accordance with this Plan. -1- Stock Options granted pursuant to this Plan are intended to be Incentive Stock Options or Non-Qualified Stock Options, as shall be determined and designated by the Stock Option Committee upon the grant of each Stock Option hereunder. 2. DEFINITIONS For the purposes of this Plan, the following terms shall have the following meanings: (a) "COMMON STOCK." This term shall mean shares of the Corporation's no par value common stock, subject to adjustment pursuant to Paragraph 14 (Adjustment Upon Changes in Capitalization) hereunder. (b) "CORPORATION." This term shall mean BYL Bancorp, a California corporation. (c) "ELIGIBLE PARTICIPANT." This term shall mean: (i) all directors of the Corporation or any Subsidiary; (ii) all full time officers (whether or not they are also directors) of the Corporation or any Subsidiary; (iii) all full time key employees (as such persons may be determined by the Stock Option Committee from time to time) of the Corporation or any Subsidiary; and (iv) consultants and others with significant and material business relationships with the Corporation. (d) "EMPLOYER." This term shall mean the Corporation, as defined herein, or any other subsidiary of the Corporation, as appropriate, depending upon which company Optionee is employed. (e) "FAIR MARKET VALUE." This term shall mean the fair market value of the Corporation's Common Stock as determined by any reasonable valuation method in -2- accordance with the Commissioner of Corporations Regulation Section 260.140.50, which generally provides that in determining whether the price is fair, predominant weight will be given to the following: (a) if securities of the same class are publicly traded on an active market of substantial depth, the recent market price of such securities; (b) if the securities of the same class have not been so publicly traded, the price at which securities of reasonable comparable corporations (if any) in the same industry are being traded, subject to appropriate adjustments for the dissimilarities between the corporations being compared; or (c) in the absence of any reliable indicator under subsection (a) or (b), the earnings history, book value and prospects of the issuer in light of market conditions generally. (f) "INCENTIVE STOCK OPTION." This term shall mean a Stock Option which is an "Incentive Stock Option" within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended. (g) "NON-QUALIFIED STOCK OPTION." This term shall mean a Stock Option which is not an Incentive Stock Option. (h) "OPTION SHARES." This term shall mean shares of Common Stock which are covered by and subject to any outstanding unexercised Stock Option granted pursuant to this Plan. (i) "OPTIONEE." This term shall mean any Eligible Participant to whom a stock option has been granted pursuant to this Plan, provided that at least part of the Stock Option is outstanding and unexercised. -3- (j) "PLAN." This term shall mean the BYL Bancorp 1997 Stock Option Plan as embodied herein and as may be amended from time to time in accordance with the terms hereof and applicable law. (k) "STOCK OPTION." This term shall mean the right to purchase from the Corporation a specified number of shares of Common Stock under the Plan at a price and upon terms and conditions determined by the Stock Option Committee. (l) "STOCK OPTION COMMITTEE." The Board of Directors of the Corporation may select and designate a stock option committee consisting of at least three and not more than five persons, at least two of whom are directors, having full authority to act in the matters. Regardless of whether a Stock Option Committee is selected, the Board of Directors may act as the Stock Option Committee and any action taken by the Board of Directors as such shall be deemed to be action taken by the Stock Option Committee. All references in the Plan to the "Stock Option Committee" shall be deemed references to the Board of Directors acting as a stock option committee and to a duly appointed Stock Option Committee, if there be one. In the event of any conflict between any action taken by the Board of Directors acting as a Stock Option Committee and any action taken by a duly appointed Stock Option Committee, the action taken by the Board of Directors shall be controlling and the action taken by the duly appointed Stock Option Committee shall be disregarded. (m) "SUBSIDIARY." This term shall mean any subsidiary corporation of the Corporation as such term is defined in Section 425(f) of the Internal Revenue Code of 1986, as amended. -4- 3. ADMINISTRATION (a) STOCK OPTION COMMITTEE. This Plan shall be administered by the Stock Option Committee. The Board of Directors of the Corporation shall have the right, in its sole and absolute discretion, to remove or replace any person from or on the Stock Option Committee at any time for any reason whatsoever. (b) ADMINISTRATION OF THE PLAN. Any action of the Stock Option Committee with respect to the administration of the Plan shall be taken pursuant to a majority vote, or pursuant to the unanimous written consent, of its members. Any such action taken by the Stock Option Committee in the administration of this Plan shall be valid and binding, so long as the same is in conformity with the terms and conditions of this Plan. Subject to compliance with each of the terms, conditions and restrictions set forth in this Plan, including, but not limited to, those set forth in Section 6(a)(ii) hereof, the Stock Option Committee shall have the exclusive right, in its sole and absolute discretion, to establish the terms and conditions of any Stock Options granted under the Plan, including, without limitation, the power to: (i) establish the number of Stock Options, if any, to be granted hereunder, in the aggregate and with regard to any individual Eligible Participant; (ii) determine the time or times when such Stock Options, or any parts thereof, may be exercised; (iii) determine and designate which Stock Options granted under the Plan shall be Incentive Stock Options and which shall be Non-Qualified Stock Options; (iv) determine the Eligible Participants, if any, to whom Stock Options are granted; (v) determine the duration and purposes, if any, of leaves of absence which may be permitted to holders of unexercised, -5- unexpired Stock Options without such constituting a termination of employment under the Plan; (vi) prescribe and amend the terms, provisions and form of any instrument or agreement setting forth the terms and conditions of every Stock Option granted hereunder; and (vii) make loans to or guarantee any obligations of any Optionees, except directors, in connection with the exercise of Stock Options as specified in Section 8(d) hereof, whenever the Stock Option Committee determines that such loan or guarantee may reasonably be expected to benefit the corporation, subject to the provisions of Section 315(b) of the California General Corporations Law of 1977, as amended and subject to Regulations G, U and T promulgated by the Board of Governors of the Federal Reserve System pursuant to Section 7 of the Securities Exchange Act of 1934, if the Option Shares are listed on a stock exchange or are contained in the list of over-the-counter margin securities published by the Federal Reserve Board. (c) DECISIONS AND DETERMINATIONS. Subject to the express provisions of the Plan, the Stock Option Committee shall have the authority to construe and interpret the Plan, to define the terms used therein, to prescribe, amend, and rescind rules and regulations relating to the administration of the Plan, and to make all other determinations necessary or advisable for administration of the Plan. Determinations of the Stock Option Committee on matters referred to in this Section 3 shall be final and conclusive so long as the same are in conformity with the terms of this Plan. -6- 4. SHARES SUBJECT TO THE PLAN Subject to adjustments as provided in Section 14 hereof, the maximum number of shares of Common Stock which may be issued upon exercise of Stock Options granted under this Plan is limited to 30% of the issued and outstanding shares of the Corporation up to a maximum of 759,390 shares in the aggregate. If any Stock Option shall be canceled, surrendered, or expire for any reason without having been exercised in full, the unpurchased Option Shares represented thereby shall again be available for grants of Stock Options under this Plan. 5. ELIGIBILITY Only Eligible Participants shall be eligible to receive grants of Stock Options under this Plan. 6. GRANTS OF STOCK OPTIONS (a) GRANT. Subject to the express provisions and limitations of the Plan, the Stock Option Committee, in its sole and absolute discretion, may grant Stock Options to Eligible Participants of the Corporation, for a number of Option Shares, at the price(s) and time(s), on the terms and conditions and to such Eligible Participants as it deems advisable and specifies in the respective grants. Subject to the limitations and restrictions set forth in the Plan, an Eligible Participant who has been granted a Stock Option may, if otherwise eligible, be granted additional Stock Options if the Stock Option Committee shall so determine. The Stock Option Committee shall designate in each grant of a Stock Option whether the Stock Option is an Incentive Stock Option or a Non-Qualified Stock Option. -7- An eligible director, officer or employee shall not participate in the granting of his or her own options. (b) DATE OF GRANT AND RIGHTS OF OPTIONEE. The determination of the Stock Option Committee to grant a Stock Option shall not in any way constitute or be deemed to constitute an obligation of the Corporation, or a right of the Eligible Participant who is the proposed subject of the grant, and shall not constitute or be deemed to constitute the grant of a Stock Option hereunder unless and until both the Corporation and the Eligible Participant have executed and delivered the form of stock option agreement then required by the Stock Option Committee as evidencing the grant of the Stock Option, together with such other instruments as may be required by the Stock Option Committee pursuant to