-----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, IFR0OpWZ9tReKbe6y5hch2MV01l4rWXM8WG+6vZ6jdTM9flxHGD6lXMojJpg3j0K V8OnORzZAxt2va3JYxa8Zw== 0000944209-99-000614.txt : 19990423 0000944209-99-000614.hdr.sgml : 19990423 ACCESSION NUMBER: 0000944209-99-000614 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990422 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROFESSIONAL BANCORP INC CENTRAL INDEX KEY: 0000700914 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 953701137 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10937 FILM NUMBER: 99598665 BUSINESS ADDRESS: STREET 1: 606 BROADWAY CITY: SANTA MONICA STATE: CA ZIP: 90401 BUSINESS PHONE: 3104581521 MAIL ADDRESS: STREET 1: 606 BROADWAY STREET 2: 606 BROADWAY CITY: SANTA MONICA STATE: CA ZIP: 90401 FORMER COMPANY: FORMER CONFORMED NAME: PROFESSIONAL BANCORP /CA/ DATE OF NAME CHANGE: 19890904 10-K 1 FORM 10-K ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1998 Commission File Number: 0-11223 PROFESSIONAL BANCORP, INC. (Exact name of registrant as specified in its charter) Pennsylvania 95-3701137 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 606 Broadway Santa Monica, California 90401 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (310) 458-1521 Securities registered pursuant to Section 12(b) of the Act: Common Stock $0.008 par value American Stock Exchange (Title of Class) (Name of exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- _______ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [__] The aggregate market value of the voting stock held by non-affiliates of the Registrant as of March 10, 1999: $34,306,335. The number of shares of $0.008 par value common stock outstanding as of March 10, 1999: 2,015,007. ================================================================================ 1 FORM 10-K --------- TABLE OF CONTENTS AND CROSS REFERENCE SHEET -------------------------------------------
PART I - ------ Item 1. Business 3 ------- -- Item 2. Properties 23 ------- -- Item 3. Legal Proceedings 24 ------- -- Item 4. Submission of Matters to a Vote of Security Holders 24 ------- -- PART II - ------- Item 5. Market for Registrant's Common Equity 25 ------- -- and Related Stockholder Matters Item 6. Selected Financial Data 27 ------- -- Item 7. Management's Discussion and Analysis of Financial 28 ------- -- Condition and Results of Operations Item7A. Quantitative and Qualitative Disclosures About Market Risk 50 ------- -- Item 8. Financial Statements and Supplementary Data 52 ------- -- Item 9. Changes in and Disagreements with Accountants on Accounting 52 ------- -- and Financial Disclosure PART III - -------- Item 10. Directors and Executive Officers of the Registrant 52 -------- -- Item 11. Executive Compensation 54 -------- -- Item 12. Security Ownership of Certain Beneficial Owners and Management 55 -------- -- Item 13. Certain Relationships and Related Transactions 57 -------- -- PART IV - ------- Item 14. Exhibits, Consolidated Financial Statement Schedules and Reports on Form 8-K 58 -------- INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES --
2 Part I Item 1. Business - ----------------- Professional Bancorp, Inc. Professional Bancorp, Inc. (the "Company") is a bank holding company organized as a corporation under the laws of the State of California in July 1981 and reincorporated under the laws of the Commonwealth of Pennsylvania in August 1989. As a bank holding company, the Company is subject to the Bank Holding Company Act of 1956, as amended ("BHCA"). The Company commenced operations in August 1982. On the commencement date and from the proceeds of its initial stock offering, the Company purchased all of the outstanding stock of First Professional Bank, National Association (the "Bank"). On November 18, 1998, Professional Bancorp Mortgage, Inc., a mortgage-brokerage corporation, was formed as a majority owned subsidiary of the Bank ("PBMI"). The Company's principal business is to serve as a holding company for the Bank, PBMI and for other banking or finance-related subsidiaries which the Company may establish or acquire. At December 31, 1998, the Company had total consolidated assets of approximately $259.7 million, total consolidated net loans of approximately $115.5 million, total consolidated deposits of approximately $230.6 million and total consolidated shareholders' equity of approximately $25.3 million. The discussion and analysis for the year ended December 31, 1998 reflect the operations of the Company, the Bank and PBMI. General First Professional Bank, National Association The Bank was organized in August 1982, the Bank commenced operations as a federally chartered national bank. Principal Marketing Area and Concentration The principal service areas of the Bank consist of the California counties of Los Angeles, Orange, Riverside, San Bernardino and Ventura and limited business in Northern California with a full-service office at its Santa Monica headquarters and four full-service branches located in Beverly Hills, Tarzana, Pasadena and Redlands. In addition, the Bank has a limited service facility in Los Angeles near Cedars Sinai Medical Center. The Bank also develops business in the Northern California counties surrounding the San Francisco East Bay Area and the City of Sacramento. Other states are serviced on a limited basis. Since inception, the Bank has operated an in-house courier service which permits the Bank to serve areas outside of each branch's immediate vicinity. Couriers are licensed branches of the Company and able to facilitate limited banking transactions. The Bank's strategy is to deliver value-added products and services that satisfy the financial services needs of its targeted customers, the outpatient services sector, emphasizing superior service and relationships. The Bank provides a wide range of commercial banking products and services primarily directed towards the health care community, which includes, physicians, independent practice associations (IPA), practice management companies (PPM), preferred provider organizations (PPO), medical billing faculty management companies, home health agencies and hospital based practices. Attorneys, accountants and other clientele compose the remainder of the Bank's market. There is no significant concentration of outstanding loans in the control of a single person or group. Commercial Banking The Bank is engaged in the business of general commercial banking. The services which are offered include those traditionally offered by commercial banks, such as checking and savings accounts, time certificates of deposit, and commercial, consumer/installment, home equity and short-term real estate loans. The Bank also offers cashier's checks, travelers checks, safe deposit boxes, night deposit facilities, wire transfers, notary services, courier services, mortgage brokering, merchant accounts, TouchTone Banking and five bank owned 24- hour automated teller machines which are located at the Bank's Santa Monica, Cedars Sinai Medical Center, Tarzana, Pasadena and Redlands facilities. Client access to First Professional Bank, is also available through most ATM networks. 3 Professional Bancorp Mortgage, Inc. On November 18, 1998, Professional Bancorp Mortgage, Inc. ("PBMI"), commenced operations as a majority-owned subsidiary of the Bank. In keeping with the Company's strategy of providing clients access to new products through alliances, a co-venture partnership was created with REIS Mortgage Holdings, Inc. ("REIS"). REIS is a provider of mortgage brokerage services and has been a long-standing referral partner of the Bank. The combined forces have created PBMI, a mortgage brokerage company, which provides residential, non-residential and commercial mortgage products to our clients, as well as generate new relationships with non-client sources. Competition The Bank faces competition in attracting both deposits and originating loans. The Bank's competition in loans comes principally from community based, regional and multi-regional commercial banks, investment banks, asset based finance companies, savings and loan associations, mortgage companies, and to a lesser degree, thrift and loan companies, credit unions and insurance companies. Many of the nation's largest commercial banks and savings and loan associations with which the Bank competes have significantly greater lending limits than the Bank and perform other services for their customers which the Bank can offer only through correspondents or other vendors, if at all. Deregulation of the banking industry and increased competition from non-bank entities for the cash balances of individuals and businesses has had and will continue to have an impact on the competitive position of the Bank. Among the advantages of these larger institutions is their ability to make larger loans, finance extensive advertising campaigns, access international money markets and generally allocate their assets to regions of highest yield and demand. Management believes that its most direct competition for deposits comes from commercial banks, stock brokerage firms, savings and loan associations, thrift and loan companies and credit unions. In addition, competition for deposits may be expected to arise from corporate and governmental debt securities, as well as money market mutual funds. The Bank does not have a significant market share of the deposits or loans in the northern or southern California marketplace. In order to compete with other financial service entities in its service area, the Bank relies principally upon promotional activity, personal contacts obtained through its officers, directors, employees and shareholders to attract and maintain relationships. The Bank's promotional activities emphasize the advantages of banking with an institution knowledgable to the particular needs of the health care community. Additionally, the Bank is informed of the current trends and changing financial services needs of the health care industry through membership in trade associations, directorships of health care organizations and through feedback from existing health care clients of the Bank. This longstanding and continued presence of the Bank in its niche is a valuable marketing factor which not only serves well for clients and prospects, but serves as a major competitive advantage. For clients whose credit demands exceed the Bank's lending limits, the Bank attempts to arrange for such loans on a participated basis with institutions who desire to work with the Bank to leverage its industry expertise. The Bank also assists clients requiring services not offered by the Bank by obtaining these services through its correspondent banks and/or other joint relationships. 4 SUPERVISION AND REGULATION - THE COMPANY Banking is a complex, highly regulated industry. The primary goals of the regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress has created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the banking industry. As a consequence of the extensive regulation of banking activities in the United States, the business of the Company is particularly susceptible to the enactment of federal and state legislation which may have the effect of increasing or decreasing the cost of doing business, modifying permissible activities or enhancing the competitive position of the other financial institutions. Any change in applicable laws or regulations may have a material adverse effect on the business and prospects of the Company. The descriptions of and references to the statutes and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed. The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "Act"), and is subject to supervision, regular examination and regulation by the Board of Governors of the Federal Reserve System (the "FRB"). As a bank holding company, the Company is required to file with the FRB an annual report and such other additional information as the FRB may require under the Act. The FRB may also make examinations of the Bancorp and its subsidiaries. The Act requires prior approval by the FRB for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares, or substantially all the assets, of any bank or for a merger or consolidation by a bank holding company with any other bank holding company. The Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the Commissioner of the California Department of Financial Institutions. Regulations have not yet been proposed or adopted or steps otherwise taken to implement the Commissioner's powers under this statute. Bank Holding Bancorp Liquidity and Dividend Restrictions The Company is a legal entity, separate and distinct from the Bank, and is not currently intending to engage in any activities other than acting as a bank holding company. Although there exists the ability to raise capital on its own behalf or borrow from external sources, the Company's principal source of funds, including funds available for payment of cash dividends to shareholders, consists of dividends paid, fees for services provided to, and other funds advanced to the Company by the Bank. Statutory and regulatory requirements impose limitations on the amount of dividends payable by the Bank to the Company and on extensions of credit by the Bank to the Company. Regarding the Bank, the Company is entitled to receive dividends, when and as declared by the Bank's Board of Directors, out of funds legally available therefor, as specified and limited by Section 56 of Title 12 of the United States Code, which prohibits payments of dividends from a national bank's permanent capital. All dividends must be paid out of net earnings then on hand, after deducting expenses, including losses and bad debts. In addition, the payment of dividends out of net earnings of a national bank is further limited by 12 U.S.C. Section 60(a), which provides that until the surplus equals the amount of capital stock, dividends can only be paid if there has been transferred to the surplus fund not less than one-tenth of the bank's net earnings for the preceding half-year in the case of quarterly or semi-annual dividends. Pursuant to 12 U.S. C. Section 60(b), the approval of the Office of the Comptroller of the Currency (the "OCC") shall be required if the total of dividends declared by a bank in any calendar year exceeds the total of its net earnings for that year, less any required transfers to surplus or to a fund for the retirement of any preferred stock. Furthermore, if the OCC determines that the shareholders' equity of the bank is not adequate or that the payment of a dividend would be unsafe or unsound for the bank, the OCC may order the bank not to pay a dividend to the Bancorp, even if such payments are not expressly prohibited by statute. Under the Financial Institutions Supervisory Act, the FDIC also has the authority to prohibit an insured institution from engaging in business practices which the FDIC considers to be unsafe or unsound. Since the Bank is an insured institution, it is therefore possible, depending upon their financial conditions and other factors, that the FDIC 5 could assert that the payment of dividends or other payments might, under some circumstances, constitute an unsafe or unsound practice and thereby prohibit such payments. Additionally, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if after such transaction, the institutions would be undercapitalized. The FRB also limits transactions between the Company and the Bank. FRB policies forbid the payment by bank subsidiaries of management fees which are unreasonable in amount or exceed the fair market value of the services rendered (or, if no market exists, actual costs plus a reasonable profit). Section 1551 of the Pennsylvania Business Corporation Law of 1988 (the "PBCL") provides that the board of directors may authorize a business corporation to make distributions to shareholders subject to certain limitations. A distribution to shareholders may not be made if: (i) the corporation would be unable to pay its debts as they become due in the usual course of business; or (ii) the total assets of the corporation would be less than the sum of its total liabilities, plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. Transactions With Affiliates The Company, the Bank, PBMI and any other subsidiaries it may purchase or organize or otherwise acquire are deemed to be affiliates of the Bank within the meaning of the Act. Pursuant thereto, loans by the Bank to affiliates, investments by the Bank in affiliates' stock, and taking affiliates' stock by the Bank as collateral for loans to any borrower will be limited to 10% of the Bank's capital, in the case of any one affiliate, and will be limited to 20% of the Bank's capital in the case of all affiliates. In addition, such transactions must be on terms and conditions that are consistent with safe and sound banking practices; in particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act. Such restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. The Company and the Bank are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities. Limitations on Businesses and Activities With certain limited exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to or performing services for its authorized subsidiaries. A bank holding company may, however, engage or acquire an interest in a company that engages in activities which the FRB has determined to be closely related to banking or managing or controlling banks as to be properly incident thereto. In making such a determination, the FRB is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, or unsound banking practices. Although the future scope of permitted activities is uncertain and cannot be predicted, some of the activities that the FRB has determined by regulation to be closely related to banking are: . making or acquiring loans or other extensions of credit for its own account or for the account of others; . servicing loans and other extensions of credit for any person; . operating an industrial bank, Morris Plan bank, or industrial loan company, as authorized under state law, so long as the institution is not a bank; . operating a trust company in the manner authorized by federal or state law, so long as the institution is not a bank and does not make loans or investments or accept deposits, except as permitted under the FRB's Regulation Y; 6 . subject to certain limitations, acting as an investment or financial adviser to investment companies and other persons; . leasing personal and real property or acting as agent, broker, or adviser in leasing such property in accordance with various restrictions imposed by Regulation Y, including a restriction that it is reasonably anticipated that each lease will compensate the lessor for not less than the lessor's full investment in the property; . making equity and debt investments in corporations or projects designed primarily to promote community welfare; . providing financial, banking, or economic data processing and data transmission services, facilities, data bases, or providing access to such services, facilities, or data bases; . acting as principal, agent, or broker for insurance directly related to extensions of credit which are limited to assuring the repayment of debts in the event of death, disability, or involuntary unemployment of the debtor; . acting as agent or broker for insurance directly related to extensions of credit by a finance company subsidiary; . owning, controlling, or operating a savings association provided that the savings association engages only in activities permitted for bank holding companies under Regulation Y; . providing courier services of limited character; . providing management consulting advice to non-affiliated bank and nonbank depository institutions, subject to the limitations imposed by Regulation Y; . selling money orders, travelers' checks and U.S. Savings Bonds; . appraisal of real estate and personal property; . acting as an intermediary for the financing of commercial or industrial income-producing real estate; . providing securities brokerage services, related securities credit activities pursuant to Regulation T, and other incidental activities; . underwriting and dealing in obligations of the U.S., general obligations of states and their political subdivisions, and other obligations authorized for state member banks under federal law; and . providing general information and statistical forecasting, advisory and transactional services with respect to foreign exchange through a separately incorporated subsidiary. Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, the Bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: . the customer must obtain or provide some additional credit, property or services from or to the Bank other than a loan, discount, deposit or trust service; . the customer must obtain or provide some additional credit, property or service from or to the Company, the Bank or the Bank's subsidiary; or 7 . the customer may not obtain some other credit, property or services from competitors, except reasonable requirements to assure soundness of credit extended. Under the Act, an investor generally must obtain the prior approval of the FRB before it exercises a controlling influence over or acquires, directly or indirectly, more than 5% of any class of voting shares or substantially all of the assets of the bank or bank holding company or other company. Thus, Company is required to obtain the prior approval of the FRB before it acquires, merges or consolidates with any bank or bank holding company; any company seeking to acquire, merge or consolidate with the Company also would be required to obtain the approval of the FRB. In addition, and subject to certain exceptions, the Change in Bank Control Act (the "Control Act") and regulations promulgated thereunder by the FRB required any person acting directly or indirectly, or through or in concert with one or more persons, to give the FRB 60 days written notice before acquiring control of a bank holding company. Transactions which are presumed to constitute the acquisition of control include the acquisition of any voting securities of a bank holding company having securities registered under section 12 of the Securities Exchange Act (such as the Common Stock of the Company) if, after the transaction, the acquiring person (or persons acting in concert) own, controls or holds with power to vote 10% or more of any class of voting securities of the institution. The acquisition may not be consummated subsequent to such notice if the FRB issues a notice within 60 days, or within certain extensions of such period, disapproving the same. Capital Adequacy The FRB's risk-based capital adequacy guidelines for bank holding companies and member banks, discussed in more detail below (see "SUPERVISION AND REGULATION - THE BANK - Recent Legislation and Regulatory Developments - 3. Risk-Based Capital Guidelines" herein), assign various risk percentages to different categories of assets, and capital is measured as a percentage of risk assets. While in many cases total risk assets calculated in accordance with the guidelines is less than total assets calculated absent the rating, certain non- balance sheet assets, including loans sold with recourse, legally binding loan commitments and standby letters of credit, are treated as risk assets, with the assigned rate varying with the type of asset. As a result, it is possible that total risk assets for purposes of the guidelines exceeds total assets under generally accepted accounting principles, thereby reducing the capital-to-assets ratio. Under the terms of the guidelines, bank holding companies are expected to meet capital adequacy guidelines based both on total assets and on total risk assets. SUPERVISION AND REGULATION - THE BANK General The Bank as a nationally chartered banking association which is a member of the Federal Reserve System, is subject to regulation, supervision, and regular examinations by the OCC, the FDIC and the FRB. The Bank's deposits are insured by the Bank Insurance Fund ("BIF") of the FDIC, up to the maximum extent provided by law. The regulations of these agencies govern most aspects of the Bank's business, including capital ratios, reserves against deposits, interest rates payable on certain types of deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. The Bank is also subject to applicable provisions of California law and Pennsylvania law for the holding company, insofar as such provisions are not in conflict with or preempted by federal banking law. California law exempts all banks from usury limitations on interest rates. Supervision, legal action and examination of the Bank by the regulatory agencies are generally intended to protect depositors and are not intended for the protection of shareholders. Recent Legislation And Regulatory Developments 1. Introduction ------------ General. From time to time legislation is proposed or enacted which has ------- the effect of increasing the cost of doing business and changing the competitive balance between banks and other financial and non-financial institutions. Various federal laws enacted over the past several years have provided, among other things, for the maintenance of mandatory reserves with the Federal Reserve on deposits by depository institutions (state reserve requirements have been eliminated); the phasing-out of the restrictions on the amount of interest which financial institutions may pay on certain 8 of their customers' accounts; and the authorization of various types of new deposit accounts, such as NOW accounts, "Money Market Deposit" accounts and "Super NOW" accounts, designed to be competitive with money market mutual funds and other types of accounts and services offered by various financial and non- financial institutions. The lending authority and permissible activities of certain non-bank financial institutions such as savings and loan associations and credit unions have been expanded, and federal regulators have been given increased authority and means for providing financial assistance to insured depository institutions and for effecting interstate and cross-industry mergers and acquisitions of failing institutions. These laws have generally had the effect of altering competitive relationships existing among financial institutions, reducing the historical distinctions between the services offered by banks, savings and loan associations and other financial institutions, and increasing the cost of funds to banks and other depository institutions. Other legislation has been proposed or is pending before the United States Congress which would affect the financial institutions industry. Such legislation includes wide-ranging proposals to further alter the structure, regulation and competitive relationships of the nation's financial institutions, to reorganize the federal regulatory structure of the financial institutions industry, to subject banks to increased disclosure and reporting requirements, and to expand the range of financial services which banks and bank holding companies can provide. Other proposals which have been introduced or are being discussed would equalize the relative powers of savings and loan holding companies and bank holding companies, and authorize such holding companies to engage in insurance underwriting and brokerage, real estate development and brokerage, and certain securities activities, including underwriting and dealing in United States Government securities and municipal securities, sponsoring and managing investment companies and underwriting the securities thereof. It cannot be predicted whether or in what form any of these proposals will be adopted, or to what extent they will effect the various entities comprising the financial institutions industry. Certain of the potentially significant changes which have been enacted in the past several years are discussed below. Interstate Banking. The Riegle-Neal Interstate Banking and Branching ------------------ Efficiency Act of 1994 (the "Riegle-Neal Act"), enacted on September 29, 1994, repealed the McFadden Act of 1927, which required states to decide whether national or state banks could enter their state, and, effective June 1, 1997, allows banks to open branches across state lines. The Riegle-Neal Act also repealed the 1956 Douglas Amendment to the Bank Holding Company Act, which placed the same requirements on bank holding companies. The repeal of the Douglas Amendment made it possible for bank holding companies to buy out-of- state banks in any state after September 29, 1995, which, after June 1, 1997, may now be converted into interstate branches. The Riegle-Neal Act permitted interstate banking to begin effective September 29, 1995. The amendment to the Bank Holding Company Act permits bank holding companies to acquire banks in other states provided that the acquisition does not result in the bank holding company controlling more than 10 percent of the deposits in the United States, or 30 percent of the deposits in the state in which the bank to be acquired is located. However, the Riegle-Neal Act also provides that states have the authority to waive the state concentration limit. Individual states may also require that the bank being acquired be in existence for up to five years before an out-of-state bank or bank holding company may acquire it. The Riegle-Neal Act provides that, since June 1, 1997, interstate branching and merging of existing banks is permitted, provided that the banks are at least adequately capitalized and demonstrate good management. Interstate mergers and branch acquisitions were permitted at an earlier time if the state choose to enact a law allowing such activity. The states were also authorized to enact laws to permit interstate banks to branch de novo. On September 28, 1995, the California Interstate Banking and Branching Act of 1995 ("CIBBA") was enacted and signed into law. CIBBA authorized out-of- state banks to enter California by the acquisition of or merger with a California bank that has been in existence for at least 5 years, unless the California bank is in danger of failing or in certain other emergency situations. CIBBA does not permit out-of-state banks to enter California by branch acquisition or de novo branching. CIBBA allows a California state bank to have agency relationships with affiliated and unaffiliated insured depository institutions and allows a bank subsidiary of a bank holding company to act as an agent to receive deposits, renew time deposits, service loans and receive payments for a depository institution affiliate. 9 Proposed Expansion of Securities Underwriting Authority. Various bills ------------------------------------------------------- have been introduced in the United States Congress which would expand, to a lesser or greater degree and subject to various conditions and limitations, the authority of bank holding companies to engage in the activity of underwriting and dealing in securities. Some of these bills would authorize securities firms (through the holding company structure) to own banks, which could result in greater competition between banks and securities firms. No prediction can be made as to whether any of these bills will be passed by the United States Congress and enacted into law, what provisions such a bill might contain, or what effect it might have on the Bancorp or its Banking Subsidiaries. Expansion of Investment Opportunities for California State-Chartered Banks. -------------------------------------------------------------------------- Legislation enacted by the State of California has substantially expanded the authority of California state-chartered banks to invest in real estate, corporate stock and other corporate securities. National banks are governed in these areas by federal law, the provisions of which are more restrictive than California law. However, provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991, discussed below, limits state-authorized activities to that available to national banks, unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the institution is in compliance with applicable regulatory requirements. 2. Financial Institutions Reform, Recovery, and Enforcement Act of 1989 -------------------------------------------------------------------- General. On August 9, 1989, the Financial Institutions Reform, Recovery, ------- and Enforcement Act of 1989 ("FIRREA") was signed into law. This legislation has resulted in major changes in the regulation of insured financial institutions, including significant changes in the authority of government agencies to regulate insured financial institutions. Under FIRREA, the Federal Savings and Loan Insurance Corporation ("FSLIC") and the Federal Home Loan Bank Board were abolished and the FDIC was authorized to insure savings associations, including federal savings associations, state chartered savings and loans and other corporations determined to be operated in substantially the same manner as a savings association. FIRREA established two deposit insurance funds to be administered by the FDIC. The money in these two funds is separately maintained and not commingled. The FDIC Permanent Insurance Fund was replaced by the BIF and the FSLIC deposit insurance fund was replaced by the Savings Association Insurance Fund (the "SAIF"). The Bank's deposit accounts are insured by the BIF, as administered by the FDIC, up to the maximum amount permitted by law. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the institution's primary regulator which, in the case of the Bank, is the OCC. Deposit Insurance Assessments. Under FIRREA, the premium assessments made ----------------------------- on banks and savings associations for deposit insurance were initially increased, with rates set separately for banks and savings associations, subject to statutory restrictions. The Omnibus Budget Reconciliation Act of 1990, designed to address the federal budget deficit, increased the insurance assessment rates for members of the BIF and the SAIF over that provided by FIRREA, and eliminated FIRREA's maximum reserve-ratio constraints on the BIF. The FDIC raised BIF premiums to 23c per $100 in insured deposits for 1993 from a base of 12c in 1990. Effective January 1, 1994, the FDIC implemented a risk-based assessment system, under which an institution's premium assessment is based on the probability that the deposit insurance fund will incur a loss with respect to the institution, the likely amount of such loss, and the revenue needs of the deposit insurance fund. As long as BIF's reserve ratio is less than a specified "designated reserve ratio," 1.25%, the total amount raised from BIF members by the risk-based assessment system may not be less than the amount that would be raised if the assessment rate for all BIF members were 23c per $100 in insured deposits. The FDIC determined that the designated reserve ratio was achieved on May 31, 1995. Accordingly, on August 8, 1995, the FDIC issued final regulations adopting an assessment rate schedule for BIF members of 4c to 31c per $100 in insured deposits that became effective June 1, 1995. On November 14, 1995, the FDIC further reduced the BIF assessment rates by 4c so that effective January 1, 1996, the BIF premiums ranged from zero to 27c per $100 in insured deposits, but in any event not less than $2,000 per year. The Deposit Insurance Funds Act of 1996, signed into law on September 30, 1996, eliminated the minimum assessment, commencing with the fourth quarter of 1996. 10 Under the risk-based assessment system, as of December 31, 1995, SAIF members paid within a range of 23c to 31c per $100 in insured deposits, depending upon the institution's risk classification. Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "EGPRA"), the FDIC imposed a special assessment on SAIF members to capitalize SAIF at the "designated reserve ratio" of 1.25% as of October 1, 1996. Under the risk-based assessment system, a BIF member institution such as the Bank is categorized into one of three capital categories (well capitalized, adequately capitalized, and undercapitalized) and one of three categories based on supervisory evaluations by its primary federal regulator (in the Bank's case, the OCC). The three supervisory categories are: financially sound with only a few minor weaknesses (Group A), demonstrates weaknesses that could result in significant deterioration (Group B), and poses a substantial probability of loss (Group C). The capital ratios used by the OCC to define well-capitalized, adequately capitalized and undercapitalized are the same as in the FRB's prompt corrective action regulations (discussed below). The BIF assessment rates since January 1, 1997 are summarized below; assessment figures are expressed in terms of cents per $100 in insured deposits. The capital and supervisory group ratings for SAIF institutions are the same as for BIF institutions and are derived from the following table: Assessment Rates Effective January 1, 1997 - ------------------------------------------
Supervisory Group ----------------- Capital Group Group A Group B Group C ------------- ------- ------- ------- Well Capitalized 0 3 17 Adequately Capitalized 3 10 24 Undercapitalized 10 24 27
Pursuant to the EGPRA, SAIF insured institutions pay their normal deposit insurance premiums as members of the SAIF. In addition, SAIF insured institutions also pay an amount equal to 6.4c per $100 deposits towards the retirement of the Financing Corporation bonds ("FICO Bonds") issued in the 1980s to assist in the recovery of the savings and loan industry. In addition, after December 31, 1996, banks are required to share in the payment of interest on the FICO Bonds. Previously, the FICO debt was paid solely out of the SAIF assessment base. The assessments imposed on insured depository institutions with respect to any BIF-assessable deposit are assessed at a rate equal to 1/5 of the rate of the assessments imposed on insured depository institutions with respect to any SAIF-assessable deposit. Although the FICO assessment rates are annual rates, they are subject to change quarterly. Since the FICO bonds do not mature until the year 2019, it is conceivable that banks will continue to share in the payment of the interest on the bonds until then. The following table shows the quarterly assessment rates for SAIF and BIF insured deposits, expressed in cents per $100 in insured deposits:
FICO Assessment Rates SAIF BIF - --------------------- ---- ---- First Quarter, 1997 6.48c 1.296c Second Quarter, 1997 6.50 1.300 Third Quarter, 1997 6.30 1.260 Fourth Quarter, 1997 6.32 1.264 First Quarter, 1998 6.28 1.256 Second Quarter, 1998 6.22 1.244 Third Quarter, 1998 6.10 1.220 Fourth Quarter, 1998 5.82 1.164
Under EGPRA, the FDIC is not permitted to establish SAIF assessment rates that are lower than comparable BIF assessment rates. Beginning no later than January 1, 2000, the rate paid to retire the FICO Bonds will be equal for members of the BIF and the SAIF. The EGPRA also provides for the merging of the BIF and the SAIF by January 1, 2000, provided there are no financial institutions still chartered as savings associations at that time. Should the insurance funds be merged before January 1, 2000, the rate paid by all members of this new fund to retire the FICO Bonds would be equal. 11 With certain limited exceptions, FIRREA prohibits a bank from changing its status as an insured depository institution with the BIF to the SAIF and prohibits a savings association from changing its status as an insured depository institution with the SAIF to the BIF, without the prior approval of the FDIC. 12 FDIC Receiverships. Pursuant to FIRREA, the FDIC may be appointed ------------------ conservator or receiver of any insured institution. In addition, FIRREA authorized the FDIC to appoint itself as sole conservator or receiver of any insured institution for any, among others, of the following reasons: . insolvency of such institution; . substantial dissipation of assets or earnings due to any violation of law or regulation or any unsafe or unsound practice; . an unsafe or unsound condition to transact business, including substantially insufficient capital or otherwise; . any willful violation of a cease and desist order which has become final; . any concealment of books, papers, records or assets of the institution; . the likelihood that the institution will not be able to meet the demands of its depositors or pay its obligations in the normal course of business; . the incurrence or likely incurrence of losses by the institution that will deplete all or substantially all of its capital with no reasonable prospect for the replenishment of the capital without federal assistance; or . any violation of any law or regulation, or an unsafe or unsound practice or condition which is likely to cause insolvency or substantial dissipation of assets or earnings, or is likely to weaken the condition of the institution or otherwise seriously prejudice the interest of its depositors. As a receiver of any insured depository institution, the FDIC may liquidate such institution in an orderly manner and make such other disposition of any matter concerning such institution as the FDIC determines is in the best interests of such institution, its depositors and the FDIC. Further, the FDIC shall as the conservator or receiver, by operation of law, succeed to all rights, titles, powers and privileges of the insured institution, and of any stockholder, member, account holder, depositor, officer or director of such institution with respect to the institution and the assets of the institution; may take over the assets of and operate such institution with all the powers of the members or shareholders, directors and the officers of the institution and conduct all business of the institution; collect all obligations and money due to the institution and preserve; and conserve the assets and property of such institution. Enforcement Powers. Some of the most significant provisions of FIRREA were ------------------ the expansion of regulatory enforcement powers. FIRREA has given the federal regulatory agencies broader and stronger enforcement authorities reaching a wider range of persons and entities. Some of those provisions included those which: . expanded the category of persons subject to enforcement under the Federal Deposit Insurance Act; . expanded the scope of cease and desist orders and provided for the issuance of a temporary cease and desist orders; . provided for the suspension and removal of wrongdoers on an expanded basis and on an industry-wide basis; . prohibited the participation of persons suspended or removed or convicted of a crime involving dishonesty or breach of trust from serving in another insured institution; . required regulatory approval of new directors and senior executive officers in certain cases; 13 . provided protection from retaliation against "whistleblowers" and establishes rewards for "whistleblowers" in certain enforcement actions resulting in the recovery of money; . required the regulators to publicize all final enforcement orders; . required each insured financial institution to provide its independent auditor with its most recent Report of Condition ("Call Report"); . significantly increased the penalties for failure to file accurate and timely Call Reports; and . provided for extensive increases in the amounts and circumstances for assessment of civil money penalties, civil and criminal forfeiture and other civil and criminal fines and penalties. Crime Control Act of 1990. The Crime Control Act of 1990 further ------------------------- strengthened the authority of federal regulators to enforce capital requirements, increased civil and criminal penalties for financial fraud, and enacted provisions allowing the FDIC to regulate or prohibit certain forms of golden parachute benefits and indemnification payments to officers and directors of financial institutions. 3. Risk-Based Capital Guidelines ------------------------------ The federal banking agencies have established risk-based capital guidelines. The risk-based capital guidelines include both a new definition of capital and a framework for calculating risk weighted assets by assigning assets and off-balance sheet items to broad credit risk categories. A bank's risk-based capital ratio is calculated by dividing its qualifying capital (the numerator of the ratio) by its risk weighted assets (the denominator of the ratio). A bank's qualifying total capital consists of two types of capital components: "core capital elements" (comprising Tier 1 capital) and "supplementary capital elements" (comprising Tier 2 capital). The Tier 1 component of a bank's qualifying capital must represent at least 50% of qualifying total capital and may consist of the following items that are defined as core capital elements: . common stockholders' equity; . qualifying noncumulative perpetual preferred stock (including related surplus); and . minority interest in the equity accounts of consolidated subsidiaries. The Tier 2 component of a bank's qualifying total capital may consist of the following items: . allowance for loan and lease losses (subject to limitations); . perpetual preferred stock and related surplus (subject to conditions); . hybrid capital instruments (as defined) and mandatory convertible debt securities; and . term subordinated debt and intermediate-term preferred stock, including related surplus (subject to limitations). Assets and credit equivalent amounts of off-balance sheet items are assigned to one of several broad risk categories, according to the obligor, or, if relevant, the guarantor or the nature of collateral. The aggregate dollar value of the amount in each category is then multiplied by the risk weight associated with that category. The resulting weighted values from each of the risk categories are added together, and this sum is the bank's total risk weighted assets that comprise the denominator of the risk-based capital ratio. Risk weights for all off-balance sheet items are determined by a two-step process. First, the "credit equivalent amount" of off-balance sheet items such as letters of credit and recourse arrangements is determined, in most cases by 14 multiplying the off-balance sheet item by a credit conversion factor. Second, the credit equivalent amount is treated like any balance sheet asset and generally is assigned to the appropriate risk category according to the obligor, or, if relevant, the guarantor or the nature of the collateral. The supervisory standards set forth below specify minimum supervisory ratios based primarily on broad risk considerations. The risk-based ratios do not take explicit account of the quality of individual asset portfolios or the range of other types of risks to which banks may be exposed, such as interest rate, liquidity, market or operational risks. For this reason, banks are generally expected to operate with capital positions above the minimum ratios. All banks are required to meet a minimum ratio of qualifying total capital to risk weighted assets of 8%, of which at least 4% should be in the form of Tier 1 capital net of goodwill, and a minimum ratio of Tier 1 capital to risk weighted assets of 4%. The maximum amount of supplementary capital elements that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital net of goodwill. In addition, the combined maximum amount of subordinated debt and intermediate-term preferred stock that qualifies as Tier 2 capital is limited to 50% of Tier 1 capital. The maximum amount of the allowance for loan and lease losses that qualifies as Tier 2 capital is limited to 1.25% of gross risk weighted assets. Allowance for loan and lease losses in excess of this limit may, of course, be maintained, but would not be included in a bank's risk-based capital calculation. In addition to the risk-based guidelines, the federal banking agencies require all banks to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a bank rated in the highest of the five categories used by regulators to rate banks, the minimum leverage ratio of Tier 1 capital to total assets is 3%. For all banks not rated in the highest category, the minimum leverage ratio must be at least 4% to 5%. 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 December, 1993, the federal banking agencies issued an interagency policy statement on the allowance for loan and lease losses which, among other things, establishes certain benchmark ratios of loan loss reserves to classified assets. The benchmark set forth by the policy statement is the sum of: (1) assets classified loss; (2) 50% of assets classified doubtful; (3) 15% of assets classified substandard; and (4) estimated credit losses on other assets over the upcoming twelve months. On December 28, 1993, the FRB published a proposed rule to amend the capital adequacy guidelines for bank holding companies to include in Tier 1 capital that component of shareholders' equity concerning comprehensive income. Comprehensive income included in shareholders' equity, represents securities available-for-sale, and are carried at market value with the unrealized gain or loss, net of income taxes, shown as an addition to or deduction from shareholders' equity. Accordingly, the Company's and the Bank's shareholders' equity will be increased or decreased as the market value of the securities available-for-sale portfolio changes. The federal banking agencies have recently revised their risk-based capital rules to take account of concentrations of credit and the risks of non- traditional activities. Concentrations of credit refers to situations where a lender has a relatively large proportion of loans involving one borrower, industry, location, collateral or loan type. Non-traditional activities are considered those that have not customarily been part of the banking business but that start to be conducted as a result of developments in, for example, technology or financial markets. The regulations require institutions with high or inordinate levels of risk to operate with higher minimum capital standards. The federal banking agencies also are authorized to review an institution's management of concentrations of credit risk for adequacy and consistency with safety and soundness standards regarding internal controls, credit underwriting or other operational and managerial areas. 15 Further, the banking agencies recently have adopted modifications to the risk-based capital rules to include standards for interest rate risk exposures. Interest rate risk is the exposure of a bank's current and future earnings and equity capital arising from adverse movements in interest rates. While interest rate risk is inherent in a bank's role as financial intermediary, it introduces volatility to bank earnings and to the economic value of the bank. The banking agencies have addressed this problem by implementing changes to the capital standards to include a bank's exposure to declines in the economic value of its capital due to changes in interest rates as a factor that the banking agencies will consider in evaluating an institution's capital adequacy. Bank examiners consider a bank's historical financial performance and its earnings exposure to interest rate movements as well as qualitative factors such as the adequacy of a bank's internal interest rate risk management. The federal banking agencies recently considered adopting a uniform supervisory framework for all institutions to measure and assess each bank's exposure to interest rate risk and establish an explicit capital charge based on the assessed risk, but ultimately elected not to adopt such a uniform framework. Even without such a uniform framework, however, each bank's interest rate risk exposure is assessed by its primary federal regulator on an individualized basis, and it may be required by the regulator to hold additional capital for interest rate risk if it has a significant exposure to interest rate risk or a weak interest rate risk management process. Effective April 1, 1995, the federal banking agencies issued rules which limit the amount of deferred tax assets that are allowable in computing a bank's regulatory capital. The standard had 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, 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. 4. Federal Deposit Insurance Corporation Improvement Act of 1991 ------------------------------------------------------------- General. The Federal Deposit Insurance Corporation Improvement Act of 1991 ------- ("FDICIA") was signed into law on December 19, 1991. FDICIA recapitalized the FDIC's Bank Insurance Fund, granted broad authorization to the FDIC to increase deposit insurance premium assessments and to borrow from other sources, and continued the expansion of regulatory enforcement powers, along with many other significant changes. Prompt Corrective Action. FDICIA established five categories of bank ------------------------ capitalization: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized" and mandated the establishment of a system of "prompt corrective action" for institutions falling into the lower capital categories. Under FDICIA, banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment the bank would be undercapitalized, that is, the bank fails to meet the required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to undercapitalized banks, which are required to submit acceptable capital plans guaranteed by its holding company, if any. Broad regulatory authority was granted with respect to significantly undercapitalized banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by its holding company, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to critically undercapitalized banks, those with capital at or less than 2%, including the appointment of a receiver or conservator after 90 days, even if a bank is still solvent. The federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action. Under the regulations, a bank shall be deemed to be: . "well capitalized" if it has a total risk-based capital ratio of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a leverage capital ratio of 5.0% or more and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure; 16 . "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized"; . "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0%, or a leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); . "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a leverage capital ratio that is less than 3.0%; and . "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Information concerning the Company's and the Bank's capital adequacy at December 31, 1998 is as follows:
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions -------------------------- --------------------------- ---------------------------- (in thousands) Amount Ratio Amount Ratio Amount Ratio ----------- ------------ ------------ ------------ ------------ ------------- Company Leverage $25,592 9.59% $10,677 4.00% $13,346 5.00% Tier 1 Risk-Based 25,592 17.31 5,914 4.00 8,872 6.00 Total Risk-Based 28,561 19.32 11,829 8.00 14,786 10.00 Bank Leverage $22,297 8.37% $10,661 4.00% $13,326 5.00% Tier 1 Risk-Based 22,297 15.12 5,899 4.00 8,848 6.00 Total Risk-Based 24,145 16.37 11,797 8.00 14,747 10.00