this Plan; provided, however, that the Stock Option Committee may fix the date of grant as any date on or after the date of its final determination to grant the Stock Option (or if no such date is fixed, then the date of grant shall be the date on which the determination was finally made by the Stock Option Committee to grant the Stock Option), and such date shall be set forth in the stock option agreement. The date of grant as so determined shall be deemed the date of grant of the Stock Option for purposes of this Plan. (c) SHAREHOLDER-EMPLOYEES. Notwithstanding anything to the contrary contained elsewhere herein, a Stock Option shall not be granted hereunder to an Eligible Participant who owns, directly or indirectly, at the date of the grant of the Stock Option, more than ten percent (10%) of the total combined voting power of all classes of capital stock of the Corporation or a Subsidiary corporation, unless the -8- purchase price of the Option Shares subject to said Stock Option is at least 110% of the Fair Market Value of the Option Shares, determined as of the date said Stock Option is granted. (d) MAXIMUM VALUE OF STOCK OPTIONS. Except as provided in paragraph (e) of this Section 6, the maximum aggregate Fair Market Value of Option Shares (determined as of the respective Stock Option grant dates) for which an Eligible Participant may be granted Incentive Stock Options in any calendar year shall not exceed $100,000, plus any "unused carryover amount." The unused carryover amount, determined on a yearly basis, shall be equal to one-half (1/2) of the difference between $100,000 and the aggregate Fair Market Value (determined as of the respective Stock Option grant dates) of all of the Option Shares subject to Incentive Stock Options granted to the Optionee during the calendar year under the Plan. The provisions of Section 422A(c)(4) of the Internal Revenue Code of 1986, as amended, are incorporated herein by this reference for the purpose of the determination and application of the unused carryover amount. The aggregate fair market value (determined at the time the option is granted) of the stock with respect to which incentive stock options are exercisable for the first time by such individual under the terms of the Plan during any calendar year is limited to $100,000, but the value of stock for which options may be granted to an employee in a given year may exceed $100,000, but such options in excess of $100,000 shall be treated as non-qualified options. -9- (e) SUBSTITUTED STOCK OPTIONS. If all of the outstanding shares of common stock of another corporation are changed into or exchanged solely for common stock in a transaction to which Section 425(a) of the internal Revenue Code of 1986, as amended, applies, then, subject to the approval of the Board of Directors of the Bank, Stock Options under the Plan may be substituted ("Substituted Options") in exchange for valid, unexercised and unexpired stock options of such other corporation. Substituted options shall qualify as Incentive Stock Options under the Plan, provided that (and to the extent) the stock options exchanged for the Substituted Options were "Incentive Stock Options" within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended. (f) NON-QUALIFIED STOCK OPTIONS. All Stock Options granted by the Stock Option Committee which: (i) are designated at the time of grant as Incentive Stock Options but do not so qualify under the provisions of Section 422A of the Code or any regulations or rulings issued by the Internal Revenue Service for any reason; (ii) are in excess of the fair market value limitations set forth in Section 6(d); or (iii) are designated at the time of grant as Non-Qualified Stock Options, shall be deemed Non-Qualified Stock Options under this Plan. Non-Qualified Stock Options granted or substituted hereunder shall be so designated in the stock option agreement entered into between the Corporation and the Optionee. 7. STOCK OPTION EXERCISE PRICE (a) MINIMUM PRICE. The exercise price of any Option Shares shall be determined by the Stock Option Committee, in its sole and absolute discretion, upon -10- the grant of a Stock Option. Except as provided elsewhere herein, said exercise price shall not be less than one hundred percent (100%) of the Fair Market Value of the Common Stock represented by the Option Share on the date of grant of the related Stock Option. (b) EXCHANGED STOCK OPTIONS. Where the outstanding shares of stock of another corporation are changed into or exchanged for shares of Common Stock of the Corporation without monetary consideration to that other corporation, then, subject to the approval of the Board or Directors of the Corporation, Stock Options may be granted in exchange for unexercised, unexpired stock options of the other corporation, and the exercise price of the Option Shares subject to each Stock Option so granted may be fixed at a price less than one hundred percent (100%) of the Fair Market Value of the Common Stock at the time such Stock Option is granted if said exercise price has been computed to be not less than the exercise price set forth in the stock option of the other corporation, with appropriate adjustment to reflect the exchange ratio of the shares of stock of the other corporation into the shares of Common Stock of the Corporation. (c) SUBSTITUTED OPTIONS. The exercise price of the Option Shares subject to each Substituted Option may be fixed at a price less than one hundred percent (100%) of the Fair Market Value of the Common Stock at the time such Substituted option is granted if said exercise price has been computed to be not less than the exercise price set forth in the stock option of the other corporation for which it was -11- exchanged, with appropriate adjustment to reflect the exchange ratio of the shares of stock of the other corporation into the shares of Common Stock. 8. EXERCISE OF STOCK OPTIONS. (a) EXERCISE. Except as otherwise provided elsewhere herein, each Stock Option shall be exercisable in such increments, which need not be equal, and upon such contingencies as the Stock Option Committee shall determine at the time of grant of the Stock Option; provided, however, (i) that if an Optionee shall not in any given period exercise any part of a Stock Option which has become exercisable during that period, the Optionee's right to exercise such part of the Stock Option shall continue until expiration of the Stock Option or any part thereof as may be provided in the related Stock Option Agreement, and (ii) in the case of options that are not granted to officers, directors, consultants of, or others with significant and material business relationships with, the Company, a minimum of 20% of the stock options shall be exercisable in each year over a five year period from the date the option is granted. No Stock Option or part thereof shall be exercisable except with respect to whole shares of Common Stock, and fractional share interests shall be disregarded except that they may be accumulated. (b) PRIOR OUTSTANDING INCENTIVE STOCK OPTIONS. Incentive Stock Options granted to an Optionee may be exercisable while such Optionee has outstanding and unexercised any Incentive Stock Option previously granted (or substituted) to him or her pursuant to this Plan. The Stock Option Committee shall determine if such options shall be exercisable if there are any Incentive Stock Options previously granted (or -12- substituted) to him or her pursuant to this Plan, and such determination shall be evidenced in the Agreement executed by the Optionee and Company, subject to the requirements of Rule 260.141.41(f) of the California Commissioner of Corporations. An Incentive Stock Option shall be treated as outstanding until it is exercised in full or expires by reason of lapse of time. (c) NOTICE AND PAYMENT. Stock Options granted hereunder shall be exercised by written notice delivered to the Corporation specifying the number of Option Shares with respect to which the Stock Option is being exercised, together with concurrent payment in full of the exercise price as hereinafter provided in Section 8(d) hereof. If the Stock Option is being exercised by any person or persons other than the Optionee, said notice shall be accompanied by proof, satisfactory to counsel for the Corporation, of the right to such person or persons to exercise the Stock Option. The Corporation's receipt of a notice of exercise without concurrent receipt of the full amount of the exercise price shall not be deemed an exercise of a Stock Option by an Optionee, and the Corporation shall have no obligation to an Optionee for any Option Shares unless and until full payment of the exercise price is received by the Corporation in accordance with Section 8(d) hereof, and all of the terms and provisions of the Plan and the related stock option agreement have been complied with. (d) PAYMENT OF EXERCISE PRICE. The exercise price of any Option Shares purchased upon the proper exercise of a Stock Option shall be paid in full at the time of each exercise of a Stock Option in cash and/or, with the prior written approval of the Stock Option Committee, in Common Stock of the Corporation which, when added -13- to the cash payment, if any, has an aggregate Fair Market Value equal to the full amount of the exercise price of the Stock Option, or part thereof, then being exercised and/or, with the prior written approval of the Stock Option Committee and if legally permitted, on a deferred basis evidenced by a promissory note, containing such terms and subject to such security as the Stock Option Committee shall determine to be fair and reasonable from time to time, for the total option price for the number of shares so purchased. No Director may purchase any Stock Option on a deferred basis evidenced by a promissory note. Unless payment is on a deferred basis, payment by an Optionee as provided herein shall be made in full concurrently with the Optionee's notification to the Corporation of his intention to exercise all or part of a Stock Option. If all or part of payment is made in shares of Common Stock as heretofore provided, such payment shall be deemed to