/1/ The minimum required by the FRB is 3%; for all but the most highly rated bank holding companies, the FRB expects a leverage ratio of 3% plus 100 to 200 basis points. FDICIA and the implementing regulations also provide that a federal banking agency may, after notice and an opportunity for a hearing, reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category if the institution is in an unsafe or unsound condition or engaging in an unsafe or unsound practice. (The federal banking agency may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized.) If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency. Undercapitalized institutions must submit an acceptable capital restoration plan with a guarantee of performance issued by the holding company. Further restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. The most important additional consequence is that the appropriate federal banking agency is required to either appoint a receiver for the institution within 90 days, or obtain the concurrence of the FDIC in another form of action. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include, among other things, the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of 17 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 were not granted. Additionally, a holding company's inability to serve as a source of strength to its subsidiary banking organizations could serve as an additional basis for a regulatory action against the holding company. Operational Standards. FDICIA also granted the regulatory agencies --------------------- authority to prescribe standards relating to internal controls, credit underwriting, asset growth and compensation, among others, and required the regulatory agencies to promulgate regulations prohibiting excessive compensation or fees. Many regulations have been adopted by the regulatory agencies to implement these provisions and subsequent legislation (the "Riegle Community Development and Regulatory Improvement Act of 1994" discussed below) gave the regulatory agencies the option of prescribing the safety and soundness standards as guidelines rather than regulations. Regulatory Accounting Reports. Each bank with $500 million or more in ----------------------------- assets is required to submit an annual report to the FDIC, as well as any other federal banking agency with authority over the bank, and any appropriate state banking agency. This report must contain a statement regarding management's responsibilities for: (1) preparing financial statements; (2) establishing and maintaining adequate internal controls; and (3) complying with applicable laws and regulations. In addition to having an audited financial statement by an independent accounting firm on an annual basis, the accounting firm must determine and report as to whether the financial statements are presented fairly and in accordance with generally accepted accounting principles and comply with other requirements of the applicable federal banking authority. In addition, the accountants must attest to and report to the regulators separately on management's compliance with internal controls. Truth in Savings. FDICIA further established a new truth in savings ---------------- scheme, providing for clear and uniform disclosure of terms and conditions on which interest is paid and fees are assessed on deposits. The Federal Reserve's Regulation DD, implementing the Truth in Savings Act, became effective June 21, 1993. Brokered Deposits. Effective June 16, 1992, FDICIA placed restrictions on ----------------- the ability of banks to obtain brokered deposits or to solicit and pay interest rates on deposits that are significantly higher than prevailing rates. FDICIA provides that a bank may not accept, renew or roll over brokered deposits unless: (1) it is "well capitalized"; or (2) it is adequately capitalized and receives a waiver from the FDIC permitting it to accept brokered deposits paying an interest rate not in excess of 75 basis points over certain prevailing market rates. FDIC regulations define brokered deposits to include any deposit obtained, directly or indirectly, from any person engaged in the business of placing deposits with, or selling interests in deposits of, an insured depository institution, as well as any deposit obtained by a depository institution that is not "well capitalized" for regulatory purposes by offering rates significantly higher (generally more than 75 basis points) than the prevailing interest rates offered by depository institutions in such institution's normal market area. In addition to these restrictions on acceptance of brokered deposits, FDICIA provides that no pass-through deposit insurance will be provided to employee benefit plan deposits accepted by an institution which is ineligible to accept brokered deposits under applicable law and regulations. Lending. New regulations have been issued in the area of real estate ------- lending, prescribing standards for extensions of credit that are secured by real property or made for the purpose of the construction of a building or other improvement to real estate. In addition, the aggregate of all loans to executive officers, directors and principal shareholders and related interests may now not exceed 100% (200% in some circumstances) of the depository institution's capital. State Authorized Activities. The new legislation also created restrictions --------------------------- on activities authorized under state law. FDICIA generally restricts activities through subsidiaries to those permissible for national banks, unless the FDIC has determined that such activities would pose no risk to the insurance fund of which it is a member and the bank is in compliance with applicable regulatory capital requirements, thereby effectively eliminating real estate investment authorized under California law, and provided for a five-year divestiture period for impermissible investments. Insurance activities were also limited, except to the extent permissible for national banks. Activities of Subsidiaries. A national banking association may establish -------------------------- or acquire an operating subsidiary to conduct, or may conduct in an existing operating subsidiary, activities that are part of or incidental to the business of 18 banking, as determined by the OCC. Such national banking associations must submit an application to and receive OCC approval before acquiring or establishing the subsidiary, or commencing the new activity contemplated. National banking associations which are "adequately capitalized" or "well capitalized" and have not been notified that they are in "troubled condition" may acquire or establish an operating subsidiary by providing the OCC with ten (10) days written notice after acquiring or establishing the subsidiary. After commencing operations, each subsidiary is subject to examination and supervision by the OCC and applicable provisions of federal banking laws and regulations pertaining to the operations of the parent bank, shall apply to the subsidiary. The OCC has the power to require a national banking association to divest itself of any subsidiary or terminate any activity conducted by a subsidiary that the OCC determines to pose a threat to the parent bank's financial safety, soundness or stability. 5. Riegle Community Development and Regulatory Improvement Act of 1994 ------------------------------------------------------------------- The Riegle Community Development and Regulatory Improvement Act of 1994 (the "1994 Act"), which has been issued as the most important piece of banking legislation since the enactment of FDICIA, was signed into law on September 23, 1994. In addition to providing funding for the establishment of a Community Development Financial Institutions Fund (the "Fund"), which provides assistance to new and existing community development lenders to help to meet the needs of low- and moderate-income communities and groups, the 1994 Act mandated changes to a wide range of banking regulations. These changes included: . modifications to the publication requirements for Call Reports, . less frequent regulatory examination schedules for small institutions, small business and commercial real estate loan securitization, . amendments to the money laundering and currency transaction reporting requirements of the Bank Secrecy Act, . clarification of the coverage of the Real Estate Settlement Procedures Act for business, . commercial and agricultural real estate secured transactions, . amendments to the national flood insurance program, and . amendments to the Truth in Lending Act to provide greater protection for consumers by reducing discrimination against the disadvantaged. The "Paperwork Reduction and Regulatory Improvement Act," Title III of the 1994 Act, required the federal banking agencies to consider the administrative burdens that new regulations will impose before their adoption and requires a transition period in order to provide adequate time for compliance. This act also requires the federal banking agencies to work together to establish uniform regulations and guidelines as well as to work together to eliminate duplicative or unnecessary requests for information in connection with applications or notices. This act reduces the frequency of examinations for well-rated institutions, simplifies the quarterly Call Reports and eliminated the requirement that financial institutions publish their Call Reports in local newspapers. This act also established an internal regulatory appeal process and independent ombudsman to provide a means for review of material supervisory determinations. The Paperwork Reduction and Regulatory Improvement Act also amended the Bank Holding Company Act and Securities Act of 1933 to simplify the formation of bank holding companies. Title IV of the 1994 Act amended the Bank Secrecy Act by reducing the reporting requirements imposed on financial institutions for large currency transactions, expanding the ability of financial institutions to provide exemptions to the reporting requirements for businesses that regularly deal in large amounts of currency, and providing for the delegation of civil money penalty enforcement from the Treasury Department to the individual federal banking agencies. 6. Safety and Soundness Standards ------------------------------ 19 In July, 1995, the federal banking agencies adopted final guidelines establishing standards for safety and soundness, as required by FDICIA and the 1994 Act. The guidelines set forth operational and managerial standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. Guidelines for asset quality and earnings standards will be adopted in the future. The guidelines establish the safety and soundness standards that the agencies will use to identify and address problems at insured depository institutions before capital becomes impaired. If an institution fails to comply with a safety and soundness standard, the appropriate federal banking agency may require the institution to submit a compliance plan. Failure to submit a compliance plan or to implement an accepted plan may result in enforcement action. The federal banking agencies issued regulations prescribing uniform guidelines for real estate lending. The regulations require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations. Appraisals for "real estate related financial transactions" must be conducted by either state certified or state licensed appraisers for transactions in excess of certain amounts. State certified appraisers are required for all transactions with a transaction value of $1,000,000 or more; for all nonresidential transactions valued at $250,000 or more; and for "complex" 1-4 family residential properties of $250,000 or more. A state licensed appraiser is required for all other appraisals. However, appraisals performed in connection with "federally related transactions" must now comply with the agencies' appraisal standards. Federally related transactions include the sale, lease, purchase, investment in, or exchange of, real property or interests in real property, the financing or refinancing of real property, and the use of real property or interests in real property as security for a loan or investment, including mortgage-backed securities. 7. Consumer Protection Laws and Regulations ---------------------------------------- The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with various consumer protection laws and their implementing regulations. Banks are subject to many federal consumer protection laws and regulations including, but not limited to, the Community Reinvestment Act (the "CRA"), the Truth in Lending Act (the "TILA"), the Fair Housing Act (the "FH Act"), the Equal Credit Opportunity Act (the "ECOA"), the Home Mortgage Disclosure Act ("HMDA"), and the Real Estate Settlement Procedures Act ("RESPA"). The CRA, enacted into law in 1977, is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution's record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations. The federal banking agencies have adopted regulations which measure a bank's compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution's actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from "outstanding" to a low of "substantial noncompliance." The ECOA, enacted into law in 1974, prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act. In March, 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment and evidence of disparate 20 impact. This means that if a creditor's actions have had the effect of discriminating, the creditor may be held liable -- even when there is no intent to discriminate. The FH Act, enacted into law in 1968, regulates may practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap, or familial status. The FH Act is broadly written and has been broadly interpreted by the courts. A number of lending practices have been found to be, or may be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself. Among those practices that have been found to be, or may be considered, illegal under the FH Act are: declining a loan for the purposes of racial discrimination; making excessively low appraisals of property based on racial considerations; pressuring, discouraging, or denying applications for credit on a prohibited basis; using excessively burdensome qualifications standards for the purpose or with the effect of denying housing to minority applicants; imposing on minority loan applicants more onerous interest rates or other terms, conditions or requirements; and racial steering, or deliberately guiding potential purchasers to or away from certain areas because of race. The TILA, enacted into law in 1968, is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology and expressions of rates, the annual percentage rate, the finance charge, the amount financed, the total payments and the payment schedule. HMDA, enacted into law in 1975, grew out of public concern over credit shortages in certain urban neighborhoods. One purpose of HMDA is to provide public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. HMDA also includes a "fair lending" aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes. HMDA requires institutions to report data regarding applications for one-to-four family loans, home improvement loans, and multifamily loans, as well as information concerning originations and purchases of such types of loans. Federal bank regulators rely, in part, upon data provided under HMDA to determine whether depository institutions engage in discriminatory lending practices. RESPA, enacted into law in 1974, requires lenders to provide borrowers with disclosures regarding the nature and costs of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Violations of these various consumer protection laws and regulations can result in civil liability to the aggrieved party, regulatory enforcement including civil money penalties, and even punitive damages. 8. Conclusion ---------- As a result of the recent federal and California legislation, there has been a competitive impact on financial institutions. There has been a lessening of the historical distinction between the services offered by banks, savings and loan associations, credit unions, and other financial institutions, banks have experienced increased competition for deposits and loans which may result in increases in their cost of funds, and banks have experienced increased costs. Further, the federal banking agencies have increased enforcement authority over financial institutions and their directors and officers. Future legislation is also likely to impact the Company's and the Bank's businesses. Consumer legislation has been proposed in Congress which may require banks to offer basic, low-cost, financial services to meet minimum consumer needs. Various proposals to restructure the federal bank regulatory agencies are currently pending in Congress, some of which include proposals to expand the ability of banks to engage in previously prohibited businesses. Further, the regulatory agencies have proposed and may propose a wide range of regulatory changes, including the calculation of capital adequacy and limiting business dealings with affiliates. These and other legislative and regulatory changes may have the impact of increasing the cost of business or otherwise impacting the earnings of financial institutions. However, the degree, timing and full extent of the impact of these proposals cannot be predicted. Management of the Company and the Bank cannot predict what other legislation might be enacted or what other regulations might be adopted or the effects thereof. 21 The foregoing summary of the relevant laws, rules and regulations governing banks and bank holding companies do not purport to be a complete summary of all applicable laws, rules and regulations governing banks and bank holding companies. Impact of Monetary Policies Banking is a business which depends on rate differentials. In general, the difference between the interest rate paid by the Banking Subsidiaries on their deposits and their other borrowings and the interest rate earned by the Banking Subsidiaries on loans, securities and other interest-earning assets will comprise the major source of the Bancorp's earnings. These rates are highly sensitive to many factors which are beyond the Bancorp's and the Banking Subsidiaries' control and, accordingly, the earnings and growth of the Banking Subsidiaries are subject to the influence of economic conditions generally, both domestic and foreign, including inflation, recession, and unemployment; and also to the influence of monetary and fiscal policies of the United States and its agencies, particularly the FRB. The FRB implements national monetary policy, such as seeking to curb inflation and combat recession, by its open-market dealings in United States government securities, by adjusting the required level of reserves for financial institutions subject to reserve requirements, by placing limitations upon savings and time deposit interest rates, and through adjustments to the discount rate applicable to borrowings by banks which are members of the Federal Reserve System. The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates. The nature and timing of any future changes in such policies and their impact on the Company or the Banking Subsidiaries cannot be predicted; however, depending on the degree to which the Banking Subsidiaries' interest- earning assets and interest-bearing liabilities are rate sensitive, increases in rates would have the temporary effect of increasing their net interest margin, while decreases in interest rates would have the opposite effect. Recent Accounting Pronouncements In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting For Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, and unrecognized firm commitment, an available for sale security, or a foreign- currency-denominated forecasted transaction. Under SFAS 133, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk. This statement is effective for the Company on January 1, 2000. Management is in the process of determining what effect, if any, adoption of this statement will have on the financial position or results of operations of the Company. In October 1998, the Financial Accounting Standards Board "FASB" issued Statement No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise, an amendment of FASB Statement No. 65." Under SFAS 134, After the securitization of a mortgage loan held for sale, any retained mortgage-backed securities shall be classified in accordance with the provisions of Statement 115. However, a mortgage banking enterprise must classify as trading any retained mortgage-backed securities that it commits to sell before or during the securitization process. SFAS 134 is effective for the first quarter beginning after December 15, 1998 and enterprises may reclassify mortgage-backed securities and other beneficial interests retained after the securitization of mortgage loans held for sale from the trading category, except for those with sales commitments in place when the Statement is initially applied. Management does not believe the adoption of this statement will have a significant impact on the financial position or results of operations of the Company. 22 Employees As of December 31, 1998, the Company had no full-time salaried employees. All compensation of Bancorp's executive officers was paid by the Bank with a portion of such compensation reimbursed by Bancorp. The Bank employed 111.5 full-time equivalent employees as of December 31, 1998. Factors That May Affect Future Results - -------------------------------------- Discussion and analysis of certain matters contained in our Annual Report and this Form 10-K may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act") and as such, may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market and statements regarding the Company's mission and vision. The Company's actual results, performance or achievements may differ significantly from the results, performance, or achievements expressed or implied in such forward-looking statements. Consequently, no forward-looking statement can be guaranteed. The following is a discussion of certain factors which may affect the Company's financial results and operations, and should be considered in evaluating the Company. Economic Conditions and Geographic Concentration. The Company's operations are - ------------------------------------------------ concentrated in Southern California. The results of the Company depend largely upon economic conditions in this area, which have been relatively volatile over the last several years. While the Southern California economy recently has exhibited positive economic and employment trends, there is no assurance that such trends will continue. A deterioration in economic conditions could have material adverse impact on the quality of the Company's loan portfolio and the demand for its products and services. Interest Rates. The Company anticipates that interest rate levels will remain - -------------- generally stable in the near future, but if interest rates vary substantially from present levels, the Company's results may differ materially from the results currently anticipated. Changes in interest rates will influence the growth of loans, investments and deposits and affect the rates received on loans and investment securities and those paid on deposits. Government Regulation and Monetary Policy. The banking industry is subject to - ----------------------------------------- extensive federal and state supervision and regulation. Significant new laws or changes in, or repeals of, existing laws may cause the Company's results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, primarily through open market operations in United States government securities, the discount rate for bank borrowings and bank reserve requirements, and a material change in these conditions would be likely to have a material impact on the Company's results. Competition. The banking and financial services business in the Company's - ----------- market areas are highly competitive. The increasingly competitive environment is a result in part of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. The results of the Company may differ if circumstances affecting the nature or level of competition change. Credit Quality. A significant source of risk arises from the possibility that - -------------- losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Company has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Company's credit portfolio. Such policies and procedures, however, may not prevent unexpected losses that could materially adversely affect the Company's results. Other Risks. From time to time, the Company details other risks with respect to - ----------- its business and/or financial results in its filings with the Commission. Item 2. Properties - ------------------- 23 The principal executive offices of the Company are located in leased premises at 606 Broadway, Santa Monica, California. The original lease was signed on February 1, 1982, for a ten-year period with two five-year renewal options, covering the first floor and basement areas of the two-story building. On March 23, 1984, the Company renegotiated this lease to include the entire building and tenant improvements. In addition, both five-year options were exercised at that time, and one additional five-year option was also granted, permitting the Company to occupy the premises until January 31, 2007. The Company acquired its second full-service branch office at 9647 Brighton Way, Beverly Hills, California, on April 30, 1984 and assumed the lease for 10 years. During 1998, the Company exercised its option to extend the lease, which otherwise would have expired January 31, 1999, and currently expires January 31, 2014. The current lease calls for periodic rent adjustments every five years. The Company opened its third full-service office on December 1, 1986 at 5525 Etiwanda Street, Tarzana, California. The facility is located in a medical building known as the Tarzana Clark Medical Center. The lease calls for periodic rent adjustments and expires on November 30, 2001. The lease contains a five-year option to renew at the then comparable market rate for similar space. The Company opened its fourth full-service office on October 15, 1991 at 55 East California Boulevard, Pasadena, California. The facility is located in close proximity to Huntington Memorial Hospital. The lease calls for periodic rent adjustments, and expires on October 1, 2001. The lease contains two five- year renewal options, the second of which adjusts the rent to the then comparable market rate for similar space. The Company opened its fifth full-service office also on October 15, 1991, at 10 North 5th Street, Redlands, California. The lease calls for periodic rent adjustments, and expires on March 31, 2001. The lease contains two five-year options which continue the periodic rate adjustments. The Company also leases two additional facilities. The first facility is a limited service office located at 8600 West 3rd Street, Los Angeles, California, in conjunction with an automated banking terminal facility. The second facility, opened during 1992, is located at 9900 Norwalk Boulevard, Santa Fe Springs, California, and contains the Company's note department and data processing operations. In January 1994, this facility was granted status as a full-service branch for the purpose of processing deposits. The lease calls for periodic rent adjustments and expires on August 31, 2003. All of the leased properties are suitable to the Company's needs and all of the leased areas were utilized in 1998. Item 3. Legal Proceedings - ------------------------- The Company and its subsidiaries from time to time a party to various legal actions arising in the ordinary course of business. Management believes that there is no proceeding, threatened or pending, against the Company which, if determined adversely, would have a material adverse effect on the business, financial position or results of operations of the Company or the Bank. A settlement between the Company and St. Paul Mercury Insurance Company, the Company and the Bank's director and officer liability insurance carrier, was finalized in December 1997. Pursuant to the settlement agreement, St. Paul reimbursed the Company $600,000 for certain non-recurring legal expenses in connection with the 1996 proxy contest and the litigation related thereto. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ The Company did not submit any matters to a vote of its stockholders during the fourth quarter of 1998. Part II 24 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters - ------------------------------------------------------------------------------ Market Information and Holders - ------------------------------ The Company sold its shares of Common Stock on a best-efforts basis commencing May 12, 1982, at $7.62 per share. The offering was completed in August 1982, and the stock was traded on NASDAQ until December 1991. The Company's Common Stock began trading on the American Stock Exchange on December 3, 1991 under the symbol "MDB." On January 19, 1993, the Company completed a private offering of 341,775 shares of common stock at a price of $12.62 per share; 326,550 shares were purchased as of December 31, 1992. On June 23, 1995, the Company declared a 5% stock dividend which was paid on July 19, 1995. On May 14, 1996, the Company declared a 5% stock dividend which was paid on June 21, 1996. As of December 31, 1998, the Bancorp estimated there were approximately 690 registered shareholders. The following table sets forth the range of stock price for the Bancorp's common stock for each of the quarters in the two years ended December 31, 1998, adjusted for the 5% stock dividends mentioned above:
Quarter High Low ------- ---- --- 1st Quarter 1997 12.63 10.13 2nd Quarter 1997 12.00 11.50 3rd Quarter 1997 16.75 13.25 4th Quarter 1997 16.00 14.38 1st Quarter 1998 19.38 14.38 2nd Quarter 1998 21.69 17.88 3rd Quarter 1998 20.13 13.81 4th Quarter 1998 17.75 13.63
The foregoing reflects information available to the Company and does not necessarily include all trades in the Company's stock during the relevant period. According to information available to the Company, the closing price of the Company's common stock on December 31, 1998, was $17.50. Dividends - --------- On May 31, 1998 and December 10, 1998, the Board of Directors of Bancorp paid cash dividends of $0.05 per share to stockholders of record on May 13, 1998 and November 15, 1998, respectively. The power of the board of directors of insured depository institutions to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distributions depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions. FDICIA prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if after such transaction, the institution would be undercapitalized. Regulators also have authority to prohibit a depository institution from engaging in any business practice which is considered to be unsafe or unsound, possibly including payment of dividends or other payments under certain circumstances even if such payments are not expressly prohibited by statute. In a policy statement adopted in November 1985, the Federal Reserve Board advised banks and bank holding companies that payment of cash dividends in excess of current earnings from operations is inappropriate and may be cause for supervisory action. As a result of this policy, banks and their holding companies may find it difficult to pay dividends out of retained earnings from periods prior to the most recent fiscal year or to take advantage of earnings 25 generated by extraordinary items, such as sales of buildings, other large assets, or business segments, in order to generate earnings sufficient for the payment of future dividends. The Company is a legal entity separate and distinct from its banking subsidiary, and is not currently intending to engage in any activities other than acting as a BHC. Accordingly, the Company's principal source of funds, including funds available for payment of cash dividends to shareholders, will consist of dividends paid and other funds advanced to the Company by its subsidiary. Statutory and regulatory requirements impose limitations on the amount of dividends payable by the Bank to the Company and on extensions of credit by the Bank to the Company. No national bank may, pursuant to 12 U.S.C. Section 56, pay dividends from its capital (which includes capital stock, retained earnings and surplus reserves for contingencies); all dividends must be paid out of net earnings then on hand, after deducting expenses, including losses and bad debts. In addition, the payment of dividends out of net earnings of a national bank is further limited by 12 U.S.C. Section 60(a), which provides that until the surplus equals the amount of capital stock, dividends can only be paid if there has been transferred to the surplus fund not less than one-tenth of the bank's net earnings for the preceding half-year in the case of quarterly or semi-annual dividends. Pursuant to 12 U.S.C. Section 60(b), the approval of the OCC shall be required if the total of dividends declared by a bank in any calendar year exceeds the total of its net earnings for that year, less any required transfers to surplus or to a fund for the retirement of any preferred stock. Section 1551 of the Pennsylvania Business Corporation Law of 1988 (the "PBCL") provides that the board of directors may authorize a business corporation to make distributions to shareholders subject to certain limitations. A distribution to shareholders may not be made if; (i) the corporation would be unable to pay its debts as they become due in the usual course of business; or (ii) the total assets of the corporation would be less than the sum of its total liabilities, plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. 26 Item 6. Selected Consolidated Financial Data - --------------------------------------------- The following table presents selected consolidated financial data for the Company at or for the five years ended December 31, 1998. The information below is qualified in its entirety by the detailed information and financial statements of the Company included elsewhere herein or incorporated by reference and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and the Company's Consolidated Financial Statements and Notes thereto included elsewhere herein.
At or For the Year Ended December 31, 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Statement of Operations Data: (Dollars in thousands, except per share data) Interest income $ 16,948 $ 16,709 $ 17,650 $ 20,903 $ 17,799 Interest expense 3,630 3,826 4,850 6,539 4,180 Net interest income 13,318 12,883 12,800 14,364 13,619 Provision for loan losses 406 180 4,136 1,539 703 Net gain (loss) on sale of securities available-for-sale (6) - (71) 1,018 (213) Other noninterest income 1,741 1,793 1,515 1,435 1,524 Noninterest expense 12,227 12,125 15,545 12,090 12,093 Income tax provision (benefit) 990 892 (1,712) 1,182 881 Net earnings (loss) 1,432 1,479 (3,725) 2,006 1,253 Per Share Data: Basic earnings (loss) per share $ 0.81 $ 1.10 $ (2.78) $ 1.57 $ 1.00 Diluted earnings (loss) per share 0.74 0.97 (2.78) 1.28 0.82 Book value per share 12.68 11.69 10.47 13.69 12.37 Balance Sheet Data: Total assets $259,701 $253,828 $264,287 $322,165 $315,005 Total loans 117,912 105,857 93,133 100,085 103,745 Securities held-to-maturity 24,081 34,661 41,433 48,086 120,304 Securities available-for-sale 80,891 53,135 54,907 81,951 47,434 Total deposits 230,581 229,464 241,277 297,466 293,631 Shareholders' equity 25,321 15,863 14,042 17,508 15,432 Performance and Leverage Ratios: Return on average assets 0.57% 0.61% (1.38%) 0.64% 0.43% Return on average equity 6.41 9.48 (23.89) 12.40 8.78 Average equity to average assets 8.93 6.45 5.78 5.14 5.27 Net interest margin/1/ 6.02 6.04 5.38 5.07 5.19 Efficiency ratio/2/ 81.22 82.62 109.13 71.89 81.00 Asset Quality Ratios:/3/ Nonperforming loans to total loans 1.15% 0.83% 1.63% 4.18% 2.57% Nonperforming assets: to total loans 1.38 1.09 1.93 4.27 2.67 to total loans and OREO 1.38 1.08 1.92 4.26 2.67 to total assets 0.63 0.45 0.68 1.32 0.88 Allowance for loan losses: to total loans 1.87 1.70 2.42 1.07 0.95 to nonperforming loans 161.88 205.47 148.13 25.64 36.91 to nonperforming assets 134.89 156.83 125.66 25.11 35.50 Net charge-offs to average total loans 0.01 0.65 3.04 1.45 0.69
/1/Ratio of net interest income to average interest-earning assets. /2/Efficiency ratio equals operating expense divided by net interest income and other operating income. /3/Nonperforming loans and nonperforming assets do not include accruing loans 90 days or more past due. 27 Item 7. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations - ------------- Overview Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a better understanding of the material changes in trends relating to the financial condition, results of operations, and liquidity of the Company. The following presentation is prepared as of the dates and for the periods indicated. This discussion should be read in conjunction with "Selected Consolidated Financial Data," the Company's Consolidated Financial Statements and the accompanying Notes included elsewhere herein. The Company's business strategy is to provide commercial banking products and services to individuals and other organizations related to the health care services industry as well as other professionals in California and on a limited basis in other western states. The Company is seeking to increase its market share of loans and deposits through marketing in areas where there is a concentration of health care and health care related activities, through possible acquisitions of other financial institutions and/or branches within its target market, emphasizing the expertise and understanding of the medical marketplace that the Company has stressed since its inception, and through development of joint relationships expanding the product capability of the Company. The Company's results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on its loan portfolio, securities and other earning assets, and its cost of funds, consisting of interest paid on its deposits and borrowings. The Company's operating results are also impacted by provisions for loan losses, and to a lesser extent service charges on deposit accounts and other noninterest income. In addition, the Company's operating expenses principally consist of salaries, wages and employee benefits, occupancy expenses, professional services and other general noninterest expenses. The Company's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates and actions of regulatory authorities. The Company recorded net earnings of $1,432,000, or $0.74 diluted earnings per share, for the year ended December 31, 1998, compared with net earnings of $1,479,000, or $0.97 diluted earnings per share for the year ended December 31, 1997. For the year ended December 31, 1996, the Company recorded a net loss of $3,725,000 or $2.78 diluted loss per share. Return on average assets for the periods ended December 31, 1998, 1997 and 1996 were 0.57%, 0.61% and (1.38)%, respectively. Return on average equity for the period ended December 31, 1998 was 6.41% as compared to 9.48% and (23.89)% for the same respective periods in 1997 and 1996. The Company experienced an increase in gross loans of $12,055,000, or 11.4% to $117,912,000 at December 31, 1998 compared to $105,857,000 at December 31, 1997. In addition, investments in securities increased $17,176,000, or 20.0% to $104,972,000 at December 31, 1998 compared to $87,796,000 at December 31, 1997. The increase in securities and gross loans were funded primarily with cash and cash equivalents. Total cash and cash equivalents declined to $31,965,000 at December 31, 1998 or 41.2% from $54,340,000 at December 31, 1997. Total deposits remained relatively unchanged at $230,581,000 at December 31, 1998 compared to $229,464,000 at December 31, 1997. At December 31, 1998, nonaccrual loans totaled $1,359,000, or 1.15%, of total loans as compared with $877,000 or 0.83% of total loans at December 31, 1997. Net charge-offs decreased to $8,000 or 0.01% of average outstanding loans of $103,718,000 in 1998, as compared with $631,000 or 0.65% of average loans of $97,197,000 in 1997. 28 Results of Operations Net Income (Loss) - ----------------- The Company recorded net income of $1,432,000 or $0.81 basic earnings per share and $0.74 diluted earnings per share, for the year ended December 31, 1998. For the year ended December 31, 1997, net earnings for the Company were $1,479,000 or $1.10 basic earnings per share and $0.97 diluted earnings per share. The decrease in net income for the period ended December 31, 1998, as compared to 1997 is primarily the result a provision for loan losses during the fourth quarter of 1998. Included in pretax income in 1997 is $600,000 which the Company received in a settlement with its insurance carrier in connection with a 1996 proxy contest and the litigation related thereto. Net income for the period ended December 31, 1998 and 1997 compare to a net loss of $3,725,000, or $2.78 basic and diluted loss per share for the year ended December 31, 1996. Net income for the period ended December 31, 1998 as compared to the same period in 1997 and 1996, excluding the provision for loan losses in 1998, was positively impacted by an increase in interest income on loans due to growth of the loan portfolio, lower interest expenses associated with the convertible notes and continued implementation of the Company's cost containment program. Net Interest Income - ------------------- A significant component of the Company's operations is net interest income, which is the difference between interest and fees received on earning assets and interest paid on deposits and other sources of funds. Net interest income, when expressed as a percentage of average total interest earning assets, is referred to as the net interest margin. The Company's net interest income is affected by the change in the amount and mix of interest-earning assets and interest-bearing liabilities. It is also affected by changes in yields earned on interest- earning assets and rates paid on deposits and other borrowed funds. Approximately 86% of the Bank's loan portfolio adjusts with the prime rate. 29 Analysis of Net Interest Income - ------------------------------- The following table presents the distribution of average assets, liabilities and shareholders' equity as well as the total dollar amount of interest income from average interest-earning assets and resultant yields, and the dollar amounts of interest expense and average interest-bearing liabilities, expressed both in dollars and rates for the three years ended December 31, 1998.
Year Ended December 31, ---------------------------------------------------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Average Yield/ Average Yield/ Average (in thousands) Balance (2) Rate Interest Balance (2) Rate Interest Balance (2) ----------- ------- -------- ----------- ------- -------- ----------- Assets Interest-earning assets: Securities $ 83,600 5.85% $ 4,890 $ 94,084 6.20% $ 5,834 $119,819 Loans/(1)/ 103,718 9.90 10,265 97,197 9.97 9,686 97,147 Federal funds sold 33,161 5.35 1,773 21,510 5.39 1,160 20,020 Interest-earning deposits - banks 634 3.15 20 463 6.26 29 992 -------- ------- -------- ------- -------- Total interest-earning assets 221,114 7.66 16,948 213,254 7.84 16,709 237,978 -------- ------- -------- ------- -------- Deferred loan fees (107) (170) (87) Allowance for loan losses (1,858) (2,157) (2,260) Nonearning assets: Cash and due from banks 23,390 22,264 24,318 Premises and equipment 1,531 1,658 1,741 Accrued interest receivable 1,188 1,152 1,320 Other assets 4,859 5,951 6,810 -------- -------- -------- Total assets $250,116 $241,952 $269,820 ======== ======== ======== Liabilities and shareholders' equity Interest-bearing liabilities: Interest-bearing deposits $ 14,325 0.94% $ 134 $ 12,887 0.84% $ 108 $ 13,247 Savings and money market deposits 84,273 2.14 1,800 94,755 1.92 1,821 98,363 Time deposits 30,993 4.65 1,440 29,377 4.79 1,408 49,065 Convertible notes 3,051 8.29 253 5,572 8.49 473 5,612 Repurchase agreements 54 5.56 3 274 5.84 16 3,422 -------- ------- -------- ------- -------- Total interest-bearing liabilities 132,696 2.74 3,630 142,865 2.68 3,826 169,709 -------- ------- -------- ------- -------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits 93,306 81,379 81,869 Other liabilities 1,779 2,113 2,653 Shareholders' equity 22,335 15,595 15,589 -------- -------- -------- Total liabilities and shareholders' $250,116 $241,952 $269,820 equity ======== ======== ======== Interest income as a percentage of average earning assets 7.66% 7.84% Interest expense as a percentage of average interest-bearing liabilities 2.74 2.68 Net interest margin and income (3) 6.02 $13,318 6.04 $12,883 ======= ======= Yield/ (in thousands) Rate Interest ------- -------- Assets Interest-earning assets: Securities 6.29% $ 7,541 Loans/(1)/ 9.30 9,030 Federal funds sold 5.27 1,056 Interest-earning deposits - banks 2.32 23 ------- Total interest-earning assets 7.42 17,650 ------- Deferred loan fees Allowance for loan losses Nonearning assets: Cash and due from banks Premises and equipment Accrued interest receivable Other assets Total assets Liabilities and shareholders' equity Interest-bearing liabilities: Interest-bearing deposits 0.72% $ 96 Savings and money market deposits 1.72 1,693 Time deposits 4.89 2,399 Convertible notes 8.50 477 Repurchase agreements 5.41 185 ------- Total interest-bearing liabilities 2.86 4,850 ------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits Other liabilities Shareholders' equity Total liabilities and shareholders' equity Interest income as a percentage of average earning assets 7.42% Interest expense as a percentage of average interest-bearing liabilities 2.86 Net interest margin and income (3) 5.38 $12,800 =======
/(1)/ Nonaccrual loans are included in average balance calculations; however, interest on such loans has been excluded in computing the average yields for the periods. /(2)/ Average balances are primarily computed on daily balances during the period. When such balances are not available, averages are computed on a monthly basis. /(3)/ The net interest margin for a period is net interest income divided by average interest-earning assets. 30 Net interest income before provision for loan losses for the year ended December 31, 1998 was $13,318,000 an increase of $436,000 or 3.4% from December 31, 1997. The increase in net interest income is primarily the result of a 3.7% or $7,860,000 increase in average interest-earnings assets, offset by a decrease in the yield on average interest-earnings assets which declined to 7.66% for the period ended December 31, 1998 from 7.84% for the same period in 1997. Further, net interest income was positively impacted by a $10,169,000 or 7.1% decrease in average interest-bearing liabilities outstanding during the period ended December 31, 1998 as compared to the same period in 1997. Net interest income before provision for loan losses for the year ended December 31, 1997 was $12,883,000 and $12,800,000 at December 31, 1996. In 1997 net interest margin was impacted by a decline in average interest-earning assets, which declined $24,724,000 or 10.4%, from $237,978,000 at December 31, 1996 to $213,254,000 at December 31, 1997. In addition, the yield on average interest-earning assets increased 42 basis points to 7.84% from 7.42% at December 31, 1997 and 1996, respectively. The primary decline in average interest-earning assets in 1997 was in average securities, which declined $25,735,000 from December 31, 1996 to December 31, 1997. Analysis of Changes in Net Interest Income - ------------------------------------------ The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." It is also affected by changes in yields earned on interest- earning assets and interest rates paid on interest-bearing deposits and other borrowed funds, referred to as a "rate change." The following table sets forth changes in interest income and interest expense for each major category of interest-earning assets and interest-bearing liabilities, and the amount of change attributable to volume and rate changes for the years indicated. The changes due to rate and volume have been allocated to rate and volume in proportion to the relationship between their absolute dollar amounts. The effects of tax-equivalent yields have not been presented because they were deemed to be immaterial.
1998 Compared With 1997 1997 Compared With 1996 -------------------------- ------------------------- (in thousands) Volume Rate Total Volume Rate Total ------ ---- ----- ------ ---- ----- Increase (decrease) in interest income: Securities $(626) $(318) $(944) $(1,598) $(109) $(1,707) Loans 646 (67) 579 5 651 656 Federal funds sold 623 (10) 613 80 24 104 Interest-bearing deposits - banks 9 (18) (9) (17) 23 6 ----- ----- ----- ------- ----- ------- 652 (413) 239 (1,530) 589 (941) Increase (decrease) in interest expense: Interest-bearing demand deposits 13 13 26 (3) 15 12 Savings and money market deposits (212) 191 (21) (64) 192 128 Time deposits 78 (46) 32 (945) (46) (991) Convertible notes (209) (11) (220) (3) (1) (4) Repurchase agreements (12) (1) (13) (183) 14 (169) ----- ----- ----- ------- ----- ------- (342) 146 (196) (1,197) 173 (1,024) ----- ----- ----- ------- ----- ------- Increase (decrease) in net interest income $ 994 $(559) $ 435 $ (333) $ 416 $ 83 ===== ===== ===== ======= ===== =======
Interest income for the period ended December 31, 1998 was $16,948,000 compared to $16,709,000 for the same period in 1997 and $17,650,000 for the same period in 1996. The $239,000 increase in interest income from 1997 to 1998 is primarily the result of increases in the average volume of interest-earning assets outstanding for the period presented. In particular, interest income on loans and federal funds sold increased $579,000 and $613,000, respectively for the period ended December 31, 1998 as compared to the same period in 1997. This increase was offset by declines in interest income on securities and to a lessor extent interest income on interest-bearing deposits. Interest income on securities decreased $944,000 for the period ended December 31, 1998 as compared to the same period in 1997, principally as a result of lower volume outstanding in 1998 as compared to 1997. During the period ending December 31 31, 1998, maturities in the securities portfolio as well as sales of securities during the year, were used to fund the growth in the Company's loan portfolio. The $941,000 decrease in interest income for the period ended December 31, 1997 as compared to the same period in 1996, is primarily the result of a 21.5% decrease in average securities outstanding during 1997 as compared to 1996. This decrease was positively impacted by a 67 basis point increase in interest earned on loans for the period ended December 31, 1997 as compared to the same period in 1996. Interest expense for the period ended December 31, 1998 was $3,630,000 compared to $3,826,000 for the same period in 1997 and $4,850,000 for the same period in 1996. The $196,000 decrease in interest expense from 1997 to 1998 was primarily the result of a 46.5% decrease in interest expenses on convertible notes. Convertible note interest declined as a result of approximately $4.3 million of the notes being converted into common stock of the company during the period ended December 31, 1998. The $1,024,000 decrease in interest expenses from 1996 to 1997 is primarily related to $991,000 decrease in interest expenses on time deposits, for the period ended December 31, 1997 as compared to the same period in 1996. For the period ended December 31, 1996, the growth in the securities portfolio was funded with higher cost time deposits. Securities were sold during 1996 to reflect the decreased deposit base as well as the restructuring of the investment securities portfolio. A changing interest rate environment may have a significant impact on the Company's net interest margin as measured against average interest-earning assets. Management monitors the Company's net interest margin by utilizing an interest rate simulation model under various interest rate scenarios. This process quantifies the impact of changes in interest rates on the Company's net interest margin. Interest rate scenarios are increased and decreased up to 300 basis points in determining the impact on net interest income. These results provide a basis for repricing loan and deposit products after giving consideration to such factors as competition, the economic environment and expected maturities in the loan, investment securities and deposit portfolios. Provision for Loan Losses The provision for loan losses is determined by management based upon the Company's loan loss experience, the performance of loans in the Company's portfolio, the quality of loans in the Company's portfolio, evaluation of collateral for such loans, the economic conditions affecting collectibility of loans, the prospects and financial condition of the respective borrowers or guarantors and such other factors which in management's judgment deserve recognition in the estimation of probable loan losses. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance or to take charge-offs (reductions in the allowance) in anticipation of losses. The provision for loan losses for 1998 was $406,000, $180,000 for 1997 and $4,136,000 for 1996. The increase in the provision for loan losses in 1998 as compared to 1997 is in response to growth in the loan portfolio and increases in nonperforming loans in the fourth quarter of 1998. The decrease in the provision for loan losses in 1997 as compared to 1996, was a result of an overall improvement in the loan portfolio as a result of improved credit administration practices. Net charge-offs to average outstanding loans decreased to 0.01% for 1998, 0.65% in 1997 from 3.04% in 1996. The allowance for loan losses was 1.86% of total loans as of December 31, 1998, compared to 1.70% and 2.42% of total loans as of December 31, 1997 and December 31, 1996, respectively. See "Allowance for Loan Losses" for further information on net charge-offs. 32 Other Operating Income The following table sets forth information by category of other operating income for the three years ended December 31, 1998, 1997 and 1996:
1998 1997 1996 Net losses on sale of securities available-for-sale $ (5,640) $ - $ (71,309) Merchant discount 207,572 272,763 224,745 Mortgage brokering fees 162,811 105,660 117,275 Service charges on deposits 918,354 791,247 668,855 Other income 452,043 622,964 504,213 ---------- ---------- ---------- Total other operating income: $1,735,140 $1,792,634 $1,443,779
Mortgage brokering fees increased to $162,811 or 54.1% for the period ended December 31, 1998, as compared to $105,660 for the same period in 1997 and 38.8% over the $117,275 recorded for the period ended December 31, 1996. The increase in mortgage brokering fees reflects the Banks emphasis on increasing the fees it generates from providing a mortgage brokering service to its customers. In addition, the Company continues to benefit from increases in service charges on deposit accounts. Service charges on deposits increased to $918,354 for the period ended December 31, 1998, from $791,247 and $668,855 for the same twelve month periods ended December 31, 1997 and 1996, respectively. Other Operating Expenses For the year ended December 31, 1998, other operating expenses were $12,227,000, compared to $12,125,000 and $15,545,000 for the period ended December 31, 1997 and 1996, respectively. The 1997 operating expenses include a one time recovery of $600,000 received in a settlement with the Company's insurance carrier in connection with a 1996 proxy contest, and the litigation related thereto. The increase in other operating expenses in 1996 as compared to 1997 was due primarily to the recognition of approximately $2,579,000 in nonrecurring legal expenses, settlement costs associated with the proxy contest and related litigation, certain other nonrecurring costs associated with a management restructuring and other one time expenses related to prior benefits. The ratios of operating expenses to average assets for 1998, 1997 and 1996 were 4.89%, 5.01% and 5.76%, respectively. 33 The following table summarizes changes in other operating expenses for the years ended December 31, 1998, 1997 and 1996.
Increase (Decrease) (in thousands) 1998 1997 1996 1998/1997 1997/1996 -------- --------- -------- ----------- ----------- Salaries and employee benefits $ 5,987 $ 5,804 $ 5,945 $ 183 $ (141) Occupancy 1,439 1,481 1,386 (42) 95 Legal fees, net of legal settlement 395 (106) 2,754 501 (2,860) Furniture and equipment 811 829 697 (18) 132 Professional services 1,146 1,346 930 (200) 416 Strategic planning and investor relations 148 375 - (227) 375 FDIC assessment 25 27 1 (2) 26 Office supplies 237 227 288 10 (61) Other assessments 190 225 299 (35) (74) Telephone 288 273 271 15 2 Audit, accounting and examinations 189 132 201 57 (69) Postage 160 150 154 10 (4) Messenger service 34 71 178 (37) (107) Imprinted checks 43 91 138 (48) (47) Donations 94 101 135 (7) (34) Meetings and business development 191 163 126 28 37 Severance payments and accruals - - 1,006 - (1,006) Other 850 936 1,036 (86) (100) ------- ------- ------- ---------- ---------- Total other operating expenses $12,227 $12,125 $15,545 $ 102 $ (3,420) ======= ======= ======= ========== ==========
Operating expenses in 1998 as compared to 1997, increased $102,000 or 0.84%. Excluding a nonrecurring legal settlement of $600,000 received in December 1997, operating expenses in 1998 actually decreased $498,000 or 3.9%. The decrease in 1998, is primarily the result of lower costs associated with professional services and strategic planning and investor relation expenses. The increase in operating expenses in 1996 was primarily the result of the expenses incurred in connection with a contested election of directors at the 1996 Annual Shareholders Meeting and related litigation, including legal fees in the amount of $1,404,000, proxy solicitation costs of $58,000, and printing costs of $111,000. As part of the Settlement Agreement, proxy costs incurred by the Shareholders Protective Committee were reimbursed by the Company. In December 1997, Bancorp and Bank received a settlement of $600,000 for reimbursement of a portion of these fees from St. Paul Mercury Insurance Company. Management changes related to the settlement, including payments to Mr. Kovner, the former Chairman, Chief Executive Officer and President of the Company and the Bank, resulted in severance payments of $1,006,000. Excluding these nonrecurring expenses of approximately $2,579,000, other operating expenses in 1996 were $841,000 greater than other operating expenses in 1997. Substantially, most of the decline in 1997 was in the area of legal fees, which were improved due to receipt of an insurance settlement regarding certain non-recurring legal expenses. The Company and the Bank entered into a Consulting Agreement dated August 12, 1996 with Network Health Financial Services, Inc. ("NHFS"), a California corporation for which Melinda McIntyre-Kolpin serves as Chief Executive Officer. Pursuant to the Consulting Agreement, Ms. McIntyre serves as President and Chief Executive Officer of the Bank and NHFS provides consulting services to the Company and the Bank with respect to personnel matters, operational procedures and client development and retention. NHFS is paid its actual costs incurred in the performance of its duties under the Consulting Agreement (including hourly rates for certain specified NHFS personnel while they are performing consulting services), plus an additional 25% of such costs. In addition, the Company and Bank pay flat monthly rates for the services of Ms. McIntyre-Kolpin and Patti Derry. During 1998, the Company and the Bank paid NHFS the amount of $693,257 pursuant to the Consulting Agreement. Either party may terminate the Consulting Agreement by giving 30 day notice to the other party. The Company is also exploring a strategic alliance with NHFS to integrate with the Company's growth strategy. 34 Income Taxes The Company recorded an income tax provision (benefit) of $990,000, $892,000 and $(1,712,000) in 1998, 1997 and 1996 respectively. The effective tax rate in these years were 40.9%, 37.6% and 31.5%. For further information, see Note 7 of Notes to Consolidated Financial Statements. Financial Condition - ------------------- Distribution of Assets, Liabilities, and Shareholders' Equity - ------------------------------------------------------------- The following table sets forth the Company's consolidated average balances of each principal category of assets, liabilities and shareholders' equity and the percentage distribution of these items for each of the past two fiscal years (dollars in thousands).