have been made only upon receipt by the Corporation of all required share certificates, and all stock powers and other required transfer documents necessary to transfer the shares of Common Stock to the Corporation. (e) REORGANIZATION. Notwithstanding any provision in any stock option agreement pertaining to the time of exercise of a Stock Option, or part thereof, upon adoption by the requisite holders of the Corporation's outstanding shares of Common Stock of any plan of dissolution, liquidation, reorganization, merger, consolidation or sale of all or substantially all of the assets of the Corporation to another corporation, or the acquisition of stock representing more than 50% of the voting power of the Corporation then outstanding, by another corporation or person, which would, upon -14- consummation, result in termination of a Stock Option in accordance with Section 16 hereof, the Stock Option shall become immediately exercisable as to all Option Shares, whether or not vested, for such period of time as may be determined by the Stock Option Committee, but in any event not less than 30 days prior to the adoption of the plan of dissolution, liquidation, reorganization, merger, consolidation, sale, or acquisition on the condition that the terminating event described in Section 16 hereof is consummated. Any Option Shares not exercised will be terminated. If such Terminating Event is not consummated, Stock Options granted pursuant to the Plan shall be exercisable in accordance with their respective terms. (f) MINIMUM EXERCISE. Not less than ten (10) Option Shares may be purchased at any one time upon exercise of a Stock Option unless the number of shares purchased is the total number which remains to be purchased under the Stock Option. (g) COMPLIANCE WITH LAW. No shares of Common Stock shall be issued by the Corporation upon exercise of any Stock Option, and an Optionee shall have no rights or claim to such shares, unless and until: (a) payment in full as provided in Section 8(d) hereof has been received by the Corporation; (b) in the opinion of the counsel for the Corporation, all applicable registration requirements of the Securities Act of 1933, all applicable listing requirements of securities exchanges or associations on which the Corporation's Common Stock is then listed or traded, and all other requirements of law and of regulatory bodies having jurisdiction over such issuance and delivery, have been fully complied with; and (c) if required by federal or state law -15- or regulation, the Optionee shall have paid to the Corporation the amount, if any, required to be withheld on the amount deemed to be compensation to the Optionee as a result of the exercise of his or her Stock Option, or made other arrangements satisfactory to the Corporation, in its sole discretion, to satisfy applicable income tax withholding requirements. 9. NONTRANSFERABILITY OF STOCK OPTIONS. Each Stock Option shall, by its terms, be nontransferable by the Optionee other than by will or the laws of descent and distribution, and shall be exercisable during the Optionee's lifetime only by the Optionee or his or her guardian or legal representative. 10. CONTINUATION OF EMPLOYMENT Except for Optionees with a written contract for any definite term, this Agreement shall not obligate the Corporation or a Subsidiary to employ Optionee. 11. CESSATION OF EMPLOYMENT Except as provided in Sections 8(e), 12, 13, 14, 15 or 16 hereof, if, for any reason, an Optionee's status as an Eligible Participant is terminated, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their initial grant, or three (3) months after the Optionee's status as an Eligible Participant is terminated, whichever is earlier. Thereafter, Options shall be exercisable only as to those increments, if any, which had become exercisable as of such expiration date, and any Stock Options or increments which had not become exercisable as of such date shall expire and terminate automatically on such expiration date. -16- 12. TERMINATION FOR VIOLATION OF STANDARDS OF CONDUCT AS REFERENCED IN OPTIONEE'S EMPLOYEE HANDBOOK If Optionee's status as an Eligible Participant is terminated for violation of the Employer's Standards of Conduct, the vested portion of Stock Options granted to such Optionee shall be exercisable for a thirty (30) day period following such termination, and thereafter such Stock Options shall automatically expire and terminate in their entirety; provided, however, that the Stock Option Committee may, in its sole discretion, within thirty (30) days of such termination, reinstate such Stock Options to the status of options terminated for reasons other than violations of the Employer's Standards of Conduct, death or disability by giving written notice of such reinstatement to the Optionee. In the event of such reinstatement, the Optionee may exercise the Stock Options as provided in Section 11 herein. Reasons for termination for violation of the Employer's Standards of Conduct shall include, but not be limited to, termination for malfeasance or gross misfeasance in the performance of duties or conviction of illegal activity in connection therewith, and, in any event, the determination of the Stock Option Committee with respect thereto shall be final and conclusive. 13. DEATH OF OPTIONEE If an Optionee loses his status as an Eligible Participant by reason of death, or if an Optionee dies during the three-month period referred to in Section 12 hereof, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their initial grant, or one (l) year after the date of -17- such death, whichever is earlier. After such death but before such expiration, subject to the terms and provisions of the Plan and the related stock option agreements, the person or persons to whom such Optionee's rights under the Stock Options shall have passed by will or by the applicable laws of descent and distribution, or the executor or administrator of the Optionee's estate, shall have the right to exercise such Stock Options to the extent that increments, if any, had become exercisable as of the date on which the Optionee's status as an Eligible Participant had been lost. 14. DISABILITY OF OPTIONEE If an Optionee is disabled while employed by or while serving as a director of the Corporation or a Subsidiary or during the three-month period referred to in Section 12 hereof, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their initial grant, or one (l) year after the date of such disability, whichever is earlier. After such disability but before such expiration, the Optionee or a guardian or conservator of the Optionee's estate, as duly appointed by a court of competent jurisdiction, shall have the right to exercise such Stock Options to the extent that increments, if any, had become exercisable as of the date on which the Optionee became disabled or ceased to be employed by the Corporation or a Subsidiary as a result of the disability. For the purpose of this Section 14, an Optionee shall be deemed to have become "disabled" if it shall appear to the Stock Option Committee, upon written certification delivered to the Corporation by a qualified licensed physician, that the Optionee has become permanently and totally unable to engage in any substantial gainful activity by reason of any medically -18- determinable physical or mental impairment which can be expected to result in death, or which has lasted or can be expected to last for a continuous period of not less than 12 months. 15. ADJUSTMENT UPON CHANGES IN CAPITALIZATION If the outstanding shares of Common Stock of the Corporation are increased, decreased, or changed into or exchanged for a different number or kind of shares or securities of the Corporation, through a reorganization, merger, recapitalization, reclassification, stock split, stock dividend, stock consolidation, or otherwise, without consideration to the Corporation, an appropriate and proportionate adjustment shall be made in the number and kind of shares as to which Stock Options may be granted. A corresponding adjustment changing the number or kind of Option Shares and the exercise prices per share allocated to unexercised Stock Options, or portions thereof, which shall have been granted prior to any such change, shall likewise be made. Any such adjustment, however, in an outstanding Stock Option shall be made without change in the total price applicable to the unexercised portion of the Stock Option, but with a corresponding adjustment in the price for each Option Share subject to the Stock Option. Any adjustment under this Section shall be made by the Stock Option Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final and conclusive. No fractional shares of stock shall be issued or made available under the Plan on account of any such adjustment, and fractional share interests shall be disregarded and the fractional share interest shall be rounded down to the nearest whole number. -19- 16. TERMINATING EVENTS Not less than thirty (30) days prior to consummation of a plan of dissolution or liquidation of the Corporation, or consummation of a plan of reorganization, merger or consolidation of the Corporation with one or more corporations, as a result of which the Corporation is not the surviving corporation and the outstanding securities of the class then subject to options hereunder are changed or exchanged for cash or property or securities not of the Corporation's issue, or upon the sale of all or substantially all the assets of the Corporation to another corporation, or the acquisition of stock representing more than fifty percent (50%) of the voting power of the Corporation then outstanding by another corporation or person (the "Terminating Event"), the Stock Option Committee or the Board of Directors shall notify each Optionee of the pendency of the Terminating Event. Upon the effective date of the Terminating Event, the Plan shall automatically terminate and all Stock Options theretofore granted shall terminate, unless provision is made in connection with such transaction for the continuance of the Plan and/or assumption of Stock Options theretofore granted, or substitution for such Stock Options with new stock options covering stock of a successor employer corporation, or a parent or subsidiary corporation thereof, solely at the discretion of such successor corporation, or parent or subsidiary corporation, with appropriate adjustments as to number and kind of shares and prices, in which event the Plan and options theretofore granted shall continue in the manner and under the terms so provided. If the Plan and unexercised options shall terminate pursuant to the foregoing sentence, all persons shall have the right to exercise any unexercised -20- portions of options outstanding and not exercised, shall have the right, at such time prior to the consummation of the transaction causing such termination as the Corporation shall designate and for a period of not less than 30 days, to exercise all unexercised portions of teir options, including the portions which would, but for this paragraph entitled "Terminating Events," not yet be exercisable. 