1998 1997 -------- -------- Average Percent Average Percent ASSETS: Balance of Total Balance of Total - ------- Cash and due from banks $ 24,024 9.60% $ 22,727 9.39% Federal funds sold 33,161 13.26 21,510 8.89 Securities available-for-sale 54,228 21.68 55,681 23.01 Securities held-to-maturity 29,372 11.74 38,403 15.87 Loans, net of allowance for loan losses 101,753 40.68 94,870 39.21 Premises and equipment, net 1,531 0.61 1,658 0.69 Accrued interest receivable and other assets 6,047 2.43 7,103 2.94 --------------------------------------------------------- Total assets $250,116 100.00% $241,952 100.00% ========================================================= LIABILITIES AND SHAREHOLDERS' EQUITY: - ------------------------------------- Deposits: Demand, noninterest-bearing $ 93,306 37.34% $ 81,379 33.63% Demand, interest-bearing 14,325 5.73 12,887 5.33 Savings and money market 84,273 33.69 94,755 39.16 Time deposits 30,993 12.39 29,377 12.14 Convertible notes 3,051 1.22 5,572 2.31 Repurchase agreements 54 0.03 274 0.11 Accrued interest payable and other liabilities 1,779 0.71 2,113 0.87 --------------------------------------------------------- Total liabilities 227,781 91.07 226,357 93.55 Shareholders' equity 22,335 8.93 15,595 6.45 --------------------------------------------------------- Total liabilities and shareholders' equity $250,116 100.00% $241,952 100.00% =========================================================
35 The Company's total average assets increased to $250,116,000 or 3.4% at December 31, 1998, from $241,952,000 at December 31, 1997. The Company's ratio of average interest-earning assets to average assets was 88.40% at December 31, 1998 as compared to 88.13% at December 31, 1997. The increase in total average assets primarily occurred in the loan portfolio. Average loans outstanding for the period ending December 31, 1998 increased to $103,718,000 or 6.71% from $97,197,000 for the same period in 1997. The Company continued to benefit from increase loan demand as a result of its marketing efforts in 1998. In addition, average shareholders' equity increased 43.22% to $22,335,000 at December 31, 1998 from $15,595,000 for the same period in 1997. The increase in shareholders' equity is the result of 304,628 shares of stock options exercised which resulted in $3,794,363 in cash and approximately $3.8 million of notes converted into common stock, during the twelve month period ended December 31, 1998. Securities The average yield on the Company's securities was 5.85% in 1998 compared with 6.20% in 1997 and 6.29% in 1996. The decrease in average for the periods presented in primarily related to the effect of the Company restructuring the securities portfolio, in order to better meet the Company's interest rate risk goals and continued liquidity needs. The following table sets forth the carrying value of securities available-for- sale at the dates indicated.
December 31, ---------------------------------------------- (in thousands) 1998 1997 1996 ---- ---- ---- U.S. Government securities $ - $ 2,004 $ - U.S. Government agency and mortgage-backed securities 68,126 34,740 35,786 Small Business Administration securities 852 1,292 1,742 Municipal securities 2,546 - - Federal reserve bank stock 439 439 439 Collateralized mortgage obligations 8,928 14,660 16,940 ------- ------- ------- Total $80,891 $53,135 $54,907 ======= ======= =======
The following table sets forth the maturities of securities available- for-sale at December 31, 1998 and the weighted average yields of such securities. Borrowers may have the right to prepay obligations with or without prepayment penalties. This right may cause actual maturities to differ from the contractual maturities summarized below. Collateralized mortgage obligations often have stated maturities of over ten years but are subject to prepayments which accelerate actual maturities. See Notes 1 and 3 of Notes to Consolidated Financial Statements for further information about the available-for-sale portfolio. 36
Maturing -------------------------------------------------------------------------------------------------- After One After Five Within Through Through After One Year Five Years Ten Years Ten Years Total (in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield -------- ------ ---------- ------ ---------- ------ --------- ------ ------- ----- Securities Available-for-Sale: U.S. Government agency and mortgage-backed securities $3,019 5.77% $ - -% $ 9,761 6.09% $55,346 6.06% $68,126 5.97% Small Business Administration securities - - - - 154 6.00 698 6.22 852 6.28 Municipal securities - - - - 1,290 4.17 1,256 4.37 2,546 4.27 Federal reserve bank stock - - - - - - 439 6.00 439 6.00 Collateralized mortgage obligations $ - - - - - - $ 8,928 5.79 $ 8,928 5.79 -------- ----- ------ ---- ------- ---- ------- ---- ------- ---- Total $3,019 5.77% $ - -% $11,205 5.42% $66,667 5.61% $80,891 5.58% ======== ====== ======= ======= =======
The following table sets forth the amortized cost of securities held-to-maturity at the dates indicated.
December 31, ------------------------------------------------------------------- (in thousands) 1998 1997 1996 ---- ---- ---- U.S. Government securities $ 3,043 $ 3,054 $ 3,064 U.S. Government Agency securities 2,250 3,189 3,250 U.S. Government Agency mortgage-backed securities 18,788 28,857 35,119 Collateralized mortgage obligations - - - ------- ------- ------- Total $24,081 $35,100 $41,872 ======= ======= =======
The following table sets forth the maturities of securities held-to- maturity at December 31, 1998 and the weighted average yields of such securities. Borrowers may have the right to prepay obligations with or without call or prepayment penalties. This right may cause actual maturities to differ from the contractual maturities summarized below. Mortgage-backed securities generally have stated maturities of over ten years but are subject to likely and substantial prepayments which effectively accelerate actual maturities. See Notes 1 and 3 of Notes to Consolidated Financial Statements for further information about the held-to-maturity portfolio.
Maturing ------------------------------------------------------------------------------------- After One After Five Within Through Through After One Year Five Years Ten Years Ten Years (in thousands) Amount Yield Amount Yield Amount Yield Amount Yield -------- ----- ---------- ----- ---------- ----- --------- ----- Securities Held-to-Maturity: U.S. Government securities $ - -% $3,043 6.20% $ - -% $ - -% U.S. Government Agency securities - - 2,250 5.65 - - - - U.S. Government Agency mortgage-backed securities - - - - 13,077 6.16 5,711 6.08 -------- ------ -------- ------- Total $ - -% $5,293 5.93% $13,077 6.16% $5,711 6.08% ======== ====== ======== =======
Total (in thousands) Amount Yield -------- ----- Securities Held-to-Maturity: U.S. Government securities $ 3,043 6.20% U.S. Government Agency securities 2,250 5.65 U.S. Government Agency mortgage-backed securities 18,788 6.12 ------- Total $24,081 5.99% =======
37 Loan Portfolio The Company focuses its lending activities in three principal areas: commercial loans, lines of credit and installment loans. Commercial loans include commercial loans secured by the operating cash flow and business assets of the borrower, and to a lesser extent real estate, and unsecured commercial loans. Lines of credit include equity lines, overdraft protection lines and other secured, collateralized and unsecured lines of credit. Installment loans include automobile and boat loans and other loans for personal and corporate use. The interest rates charged for the loans made by the Company vary with the degree of risk, the size and maturity of the loan, the borrowers' depository relationships with the Company, and prevailing market rates. Although the risk of non-payment exists with respect to all types of loans, certain other specific risks are associated with each type of loan. The primary risks associated with commercial loans, including real estate secured commercial loans, are the quality of the borrower's management and a number of economic and other factors, including competition, insufficient capital, changes in laws and regulations and general changes in the marketplace, which induce business failures and cause the value of business assets pledged to secure the loan to depreciate. Although the Company's portfolio concentration in the health care services industry may expose the Company to risks or adverse developments in this sector, including any such developments resulting from health care reform, these risks are mitigated in part by the diversity of clientele within the market niche. Equity lines of credit, installment loans and other lines of credit are affected primarily by domestic instability and a variety of factors that may lead to the borrower's unemployment, including deteriorating economic conditions in one or more segments of a local or broader economy. The following table sets forth the amounts of loans outstanding by type of credit extension as of the dates indicated.
December 31, --------------------------------------------------------------------------------------------- (in thousands) 1998 1997 1996 1995 1994 --------------------------------------------------------------------------------------------- Commercial $ 93,952 $ 86,243 $73,577 $ 77,012 $ 83,239 Real estate secured commercial 11,698 10,512 10,079 13,241 8,863 -------- -------- ------- -------- -------- Subtotal 105,650 96,755 83,656 90,253 92,102 Equity lines of credit 5,931 6,288 6,202 6,070 7,195 Other lines of credit 4,817 1,524 1,832 1,997 2,119 Installment 1,482 1,253 1,375 1,625 2,072 Lease financing 32 37 68 140 257 -------- -------- ------- -------- -------- Total loans 117,912 105,857 93,133 100,085 103,745 Less: allowance for loan losses (2,200) (1,802) (2,253) (1,070) (983) Less: deferred loan fees, net (193) (155) (121) (71) (82) -------- -------- ------- -------- -------- Net loans $115,519 $103,900 $90,759 $ 98,944 $102,680 ======== ======== ======= ======== ======== Fixed rate $ 16,784 14% $ 6,935 7% $ 7,075 8% $ 11,240 11% $ 7,756 7% Variable rate 101,128 86% 98,922 93% 86,058 92% 88,845 89% 95,989 93% -------- -------- ------- -------- -------- Total loans $117,912 $105,857 $93,133 $100,085 $103,745 ======== ======== ======= ======== ========
There was no category of loans exceeding 10% of total loans which was not otherwise disclosed as a distinct line item in the above table. Commercial loans represent extensions to a wide array of individuals, companies, both within and outside of the Company's market area. In addition, there were no construction loans outstanding at December 31, 1998 or 1997. 38 The Company generally underwrites loans on the basis of adequate cash flow, historical, current and as appropriate pro forma, and looks to supporting collateral as a secondary source of repayment in most extensions. In the opinion of management, the Company's loan policies conform with applicable regulatory lending standards. Commercial Loans and Real Estate Secured Commercial Loans At December 31, 1998 the Company's commercial and real estate secured commercial loans totaled $105,650,000 or 90% of total loans compared to $96,755,000 or 91% of total loans at December 31, 1997. Total real estate secured commercial loans were $11,698,000 at December 31, 1998 and $10,512,000 at December 31, 1997. Commercial and real estate secured commercial loans consist primarily of short- to medium-term financing for small- to medium-sized health care-related companies and professionals located in Southern California. The commercial and real estate secured commercial loans are primarily concentrated in the same sectors of the medical community as the Company's deposit base is drawn from and consists of sole medical practitioners, small groups practices, large single-specialty groups, multi-specialty medical groups and other outpatient health care service companies. Real estate transactions are underwritten with cash flow adequacy and diversity as the primary underwriting criteria. Although collateral offered provides adequate secondary support, the underwriting additionally considers other assets/net worth available to support repayment. Approximately 80% of total loans at December 31, 1998 were commercial loans which were unsecured or collateralized by various business and personal property assets, including equipment, accounts receivable contracts, and proceeds thereof, including capitation payments. As a matter of policy, the Company's commercial loan borrowers are required to submit financial statements and other financial data (for example, accounts receivable agings and enrollment summaries) on a periodic basis, in conformity with loan policies and procedures and regulatory guidelines, to loan officers for their review in monitoring the financial position and cash flows trends of borrowers. Under this policy, management generally places a higher level of scrutiny on borrowers failing to submit the required financial information. Senior lending officers review delinquency reports, overdrafts, borrowers' payment histories and periodic financial data to monitor creditworthiness and identify potential problem loans. Loan to value ratios on commercial loans secured by real estate generally range from approximately 30% to 80% at origination. The Company's real estate secured commercial loans are repaid typically through cash flows from the borrowers' business with shorter term maturities (three to five years) and amortizations usually no longer than 20 years and are not classified by the Company as real estate-mortgage loans. Equity Lines of Credit At December 31, 1998 and 1997, equity lines of credit aggregated approximately $5,931,000 or 5% of total loans, and $6,288,000 or 6% of total loans, respectively. Loan-to-appraised value ratios at the loan origination date generally do not exceed 85% and all such loans have variable rate structures. A majority of these lines of credit are secured by junior trust deeds on residential real estate and require monthly principal payments. Equity lines generally have a five year maturity and are subject to an annual review of the financial condition of the borrower. Other Lines of Credit At December 31, 1998 and 1997, other lines of credit aggregated approximately $4,817,000 or 4% of total loans, and $1,524,000 or 1% of total loans, respectively. Other lines of credit are generally unsecured and include overdraft protection facilities and revolving lines of credit. Overdraft lines are attached to checking accounts to cover short-term shortfalls in cash flow. Installment Loans At December 31, 1998 and 1997, installment loans aggregated approximately $1,482,000 and $1,253,000, respectively. This loan category primarily includes automobile loans. Loan-to-appraised value ratios at the loan origination date range up to 100% for automobile installment loans with maturity and amortization generally up to 60 months. 39 The following table shows the maturity distribution of the Company's loans outstanding at December 31, 1998, and is based on the remaining scheduled repayments of principal, as due within the periods indicated.
After One After Through through Five (in thousands) One Year Five Years Years Total -------------------------------------------------------------------------------------------------- Commercial $54,068 $38,301 $1,583 $ 93,952 Real estate commercial 2,700 6,757 2,241 11,698 Equity lines of credit 614 4,899 418 5,931 Other lines of credit 3,846 971 - 4,817 Installment 114 1,321 47 1,482 Lease financing 32 - - 32 ------- ------- ------ -------- Total $61,374 $52,249 $4,289 $117,912 ======= ======= ====== ======== Fixed rate $ 9,094 $ 6,359 $1,280 $ 16,784 Variable rate 52,280 45,890 3,009 101,128 ------- ------- ------ -------- Total $61,374 $52,249 $4,289 $117,912 ======= ======= ====== ========
Loan Commitments In the normal course of business, there are various commitments outstanding to extend credit that are not reflected in the consolidated financial statements. These financial instruments include commitments to extend credit for working capital, tenant improvements, other term purposes and include standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk. The Company's exposure to credit loss in the event of nonperformance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual notional (principal) amount of those instruments. However, other than letters of credit, all such documents contain legal language that would allow the Company an ability for non-advance. Accordingly, loss potential is minimized for commitments extended under such document. At December 31, 1998 and 1997, the Company had commitments to extend credit of approximately $49,939,000 and $32,048,000, respectively, and obligations under standby letters of credit of approximately $6,517,000 and $6,832,000, respectively. Standby letters of credit are commitments issued by the Company to support the performance of a client to a third party. Those standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, lease arrangements and similar transactions. All such standby letters of credit are extended for a period of two years or less. In making commitments and issuing letters of credit, the Company uses credit policies similar to those used in connection with extension of credit to all customers with creditworthiness evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on a credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, contract, contract rights and income-producing commercial real estate. Credit Risk Management and Asset Quality Management believes that the objective of sound credit policy is to extend loans to qualified customers while managing risks which could affect shareholders' returns. The loan committee, made up of outside members of the Board of Directors of the Bank and executive management, approve credit policy, review asset quality, and determine compliance to credit policy and procedure. Management periodically reviews loan quality and monitors the progress of watch list loans, some of which may require an action plan for rehabilitation or refinancing. In addition, credit underwriting guidelines are periodically reviewed and adjusted to reflect current economic conditions, industry practices and regulatory guidelines. 40 In accordance with management's credit administration and regulatory policy, loans are placed on nonaccrual status when collection of principal or interest is questionable. Generally, this means that loans are put on nonaccrual status when interest is 90 days or more past due, unless the loan is well secured and in the process of collection. The table below sets forth information about nonperforming assets, which included nonaccrual loans and other real estate owned ("OREO"), and accruing loans 90 days or more past due and certain ratios:
December 31, ---------------------------------------------------- (in thousands) 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- Nonperforming Assets: Nonperforming loans $1,359 $ 877 $1,521 $4,173 $2,663 Other real estate owned (OREO) - - - 90 106 Other repossessed assets 272 272 272 - - ------ ------ ------ ------ ------ Total nonperforming assets $1,631 $1,149 $1,793 $4,263 $2,769 ====== ====== ====== ====== ====== Accruing loans 90 days or more past due $ 100 $ 17 $ 507 $ 632 $ 964 ====== ====== ====== ====== ====== Nonperforming loans to total loans/(1)/ 1.15% 0.83% 1.63% 4.18% 2.57% Nonperforming assets/(1)/ to total loans 1.38 1.09 1.93 4.27 2.67 to total loans, OREO and repossessed assets 1.38 1.08 1.92 4.26 2.67 to total assets 0.63 0.45 0.68 1.32 0.88
/(1)/ Nonperforming loans and nonperforming assets do not include accruing loans 90 days or more past due where the loan is well secured and in the process of collection. Allowance for Loan Losses Management's determination of the allowance for loan losses requires the use of estimates and assumptions related to the both actual and inherent risks in the loan portfolio. Actual results may, however, differ significantly from such estimates. In connection with the determination of the allowance for loan losses where real estate secures the loan, management generally obtains independent appraisals for all properties. Management believes its current appraisal policy conforms to regulatory guidelines. An evaluation of the overall quality of the portfolio is performed at least quarterly to determine the level of the allowance for loan losses. This evaluation takes into consideration the classification of loans and the application of loss estimates attributable to these classifications. The Company classifies loans as pass, watch, special mention, substandard, doubtful, or loss based on classification criteria believed by management to be consistent with the criteria applied by regulatory agencies and consistent with sound banking practices. These classifications and loss estimates take into consideration all sources of repayment, underlying collateral, the value of such collateral, current and anticipated economic conditions, trends, and uncertainties and the historical accuracy of specific reserves attached to loans with serious perceived weakness. Additionally, the Company utilizes "migration analysis" as another means to assist management in estimating the level of the allowance for loan losses. Migration analysis is a statistical method which examines historic charge-off and classification trends prior to charge-off to estimate potential losses inherent in the loan portfolio. The above processes provide management with a reasonable basis to estimate the risk both actual and inherent in the portfolio. In addition, the Company utilizes a comprehensive program that considers numerous variables, of which migrations is one, to determine the adequacy of the allowance for loan losses for reserves nonspecific to certain credits. This program is consistent with methodologies in Banking Circular 201. Amongst others, consideration is given to historical and current trends in past due loans, charged-off loans, nonaccruals, and the nature and mix of the loan portfolio; and local, regional, industry, and national economic trends in determining loan loss adequacy. Finally, credit administration, corresponding loan policies and procedures, and timely problem loan identification are integral to a sound determination of the allowance for loan losses. Based on information available at December 31, 1998, management was of the opinion that a $2,200,000 allowance for loan losses, which constitutes 1.87% of total loans, was adequate as an allowance against probable and estimable losses. 41 While the Company's policy is to charge-off in the current period those loans for which a loss is considered probable, there also exists the risk of future losses which cannot be precisely quantified or attributed to particular loans. As this risk is continually changing in response to factors beyond the control of the Company, such as the state of the economy, management's judgment as to the adequacy of the allowance for loan losses in future periods, while approximate, is in part based on a reasonable methodology. In addition, various regulatory agencies, as an integral part of their examination process, review the Company's allowance for loan losses. Such agencies may require the Bank to record additions or deletions to the allowance based on their judgments of information available to them at the time of their examination. The following tables provide a summary of the Company's allowance for loan losses and charge-off and recovery activity.
December 31, --------------------------------------------------------------------- (in thousands) 1998 1997 1996 1995 1994 --------------- ------------- --------- ---------- ---------- Gross loans outstanding at end of period $117,912 $105,857 $93,133 $100,085 $103,745 Average loans outstanding 103,548 97,197 97,147 100,985 111,446 Net charge-offs to average loans 0.01% 0.65% 3.04% 1.45% 0.69% Allowance for loan losses: to total loans 1.87 1.70 2.42 1.07 0.95 to nonperforming loans/(1)/ 161.88 205.47 148.13 25.64 36.91 to nonperforming assets/(1)/ 134.89 156.83 125.66 25.11 35.50
/(1)/ Nonperforming loans and nonperforming assets do not include accruing loans 90 days or more past due. The following table shows the historical allocation of the Company's allowance for loan losses and the percent of loans in each category to total loans at the dates indicated.
December 31, --------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 Allowance Allowance Allowance Allowance Allowance for Loan % of for Loan % of for Loan % of for Loan % of for Loan (in thousands) Losses Loans Losses Loans Losses Loans Losses Loans Losses --------- ------ --------- ------ --------- ------ --------- ------ --------- Commercial $ 878 80% $ 683 82% $1,584 79% $ 711 77% $ 587 Real estate secured commercial 76 10% 104 10% 237 11 46 13 76 Equity lines of credit 34 5% 111 6% 150 7 118 6 220 Other lines of credit 335 4% 43 1% 24 2 7 2 7 Installment 173 1% 177 1% 5 1 5 2 5 Lease financing - - - - - - - - 1 Unallocated 704 - 684 - 253 - 183 - 87 ------ --- ------ --- ------ --- ------ --- ----- $2,200 100% $1,802 100% $2,253 100% $1,070 100% $ 983 ====== === ====== === ====== === ====== === ===== December --------- 1994 % of (in thousands) Loans ------ Commercial 80% Real estate secured commercial 9 Equity lines of credit 7 Other lines of credit 2 Installment 2 Lease financing - Unallocated - --- 100% ===
The Company had approximately $1,836,000 in impaired loans as of December 31, 1998. The carrying value of impaired loans for which there is a related allowance for loan losses was $153,000, with the amount of specific allowance for loan losses allocated to these loans of $41,000. There were $1,683,000 in impaired loans for which there was no related specific allowance for loan losses. However, general allowance consistent with the level of allowance for similar loans with similar risk characteristics were maintained for impaired loans without specific allowance. The 42 average recorded investment in impaired loans during 1998 was $1,131,085. Impaired loans at December 31, 1998 included $1,359,000 of nonaccrual loans. The Company had approximately $1,199,000 in impaired loans as of December 31, 1997. The carrying value of impaired loans for which there is a related allowance for loan losses was $234,000, with the amount of specific allowance for loan losses allocated to these loans of $80,000. However, a general allowance consistent with the level of allowance for similar loans with similar risk characteristics were maintained for impaired loans without specific allowance. There were $965,000 in impaired loans for which there was no related specific allowance for loan losses. The average recorded investment in impaired loans during 1997 was $1,342,000 and there was no income recorded utilizing either the cash basis or accrual basis method of accounting. Impaired loans at December 31, 1997, included $877,000 of nonaccrual loans. Deposits and Short-term Borrowings The Company attracts deposits primarily from individuals and businesses related to the health care services industry. The Company has no brokered deposits and the Company's current practice is to not purchase brokered deposits. The Company has no known foreign deposits. The average daily amount of deposits and interest rates paid on deposits is summarized below.
1998 1997 1996 --------- --------- --------- Average Average Average (in thousands) Balance Rate Balance Rate Balance Rate --------- ----- --------- ----- --------- ----- Noninterest-bearing transaction accounts $ 93,306 -% $ 81,379 -% $ 81,869 -% Interest-bearing transaction accounts 14,325 0.93 12,887 0.84 13,247 0.72 Savings and money market accounts 84,273 2.14 94,755 1.92 98,363 1.72 -------- -------- -------- 191,904 1.96 107,642 1.79 111,610 1.60 -------- -------- -------- Time deposits: Less than $100,000 8,273 4.64 8,737 4.48 9,936 4.55 More than $100,000 22,721 4.65 20,640 4.93 39,129 4.98 -------- -------- -------- Total time deposits 30,994 4.64 29,377 4.79 49,065 4.89 -------- -------- -------- Total deposits $222,898 1.63% $218,398 1.53% $242,544 1.73% ======== ======== ========
Time deposits of $100,000 or more are generally received from the Company's medical and professional client base. The impact on the Company's liquidity from the potential withdrawal of these deposits is considered in the Company's asset/liability management policies, which anticipates the Company's liquidity needs through the management of investments, federal funds sold, and/or by generating additional deposits. The table below sets forth the remaining maturities of time deposits of $100,000 or more at December 31, 1998:
(in thousands) December 31, 1998 ----------------- Three months or less $17,253 Over three through six months 1,990 Over six through twelve months 1,080 Over twelve months - ------- Total $20,323 =======
In addition to the time deposits of $100,000 or more, a significant amount of the Company's deposits are in accounts with balances in excess of $100,000. At December 31, 1998, there were 493 such deposit accounts with 43 balances totaling $153,427,000. These accounts are reviewed for purposes of monitoring the Company's liquidity. While increased volatility to the Company's deposit base may be present in this group of accounts, the investment management practices of the Company consider such potential volatility. The Company also uses repurchase agreements from time to time as an additional source of funds. On December 31, 1998 and 1997, there were no repurchase agreements outstanding. The following table sets forth certain information with respect to the Company's repurchase agreements for the periods indicated.
Year Ended December 31, ----------------------------------------------- (in thousands) 1998 1997 1996 ---- ---- ---- Maximum daily amount outstanding $5,000 $8,000 $17,929 Average amount outstanding 55 274 3,422 Average interest rate 5.50% 5.77% 5.41%
The Company had no repurchase agreements outstanding at December 31, 1998, 1997, or 1996, respectively. Capital Resources The Office of the Comptroller of the Currency ("OCC"), the Bank's primary regulator, has established minimum leverage ratio guidelines for national banks. These guidelines provide for a minimum Tier 1 capital leverage ratio (Tier 1 capital to adjusted average total assets) of 3.0% for national banks that meet certain specified criteria, including having the highest regulatory rating. All other national banks will generally be required to maintain a minimum Tier 1 capital leverage ratio of 3.0% plus an additional cushion of 100 to 200 basis points. The OCC has not advised the Bank of any specific minimum Tier 1 capital leverage ratio applicable to it. The FRB, as Bancorp's primary regulator, has similarly established minimum leverage ratio guidelines for bank holding companies. These guidelines also provide for a minimum Tier 1 leverage ratio of 3.0% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a minimum Tier 1 capital leverage ratio of 3.0% plus an additional cushion of 100 to 200 basis points. The FRB has not advised the Company of any specific minimum Tier 1 capital leverage ratio applicable to it. Risk-based capital standards were implemented on December 31, 1992. Since December 31, 1992, banking organizations have been expected to meet a minimum ratio for qualifying total capital to risk-weighted assets of 8.0%, 4.0% of which must be Tier 1 capital. A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk- adjusted assets and risk-weighted off-balance-sheet items. Although the Company and the Bank at December 31, 1998 were considered well capitalized and exceeded all applicable minimum capital requirements, the capital requirements of the federal banking regulators could limit the Company's future growth if the Company were to rely solely on the retention of earnings to generate additional capital or rapid growth. The Company completed a $5.75 million convertible note offering in May 1994. The interest rate is 7.21% to March 1999 at which time the rate resets at 150 basis points over the 5 year Constant Maturity Treasury Index. The conversion price of the notes is $12.6984 per share and is scheduled to mature in March 2004. Of the proceeds, $3.6 million was invested in First Professional Bank in order to increase the Bank's regulatory capital ratios and allow the Bank to grow, within the bounds of safety and soundness. $930,000 of the proceeds were used to retire the Company's remaining indebtedness as required by a stock repurchase agreement. 44 The following table sets forth the minimum required federal capital ratios for a bank holding company and bank, and various federal regulatory capital ratios of the Bancorp and the Bank at December 31, 1998.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions -------------------------- ------------------------------ ------------------------------ (in thousands) Amount Ratio Amount Ratio Amount Ratio ----------- ------------ ------------ ------------- ------------ ------------- Company Leverage $25,592 9.59% $10,677 4.00% $13,346 5.00% Tier 1 Risk-Based 25,592 17.31 5,914 4.00 8,872 6.00 Total Risk-Based 28,561 19.32 11,829 8.00 14,786 10.00 Bank Leverage $22,297 8.37% $10,661 4.00% $13,326 5.00% Tier 1 Risk-Based 22,297 15.12 5,899 4.00 8,848 6.00 Total Risk-Based 24,145 16.37 11,797 8.00 14,747 10.00
/1/ The minimum required by the FRB is 3%; for all but the most highly-rated bank holding companies, the FRB expects a leverage ratio of 3% plus 100 to 200 basis points. Warrants In connection with a private placement of common stock (the "Private Placement"), the Company issued (i) a warrant to Robert H. Leshner, principal of the placement agent, to purchase 110,250 shares of Common Stock (the "Leshner Warrant") and (ii) warrants to each of Andrew E. Haas and Curtis Swindal to purchase 13,781 shares of Common Stock, each at a purchase price of $12.70 per share exercisable in full on or after December 31, 1994 and before December 31, 2002. The Company agreed to grant the holders of the shares issued upon exercise of the warrant ("Warrant Shares") the right, on two occasions during the five-year period beginning December 31, 1994, to require the Company to register (the "Demand Registration") the Warrant Shares under the Act. The Company will pay the expenses of one Demand Registration. Assuming the Demand Registration could be filed under a Form 3, such expense would be minimal. See Note 8 of Notes to Consolidated Financial Statements. Under the terms of the Leshner Warrant, if Dr. Joel W. Kovner, former Chairman of the Board and Chief Executive Officer of the Company, dies before December 31, 2002, then the Company will purchase, at the option of Mr. Leshner, some or all of the warrants and/or Warrant Shares then owned by Mr. Leshner, provided that (i) the maximum aggregate purchase price paid by the Company shall be not more than $1,000,000 and (ii) the funds to purchase such warrants and/or Warrant Shares shall come solely from the proceeds of the key person insurance policy on Dr. Kovner. Since such life insurance is in excess of the cash value recognized on the Company's balance sheet, there would be no net reduction in capital nor any impact on liquidity. Furthermore, if at any time prior to December 31, 2002, Mr. Leshner wishes to sell some or all of the warrants and/or Warrant Shares to a third party, Mr. Leshner must offer to sell such warrants and/or Warrant Shares to the Company on the same terms and conditions being offered to such third party. Another term of the Leshner Warrant restricts the Company's ability to issue certain types of preferred stock which would entitle the holders thereof to receive dividends or distributions of assets which vary in amount with the Company's performance. 45 Interest Rate Sensitivity An interest rate sensitive asset or liability is one that, within a defined time period, either matures or can experience an interest rate change. As interest rate sensitive assets and liabilities have various repricings and maturities, changes in interest rates may increase or decrease the Bank's net interest income. This exposure to changes in interest rates is measured among other methodologies by an institutions "gap," or the difference between interest rate sensitive assets and interest rate sensitive liabilities within specified periods of time. An excess of maturing or repricing assets over maturing or repricing liabilities during a given period will serve to increase net interest income in a rising rate environment and decrease net interest income when interest rates decline. In a rising interest rate environment, the assets will reprice at current interest rates earlier than the liabilities thus increasing the Bank's net interest margin. Conversely, when maturing or repricing liabilities exceed maturing or repricing assets during a given period, a rising interest rate environment generally will reduce the Bank's net interest margin. The following table sets forth the distribution of the Company's interest rate sensitive assets and liabilities as of December 31, 1998. The table also sets forth the time period in which assets and liabilities will mature or reprice in accordance with their contractual terms. Mortgage-backed securities provide cash flows on a monthly basis; however, this analysis does not include prepayment assumptions. Prepayments assumptions are utilized in an interest rate simulation model which is routinely used by the Company in evaluating the impact of changes in interest rates on the Bank's net interest income.
As of December 31, 1998 ------------------------------------------------------------------------------------------- After Three After One Next Day Months Year After through Three through 12 through Five Five (in thousands) Immediately Months Months Years Years Total ------------- --------------- ------------- ------------- --------- --------- Loans/(1)/ $101,178 $ 5,964 $ 3,130 $ 6,359 $ 1,281 $117,912 Investment securities 439 849 - 8,312 95,372 104,972 Federal funds sold 10,400 - - - - 10,400 Due from banks 383 - 190 - - 573 -------- -------- ------- ------- -------- -------- Total interest-earning assets $112,400 $ 6,813 $ 3,320 $14,671 $ 96,653 $233,857 ======== ======== ======= ======= ======== ======== Interest-bearing transaction accounts $ 16,711 - - - - $ 16,711 Savings accounts 75,501 - - - - 75,501 Time deposits - 22,512 6,216 220 - 28,948 Convertible notes - - - - 1,116 1,116 -------- -------- ------- ------- -------- -------- Total interest-bearing $ 92,212 $ 22,512 $ 6,216 $ 220 $ 1,116 $122,276 liabilities ======== ======== ======= ======= ======== ======== Interest sensitive Gap $ 20,188 $(15,699) $(2,896) $14,451 $ 95,537 Effect of interest rate swaps (15,000) 15,000 - - - -------- -------- ------- ------- -------- Hedged Gap $ 5,188 $ (699) $(2,896) $14,451 $ 95,537 Hedged Gap as a percentage of earning assets 5% -10% -87% 99% 99% Cumulative hedged Gap $ 5,188 $ 4,489 $ 1,593 $16,044 $111,581 Cumulative hedged Gap as a percentage of earning assets 5% 66% 48% 109% 115%
(1) Nonaccrual loans of $1,359,000 are included in average balances and rate calculations. 46 The Company desired to maintain the existing spread between a portion of its repricing liabilities and its repriceable assets and subsequently, entered into an interest rate exchange agreement in May 1994 with a notional amount of $15,000,000. This swap is intended to protect against the rise of deposit costs relative to the prime rate. Under the terms of the basic swap, for a period of five years, the Company pays an interest rate of prime rate less 190 basis points while receiving the three-month London Interbank Offered Rate ("LIBOR"). Because the Company's repricing liabilities typically move to a lesser degree than does the three-month LIBOR, the terms of the original swap included limits on the interest rate to be received by the Company. This feature of the swap required mark-to-market accounting and the Company terminated this feature of the swap and recorded a pre-tax expense of $385,000 in 1994. Although this swap reduces current earnings, the management of the Company believes this reduction in earnings is justified by the protection against a narrowing spread. As additional protection against lower interest rates, in December 1994 and January 1995, the Company entered into three interest rate floor contracts with a notional amount of $60,000,000. The agreements entitled the Company to receive from counterparties on a monthly basis the amounts, if any, by which the one-month LIBOR rate falls below 6%. The floor agreements were for a period of three years. The average premium paid for the floor agreements was approximately 20 basis points or $120,000, and was being amortized over three years. In May 1995, the Company sold the floor contracts for total consideration of $722,500. This amount is being amortized over the original three year term. In order to protect the fair value of a portion of the Company's GNMA variable rate securities, in December 1995, the Company purchased two interest rate caps with a notional amount $10,000,000 each. The agreements entitled the Company to receive from counterparties on a quarterly basis the amounts, if any, by which the one year CMT rate rises above 6.50% for one of the agreements and 6.75% on the other. The cap agreements are for a period of three years. The average premium paid for the cap agreements was 63.5 basis points or $127,000, which is being amortized over the three year period. Liquidity Adequate liquidity and maintenance of an appropriate balance between interest rate sensitive earning assets and interest rate sensitive liabilities are the principal imperatives associated with the asset/liability management function of a financial institution. Liquidity management involves the ability to meet the cash flow requirements of clients who may be depositors desiring to withdraw funds or borrowers requiring assurance that sufficient funds will be available to meet their credit needs. Aside from asset/liability management, the Company maintains short-term sources of funds to meet periodic planned and unplanned increases in loan demand and deposit withdrawals and maturities. The initial source of liquidity is the excess funds sold daily to other banks in the form of federal funds. In addition to cash and cash equivalents, the Company maintains a large percentage of its assets in investment securities. These securities include both securities available-for- sale and securities held-to-maturity. Securities available-for-sale can be sold in response to liquidity needs or used as collateral under reverse repurchase agreements. Securities held-to-maturity are available for liquidity needs solely as collateral for reverse repurchase agreements. The Company had no reverse repurchase agreements on December 31, 1998 and 1997. As evidence of the Company's high level of liquidity at December 31, 1998, cash and cash equivalents totaled $31,965,000, while securities available for reverse repurchase agreements totaled approximately $80,891,000. The combined amount of $113,334,000 represents approximately 44% of the Company's total assets. Management is of the opinion that the existing level of liquidity and borrowing capacity is sufficient to insulate the Bank against unforeseen liquidity demands. On a stand-alone basis, the Company's primary source of liquidity is dividends from the Bank. Dividends by the Bank to the Company are subject to regulatory restrictions. For further information on the Bank's dividend restrictions, see "Business - Supervision and Regulation - Restrictions on Dividends and Other Distributions" and Note 11 of Notes to Consolidated Financial Statements. 47 Year 2000 The Year 2000 issue presents a very real and significant challenge to the Company, along with the entire financial services industry. This problem has the potential to affect a wide range of systems and equipment, including software and hardware, utilities, communications platforms and devices, and facilities. The Year 2000 issue is the result of computer programs being written using two digits rather than four to represent the calendar year. Software so developed and not corrected could produce inaccurate or unpredictable results when dates change in the year 2000. Such occurrences may have a material adverse effect on the Company's financial condition, results of operations, or business as the Company, like most financial organizations, is significantly subject to the potential Year 2000 issues due to the nature of financial information. While no one can accurately predict what will happen with the date change to the Year 2000, the Company's management and Board of Directors take the potential risks seriously, and have been working since early in 1997, and will continue to work hard, to be prepared for the Year 2000 transition. There are a number of broad concerns that may affect the Company, our customers, and business partners. In the event of a Year 2000 failure, the Company could be adversely impacted in a number of ways. Internal operations problems and problems resulting from primary vendors and suppliers inability to perform could cause increased costs in determining correct results and lost customers resulting in lost revenue. Large customers negatively effected by Year 2000 problems could lead to deposit outflows or increased risk of collecting loans. As part of our efforts to ensure compliance with government regulatory standards and establish prudent business practices for Year 2000 issues, the Board of Directors and senior management have previously developed and approved a Year 2000 preparedness plan, which is currently being implemented. The Company's Year 2000 risk mitigation program is a dynamic process of reassessment, evaluation and testing. As a result, responses may change especially as vendors and manufacturers find and report Year 2000 product and services issues. The following outlines major areas within the plan and provides the status of our efforts: Awareness: Our plan provides for a Year 2000 task force which reports at least quarterly reporting to the Audit Committee and Board of Directors of the Company. The task force, which meets monthly, consists of members of senior management representatives from key areas within the Company. The task force, among other roles, monitors and report progress, and provides direction toward preparation for the Year 2000 date change. Assessment: The task force has developed an overall strategy which identifies and categorizes internal information and operating systems, and external vendors, customers, auditors and business partners, according to risk of business disruption. Each operating system, process, vendor, or other business partner is risk assessed based upon the impact on the Company's business. High risk processes and systems have been categorized as "mission critical" and have been prioritized in our Year 2000 risk mitigation process. Testing plans have been developed, and we have completed testing all mission critical and many other identified systems. The testing of all systems is scheduled to be completed by June 30, 1999. We have identified contingency plans and alternatives, including replacement or elimination, for mission critical systems and other systems in the event that such actions become necessary. Also, we have integrated the Year 2000 business risks into our overall bankwide business resumption plans. We will test mission critical and other systems on an ongoing basis to reasonably determine that they will continue to operate after the Year 2000. In addition, as a lending institution, the Company is exposed to potential risk if it's customers suffer Year 2000 related difficulties. Therefore, we have developed, and implemented, a process to assess the potential risks to the Company of both our lending and deposit customer's preparedness for the Year 2000 date change. Also, potential borrower's readiness for Year 2000 is assessed and included within the credit underwriting and approval process. 48 Remediation: The remediation phase includes upgrading or replacing information or operating systems, vendor certifications, and other associated changes. We have begun renovation of systems, including non-information technology systems, that have been identified as non-compliant to Year 2000, including replacing some personal computers, or upgrading software and other operating systems. The renovation of mission critical systems where indicated is complete. The extent of our identified renovation needs have been budgeted within our corporate budgeting process. The remaining system renovation is anticipated to be complete by June 30, 1999. Additionally, we have received vendor responses or certification for all of our mission critical systems, along with most of our other information and operating systems. These responses are monitored continually to determine the vendors' progress toward preparedness. Validation/Implementation: As operating systems are validated, upgraded, and successfully tested the systems are integrated into ongoing operations. As with any new system, or system change, internal/external users are provided training, connectivity with other systems is determined and integration into current processes occurs. Validation and implementation of mission critical systems was completed by December 31, 1998. In addition, we have instituted an independent third party review of our Year 2000 efforts for all mission critical systems. Significant progress has been accomplished in our efforts to prepare for the Year 2000-century date change. All of our mission critical systems have been tested and none have failed. Additionally, we are 85% complete assessing, renovating, testing and implementing Year 2000 preparedness for all other identified systems. Management currently estimates the overall cost of Year 2000 risk mitigation not to exceed $100,000 in operating expenses and $300,000 in fixed asset purchases of which approximately 50% has been incurred. These costs are included within our ongoing budget and planning process. We continue with the execution of our Year 2000 Preparedness Plan and remain on schedule to meet our internal timeline and regulatory expectations and continue to project that we will complete renovation and implementation prior to June 30, 1999. Also, we have developed and presented internal and external awareness programs, which reinforce the awareness and the need for preparedness to the Year 2000 problem for the Company's Board of Directors, employees, and our customers. Based upon the information we have developed through our Year 2000 Preparedness Plan, we have not identified risks associated with the date change to Year 2000 that will have a material financial impact on the Company. Forward-Looking Information The discussions contained above in "Management's Discussion and Analysis of Financial condition and Results of Operations" and Item 1. "Business" are intended to provide information to facilitate the understanding and assessment of the consolidated financial statements and footnotes and should be read and considered in conjunction therewith. These discussions included forward-looking statements within the meaning of Section 21E of the Exchange Act regarding management's beliefs, estimates, projections, and assumptions with respect to future operations. Actual results and operations for any future period may vary materially from those projected herein and from past results discussed herein. 49 Item 7A. Quantitative and Qualitative Disclosures About Market Risk - -------------------------------------------------------------------- Interest Rate Sensitivity The table below provides information about the Company's derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including interest rate swaps. Investment securities and loans are presented based upon contractual maturity and related weighted average interest rates by expected maturity dates. The information is presented in US dollar equivalents, which is the Company's reporting currency.
There 1999 2000 2001 2002 2003 After Total ---- ---- ---- ---- ---- ----- ----- (U.S. $ equivalent in thousands) ASSETS (1) - ---------- Securities U.S. government securities Fixed $ - $ - $1,017 $ - $ 2,026 $ - $ 3,043 Weighted average interest rate 6.81% 5.89% 6.35% U.S. government agency and mortgage-backed securities Fixed 3,002 - - - 2,250 60,958 66,210 Weighted average interest rate 5.77% 5.65% 6.12% 5.85% Variable - - - - - 23,315 23,315 Weighted average interest rate 5.71% 5.71% Municipal securities Fixed - - - - - 2,551 2,551 Weighted average interest rate 5.72% 5.72% Small Business Administration securities Variable - - - - - 858 858 Weighted average interest rate 6.28% 6.28% Collateralized mortgage securities Fixed - - - - - 7,191 7,191 Weighted average interest rate 5.84% 5.84% Variable - - - - - 1,843 1,843 Weighted average interest rate 5.62% 5.62% Federal reserve bank stock Fixed - - - - - 439 439 Weighted average interest rate - - - - - 6% 6% Loans Fixed 9,094 988 811 1,155 3,405 1,281 16,734 Weighted average interest rate 8.84% 7.86% 8.87% 8.97% 8.64% 7.89% 8.68% Variable 52,279 9,080 6,862 14,257 15,692 3,008 101,178 Weighted average interest rate 9.01% 9.08% 9.08% 9.08% 8.98% 8.66% 9.02% Fair Value ----- ASSETS (1) - ---------- Securities U.S. government securities Fixed $ 3,195 Weighted average interest rate U.S. government agency and mortgage-backed securities Fixed 66,246 Weighted average interest rate Variable 22,821 Weighted average interest rate Municipal securities Fixed 2,546 Weighted average interest rate Small Business Administration securities Variable 852 Weighted average interest rate Collateralized mortgage securities Fixed 7,084 Weighted average interest rate Variable 1,843 Weighted average interest rate Federal reserve bank stock Fixed 439 Weighted average interest rate Loans Fixed 17,113 Weighted average interest rate Variable 101,178 Weighted average interest rate
50 The table below provides information about the Company's derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including rate interest swaps. Certificates of deposit and convertible notes are presented based upon contractual maturity and related weighted average interest rates by expected maturity dates. For interest rate swaps and caps, the table present notional amounts and weighted average interest rates by contractual maturity dates. The information is presented in US dollar equivalents, which is the Company's reporting currency.