17. AMENDMENT AND TERMINATION The Board of Directors of the Corporation may at any time and from time-to-time suspend, amend, or terminate the Plan and may, with the consent of Optionee, make such modifications of the terms and conditions of a Stock Option as it shall deem advisable; provided that, except as permitted under the provisions of Section 16 hereof, no amendment or modification may be adopted without the Corporation having first obtained all necessary regulatory approvals and approval of the holders of a majority of the Corporation's shares of Common Stock present, or represented, and entitled to vote at a duly held meeting of shareholders of the Corporation if the amendment or modification would: (a) materially increase the benefits accruing to participants under the Plan; (b) materially increase the number of securities which may be issued under the Plan; (c) materially modify the requirements as to eligibility for participation in the Plan; -21- (d) increase or decrease the exercise price of any Stock Options granted under the Plan; (e) increase the maximum term of Stock Options provided for herein; (f) permit Stock Options to be granted to any person who is not an Eligible Participant; or (g) change any provision of the Plan which would affect the qualification as an Incentive Stock Option under the Plan. No Stock Option may be granted during any suspension of the Plan or after termination of the Plan. Amendment, suspension, or termination of the Plan shall not (except as otherwise provided in Section 17 hereof), without the consent of the Optionee, alter or impair any rights or obligations under any Stock Option theretofore granted. 18. RIGHTS OF ELIGIBLE PARTICIPANTS AND OPTIONEES Neither any Eligible Participant, any Optionee or any other person shall have any claim or right to be granted any Stock Option under this Plan, and neither this Plan nor any action taken hereunder shall be deemed or construed as giving any Eligible Participant, Optionee or any other person any right to be retained in the employ of the Corporation or any subsidiary of the Corporation. Without limiting the generality of the foregoing, there is no vesting of any right in the classification of any person as an Eligible Participant or Optionee, such classification being used solely to define and limit those persons who are eligible for consideration of the grant of Stock Options under the Plan. -22- 19. PRIVILEGES OF STOCK OWNERSHIP; SECURITIES LAW COMPLIANCE; NOTICE OF SALE No Optionee shall be entitled to the privileges of stock ownership as to any Option Shares not actually issued and delivered. No Option Shares may be purchased upon the exercise of a Stock Option unless and until all then applicable requirements of all regulatory agencies having jurisdiction and all applicable requirements of securities exchanges upon which the stock of the Corporation is listed (if any) shall have been fully complied with. The Corporation will diligently endeavor to comply with all applicable securities laws before any options are granted under the Plan and before any stock is issued pursuant to options. The Optionee shall, not more than five (5) days after each sale or other disposition of shares of Common Stock acquired pursuant to the exercise of Stock Options, give the Corporation notice in writing of such sale or other disposition. The Corporation will provide to each Optionee its Annual Report as required by Section 260.140.46 of the regulations of the California Commissioner of Corporations. 20. EFFECTIVE DATE OF THE PLAN The Plan shall be deemed adopted as of April 23, 1997, and shall be effective immediately, subject to approval of the Plan by the holders of at least a majority of the Corporation's outstanding shares of Common Stock and approval of the Plan by the California Commissioner of Corporations. 21. TERMINATION Unless previously terminated as aforesaid, the Plan shall terminate ten (10) years from the earliest date of (i) adoption of the Plan by the Board of Directors, or (ii) -23- approval of the Plan by holders of at least a majority of the Corporation's outstanding shares of Common Stock. No Stock Options shall be granted under the Plan thereafter, but such termination shall not affect any Stock Option theretofore granted. 22. OPTION AGREEMENT Each Stock Option granted under the Plan shall be evidenced by a written stock option agreement executed by the Corporation and the Optionee, and shall contain each of the provisions and agreements herein specifically required to be contained therein, and such other terms and conditions as are deemed desirable by the Stock Option Committee and are not inconsistent with the Plan. 23. STOCK OPTION PERIOD Each Stock Option and all rights and obligations thereunder shall expire on such date as the Stock Option Committee may determine, but not later than ten (10) years from the date such Stock Option is granted, and shall be subject to earlier termination as provided elsewhere in the Plan. -24- 24. EXCULPATION AND INDEMNIFICATION OF STOCK OPTION COMMITTEE In addition to such other rights of indemnification which they may have as directors of the Corporation or as members of the Stock Option Committee, the present and former members of the Stock Option Committee, and each of them, shall be indemnified by the Corporation for and against all costs, judgments, penalties and reasonable expenses, including reasonable attorney's fees, actually and necessarily incurred by them in connection with any action, suit or proceeding, or in connection with any appeal thereof, to which they or any of them may be a party by reason of any act or omission of any member of the Stock Option Committee under or in connection with the Plan or any Stock Option granted thereunder; provided, however, that a member of the Stock Option Committee shall not be entitled to any indemnification whatsoever pursuant to this Section for or as a result of any act or omission of such member which was not taken in good faith and which constituted willful misconduct or gross negligence by such member; provided further, that any amounts paid by any member of the Stock Option Committee in settlement of any action, suit or proceeding for which indemnification may be sought pursuant to this Section shall be first approved in writing by independent legal counsel selected by the Corporation; and, provided further, that within thirty (30) days after institution of any action, suit or proceeding against any member with respect to which such member is entitled to indemnification hereunder, such member shall, in writing, offer the Corporation the opportunity, at its own expense, to handle (including settle) and -25- conduct the defense thereof. The provisions of this Section shall apply to the estate, executor and administrator of each member of the Stock Option Committee. 25. (Reserved) 26. NOTICES All notices and demands of any kind which the Stock Option Committee, any Optionee, Eligible Participant, or any other person may be required or desires to serve under the terms of this Plan shall be in writing and shall be served by personal service upon the respective person or by leaving a copy of such notice or demand at the address of such person as may be reflected in the records of the Corporation, or in the case of the Stock Option Committee, with the Secretary of the Corporation, or by mailing a copy thereof by certified or registered mail, postage prepaid, with return receipt requested. In the case of service by mail, it shall be deemed complete at the expiration of the third day after the day of mailing, except for notice of the exercise of any Stock Option and payment of the Stock Option exercise price, both of which must be actually received by the Corporation. 27. (Reserved) 28. LIMITATION OF RIGHTS The Stock Option Committee, in its sole and absolute discretion, is entitled to determine who, if anyone, is an Eligible Participant under this Plan, and which, if any, Eligible Participant shall receive any grant of a Stock Option. No oral or written agreement by any person on behalf of the Corporation relating to this Plan or any -26- Stock Option granted hereunder is authorized, and such agreement may not bind the Corporation or the Stock Option Committee to grant any Stock Option to any person. 29. SEVERABILITY If any provision of this Plan as applied to any person or to any circumstances shall be adjudged by a court of competent jurisdiction to be void, invalid, or unenforceable, the same shall in no way effect any other provision hereof, the application of any such provision in any other circumstances, or the validity of enforceability hereof. 30. CONSTRUCTION Where the context or construction requires, all words applied in the plural shall be deemed to have been used in the singular and vice versa, and the masculine gender shall include the feminine and the neuter. 31. HEADINGS The headings of the several paragraphs of this Plan are inserted solely for convenience of reference and are not intended to form a part of and are not intended to govern, limit or aid in the construction of any term or provision hereof. 32. SUCCESSORS This Plan shall be binding upon the respective successors, assigns, heirs, executors, administrators, guardians and personal representatives of the Corporation and any Optionee. -27- 33. GOVERNING LAW This Plan shall be governed by and construed in accordance with the laws of the State of California. 34. CONFLICT In the event of any conflict between the terms and provisions of this Plan, and any other document, agreement or instrument, including, without limitation, any stock option agreement, the terms and provisions of this Plan shall control. -28- SECRETARY'S CERTIFICATE OF ADOPTION I, the undersigned, do hereby certify: 1. That I am the duly elected and acting Assistant Secretary of BYL Bancorp; and 2. That the foregoing BYL Bancorp 1997 Stock Option Plan, as amended, was duly adopted by the Board of Directors of BYL Bancorp as the Stock Option Plan for the Corporation at a meeting duly called as required by law and convened on the 24th day of March, 1999. IN WITNESS WHEREOF, I have hereunto subscribed my name and affixed the seal of the Corporation this 24th day of March, 1999. /s/ John F. Myers ----------------------------------- John F. Myers, Secretary [SEAL] -29- OPTIONEES TO WHOM INCENTIVE STOCK OPTIONS ARE GRANTED MUST MEET CERTAIN HOLDING PERIOD AND EMPLOYMENT REQUIREMENTS FOR FAVORABLE TAX TREATMENT. UNLESS OTHERWISE STATED, ALL DEFINED TERMS IN THE PLAN SHALL HAVE THE SAME MEANING HEREIN AS SET FORTH IN THE PLAN. IT IS UNLAWFUL TO CONSUMMATE A SALE OR TRANSFER OF THIS SECURITY, OR ANY INTEREST THEREIN, OR TO RECEIVE ANY CONSIDERATION THEREFOR, WITHOUT THE PRIOR WRITTEN CONSENT OF THE COMMISSIONER OF CORPORATIONS OF THE STATE OF CALIFORNIA, EXCEPT AS PERMITTED IN THE COMMISSIONER'S RULES. BYL BANCORP STOCK OPTION AGREEMENT / / Incentive Stock Option / / Non-Qualified Stock Option THIS AGREEMENT, dated the ____ day of ____________, 19__, by and between BYL Bancorp, a California corporation (the "Corporation"), and _____________________ (the "Optionee"); WHEREAS, pursuant to the Corporation's 1997 Stock Option Plan (the "Plan"), the Stock Option Committee has authorized the grant to Optionee of a Stock Option to purchase all or any part of _____________________ (______) authorized but unissued shares of the Corporation's Common Stock at the price of _________________ Dollars ($_____) per share, such Stock Option to be for the term and upon the terms and conditions hereinafter stated; NOW, THEREFORE, it is hereby agreed: -1- 1. GRANT OF STOCK OPTION. Pursuant to said action of the Stock Option Committee and pursuant to authorizations granted by all appropriate regulatory and governmental agencies, the Corporation hereby grants to Optionee a Stock Option to purchase, upon and subject to the terms and conditions of the Plan, which is incorporated in full herein by this Reference, all or any part of ________________ (_______) Option Shares of the Corporation's Common Stock, at the price of ____________________ Dollars ($_____) per share. For purposes of this Agreement and the Plan, the date of grant shall be _________________, 19__. At the date of grant, Optionee [DOES] [DOES NOT OWN] stock possessing more than 10% of the total combined voting power of all classes of capital stock of the Corporation or any Subsidiary. The Stock Option granted hereunder [IS] [IS NOT] intended to qualify as an Incentive Stock Option within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended. 2. EXERCISABILITY. This Stock Option shall be exercisable as to ________________ Option Shares on ________________, 19__, as to __________________ Option Shares on ________________, 19__, as to __________________ Option Shares on ________________, 19__, as to __________________ Option Shares on ________________, 19__, and as to _________________ Option Shares on ________________, 19__. This Stock Option shall remain exercisable as to all of such Option Shares until _______________, 19__ (but not later than ten (10) years from the date hereof), at which time it shall expire in its entirety, unless this Stock Option has expired or -2- terminated earlier in accordance with the provisions hereof. Option shares as to which this Stock Option becomes exercisable may be purchased at any time prior to expiration of this Stock Option. 3. EXERCISE OF STOCK OPTION. Subject to the provision of Paragraph 4 hereof, this Stock Option may be exercised by written notice delivered to the Corporation stating the number of Option Shares with respect to which this Stock Option is being exercised, together with cash and/or, if permitted at the time of exercise by the Stock Option Committee, shares of Common Stock of the Corporation which, when added to the cash payment, if any, have an aggregate Fair Market Value equal to the full amount of the purchase price of such Option Shares, and/or, if permitted at the time of exercise by the Stock Option Committee and if legally permitted, and if Optionee is not also a director, consultant or business advisor of the Corporation or any of its subsidiaries, on a deferred basis evidenced by a promissory note. Not less than ten (10) Option shares may be purchased at any one time unless the number purchased is the total number which remains to be purchased under this Stock Option and in no event may the Stock Option be exercised with respect to fractional shares. Upon exercise, Optionee shall make appropriate arrangements and shall be responsible for the withholding of any federal and state income taxes then due. 4. PRIOR OUTSTANDING STOCK OPTIONS. Incentive Stock Options granted to an Optionee may be exercisable while such Optionee has outstanding and unexercised any Incentive Stock Option previously granted to him or her pursuant to this Plan. The -3- Stock Option Committee shall determine if such options shall be exercisable if there are any Incentive Stock Options previously granted (or substituted) to him or her pursuant to this Plan, and such determination shall be evidenced in the Agreement executed by the Optionee and the Corporation, subject to the requirements of Rule 260.141.41(f) of the California Commissioner of Corporations. An Incentive Stock Option shall be treated as outstanding until it is exercised in full or expires by reason of lapse of time. 5. CESSATION OF EMPLOYMENT. Except as provided in paragraphs 7, 9, or 11 hereof, if Optionee's status as an Eligible Participant under the Plan is terminated, this Stock Option shall expire three (3) months thereafter or on the date specified in Paragraph 2 hereof, whichever is earlier. During such period after termination of status as an Eligible Participant, this Stock Option shall be exercisable only as to those increments, if any, which had become exercisable as of the date on which the Optionee's status as an Eligible Participant was terminated, and any Stock Options or increments which had not become exercisable as of such date shall expire and terminate automatically on such date. 6. TERMINATION FOR VIOLATION OF STANDARDS OF CONDUCT AS REFERENCED IN OPTIONEE'S EMPLOYEE HANDBOOK. If Optionee's status as an Eligible Participant under the Plan is terminated for violation of the Employer's Standard of Conduct, the vested portion of this Stock Option shall be exercisable for a thirty (30) day period following such termination, and thereafter this Stock Option shall automatically expire and terminate in their entirety; provided, however, that the Stock Option Committee may, -4- in its sole discretion, within thirty (30) days of such termination, reinstate such Stock Options to the status of options terminated for reasons other than voilations of the Employer's Standards of Conduct, death or disability by giving written notice of such reinstatements to the Optionee. In the event of such reinstatement, the Optionee may exercise the Stock Options as provided in Section 11 herein. Termination for violation of the Employer's Standard of Conduct shall include, but not be limited to, or termination for malfeasance or gross misfeasance in the performance of duties or conviction of illegal activity in connection therewith, and, in any event, the determination of the Stock Option Committee with respect thereto shall be final and conclusive. 7. DISABILITY OR DEATH OF OPTIONEE. If Optionee loses his or her status as an Eligible Participant under the Plan by reason of death or if Optionee is disabled while employed by the Corporation or a Subsidiary, or if Optionee dies or becomes so disabled during the three-month period referred to in Paragraph 5 hereof, this Stock Option shall automatically expire and terminate one (l) year after the date of Optionee's disability or death or on the day specified in Paragraph 2 hereof, whichever is earlier. After Optionee's disability or death but before such expiration, the person or persons to whom Optionee's rights under this Stock Option shall have passed by order of a court of competent jurisdiction or by will or the applicable laws of descent and distribution, or the executor, administrator or conservator of Optionee's estate, shall have the right to exercise this Stock Option to the extent that increments, if any, had become exercisable as of the date on which Optionee's status as an Eligible Participant -5- under the Plan had been terminated. For purposes hereof, "disability" shall have the same meaning as set forth in Section 14 of the Plan. 8. NONTRANSFERABILITY. This Stock Option shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable during Optionee's lifetime only by Optionee or his or her guardian or legal representative. 9. EMPLOYMENT. Except for optionees with a written contract for any definite term, this Agreement shall not obligate the Corporation or a Subsidiary to employ Optionee. 10. PRIVILEGES OF STOCK OWNERSHIP. Optionee shall have no rights as a stockholder with respect to the Option Shares unless and until said Option Shares are issued to Optionee as provided in the Plan. Except as provided in Section 15 of the Plan, no adjustment will be made for dividends or other rights in respect of which the record date is prior to the date such stock certificates are issued. 