There Fair 1999 2000 2001 2002 2003 After Total Value ---- ---- ---- ---- ---- ----- ----- ----- (U.S. $ equivalent in thousands) LIABILITIES (1) - --------------- Deposits Noninterest-bearing transaction accounts $109,422 $ - $ - $ - $ - $ - $109,422 $109,422 Weighted average interest rate 0.00% - - - - - 0.00% Interest-bearing transaction accounts 16,710 - - - - - 16,710 16,710 Weighted average interest rate 0.93% - - - - - 0.93% Savings and money market accounts 75,501 - - - - - 75,501 75,501 Weighted average interest rate 2.14% - - - - - 2.14% Certificates of deposit and other time deposits Fixed 28,728 220 - - - - 28,948 28,799 Weighted average interest rate 4.57% 3.50% - - - - 4.65% Convertible notes - - - - - 1,116 1,116 1,051 Weighted average interest rate - - - - - 8.29% 8.29% OFF-BALANCE SHEET ASSETS - ------------------------ Interest rate swaps 15,000 - - - - - 15,000 57 Weighted average interest rate - pay 6.60% - - - - - 6.60% Weighted average interest rate - receive 5.69% - - - - - 5.69%
(1) The Company used certain assumptions to estimate fair values and expected maturities. For loans, expected maturities are contractual maturities adjusted for estimated prepayments of principal based on market indicators. Investment securities are at quoted market rates and stated maturities. For loan fair value computations, the company used a discounted cashflow model with discount rates based upon prevailing market rates for similar types of loans, incorporating adjustments for credit risk. For deposit liabilities, fair values were calculated using discounted cashflow models based on market interest rates for different product types and maturity dates for which the deposits are held. Exchange Rate Sensitivity All of the Company's derivative financial instruments and other financial instruments are denominated in US dollars. The Company does not have, or anticipate having, any foreign currency exchange rate exposure. Commodity Price Sensitivity The Company does not have, or anticipate having, any derivative commodity instruments. 51 Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The Company's Financial Statements are identified in Item 14(a) below. Item 9. Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure - -------------------- None PART III Item 10. Directors and Executive Officers of the Registrant - ----------------------------------------------------------- BOARD OF DIRECTORS ------------------ The principal occupations and certain other information about the current directors of the Company is as follows:
Business Experience Year Elected During the Past Director Name and Address Age Five Years -------- ---------------- --- ---------- Richard A. Berger 67 President, Richard A. Berger & Assoc. (Real 1982 45495 Osage Court Estate Investments); Realtor, Fred Sands Indian Wells, CA 92210 Desert Realty Ronald L. Katz, M.D. 66 Chairman and Professor of Anesthesiology, USC 1982 1200 N. State Street Medical Center; Professor (until June, 1995) Suite 14901 and Chairman (until June, 1990) of Los Angeles, CA 90033 Anesthesiology, UCLA Medical Center Terry O. Hartshorn 53 Vice-Chairman, Chairman (until 1998) and CEO January, 1999 3120 W. Lake Center Dr. (1976 - 1993), PacifiCare Health Systems, Santa Ana, CA 92704 Inc. (HMO); Director, Aracadian Health Management; Director, Red Cross of Orange County; President and CEO, UniHealth (1993 - 1997) Ray T. Oyakawa, M.D. 5670 51 Director and President of Pacific EyeNet, 1987-until Wilshire Blvd. Suite Inc., A Medical Group (a single specialty February 1999 2350 physician practice company); Chairman of the Los Angeles, CA 90036 Board and former Chief Executive Officer, Pacific EyeNet, Inc., (a physician practice management company) (until August 1998); President, Ray T. Oyakawa, M.D., Inc. (until December, 1993) Walter T. Mullikin, M.D. 81 Director of MedPartners Inc.; Director of 1997 MedPartners/Mullikin Health Net (HMO); former Founder and Chairman 5000 Airport Plaza Drive of the Board and President of Mullikin Long Beach, CA 90815 Medical Enterprises (until November, 1995) Lynn O. Poulson 61 Secretary, Professional Bancorp, Inc. and 1982 10880 Wilshire Blvd. First Professional Bank, N.A. (since May, Suite 1100 1997); President of Johnson, Poulson, Coons & Los Angeles, CA 90024 Slater (law firm)
52 Julie P. Thompson 40 Chairman of the Board, Professional Bancorp, 1996 27281 Las Ramblas Inc. and First Professional Bank, N.A. (since #200 July, 1996); President and Chief Executive Mission Viejo, CA 92691 Officer, Health Research Network (a clinical research management company)
EXECUTIVE OFFICERS OF THE COMPANY The following persons are the executive officers of the Company and/or the Bank:
Name Age Business Experience During the Past Five Years ---- --- ----------------------------------------------- Melinda McIntyre-Kolpin 42 President, Chief Executive Officer and a Director, First Professional Bank, N.A. (since September, 1996); Chief Executive Officer of Network Health Financial Services, Inc. (since February, 1996); Director, Molina Medical Centers (since 1996); Director, Pediatric & Family Medical Center (since 1997); President, First Professional Bank, N.A. (from January, 1984 until February, 1996). Eric J. Woodstrom 40 Acting Chief Financial Officer of the Company (since December, 1998); Executive Vice President, First Professional Bank, N.A. (since January, 1997); Manager, The Secura Group (Bank Consulting) (from January, 1993 until January, 1997). Gary W. Mounce 35 Senior Vice President and Senior Loan Officer (since January, 1997), formerly Vice President/Manager of Tarzana Regional Office (until December, 1996), First Professional Bank, N.A.; Bank Examiner, Dept. of Treasury, Office of the Comptroller of the Currency (until August, 1995); Manager, Great Western Bank (until June, 1993). Janet L. Peevey 41 Senior Vice President Credit Administration (since September, 1998) and Vice President (March, 1990 until January, 1996), First Professional Bank, N.A.; Senior Vice President, Pacific Eyenet, Inc. (from January, 1996 until September, 1998). Sharon A. Schmidt 41 Senior Vice President, Chief Operations Officer (since February, 5525 Etiwanda Avenue 1998), formerly Vice President, Operations Administration of First Suite 110 Professional Bank, N.A. (until February, 1998). Tarzana, CA 91356 Nancy Ferretti-Foster 39 Senior Vice President, Chief Information Officer (since February, 9900 Norwalk Blvd. 1998), formerly Vice President, Information Systems of First Suite 150 Professional Bank, N.A. (until February, 1998); Co-Owner, Time Santa Fe Springs, CA 90670 Traveler Antique Toys (since October, 1996), Vice President and Secretary, 7-W Investigations, Inc. (since June, 1997).
The business address of all executive officers is 606 Broadway, Santa Monica, California 90401, unless otherwise indicated. 53 SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than ten percent of the Company's Common Stock, to file with the Securities and Exchange Commission and the American Stock Exchange initial reports of ownership and reports of changes in ownership of Common Stock of the Company. Officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) reports they file. To the Company's knowledge, based solely upon review of the copies of such reports furnished to the Company and written representations that no other reports were required, during the year ended December 31, 1998, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were fulfilled in a timely manner, except that one report, covering one transaction reporting the purchase of 200 shares was filed late by Julie P. Thompson. Item 11. Executive Compensation - -------------------------------- The following tables list information on compensation received for services by any person who served as the chief executive officer or functioned in a similar capacity of the Company, and the four highest compensated executive officers of the Company and/or the Bank for services in all capacities to the Company and the Bank, during the year ended December 31, 1998. Summary Compensation Table --------------------------
Annual Compensation ------------------- Other Annual Name and Principal Position Year Salary Bonus Compensation - --------------------------- ------- --------- ----------- --------------- Julie P. Thompson, Chairman of the Board 1998 -0- -0- $31,000 /1/ 1997 -0- -0- 26,000 /1/ 1996 -0- -0- 24,002 /1/ Melinda McIntyre-Kolpin,/2/ President and Chief 1998 -0- -0- -0- Executive Officer of the Bank 1997 -0- -0- -0- 1996 31,667 22,500 -0- Eric J. Woodstrom, Acting Chief Financial 1998 125,000 -0- 6,000/3/ Officer of the Company and Executive Vice 1997 118,903 20,000 -0- President of the Bank 1996 -0- -0- -0- Gary W. Mounce, Senior Vice President and Senior 1998 115,000 -0- 6,000/4/ Loan Officer of the Bank 1997 99,999 50,000/5/ 6,000/4/ 1996 55,008 25,101/6/ -0- Janet L. Peevey, Senior Vice President Credit 1998 95,000 -0- 6,000/7/ Administration of the Bank 1997 28,958/8/ 4,000 -0- 1996 9,399/8/ -0- -0- Sharon A. Schmidt, Senior Vice President and 1998 90,000 -0- 4,800/9/ Chief Operations Officer of the Bank 1997 76,992 40,000/10/ 2,000/11/ 1996 70,000 7,855/12/ -0- Nancy Ferretti-Foster, Senior Vice President and 1998 90,000 -0- 12,069/13/ Chief Information Officer of the Bank 1997 76,992 40,000/14/ 2,000/15/ 1996 70,000 8,240/16/ -0-
54 /1/ Represents an annual fee of $5,000 for serving as Chairman of the Board, Board meeting and committee fees, and a fee of $125 per hour for the time she exercised operational authority for the Company while there was no acting chief executive officer. /2/ Ms. McIntyre-Kolpin resigned as a Director of the Company and as President and a Director of the Bank effective February 9, 1996, at which time she was paid $43,115 for accrued vacation time, $37,000 of which Ms. McIntyre-Kolpin paid back to the Bank to purchase her Bank vehicle for its then current market value. In September, 1996, Ms. McIntyre-Kolpin was appointed Interim Chief Executive Officer, President and a Director of the Bank. Ms. McIntyre-Kolpin is also Chief Executive Officer and the principal shareholder of Network Health Financial Services, Inc., a Delaware corporation which receives consulting fees from the Company and Bank pursuant to the terms of a Consulting Agreement. Effective March 11, 1997, Bancorp and the Bank paid NHFS a flat monthly fee of $25,000 for Ms. McIntyre-Kolpin's full-time services as President and Chief Executive Officer of the Bank. Prior to March 11, 1997, Bancorp and the Bank paid NHFS a flat monthly rate of $19,000 for Ms. McIntyre-Kolpin's part-time services as Interim President and Chief Executive Officer of the Bank. See also, "Certain Relationships and Related Transactions." /3/ Reflects a $500 per month car allowance. /4/ Reflects a $500 per month car allowance. /5/ Reflects bonus earned in 1997 and paid in 1998. /6/ Reflects bonus earned in 1996, $25,000 of which was paid in 1997. /7/ Reflects a $500 per month car allowance. /8/ Ms. Peevey resigned from the Bank on January 18, 1996 and began employment again with the Bank on September 15, 1997. /9/ Reflects a $400 per month car allowance. /10/ Reflects bonus earned in 1997, $20,000 of which was paid in 1998. /11/ Reflects $400 per month car allowance which began in October, 1997. /12/ Reflects bonus earned in 1996, $7,500 of which was paid in 1997. /13/ Reflects a payout of $7,268 for previously accrued but unused vacation and a $400 per month car allowance. /14/ Reflects bonus earned in 1997, $20,000 of which was paid in 1998. /15/ Reflects a $400 per month car allowance which began in October, 1997. /16/ Reflects bonus earned in 1996, $7,500 of which was paid in 1997.
Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ Certain Beneficial Owners The following table lists the holdings of the only persons (including any "group" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended) known by the Company to be the beneficial owners of more than five percent (5%) of the Company's outstanding Common Stock as of March 1, 1999, based upon 2,015,007 shares outstanding on that date.
Name and Address Amount and Nature of Percent of Beneficial Owner Beneficial Ownership of Class ------------------- -------------------- --------- Franklin Mutual Advisers, Inc. 155,616/1/ 7.7% 51 John F. Kennedy Parkway Short Hills, New Jersey 07078 Basswood Partners, L.P. 150,211/2/ 7.5%
55 Basswood Management, Inc. Matthew Lindenbaum Bennett Lindenbaum 645 Madison Avenue 10/th/ Floor New York, New York 10022 Banc Fund III L.P. 137,650/3/ 6.8% Bank Fund III Trust Banc Fund IV L.P. Banc Fund IV Trust Banc Fund V L.P. 208 S. LaSalle Street Chicago, Illinois 60604 Jay Spellman 127,188/4/ 6.3% Redwood Asset Management, L.P. 200 Park Avenue Suite 3900 New York, New York 10166 Robert H. Leshner 117,416 /5/ 5.5%/6/ 312 Walnut Street Suite 2100 Cincinnati, OH 45202 _________________________
/1/ As reported in a Schedule 13G filed with the Securities and Exchange Commission ("SEC") on January 29, 1999. /2/ As reported in Amendment No. 1 to a Schedule D filed with the SEC on January 5, 1999. /3/ As reported in Amendment No. 1 to a Schedule 13D filed with the SEC on November 5, 1998 /4/ As reported in a Schedule 13D filed with the SEC on November 3, 1998. /5/ As reported in Amendment No. 3 to Schedule 13D filed with the SEC on November 15, 1996. 110,250 of the reported shares are related to a presently exercisable Warrant. /6/ Warrants convertible into shares of Common Stock held by Mr. Leshner which are exercisable within 60 days after March 1, 1999, are treated as outstanding for the purpose of computing the percentage of outstanding Common Stock owned by Mr. Leshner, but not for the purpose of computing the percentage of Common Stock owned by any other person.
Management - ---------- The following table sets forth certain information concerning the beneficial ownership of the Company's outstanding Common Stock as of March 1, 1999, by each director and executive officer of the Company and the Bank, and by all directors and executive officers of the Company and the Bank as a group.
Amount and Nature Percent of Beneficial Of Name/Title Ownership/1/ Class/2/ ---------- ------------- --------- Richard A. Berger, Director 22,697/3/ 1.1% Ronald L. Katz, M.D., Director 16,836/4/ *
56 Lynn O. Poulson, Director and Secretary 9,210/5/ * Julie P. Thompson, Chairman of the Board and Director 900 * Walter T. Mullikin, M.D., Director 600 * Terry O. Hartshorn, Director 0 * Melinda McIntyre-Kolpin, Chief Executive Officer and President of 250 * the Bank Eric J. Woodstrom, Acting Chief Financial Officer of the Company 0 * and Executive Vice President of the Bank Gary W. Mounce, Senior Vice President and Senior Loan Officer of 935 * the Bank Sharon A. Schmidt, Senior Vice President and Chief Operations 0 * Officer of the Bank Nancy Ferretti-Foster, Senior Vice President and Chief Information 10 * Officer of the Bank All Directors and Executive Officers 51,438 /6/ 2.55%
_________________________ * Less than 1% of the shares outstanding. /1/ Unless otherwise indicated, the persons named herein have sole voting and investment power over the shares reported. /2/ Convertible Notes and Options and Warrants to purchase shares of Common Stock held by directors, executive officers and other persons that were exercisable or convertible within 60 days after March 1, 1999 are treated as outstanding for the purpose of computing the number and percentage of outstanding securities of the class owned by such persons, but not for the purpose of computing the percentage of the class owned by any other person. /3/ Includes 1,874 exercisable option shares. /4/ Includes 1,874 exercisable option shares. /5/ Includes 1,874 exercisable option shares. Mr. Poulson has shared voting and investment power over these shares. /6/ Includes the shares owned by the current directors and named executive officers (11 in number) as a group, and includes 5,622 exercisable option shares.
Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- The Company and the Bank entered into a Consulting Agreement dated August 12, 1996 with Network Health Financial Services, Inc. ("NHFS"), a Delaware corporation. Melinda McIntyre-Kolpin, President, Chief Executive Officer and a director of the Bank, is the Chief Executive Officer and principal shareholder of NHFS. Pursuant to the Consulting Agreement, NHFS provides consulting services to the Company and the Bank with respect to personnel matters, operational procedures and client development and retention. NHFS is paid its actual costs incurred in the performance of its duties under the Consulting Agreement (including hourly rates for certain specified NHFS personnel while they are performing consulting services), plus an additional 25% of such costs. In addition, the Company and Bank pay flat monthly rates for the services of Ms. McIntyre-Kolpin, in her capacity as Chief Executive Officer and President of the Bank, and Patti Derry. During 1998, the Company and the Bank paid NHFS the total amount of $693,257 pursuant to the Consulting Agreement. Any party may terminate the Consulting Agreement by giving 30 days' notice to the other parties. Mr. Berger, Dr. Oyakawa, Mr. Poulson, Mr. Hartshorn, Ms. McIntyre, Mr. Mounce, Ms. Foster and Ms. Schmidt and companies with which the foregoing are associated, are customers of, and have had banking transactions 57 with the Bank, some of which have included extensions of credit during 1998. A director of the Company and the Bank, who resigned in 1999, and a company to which he is associated, had extensions of credit totaling approximately $810,000 that were on nonaccrual status as of December 31, 1998. In management's opinion, all other loans and commitments to lend included in such transactions were made in the ordinary course of business and in compliance with applicable laws on substantially the same terms, including interest rates, collateral and repayment terms, as those prevailing for comparable transactions with other persons of similar creditworthiness and did not involve more than the normal risk of collectibility or present other unfavorable terms when initially underwritten. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - ------------------------------------------------------------------------- (a) Financial Statements See Index to Consolidated Financial Statements of Professional Bancorp, Inc. and Subsidiaries which is part of this Form 10-K. (b) Reports on Form 8-K During the fourth quarter of 1998, the Company did not file any Current Reports on Form 8-K. (c) Exhibits
Exhibit No. - ----------- 3.1 Articles of Incorporation (filed as Exhibit 3.3 to Bancorp's 1989 10-K Report and incorporated herein by this reference). 3.2 Amendment to Articles of Incorporation, dated September 8, 1992 (filed as Exhibit 3.3 to Bancorp's 1995 10-K/A Report filed on June 3, 1996 and incorporated herein by this reference). 3.3 Bylaws adopted April 25, 1990, as amended July 25, 1990 (filed as Exhibit 3.2 to Bancorp's 1995 10-K/A Report filed on June 3, 1996 and incorporated herein by this reference). 4.1 Warrant to purchase 100,000 shares of Common Stock dated 12-31-92, issued to Robert H. Leshner (filed as Exhibit 4.1 in Bancorp's 1992 10-K Report and incorporated herein by this reference). 4.2 Warrant to purchase 12,500 shares of Common Stock dated 12-31-92 issued to Andrew E. Haas. 4.3 Warrant to purchase 12,500 shares of Common Stock dated 12-31-92, issued to Curtis Swindall. 10.1* Indemnity Agreement entered into with directors and certain officers dated October 25, 1989 (filed as Exhibit 10.11 to Bancorp's 1995 10-K/A Report filed on June 3, 1996 and incorporated herein by this reference). 10.2* 1990 Stock Option Plan (filed as Exhibit 28.A in Bancorp's 1990 10-K Report on Form 8, Amendment No. 1 dated April 29, 1991 and incorporated herein by this reference). 10.3* 1992 Stock Option Plan (filed as Exhibit A in Bancorp's 1992 Proxy Statement and incorporated herein by this reference). 10.4* 1998 Stock Option Plan. 10.5* Stock repurchase agreement (filed as Exhibit 10.1 in Form 8-K, dated December 18, 1990 and incorporated herein by this reference).
58 10.6 Consulting Agreement dated as of August 12, 1996 between Bancorp, First Professional Bank, N.A. and Network Health Financial Services, Inc. (filed as Exhibit 10.6 to Bancorp's 1996 Form 10-K Report and incorporated herein by this reference). 10.7 Amendment No. 1 to Consulting Agreement dated as of August 12, 1996 between Professional Bancorp, Inc., First Professional Bank, N.A. and Network Health Financial Services, Inc. 10.8* Salary Continuation Agreement entered into between the Bank and Joel W. Kovner dated May 1, 1992 (filed as Exhibit 10.25 to Bancorp's 1992 10-K Report and incorporated herein by this reference). 10.9 Settlement Agreement dated as of July 8, 1996 among Bancorp, the Bank, the Shareholders Protective Committee and certain officers and directors (filed as Exhibit 1 to Bancorp's Form 8-K filed July 22, 1996 and incorporated herein by this reference). 10.10 Lease for premises at 606 Broadway, Santa Monica, California (filed as Exhibit 10(a) to Bancorp's Registration Statement on Form S-1, File No. 2-76371 filed March 8, 1982 and incorporated herein by this reference). 10.11 Lease for premises at 520 Broadway, Santa Monica, California (filed as Exhibit 10.5 in Bancorp's 1983 10-K Report and incorporated herein by this reference). 10.12 Lease for premises at 8600 West 3rd Street, Suite #1, Los Angeles, California (filed as Exhibit 10.6 in Bancorp's 1983 10-K Report and incorporated herein by this reference). 10.13 Lease for second floor premises and extension of lease of entire premises at 606 Broadway, Santa Monica, California (filed as Exhibit 10.8 in Bancorp's 1984 10-K Report and incorporated herein by this reference). 10.14 Lease for premises at 9629 Brighton Way, Beverly Hills, California (filed as Exhibit 10.9 in Bancorp's 1984 10-K Report and incorporated herein by this reference). 10.15 Lease for premises at 5525 Etiwanda Street, Tarzana, California (filed as Exhibit 10.8 in Bancorp's 1986 10-K Report and incorporated herein by this reference). 10.16 Lease for premises at 55 E. California, Pasadena, California (filed as Exhibit 10.65 in Bancorp's 1991 10-K Report and incorporated herein by this reference). 10.17 Lease for premises at 10 North 5th Street, Redlands, California, (filed as Exhibit 10.7 in Bancorp's 1991 10-K Report and incorporated herein by this reference). 10.18 Lease for premises at 9900 Norwalk Boulevard, Santa Fe Springs, California, (filed as Exhibit 10.75 in Bancorp's 1992 10-K Report and incorporated herein by this reference). 11 Earnings (loss) per share computation. 21 Subsidiaries of the Registrant (filed as Exhibit in Bancorp's 1986 10- K Report and incorporated herein by this reference). 23.1 Consent of KPMG LLP 27 Financial Data Schedule *Identified as a management contract or compensatory agreement pursuant to Item 14(a)# of Form 10-K. 59 (d) Financial Statements All schedules are omitted because they are not required, not applicable or because the information is included in the financial statements or notes thereto or is not material. 60 SIGNATURES Pursuant to requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Date: April 15, 1999 PROFESSIONAL BANCORP, INC. (Registrant) By: /s/Eric J. Woodstrom ---------------------------------------- Eric J. Woodstrom, Acting Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf the registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Richard A. Berger Director April 15, 1999 - ------------------------------- ---- Richard A. Berger /s/ Terry O. Hartshorn Director April 15, 1999 - ------------------------------- ---- Terry O. Hartshorn /s/ Ronald L. Katz, M.D. Director April 15, 1999 - ------------------------------- ---- Ronald L. Katz, M.D. /s/ Walter T. Mullikin, M.D. Director April 15, 1999 - ------------------------------- ---- Walter T. Mullikin, M.D. /s/ Lynn O. Poulson, J.D. Director April 15, 1999 - ------------------------------- Secretary ---- Lynn O. Poulson, J.D. /s/ Julie P. Thompson Chairman of the Board April 15, 1999 - ------------------------------- Director ---- Julie P. Thompson
61 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Independent Auditors' Report....................................... 63 -- Consolidated Financial Statements of Professional Bancorp, Inc. Consolidated Balance Sheets...................................... 64 -- Consolidated Statements of Operations and Comprehensive Income... 65 -- Consolidated Statements of Changes in Shareholders' Equity....... 66 -- Consolidated Statements of Cash Flows............................ 67 -- Notes to Consolidated Financial Statements....................... 68 --
62 INDEPENDENT AUDITORS' REPORT The Board of Directors Professional Bancorp, Inc.: We have audited the accompanying consolidated balance sheets of Professional Bancorp, Inc. (a Pennsylvania corporation) and subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of operations and comprehensive income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Professional Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. KPMG LLP Los Angeles, California April 19, 1999 63 PROFESSIONAL BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
December 31, December 31, Notes 1998 1997 ----- -------------- -------------- Assets Cash and due from banks: Noninterest-bearing 2 $ 20,992,183 $ 28,627,771 Interest-bearing 572,519 111,899 Federal funds sold 10,400,000 25,600,000 ------------ ------------ Cash and cash equivalents 31,964,702 54,339,670 Securities available-for-sale (cost of $81,369,000 and 3 $53,584,000 in 1998 and 1997, respectively) 80,891,072 53,135,380 Securities held-to-maturity (fair value of $24,135,000 3 and $34,708,000 in 1998 and 1997, respectively) 24,080,592 34,660,372 Loans (net of allowance for loan losses of $2,200,000 and $1,802,000 in 1998 and 1997, respectively) 4, 10 115,518,693 103,900,082 Premises and equipment, net 5 1,390,128 1,547,771 Deferred tax asset 7 1,242,748 1,183,639 Accrued interest receivable and other assets 4,613,504 5,060,647 ------------ ------------ $259,701,439 $253,827,561 ============ ============ Liabilities and Shareholders' Equity Liabilities Deposits: 6 Demand, noninterest-bearing $109,421,629 $ 97,746,304 Demand, interest-bearing 16,710,541 14,961,400 Savings and money market 75,500,642 89,226,025 Time deposits 28,947,934 27,529,935 ------------ ------------ Total deposits 230,580,746 229,463,664 Convertible notes 12 1,116,000 5,437,000 Accrued interest payable and other liabilities 7 2,683,582 3,063,744 ------------ ------------ Total liabilities 234,380,328 237,964,408 ------------ ------------ Commitments and contingent liabilities 9 Shareholders' equity: 8, 11 Common stock, $.008 par value; 12,500,000 shares authorized; 2,065,811 and 1,426,689 issued and 1,996,344 and 1,357,222 outstanding in 1998 and 1997, respectively 16,526 11,413 Additional paid-in-capital 20,873,603 12,659,774 Retained earnings 5,239,275 3,993,026 Treasury stock, at cost (69,467 and 69,467 shares in 1998 (537,251) (537,251) and 1997, respectively) Accumulated other comprehensive income (loss) 3 (271,042) (263,809) ------------ ------------ Total shareholders' equity 25,321,111 15,863,153 ------------ ------------ $259,701,439 $253,827,561 ============ ============
See accompanying notes to consolidated financial statements. 64 PROFESSIONAL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31,
Notes 1998 1997 1996 ----- ----------- ----------- ------------ Interest income Loans 4 $10,264,651 $ 9,686,133 $ 9,030,090 Securities 3 4,890,065 5,834,456 7,540,804 Federal funds sold and securities purchased under agreements to resell 1,773,156 1,159,971 1,056,214 Interest-bearing deposits in other banks 20,550 28,779 23,348 ----------- ----------- ------------- Total interest income 16,948,422 16,709,339 17,650,456 ----------- ----------- ------------- Interest expense Deposits 6 3,373,818 3,336,954 4,187,859 Convertible notes 252,882 473,619 477,348 Federal funds purchased and securities sold under agreements to repurchase 3,055 15,807 185,023 ----------- ----------- ------------- Total interest expense 3,629,755 3,826,380 4,850,230 ----------- ----------- ------------- Net interest income 13,318,667 12,882,959 12,800,226 Provision for loan losses 4 405,829 180,000 4,136,000 ----------- ----------- ------------- Net interest income after provision for loan losses 12,912,838 12,702,959 8,664,226 ----------- ----------- ------------- Other operating income Net loss on sale of securities available-for-sale 3 (5,640) - (71,309) Merchant discount 207,572 272,763 224,745 Mortgage brokering fees 162,811 105,660 117,275 Service charges on deposits 918,354 791,247 668,855 Other income 452,043 622,964 504,213 ----------- ----------- ------------- Total other operating income 1,735,140 1,792,634 1,443,779 ----------- ----------- ------------- Other operating expenses Salaries and employee benefits 5,987,476 5,803,575 5,944,998 Occupancy 1,438,988 1,481,016 1,386,322 Legal fees, net of legal settlement 394,908 (105,834) 2,754,123 Furniture and equipment 810,920 828,845 697,291 Professional services 10 1,145,885 1,346,273 930,381 Strategic planning and investor relations 147,743 375,086 - FDIC assessment 24,951 27,063 1,000 Office supplies 237,273 226,620 288,397 Other assessment 189,556 224,613 298,695 Telephone 287,849 272,692 271,602 Audit, accounting and examinations 188,733 131,603 200,840 Postage 160,151 150,353 153,825 Messenger service 33,615 70,692 177,993 Imprinted checks 42,709 90,939 137,670 Donations 93,900 101,427 134,615 Meetings and business developments 191,026 163,488 125,942 Settlement costs 9 - - 1,006,000 Other expense 851,043 936,317 1,035,628 ----------- ----------- ------------- Total other operating expenses 12,226,726 12,124,768 15,545,322 ----------- ----------- ------------- Earnings (loss) before taxes 7 2,421,252 2,370,825 (5,437,317) Provision (benefit) for income taxes 989,653 892,300 (1,712,400) ----------- ----------- ------------- Net earnings (loss) 1 $ 1,431,599 $ 1,478,525 $ (3,724,917) Other comprehensive income (loss): Unrealized gain (loss) on available for sale securities, net of tax (17,722) 171,134 72,649 of $12,190, $64,346, $24,954 for 1998, 1997 and 1996, respectively. Reclassification adjustment, net of tax of $7,258 and $3,021, respectively 10,489 - 6,569 ----------- ----------- ------------ Comprehensive income (loss) $ 1,424,366 $ 1,649,659 $ (3,645,699) =========== =========== ============ Earnings (loss) per share Basic $ 0.81 $1.10 $(2.78) Diluted $ 0.74 $0.97 $(2.78)
See accompanying notes to consolidated financial statements. 65 PROFESSIONAL BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
Accumulated Additional Other Common Stock Paid-In Retained Treasury Comprehensive Shares Amount Capital Earnings Stock Loss Total ------------------------------------------------------------------------------------- Balance, December 31, 1995 1,278,988 $10,620 $11,682,751 $ 6,983,629 $(655,085) $(514,161) $17,507,754 Conversion of notes (Note 12) 157 1 1,699 - - - 1,700 Dividend in lieu of fractional shares (Note 8) - - (3,664) - - - (3,664) Reissuance of treasury stock (Note 12) - - (388,284) - 388,284 - - Purchase of treasury stock (25,000) - - - (270,450) - (270,450) Issuance of stock dividend (Note 8) - - 744,211 (744,211) - - - Exercise of stock options (Note 8) 87,171 665 181,234 - - 181,899 Tax benefit on stock options exercised - - 270,054 - - - 270,054 Change in net unrealized holding loss on securities available-for-sale - - - - - 79,218 79,218 Net loss - - - (3,724,917) - - (3,724,917) ------------------------------------------------------------------------------------- Balance, December 31, 1996 1,341,316 11,286 12,488,001 2,514,501 (537,251) (434,943) 14,041,594 Conversion of notes (Note 12) 14,174 113 158,433 - - - 158,546 Exercise of stock options (Note 8) 1,732 14 13,340 - - - 13,354 Change in net unrealized holding loss on securities available-for-sale - - - - - 171,134 171,134 Net earnings - - - 1,478,525 - - 1,478,525 ------------------------------------------------------------------------------------- Balance, December 31, 1997 1,357,222 11,413 12,659,774 3,993,026 (537,251) (263,809) 15,863,153 Conversion of notes (Note 8) 334,494 2,676 3,798,376 - - - 3,801,052 Issuance of cash dividend - - - (185,350) - - (185,350) Exercise of stock options (Note 8) 304,628 2,437 3,791,926 - - - 3,794,363 Tax benefit on stock options exercised - - 561,344 - - - 561,344 Forfeited interest on conversion of convertible notes - - 62,183 - - - 62,183 Change in net unrealized holding lost on securities available-for-sale - - - - - (7,233) (7,233) Net earnings - - - 1,431,599 - - 1,431,599 ------------------------------------------------------------------------------------- Balance, December 31, 1998 1,996,344 $16,526 $20,873,603 $ 5,239,275 $(537,251) $(271,042) $25,321,111 =====================================================================================
See accompanying notes to consolidated financial statements. 66 PROFESSIONAL BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31,
1998 1997 1996 ------------- ------------- ------------- Cash flows from operating activities: Net earnings (loss) $ 1,431,599 $ 1,478,525 $ (3,724,917) Adjustments to reconcile net earnings (loss) to net cash provided by operating activities: Depreciation and amortization 590,804 563,171 605,771 Provision for loan losses 405,829 180,000 4,136,000 Loss on securities available-for-sale 5,640 - 71,309 Amortization of convertible note expense 69,019 103,495 104,334 Decrease (increase) in deferred tax asset 19,553 1,919,341 (2,426,243) Decrease (increase) in accrued interest receivable and other assets (197,390) 810,887 63,441 Increase (decrease) in accrued interest payable and other liabilities 243,364 (288,120) 1,197,126 Net amortization of premiums and discounts on securities held-to-maturity 332,861 262,390 326,475 Net amortization of premiums and discounts on securities available-for-sale 318,562 263,101 181,351 ------------ ------------ ------------ Net cash provided by operating activities 3,219,841 5,292,790 534,647 ------------ ------------ ------------ Cash flows from investing activities: Proceeds from: Maturities of securities held-to-maturity 500,000 3,000,000 500,000 Maturities of securities available-for-sale 8,550,000 4,000,000 4,363,817 Principal payments and maturities of: Mortgage-backed securities held-to-maturity 9,746,919 6,501,551 6,832,983 Mortgage-backed securities available-for-sale 13,155,115 8,404,884 6,405,609 Sales of securities available-for-sale 15,331,685 - 26,053,425 Purchases of: Securities held-to-maturity - (2,991,950) (8,100) Securities available-for-sale (65,147,023) (10,587,422) (9,904,845) Mortgage-backed securities held-to-maturity - - (1,005,904) Net (increase) decrease in loans (12,024,440) (13,320,921) 4,049,113 Purchases of bank premises and equipment, net (433,161) (499,460) (399,271) ------------ ------------ ------------ Net cash provided by (used in) investing activities (30,320,905) (5,493,318) 36,886,827 ------------ ------------ ------------ Cash flows from financing activities: Net increase (decrease) in demand deposits and savings accounts (300,917) (8,020,242) 628,133 Net increase (decrease) in time certificates of deposit 1,417,999 (3,792,842) (56,817,087) Proceeds from exercise of stock options 3,794,364 13,354 181,899 Purchase of treasury stock - - (270,450) Cash dividends paid (185,350) - - Dividend in lieu of fractional shares - - (3,664) ------------ ------------ ------------ Net cash (used in) provided by financing activities 4,726,096 (11,799,730) (56,281,169) ------------ ------------ ------------ Net (decrease) increase in cash and cash equivalents (22,374,968) (12,000,308) (18,859,695) Cash and cash equivalents, beginning of year 54,339,670 66,339,978 85,199,673 ------------ ------------ ------------ Cash and cash equivalents, end of year $ 31,964,702 $ 54,339,670 $ 66,339,978 ============ ============ ============ Supplemental disclosure of cash flow information (see Notes 6, 7 and 12) - cash paid during the year for: Interest $ 3,687,607 $ 3,907,889 $ 5,021,080 Income taxes 187,000 523,009 61,482 Supplemental disclosure of noncash items: Pretax change in unrealized losses on securities available-for-sale 30,330 309,059 117,951 Conversion of notes (see Note 12) 3,801,052 158,546 1,700 Tax benefit on stock options exercised 561,344 - 270,054 Forfeited interest on conversion of convertible notes 62,183 - - See accompanying notes to consolidated financial statements
See accompanying notes to consolidated financial statments. 67 PROFESSIONAL BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997 AND 1996 Note 1 - Summary of Significant Accounting Policies Professional Bancorp, Inc. and its subsidiary are engaged in the general commercial banking business and provides a wide range of commercial banking services primarily directed towards meeting the financial needs of the medical services community and other distinct non-medical service organizations. Services include those traditionally offered by commercial banks such as checking and savings accounts; time certificates of deposit; and commercial, consumer/installment, home equity and short-term real estate loans, with an emphasis on cash flow lending. The service area of the Company consists of the California counties of Los Angeles, Orange, Riverside, San Bernardino and Ventura with a full-service office at its Santa Monica headquarters and four full-service branches located in Beverly Hills, Tarzana, Pasadena and Redlands. The accounting and reporting policies of the Company are in accordance with generally accepted accounting principles and conform to general practices within the banking industry. The preparation of these financial statements requires management to make estimates and assumptions that effect the reported amount 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 reported periods. The allowance for loan losses and the deferred tax asset are material estimates subject to change. Consolidation The consolidated financial statements include the accounts of Professional Bancorp, Inc. (the "Company") and its wholly owned subsidiary, First Professional Bank, N.A. (the "Bank") and Professional Bancorp Mortgage, Inc. a majority owned subsidiary of the Bank. All material intercompany accounts and transactions have been eliminated in the consolidated financial statements. Financial Instruments Statement of Financial Accounting Standards No. 107 "Disclosures about Fair Value of Financial Instruments" ("SFAS No. 107") requires the disclosure of the fair value of financial instruments, whether or not recognized on the statement of financial condition, for which it is practicable to estimate the value. A significant portion of the Bank's assets and liabilities are financial instruments as defined under SFAS No. 107. Fair values, estimates and assumptions are set forth in Note 14, Fair Value of Financial Instruments. Interest Rate Risks The Company, as an institution with long-term assets (both loans and investments), may experience a decrease in profitability and the value of such assets if the general level of interest rates rise. Interest rates paid on certain deposits may rise more quickly in a rapidly rising interest rate environment than do interest rates on securities, in which case the Company would be exposed to the risk that its cost of funds may rise more quickly than its interest income. Changes in the general level of interest rates affect the Company's various securities in differing ways. In a declining interest rate environment, the rate at which the underlying mortgages of mortgage-backed securities are prepaid tends to increase as borrowers refinance their loans. If a higher than anticipated level of prepayments were to continue for an extended period of time, there could be an adverse effect on the level of the Company's outstanding securities. Securities held in the Company's available-for-sale portfolio are reported at fair value, with unrealized gains and losses, net of taxes, excluded from earnings and reported as a separate component of shareholders' equity. In a rising interest rate environment, unrealized losses may negatively affect the Company's shareholders' equity from quarter to quarter. 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Concentration of Credit Risk Concentrations of credit risk exist for groups of borrowers when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The ability of the Bank's borrowers to repay their commitments is contingent on several factors, including the economic conditions in the borrowers' geographic area and the individual financial condition of the borrowers. The Bank's lending activities are primarily conducted in Southern California. The Bank currently focuses on the origination of commercial loans to health care organizations ranging from single practitioners to large multi- specialty medical groups. Ongoing changes in the delivery of health care could negatively impact certain borrowers. The Bank has loans and loan commitments to a small number of clients that total between $2,000,000 and the Bank's legal lending limit of approximately $3.7 million. Statement of Cash Flows For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one day periods. Securities The Company classifies its investment in debt and equity securities as held-to-maturity, available-for-sale or trading securities, as applicable. Securities held-to-maturity are those debt securities for which the Company has the ability and intent to hold until maturity. Trading securities are acquired and sold to benefit from short-term movements in market prices. All other securities are classified as available-for-sale. All securities are under the control of the Company. Securities held-to-maturity are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Trading securities are carried at fair value and are recorded as of their trade dates. Gains or losses on trading securities, both realized and unrealized, are recognized currently in income. As of December 31, 1998, the Company does not have, nor contemplates having, any securities classified as trading securities. Securities classified as available-for-sale are recorded at fair value with any unrealized gains or losses, net of taxes, reflected as an addition or reduction of accumulated other comprehensive income, net of tax, as a separate component of shareholders' equity. Unrealized losses on securities, reflecting a decline in value judged to be other than temporary, are charged to income in the consolidated statements of operations. Premiums and discounts are amortized or accreted over the life of the related securities held-to-maturity and available-for-sale as an adjustment to yield using the interest method. Interest income is recognized when earned. Realized gains and losses on securities are included in operations and are derived using the specific identification method for determining the cost of the securities sold. Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase The Bank purchases securities under agreements to resell and sells securities under agreements to repurchase. The agreements have a duration of one business day and are fully collateralized. Securities purchased under resale agreements are recorded as short-term investments, while securities sold under repurchase agreements are recorded as short-term obligations. At December 31, 1998 and 1997, the Bank had no such agreements outstanding. 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Derivatives The Bank enters into interest rate exchange agreements and cap and floor agreements for protection against future fluctuations in the interest rates of specifically identified assets or liabilities. Interest rate swap agreements are for the purpose of synthetically altering the interest rates on a portion of the Bank's super NOW and money market accounts. Interest rate floor agreements are used to reduce the potential impact of lower interest rates which would reduce the interest income on loans and on certain securities. Interest rate cap agreements are used to reduce the potential impact of rising interest rates which would reduce the interest income on certain securities. Interest rate swap agreements and interest rate cap and floor agreements are accounted for as hedges. Gains or losses on the sales of such agreements are deferred and transferred into interest income or expense over the maturity period of the agreement. Net interest income (expense) resulting from the differential between interest rate exchange payments is recorded on a current basis. Premiums paid for purchased interest rate cap and floor agreements are amortized on a straight-line basis to interest expense over the terms of the agreements. Unamortized premiums are included in other assets in the consolidated financial statements. Amounts receivable under cap and floor agreements are recorded as an increase to interest income. Mortgage Brokering Fees The Company's mortgage brokering operations, conducted by PBMI, consist solely of a broker function. This service is provided to assist the Bank's clients in obtaining mortgage loans with other institutions. PBMI does not originate or sell mortgage loans. PBMI earns revenue, in the form of points and any documentation fees charged on a loan, but is otherwise not involved in the loan. Merchant Discount Income Merchant discount income consists of the fees charged on credit card receipts submitted by the Bank's business clients for processing. The income received and the fees paid by the Bank to credit card issuers and expenses for third party processors are netted and reported as a component of other income. Such amounts are recognized when received or paid. Loans and the Related Allowance for Loan Losses Loans are recorded at face value, less payments received. Interest on loans is accrued daily as earned, except where a reasonable doubt exists as to the full collectibility of interest or principal, in which case the accrual of income is discontinued and the balance of accrued interest is reversed. Generally, this means that loans are put on nonaccrual status when interest is ninety days or more past due, unless the loan is well secured and in the process of collection. All payments received subsequent to the loan being put on nonaccrual are used to reduce the principal balance. Only after the principal is reduced to zero is interest income realized. Once a loan is placed on nonaccrual it generally remains on nonaccrual unless the borrower has the capacity to make payments as evidenced by tax returns and other financial statements and has the intent to make payments as evidenced by keeping the loan current for a period of three to six months. Loan fees in excess of certain direct origination costs are deferred and amortized into interest income utilizing the interest method over the lives of the related loans. When a loan is repaid or sold, any unamortized net deferred fee balance is credited to income. Accretion of deferred loan fees is discontinued when loans are placed on nonaccrual status. 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The allowance for loan losses is maintained at a level considered adequate by management to provide for potential loan losses. Credits deemed uncollectible are charged to the allowance. Provisions for loan losses and recoveries on loans previously charged off are added to the allowance. Management, in determining the adequacy of the allowance for loan losses, takes into consideration (1) loan loss experience, (2) collateral values, (3) changes in the loan portfolio, (4) an assessment of the effect of current and anticipated economic conditions on the loan portfolio, and (5) examinations conducted by Bank regulatory agencies. While management believes the allowance for loan losses is adequate to absorb losses inherent in the loan portfolio, there exists the risk of future losses which cannot be precisely quantified. Because this risk is continually changing in response to factors beyond the control of the Bank, such as the state of the economy, management's judgment as to the adequacy of the allowance for loan losses in future periods is necessarily an estimate. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to record additions to the allowance based on their judgments of information available to them at the time of their examination. Impaired Loans The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement on a timely basis. Impairment of a loan is measured by the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. If the measure of the impaired loan is less than the recorded investment in the loan, the Company recognizes impairment by creating a valuation allowance with a corresponding charge to provision for loan losses. Large groups of smaller balance homogenous loans that are collectively evaluated for impairment are not subject to this accounting treatment. For loans classified as nonaccrual and troubled debt restructurings, specific valuation allowances are established for the difference between the loan amount and the fair value of collateral less estimated selling costs. Impaired loans which are performing under their contractual terms are reported as performing loans, and cash payments are allocated to principal and interest in accordance with the terms of the loan. Premises and Equipment, net Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation on furniture, fixtures, and equipment is computed using the straight-line method over the estimated useful lives of the related assets, which range from two to fifteen years. Leasehold improvements are capitalized and amortized over the lease term or estimated useful lives of the improvements, whichever is shorter, using the straight-line method. Amortization of Convertible Note Expenses Expenses associated with the convertible note offering in 1994 are being amortized on a straight-line basis over the 10 year term of the note. 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Income Taxes The Company and its subsidiary file consolidated federal income and state franchise tax returns. Provisions for income taxes are based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and include deferred taxes on temporary differences between tax and financial statement purposes. Deferred taxes are computed using the asset and liability approach. A valuation allowance is established for deferred tax assets if based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance is sufficient to reduce the deferred tax assets to the amount that is more likely than not to be realized. Earnings (Loss) Per Share The Company adopted, effective December 31, 1997, Statement of Accounting Standards No. 128, "Earnings per Share" (SFAS 128). SFAS 128 simplifies the standards for computing and presenting earnings per share (EPS) as previously prescribed by Accounting Principles Board Opinion No. 15, "Earnings per Share." SFAS 128 replaces primary EPS with basic EPS and fully-diluted EPS with diluted 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 from issuance of common stock that then shared in earnings. Comprehensive Income On January 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income consists of net earnings and net unrealized gains (losses) on securities and is presented in the consolidated statements of operations and comprehensive income. The Statement requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. Prior year financial statements have been reclassified to conform to the requirements of SFAS No. 130. Stock Option Plan Prior to January 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS"), which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS 123 also allows entities to continue to apply the provisions of APB 25 and provide pro forma net income and pro forma net income per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value- based method defined in SFAS 123 had been applied. The Company has elected to continue to apply the provisions of APB 25 and provide the pro forma disclosure provisions of SFAS 123. 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 401(k) Savings Plan The Bank has a 401(k) savings plan in effect for substantially all of its full-time employees who have completed one year of continuous service. Employee contributions under the plan are matched by the Bank up to a maximum of 3.0% of the employee's annual salary for 1998, 1997 and 1996. Salaries and employee benefits expense includes $95,100, $71,700, and $80,600 for 1998, 1997, and 1996, respectively, related to the Bank's contributions. Reclassifications Certain amounts have been reclassified in the 1997 and 1996 financial statements to conform with the 1998 presentation of those items. Year 2000 (Unaudited) The Year 2000 issue presents a very real and significant challenge to the Company, along with the entire financial services industry. This problem has the potential to affect a wide range of systems and equipment, including software and hardware, utilities, communications platforms and devices, and facilities. The Year 2000 issue is the result of computer programs being written using two digits rather than four to represent the calendar year. Software so developed and not corrected could produce inaccurate or unpredictable results when dates change in the year 2000. Such occurrences may have a material adverse effect on the Company's financial condition, results of operations, or business as the Company, like most financial organizations, is significantly subject to the potential Year 2000 issues due to the nature of financial information. While no one can accurately predict what will happen with the date change to the Year 2000, the Company's management and Board of Directors take the potential risks seriously, and have been working since early in 1997, and will continue to work hard, to be prepared for the Year 2000 transition. Significant progress has been accomplished in our efforts to prepare for the Year 2000-century date change. All of our mission critical systems have been tested and none have failed. Additionally, we are 85% complete assessing, renovating, testing and implementing Year 2000 preparedness for all other identified systems. Management currently estimates the overall cost of Year 2000 risk mitigation not to exceed $100,000 in operating expenses and $300,000 in fixed asset purchases of which approximately 50% has been incurred. These costs are included within our ongoing budget and planning process. We continue with the execution of our Year 2000 Preparedness Plan and remain on schedule to meet our internal timeline and regulatory expectations and continue to project that we will complete renovation and implementation prior to June 30, 1999. Also, we have developed and presented internal and external awareness programs, which reinforce the awareness and the need for preparedness to the Year 2000 problem for the Company's Board of Directors, employees, and our customers. Based upon the information we have developed through our Year 2000 Preparedness Plan, we have not identified risks associated with the date change to Year 2000 that will have a material financial impact on the Company. 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Recent Accounting Pronouncements In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting For Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, and unrecognized firm commitment, an available for sale security, or a foreign- currency-denominated forecasted transaction. Under SFAS 133, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk. This statement is effective for the Company on January 1, 2000. Management is in the process of determining what effect, if any, adoption of this statement will have on the financial position or results of operations of the Company. In October 1998, the Financial Accounting Standards Board "FASB" issued Statement No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise, an amendment of FASB Statement No. 65." Under SFAS 134, After the securitization of a mortgage loan held for sale, any retained mortgage-backed securities shall be classified in accordance with the provisions of Statement 115. However, a mortgage banking enterprise must classify as trading any retained mortgage-backed securities that it commits to sell before or during the securitization process. SFAS 134 is effective for the first quarter beginning after December 15, 1998 and enterprises may reclassify mortgage-backed securities and other beneficial interests retained after the securitization of mortgage loans held for sale from the trading category, except for those with sales commitments in place when the Statement is initially applied. Management does not believe the adoption of this statement will have a significant impact on the financial position or results of operations of the Company. 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 2 - Restricted Cash Balances Aggregate cash balances in the form of deposits with the Federal Reserve Bank of approximately $5,661,000 and $4,351,000 were maintained to satisfy federal regulatory requirements at December 31, 1998 and 1997, respectively. Note 3 - Investment Securities The amortized cost and fair value of securities available-for-sale are as follows:
December 31, 1998 ------------------------------------------------------------------------ Gross Gross Gross Amortized Unrealized Unrealized Fair Realized (in thousands) Cost Gain Loss Value Gain (Loss) --------- ---------- ---------- -------- ----------- U.S. Government agency and mortgage-backed securities $68,487 $153 $514 $68,126 $(6) Small Business Administration securities 858 1 7 852 - Municipal securities 2,551 3 8 2,546 - Federal Reserve Bank Stock 439 - - 439 - Collateralized mortgage obligations 9,034 - 106 8,928 - ------- ---- ---- ------- ---------- Total $81,369 $157 $635 $80,891 $(6) ======= ==== ==== ======= ========== December 31, 1997 ------------------------------------------------------------------------- Gross Gross Gross Amortized Unrealized Unrealized Fair Realized (in thousands) Cost Gain Loss Value Gain (Loss) --------- ---------- ---------- -------- ---------- U.S. Government securities $ 2,003 $ 1 $ - 2,004 $ - U.S. Government agency and mortgage-backed securities 34,963 99 322 34,740 - Small Business Administration securities 1,281 11 - 1,292 - Federal Reserve Bank Stock 439 - - 439 - Collateralized mortgage obligations 14,898 - 238 14,660 - ------- ---- ---- ------- ---------- Total $53,584 $111 $560 $53,135 $ - ======= ==== ==== ======= ==========
During the years ended December 31, 1998, 1997 and 1996, securities available-for-sale were sold for aggregate proceeds of $15,337,000, $0, and $26,125,000, respectively. These sales resulted in gross realized gains and losses of $12,000 and (18,000) in 1998 and $21,000 and ($92,000) in 1996 and no gross realized gains or losses in 1997. The amortized cost and estimated fair value of securities available-for- sale at December 31, 1998, by contractual maturity is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties. 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Amortized Fair (in thousands) Cost Value ------------------- ------------------- Due within one year $ 3,002 $ 3,019 Due after one year through five years - - Due after five years through ten years 11,187 11,202 Due after ten years 67,180 66,670 ------- ------- Total $81,369 $80,891 ======= =======
The amortized cost and fair value of securities held-to-maturity are as follows:
December 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair (in thousands) Cost Gain Loss Value -------------- --------------- ---------------- ----------- U.S. Government securities $ 3,043 $151 - $ 3,194 U.S. Government agency securities 2,250 21 - 2,271 U.S. Government agency mortgage-backed securities $18,788 1 119 $18,670 ------- ---- ---- ------- Total $24,081 $173 $119 $24,135 ======= ==== ==== ======= December 31, 1997 Gross Gross Amortized Unrealized Unrealized Fair (in thousands) Cost Gain Loss Value -------------- ---------------- ---------------- ------------ U.S. Government securities $ 3,054 $ 55 $ - $ 3,109 U.S. Government agency securities 2,750 - 10 2,740 U.S. Government agency mortgage-backed securities 28,857 72 70 28,859 ------- ---- ---- ------- Total $34,661 $127 $ 80 $34,708 ======= ==== ==== =======
The amortized cost and estimated fair value of securities held-to-maturity at December 31, 1998 by contractual maturity is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Amortized Fair (in thousands) Cost Value -------------- -------------- Due after one year through five years $ 5,293 $ 5,465 Due after five years through ten years 13,077 12,979 Due after ten years 5,711 5,691 ------- ------- Total $24,081 $24,135 ======= =======
There were no trading securities during 1998 and 1997. 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) During 1998, the highest daily balance and the average balance for the securities was $107,941,000 and $83,900,000, respectively. During 1997, the highest daily outstanding balance and average balance for the securities was $98,828,000 and $94,084,000, respectively. Pledged Securities U.S. Treasury securities with a carrying value of approximately $3,043,000 and $3,054,000 were pledged to secure treasury tax and loan deposits as required by law at December 31, 1998 and 1997, respectively. Note 4 - Loans and the Related Allowance for Loan Losses A summary of the major components of loans outstanding at December 31, 1998 and 1997 is as follows:
(in thousands) 1998 1997 Commercial loans $ 93,952 $ 86,243 Real estate secured commercial loans 11,698 10,512 Equity lines of credit 5,931 6,288 Other lines of credit 4,817 1,524 Installment loans 1,482 1,253 Lease financing 32 37 -------- -------- Total 117,912 105,857 Less: Allowance for loan losses 2,200 1,802 Deferred loan fees, net 193 155 -------- -------- Loans, net $115,519 $103,900 ======== ======== The composition of gross loans outstanding between fixed and variable is as follows: Fixed rate $ 16,734 $ 6,935 Variable rate 101,178 98,922 -------- -------- Total $117,912 $105,857 ======== ========
The following table provides information with respect to the Company's past due loans.
December 31, (in thousands) 1998 1997 -------------- ------------ Loans 90 days or more past due and still accruing $ 100 $ 17 Nonaccrual loans 1,359 877 ------ ----- Total past due loans $1,459 $ 894 ====== =====
Total accrued interest on loans 90 days past due and still accruing was $1,000 at December 31, 1997, and the Company had no accrued interest due on loans 90 days past due at December 31, 1998. 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The effect of nonaccrual loans on interest income for the years 1998 and 1997 is presented below:
(in thousands) 1998 1997 ---- ---- Contractual interest due $ 126 $ 98 Interest recognized 90 40 ----- ----- Net interest foregone $ 36 $ 58 ===== =====
The Company had approximately $1,836,000 in impaired loans as of December 31, 1998. The carrying value of impaired loans for which there is a related allowance for loan losses was $153,000, with the amount of specific allowance for loan losses allocated to these loans of $41,000. There were $1,683,000 in impaired loans for which there was no related specific allowance for loan losses. However, a general allowance consistent with the level of allowance for similar loans with similar risk characteristics was maintained for impaired loans without specific allowances. The average recorded investment in impaired loans during 1998 was $1,131,085 and there was no income recorded utilizing either the cash basis or accrual basis method of accounting. Impaired loans at December 31, 1998, included $1,359,000 of nonaccrual loans. The Company had approximately $1,199,000 in impaired loans as of December 31, 1997. The carrying value of impaired loans for which there is a related allowance for loan losses was $234,000, with the amount of specific allowance for loan losses allocated to these loans of $80,000. There was $965,000 in impaired loans for which there was no related specific allowance for loan losses. However, a general allowance consistent with the level of allowance for similar loans with similar risk characteristics was maintained for impaired loans without specific allowances. The average recorded investment in impaired loans during 1997 was $1,342,000 and there was no income recorded utilizing either the cash basis or accrual basis method of accounting. Impaired loans at December 31, 1997, included $877,000 of nonaccrual loans. The Company had approximately $1,894,000 in impaired loans as of December 31, 1996. The carrying value of impaired loans for which there is a related allowance for loan losses was $700,000, with the amount of specific allowance for loan losses allocated to these loans of $379,000. There were $1,194,000 in impaired loans for which there was no related specific allowance for loan losses. The average recorded investment in impaired loans during 1996 was $4,161,000 and income recorded utilizing either the cash basis or accrual basis method of accounting was $53,000. A summary of the activity within the allowance for loan losses is as follows:
(in thousands) 1998 1997 1996 Balance, beginning of year 1,802 $2,253 $ 1,070 Provision for loan losses 406 180 4,136 Loans charged-off (269) (882) (3,353) Recoveries on loans previously charged-off 261 251 400 ------ ------ ------- Balance, end of year $2,200 $1,802 $ 2,253 ====== ====== =======
78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company's commercial loans as of December 31, 1998 are partially secured by the following collateral:
(in thousands) December 31, 1998 ----------------- Stock $ 3,395 Cash 2,504 Furniture, equipment and/or accounts receivables 65,314 Unsecured, real estate, automobiles, or assignment of life insurance 22,739 ------- Total $93,952 =======
Note 5 - Premises and Equipment A summary of the major components of premises and equipment at December 31, 1998 and 1997 is as follows:
1998 1997 (in thousands) Furniture, fixtures and equipment $ 3,498 $ 3,262 Leasehold improvements 1,470 1,444 ------- ------- Total premises and equipment, at cost 4,968 4,706 Less accumulated depreciation and amortization (3,578) (3,158) ------- ------- Net premises and equipment $ 1,390 $ 1,548 ======= =======
Depreciation and amortization expense related to premises and equipment was approximately $591,000, $563,000 and $606,000 for the years ended December 31, 1998, 1997 and 1995, respectively. Note 6 - Deposits and Short-Term Borrowings A summary of time certificates of deposit outstanding at December 31, 1998 and 1997 is as follows:
(in thousands) 1998 1997 Time certificates of deposit under $100,000 $ 8,625 $ 7,374 Time certificates of deposit of $100,000 and over 20,323 20,156 ------- ------- Total $28,948 $27,530 ======= =======
79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Interest expense for the years ended December 31, 1998, 1997 and 1996 relating to interest-bearing deposits and other borrowings amounted to the following:
(in thousands) 1998 1997 1996 Interest-bearing demand deposits $ 134 $ 108 $ 96 Savings and money market deposits 1,801 1,821 1,693 Time certificates of deposit under $100,000 383 391 452 Time certificates of deposit of $100,000 and over 1,056 1,017 1,947 ------ ------ ------ Interest expense on deposits 3,374 3,337 4,188 ------ ------ ------ Federal funds purchased and securities sold under agreements to repurchase 3 16 185 Convertible notes 253 473 477 ------ ------ ------ Interest expense on deposits and other borrowings $3,630 $3,826 $4,850 ====== ====== ======
The Bank sells securities under agreements to repurchase. Securities sold under repurchase agreements are recorded as short-term obligations. During 1998, the highest daily outstanding balance and the average balance of securities sold under agreements to repurchase was $5,000,000 and $55,000, respectively; the average rate paid was 5.50%. During 1997, the highest daily outstanding balance and the average balance of securities sold under agreements to repurchase was $8,000,000 and $274,000, respectively; the average rate paid was 5.77%. During 1996, the highest daily outstanding balance and the average balance of securities sold under agreements to repurchase was $17,929,000 and $3,422,000, respectively; the average rate paid was 5.41%. Securities subject to repurchase agreements, are retained by the Company's custodian under written agreements that recognize the customers' interests in the securities. Note 7 - Income Taxes The provision for income taxes for the years ended December 31, 1998, 1997 and 1996 is comprised of the following:
(in thousands) 1998 1997 1996 ---- ---- ---- Current taxes: Federal $ 471 $ 395 $ 559 State 3 8 155 ----- ----- ------- Total current taxes 474 403 714 ----- ----- ------- Deferred taxes (credits): Federal 257 248 (1,999) State 259 241 (427) ----- ----- ------- Total deferred taxes 516 489 (2,426) ----- ----- ------- Provision (benefit) for income taxes $ 990 $ 892 $(1,712) ===== ===== =======
80 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following summarizes the differences between the income taxes reported for financial statement purposes and income taxes at the federal statutory rate of 34%, in 1998, 1997 and 1996, respectively:
(in thousands) 1998 1997 1996 ---- ---- ---- Tax expense at statutory rate $ 827 $ 806 $(1,849) Increase (decrease) in taxes resulting from: State franchise taxes, net of federal income tax 173 164 (179) benefit Other (10) (78) 316 ----- ----- ------- Total $ 990 $ 892 $(1,712) ===== ===== ======= Effective tax rate 40.9% 37.6% 31.5%
Included in accrued interest payable and other liabilities is current income taxes payable of $837,000 and $175,000 at December 31, 1998 and 1997, respectively. The components of the net deferred tax asset are as follows:
(in thousands) 1998 1997 ---- ---- Deferred tax liabilities: Prepaid expenses $ 211 $ 220 State taxes 11 11 ------ ------ Gross deferred tax liabilities 222 231 ------ ------ Deferred tax assets: Other 76 - Depreciation, leasing transactions, fixed asset gain or loss 169 104 Bad debt deductions 377 281 Deferred compensation 379 540 Core deposit amortization 20 20 Loan fee amortization 48 64 Accrued vacation 148 149 Contributions carryforward 9 9 Net operating loss carryforward 32 64 Unrealized loss on securities available-for-sale 207 184 ------ ------ Gross deferred tax assets 1,465 1,415 ------ ------ Net deferred tax asset $1,243 $1,184 ====== ======
The gross net operating loss carryover for state income taxes of approximately $441,417 expires in 2001. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize all benefits related to these deductible differences. 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 8 - Shareholders' Equity The Company's stock option plans allow option holders to "pyramid" their options upon exercise. Through this process, which utilizes the intrinsic value of the options at the time of exercise, the option holders avoid incurring additional costs. As a result, more options may be exercised than shares issued, depending on the intrinsic value of the options at the time of exercise. The Company has a stock option plan dated December 18, 1990 (the "1990 Plan") as amended and restated on September 22, 1992, which authorizes the issuance of up to 120,000 shares of the Company's unissued common stock to directors, officers and other personnel. Option prices may not be less than 100% of the fair market value at the date of the grant for incentive stock options and 85% of the fair market value for non-qualified stock options. Options granted under the 1990 Plan expire not more than ten years after the date of grant and must be fully paid when exercised. The status of options granted under the 1990 Plan is shown as follows:
Exercise Options Price ($) Outstanding --------- ----------- Outstanding at December 31, 1995 7.71 - 14.22 84,769 Exercised 7.71 (11,688) Canceled 12.92 (10,474) ------- Outstanding at December 31, 1996 7.71 - 14.22 62,607 ($10.59 weighted-average) Exercised 7.71 (1,732) Canceled 12.92 (3,307) ------- Outstanding at December 31, 1997 7.71 - 14.22 57,568 ($10.54 weighted-average) Exercised 7.71 - 14.22 (40,028) Canceled -- -- Granted 17.00 1,500 ------- Outstanding at December 31, 1998 19,040 ($11.32 weighted-average) (3.0 years weighted-average life) Available for future grant at December 31, 1998 42,824 =======
At December 31, 1998, there were 42,824 shares available for grant under the 1990 Plan. Of the options outstanding at December 31, 1998 and 1997, 19,040 and 57,568, respectively, were exercisable with weighted-average prices of $11.32 and $10.54, respectively. 82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company applies APB Opinion No. 25 in accounting for stock options and, accordingly, no compensation expense has been recognized in the financial statements. Had the Company determined compensation expense based on the fair value at the grant date for its stock options under SFAS 123, the Company's net income would have been reduced to the pro forma amounts indicated below: (in thousands, except per share data) - ---------------------------------------------------------------- 1998 ---- - ---------------------------------------------------------------- Net income as reported $1,432 - ---------------------------------------------------------------- Pro forma net income $1,424 - ---------------------------------------------------------------- Earnings per common share - ---------------------------------------------------------------- as reported (basic) $ 0.81 - ---------------------------------------------------------------- Pro forma earnings per - ---------------------------------------------------------------- common share (basic) $ 0.81 Earnings per common - ---------------------------------------------------------------- share as reported (diluted) $ 0.74 - ---------------------------------------------------------------- Pro forma earnings per - ---------------------------------------------------------------- common share (diluted) $ 0.73 - ----------------------------------------------------------------
The per share weighted average fair value of stock options granted during the year ended December 31, 1998 was $8.29 at the date of grant using the Black- Scholes option pricing model with the following weighted-average assumptions: 1998 ---- Expected life (years) 5.0 Risk-free interest rate 4.93% Volatility 46% Expected dividend yield - The Company also has a stock option plan dated December 31, 1992 (the "1992 Plan"), which authorizes the issuance of up to 393,750 shares of the Company's unissued common stock to directors, officers and other personnel. Option prices may not be less than 100% of the fair market value at the date of the grant for incentive stock options and 85% of the fair market value for non-qualified stock options. Options granted under the 1992 Plan expire not more than ten years after the date of grant and must be fully paid when exercised. The status of options granted under the 1992 Plan is shown as follows:
Exercise Options Price ($) Outstanding ------------------ ------------------- Outstanding at December 31, 1995 12.70 413,438 Canceled 12.70 (55,125) -------- Outstanding at December 31, 1996 and 1997 12.70 358,313 Exercised 12.70 (264,600) -------- Outstanding at December 31, 1998 93,713 --------
At December 31, 1998, 93,713 option shares were exercisable at a weighted- average exercise price per share of $12.70. 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In addition, the Company also has a stock option plan dated March 25, 1998 (the "1998 Plan"), which authorizes the issuance of up to 100,000 shares of the Company's unissued common stock to directors, officers and other personnel. Option prices may not be less than 100% of the fair market value at the date of the grant for incentive stock options and 85% of the fair market value for non- qualified stock options. Options granted under the Plan expire not more than ten years after the date of grant and must be fully paid when exercised. As of December 31, 1998, there were no options granted or outstanding under the 1998 Plan. On May 14, 1996, the Company declared a 5% stock dividend paid on June 21, 1996, primarily by a distribution of 64,714 treasury shares. On June 23, 1995, the Company declared a 5% stock dividend primarily paid by a distribution of 56,274 treasury shares on July 19, 1995. On January 19, 1993, the Company concluded a private placement offering of 341,250 shares of common stock at a price of $12.70 per share. All but 15,225 shares were sold as of December 31, 1992. In connection with the offering, 413,438 options and 137,812 warrants were issued on December 31, 1992 and are considered issued and outstanding. The options and warrants became exercisable on December 31, 1994 at a price of $12.70 per share and expire on December 31, 2002. Proceeds to the Company from the offering totaled $3,559,000 as of December 31, 1992. Additional proceeds of $182,000 were received on January 19, 1993. In connection with the private placement, the Company issued (i) a warrant to Robert H. Leshner, principal of the placement agent, to purchase 110,250 shares of Common Stock (the "Leshner Warrant") and (ii) a warrant to Andrew E. Haas, which was subsequently reissued as two warrants to purchase 13,781 shares to each of Mr. Haas and Curtis Swindal, each at a purchase price of $12.70 per share exercisable in full on or after December 31, 1994 and before December 31, 2002. The Company agreed to grant the holders of the shares issued upon exercise of the warrants ("Warrant Shares") the right, on two occasions during the five-year period beginning December 31, 1994, to require the Company to register (the "Demand Registration") the Warrant Shares under the Securities Exchange Act of 1934 (the "Act"). The Company will pay the expenses of one Demand Registration. Under the terms of the Leshner Warrant, if Dr. Joel W. Kovner, former Chairman of the Board and Chief Executive Officer of the Company, dies before December 31, 2002, then the Company will purchase, at the option of Mr. Leshner, some or all of the warrants and/or Warrant Shares then owned by Mr. Leshner, provided that (i) the maximum aggregate purchase price paid by the Company shall be not more than $1,000,000 and (ii) the funds to purchase such warrants and/or Warrant Shares shall come solely from the proceeds of the key person life insurance policy on Dr. Kovner. Furthermore, if at any time prior to December 31, 2002 Mr. Leshner wishes to sell some or all of the warrants and/or Warrant Shares to a third party, Mr. Leshner must offer to sell such warrants and/or Warrant Shares to the Company on the same terms and conditions being offered to such third party. Another term of the Leshner Warrant restricts Bancorp's ability to issue certain types of preferred stock which would entitle the holders thereof to receive dividends or distributions of assets that vary in amount with Bancorp's performance. 84 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 9 - Commitments and Contingent Liabilities The Company leases its premises and certain equipment under several noncancellable operating leases which expire on various dates through January 31, 2007. Rental expense for the years ended December 31, 1998, 1997 and 1996 amounted to approximately $1,007,000, $1,089,000 and $1,000,000, respectively. The following is a schedule of future minimum rental commitments required under operating leases that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 1998:
Year ending December 31, (in thousands) - ------------------------ 1999 $1,056 2000 1,037 2001 949 2002 491 2003 348 Thereafter 2,198 ------ Total $6,079 ======
The building lease commitments are subject to cost-of-living adjustments to reflect future changes in the consumer price index or a fixed periodic rate increase. Those leases with fixed periodic rate increases and/or specified months with no rent due are amortized so that the average monthly cost of the lease is charged each month. Lending Commitments The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its clients. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The Bank's exposure to credit loss in the event of nonperformance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. At December 31, 1998 and 1997, the Company had commitments to extend credit of approximately $49,939,000 and $32,048,000, respectively, and obligations under standby letters of credit of approximately $6,517,000 and $6,832,000, respectively. These commitments and obligations were variable rate in structure. 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. At December 31, 1998, all guarantees extended for a period of 12 months or less. The Company uses the same credit policies in making commitments and conditional obligations as it does for extending loan facilities to clients. The Company evaluates each client's creditworthiness on a case-by-case basis. The amount of collateral obtained, if necessary by the Company upon an extension of credit, is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property plant and equipment and income-producing commercial real estate. Litigation The Company and its subsidiary are defendants in legal actions arising from transactions conducted in the ordinary course of their business. Based upon discussion with the Company's attorneys, management believes that the ultimate liability, if any, arising from such actions will not materially affect the Company's consolidated financial statements. A settlement between the Bancorp, Bank and St. Paul Mercury Insurance Company ("St. Paul"), Bancorp's and the Bank's director and officer liability insurance carrier, was finalized in December 1997. Pursuant to the settlement, St. Paul reimbursed the Company and the Bank $600,000 for certain non-recurring legal expenses in connection with the 1996 proxy contest and the litigation related thereto. Note 10 - Transactions Involving Directors and Affiliated Parties As part of its normal banking activities, the Company has extended credit to various directors and employees and their related interest. The credit extended to these individuals and affiliates for the two years ended December 31, 1998, is summarized as follows:
(in thousands) 1998 1997 ---- ---- Balance, beginning of year $3,711 $2,933 Credit granted 293 1,079 Loan payments (354) (301) ------ ------ Balance, end of year $3,650 $3,711 ====== ======
Interest income earned on these loans amounted to approximately $343,000, $286,000 and $276,000 during the years 1998, 1997 and 1996, respectively. A director of the Company and the Bank, who resigned in 1999, and a company to which he is associated, had extensions of credit totaling approximately $810,000 that were on nonaccrual status as of December 31, 1998. In the opinion of management, all of the above reference extensions of credit are on terms similar to transactions with nonaffiliated parties and involve only normal credit risk, when initially underwritten. Amounts included in deposits at December 31, 1998, related to directors and affiliated parties was approximately $418,000. 86 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company and the Bank entered into a Consulting Agreement with Network Health Financial Services, Inc. ("NHFS"), a California Corporation for which Melinda McIntyre-Kolpin serves as Chief Executive Officer. Pursuant to the Consulting Agreement, NHFS provides consulting services to the Company and the Bank with respect to personnel matters, operational procedures and client development and retention. NHFS is paid its actual costs incurred in the performance of its duties under the Consulting Agreement (including hourly rates for certain specified NHFS personnel while they are performing consulting services), plus an additional 25% of such costs. In addition, the Bancorp and Bank pay flat monthly rates for the services of Ms. McIntyre-Kolpin and Ms. Patti Derry. During 1998, the Bancorp and the Bank paid NHFS total fees in the amount of approximately $693,257 pursuant to the Consulting Agreement. Either party may terminate the Consulting Agreement by giving 30 days notice to the other party. Note 11 - Capital Adequacy and Restrictions on Dividend Payments The Office of the Comptroller of the Currency (the "OCC"), the Bank's primary regulator, has established minimum leverage ratio guidelines for national banks. These guidelines provide for a minimum Tier 1 capital leverage ratio (Tier 1 capital to adjusted total assets) of 3.0% for national banks that meet certain specified criteria, including having the highest regulatory rating. All other national banks will generally be required to maintain a minimum Tier 1 capital leverage ratio of 3.0% plus an additional 100 to 200 basis points. The OCC has not advised the Bank of any specific minimum Tier 1 capital leverage ratio applicable to it. The Federal Reserve Board, as the Company's primary regulator, has similarly established minimum leverage ratio guidelines for bank holding companies. These guidelines also provide for a minimum Tier 1 leverage ratio of 3.0% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a minimum Tier 1 capital leverage ratio of 3.0% plus an additional 100 to 200 basis points. The Federal Reserve Board has not advised the Company of any specific minimum Tier 1 capital leverage ratio applicable to it. Under risk-based capital standards, banking organizations are expected to meet a minimum ratio for qualifying total capital to risk-weighted assets of 8.0%, 4.0% of which must be Tier 1 capital. The Federal Deposit Insurance Act of 1991 contains "prompt correction action" provisions pursuant to which insured depository institutions are to be classified into one of five categories based primarily upon capital adequacy, ranging from "well capitalized" to "critically undercapitalized" and which require, subject to certain exceptions, the appropriate federal banking agency to take prompt corrective action with respect to an institution which becomes "undercapitalized" and to take additional actions if the institution becomes "significantly undercapitalized" or "critically undercapitalized." At December 31, 1998, the Company's and Bank's regulatory capital exceeded the thresholds necessary to be considered "well capitalized." There are no conditions or events since that date that management believes have changed the institution's category. 87 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table sets forth the minimum required regulatory capital ratios for a bank holding company and bank, and various regulatory capital ratios of the Company and the Bank at December 31, 1998.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------------------- ------------------------------ ------------------------------ (in thousands) Amount Ratio Amount Ratio Amount Ratio ----------- ------------ ------------ ------------- ------------ ------------- Company Leverage $25,592 9.59% $10,677 4.00% $13,346 5.00% Tier 1 Risk-Based 25,592 17.31 5,914 4.00 8,872 6.00 Total Risk-Based 28,561 19.32 11,829 8.00 14,786 10.00 Bank Leverage $22,297 8.37% $10,661 4.00% $13,326 5.00% Tier 1 Risk-Based 22,297 15.12 5,899 4.00 8,848 6.00 Total Risk-Based 24,145 16.37 11,797 8.00 14,747 10.00
Under federal banking law, dividends declared by the Bank in any calendar year may not, without the approval of the OCC, exceed its net earnings, as defined, for that year combined with its retained net earnings for the preceding two years. Dividends declared may not exceed amounts necessary to satisfy the aforementioned capital requirements. As of December 31, 1998, the Bank could not declare dividends without obtaining regulatory approval. Federal banking law also restricts the Bank from extending credit to the Company in excess of 10% of the capital stock and surplus, as defined. Any such extensions of credit are subject to strict collateral requirements. Note 12 - Convertible Notes On June 19, 1994, the Company completed a public offering of $5,750,000 in convertible subordinated reset notes (the "Notes") which mature on March 1, 2004 and incurred expenses of $1,205,000. Interest on the Notes is payable semiannually on March 1 and September 1 of each year, commencing on September 1, 1994 at the rate of 8.50% per annum until March 1, 1998, and from March 2, 1998 until the principal thereof is paid or made available for payment at a rate of 7.21% per annum, or the Reference Rate (as defined below) plus 150 basis points. The "Reference Rate" is the most recent "Five Year Constant Treasury Maturity Index" published by the Federal Reserve Bank, or its successor, at least 60 days prior to March 2, 1998. The Notes are convertible into common stock of the Company at any time prior to maturity, unless previously redeemed, at a conversion price of $12.6984 per share, subject to adjustment in certain events. The Notes are redeemable in whole or in part at the option of the Company at any time on or after March 2, 1998 at the redemption prices set, subject to the prior approval of the Board of Governors of the Federal Reserve System. During 1998, $4,321,000 of the Notes were converted into 334,494 common stock shares. During 1997, $180,000 of the Notes were converted into 14,174 common stock shares. During 1996, $2,000 of the Notes were converted into 157 common stock shares. During 1995, $131,000 of the Notes were converted into 10,316 common stock shares. If all $1,116,000 of the remaining Notes were converted into common stock, 87,885 shares of common stock would be issued. 88 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 13 - Derivative Financial Instruments The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. They are used to manage well-defined interest rate price risks. Interest rate floor and cap agreements are used to reduce the potential impact of changes in interest rates which would reduce the interest income and/or market value on loans and on certain securities. The Company entered into three interest rate floor agreements during December 1994 and January 1995 for a total notional amount of $60 million. The agreements entitled the Company to receive from counterparties on a monthly basis the amounts, if any, by which the one-month London Interbank Offered Rate ("LIBOR") falls below 6%. The floor agreements were for a period of three years. The average premium paid for the floor agreements was approximately 20 basis points or $120,000 and was being amortized over three years. In May 1995, the Company sold the floor contracts for total consideration of $722,500. This amount is being amortized over the original three year term. In 1997, 1996 and 1995, net interest income was increased approximately $235,000, $235,000 and $141,000, respectively, as a result of the interest rate floor agreements. In December 1995, the Company entered into two interest rate cap agreements for a notional amount of $10 million each. The agreements entitle the Company to receive from counterparties on a quarterly basis the amounts, if any, by which the one year Constant Maturity Treasury Index ("CMT") rises above 6.50% on a $10 million notional amount and 6.75% on a $10 million notional amount. The cap agreements are for a period of three years and expired December 1998. The average premium paid for the cap agreements was approximately 63.5 basis points or $127,000 and is being amortized over three years. Net interest income in 1998, 1997 and 1996 was decreased by the interest rate caps by approximately $40,000, $42,000 and $42,000, respectively. The Company uses interest rate swap agreements for the purpose of synthetically altering the interest rates on a portion of the Bank's super NOW and money market accounts. In January 1993, the Company entered into two interest rate swap agreements that paid the Company a fixed rate of 7.21% for three years beginning in January 1993, while the Company paid the prime rate. These swaps had a total notional amount of $40 million and terminated in January 1996. Net interest income for 1996 and 1995 was reduced by the two swaps by approximately $15,000 and $694,000, respectively. In November 1993, the Bank entered into a swap with a notional amount of $15 million to synthetically alter interest rates on a portion of the Bank's super NOW and money market accounts. The effective date of the swap is May 26, 1994 and it covers a period of five years ending in May 1999. Under the terms of the swap, the Bank pays a rate of prime less 190 basis points while receiving the three-month LIBOR. The rate the Bank pays adjusts daily while the rate the Bank receives adjusts quarterly. The terms of the swap originally included an interest rate cap, which was terminated in 1994, and an expense of approximately $385,000 was recorded. Net interest income for 1998, 1997 and 1996 was reduced by the swap by approximately $134,000 for each year, respectively. As of December 31, 1998, the Company was paying 6.31% and receiving 5.69%. The Company is exposed to potential credit losses in the event of nonperformance by the counterparties to its interest rate floor agreements, interest rate swap agreements and nonderivative financial assets, but has no off-balance-sheet credit risk of accounting loss. The Company anticipates, however, that counterparties will be able to fully satisfy their obligations under the contracts. The Company does not obtain collateral or other security to support the financial instruments subject to credit risk but monitors the credit standing of counterparties. 89 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 14 - Fair Value of Financial Instruments The estimated fair value amounts have been determined by the Bank using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Bank could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
December 31, 1998 December 31, 1997 ------------------------- ---------------------------- Carrying Estimated Carrying Estimated (in thousands) Value Fair Value Value Fair Value -------- ---------- -------- ------------ Assets: Cash and cash equivalents $ 31,965 $ 31,965 $ 54,340 $ 54,340 Securities available-for-sale 80,891 80,891 53,136 53,136 Securities held-to-maturity 24,081 24,135 34,660 34,708 Loans, net 115,519 116,091 103,900 104,979 Liabilities: Noninterest-bearing transaction accounts 109,422 109,422 97,746 97,746 Interest-bearing transaction accounts 16,710 16,710 14,961 14,961 Savings and money market accounts 75,501 75,501 89,226 89,226 Certificates of deposit and other time 28,948 28,799 27,530 27,526 deposits Convertible notes 1,116 1,051 5,437 6,518 Off-balance sheet assets: Interest rate swaps - 57 - (325) Interest rate caps - - 41 8 Lending commitments - - - - Standby letters of credit - - - -
The carrying values of cash and cash equivalents reported in the balance sheet approximate fair values due to the short-term nature of the assets. The fair value of marketable securities and interest rate swaps and caps is based on quoted market prices, dealer quotes, and prices obtained from independent pricing services. The fair values of loans are estimated using discounted cash flow analysis. The analysis was performed on a loan-by-loan basis by projecting each loan's expected cash flows and discounting these flows at appropriate discount rates. The expected cash flows were determined by contractually scheduled payments of principal and interest, incorporating scheduled rate adjustments, periodic caps, and lifetime ceilings and floors for adjustable loans. The fair values are based on a stable interest rate scenario and do not incorporate bid-ask spreads or discounts that might be required to dispose of assets in bulk. Discount rates applied to the expected cash flows were based on the Bank's offer rates for new loans with similar collateral and terms, adjusted to reflect differential risk based on collateral value, payment status, and/or credit classification at December 31, 1998 and 1997, respectively. 90 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The fair value of deposits with no defined maturities, such as demand deposits, money market deposits and savings accounts, is the amount payable on demand at the valuation date. For deposit liabilities with defined maturities, such as time certificates of deposit, estimation of fair value was based on the discounted value of future cash flows expected to be paid, where the discount rate was the Bank's offer rate for similar deposits with maturities equivalent to the remaining terms on the deposits being valued at December 31, 1998 and 1997, respectively. Standby letters of credit principally support corporate obligations and include $395,000 and $760,000 that was collateralized with cash at December 31, 1998 and 1997, respectively. At December 31, 1998, $6,517,000 of the standby letters of credit and $43,045,000 of other lending commitments expire within one year. The estimated fair value of lending commitments and letters of credit is estimated using fees currently charged for similar arrangements, adjusted for changes in interest rates and credit that occurred subsequent to origination. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1998 and 1997. 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 those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. 91 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 15 - Earnings Per Share The following table illustrates the computation of basic and diluted earnings per share:
Year ended December 31, -------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Numerator: Net earnings per statement of operations used in basic earnings per share consolidation: Basic earnings (loss) $1,431,599 $1,478,525 $(3,724,917) Interest savings on conversion of convertible notes, net of income taxes 149,200 279,435 /(1)/ ---------- ---------- ----- Diluted earnings (loss) $1,580,799 $1,757,960 $(3,724,917) ========== ========== =========== Denominator: Denominator for basic earnings per share - weighted average number of shares outstanding 1,768,663 1,345,972 1,341,316 Effect of dilutive securities: Warrants and Options 125,596 33,835 /(1)/ Convertible notes 253,942 428,164 - ---------- ---------- ----------- Denominator for diluted earnings per share 2,148,201 1,807,971 1,341,316 ========== ========== =========== Basic earnings (loss) per share $ 0.81 $ 1.10 $ (2.78) ========== ========== =========== Diluted earnings (loss) per share $ 0.74 $ 0.97 $ (2.78) ========== ========== ===========
(1) Anti-dilutive 92 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 16 - Parent Company Information The Bancorp has met its obligations principally from the payment of dividends from the Bank. As of December 31, 1998, the Bank was unable to pay dividends without obtaining regulatory approval. The following financial information represents the balance sheets of the Bancorp as of December 31, 1998 and 1997, the related statements of operations and of cash flows for the three-year period ended December 31, 1998.
Balance Sheets December 31, 1998 and 1997 1998 1997 ------------ ------------- (in thousands) Assets: Cash in First Professional Bank, N.A. $ 3,276 $ 638 Investment in First Professional Bank, N.A. 22,296 20,202 Loans 244 100 Other assets 708 666 ------- ------- $26,524 $21,606 ======= ======= Liabilities: Accrued expenses $ 77 $ 155 Convertible notes 1,116 5,437 Other liabilities 10 151 ------- ------- Total liabilities 1,203 5,743 Shareholders' equity 25,321 15,863 ------- ------- $26,524 $21,606 ======= =======
93 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Statement of Operations Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 ------------------- -------------- --------------- (in thousands) Income: Cash dividends from First Professional Bank, N.A. $ -- $ 425 $ 2,819 Interest 15 7 7 Other 4 4 - ------ ------ ------- Total income 19 436 2,826 ------ ------ ------- Expenses: Interest 253 474 477 Salaries and employer taxes 22 31 85 Amortization of convertible note expenses 69 104 104 Legal fees, net of legal settlement 218 (481) 1,805 Other professional services 117 67 101 Settlement costs - - 184 Pamphlets and brochures - - 8 Other 11 2 16 ------ ------ ------- Total expenses 690 196 2,780 ------ ------ ------- Earnings (loss) before income taxes and equity in undistributed net earnings of First Professional Bank, N.A. (671) 240 46 Provision for income taxes - - 1 ------ ------ ------- Earnings before equity in undistributed net earnings of First Professional Bank, N.A. (671) 240 45 Equity in undistributed net (loss) earnings of First Professional Bank, N.A. 2,103 1,239 (3,770) ------ ------ ------- Net (loss) earnings $1,432 $1,479 $(3,725) ====== ====== =======
94 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Statement of Cash Flows Years ended December 31, 1998, 1997 and 1996
1998 1997 1996 ---------- ---------- ---------- (in thousands) Cash flows from operating activities: Net earnings (loss) $ 1,432 $ 1,479 $(3,725) Adjustments to reconcile net income to net cash provided by (used in) operating activities: (Increase) decrease in other assets (39) (14) (1) (Decrease) increase in accrued expenses and other liabilities (186) (6) 153 Amortization of convertible note expenses 69 104 104 Equity in undistributed (earnings) loss of First Professional Bank, N.A. (2,103) (1,239) 3,770 ------- ------- ------- Net cash provided by (used in) operating activities (827) 324 301 ------- ------- ------- Cash flows from investing activities: Net decrease (increase) in loans (144) - 63 ------- ------- ------- Net cash provided by (used in) investing activities (144) - 63 ------- ------- ------- Cash flows from financing activities: Purchase of treasury stock - - (270) Proceeds from exercise of stock options 3,794 14 182 Other (185) - (4) ------- ------- ------- Net cash provided by (used in) financing activities 3,609 14 (92) ------- ------- ------- Net increase (decrease) in cash 2,638 338 272 Cash, beginning of year 638 300 28 ------- ------- ------- Cash, end of year $ 3,276 $ 638 $ 300 ======= ======= ======= Supplemental disclosure of cash flow information - cash paid during the year for: Interest $ 381 $ 474 $ 477 Income taxes $ - $ - $ 8
95 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 17 - Quarterly Financial Data (Unaudited) The following tables set forth the Company unaudited data regarding operations for each quarter of 1998, 1997 and 1996. This information, in the opinion of management, includes all normal recurring adjustments necessary to state fairly the information set forth therein. The operating results for any quarter are not necessarily indicative of results for any future period.