11. MODIFICATION AND TERMINATION BY BOARD OF DIRECTORS. The rights of Optionee are subject to modification and termination upon the occurrence of certain events as provided in Sections 12, 13, 14, 15 and 16 of the Plan. Upon adoption by the requisite holders of the Corporation's outstanding shares of Common Stock of any plan of dissolution, liquidation, reorganization, merger, consolidation or sale of all or substantially all of the assets of the Corporation to, or the acquisition of stock representing more than fifty percent (50%) of the voting power of the Corporation then outstanding by another corporation or person which would, upon consummation, result in termination of this Stock Option in accordance with Section 16 of the Plan, -6- this Stock Option shall become immediately exercisable as to all unexercised Option Shares notwithstanding the incremental exercise provisions of paragraph 2 of this Agreement for a period then specified by the Stock Option Committee, but in any event not less than 30 days, in accordance with Section 8(e) of the Plan, on the condition that the terminating event described in Section 16 of the Plan is consummated. If such terminating event is not consummated, this Stock Option shall be exercisable in accordance with the terms of the Agreement, excepting this Paragraph 11. 12. NOTIFICATION OF SALE. Optionee agrees that Optionee, or any person acquiring Option Shares upon exercise of this Stock Option, will notify the Corporation in writing not more than five (5) days after any sale or other disposition of such Shares. 13. (Reserved) 14. NOTICES. All notices to the Corporation provided for in this Agreement shall be addressed to it in care of its President or Chief Financial Officer at its principal office and all notices to Optionee shall be addressed to Optionee's address on file with the Corporation or a subsidiary corporation, or to such other address as either may designate to the other in writing, all in compliance with the notice provisions set forth in Section 26 of the Plan. 15. INCORPORATION OF PLAN. All of the provisions of the Plan are incorporated herein by reference as if set forth in full hereat. In the event of any conflict between the terms of the Plan and any provision contained herein, the terms -7- of the Plan shall be controlling and the conflicting provisions herein shall be disregarded. IN WITNESS WHEREOF, the parties hereto have executed this Agreement. BYL BANCORP By: ---------------------------------- By: ---------------------------------- OPTIONEE ------------------------------------- -8- EX-10.3 3 EXHIBIT 10.3 PROXY BYL BANCORP PROXY ANNUAL MEETING OF SHAREHOLDERS ____ __, 1999 THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS The undersigned shareholder acknowledges receipt of the Notice of Annual Meeting of Shareholders of BYL Bancorp (the "Company") and the accompanying Proxy Statement dated ________ __, 1999, and revoking any proxy heretofore given, hereby appoints ________________, _____________, and ________________, or any one of them, with full power to act alone, my true and lawful attorney(s), agent(s) and proxy, with full power of substitution, for me and in my name, place and stead to vote and act with respect to all shares of common stock of the Company which the undersigned would be entitled to vote at the Annual Meeting of Shareholders to be held on ____ __, 1999, at 5:30 p.m., in the Main Lobby, BYL Bank Group, 1875 North Tustin Avenue, Orange, California, and at any and all adjournment or adjournments thereof, with all the powers that the undersigned would possess if personally present, as follows: 1. ELECTION OF DIRECTORS. To elect for a two (2) year term as directors the nominees set forth below: / / FOR all nominees listed below (except as indicated to the contrary below). / / WITHHOLD AUTHORITY to vote for all nominees listed below. H. Rhoads Martin, Jr. _________________ John F. Myers _________________ Robert Ucciferri ___________________________________________________ (Instruction: To withhold authority to vote for any individual nominee(s), write the nominee(s) name in the space above.) 2. APPROVAL OF AMENDMENT TO BYL BANCORP'S 1997 STOCK OPTION PLAN. Approval of an amendment to BYL Bancorp's 1997 Stock Option Plan would increase the shares subject to the Plan from 460,519 shares to 759,390 shares of the unissued common stock of the Company as described in the Proxy Statement 1 dated __________, 1999, subject to any necessary changes required by any regulatory agency. / / FOR / / AGAINST / /ABSTAIN 3. OTHER BUSINESS. To transact such other business as may properly come before the meeting. Execution of this proxy confers authority to vote "FOR" each proposal listed above unless the shareholder directs otherwise. If any other business is presented at said meeting, this proxy shall be voted in accordance with the recommendations of the Board of Directors. When signing as attorney, executor, administrator, trustee or guardian, please give full title. If more than one trustee, all should sign. All joint owners SHOULD sign. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" EACH OF THE LISTED PROPOSALS. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS AND MAY BE REVOKED PRIOR TO ITS EXERCISE. I/WE DO / / or I/WE DO NOT / / expect to attend the meeting. Dated: _________________, 1999 __________________ (Number of Shares) ______________________________ Signature of Shareholder(s) ______________________________ Signature of Shareholder(s) 2 EX-10.7 4 EXHIBIT 10.7 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is entered into as of May 29, 1998, by and between BANK OF YORBA LINDA, a California banking corporation, with its headquarters office located at 18206 Imperial Highway, Yorba Linda California 92686 (the "Bank"), and GLORIA VAN KAMPEN, residing at 24692 Evening Star Drive, Dana Point, California 92629 (the "Employee"). A. The Bank is a corporation organized for the purpose of carrying on the business of banking. B. The Bank desires to avail itself of the skill, knowledge and experience of Employee in order to insure the successful management of its business; C. The parties hereto desire to specify the terms of Employee's employment by Bank as an Executive Vice President in this written agreement which supersedes all prior agreements, whether written or oral; and D. The employment, the duration thereof, the compensation to be paid to Employee, termination and other terms and conditions of employment provided in this Agreement were duly fixed, stated, approved and authorized for and on behalf of the Bank by action of its Board of Directors at a meeting held on May 20, 1998, at which meeting a quorum was present and voted. NOW, THEREFORE, on the basis of the foregoing facts and in consideration of the mutual covenants and agreements contained herein, the parties hereto agree as follows: 1. TERM (a) Subject to the provisions below, the Bank agrees to continue to employ Employee, and Employee agrees to be employed by the Bank, subject to the terms and conditions of this Agreement, for a three-year period commencing on May 29, 1998 and ending on May 29, 2001. The term for which Employee is employed hereunder is hereinafter referred to as the "Employment Period". (b) Subject to the notice provisions set forth in this paragraph, the term of this Agreement shall automatically be extended for one (1) additional year on June 1 of each calendar year after the expiration of the three (3) year term described in Paragraph 1(a). The term shall not be automatically extended as provided in this paragraph if either party shall give written notice to the other, on or before January 1 of each year, that the Agreement shall not be automatically renewed on the next June 1. In the event either party shall give the other written notice as provided in this paragraph, the term of this Agreement shall thereafter terminate on the next following agreement termination date. -1- 2. DUTIES AND AUTHORITY (a) During the Employment Period, Employee shall devote all her productive time, ability and attention to the business and affairs of the Bank. Employee shall not directly render service of a business, commercial or professional nature to any other person or organization without the consent of the Board of Directors of the Bank (the "Board of Directors"); provided, however, that nothing contained herein shall prohibit Employee, or require the Board of Directors to approve or consent to Employee serving a charitable or nonprofit organization or serving as an advisor or director of any corporation which does not compete with the business of the Bank. Employee agrees during the Employment Period to use her best efforts, skill and abilities to promote the Bank's interests and to serve as an Executive Vice President of the Bank. Employee's duties shall include all responsibilities assigned to the Executive Vice President. 3. BANK'S AUTHORITY. Employee agrees to observe and comply with all laws and the Bank's rules and regulations as adopted by the Board of Directors regarding performance of her duties and to carry out and to perform all appropriate orders, directions and policies stated by the Board of Directors to her periodically, either orally or in writing. 