Quarter Ended ------------------------------------------------------------------------ Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, (in thousands, except per share data) 1998 1998 1998 1998 1997 1997 ---- ---- ---- ---- ---- ---- Interest income $4,476 $4,343 $4,120 $4,009 $ 4,375 $4,168 Interest expense 1,040 793 896 901 1,044 965 Net interest income 3,437 3,550 3,224 3,108 3,331 3,203 Provision for loan losses 406 - - - 60 Gains (losses) on securities: Available-for-sale 3 - (9) - - - Other income 387 418 469 467 368 455 Other expenses 2,702 3,096 3,296 3,133 2,453 3,325 Earnings (loss) before income taxes 719 872 388 442 1,246 273 Net earnings (loss) 392 512 224 304 778 199 Earnings (loss) per share (as restated): Basic 0.20 0.26 0.13 0.22 0.49 0.15 Diluted 0.18 0.22 0.13 0.17 0.45 0.15 Quarter Ended ------------------------------------------------------------------------- June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, (in thousands, except per share data) 1997 1997 1996 1996 1996 1996 ------ ------ ------ ------ ------- ------ Interest income $4,148 $4,019 $4,188 $4,207 $ 4,477 $4,778 Interest expense 896 921 992 1,053 1,302 1,503 Net interest income 3,252 3,098 3,196 3,154 3,175 3,275 Provision for loan losses 60 60 (120) 836 3,240 180 Gains (losses) on securities: Available-for-sale - - (92) 21 - - Other income 541 428 328 432 393 362 Other expenses 3,202 3,144 3,036 3,473 6,035 3,001 Earnings (loss) before income taxes 531 322 516 (702) (5,707) 456 Net earnings (loss) 312 190 333 (607) (3,726) 275 Earnings (loss) per share (as restated): Basic 0.23 0.14 0.24 (0.44) (2.73) 0.21 Diluted 0.23 0.14 0.24 (0.44) (2.73) 0.20
96 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In the second quarter of 1996, the Company added $3,240,000 to the allowance for loan losses in recognition that the quality of certain loans had deteriorated and to provide protection against future potential losses. Of the $3,240,000 provision, more than $1,915,000 related to one specific loan. In addition, nonrecurring costs of approximately $2,579,000 associated with the proxy contest and management restructuring were recorded in the same quarter. Earnings (loss) per share is based on the weighted average number of shares outstanding during each period. Full-year weighted average shares differ from quarterly weighted average shares and, therefore annual earnings (loss) per share may not equal the sum of the quarters. 97 EX-4.2 2 WARRANT TO PURCHASE 12,500 SHARES EXHIBIT 4.2 PROFESSIONAL BANCORP, INC. WARRANT TO PURCHASE 12,500 SHARES OF COMMON STOCK TABLE OF CONTENTS -----------------
Page ---- ARTICLE I - DEFINITIONS................................................ 1 Section 1.1: Definition of Terms.................................. 1 ARTICLE II - DURATION AND EXERCISE OF WARRANT........................... 3 Section 2.1: Duration of Warrant.................................. 3 Section 2.2: Exercise of Warrant.................................. 4 Section 2.3: Reservation of Shares................................ 4 Section 2.4: Fractional Shares.................................... 5 Section 2.5: Listing.............................................. 5 Section 2.6: Issue of Preferred Stock............................. 5 ARTICLE III - ADJUSTMENT OF SHARES OF COMMON STOCK PURCHASABLE AND OF EXERCISE PRICE...................... 6 Section 3.1: Mechanical Adjustments............................... 6 Section 3.2: Notices of Adjustment................................ 10 Section 3.3: No Adjustment for Dividends or Stock Options.............................................. 10 Section 3.4: Preservation of Purchase Rights in Certain Transactions................................. 11 Section 3.5: Form of Warrant After Adjustments.................... 12 Section 3.6: Treatment of Warrantholder........................... 12 ARTICLE IV - OTHER PROVISIONS RELATING TO RIGHTS OF WARRANTHOLDER.............................................. 12 Section 4.1: No Rights as Shareholders; Notice to Warrantholders....................................... 12 Section 4.2: Lost, Stolen, Mutilated or Destroyed Warrants........................................................... 14 ARTICLE V - SPLIT-UP, COMBINATION EXCHANGE AND TRANSFER OF WARRANTS................................................ 14 Section 5.1: Split-Up, Combination, Exchange and Transfer of Warrants................................. 14 Section 5.2: Restrictions on Transfer............................. 14 ARTICLE VI - REGISTRATION UNDER THE SECURITIES ACT OF 1933....................................................... 15 Section 6.1: Definitions.......................................... 15 Section 6.2: Demand for Registration.............................. 15 Section 6.3: Company Registration................................. 17 Section 6.4: Obligations of the Company........................... 17
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Page ---- Section 6.5: Furnish Information.................................. 19 Section 6.6: Expenses of Demand Registrations..................... 19 Section 6.7: Expenses of Company Registration..................... 19 Section 6.8: Underwriting Requirements............................ 19 Section 6.9: Delay of Registration................................ 20 Section 6.10: Indemnification...................................... 20 Section 6.11: Reports Under Securities Exchange Act of 1934.............................................. 22 Section 6.12: Assignment of Registration Rights.................... 23 Section 6.13: Limitations on Subsequent Registration Rights.................................. 23 Section 6.14: "Market Stand-off" Agreement......................... 23 ARTICLE VII - OTHER MATTERS........................................... 24 Section 7.1: Successors and Assigns............................... 24 Section 7.2: Integration/Entire Agreement......................... 24 Section 7.3: Amendments and Waivers............................... 24 Section 7.4: Counterparts......................................... 24 Section 7.5: Governing Law........................................ 24 Section 7.6: Severability......................................... 25 Section 7.7: Attorneys' Fees...................................... 25 Section 7.8: Computations of Consent.............................. 25 Section 7.9: Notice............................................... 25
-ii- THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY NOT BE OFFERED FOR SALE, SOLD OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT FILED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT. ANY SUCH TRANSFER MAY ALSO BE SUBJECT TO APPLICABLE STATE SECURITIES LAWS. VOID AFTER 5:00 P.M., LOS ANGELES TIME, ON DECEMBER 31, 2002 OR IF NOT A BUSINESS DAY, AS DEFINED HEREIN, AT 5:00 P.M., LOS ANGELES TIME, ON THE NEXT FOLLOWING BUSINESS DAY. WARRANT TO PURCHASE NO. 3 12,500 SHARES OF THE COMMON STOCK OF PROFESSIONAL BANCORP, INC. TRANSFER RESTRICTED -- SEE SECTION 5.2 This certifies that, for and in consideration of the closing of a private offering of the common stock of Professional Bancorp, Inc., a Pennsylvania corporation (the "Company"), Andrew E. Haas and his registered, permitted assigns (collectively, the "Warrantholder"), is entitled to purchase from the Company, subject to the terms and conditions hereof, at any time on or after 9:00 A.M., Los Angeles time, on December 31, 1994, and before 5:00 P.M., Los Angeles time on December 31, 2002, (or, if such day is not a Business Day, at or before 5:00 P.M., Los Angeles time, on the next following Business Day), the number of fully paid and non-assessable shares of Common Stock of the Company stated above at the Exercise Price (as defined herein). The Exercise Price and the number of shares purchasable hereunder are subject to adjustment from time to time as provided in Article III hereof. ARTICLE I DEFINITIONS Section 1.1: Definition of Terms. As used in this Warrant, the following ------------------- capitalized terms shall have the following respective meanings: (a) Business Day: A day other than a Saturday, Sunday or other day on ------------ which banks in the State of California are authorized by law to remain closed. (b) Common Stock: Common stock,, $.008 par value per share, of the ------------ Company. (c) Common Stock Equivalents: Securities that are convertible into, ------------------------ exchangeable for or exercisable for shares of Common Stock, including, without limitation, rights to subscribe for or to purchase, or any options for the purchase of, shares of Common Stock. (d) Current Market Price: The average of the high and low prices of -------------------- sales of the common Stock on all domestic exchanges on which the Common Stock may at the time be listed, or, if there shall have been no sales on any such exchange on any such day, the average of the bid and asked prices at the end of such day, or, if the Common Stock shall not be so listed, the average of the bid and asked prices at the end of the day on the over-the-counter market, in each such case averaged over a period of 20 consecutive business days prior to the day as of which "market price" is being determined. If at any time the Common Stock is not listed on many domestic exchange or quoted in the domestic over-the-counter market, the "market price" shall be deemed to be the higher of (a) the book value thereof as determined by any firm of independent public accountants of recognized standing selected by the Board of Directors of the Company as of the last day of any month ending within 60 days preceding the date as of which the determination is to be made or (b) the fair value thereof determined in good faith by the Board of Directors of the Company as of a date with is within 15 days of the date as of which the determination is to be made. (e) Exchange Act: The Securities Exchange Act of 1934, as amended. ------------ (f) Exercise-Price: $14.00 per Warrant Share, as such price may be -------------- adjusted from time to time pursuant to Article III hereof. (g) Expiration Date: 5:00 P.M., Los Angeles time, on December 31, 2002 or --------------- if such day is not a Business Day, the next succeeding day which is a Business Day. (h) Holder: A Holder of Registrable Securities. ------ (i) NASD: National Association of Securities Dealers, Inc. ---- and NASDAQ: NASD Automatic Quotation System. (j) Person: An individual, partnership, joint venture, corporation, ------ trust, unincorporated organization or government of any department or agency thereof. (k) Public Offering: A public offering of any of the Company's equity or --------------- debt securities pursuant to a registration statement under the Securities Act. -2- (1) Registrable.securities: Any Warrant Shares issued to Andrew E. Haas ----------------------- and/or his designees or transferees as permitted under Section 5.2 and/or other securities that may be or are issued by the Company upon exercise of this Warrant, including those which may thereafter be issued by the Company in respect of any such securities by means of any stock splits, stock dividends, recapitalizations, reclassifications or the like, and as adjusted pursuant to Article III hereof; provided, however, that as to any particular security contained in Registrable Securities, such securities shall cease to be Registrable securities when (i) a Registration Statement with respect to the sale of such securities shall have become effective under the Securities Act and such securities shall have been disposed of in accordance with such Registration Statement; or (ii) they shall have been sold to the public pursuant to Rule 144 (or any successor provision) under the Securities Act; or (iii) they shall have been sold, assigned or otherwise transferred to any person other than those persons specified in Section 5.2(i) below ("5.2(i) Persons") and other than any spouses, lineal descendants or adopted children of 5.2(i) Persons. (m) SEC: The Securities and Exchange Commission or any other federal ---- agency at the time administering the Securities Act or the Exchange Act. (n) Securities Act: The Securities Act of 1933, as amended. --------------- (o) Transfers: See Section 5.2. ---------- (p) Warrants: This Warrant, all other warrants issued on the date hereof -------- upon the terms of this Warrant and all other warrants that may be issued in its or their place (together evidencing the right to purchase an aggregate of up to 12,500 shares of Common Stock), originally issued as set forth in the definition of Registrable Securities. (q) Warrantholder: The person(s) or entity(ies) to whom this warrant is -------------- originally issued, or any successor in interest thereto, or any assignee or transferee thereof, in whose name this Warrant is registered upon the books to be maintained by the Company for that purpose. (r) Warrant Shares: Common Stock, Common Stock Equivalents and other --------------- securities purchased or purchasable upon exercise of the Warrants. ARTICLE II DURATION AND EXERCISE OF WARRANT Section 2.1: Duration of Warrant. The Warrantholder may exercise this ------------------- Warrant at any time and from time to time after -3- 9:00 A.M., Los Angeles time, on December 31, 1994, and before 5:00 P.M., Los Angeles time, on the Expiration Date. If this Warrant is not exercised on the Expiration Date, it shall become void, and all rights hereunder shall thereupon cease. Section 2.2: Exercise of Warrant: -------------------- (a) The Warrantholder may exercise this Warrant, in whole or in part, by presentation and surrender of this Warrant to the Company at its corporate office at 606 Broadway, Santa Monica,, California 90401, or at the office of its stock transfer agent with the Subscription Form annexed hereto duly executed and accompanied by payment of the full Exercise Price for each Warrant Share to be purchased. (b) Upon receipt of this Warrant with the Subscription Form fully executed and accompanied by payment of the aggregate Exercise Price for the Warrant Shares for which this Warrant is then being exercised, the Company shall cause to be issued certificates for the total number of whole shares of Common Stock for which this Warrant is being exercised (adjusted to reflect the effect of the anti-dilution provisions contained in Article III hereof, if any, and as provided in Section 2.4 hereof) in such denominations as are requested for delivery to the Warrantholder, and the Company shall thereupon deliver such certificates to the Warrantholder. The Warrantholder shall be deemed to be the holder of record of the shares of Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of the Company shall then be closed or that certificates representing such shares of Common Stock shall not then be actually delivered to the Warrantholder. If at the time this Warrant is exercised, a Registration Statement is not in effect to register under the Securities Act the Warrant Shares issuable upon exercise of this Warrant, the Company may require the Warrantholder to make such representations, and may place such legends on certificates representing the Warrant Shares, as may be reasonably required in the opinion of counsel to the Company to permit the Warrant Shares to be issued without such registration. (c) In the case the Warrantholder shall exercise this Warrant with respect to less than all of the Warrant Shares that may be purchased under this Warrant, the Company shall execute a new warrant in the form of this Warrant for the balance of such Warrant Shares and deliver such new warrant to the Warrantholder. (d) The Company shall pay any and all stock transfer and similar taxes which may be payable in respect of the issue of any Warrant Shares. Section 2.3: Reservation of Shares. The Company hereby agrees that at all --------------------- times there shall be reserved for issuance and -4- delivery upon exercise of this Warrant such number of shares of Common Stock or other shares of capital stock of the Company from time to time issuable upon exercise of this Warrant. All such shares shall be duly authorized, and when issued upon such exercise, shall be validly issued, fully paid and non- assessable, free and clear of all liens, security interests, charges and other encumbrances or restrictions on sale and free and clear of all preemptive rights. Section 2.4: Fractional Shares. The Company shall not be required to issue ----------------- any fraction of a share of its capital stock in connection with the exercise of this Warrant, and in any case where the Warrantholder would, except for the provisions of this Section 2.4, be entitled under the terms of this Warrant to receive a fraction of a share upon the exercise of this Warrant, the Company shall, upon the exercise of this Warrant and receipt of the Exercise Price, issue the largest number of whole shares purchasable upon exercise of this Warrant, and make a cash payment in respect of such fraction of a share to which the Warrantholder would otherwise be entitled. Section 2.5: Listing. Prior to the issuance of any shares of Common Stock ------- upon exercise of this Warrant, the Company shall secure the listing of such shares of Common Stock upon each national securities exchange or automated quotation system, upon which shares of Common Stock are then listed (subject to official notice of issuance upon exercise of this Warrant) if any, and shall maintain, so long as any other shares of Common Stock shall be so listed, such listing of all shares of Common Stock from time to time issuable upon the exercise of this Warrant; and the Company shall so list on each national securities exchange or automated quotation system, and shall maintain such listing of, any other shares of capital stock of the Company issuable upon the exercise of this Warrant if and so long as any shares of the same class shall be listed on such national securities exchange or automated quotation system. Section 2.6: Issue of Preferred Stock. So long as this warrant remains ------------------------ outstanding, the company will not issue any capital stock of any class preferred as to dividends or as to the distribution of assets upon voluntary or involuntary liquidation, dissolution or winding up unless the right of the holders thereof to participation in dividends shall be limited to a fixed sum, percentage of par value or percentage of the liquidation preference specified for such stock, whether cumulative or noncumulative, and the right of the holders thereof to such distribution of assets shall be limited to a fixed sum plus, if applicable, an amount equal to any accumulated but unpaid dividends thereon. 2.7 No Dilution or Impairment. The Company will not, by amendment ------------------------- of its certificate of incorporation or bylaws, or -5- through reorganization, consolidation, merger, dissolution, issue or sale of securities, sale of assets or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate in order to protect the rights of the holder of the Warrant against dilution or other impairment. ARTICLE III ADJUSTMENT OF SHARES OF COMMON STOCK PURCHASABLE AND OF EXERCISE PRICE The Exercise Price and the number and kind of Warrant Shares shall be subject to adjustment from time to time upon the happening of certain events as provided in this Article III. Section 3.1: Mechanical Adjustments. ---------------------- (a) If at any time prior to the exercise of this Warrant in full, the Company shall (i) declare a dividend or make a distribution on the Common Stock payable in its securities (whether shares of Common Stock or of capital stock of any other class,, or of Common Stock Equivalents); (ii) subdivide,, reclassify or recapitalize its outstanding common Stock into a greater number of shares; (iii) combine, reclassify or recapitalize its outstanding Common Stock into a smaller number of shares, or (iv) issue any shares of its capital stock by reclassification of its Common Stock (including any such reclassification in connection with a consolidation or a merger in which the Company is the continuing corporation), the Exercise Price in effect at the time of the record date of such dividend, distribution, subdivision, combination, reclassification or recapitalization shall be adjusted so that the Warrantholder shall be entitled to receive the aggregate number and kind of shares which, if this Warrant had been exercised in full immediately prior to such event, he would have owned upon such exercise and been entitled to receive by virtue of such dividend, distribution, subdivision, combination, reclassification or recapitalization. Any adjustment required by this paragraph 3.1(a) shall be made concurrently on the record date,, in the case of a dividend or distribution, or the effective date,, in the case of subdivision, combination, reclassification or recapitalization, to allow the purchase of such aggregate number and kind of shares. (b) If at any time prior to the exercise of this Warrant in full, the Company shall (i) issue or sell any Common Stock or Common Stock Equivalents without consideration or for consideration per share less than the Exercise Price or Current -6- Market Price in effect immediately prior to the date of such issuance or sale or (ii) fix a record date for the issuance of subscription rights, options or warrants to all holders of Common Stock entitling them to subscribe for or purchase Common Stock (or Common Stock Equivalents) at a price (or having an exercise or conversion price per share) less than the Exercise Price or Current Market Price in effect immediately prior to the record date described below, the Exercise Price shall be adjusted so that the Exercise Price shall equal the lower of the prices (determined to the nearest cent) determined by multiplying the Exercise Price in effect immediately prior to the date of such sale or issuance (which date in the event of distribution to shareholders shall be deemed to be the record date set by the Company to determine shareholders entitled to participate in such distribution) by each of the following fractions: (A) The numerator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such sale or issuance, plus (ii) the number of additional shares of Common Stock which the aggregate consideration received by the Company upon such issuance or sale (plus the aggregate of any additional amount to be received by the Company upon the exercise of such subscription rights, options or warrants) would purchase at such current Exercise Price per share of the Common Stock; and the denominator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such issuance or sale, plus (ii) the number of additional shares of Common Stock offered for the subscription or purchase (or into which the Common Stock Equivalents so offered are exercisable or convertible) and (B) The numerator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such sale or issuance, plus (ii) the number of additional shares of Common Stock which the aggregate consideration received by the Company upon such issuance or sale (plus the aggregate of any additional amount to be received by the Company upon the exercise of such subscription rights, options or warrants) would purchase at such Current Market Price per share of the Common Stock; and the denominator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such issuance or sale,, plus (ii) the number of additional shares of Common Stock offered for the subscription or purchase (or into which the Common stock Equivalents so offered are exercisable or convertible). Any adjustments required by this paragraph 3.1(b) shall be made concurrently with-such issuance or sale or record date, as the case may be. Such adjustments shall be made successively whenever such event shall occur. To the extent that shares of Common Stock (or Common Stock Equivalents) are not delivered after the expiration of such subscription rights, options or warrants, the Exercise Price shall be readjusted to the Exercise Price which would then be in effect had the adjustments made upon -7- the issuance of such rights, options or warrants been made upon the basis of delivery of only the number of shares of Common Stock (or Common Stock Equivalents) actually delivered. (c) If at any time prior to the exercise of this Warrant in full, the Company shall fix a record date for the issuance or making a distribution to all holders of the Common Stock (including any such distribution to be made in connection with a consolidation or merger in which the Company is to be the continuing corporation) of evidences of its indebtedness, any other securities of the Company or any cash, property or other assets (excluding a combination, reclassification or recapitalization referred to in Section 3.1(a), regular cash dividends or cash distributions paid out of net profits legally available therefor and in the ordinary course of business or subscription rights, options or warrants for Common Stock or Common Stock Equivalents (excluding those referred to in Section 3.1(b)) (any such non-excluded event being herein called a "Special Dividend"), (i) the Exercise Price shall be decreased immediately after the record date for such Special Dividend to a price determined by multiplying the Exercise Price then in effect by a fraction, the numerator of which shall be the Exercise Price in effect on such record date less the fair market value (as determined by the Company's Board of Directors) of the evidences of indebtedness, securities or property, or other assets issued or distributed in such Special Dividend applicable to one share of Common Stock or of such subscription rights or warrants applicable to one share of Common Stock and the denominator of which shall be such Exercise Price then in effect and (ii) the number of shares of Common Stock subject to purchase upon exercise of this Warrant shall be increased to a number determined by multiplying the number of shares of Common Stock subject to purchase immediately before such Special Dividend by a fraction, the numerator of which shall be the Exercise Price in effect immediately before such special Dividend and the denominator of which shall be the Exercise Price in effect immediately after such Special Dividend. Any adjustment required by this paragraph 3.1(c) shall be made successively whenever such a record date is fixed and in the event that such distribution is not so made, the Exercise Price shall again be adjusted to be the Exercise Price that was in effect immediately prior to such record date. (d) In case at any time the Company shall declare a dividend upon the Common Stock payable otherwise than out of earnings or earned surplus and otherwise than in common Stock or Common Stock Equivalents, then thereafter the holder hereof, upon the exercise of any of the rights represented by this Warrant, will be entitled to receive the number of shares of Common Stock being purchased upon such exercise and, in addition and without further payment, the cash, stock or other securities and other property which the holder hereof would have received by way of -8- dividends (otherwise than out of such earnings or surplus or in Common Stock or Common Stock Equivalents) if continuously since the date hereof such holder (i) had been the record holder of the number of shares of Common Stock then being purchased, or the rights to purchase such shares and (ii) had retained all dividends in stock or securities (other than Common Stock or Common Stock Equivalents) payable in respect of such Common Stock or in respect of any stock or securities paid as dividends and originating directly from such common Stock. For the purposes of the foregoing a dividend other than in cash shall be considered payable out of earnings or earned surplus only to the extent that such earnings or surplus are charged an amount equal to the fair value of such dividend as determined by the Board of Directors of the Company. (e) If at any time prior to the exercise of this Warrant in full, the Company shall make a distribution to all holders of the Common Stock of stock of a subsidiary or securities convertible into or exercisable for such stock, then in lieu of an adjustment in the Exercise Price or the number of Warrant Shares purchasable upon the exercise of this Warrant, each Warrantholder, upon the exercise hereof at any time after such distribution, shall be entitled to receive from the Company, such subsidiary or both, as the Company shall determine, the stock or other securities to which such Warrantholder would have been entitled if such Warrantholder had exercised this Warrant immediately prior thereto, all subject to further adjustment as provided in this Article III, and the Company shall reserve, for the life of the Warrant, such securities of such subsidiary or other corporation; provided, however, that no adjustment in respect of dividends or interest on such stock or other securities shall be made during the term of this Warrant or upon its exercise. (f) Whenever the Exercise Price payable upon exercise of each Warrant is adjusted pursuant to one or more of paragraphs (a), (b) and (c) of this Section 3.1, the number of Warrant Shares shall simultaneously be adjusted by multiplying the number of Warrant Shares initially issuable upon exercise of each Warrant by the Exercise Price in effect on the date thereof and dividing the product so obtained by the Exercise Price, as adjusted. (g) No adjustment in the Exercise Price shall be required unless such adjustment would require an increase or decrease of at least five cents ($.05) in such price; provided, however, that any adjustments which by reason of this paragraph (g) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 3.1 shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. Notwithstanding anything in this Section 3.1 to the contrary, the Exercise Price shall not be reduced to less than the then -9- existing par value of the Common Stock as a result of any adjustment made hereunder. (h) In the event that at any time, as a result of any adjustment made pursuant to Section 3.1(a), the Warrantholder thereafter shall become entitled to receive any shares of the Company other than Common Stock, thereafter the Exercise Price and number of such other shares so receivable upon exercise of any Warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in section 3.1(a). (i) In the case of an issue of additional Common Stock or Common Stock Equivalents for cash, the consideration received by the Company therefor, after deducting therefrom any discount or commission or other expenses paid by the Company for any underwriting of, or otherwise in connection with, the issuance thereof, shall be deemed to be the amount received by the Company therefor. The term "issue" shall include the sale or other disposition of shares held by or on account of the company or in the treasury of the Company but until so sold or otherwise disposed of such shares shall not be deemed outstanding. (j) In case at any time after the date hereof any shares of Common Stock or Common Stock Equivalents shall be issued or sold, in whole or in part, for a consideration other than cash, the amount of the consideration other than cash shall be valued by the Company's Board of Directors and such established value shall be deemed to be the fair value of such consideration. such established value plus any cash consideration received by the Company, after deducting any expenses incurred or any underwriting commission or concessions paid or allowed by the Company in connection with the sale of such securities, shall be deemed to be the consideration received by the Company. Section 3.2: Notice of Adjustment. Whenever the number of Warrant -------------------- Shares or the Exercise Price is adjusted as herein provided, the Company shall prepare and deliver forthwith to the Warrantholder a certificate signed by its President, and by any Vice President, Treasurer or Secretary, setting forth the adjusted number of shares purchasable upon the exercise of this Warrant and the Exercise Price of such shares after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which adjustment was made. Section 3.3: No Adjustment for Dividends or Stock Options. Except as -------------------------------------------- provided in Section 3.1 of this Agreement, no adjustment in respect of any cash dividends shall be made during the term of this Warrant or upon the exercise of this Warrant. Further, notwithstanding anything to the contrary in this Article -10- III, no adjustment shall be made in respect of (i) up to 648,660 shares of Common Stock issued to employees, officers and directors of the Company or any subsidiary of the Company pursuant to stock purchase or stock option plans or arrangements, or both, approved by the Board of Directors and (ii) up to an aggregate of 125,000 shares of Common Stock issued upon exercise of this Warrant and any other warrant originally issued on the date hereof. Section 3.4: Preservation of Purchase Rights in Certain Transactions. In ------------------------------------------------------- case of any reclassification, capital reorganization or other change of outstanding shares of Common Stock (other than a subdivision or combination of the outstanding Common Stock and other than a change in the par value of the Common Stock) or in case of any consolidation or merger of the Company with or into another corporation (other than merger with a subsidiary in which the Company is the continuing corporation and that does not result in any reclassification, capital reorganization or other change of outstanding shares of Common Stock of the class issuable upon exercise of this Warrant) or in the case of any sale, lease, transfer or conveyance to another corporation of the property and assets of the Company as an entirety or substantially as an entirety, the Company shall, as a condition precedent to such transaction cause such successor or purchasing corporation, as the case may be, to execute with the Warrantholder an agreement granting the Warrantholder the right thereafter, upon payment of the Exercise Price in effect immediately prior to such action, to receive upon exercise of this Warrant the kind and amount of shares and other securities and property which he would have owned or have been entitled to receive after the happening of such reclassification, change, consolidation, merger, sale or conveyance had this Warrant been exercised immediately prior to such action. Such agreement shall provide for adjustments in respect of such shares of stock and other securities and property, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Article III (including an immediate adjustment, by reason of such consolidation, merger or sale, of the Exercise Price to the value for the Common Stock reflected by the terms of such consolidation, merger or sale if the value so reflected is less than the Exercise Price in effect immediately prior to such consolidation, merger or sale). In the event that in connection with any such reclassification, capital reorganization, change, consolidation, merger, sale or conveyance, additional shares of Common Stock shall be issued in exchange, conversion, substitution or payment, in whole or in part, for, or of, a security of the Company other than Common Stock, any such issue shall be treated as an issue of Common Stock covered by the provisions of Article III. In the event of any consolidation or merger of the Company in which the Company is not the surviving corporation or in the event of any sale of all or substantially all of the assets of the Company for stock or other securities of any -11- corporation, the Company shall be deemed to have issued a number of shares of its Common Stock for stock or securities of the other corporation computed on the basis of the actual exchange ratio on which the transaction was predicated and for a consideration equal to the fair market value on the date of such transaction of such stock or securities of the other corporation, and if any such calculation results in adjustment of the Exercise Price, the determination of the number of shares of Common Stock issuable upon exercise of the Warrant immediately prior to such merger, conversion or sale, for purposes of this Section 3.4 shall be made after giving effect to such adjustment of the Exercise Price. In the event of a merger or consolidation of the Company with or into another corporation as a result of which a greater or lesser number of shares of Common Stock of the surviving corporation are issuable to holders of Common Stock of the company in respect of the number of shares of Common Stock of the company outstanding immediately prior to such merger or consolidation, then the Exercise Price in effect immediately prior to such merger or consolidation shall be adjusted in the same manner as though there were a subdivision or combination of the outstanding shares of Common Stock of the Company. The provisions of this Section 3.4 shall similarly apply to successive reclassifications, capital reorganizations, consolidations, mergers, sales or conveyances. Section 3.5: Form of Warrant After Adjustments. The form of this Warrant --------------------------------- need not be changed because of any adjustments in the Exercise Price of the number or kind of the Warrant Shares, and Warrants theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in this Warrant, as initially issued. Section 3.6: Treatment of Warrantholder. Prior to due presentment for -------------------------- registration of transfer of this Warrant, the Company may deem and treat the Warrantholder as the absolute owner of this Warrant (notwithstanding any notation of ownership or other writing hereon) for all purposes and shall not be affected by any notice to the contrary. ARTICLE IV OTHER PROVISIONS RELATING TO RIGHTS OF WARRANTHOLDER Section 4.1: No Rights as Shareholders; Notice to Warrantholders. Nothing --------------------------------------------------- contained in this Warrant shall be construed as conferring upon the Warrantholder or his or its transferees the right to vote or to receive dividends or to consent or to receive notice as a shareholder in respect of any meeting of shareholders for the election of directors of the -12- Company or of any other matter, or any rights whatsoever as shareholders of the Company. The Company shall give notice to the Warrantholder by registered mail if at any time prior to the expiration or exercise in full of the Warrants, any of the following events shall occur: (a) the Company shall authorize the payment of any dividend payable in any securities upon shares of Common Stock or authorize the making of any distribution (other than a cash dividend subject to the parenthetical set forth in Section 3.1(c)) to all holders of Common Stock; (b) the Company shall authorize the issuance to all holders of Common Stock of any additional shares of Common Stock or Common Stock Equivalents or of rights, options or warrants to subscribe for or purchase Common Stock or Common Stock Equivalents or of any other subscription rights, options or warrants; (c) a dissolution, liquidation or winding up of the Company shall be proposed; or (d) a capital reorganization or reclassification of the Common Stock (other than a subdivision or combination of the outstanding Common Stock and other than a change in the par value of the Common Stock) or any consolidation or merger of the Company with or into another corporation (other than a consolidation or merger in which the Company is the continuing corporation and that does not result in any reclassification or change of Common Stock outstanding) or in the case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety. Such notice shall be given on a date which is the earlier of a date (i) at least twenty (20) Business Days prior to the date fixed as a record date or effective date or the date of closing of the Company's stock transfer books for the determination of the shareholders entitled to such dividend, distribution or subscription rights, or for the determination of the shareholders entitled to vote on such proposed merger, consolidation, sale conveyance, dissolution, liquidation or winding up or (ii) at least twenty (20) Business Days prior to the payment of such dividend or distribution, issuance of such subscription rights, or effecting such merger, consolidation ' sale, conveyance, dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the stock transfer books, as the case may be. Failure to provide such notice shall not affect the validity of any action taken in connection with such dividend, distribution or subscription rights, or proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. -13- Section 4.2: Lost, Stolen, Mutilated or Destroyed Warrants. If this --------------------------------------------- Warrant is lost, stolen, mutilated or destroyed, the Company may, on such terms as to indemnity or otherwise as it may in its discretion impose (which shall, in the case of a mutilated Warrant,, include the surrender thereof), issue a new Warrant of like denomination and tenor as, and in substitution for, this Warrant. ARTICLE V SPLIT-UP, COMBINATION EXCHANGE AND TRANSFER OF WARRANTS Section 5.1: Split-up, Combination, Exchange and Transfer of Warrants. -------------------------------------------------------- Subject to the provisions of Section 5.2 hereof, this Warrant may be split up, combined or exchanged for another warrant or Warrants containing the same terms to purchase a like aggregate number of Warrant Shares. If the Warrantholder desires to split up, combine or exchange this Warrant, he shall make such request in writing delivered to the Company and shall surrender to the Company this Warrant and any other Warrants to be so split-up, combined or exchanged. Upon any such surrender for a split-up, combination or exchange, the Company shall execute and deliver to the person entitled thereto a Warrant or Warrants, as the case may be, as so requested. The Company shall not be required to effect any split-up, combination or exchange which will result in the issuance of a Warrant entitling the Warrantholder to purchase upon exercise a fraction of a share of Common Stock or a fractional Warrant. The Company may require such Warrantholder to pay a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any split-up, combination or exchange of Warrants. Section 5.2: Restrictions on Transfer. This Warrant may not be ------------------------ transferred, sold, assigned or hypothecated (any such action, a "Transfer") prior to a date two (2) years after the date hereof, except that, subject to regulatory approval, it may be Transferred to the spouse, lineal descendants or adopted children of Andrew E. Haas during such two-year period. Thereafter, neither this Warrant nor the Warrant Shares may be Transferred, except (i) to the spouse, lineal descendants or adopted children of Andrew E. Haas or (ii) to any underwriter in connection with a Public Offering of the Common Stock, provided (as to (ii)) that this Warrant is exercised upon such Transfer and the shares of Common Stock issued upon such exercise are sold by such underwriter as part of such Public Offering and, as to both (i) and (ii), only in accordance with and subject to the provisions of the Securities Act and the rules and regulations promulgated thereunder. If at the time of a Transfer, a Registration Statement is not in effect to register the Warrant Shares, the company may require the Warrantholder to make such -14- representations, and may place such legends on certificates representing the Warrant Shares, as may be reasonably required in the opinion of counsel to the Company to permit a Transfer without such registration. ARTICLE VI REGISTRATION UNDER THE SECURITIES ACT OF 1933 Section 6.1: Definitions. For purposes of this Article VI, the ----------- following additional definitions shall apply: (a) The terms "register", "registered," and "registration" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Securities Act of 1933, as amended (the "Act"), and the declaration or ordering of effective ness of such registration statement or document; (b) The term "Registered Securities" means any Registrable Securities which have been included in an effective registration statement pursuant to the terms hereof; (c) The number of shares of "Registrable Securities then outstanding" shall be determined by the number of shares of Common Stock outstanding which are, and the number of shares of Common Stock issuable pursuant to then exercisable or convertible securities which are, respectively, Registrable Securities. Section 6.2: Demand for Registration. ----------------------- (a) If the Company shall receive at any time after a date two years after the date hereof, but prior to a date seven (7) years after the date hereof, a written request from the holders of a majority of the Registrable Securities then outstanding that the Company file a registration statement under the Act covering the registration of the shares of Registrable Securities that are the subject of such request (a "Demand Registration"), then the Company shall, within ten (10) days of the receipt thereof, give written notice of such request to all holders of Registrable Securities and shall, subject to the limitations of Subsection 6.2(e), use its best efforts to effect as soon as practicable the registration under the Act in accordance with this Section 6.2(a) of all Registrable Securities which the holders request be registered within thirty (30) days after the mailing of such notice by the Company in accordance wi.with Section 7.9. (b) If the holders initiating a registration request under Subsection 6.2(a) (the "Initiating Holders") intend to distribute the Registrable Securities, covered by their request by means of an underwriting, they shall so advise the Company as a part of -15- their request made pursuant to this Section 6.2, and the Company shall include such information in the written notice referred to in Subsection 6.2(a). The underwriter will be selected by a majority in interest of the respective Initiating Holders and shall be reasonably acceptable to the Company. In such event, the right of any holder to include his securities in such registration shall be conditioned upon such holder's participation in such underwriting and the inclusion of such holder's securities in the underwriting (unless otherwise mutually agreed by a majority in interest of the Initiating Holders and such holder) to the extent provided herein. All holders proposing to distribute their securities through such underwriting shall (together with the Company as provided in Subsection 6.4(e)) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by a majority in interest of the Initiating Holders. Notwithstanding any other provision of this section 6.2, if the underwriter advises the Initiating Holders in writing that marketing factors require a limitation of the number of shares to be underwritten, then the Initiating Holders shall so advise all holders of Registrable Securities, which would otherwise be underwritten pursuant hereto, and the number of shares of such securities that may be included in the underwriting shall be allocated among all of the respective holders thereof, including the Initiating Holders. (c) The Company is obligated to effect only two Demand Registrations pursuant to this Section 6.2. (d) Notwithstanding the foregoing, if the Company shall furnish to the Initiating Holders requesting a registration statement pursuant to Subsection 6.2(a), a certificate signed by the President of the Company stating that in the good faith judgment of the Board of Directors of the Company, it would be seriously detrimental to the Company and its stockholders for such registration statement to be filed and it is therefore essential to defer the filing of such registration statement, the Company shall have the right to defer such filing for a period of not more than sixty (60) days after receipt of the request of the Initiating Holders; provided, however, that the Company may not utilize this right with respect to a request under Subsection 6.2(a) more than once in any twelve (12) month period. (e) Notwithstanding the foregoing provisions of this Section 6.2, if at the time of any request by the Initiating Holders under this Section 6.2, the Company has fixed plans to file within forty-five (45) days after such request for the sale of any of its securities in a public offering under the Act, no registration of the Initiating Holders, securities shall be initiated under this Section 6.2 until one hundred eighty (180) days after the effective date of such registration unless the company is no longer proceeding diligently to effect such -16- registration; provided that the Company shall provide the holders of Registrable Securities the right to participate in such public offering pursuant to, and subject to Section 6.3 hereof. Section 6.3: Company Registration. -------------------- If at any time after a date two years after the date hereof, but prior to a date five (5) years after the date of exercise of this Warrant (but without any obligation to do so), the Company proposes to register (a "Piggy Back Registration") (including for this purpose a registration effected by the Company for stockholders other than the Holders of Registrable Securities) any of its Common Stock under the Act in connection with the public offering of such Common Stock solely for cash (other than a registration relating solely to the sale of Common Stock to participants in a Company stock plan, or a registration on any form which does not include substantially the same information as would be required to be included in a registration statement covering the sale of the Registrable Securities), the Company shall, at such time, promptly give each Holder of Registrable Securities written notice of such registration. Upon the written request of each Holder given within thirty (30) days after mailing of such notice by the Company in accordance with Section 7.9, the Company shall use its best efforts, subject to the provisions of Section 6.8, to cause to be registered under the Act all of the Registrable Securities that each Holder has requested to be registered; provided that the Company shall have the right to postpone or withdraw any registration effected pursuant to this Subsection 6.3 without obligation to any Holder. Section 6.4: Obligations of the Company. Whenever required under this -------------------------- Agreement to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible: (a) Prepare and file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective for up to one hundred twenty (120) days. (b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Act with respect to the disposition of all securities covered by such registration statement. (c) Furnish to the Holders of Registered securities such numbers of copies of a prospectus, including a preliminary -17- prospectus, in conformity with the requirements of the Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registered Securities owned by them. (d) Use its best efforts to register and qualify the Registered Securities under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the holders thereof, provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions. (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering. Each holder of Registrable Securities participating in such underwriting shall also enter into and perform its obligations under such an agreement. (f) Notify each holder of Registered Securities covered by such registration statement in the event the company has delivered preliminary or final prospectuses to any such holder and, after having done so, such prospectus is amended to comply with the requirements of the Act. Upon such notification, such holders shall immediately cease making offers of Registered Securities and return all prospectuses to the Company. The Company shall promptly provide such holders with revised prospectuses and, following receipt of the revised prospectuses,, such Holders shall be free to resume making offers of the Registered securities. (g) Furnish, at the request of any holder requesting registration of Registrable Securities pursuant to this Agreement, on the date that such Registrable Securities are delivered to the underwriters for sale in connection with a registration pursuant to this Agreement, if such securities are being sold through underwriters, or, if such securities are not being sold through underwriters ' on the date that the registration statement with respect to such securities becomes effective, (i) an opinion, dated such date, of the counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the holders of such Registered Securities and (ii) a letter dated such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the holders of such Registered Securities. -18- Section 6.5: Furnish Information. It shall be a condition precedent to the ------------------- obligations of the Company to take any action pursuant to this Agreement with respect to the Registrable Securities of any selling Holder (the "Selling Holder") that such Selling Holder shall furnish to the Company such information regarding itself, the Registrable Securities held by it, and the intended method of disposition of such securities as shall be required to effect the registration o f such Selling Holder's Registrable Securities. Section 6.6: Expenses of Demand Registrations. All expenses other than -------------------------------- underwriting discounts and commissions incurred in connection with the first Demand Registration conducted pursuant to Section 6.2, including (without limitation) all registration, filing and qualification fees, printing and accounting fees, fees and disbursements of counsel for the Company, and the reasonable fees and disbursements of one counsel for the Selling Holders shall be borne by the Company, and all such expenses incurred in connection with any subsequent Demand Registration shall be borne by the Selling Holders; provided, however, that the Company shall not be required to pay for any expenses of any registration proceeding begun pursuant to Section 6.2 if the registration request is subsequently withdrawn at the request of the holders of a majority of the Registrable Securities to be registered (in which case all Initiating Holders shall bear such expenses and a Demand Registration shall be deemed not to have been conducted for purposes of this Section 6.6), unless the holders of a majority of the securities to be registered agree to forfeit their right to such Demand Registration; provided further, however, that if at the time of such withdrawal, such holders have learned of a material adverse change in the condition or business of the Company from that known to such holders at the time of their request and have withdrawn the request with reasonable promptness following disclosure by the Company of such material adverse change, then such holders shall not be required to pay any of such expenses and shall retain their rights pursuant to Subsection 6.2. Section 6.7: Expenses of Company Registration. The company shall bear and -------------------------------- pay all expenses incurred in connection with all registrations, filings or qualifications of Registrable Securities with respect to all Piggy Back Registrations pursuant to Section 6.3 for each Holder (which right may be assigned as provided in Section 6.12), including (without limitation) all registration, filing, and qualification fees, printing and accounting fees relating or apportionable thereto, and the fees and disbursements of one counsel for the Selling Holders, but excluding underwriting discounts and commissions relating to Registrable Securities. Section 6.8: Underwriting Requirements. In connection with any offering ------------------------- involving an underwriting of shares of the Company's -19- capital stock, the Company shall not be required under section 6.3 to include any of the Holders' securities in such underwriting unless they accept the terms of the underwriting as agreed upon between the Company and the underwriters selected by it (or by other persons entitled to select the underwriters), and then only in such quantity as the underwriters determine in their sole discretion will not jeopardize the success of the offering by the Company. If the total amount of securities, including Registrable Securities, requested by stockholders to be included in such offering exceeds the amount of securities sold other than by the Company that the underwriters determine in their sole discretion is compatible with the success of the offering, then the company shall be required to include in the offering only that number of such securities, including Registrable securities, which the underwriters determine in their sole discretion will not jeopardize the success of the offering (the securities so included to be apportioned pro rata among the selling stockholders according to the total amount of securities entitled to be included therein owned by each selling stockholder or in such other proportions as shall mutually be agreed to by such selling stockholders) but in no event shall (i) the amount of Registrable Securities of the Selling Holders included in the offering be reduced below twenty-five percent (25%) of the total amount of securities included in such offering, or (ii) notwithstanding (i) above, any shares being sold by a Selling Holder exercising a demand registration right under Section 6.2 be excluded from such offering except in accordance with Section 6.2. Section 6.9: Delay of-Registration. No Holder shall have any right to --------------------- obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of t his Agreement. Section 6.10: Indemnification. In the event any Registrable Securities are --------------- included in a registration statement under this Warrant: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Selling Holder of Registered Securities and such Selling Holder's officers and directors, any underwriter (as defined in the Act) for such Selling Holder and each person, if any, who controls such Selling Holder or underwriter within the meaning of the Act or the Securities Exchange Act of 1934, as amended (the 111934 Act") (each, an "Indemnitee), against any losses, claims, damages, or liabilities (joint or several) to which they may become subject under the Act, or the 1934 Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively a -20- "Violation"): (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein not misleading, or (iii) any violation or alleged violation by the Company of the Act, the 1934 Act, any state securities law or any rule or regulation promulgated under the Act, or the 1934 Act or any state securities law; and the Company will pay to each such Indemnitee, as incurred, any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Subsection 10(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld), nor shall the Company be liable in any such case for any such loss, claim, damage, liability, or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by any such Indemnitee. (b) To the extent permitted by law, each Selling Holder will indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the registration statement, each person, if any, who controls the Company within the meaning of the Act, any underwriter, any other Selling Holder selling securities in such registration statement and any controlling person of any such underwriter or other Selling Holder, against any losses, claims, damages, or liabilities (joint or several) to which any of the foregoing persons may become subject, under the Act, or the 1934 Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereto) arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Selling Holder expressly for use in connection with such registration; and each such Selling Holder will pay, as incurred, any legal or other expenses reasonably incurred by any person intended to be indemnified pursuant to this Subsection 6.10(b), in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Subsection 6.10(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Selling Holder, which consent shall not be unreasonably withheld; provided, that, in no event shall any -21- indemnity under this Subsection 6.10(b) exceed the gross proceeds from the offering received by such Selling Holder. (c) Promptly after receipt by an indemnified party under this Section 6.10 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 6.10, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties, provided, however, that an indemnified party (together with all other indemnified parties which may be represented without conflict by one counsel) shall have the right to retain one separate counsel, with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action, if prejudicial to its ability to defend such action, shall relieve such indemnifying party of any liability to the indemnified party under this Section 6.10 to the extent of such prejudice, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this Section 6.10. (d) The obligations of the Company and Selling Holders under this Section 6.10 shall survive the completion of any offering of Registered Securities under this Agreement, and otherwise. Section 6.11: Reports Under Securities Exchange Act of 1934. With a view --------------------------------------------- to making available to the Holders of Registrable Securities the benefits of Rule 144 promulgated under the Act and any other rule or regulation of the SEC that may at any time permit a holder thereof to sell securities of the Company to the public without registration or pursuant to a registration on Form S-3, the Comp any agrees to: (a) file with the SEC in a timely manner all reports and other documents required of the Company under the Act and the 1934 Act; and (b) furnish to any holder, so long as the holder owns any Registrable Securities, forthwith upon request (i) a written statement by the Company that it has complied with the reporting requirements of SEC Rule 144, the securities Act and the 1934 Act -22- (at any time after it has become subject to such reporting requirements), (ii) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company, and (iii) such other information as may be reasonably requested in availing any holder of any rule or regulation of the SEC which permits the selling of any such securities without registration or pursuant to such form. Section 6.12: Assignment of Registration Rights. The rights to cause the --------------------------------- Company to register Registrable securities pursuant to this Agreement may be assigned (but only with all related obligations) by a holder to a transferee or assignee of such Registrable Securities, provided: (i) the Company is, within a reasonable time after such transfer, furnished with written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned; (ii) such assignment shall be effective only if immediately following such transfer the further disposition of such securities by the transferee or assignee is restricted under the Act; (iii) such transferee or assignee shall as a condition to such transfer, deliver to the Company a written instrument by which such transferee agrees to be bound by the obligations imposed upon holders of Registrable securities pursuant to this ARTICLE VI; and (iv) any such transferee or assignee may not again transfer such rights to any other person or entity, other than as provided in this Section 6.12. Section 6.13: Limitations on Subsequent Registration Rights. From and --------------------------------------------- after the date of this Agreement, the Company shall not, without the prior written consent of the holders of a majority of the outstanding Registrable Securities, enter into any agreement with any holder or prospective holder of any securities of the Company which would allow such holder or prospective holder (a) to include such securities in any registration filed under Section 6.2 hereof, unless under the terms of such agreement, such holder or prospective holder may include such securities in any such registration only to the extent that the inclusion of his securities will not reduce the amount of the Registrable Securities of the holders which is included, or (b) to make a demand registration which could result in such registration statement being declared effective within one hundred twenty (120) days of the effective date of any registration effected pursuant to Section 6.2. Section 6.14: "Market Stand-Off" Agreement. Each party to this Agreement ---------------------------- hereby agrees that, during the period of duration specified by the Company and an underwriter of Common Stock or other securities of the Company, following the effective date of a registration statement of the Company filed under the Act, it shall not, to the extent requested by the Company and such underwriter, directly or indirectly sell, offer to sell, contract to sell (including, without limitation, any short sale), grant -23- any option to purchase or otherwise transfer or dispose of (other than to donees who agree to be similarly bound) any securities of the company held by it at any time during such period except Common Stock included in such registration; provided, however, that all officers and directors of the Company and all other persons with registration rights (whether or not pursuant to this Agreement) enter into similar agreements. In order to enforce the foregoing covenant, the Company may impose stop- transfer instructions with respect to the Registrable Securities of each such holder until the end of such period. ARTICLE VII OTHER MATTERS Section 7.1: Successors and Assigns. All the covenants and provisions of ---------------------- this Warrant by or for the benefit of the Company shall bind and inure to the benefi t of its successors and assigns hereunder. Section 7.2: Integration/Entire Agreement. This Warrant is intended by ---------------------------- the parties as a final expression of their agreement and intended to be a complete and exclusive statement of the agreement and understanding of the parties hereto in respect of the subject matter contained herein. There are no restrictions, promises, warranties or undertakings, other than those set forth or referred to herein with respect to the registration rights granted by the Company with respect to the Warrants. This Warrant supersedes all prior agreements and understandings between the parties with respect to such subject matter (other than warrants previously issued by the Company to the Warrantholder.) Section 7.3: Amendments and Waivers. The provisions of this Warrant, ---------------------- including the provisions of this sentence, may not be amended, modified or supplemented, and waiver or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of holders of at least a majority of the outstanding Registrable Securities. Holders shall be bound by any consent authorized by this Section whether or not certificates representing such Registrable Securities have been marked to indicate such consent. Section 7.4: Counterparts. This Warrant may be executed-in any number of ------------ counterparts and by the parties hereto in separate counterparts, each of which so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. -24- Section 7.5: Governing Law. This Warrant shall be governed by and ------------- construed in accordance with the laws of the State of California. Section 7.6: Severability. In the event that any one or more of the ------------ provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provisions in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. Section 7.7: Attorneys' Fees. In any action or proceeding brought to --------------- enforce any provisions of this Warrant, or where any provisions hereof or thereof is validly asserted as a defense,, the successful party shall be entitled to recover reasonable attorneys' fees and disbursements in addition to its costs and expenses and any other available remedy. Section 7.8: Computations of Consent. Whenever the consent or approval ----------------------- of Holders of a specified percentage of Registrable securities is required hereunder, Registrable Securities held by the Company or its affiliates (other than the Warrantholder or subsequent Holders if they are deemed to be such affiliates solely by reason of their holdings of such Registrable Securities) shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage. Section 7.9: Notice. Any notices or certificates by the Company to the ------ Holder and by the Holder to the Company shall be deemed delivered if in writing and delivered in person or by registered mail (return receipt requested) to the Holder addressed to him in care of Bear Stearns & Company, 1999 Avenue of the Stars, Los Angeles, California 90067, if the Holder has designated, by notice in writing to the Company, any other address, to such other address, and if to the Company, addressed to it at: 606 Broadway, Santa Monica, California 90401. The Company may change its address by written notice to the Holder and the Holder may change its address by written notice to the Company. -25- IN WITNESS WHEREOF, this Warrant has been duly executed by the Company under its corporate seal as of the 16th day of March 1993. ATTEST: PROFESSIONAL BANCORP, INC. /s/ [ILLEGIBLE SIGNATURE] By: /s/ Joel W. Kovner - ------------------------- ---------------------------- Secretary Joel W. Kovner, Dr., P.H. Chairman of the Board, President and Chief Executive officer -26- PROFESSIONAL BANCORP, INC. ASSIGNMENT (To be executed only upon assignment of Warrant Certificate) For value received , hereby sells, assigns and ---------------------- transfers unto the within Warrant Certificate, together with ------------------- all right, title and interest therein, and does hereby irrevocably constitute and appoint attorney, to transfer said Warrant Certificate ---------------------- on the books of the within-named Company with respect to the number of Warrants set forth below, with full power of substitution in the premises: Name(s) of Assignee(s) Address No. of Warrants ------------------- --------------- And if said number of Warrants shall not be all the Warrants represented by the Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the Warrants registered by said Warrant Certificate. Dated: , 19 ------------------- --- Signature ------------------------ Note: The above signature should correspond exactly with the name on the face of this Warrant Certificate -27- SUBSCRIPTION FORM (To be executed upon exercise of Warrant) PROFESSIONAL BANCORP, INC. The undersigned hereby irrevocably elects to exercise the right of purchaser represented by the within Warrant Certificate for, and to purchase thereunder, shares of Common Stock, as provided for --------------------- therein, and tenders herewith payment of the purchase price in full in the form of cash or a certified or official bank check in the amount of $ . ----------------------- Please issue a certificate or certificates for such Common Stock in the name of, and pay any cash for any fractional share to: Name ----------------------------------- (Please print Name, Address and Social Security No.) Signature ------------------------------ Note: The above signature should correspond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment from below. If said number of shares shall not be all the shares purchasable under the within Warrant Certificate, a new Warrant certificate is to be issued in the name of said undersigned for the balance remaining of the shares purchasable thereunder rounded up to the next higher number of shares. -28- EX-4.3 3 WARRANT TO PURCHASE - CURTIS SWINDAL EXHIBIT 4.3 PROFESSIONAL BANCORP, INC. WARRANT TO PURCHASE 12,500 SHARES OF COMMON STOCK TABLE OF CONTENTS
Page ---- ARTICLE I - DEFINITIONS................................................... 1 Section 1.1: Definition of Terms.................................... 1 ARTICLE II - DURATION AND EXERCISE OF WARRANT.............................. 3 Section 2.1: Duration of Warrant.................................... 3 Section 2.2: Exercise of Warrant.................................... 4 Section 2.3: Reservation of Shares.................................. 4 Section 2.4: Fractional Shares...................................... 5 Section 2.5: Listing................................................ 5 Section 2.6: Issue of Preferred Stock............................... 5 ARTICLE III - ADJUSTMENT OF SHARES OF COMMON STOCK PURCHASABLE AND OF EXERCISE PRICE............................. 6 Section 3.1: Mechanical Adjustments................................. 6 Section 3.2: Notices of Adjustment.................................. 10 Section 3.3: No Adjustment for Dividends or Stock Options................................................ 10 Section 3.4: Preservation of Purchase Rights in Certain Transactions................................... 11 Section 3.5: Form of Warrant After Adjustments...................... 12 Section 3.6: Treatment of Warrantholder............................. 12 ARTICLE IV - OTHER PROVISIONS RELATING TO RIGHTS OF WARRANTHOLDER................................................. 12 Section 4.1: No Rights as Shareholders; Notice to Warrantholders......................................... 12 Section 4.2: Lost, Stolen, Mutilated or Destroyed Warrants............................................... 14 ARTICLE V - SPLIT-UP, COMBINATION EXCHANGE AND TRANSFER OF WARRANTS................................................... 14 Section 5.1: Split-Up, Combination, Exchange and Transfer of Warrants................................... 14 Section 5.2: Restrictions on Transfer............................... 14 ARTICLE VI - REGISTRATION UNDER THE SECURITIES ACT OF 1933.......................................................... 15 Section 6.1: Definitions............................................. 15 Section 6.2: Demand for Registration................................. 15 Section 6.3: Company Registration.................................... 17 Section 6.4: Obligations of the Company.............................. 17
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Page ---- Section 6.5: Furnish Information.................................... 19 Section 6.6: Expenses of Demand Registrations....................... 19 Section 6.7: Expenses of Company Registration....................... 19 Section 6.8: Underwriting Requirements.............................. 19 Section 6.9: Delay of Registration.................................. 20 Section 6.10: Indemnification........................................ 20 Section 6.11: Reports Under Securities Exchange Act of 1934................................................ 22 Section 6.12: Assignment of Registration Rights...................... 23 Section 6.13: Limitations on Subsequent Registration Rights.................................... 23 Section 6.14: "Market Stand-Off" Agreement........................... 23 ARTICLE VII - OTHER MATTERS................................................. 24 Section 7.1: Successors and Assigns................................. 24 Section 7.2: Integration/Entire Agreement........................... 24 Section 7.3: Amendments and Waivers................................. 24 Section 7.4: Counterparts........................................... 24 Section 7.5: Governing Law.......................................... 24 Section 7.6: Severability........................................... 25 Section 7.7: Attorneys' Fees........................................ 25 Section 7.8: Computations of Consent................................ 25 Section 7.9: Notice................................................. 25
-ii- THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY NOT BE OFFERED FOR SALE, SOLD OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT FILED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT. ANY SUCH TRANSFER MAY ALSO BE SUBJECT TO APPLICABLE STATE SECURITIES LAWS. VOID AFTER 5:00 P.M., LOS ANGELES TIME, ON DECEMBER 31, 2002 OR IF NOT A BUSINESS DAY, AS DEFINED HEREIN, AT 5:00 P.M., LOS ANGELES TIME, ON THE NEXT FOLLOWING BUSINESS DAY. WARRANT TO PURCHASE NO. 4 12,500 SHARES OF THE COMMON STOCK OF PROFESSIONAL BANCORP, INC. TRANSFER RESTRICTED -- SEE SECTION 5.2 This certifies that, for and in consideration of the closing of a private offering of the Common Stock of Professional Bancorp, Inc., a Pennsylvania corporation (the "Company"), Curtis Swindal and his registered, permitted assigns (collectively, the "Warrantholder"), is entitled to purchase from the Company, subject to the terms and conditions hereof, at any time on or after 9:00 A.M., Los Angeles time, on December 31, 1994, and before 5:00 P.M., Los Angeles time on December 31, 2002, (or, if such day is not a Business Day, at or before 5:00 P.M., Los Angeles time, on the next following Business Day), the number of fully paid and non-assessable shares of Common Stock of the Company stated above at the Exercise Price (as defined herein). The Exercise Price and the number of shares purchasable hereunder are subject to adjustment from time to time as provided in Article III hereof. ARTICLE I DEFINITIONS Section 1.1: Definition of Terms. As used in this Warrant, the following ------------------- capitalized terms shall have the following respective meanings: (a) Business Day: A day other than a Saturday, Sunday or other day on which ------------ banks in the State of California are authorized by law to remain closed. (b) Common Stock: Common stock, $.008 par value per share, of the Company. ------------ (c) Common Stock Equivalents: Securities that are convertible into, ------------------------ exchangeable for or exercisable for shares of Common Stock, including, without limitation, rights to subscribe for or to purchase, or any options for the purchase of, shares of Common Stock. (d) Current Market Price: The average of the high and low prices of sales -------------------- of the Common Stock on all domestic exchanges on which the Common Stock may at the time be listed, or, if there shall have been no sales on any such exchange on any such day, the average of the bid and asked prices at the end of such day, or, if the Common Stock shall not be so listed, the average of the bid and asked prices at the end of the day on the over-thecounter market, in each such case averaged over a period of 20 consecutive business days prior to the day as of which "market price" is being determined. If at any time the Common Stock is not listed on many domestic exchange or quoted in the domestic over-the-counter market, the "market price" shall be deemed to be the higher of (a) the book value thereof as determined by any firm of independent public accountants of recognized standing selected by the Board of Directors of the Company as of the last day of any month ending within 60 days preceding the date as of which the determination is to be made or (b) the fair value thereof determined in good faith by the Board of Directors of the Company as of a date with is within 15 days of the date as of which the determination is to be made. (e) Exchange Act: The Securities Exchange Act of 1934, as amended. ------------ (f) Exercise Price: $14.00 per Warrant Share, as such price may be adjusted -------------- from time to time pursuant to Article III hereof. (g) Expiration Date: 5:00 P.M., Los Angeles time, on December 31, 2002 or --------------- if such day is not a Business Day, the next succeeding day which is a Business Day. (h) Holder: A Holder of Registrable Securities. ------ (i) NASD: National Association of Securities Dealers, Inc. ---- and NASDAQ: NASD Automatic Quotation System. (j) Person: An individual, partnership, joint venture, corporation, trust, ------ unincorporated organization or government of any department or agency thereof. (k) Public offering: A public offering of any of the Company's equity or --------------- debt securities pursuant to a registration statement under the Securities Act. -2- (1) Registrable Securities: Any Warrant Shares issued to Curtis Swindal ---------------------- and/or his designees or transferees as permitted under Section 5.2 and/or other securities that may be or are issued by the Company upon exercise of this Warrant, including those which may thereafter be issued by the Company in respect of any such securities by means of any stock splits, stock dividends, recapitalizations, reclassifications or the like, and as adjusted pursuant to Article III hereof; provided, however, that as to any particular security contained in Registrable Securities, such securities shall cease to be Registrable securities when (i) a Registration Statement with respect to the sale of such securities shall have become effective under the Securities Act and such securities shall have been disposed of in accordance with such Registration Statement; or (ii) they shall have been sold to the public pursuant to Rule 144 (or any successor provision) under the Securities Act; or (iii) they shall have been sold, assigned or otherwise transferred to any person other than those persons specified in section 5.2(i) below ("5.2(i) Persons") and other than any spouses, lineal descendants or adopted children of 5.2(i) Persons. (m) SEC: The Securities and Exchange Commission or any other federal agency --- at the time administering the Securities Act or the Exchange Act. (n) Securities Act: The Securities Act of 1933, as amended. -------------- (o) Transfers: See Section 5.2. --------- (p) Warrants: This Warrant, all other warrants issued on -------- the date hereof upon the terms of this Warrant and all other warrants that may be issued in its or their place (together evidencing the right to purchase an aggregate of up to 12,500 shares of Common Stock), originally issued as set forth in the definition of Registrable Securities. (q) Warrantholder: The person(s) or entity(ies) to whom this Warrant is ------------- originally issued, or any successor in interest thereto, or any assignee or transferee thereof, in whose name this Warrant is registered upon the books to be maintained by the Company for that purpose. (r) Warrant Shares: Common Stock, Common Stock Equivalents and other -------------- securities purchased or purchasable upon exercise of the Warrants. ARTICLE II DURATION AND EXERCISE OF WARRANT Section 2.1: Duration of Warrant. The Warrantholder may exercise this ------------------- Warrant at any time and from time to time after -3- 9:00 A.M., Los Angeles time, on December 31, 1994, and before 5:00 P.M., Los Angeles time, on the Expiration Date. If this Warrant is not exercised on the Expiration Date, it shall become void, and all rights hereunder shall thereupon cease. Section 2.2: Exercise of Warrant: -------------------- (a) The Warrantholder may exercise this Warrant, in whole or in part, by presentation and surrender of this Warrant to the Company at its corporate office at 606 Broadway, Santa Monica, California 90401, or at the office of its stock transfer agent with the Subscription Form annexed hereto duly executed and .accompanied by payment of the full Exercise Price for each Warrant Share to be purchased. (b) Upon receipt of this Warrant with the Subscription Form fully executed and accompanied by payment of the aggregate Exercise Price for the Warrant Shares for which this Warrant is then being exercised, the Company shall cause to be issued certificates for the total number of whole shares of Common Stock for which this Warrant is being exercised (adjusted to reflect the effect of the anti-dilution provisions contained in Article III hereof, if any, and as provided in Section 2.4 hereof) in such denominations as are requested for delivery to the Warrantholder, and the Company shall thereupon deliver such certificates to the Warrantholder. The Warrantholder shall be deemed to be the holder of record of the shares of Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of the Company shall then be closed or that certificates representing such shares of Common Stock shall not then be actually delivered to the Warrantholder. If at the time this Warrant is exercised, a Registration Statement is not in effect to register under the Securities Act the Warrant Shares issuable upon exercise of this Warrant, the Company may require the Warrantholder to make such representations, and may place such legends on certificates representing the Warrant Shares, as may be reasonably required in the opinion of counsel to the Company to permit the Warrant Shares to be issued without such registration. (c) In the case the Warrantholder shall exercise this Warrant with respect to less than all of the Warrant Shares that may be purchased under this Warrant, the Company shall execute a new warrant in the form of this Warrant for the balance of such Warrant Shares and deliver such new warrant to the Warrantholder. (d) The Company shall pay any and all stock transfer and similar taxes which may be payable in respect of the issue of any Warrant Shares. Section 2.3: Reservation of Shares. The Company hereby agrees that at all --------------------- times there shall be reserved for issuance and -4- delivery upon exercise of this Warrant such number of shares of Common Stock or other shares of capital stock of the Company from time to time issuable upon exercise of this Warrant. All such shares shall be duly authorized, and when issued upon such exercise, shall be validly issued, fully paid and non- assessable, free and clear of all liens, security interests, charges and other encumbrances or restrictions on sale and free and clear of all preemptive rights. Section 2.4: Fractional Shares. The Company shall not be required to issue ----------------- any fraction of a share of its capital stock in connection with the exercise of this Warrant, and in any case where the Warrantholder would, except for the provisions of this Section 2.4, be entitled under the terms of this Warrant to receive a fraction of a share upon the exercise of this Warrant, the Company shall, upon the exercise of this Warrant and receipt of the Exercise Price, issue the largest number of whole shares purchasable upon exercise of this Warrant, and make a cash payment in respect of such fraction of a share to which the Warrantholder would otherwise be entitled. Section 2.5: Listing. Prior to the issuance of any shares of Common Stock ------- upon exercise of this Warrant, the Company shall secure the listing of such shares of Common Stock upon each national securities exchange or automated quotation system, upon which shares of Common Stock are then listed (subject to official notice of issuance upon exercise of this Warrant) if any, and shall maintain, so long as any other shares of Common Stock shall be so listed, such listing of all shares of Common Stock from time to time issuable upon the exercise of this Warrant; and the Company shall so list on each national securities exchange or automated quotation system, and shall maintain such listing of, any other shares of capital stock of the company issuable upon the exercise of this Warrant if and so long as any shares of the same class shall be listed on such national securities exchange or automated quotation system. Section 2.6: Issue of Preferred Stock. So long as this Warrant remains ------------------------ outstanding, the Company will not issue any capital stock of any class preferred as to dividends or as to the distribution of assets upon voluntary or involuntary liquidation, dissolution or winding up unless the right of the holders thereof to participation in dividends shall be limited to a fixed sum, percentage of par value or percentage of the liquidation preference specified for such stock, whether cumulative or noncumulative, and the right of the holders thereof to such distribution of assets shall be limited to a fixed sum plus, if applicable, an amount equal to any accumulated but unpaid dividends thereon. 2.7 No Dilution or Impairment. The Company will not, by amendment of ------------------------- its certificate of incorporation or bylaws, or -5- through reorganization, consolidation, merger, dissolution, issue or sale of securities, sale of assets or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate in order to protect the rights of the holder of the Warrant against dilution or other impairment. ARTICLE III ADJUSTMENT OF SHARES OF COMMON STOCK PURCHASABLE AND OF EXERCISE PRICE The Exercise Price and the number and kind of Warrant Shares shall be subject to adjustment from time to time upon the happening of certain events as provided in this Article III. Section 3.1: Mechanical Adiustments. ---------------------- (a) If at any time prior to the exercise of this Warrant in full, the Company shall (i) declare a dividend or make a distribution on the Common Stock payable in its securities (whether shares of Common Stock or of capital stock of any other class, or of Common Stock Equivalents); (ii) subdivide, reclassify or recapitalize its outstanding common stock into a greater number of shares; (iii) combine, reclassify or recapitalize its outstanding Common Stock into a smaller number of shares, or (iv) issue any shares of its capital stock by reclassification of its Common Stock (including any such reclassification in connection with a consolidation or a merger in which the Company is the continuing corporation), the Exercise Price in effect at the time of the record date of such dividend, distribution, subdivision, combination, reclassification or recapitalization shall be adjusted so that the Warrantholder shall be entitled to receive the aggregate number and kind of shares which, if this Warrant had been exercised in full immediately prior to such event, he would have owned upon such exercise and been entitled to receive by virtue of such dividend, distribution, subdivision, combination, reclassification or recapitalization. Any adjustment required by this paragraph 3.1(a) shall be made concurrently on the record date, in the case of a dividend or distribution, or the effective date, in the case of subdivision, combination, reclassification or recapitalization, to allow the purchase of such aggregate number and kind of shares. (b) If at any time prior to the exercise of this Warrant in full, the Company shall (i) issue or sell any Common Stock or Common Stock Equivalents without consideration or for consideration per share less than the Exercise Price or current -6- Market Price in effect immediately prior to the date of such issuance or sale or (ii) fix a record date for the issuance of subscription rights, options or warrants to all holders of Common Stock entitling them to subscribe for or purchase Common Stock (or Common Stock Equivalents) at a price (or having an exercise or conversion price per share) less than the Exercise Price or Current Market Price in effect immediately prior to the record date described below, the Exercise Price shall be adjusted so that the Exercise Price shall equal the lower of the prices (determined to the nearest cent) determined by multiplying the Exercise Price in effect immediately prior to the date of such sale or issuance (which date in the event of distribution to shareholders shall be deemed to be the record date set by the Company to determine shareholders entitled to participate in such distribution) by each of the following fractions: (A) The numerator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such sale or issuance, plus (ii) the number of additional shares of Common Stock which the aggregate consideration received by the Company upon such issuance or sale (plus the aggregate of any additional amount to be received by the Company upon the exercise of such subscription rights, options or warrants) would purchase at such current Exercise Price per share of the Common Stock; and the denominator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such issuance or sale, plus (ii) the number of additional shares of Common Stock offered for the subscription or purchase (or into which the Common Stock Equivalents so offered are exercisable or convertible) and (B) The numerator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such sale or issuance, plus (ii) the number of additional shares of Common Stock which the aggregate consideration received by the Company upon such issuance or sale (plus the aggregate of any additional amount to be received by the Company upon the exercise of such subscription rights, options or warrants) would purchase at such Current Market Price per share of the Common Stock; and the denominator of which shall be (i) the number of shares of Common Stock outstanding immediately prior to such issuance or sale, plus (ii) the number of additional shares of Common Stock offered for the subscription or purchase (or into which the Common Stock Equivalents so offered are exercisable or convertible). Any adjustments required by this paragraph 3.1(b) shall be made concurrently with.such issuance or sale or record date, as the case may be. Such adjustments shall be made successively whenever such event shall occur. To the extent that shares of Common Stock (or Common Stock Equivalents) are not delivered after the expiration of such subscription rights, options or warrants, the Exercise Price shall be readjusted to the Exercise Price which would then be in effect had the adjustments made upon -7- the issuance of such rights, options or warrants been made upon the basis of delivery of only the number of shares of Common Stock (or Common Stock Equivalents) actually delivered. (c) If at any time prior to the exercise of this Warrant in full, the Company shall fix a record date for the issuance or making a distribution to all holders of the Common Stock (including any such distribution to be made in connection with a consolidation or merger in which the Company is to be the continuing corporation) of evidences of its indebtedness, any other securities of the Company or any cash, property or other assets (excluding a combination, reclassification or recapitalization referred to in Section 3.1(a), regular cash dividends or cash distributions paid out of net profits legally available therefor and in the ordinary course of business or subscription rights, options or warrants for Common Stock or Common Stock Equivalents (excluding those referred to in section 3.1(b)) (any such non-excluded event being herein called a "Special Dividend"), (i) the Exercise Price shall be decreased immediately after the record date for such Special Dividend to a price determined by multiplying the Exercise Price then in effect by a fraction, the numerator of which shall be the Exercise Price in effect on such record date less the fair market value (as determined by the Company's Board of Directors) of the evidences of indebtedness, securities or property, or other assets issued or distributed in such Special Dividend applicable to one share of Common Stock or of such subscription rights or warrants applicable to one share of Common Stock and the denominator of which shall be such Exercise Price then in effect and (ii) the number of shares of Common Stock subject to purchase upon exercise of this Warrant shall be increased to a number determined by multiplying the number of shares of Common Stock subject to purchase immediately before such Special Dividend by a fraction, the numerator of which shall be the Exercise Price in effect immediately before such special Dividend and the denominator of which shall be the Exercise Price in effect immediately after such Special Dividend. Any adjustment required by this paragraph 3.1(c) shall be made successively whenever such a record date is fixed and in the event that such distribution is not so made, the Exercise Price shall again be adjusted to be the Exercise Price that was in effect immediately prior to such record date. (d) In case at any time the Company shall declare a dividend upon the Common Stock payable otherwise than out of earnings or earned surplus and otherwise than in Common Stock or Common Stock Equivalents, then thereafter the holder hereof, upon the exercise of any of the rights represented by this Warrant, will be entitled to receive the number of shares of Common Stock being purchased upon such exercise and, in addition and without further payment, the cash, stock or other securities and other property which the holder hereof would have received by way of -8- dividends (otherwise than out of such earnings or surplus or in Common Stock or Common Stock Equivalents) if continuously since the date hereof such holder (i) had been the record holder of the number of shares of Common Stock then being purchased, or the rights to purchase such shares and (ii) had retained all dividends in stock or securities (other than Common Stock or Common Stock Equivalents) payable in respect of such Common Stock or in respect of any stock or securities paid as dividends and originating directly from such Common Stock. For the purposes of the foregoing a dividend other than in cash shall be considered payable out of earnings or earned surplus only to the extent that such earnings or surplus are charged an amount equal to the fair value of such dividend as determined by the Board of Directors of the Company. (e) If at any time prior to the exercise of this Warrant in full, the Company shall make a distribution to all holders of the Common Stock of stock of a subsidiary or securities convertible into or exercisable for such stock, then in lieu of an adjustment in the Exercise Price or the number of Warrant Shares purchasable upon the exercise of this Warrant, each Warrantholder, upon the exercise hereof at any time after such distribution, shall be entitled to receive from the Company, such subsidiary or both, as the Company shall determine, the stock or other securities to which such Warrantholder would have been entitled if such Warrantholder had exercised this Warrant immediately prior thereto, all subject to further adjustment as provided in this Article III, and the Company shall reserve, for the life of the Warrant, such securities of such subsidiary or other corporation; provided, however, that no adjustment in respect of dividends or interest on such stock or other securities shall be made during the term of this Warrant or upon its exercise. (f) Whenever the Exercise Price payable upon exercise of each Warrant is adjusted pursuant to one or more of paragraphs (a), (b) and (c) of this section 3.1, the number of Warrant Shares shall simultaneously be adjusted by multiplying the number of Warrant Shares initially issuable upon exercise of each Warrant by the Exercise Price in effect on the date thereof and dividing the product so obtained by the Exercise Price, as adjusted. (9) No adjustment in the Exercise Price shall be required unless such adjustment would require an increase or decrease of at least five cents ($.05) in such price; provided, however, that any adjustments which by reason of this paragraph (g) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this section 3.1 shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. Notwithstanding anything in this Section 3.1 to the contrary, the Exercise Price shall not be reduced to less than the then -9- existing par value of the Common Stock as a result of any adjustment made hereunder. (h) In the event that at any time, as a result of any adjustment made pursuant to Section 3.1(a), the Warrantholder thereafter shall become entitled to receive any shares of the Company other than Common Stock, thereafter the Exercise Price and number of such other shares so receivable upon exercise of any Warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in Section 3.1(a). (i) In the case of an issue of additional Common Stock or Common Stock Equivalents for cash, the consideration received by the Company therefor, after deducting therefrom any discount or commission or other expenses paid by the Company for any underwriting of, or otherwise in connection with, the issuance thereof, shall be deemed to be the amount received by the Company therefor. The term "issue" shall include the sale or other disposition of shares held by or on account of the Company or in the treasury of the Company but until so sold or otherwise disposed of such shares shall not be deemed outstanding. (j) In case at any time after the date hereof any shares of Common Stock or Common Stock Equivalents shall be issued or sold, in whole or in part, for a consideration other than cash, the amount of the consideration other than cash shall be valued by the Company's Board of Directors and such established value shall be deemed to be the fair value of such consideration. Such established value plus any cash consideration received by the Company, after deducting any expenses incurred or any underwriting commission or concessions paid or allowed by the Company in connection with the sale of such securities, shall be deemed to be the consideration received by the Company. Section 3.2: Notices of Adjustment. Whenever the number of Warrant Shares --------------------- or the Exercise Price is adjusted as herein provided, the Company shall prepare and deliver forthwith to the Warrantholder a certificate signed by its President, and by any Vice President, Treasurer or Secretary, setting forth the adjusted number of shares purchasable upon the exercise of this Warrant and the Exercise Price of such shares after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which adjustment was made. Section 3.3: No Adjustment for Dividend or Stock Options. Except as ------------------------------------------- provided in section 3.1 of this Agreement, no adjustment in respect of any cash dividends shall be made during the term of this Warrant or upon the exercise of this Warrant. Further, notwithstanding anything to the contrary in this Article -10- III, no adjustment shall be made in respect of (i) up to 648,660 shares of Common Stock issued to employees, officers and directors of the Company or any subsidiary of the Company pursuant to stock purchase or stock option plans or arrangements, or both, approved by the Board of Directors and (ii) up to an aggregate of 125,000 shares of Common Stock issued upon exercise of this Warrant and any other warrant originally issued on the date hereof. Section 3.4: Preservation of Purchase Rights in certain Transactions. In ------------------------------------------------------- case of any reclassification ' capital reorganization or other change of outstanding shares of Common Stock (other than a subdivision or combination of the outstanding Common Stock and other than a change in the par value of the Common Stock) or in case of any consolidation or merger of the Company with or into another corporation (other than merger with a subsidiary in which the Company is the continuing corporation and that does not result in any reclassification, capital reorganization or other change of outstanding shares of Common Stock of the class issuable upon exercise of this Warrant) or in the case of any sale, lease, transfer or conveyance to another corporation of the property and assets of the Company as an entirety or substantially as an entirety, the Company shall, as a condition precedent to such transaction cause such successor or purchasing corporation, as the case may be, to execute with the Warrantholder an agreement granting the Warrantholder the right thereafter, upon payment of the Exercise Price in effect immediately prior to such action, to receive upon exercise of this Warrant the kind and amount of shares and other securities and property which he would have owned or have been entitled to receive after the happening of such reclassification, change, consolidation, merger, sale or conveyance had this Warrant been exercised immediately prior to such action. Such agreement shall provide for adjustments in respect of such shares of stock and other securities and property, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Article III (including an immediate adjustment, by reason of such consolidation, merger or sale, of the Exercise Price to the value for the Common Stock reflected by the terms of such consolidation, merger or sale if the value so reflected is less than the Exercise Price in effect immediately prior to such consolidation, merger or sale). In the event that in connection with any such reclassification, capital reorganization, change, consolidation, merger, sale or conveyance, additional shares of Common Stock shall be issued in exchange, conversion, substitution or payment, in whole or in part, for, or of, a security of the Company other than Common Stock, any such issue shall be treated as an issue of Common Stock covered by the provisions of Article III. In the event of any consolidation or merger of the Company in which the company is not the surviving corporation or in the event of any sale of all or substantially all of the assets of the Company for stock or other securities of any -11- corporation, the Company shall be deemed to have issued a number of shares of its Common Stock for stock or securities of the other corporation computed on the basis of the actual exchange ratio on which the transaction was predicated and for a consideration equal to the fair market value on the date of such transaction of such stock or securities of the other corporation, and if any such calculation results in adjustment of the Exercise Price, the determination of the number of shares of Common Stock issuable upon exercise of the Warrant immediately prior to such merger, conversion or sale, for purposes of this Section 3.4 shall be made after giving effect to such adjustment of the Exercise Price. In the event of a merger or consolidation of the Company with or into another corporation as a result of which a greater or lesser number of shares of Common Stock of the surviving corporation are issuable to holders of Common Stock of the Company in respect of the number of shares of Common Stock of the Company outstanding immediately prior to such merger or consolidation, then the Exercise Price in effect immediately prior to such merger or consolidation shall be adjusted in the same manner as though there were a subdivision or combination of the outstanding shares of Common Stock of the Company. The provisions of this Section 3.4 shall similarly apply to successive reclassifications, capital reorganizations, consolidations, mergers, sales or conveyances. Section 3.5: Form of Warrant After Adiustments. The form of this Warrant --------------------------------- need not be changed because of any adjustments in the Exercise Price of the number or kind of the Warrant Shares, and Warrants theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in this Warrant, as initially issued. Section 3.6: Treatment of Warrantholder. Prior to due presentment for -------------------------- registration of transfer of this Warrant, the Company may deem and treat the Warrantholder as the absolute owner of this Warrant (notwithstanding any notation of ownership or other writing hereon) for all purposes and shall not be affected by any notice to the contrary. ARTICLE IV OTHER PROVISIONS RELATING TO RIGHTS OF WARRKNTHOLDER Section 4.1: No Rights as Shareholders; Notice to Warrantholders. Nothing --------------------------------------------------- contained in this Warrant shall be construed as conferring upon the Warrantholder or his or its transferees the right to vote or to receive dividends or to consent or to receive notice as a shareholder in respect of any meeting of shareholders for the election of directors of the -12- Company or of any other matter, or any rights whatsoever as shareholders of the Company. The Company shall give notice to the Warrantholder by registered mail if at any time prior to the expiration or exercise in full of the Warrants, any of the following events shall occur: (a) the Company shall authorize the payment of any dividend payable in any securities upon shares of Common Stock or authorize the making of any distribution (other than a cash dividend subject to the parenthetical set forth in Section 3.1(c)) to all holders of Common Stock; (b) the Company shall authorize the issuance to all holders of Common Stock of any additional shares of Common Stock or Common Stock Equivalents or of rights, options or warrants to subscribe for or purchase Common Stock or Common Stock Equivalents or of any other subscription rights, options or warrants; (c) a dissolution, liquidation or winding up of the Company shall be proposed; or (d) a capital reorganization or reclassification of the Common Stock (other than a subdivision or combination of the outstanding Common Stock and other than a change in the par value of the Common Stock) or any consolidation or merger of the Company with or into another corporation (other than a consolidation or merger in which the Company is the continuing corporation and that does not result in any reclassification or change of Common Stock outstanding) or in the case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety. Such notice shall be given on a date which is the earlier of a date (i) at least twenty (20) Business Days prior to the date fixed as a record date or effective date or the date of closing of the Company's stock transfer books for the determination of the shareholders entitled to such dividend, distribution or subscription rights, or for the determination of the shareholders entitled to vote on such proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up or (ii) at least twenty (20) Business Days prior to the payment of such dividend or distribution, issuance of such subscription rights, or effecting such merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the stock transfer books, as the case may be. Failure to provide such notice shall not affect the validity of any action taken in connection with such dividend, distribution or subscription rights, or proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. -13- Section 4.2: Lost, Stolen, Mutilated or Destroyed Warrants. If this --------------------------------------------- Warrant is lost, stolen, mutilated or destroyed, the Company may, on such terms as to indemnity or otherwise as it may in its discretion impose (which shall, in the case of a mutilated Warrant, include the surrender thereof), issue a new Warrant of like denomination and tenor as, and in substitution for, this Warrant. ARTICLE V SPLIT-UP, COMBINATION EXCHANGE AND TRANSFER OF WARRANTS Section 5.1: Split-Up, Combination, Exchange and Transfer of Warrants. -------------------------------------------- ----------- Subject to the provisions of Section 5.2 hereof, this Warrant may be split up, combined or exchanged for another Warrant or Warrants containing the same terms to purchase a like aggregate number of Warrant Shares. If the Warrantholder desires to split up, combine or exchange this Warrant, he shall make such request in writing delivered to the Company and shall surrender to the Company this Warrant and any other Warrants to be so split-up, combined or exchanged. Upon any such surrender for a split-up, combination or exchange, the Company shall execute and deliver to the person entitled thereto a Warrant or Warrants, as the case may be, as so requested. The Company shall not be required to effect any split-up, combination or exchange which will result in the issuance of a Warrant entitling the Warrantholder to purchase upon exercise a fraction of a share of Common Stock or a fractional Warrant. The Company may require such Warrantholder to pay a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any split-up, combination or exchange of Warrants. Section 5.2: Restrictions on Transfer. This Warrant may not be ------------------------ transferred, sold, assigned or hypothecated (any such action, a "Transfer") prior to a date two (2) years after the date hereof, except that, subject to regulatory approval, it may be Transferred to the spouse, lineal descendants or adopted children of Curtis Swindal during such two-year period. Thereafter, neither this Warrant nor the Warrant Shares may be Transferred except (i) to the spouse, lineal descendants or adopted childr'en of Curtis Swindal or (ii) to any underwriter in connection with a Public Offering of the Common Stock, provided (as to (ii)) that this Warrant is exercised upon such Transfer and the shares of Common Stock issued upon such exercise are sold by such underwriter as part of such Public Offering and, as to both (i) and (ii), only in accordance with and subject to the provisions of the Securities Act and the rules and regulations promulgated thereunder. If at the time of a Transfer, a Registration Statement is not in effect to register the Warrant Shares, the company may require the Warrantholder to make such -14- representations, and may place such legends on certificates representing the Warrant Shares, as may be reasonably required in the opinion of counsel to the Company to permit a Transfer without such registration. ARTICLE VI REGISTRATION UNDER THE SECURITIES ACT OF 1933 Section 6.1: Definitions. For purposes of this Article VI, the following ----------- additional definitions shall apply: (a) The terms "register", "registered," and "registration" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Securities Act of 1933, as amended (the "Act"), and the declaration or ordering of effectiveness of such registration statement or document; (b) The term "Registered Securities" means any Registrable Securities which have been included in an effective registration statement pursuant to the terms hereof; (c) The number of shares of "Registrable Securities then outstanding" shall be determined by the number of shares of Common Stock outstanding which are, and the number of shares of Common Stock issuable pursuant to then exercisable or convertible securities which are, respectively, Registrable Securities. Section 6.2: Demand for-Registration. ----------------------- (a) If the Company shall receive at any time after a date two years after the date hereof, but prior to a date seven (7) years after the date hereof, a written request from the holders of a majority of the Registrable Securities then outstanding that the Company file a registration statement under the Act covering the registration of the shares of Registrable Securities that are the subject of such request (a "Demand Registration"), then the Company shall, within ten (10) days of the receipt thereof, give written notice of such request to all holders of Registrable Securities and shall, subject to the limitations of Subsection 6.2(e), use its best efforts to effect as soon as practicable the registration under the Act in accordance with this Section 6.2(a) of all Registrable Securities which the holders request be registered within thirty (30) days after the mailing of such notice by the Company in accordance with Section 7.9. (b) If the holders initiating a registration request under Subsection 6.2(a) (the "Initiating Holders") intend to distribute the Registrable Securities, covered by their request by means of an underwriting, they shall so advise the Company as a part of -15- their request made pursuant to this Section 6.2, and the Company shall include such information in the written notice referred to in Subsection 6.2(a). The underwriter will be selected by a majority in interest of the respective Initiating Holders and shall be reasonably acceptable to the Company. In such event, the right of any holder to include his securities in such registration shall be conditioned upon such holder's participation in such underwriting and the inclusion of such holder's securities in the underwriting (unless otherwise mutually agreed by a majority in interest of the Initiating Holders and such holder) to the extent provided herein. All holders proposing to distribute their securities through such underwriting shall (together with the Company as provided in Subsection 6.4(e)) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by a majority in interest of the Initiating Holders. Notwithstanding any other provision of this Section 6.2, if the underwriter advises the Initiating Holders in writing that marketing factors require a limitation of the number of shares to be underwritten, then the Initiating Holders shall so advise all holders of Registrable Securities, which would otherwise be underwritten pursuant hereto, and the number of shares of such securities that may be included in the underwriting shall be allocated among all of the respective holders thereof, including the Initiating Holders. (c) The Company is obligated to effect only two Demand Registrations pursuant to this Section 6.2. (d) Notwithstanding the foregoing, if the Company shall furnish to the Initiating Holders requesting a registration statement pursuant to Subsection 6.2(a), a certificate signed by the President of the Company stating that in the good faith judgment of the Board of Directors of the Company, it would be seriously detrimental to the Company and its stockholders for such registration statement to be filed and it is therefore essential to defer the filing of such registration statement, the Company shall have the right to defer such filing for a period of not more than sixty (60) days after receipt of the request of the Initiating Holders; provided, however, that the Company may not utilize this right with respect to a request under Subsection 6.2(a) more than once in any twelve (12) month period. (e) Notwithstanding the foregoing provisions of this Section 6.2, if at the time of any request by the Initiating Holders under this Section 6.2, the Company has fixed plans to file within forty-five (45) days after such request for the sale of any of its securities in a public offering under the Act, no registration of the Initiating Holders, securities shall be initiated under this Section 6.2 until one hundred eighty (180) days after the effective date of such registration unless the Company is no longer proceeding diligently to effect such -16- registration; provided that the Company shall provide the holders of Registrable Securities the right to participate in such public offering pursuant to, and subject to Section 6.3 hereof. Section 6.3: Company Registration. -------------------- If at any time after a date two years after the date hereof, but prior to a date five (5) years after the date of exercise of this Warrant (but without any obligation to do so), the Company proposes to register (a "Piggy Back Registration") (including for this purpose a registration effected by the Company for stockholders other than the Holders of Registrable Securities) any of its Common Stock under the Act in connection with the public offering of such Common Stock solely for cash (other than a registration relating solely to the sale of Common Stock to participants in a Company stock plan, or a registration on any form which does not include substantially the same information as would be required to be included in a registration statement covering the sale of the Registrable Securities), the Company shall, at such time, promptly give each Holder of Registrable Securities written notice of such registration. Upon the written request of each Holder given within thirty (30) days after mailing of such notice by the Company in accordance with Section 7.9, the Company shall use its best efforts, subject to the provisions of Section 6.8, to cause to be