4. COMPENSATION. (a) The Bank agrees to pay to Employee during the term of this Agreement a base salary of $112,000 per annum, beginning on the effective date of this Agreement and payable on the fifteenth and thirtieth day of each month during the term of this Agreement; provided, however, that the base salary shall be reviewed annually by the Board of Directors, on or before January 31 of each year for that year, and may be changed by mutual agreement of the parties. Any such change may be subject to review by the Bank's regulatory agencies. (b) In addition to all other compensation referred to above, the Employee shall be entitled to participate in any and all other bonus plans, employee benefits and other plans currently in effect or that may be developed and adopted by the Bank. (c) All compensation shall be subject to the customary withholding tax and other employment taxes as required with respect to compensation paid by a corporation to an employee. (d) The Bank shall provide a car for Employee's use during the term, and shall pay all insurance, gas and maintenance expenses of such automobile. Any expenses of such automobile which are paid by the Bank and which are for the personal use of the automobile by Employee shall be taxable as income to Employee. The Employee shall use due care and reasonable efforts to furnish to the Bank adequate written records and other documentary evidence required by Federal and State laws and regulations substantiating the extent to which use of the automobile constitutes deductible business expenses of the Bank. (e) During the Employment Period, Employee shall be eligible to participate in any pension or profit-sharing plan, or similar employee benefit plan or retirement program of the Bank now or hereafter existing, to the extent that she is eligible under the -2- provisions thereof and commensurate with her position in relationship to other participants. The Bank shall pay for cost of an annual physical examination of Employee. (f) Employee shall accrue vacation at the rate of 8.3 hours per semi-monthly pay period (for a total of 200 hours or 25 days per year) and shall accumulate sick leave at the rate of 3.3 hours per semi-monthly pay period (for a total of 80 hours or 10 days per year). Notwithstanding any terms of the Bank's personnel policy to the contrary, any unused sick leave shall carry forward to the next year until used, but in no event shall any compensation for unused sick leave be due to Employee upon her resignation or upon the termination of this employment for any other reason, including her death or disability. Vacation time shall not accrue to more than 200 hours (25 days), except that under special circumstances up to 280 hours (35 days) of vacation may be accrued if such accrual is approved in advance by the Board of Directors in its discretion. Employee shall be required to take at least two consecutive weeks of vacation during each calendar year at a time mutually convenient to Employee and the Bank. (g) The Bank agrees to provide medical and dental insurance for Employee on the same terms as provided for all executive officers of the Bank. The Bank shall provide for Employee, at the Bank's expense, participation in medical, accident and health, and life insurance benefits equivalent to the maximum benefits available from time to time under the California Bankers Association Group insurance program for Employee's salary level, as long as Employee is insurable at a normal premium payment. Said coverage shall take effect as of the Effective Date hereof and shall continue throughout the Term. The Bank's liability to Employee for any breach of this paragraph shall be limited to the amount of premiums payable by the Bank to obtain the coverage contemplated herein. 5. REIMBURSEMENT OF EXPENSES. The services required by the Bank will require Employee to incur business, entertainment and community relations expenses and the Bank hereby agrees to provide credit cards and charge accounts for Employee's use for such expenses. The Bank agrees to reimburse Employee for all out-of-pocket expenses which are business related, upon submission of appropriate documentation therefor and approval thereof by the Board of Directors or a committee thereof appointed for such purpose. The Board or a committee thereof shall review such expenses at least monthly so that reimbursement of appropriate expenses is not unreasonably delayed. Each expense, to be reimbursed, must be of a nature qualifying it as a proper deduction on the income tax returns of the Bank as a business expense and not as deductible compensation to Employee. The records and other documentary evidence submitted by Employee to the Bank with each request for reimbursement of such expenses shall be in the form required by applicable statutes and regulations issued by appropriate taxing authorities for the substantiation of such expenditures as deductible business expenses of the Bank and not as deductible compensation to Employee. 6. CONFIDENTIAL INFORMATION. Without the prior written permission of the Bank in each case, Employee shall not publish, disclose or make available to any other person, firm or corporation, either during or after the termination of this Agreement, any confidential information which Employee -3- may obtain during the Employment Period, or which Employee may create prior to the end of the Employment Period relating to the business of the Bank, or to the business of any customer or supplier of any of them; provided, however, Employee may use such information during the Employment Period for the benefit of the Bank. Prior to or at the termination of this Agreement, Employee shall return all documents, files, notes, writings and other tangible evidence of such confidential information to the Bank. 7. COVENANT NOT TO SOLICIT CUSTOMERS OR FELLOW EMPLOYEES. Employee agrees that for a period of twelve (12) months following the termination of her employment hereunder she will not solicit the banking business of any customer with whom the Bank had done business during the preceding one year period. Employee further agrees not to solicit the services of any officer or employee of the Bank during such twelve (12) month period. 8. REMEDY. Employee understands that, because of the unique character of the services to be rendered by Employee hereunder, the Bank would not have any adequate remedy at law for the material breach or threatened breach by Employee of any one or more of the covenants set forth in this Agreement and agrees that in the event of any such material breach or threatened breach, the Bank may in addition to the other remedies which may be available to it: (a) Declare forfeited any moneys representing accrued salary, contingent payments or other fringe benefits due and payable to Employee, and, or alternatively, (b) File a suit in equity to enjoin Employee from the breach or threatened breach of such covenants. 9. TERMINATION OF EMPLOYEE WITHOUT CAUSE. (a) The Board of Directors may terminate Employee's employment hereunder without Cause (as defined in subsection 10(b) below) at any time, provided, however, that such termination by the Board without Cause shall entitle Employee to the compensation described in subsection 9(b) below. (b) In the event Employee is terminated by the Bank without Cause, the Bank shall pay to Employee an amount equal to twelve (12) months of base salary, auto allowance, vacation pay and insurance benefits, and accrued bonuses as severance pay in lieu of and in substitution for any other claims for salary and continued benefits hereunder (based on Employee's base salary and benefits prevailing at the time of termination). Such severance payment shall be in addition to all other sums owing to Employee as accrued vacation pay. However, if Employee's employment is terminated by the Bank or the Bank's successor pursuant to this Section 9 within nine (9) months as a result of the consummation -4- of a plan of dissolution or a liquidation of the Bank, or consummation of a plan of reorganization, merger or consolidation of the Bank with one or more corporations, as a result of which the Bank is not the surviving corporation, or upon the sale of all or substantially all of the assets of the Bank to another corporation, or the acquisition of stock representing more than 25% of the voting power of the Bank then outstanding by another corporation or person, the Bank shall pay to Employee an amount equal to twenty-four (24) months of base salary, auto allowance, vacation pay, and insurance benefits, as severance pay in lieu of and in substitution for any other claims for salary and continued benefits hereunder (based on Employee's base salary and benefits prevailing at the time of termination). Such severance payment shall be in addition to all sums owing to employee as accrued vacation pay. With respect to any stock options issued to the Employee that were outstanding on the date of the termination of her employment under this Section 9, any options which would become exercisable had the Employee remained in the employ of the Bank through the end of the Employment Period but which are not exercisable on the effective date of the Employee's termination of employment under this Section 9 shall automatically become exercisable upon any such termination, and shall remain exercisable in full for a period of one year after such termination of employment. 10. TERMINATION OF EMPLOYEE FOR CAUSE. (a) Notwithstanding anything herein contained, on or after the date hereof and prior to the end of the Employment Period, the Bank shall have the right to terminate Employee's employment hereunder for Cause (as defined in Subsection 10(b) below) by giving to Employee written notice of such termination as of a date (not earlier than ten (10) days after such notice) to be specified in such notice, and the Employment Period shall terminate on the date so specified, whereupon Employee shall be entitled to receive only her then accrued salary at the rate provided in Section 4(a), plus her accrued vacation pay, but only to the date on which termination shall take effect; provided, however, that if termination is due to physical or mental disability of Employee, such termination shall not affect any rights which Employee may have at the time of termination pursuant to any insurance or other death benefit, bonus, retirement, or arrangements of the Bank; or any stock option plan or any options thereunder, which rights shall continue to be governed by the provisions of such plans and arrangements. (b) For purposes of this Agreement, "Cause" shall mean the determination by the Board of Directors, acting in good faith and by majority vote, with or without a meeting, that Employee has (i) willfully failed to perform or habitually neglected the appropriate duties which she is required to perform hereunder; or (ii) willfully failed to follow any policy of the Bank which materially adversely affects the condition of the Bank; or (iii) engaged in any activity in contravention of any Bank policy, statute, regulation or governmental policy which materially adversely affects the Bank's condition, or its reputation in the