registered under the Act all of the Registrable Securities that each Holder has requested to be registered; provided that the Company shall have the right to postpone or withdraw any registration effected pursuant to this Subsection 6.3 without obligation to any Holder. Section 6.4: Obligations of the Company. Whenever required under this -------------------------- Agreement to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible: (a) Prepare and file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective for up to one hundred twenty (120) days. (b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Act with respect to the disposition of all securities covered by such registration statement. (c) Furnish to the Holders of Registered Securities such numbers of copies of a prospectus, including a preliminary -17- prospectus, in conformity with the requirements of the Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registered Securities owned by them. (d) Use its best efforts to register and qualify the Registered Securities under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the holders thereof, provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions. (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering. Each holder of Registrable Securities participating in such underwriting shall also enter into and perform its obligations under such an agreement. (f) Notify each holder of Registered Securities covered by such registration statement in the event the Company has delivered preliminary or final prospectuses to any such holder and, after having done so, such prospectus is amended to comply with the requirements of the Act. Upon such notification, such holders shall immediately cease making offers of Registered Securities and return all prospectuses to the Company. The Company shall promptly provide such holders with revised prospectuses and, following receipt of the revised prospectuses, such Holders shall be free to resume making offers of the Registered Securities. (g) Furnish, at the request of any holder requesting registration of Registrable Securities pursuant to this Agreement, on the date that such Registrable Securities are delivered to the underwriters for sale in connection with a registration pursuant to this Agreement, if such securities are being sold through underwriters, or, if such securities are not being sold through underwriters, on the date that the registration statement with respect to such securities becomes effective, (i) an opinion, dated such date, of the counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the holders of such Registered Securities and (ii) a letter dated such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the holders of such Registered Securities. -18- Section 6.5: Furnish Information. It shall be a condition precedent to the ------------------- obligations of the Company to take any action pursuant to this Agreement with respect to the Registrable Securities of any selling Holder (the "Selling Holder") that such Selling Holder shall furnish to the Company such information regarding itself, the Registrable Securities held by it, and the intended method of disposition of such securities as shall be required to effect the registration of such Selling Holder's Registrable Securities. Section 6.6: Expenses of Demand Registrations. All expenses other than -------------------------------- underwriting discounts and commissions incurred in connection with the first Demand Registration conducted pursuant to Section 6.2, including (without limitation) all registration, filing and qualification fees, printing and accounting fees, fees and disbursements of counsel for the Company, and the reasonable fees and disbursements of one counsel for the Selling Holders shall be borne by the Company, and all such expenses incurred in connection with any subsequent Demand Registration shall be borne by the Selling Holders; provided, however, that the Company shall not be required to pay for any expenses of any registration proceeding begun pursuant to Section 6.2 if the registration request is subsequently withdrawn at the request of the holders of a majority of the Registrable Securities to be registered (in which case all Initiating Holders shall bear such expenses and a Demand Registration shall be deemed not to have been conducted for purposes of this Section 6.6), unless the holders of a majority of the securities to be registered agree to forfeit their right to such Demand Registration; provided further, however, that if at the time of such withdrawal, such holders have learned of a material adverse change in the condition or business of the company from that known to such holders at the time of their request and have withdrawn the request with reasonable promptness following disclosure by the Company of such material adverse change, then such holders shall not be required to pay any of such expenses and shall retain their rights pursuant to Subsection 6.2. Section 6.7: Expenses of Company Registration. The Company shall bear and -------------------------------- pay all expenses incurred in connection with all registrations, filings or qualifications of Registrable Securities with respect to all Piggy Back Registrations pursuant to section 6.3 for each Holder (which right may be assigned as provided in Section 6.12), including (without limitation) all registration, filing, and qualification fees, printing and accounting fees relating or apportionable thereto, and the fees and disbursements of one counsel for the Selling Holders, but excluding underwriting discounts and commissions relating to Registrable Securities. Section 6.8: Underwriting-Reguirements. In connection with any offering ------------------------- involving an underwriting of shares of the Company's -19- capital stock, the Company shall not be required under Section 6.3 to include any of the Holders' securities in such underwriting unless they accept the terms of the underwriting as agreed upon between the Company and the underwriters selected by it (or by other persons entitled to select the underwriters), and then only in such quantity as the underwriters determine in their sole discretion will not jeopardize the success of the offering by the Company. If the total amount of securities, including Registrable Securities, requested by stockholders to be included in such offering exceeds the amount of securities sold other than by the Company that the underwriters determine in their sole discretion is compatible with the success of the offering, then the Company shall be required to include in the offering only that number of such securities, including Registrable Securities, which the underwriters determine in their sole discretion will not jeopardize the success of the offering (the securities so included to be apportioned pro rata among the selling stockholders according to the total amount of securities entitled to be included therein owned by each selling stockholder or in such other proportions as shall mutually be agreed to by such selling stockholders) but in no event shall (i) the amount of Registrable Securities of the Selling Holders included in the offering be reduced below twenty-five percent (25%) of the total amount of securities included in such offering, or (ii) notwithstanding (i) above, any shares being sold by a Selling Holder exercising a demand registration right under Section 6.2 be excluded from such offering except in accordance with Section 6.2. Section 6.9: Delay of Registration. No Holder shall have any right to --------------------- obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Agreement. Section 6.10: Indemnification. In the event any Registrable Securities are --------------- included in a registration statement under this Warrant: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Selling Holder of Registered Securities and such Selling Holder's officers and directors, any underwriter (as defined in the Act) for such selling Holder and each person, if any, who controls such Selling Holder or underwriter within the meaning of the Act or the Securities Exchange Act of 1934, as amended (the 111934 Act") (each, an "Indemniteell), against any losses, claims, damages, or liabilities (joint or several) to which they may become subject under the Act, or the 1934 Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively a -20- "Violation"): (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein not misleading, or (iii) any violation or alleged violation by the Company of the Act, the 1934 Act, any state securities law or any rule or regulation promulgated under the Act, or the 1934 Act or any state securities law; and the Company will pay to each such Indemnitee, as incurred, any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Subsection 10(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld), nor shall the Company be liable in any such case for any such loss, claim, damage, liability, or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by any such Indemnitee. (b) To the extent permitted by law, each Selling Holder will indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the registration statement, each person, if any, who controls the Company within the meaning of the Act, any underwriter, any other Selling Holder selling securities in such registration statement and any controlling person of any such underwriter or other Selling Holder, against any losses, claims, damages, or liabilities (joint or several) to which any of the foregoing persons may become subject, under the Act, or the 1934 Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereto) arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Selling Holder expressly for use in connection with such registration; and each such Selling Holder will pay, as incurred, any legal or other expenses reasonably incurred by any person intended to be indemnified pursuant to this Subsection 6.10(b), in connection with investigating or defending any such loss, claim, damage, liability, or action; provided,.however, that the indemnity agreement contained in this Subsection 6.10(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Selling Holder, which consent shall not be unreasonably withheld; provided, that, in no event shall any -21- indemnity under this Subsection 6.10(b) exceed the gross proceeds from the offering received by such Selling Holder. (c) Promptly after receipt by an indemnified party under uil.L5 Section 6.10 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 6.10, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties, provided, however, that an indemnified party (together with all other indemnified parties which may be represented without conflict by one counsel) shall have the right to retain one separate counsel, with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action, if prejudicial to its ability to defend such action, shall relieve such indemnifying party of any liability to the indemnified party under this section 6.10 to the extent of such prejudice, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this Section 6.10. (d) The obligations of the company and Selling Holders under this Section 6.10 shall survive the completion of any offering of Registered Securities under this Agreement, and otherwise. Section 6.11: Reports Under Securities Exchange Act of 1934. With a view --------------------------------------------- to making available to the Holders of Registrable Securities the benefits of Rule 144 promulgated under the Act and any other rule or regulation of the SEC that may at any time permit a holder thereof to sell securities of the Company to the public without registration or pursuant to a registration on Form S-3, the Company agrees to: (a) file with the SEC in a timely manner all reports and other documents required of the Company under the Act and the 1934 Act; and (b) furnish to any holder, so long as the holder owns any Registrable Securities, forthwith upon request (i) a written statement by the Company that it has complied with the reporting requirements of SEC Rule 144, the Securities Act and the 1934 Act -22- (at any time after it has become subject to such reporting requirements), (ii) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company, and (iii) such other information as may be reasonably requested in availing any holder of any rule or regulation of the SEC which permits the selling of any such securities without registration or pursuant to such form. Section 6.12: Assignment of Registration Rights. The rights to cause the --------------------------------- Company to register Registrable Securities pursuant to this Agreement may be assigned (but only with all related obligations) by a holder to a transferee or assignee of such Registrable Securities, provided: (i) the Company is, within a reasonable time after such transfer, furnished with written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned; (ii) such assignment shall be effective only if immediately following such transfer the further disposition of such securities by the transferee or assignee is restricted under the Act; (iii) such transferee or assignee shall as a condition to such transfer, deliver to the Company a written instrument by which such transferee agrees to be bound by the obligations imposed upon holders of Registrable Securities pursuant to this ARTICLE VI; and (iv) any such transferee or assignee may not again transfer such rights to any other person or entity, other than as provided in this Section 6.12. Section 6.13: Limitations on Subsequent Registration Rights. From and --------------------------------------------- after the date of this Agreement, the Company shall not, without the prior written consent of the holders of a majority of the outstanding Registrable Securities, enter into any agreement with any holder or prospective holder of any securities of the Company which would allow such holder or prospective holder (a) to include such securities in any registration filed under Section 6.2 hereof, unless under the terms of such agreement, such holder or prospective holder may include such securities in any such registration only to the extent that the inclusion of his securities will not reduce the amount of the Registrable Securities of the holders which is included, or (b) to make a demand registration which could result in such registration statement being declared effective within one hundred twenty (120) days of the effective date of any registration effected pursuant to Section 6.2. Section 6.14: "Market Stand-off" Agreement. Each party to this Agreement ---------------------------- hereby agrees that, during the period of duration specified by the Company and an underwriter of Common Stock or other securities of the Company, following the effective date of a registration statement of the Company filed under the Act, it shall not, to the extent requested by the Company and such underwriter, directly or indirectly sell, offer to sell, contract to sell (including, without limitation, any short sale), grant -23- any option to purchase or otherwise transfer or dispose of (other than to donees who agree to be similarly bound) any securities of the Company held by it at any time during such period except Common Stock included in such registration; provided, however, that all officers and directors of the Company and all other persons with registration rights (whether or not pursuant to this Agreement) enter into similar agreements. In order to enforce the foregoing covenant, the Company may impose stop- transfer instructions with respect to the Registrable Securities of each such holder until the end of such period. ARTICLE VII OTHER MATTERS Section 7.1: Successors and Assigns. All the covenants and provisions of ---------------------- this Warrant by or for the benefit of the Company shall bind and inure to the benefit of its successors and assigns hereunder. Section 7.2: Integration/Entire Agreement. This Warrant is intended by the ---------------------------- parties as a final expression of their agreement and intended to be a complete and exclusive statement of the agreement and understanding of the parties hereto in respect of the subject matter contained herein. There are no restrictions, promises, warranties or undertakings, other than those set forth or referred to herein with respect to the registration rights granted by the Company with respect to the Warrants. This Warrant supersedes all prior agreements and understandings between the parties with respect to such subject matter (other than warrants previously issued by the Company to the Warrantholder.) Section 7.3: Amendments and Waivers. The provisions of this Warrant, ---------------------- including the provisions of this sentence, may not be amended, modified or supplemented, and waiver or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of holders of at least a majority of the outstanding Registrable Securities. Holders shall be bound by any consent authorized by this Section whether or not certificates representing such Registrable Securities have been marked to indicate such consent. Section 7.4: Counterparts. This Warrant may be executedin any number of ------------ counterparts and by the parties hereto in separate counterparts, each of which so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. -24- Section 7.5: Governing Law. This Warrant shall be governed by and ------------- construed in accordance with the laws of the State of California. Section 7.6: Severability. In the event that any one or more of the ------------ provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provisions in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. Section 7.7: Attorneys' Fees. In any action or proceeding brought to --------------- enforce any provisions of this Warrant, or where any provisions hereof or thereof is validly asserted as a defense, the successful party shall be entitled to recover reasonable attorneys' fees and disbursements in addition to its costs and expenses and any other available remedy. Section 7.8: Computations of Consent. Whenever the consent or approval of ----------------------- Holders of a specified percentage of Registrable Securities is required hereunder, Registrable Securities held by the Company or its affiliates (other than the Warrantholder or subsequent Holders if they are deemed to be such affiliates solely by reason of their holdings of such Registrable Securities) shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage. Section 7.9: Notice. Any notices or certificates by the Company to the ------ Holder and by the Holder to the Company shall be deemed delivered if in writing and delivered in person or by registered mail (return receipt requested) to the Holder addressed to him in care of Bear Stearns & Company, 1999 Avenue of the Stars, Los Angeles, California 90067, if the Holder has designated, by notice in writing to the Company, any other address, to such other address, and if to the Company, addressed to it at: 606 Broadway, Santa Monica, California 90401. The Company may change its address by written notice to the Holder and the Holder may change its address by written notice to the Company. -25- IN WITNESS WHEREOF, this Warrant has been duly executed by the Company under its corporate seal as of the 16th day of March 1993. ATTEST: PROFESSIONAL BANCORP, INC. /s/ [ILLEGIBLE SIGNATURE] By: /s/ Joel W. Kovner - ------------------------- ---------------------------- Secretary Joel W. Kovner, Dr., P.H. Chairman of the Board, President and Chief Executive Officer -26- PROFESSIONAL BANCORP, INC. ASSIGNMENT (To be executed only upon assignment of Warrant Certificate) For value received, _________________________________________ hereby sells, assigns and transfers unto ________________________________________ the within Warrant Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint _______________________________ attorney, to transfer said Warrant Certificate on the books of the within-named Company with respect to the number of Warrants set forth below, with full power of substitution in the premises: Name(s) of Assignee(s) Address No. of Warrants ------------------- --------------- And if said number of Warrants shall not be all the Warrants represented by the Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the Warrants registered by said Warrant Certificate. Dated: ______________, 19__ Signature _________________________ Note: The above signature should correspond exactly with the name on the face of this Warrant Certificate -27- SUBSCRIPTION FORM (To be executed upon exercise of Warrant) PROFESSIONAL BANCORP, INC. The undersigned hereby irrevocably elects to exercise the right of purchaser represented by the within Warrant Certificate for, and to purchase thereunder, ________________________ shares of Common Stock, as provided for therein, and tenders herewith payment of the purchase price in full in the form of cash or a certified or official bank check in the amount of $_______________________. Please issue a certificate or certificates for such Common Stock in the name of, and pay any cash for any fractional share to: Name _______________________________ (Please print Name, Address and Social Security No.) Signature __________________________ Note: The above signature should correspond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment from below. If said number of shares shall not be all the shares purchasable under the within Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the shares purchasable thereunder rounded up to the next higher number of shares. -28- EX-10.4 4 1998 STOCK OPTION PLAN EXHIBIT 1O.4 PROFESSIONAL BANCORP 1998 STOCK OPTION PLAN 1. Purpose The purpose of the Professional Bancorp 1998 Stock Option Plan (the "Plan") is to strengthen Professional Bancorp, Inc. (the "Corporation") and those banks and corporations which are or hereafter become subsidiary corporations (the "Subsidiary" or "Subsidiaries") by providing additional means of attracting and retaining qualified directors and competent managerial personnel and by providing to participating directors, officers and key employees added incentive for high levels of performance and for special efforts to increase the earnings of the Corporation and any Subsidiaries. The Plan seeks to accomplish these purposes and achieve these results by providing a means whereby such directors, officers and key employees may purchase shares of the Common Stock of the Corporation pursuant to Stock Options granted in accordance with this Plan. 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 purposes of this Plan, the following terms shall have the following meanings: (a) "Common Stock." This term shall mean shares of the Corporation's common stock, subject to adjustment pursuant to Section 15 (Adjustment Upon Changes in Capitalization) hereunder. (b) "Corporation." This term shall mean Professional Bancorp, Inc. a Pennsylvania corporation. (c) "Eligible Participants." This term shall mean: (i) all directors of the Corporation or any Subsidiary; (ii) all officers (whether or not they are also directors) of the Corporation or any Subsidiary; and (iii) all key employees (as such persons may be determined by the Stock Option Committee from time to time) of the Corporation or any Subsidiary, provided that such officers and key employees have a customary work week of at least forty hours in the employ of the Corporation or a Subsidiary. (d) "Fair Market Value." This term shall mean the fair market value of the Common Stock as determined in accordance with any reasonable valuation method selected by the Stock Option Committee, including the valuation methods described in Treasury Regulations Section 20.2031-2. (e) "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. (f) "Non-Qualified Stock Option." This term shall mean a Stock Option which is not an Incentive Stock Option. (g) "Option Shares." This term shall mean Common Stock covered by and subject to any outstanding unexercised Stock Option granted pursuant to this Plan. (h) "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. (i) "Plan." This term shall mean the Professional Bancorp 1998 Stock Option Plan as embodied herein and as may be amended from time to time in accordance with the terms hereof and applicable law. (j) "Stock Option." This term shall mean the right to purchase Common Stock under this Plan in a specified number of shares, at a price and upon the terms and conditions determined by the Stock Option Committee. (k) "Stock Option Committee." The Board of Directors of the Corporation may select and designate a Stock Option Committee consisting of three or more directors of the Corporation, having full authority to act in connection with this Plan. Regardless of whether a Stock Option Committee is selected, the Board of Directors of the Corporation may act as the Stock Option Committee and any action taken by said Board 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 to refer to the Board of Directors of the Corporation acting as the Stock Option Committee and to a duly appointed Stock Option Committee, if there be one. In the event of any conflict between action taken by the Board acting as a Stock Option Committee and action taken by a duly appointed Stock Option Committee, the action taken by the Board shall be controlling and the action taken by the duly appointed Stock Option Committee shall be disregarded. (1) "Subsidiary." This term shall mean each "subsidiary corporation" (treating the Corporation as the employer corporation) as defined in Section 425(f) of the Internal Revenue Code of 1986, as amended. 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 not inconsistent with the terms and conditions of this Plan. Subject to compliance with the terms, conditions and restrictions set forth in this Plan, the Stock Option Committee shall have the exclusive right, in its sole and absolute discretion, to establish the terms and conditions of all Stock Options granted under the Plan, including, without meaning any limitation, the power to: (i) establish the number of Stock Options, if any, to be granted hereunder, in the aggregate and with regard to each Eligible Participant; (ii) determine the time or times when such Stock Options, or 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, unexpired Stock Options without such constituting a termination of employment under the Plan; and (vi) prescribe and amend the terms, provisions and form of each instrument and agreement setting forth the terms and conditions of every Stock Option granted hereunder. (c) Decisions and Determinations. Subject to the express provisions of the Plan, the Stock Option Committee shall have the authority to construe and interpret this Plan, to define the terms used herein, 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 not inconsistent with the terms of this Plan. 4. Shares Subject to the Plan Subject to adjustments as provided in Section 15 hereof, the maximum number of shares of Common Stock which may be issued upon exercise of all Stock Options granted under this Plan is limited to One Hundred Thousand (100,000) 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 of the Plan, the Stock Option Committee, in its sole and absolute discretion, may grant Stock Options: (i) In the case of grants to Eligible Participants who are officers or key employees of the Corporation or any Subsidiary, 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; and (ii) In the case of grants to Eligible Participants who are directors and who are not officers or key employees of the Corporation or any Subsidiary, for a number of Option Shares, at the price(s) and time(s), and on the terms and conditions as it deems advisable and specifies in the respective grants; provided, however, that such grants may not exceed a maximum of Thirty-Five Thousand (35,000) Option Shares to all directors at any time, exclusive of any Option Shares granted under Section 6(a)(i) hereof. The foregoing maximum numbers of Option Shares which may be granted to all directors of the Corporation at any time shall be adjusted in accordance with the provisions of Section 15 hereof. The terms upon which and the times at which, or the periods within which, the Option Shares subject to such Stock Options may become acquired or such Stock Options may be acquired and exercised shall be as set forth in the Plan and the related Stock Option Agreements. 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. (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 to the other a Stock Option Agreement in the form then required by the Stock Option Committee as evidencing the grant of the Stock Option, together with such other instrument or 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-Participants. A Stock Option may 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 unless the purchase price of the Option Shares subject to said Stock Option is at least one hundred and ten percent (110%) of the Fair Market Value of the Option Shares, determined as of the date said Stock Option is granted. In addition, a Stock Option granted hereunder to an Eligible Participant who is also an officer or key employee of the Corporation or any Subsidiary 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 (if permitted in accordance with the provisions of Section 5 herein) shall not qualify as an Incentive Stock Option unless the Stock Option by its terms is not exercisable after five (5) years from the date that it is granted. The attribution rules of Section 425(d) of the Internal Revenue Code of 1986, as amended, shall apply in the determination of indirect ownership of stock. (d) Maximum Value of Stock Options. No grant of Incentive Stock Options hereunder may be made when the aggregate fair market value of Option Shares with respect to which Incentive Stock Options (pursuant to this Plan or any other Incentive Stock Option Plan of the Corporation or any Subsidiary) are exercisable for the first time by the Eligible Participant during any calendar year exceeds $100,000. (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 Corporation, 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. Stock Options and Substituted Options granted by the Stock Option Committee shall be deemed Non-Qualified Stock Options under this Plan if they: (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 limitations on the period of exercise set forth in Section 6(c); (iii) are in excess of the fair market limitations set forth in Section 6(d); (iv) are granted to an Eligible Participant who is not an officer or key employee of the Corporation or any Subsidiary; or (v) are designated at the time of grant as Non-Qualified Stock Options. 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 the grant of a Stock Option. In the case of a Non-Qualified Stock Option, said exercise price shall not be less than the lesser of (i) an amount equal to eighty-five percent (85%) of the Fair Market Value of the Common Stock represented by the Option Shares; or (ii) an amount which under the terms of the Stock Option may not be less than eighty-five percent (85%) of the Fair Market Value of the Common Stock represented by the Option Shares on the date of the exercise of the related Stock Option. In the case of an Incentive 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 Shares on the date of grant of the related Stock Option. (b) Substituted Options. The exercise price of the Option Shares subject to each Substituted Option may be fixed at a price less than the minimum amount set forth in Section 7(a) above 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 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, 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. 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 (or substituted) to an Optionee under the Plan 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 or any other Incentive Stock Option Plan of the Corporation or any Subsidiary. 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. 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 the counsel for the Corporation, of the right of 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 and all of the terms and provisions of the Plan and the related Stock Option agreement have been fully 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, (or bank, cashier's or certified check) and/or, with the prior written approval of the Stock Option Committee at or before the time of exercise, in Common Stock of the Corporation which, when added to the cash payment, if any, which 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. 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 any part of a 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 all other required transfer documents necessary to transfer the shares of Common Stock to the Corporation. (e) 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. (f) Compliance With Law. No shares of Common Stock shall be issued upon exercise of any Stock Option, and an Optionee shall have no right or claim to such shares, unless and until: (i) payment in full as provided hereinabove has been received by the Corporation; (ii) in the opinion of the counsel for the Corporation, all applicable requirements of law and of regulatory bodies having jurisdiction over such issuance and delivery have been fully complied with; and (iii) if required by federal or state law 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. (g) 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 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 which would, upon consummation, result in termination of a Stock Option in accordance with Section 16 hereof, all Stock Options previously granted shall become immediately exercisable as to all unexercised Option Shares for such period of time as may be determined by the Stock Option Committee, but in any event not less than 30 days, on the condition that the terminating event described in Section 16 hereof is consummated. If such terminating event is not consummated, Stock Options granted pursuant to the Plan shall be exercisable in accordance with the terms of their respective Stock Option Agreements. 9. Nontransferability of Stock Options Each Incentive 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. Each Non-Qualified Stock Option shall, by its terms, be nontransferable by the Optionee other than by will, the laws of descent and distribution or pursuant to a domestic relations order and shall be exercisable during the Optionee's lifetime only by the Optionee except pursuant to a domestic relations order. 10. Continuation of Affiliation Nothing contained in this Plan (or in any Stock Option Agreement) shall obligate the Corporation or any Subsidiary to employ or continue to employ or remain affiliated with any Optionee or any Eligible Participant for any period of time or interfere in any way with the right of the Corporation or a Subsidiary to reduce or increase the Optionee's or Eligible Participant's compensation. 11. Cessation of Affiliation Except as provided in Section 12 hereof, if, for any reason other than disability or death, an Optionee ceases to be affiliated with the Corporation or a Subsidiary, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their grant, or three (3) months after the Optionee ceases to be so affiliated, whichever is earlier. During such period after cessation of affiliation, such Stock Options shall be exercisable only as to those increments, if any, which had become exercisable as of the date on which such Optionee ceased to be affiliated with the Corporation or the Subsidiary, and any Stock Options or increments which had not become exercisable as of such date shall expire automatically on such date. 12. Termination for Cause If the Stock Option Agreement so provides and if an Optionee's employment by or affiliation with the Corporation or a Subsidiary is terminated for cause, the Stock Options granted to such Optionee shall automatically expire and terminate in their entirety immediately upon such termination; provided, however, that the Stock Option Committee may, in its sole discretion, within thirty (30) days of such termination, reinstate such Stock Options by giving written notice of such reinstatement to the Optionee. In the event of such reinstatement, the Optionee may exercise the Stock Options only to such extent, for such time, and upon such terms and conditions as if the Optionee had ceased to be employed by or affiliated with the Corporation or a Subsidiary upon the date of such termination for a reason other than cause, disability or death. Termination for cause shall include, but shall 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 dies while employed by or affiliated with the Corporation or a Subsidiary, or during the three-month period referred to in Section 11 hereof, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their grant, or one (1) year after the date of 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 died. 14. Disability of Optionee If an Optionee is disabled while employed by or affiliated with the Corporation or a Subsidiary or during the three-month period referred to in Section 11 hereof, the Stock Options granted to such Optionee shall expire on the expiration dates specified for said Stock Options at the time of their grant, or one (1) year after the date such disability occurred, whichever is earlier. After such disability occurs, but before such expiration, the Optionee or the 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 or affiliated with the Corporation or a Subsidiary as a result of the disability. An Optionee shall be deemed to be "disabled" if it shall appear to the Stock Option Committee, upon written certification delivered to the Corporation of a qualified licensed physician, that the Optionee has become permanently and totally unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment which can be expected to result in the Optionee's 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. Such adjustments 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. Adjustments 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 such adjustments, and fractional share interests shall be disregarded, except that they may be accumulated. 16. Terminating Events Upon consummation of a plan of dissolution or liquidation of the Corporation, or upon 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 entity, or upon the sale of all or substantially all the assets of the Corporation to another corporation, subject to the provisions of Section 8(g) hereof the Plan shall automatically terminate and all Stock Options theretofore granted shall be terminated, unless provision is made in connection with such transaction for 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. 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 an Optionee, make such modifications of the terms and conditions of that Optionee's Stock Option as it shall deem advisable; provided that, except as permitted under the provisions of Section 15 hereof, no amendment or modification may be adopted without the Corporation having first obtained the approval of the holders of a majority of the Corporation's outstanding shares of Common Stock present, or represented, and entitled to vote at a duly held meeting of shareholders of the Corporation, or by written consent, if the amendment or modification would: (a) materially increase the number of securities which may be issued under the Plan; (b) materially increase the number of securities which may be issued at any time under the Plan to all directors who are not also officers or key employees of the Corporation or any Subsidiary; (c) materially modify the requirements as to eligibility for participation in the Plan; (d) increase or decrease the exercise price of any Stock Option 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 internal revenue laws then applicable of any Stock Option granted 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 15 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 No Eligible Participant, Optionee or other person shall have any claim or right to be granted a Stock Option under this Plan, and neither this Plan nor any action taken hereunder shall be deemed to give or be construed as giving any Eligible Participant, Optionee or other person any right to be retained in the employ of the Corporation or any Subsidiary. Without limiting the generality of the foregoing, no person shall have any rights as a result of his or her classification as an Eligible Participant or Optionee, such classifications being made solely to describe, define and limit those persons who are eligible for consideration for privileges under the Plan. 19. Privileges of Stock Ownership; Regulatory 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 the securities exchanges upon which securities of the Corporation are listed (if any) shall have been fully complied with. The Optionee shall, not more than thirty (30) 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. 20. Effective Date of the Plan The Plan shall be deemed adopted as of March 25, 1998, 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. 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 of the Corporation; or (ii) approval of the Plan by holders of at least a majority of the 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 this 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 this Plan. 24. Exculpation and Indemnification of Stock Option Committee In addition to any applicable coverage under any directors and officers liability or similar insurance policy, the present, former and future members of the Stock Option Committee, and each of them, who is or was a director, officer or employee of the Corporation shall be indemnified by the Corporation to the extent authorized in and permitted by the Corporation's Certificate of Incorporation, and/or Bylaws in connection with all actions, suits and proceedings 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. 25. Agreement and Representations of Optionee Unless the shares of Common Stock covered by this Plan have been registered with the Securities and Exchange Commission pursuant to the registration requirements under the Securities Act of 1933, each Optionee shall: (i) by and upon accepting a Stock Option, represent and agree in writing, in the form of the letter attached hereto as Exhibit "A," for himself or herself and his or her transferees by will or the laws of descent and distribution, that the Option Shares will be acquired for investment purposes and not for resale or distribution; and (ii) by and upon the exercise of a Stock Option, or a part thereof, furnish evidence satisfactory to counsel for the Corporation, including written and signed representations in the form of the letter attached hereto as Exhibit "B," to the effect that the Option Shares are being acquired for investment purposes and not for resale or distribution, and that the Option Shares being acquired shall not be sold or otherwise transferred by the Optionee except in compliance with the registration provisions under the Securities Act of 1933, as amended, or an applicable exemption therefrom. Furthermore, the Corporation, at its sole discretion, to assure itself that any sale or distribution by the Optionee complies with this Plan and any applicable federal or state securities laws, may take all reasonable steps, including placing stop transfer instructions with the Corporation's transfer agent prohibiting transfers in violation of the Plan and affixing the following legend (and/or such other legend or legends as the Stock Option Committee shall require) on certificates evidencing the shares: "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR OFFERED FOR SALE IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT WITH RESPECT TO THEM UNDER THE ACT OR A WRITTEN OPINION OF COUNSEL FOR THE HOLDER THEREOF, WHICH OPINION SHALL BE ACCEPTABLE TO PROFESSIONAL BANCORP, THAT REGISTRATION IS NOT REQUIRED." At any time that an Optionee contemplates the disposition of any of the Option Shares (whether by sale, exchange, gift or other form of transfer), he or she shall first notify the Corporation of such proposed disposition and shall thereafter cooperate with the Corporation in complying with all applicable requirements of law which, in the opinion of counsel for the Corporation, must be satisfied prior to the making of such disposition. Before consummating such disposition, the Optionee shall provide to the Corporation an opinion of Optionee's counsel, of which both such opinion and such counsel shall be satisfactory to the Corporation, that such disposition will not result in a violation of any state or federal securities laws or regulations. The Corporation shall remove any legend affixed to certificates for Option Shares pursuant to this Section if and when all of the restrictions on the transfer of the Option Shares, whether imposed by this Plan or federal or state law, have terminated. 26. Notices All notices and demands of any kind which the Stock Option Committee, any Optionee, Eligible Participant, or other person may be required or desires to give under the terms of this Plan shall be in writing and shall be delivered in hand to the person or persons to whom addressed (in the case of the Stock Option Committee, with the Chief Executive Officer, Chief Financial Officer or Secretary of the Corporation), by leaving a copy of such notice or demand at the address of such person or persons as may be reflected in the records of the Corporation, or by mailing a copy thereof, properly addressed as above, by certified or registered mail, postage prepaid, with return receipt requested. Delivery by mail shall be deemed made upon receipt by the notifying party of the return receipt request acknowledging receipt of the notice or demand. 27. Limitation on Obligations of the Corporation All obligations of the Corporation arising under or as a result of this Plan or Stock Options granted hereunder shall constitute the general unsecured obligations of the Corporation, and not of the Board of Directors of the Corporation, any member thereof, the Stock Option Committee, any member thereof, any officer of the Corporation, or any other person or any Subsidiary, and none of the foregoing, except the Corporation, shall be liable for any debt, obligation, cost or expense hereunder. 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 Stock Option granted hereunder is authorized, and such 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 circumstance shall be adjudged by a court of competent jurisdiction to be void, invalid, or unenforceable, the same shall in no way affect any other provision hereof, the application of any such provision in any other circumstances, or the validity or enforceability hereof. 30. Construction Where the context or construction requires, all words applied in the plural herein shall be deemed to have been used in the singular and vice versa, and the masculine gender shall include the feminine and the neuter and vice versa. 31. Headings The headings of the several paragraphs herein 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 Optionees. 33. Governing Law To the extent not governed by the laws of the United States, this Plan shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania. 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 meaning any limitation, any Stock Option Agreement, the terms and provisions of this Plan shall control. * * * * * * * * EXHIBIT "A" , 19 Professional Bancorp 606 Broadway Santa Monica, California 90401 Gentlemen: On this day of , 19 , the undersigned has received, pursuant to the Professional Bancorp 1998 Stock Option Plan (the "Plan") and the Stock Option Agreement (the "Agreement") by and between Professional Bancorp (the "Corporation") and the undersigned, dated , 19 an option to purchase shares of the no par value common stock of Professional Bancorp (the "Stock"). In consideration of the grant of such option by Professional Bancorp: 1. I hereby represent and warrant to you that the Stock to be acquired pursuant to the option will be acquired by me in good faith and for my own personal account, and not with a view to distributing the Stock to others or otherwise reselling the stock in violation of the Securities Act of 1933, as amended, or the rules and regulations promulgated thereunder. 2. I hereby acknowledge and agree that: (a) the Stock to be acquired by me pursuant to the Plan has not been registered and that there is no obligation on the part of Professional Bancorp to register such Stock under the Securities Act of 1933, as amended, and the rules and regulations thereunder; and (b) the Stock to be acquired by me will not be freely tradeable unless the Stock is either registered under the Securities Act of 1933, as amended, or the holder presents a legal opinion acceptable to Professional Bancorp that the transfer will not violate the federal securities laws. 3. I understand that the Corporation is relying upon the truth and accuracy of the representations and agreements contained herein in determining to grant such options to me and upon subsequently issuing any Stock pursuant to the Plan without Professional Bancorp first registering the same under the Securities Act of 1933, as amended. 4. I understand that the certificate evidencing the Stock to be issued pursuant to the Plan will contain a legend upon the face thereof to the effect that the Stock is not registered under the Securities Act of 1933 and that stop transfer orders will be placed against the shares with Professional Bancorp's transfer agent. 5. In further consideration for the grant of an option to purchase Stock of Professional Bancorp, the undersigned hereby agrees to indemnify you and hold you harmless against all liability, cost, or expenses (including reasonable attorney's fees) arising out of or as a result of any distribution or resale of shares of Stock issued by the undersigned in violation of the securities laws. The agreements contained herein shall inure to the benefit of and be binding upon the respective legal representatives, successors and assigns of the undersigned and Professional Bancorp. Very truly yours, ____________________________ (Signature) ___________________________ (Type or Print Name) EXHIBIT "B" , 19__ Professional Bancorp 606 Broadway Santa Monica, California 90401 Gentlemen: On this day of , 19 , the undersigned has acquired, pursuant to the Professional Bancorp 1998 Stock Option Plan (the "Plan") and the Stock Option Agreement (the "Agreement") by and between Professional Bancorp (the "Corporation") and the undersigned, dated , 19 , ( ) shares of the no par value Common Stock of Professional Bancorp (the "Stock"). In consideration of the issuance by Professional Bancorp to the undersigned of said shares of its Common Stock: 1. I hereby represent and warrant to you that the Stock is being acquired by me in good faith for my own personal account, and not with a view to distributing the Stock to others or otherwise reselling the Stock in violation of the Securities Act of 1933, as amended, or the rules and regulations promulgated thereunder. 2. I hereby acknowledge and agree that: (a) the Stock being acquired by me pursuant to the Plan has not been registered and that there is no obligation on the part of Professional Bancorp to register such Stock under the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder; and (b) the Stock being acquired by me is not freely tradeable and must be held by me for investment purposes unless the Stock is either registered under the Securities Act of 1933 or transferred pursuant to an exemption from such registration, as accorded by the Securities Act of 1933 and under the rules and regulations promulgated thereunder. I further represent and acknowledge that I have been informed by legal counsel in connection with said Plan of the restrictions on my ability to transfer the Stock and that I understand the scope and effect of those restrictions. 3. I understand that the effects of the above representations are the following: (i) that the undersigned does not presently intend to sell or otherwise dispose of all or any part of the shares of the Stock to any person or entity Professional Bancorp except in compliance with the terms described above, in the Plan and in the Agreement; and (ii) that the Corporation is relying upon the truth and accuracy of the representations and agreements contained herein in issuing said shares of the Stock to me without first registering the same under the Securities Act of 1933, as amended. 4. I hereby agree that the certificate evidencing the Stock may contain the following legend stamped upon the face thereof to the effect that the Stock is not registered under the Securities Act of 1933, as amended, and that the Stock has been acquired pursuant to the representations and restrictions in this letter, the Plan and in the Agreement: "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR OFFERED FOR SALE IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT WITH RESPECT TO THEM UNDER THE ACT OR A WRITTEN OPINION OF COUNSEL FOR THE HOLDER HEREOF, WHICH OPINION SHALL BE ACCEPTABLE TO PROFESSIONAL BANCORP THAT REGISTRATION IS NOT REQUIRED." 5. I hereby agree and understand that the Corporation will place a stop transfer notice with its stock transfer agent to ensure that the restrictions on transfer described herein will be observed. 6. In further consideration of the issuance of the Stock, the undersigned does hereby agree to indemnify you and hold you harmless against all liability, costs, or expenses (including reasonable attorney's fees) arising out of or as a result of any distribution or resale by the undersigned of any of the Stock. The Agreements contained herein shall inure to the benefit of and be binding upon the respective legal representatives, successors and assigns of the undersigned and Professional Bancorp. Very truly yours, ________________________ (Signature) ________________________ (Type or Print Your Name) EX-10.7 5 AMENDMENT NO. 1 TO CONSULTING AGREEMENT EXHIBIT 10.7 FIRST AMENDMENT TO CONSULTING AGREEMENT This First Amendment to Consulting Agreement is made this 19th day of November, 1997 by and among PROFESSIONAL BANCORP, INC. ("PBI"), FIRST PROFESSIONAL BANK, NATIONAL ASSOCIATION ("Bank") and NETWORK HEALTH FINANCIAL SERVICES, INC. ("NHFS"). RECITALS WHEREAS, PBI, Bank and NHFS entered into a Consulting Agreement effective as of August 12, 1997 (the "Consulting Agreement"); and WHEREAS, the parties now desire to revise the Consulting Agreement by deleting the services of Al Hester and Lyla Oyakawa and increasing the monthly fee for the services of Melinda McIntyre. NOW, THEREFORE, in consideration of the mutual promises, covenants and agreements contained herein, the parties hereby agree as follows: 1. The second and third paragraphs of Section 3 of the Consulting Agreement are amended and restated to read as follows, effective as of March 11, 1997: "'Actual costs' incurred shall include all reasonable out-of-pocket expenses incurred by NHFS, and the hourly rates set forth below for NHFS personnel: NHFS Employee Hourly Rate ------------- ----------- Linda Flintzer $80 Jenete Maslonka $50 Melinda Kirksey $25 With respect to the services of Melinda McIntyre and Patti Derry, NHFS will charge a flat monthly fee of: (a) Twenty-Five Thousand Dollars ($25,000) for Melinda McIntyre, which sum is based on an allocation of approximately fifty percent (50%) of her working time to Bancorp and Bank; and (b) Nine Thousand Dollars ($9,000) for Patti Derry, which sum is based on an allocation of approximately seventy percent (70%) of her working time to Bancorp and Bank. No percentage markup of these flat monthly fees for Melinda McIntyre and Patti Derry will be charged. Costs for all other NHFS personnel not specifically set forth herein shall be billed at reasonable rates as mutually agreed to by the parties." 2. In all other respects, the Consulting Agreement is hereby ratified and affirmed as originally written. IN WITNESS WHEREOF, the parties have executed this First Amendment as of the date first written above. NETWORK HEALTH FINANCIAL FIRST PROFESSIONAL BANK, SERVICES, INC. NATIONAL ASSOCIATION By:_________________________________ By:_________________________________ Melinda A. McIntyre, President Julie P. Thompson, Chairman PROFESSIONAL BANCORP, INC. By:_________________________________ Julie P. Thompson, Chairman EX-11 6 EARNINGS (LOSS) PER SHARE COMPUTATION EXHIBIT 11 EXHIBIT 11 - EARNINGS (LOSS) PER SHARE
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS (LOSS) YEAR ENDED DECEMBER 31, ------------------------------------------- BASIC EARNINGS (LOSS) PER SHARE 1998 1997 1996 ---- ---- ---- Computation for Statement of Operations: Net earnings per statement of operations used in basic earnings per share computation: Basic earnings (loss) $ 1,431,599 $ 1,478,525 $ (3,724,917) ============ ============ ============ Weighted average number of shares outstanding 1,768,663 1,345,972 1,341,316 ============ ============ ============ Basic earnings (loss) per share $ 0.81 $ 1.10 $ (2.78) ============ ============ ============
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS (LOSS) - (CONTINUED)
YEAR ENDED DECEMBER 31, ------------------------------------------------- DILUTED EARNINGS (LOSS) PER SHARE 1998 1997 1996 ---- ---- ---- Computation for Statement of Operations: Net earnings per statement of operations used in diluted earnings per share computation: Basic earnings (loss) $ 1,431,599 $ 1,478,525 $ (3,724,917) Interest on convertible notes, net of tax effect 149,200 279,435 /(1)/ ------------ ------------ ------------- Basic earnings (loss) as adjusted $ 1,580,799 $ 1,757,960 $ (3,724,917) ============ ============ ============= Weighted average number of shares outstanding, as per basic computation 1,768,663 1,345,972 1,341,316 Net shares issuable from assumed exercise of warrants and options, as determined by the application of the Treasury Stock Method 125,596 33,835 (1) Weighted average shares issuable from assumed conversion of convertible notes 253,942 428,164 (1) ------------ ------------ ------------ Weighted average number of shares outstanding 2,148,201 1,807,971 1,341,316 ============ ============ ============= Diluted earnings (loss) per share $ 0.74 $ 0.97 $ (2.78) ============ ============ =============
/(1)/ Anti-dilutive EX-23.1 7 CONSENT OF KPMG LLP EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT The Board of Directors Professional Bancorp, Inc.: We consent to incorporation by reference in the registration statement (No. 33-63379) on Form S-8, of Professional Bancorp, Inc. of our report dated April 19, 1999, with respect to the consolidated balance sheets of Professional Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997 and the related consolidated statements of operations and comprehensive income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, which appears in the December 31, 1998 annual report on Form 10-K of Professional Bancorp, Inc. KPMG LLP Los Angeles, California April 21, 1999 EX-27 8 FINANCIAL DATA SCHEDULE
9 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 31,964,702 121,159,117 10,400,000 0 80,891,072 24,080,592 24,135,000 117,718,693 2,200,000 259,701,439 230,580,746 0 2,683,582 1,116,000 0 0 16,526 25,304,585 259,701,439 10,264,651 4,890,065 1,793,706 16,948,422 3,373,818 3,629,756 13,318,667 405,829 (5,640) 12,226,726 2,421,252 0 0 0 1,431,599 0.81 0.74 6.02 1,359,000 100 0 0 1,802,000 269,000 261,000 2,200,000 2,200,000 0 0
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