community, or which evidences the lack of Employee's fitness or ability to perform Employee's duties; or (iv) willfully refused to follow any appropriate instruction from the Board of Directors unless Employee asserts that compliance with such instruction would cause the Bank or Employee to violate any statute, regulation or governmental or Bank policy; or (v) subject to subsection (c) below, become physically or mentally disabled or otherwise evidenced her inability to discharge her duties as an -5- Executive Vice President of the Bank, or (vi) been convicted of or pleaded guilty or nolo contendere to any felony, or (vii) committed any act which would cause termination of coverage under the Bank's Bankers Blanket Bond as to Employee, as distinguished from termination of coverage as to the Bank as a whole. (c) If Employee becomes disabled and such disability continues for a period of one hundred eighty (180) consecutive days, then upon expiration of such 180-day period, if the term of this Agreement has not already expired, the Bank may, in its discretion, terminate the Agreement and all benefits due hereunder, but Employee shall be entitled upon such termination to receive disability payments in accordance with such disability plan as may be established for the payment of disability benefits as permitted under the Internal Revenue Code; provided, however, that if such disability is job related, as determined by an arbitrator mutually acceptable to the Bank and Employee or Employee's representative, then the compensation due hereunder shall continue for a period of one year after the commencement of such disability. (d) This Agreement shall terminate immediately without further liability or obligation to Employee if the Bank is closed by any supervisory authority. 11. TERMINATION UPON EMPLOYEE'S DEATH; EFFECT OF TERMINATION ON OTHER PLANS (a) Notwithstanding anything herein contained, if Employee shall die, this Agreement shall terminate on the date of Employee's death, whereupon Employee's estate shall be entitled to receive her salary, accrued vacation, and any bonus earned up through the date of termination. Such termination shall not affect any rights which Employee may have at the time of her death pursuant to any of the Bank's plans or arrangements for insurance or for any other death benefit, bonus, or retirement benefit. (b) Notwithstanding anything herein contained, any termination of employment under this Section 11 shall not affect any accrued rights which Employee may have at the time of such termination, including, but not limited to, any of the Bank's plans for arrangements for insurance, vacation, retirement, and stock options, which then accrued rights shall continue to be governed by the provisions of such plans and arrangements to the extent they are not inconsistent with the terms of this Agreement. 12. MERGER, CONSOLIDATION OR REORGANIZATION. In the event of a merger where the Bank is not the surviving corporation, or in the event of a consolidation, or in the event of a transfer of all or substantially all of the assets of the Bank, or in the event of any other corporation reorganization where there is a change in ownership of at least twenty-five percent (25%) except as may result from a transfer of shares to another corporation in exchange for at least eighty percent (80%) control of that corporation, or in the event of the dissolution of the Bank, this Agreement shall not be terminated, in which case, except in the event of dissolution, the surviving or resulting corporation, the transferee of the Bank's assets, or the Bank shall be bound by and shall have the benefit of the provisions of this Agreement. The Bank shall endeavor to take all reasonable actions necessary to insure that -6- such corporation or transferee, if other than the Bank, is bound by the provisions of this Agreement. 13. MODIFICATION This Agreement sets forth the entire understanding of the parties with respect to the subject matter hereof, supersedes all existing agreements between them concerning such subject matter, and may be modified only by written instrument duly executed by each party. 14. NOTICES Any notice or other communication required or permitted to be given hereunder shall be in writing and shall be mailed by certified mail, return receipt requested or delivered against receipt to the party set forth in the preamble to this Agreement (or to such other address as the party shall have furnished in writing in accordance with the provisions of this Section 14). Notice to the estate of Employee shall be sufficient if addressed to Employee as provided in this Section 14. Any notice or other communication given by certified mail shall be deemed given at the time of certification thereof, except for a notice changing a party's address which shall be deemed given at the time of receipt thereof. 15. DISPUTE RESOLUTION PROCEDURES Any controversy or claim arising out of or this Agreement or the breach thereof, or the interpretation thereof, shall be settled by binding arbitration in accordance with the Rules of the American Arbitration Association; and judgment upon the award rendered in such arbitration shall be final and may be entered in any court having jurisdiction thereof. Notice of the demand for arbitration shall be filed in writing with the other party to this Agreement and with the American Arbitration Association. In no event shall the demand for arbitration be made after the date when institution or legal or equitable proceedings based on such claim, dispute or other matter in questions would be barred by the applicable statute of limitations. This agreement to arbitrate shall be specifically enforceable under the prevailing arbitration law. Any party desiring to initiate arbitration procedures hereunder shall serve written notice on the other party. The parties agree that an arbitrator shall be selected pursuant to these provisions within thirty (30) days of the service of the notice of arbitration. In the event of any arbitration pursuant to these provisions, the parties shall retain the rights of all discovery provided pursuant to the California Code of Civil Procedure and the Rules thereunder, except that all time periods contained in said Code and Rules shall be shortened by fifty percent (50%) for purposes of arbitration proceedings hereunder. Any arbitration initiated pursuant to these provisions shall be on an expedited basis and the dispute shall be heard within one hundred twenty (120) days following the serving of the notice of arbitration and a written decision shall be rendered within sixty (60) days thereafter. All rights, causes of action, remedies and defenses available under California law and equity are available to the parties hereto and shall be applicable as though in a court of law. The parties shall share equally all costs of any such arbitration. 16. MISCELLANEOUS. -7- (a) This Agreement is drawn to be effective in the State of California and shall be construed in accordance with California laws, except to the extent superseded by any other federal law. No amendment or variation of the terms of this Agreement shall be valid unless made in writing and signed by Employee and a duly authorized representative of the Bank. (b) Any waiver by either party of a breach of any provision of this Agreement shall not operate as to be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Agreement. The failure of a party to insist upon strict adherence to any term of this Agreement on one or more occasions shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. Any waiver must be in writing. (c) Employee's rights and obligations under this Agreement shall not be transferable by assignment or otherwise, such rights shall not be subject to commutation, encumbrance or the claims of Employee's creditors, and any attempt to do any of the foregoing shall be void. The provisions of this Agreement shall be binding upon and inure to the benefit of the Bank and its successors and those who are its assigns under Section 12. (d) This Agreement does not create, and shall not be construed as creating, any rights enforceable by a person not a party to this Agreement (except as provided in subsection (c) above). (e) The headings in this Agreement are solely for the convenience of reference and shall be given no effect on the construction or interpretation of this Agreement. (f) This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. It shall be governed by and construed in accordance with the laws of the State of California, without giving effect to conflict of laws, except where federal law governs. 17. RESIGNATION AS DIRECTOR UPON TERMINATION. Upon termination of this Agreement, Employee, if she is then serving as a director of the Bank and/or the Bank's holding company, agrees to immediately resign her position as a director by giving written notice of her resignation to the Chairman of the Board of Directors of the Bank and/or the Bank's holding company. IN WITNESS WHEREOF, the Bank has caused this Agreement to be signed by its duly authorized officers and Employee has executed this Agreement to be effective as of the day and year written above. BANK: BANK OF YORBA LINDA By: /s/ H. Rhoads Martin ----------------------------------------- H. Rhoads Martin Chairman of the Board -8- EMPLOYEE: /s/ Gloria Van Kampen ----------------------------------------- Gloria Van Kampen -9- EX-23.1 5 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the inclusion of our Independent Auditor's Report dated January 21, 1999 regarding the consolidated balance sheets of BYL Bancorp and Subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997 in the Form 10-K filed with the Securities and Exchange Commission. VAVRINEK, TRINE, DAY & CO., LLP March 30, 1999 Laguna Hills, California EX-27.1 6 EXHIBIT 27.1
9 1,000 YEAR DEC-31-1999 JAN-01-1998 DEC-31-1998 14,214 0 18,700 0 6,400 10,844 10,874 239,797 2,300 318,013 287,206 0 3,925 0 0 0 12,760 14,122 318,013 22,057 1,119 840 2,406 8,316 8,406 15,610 755 0 30,870 7,393 0 0 0 4,116 1.63 1.55 6.40 1,807 223 0 0 1,923 528 150 2,300 2,058 0 242
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