Item 1 - "Business--Preferred Stock." Dividend payments will also be dependent upon its separate liquidity needs. See Item 7 - "Management's Discussion and Analysis of Financial Condition." In that regard, Federal and state statutes, regulations and policies impose restrictions on the payment of management fees and cash dividends by the Bank to the Company. Information regarding the Company's cash dividend payment history can be found at Part II, Item 5 "Market for Registrant's Common Stock and Related Stockholder Matters."
Bank Regulation
The Bank is subject to regulation, supervision and regular examination by the California Superintendent of Banks (the "Superintendent"). The deposits of the Bank are insured up to the maximum legal limits by the Bank Insurance Fund ("BIF"), which is managed by the Federal Deposit Insurance Corporation ("FDIC"), and the Bank is therefore subject to applicable provisions of the Federal Deposit Insurance Act, and is also subject to regulation, supervision and regular examination by the FDIC. The regulations of these agencies affect most aspects of the Bank's business and prescribe permissible types of loans and investments, the amount of required reserves, requirements for branch offices, the permissible scope of the Bank's activities and various other requirements. While the Bank is not a member of the Federal Reserve System, it is nevertheless also subject to certain regulations of the Board of Governors dealing primarily with check clearing activities, establishment of banking reserves, Truth in Lending (Regulation Z), Equal Credit Opportunity (Regulation B) and Truth in Savings (Regulation DD).
Supervision and Examinations
Federal law mandates frequent examinations of all banks, with the costs of examinations to be assessed against the bank being examined. In the case of the Bank, its primary Federal regulator is the FDIC. The Federal banking regulatory agencies have substantial enforcement powers over the depository institutions that they regulate. Civil and criminal penalties may be imposed on such institutions and persons associated with those institutions for violations of any law or regulation. The penalties can be up to $5,000 per day that a violation continues when the violation is unintentional, or up to $1 million per day that a violation continues when the violation is willful. The amount of the penalty also depends on whether the violation is part of a pattern or causes a loss to the financial institution.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") places limits on brokered deposits and extends the limits to any bank that is not "well capitalized" or is notified that it is in "troubled condition." Previously, the limitations applied only to troubled banks. A well-capitalized institution (which generally includes an institution that is considered well capitalized for purposes of the prompt corrective action regulations discussed below) may still accept brokered deposits without restriction, unless it has been informed by its appropriate Federal regulatory agency that it is in "troubled condition." All other insured depository institutions are prohibited from accepting brokered deposits unless a waiver is obtained from the FDIC. If a waiver is obtained, the interest paid on such deposits may not exceed the rate paid for deposits in its normal market area, or the national rate as determined in the FDIC's regulation.
If a depository institution solicits deposits by offering interest rates significantly higher than rates being offered in its market area, it is deemed under FDICIA to be a deposit broker. Therefore, depending on its capital category, it may be prohibited from such practice, or need a prior waiver from the FDIC in order to offer such rates. The FDIC's regulations specify that an institution that is not well capitalized may offer rates that exceed the prevailing effective rates offered in the normal market area only if the institution obtains a waiver, but the institution may not offer rates more than 75 basis points above such prevailing rates.
The Bank is at this time considered well capitalized and not in a "troubled condition," and it is not, therefore, subject to the brokered-deposit limitations. If the Bank's status changes in the future, these regulations could restrict the ability to attract such deposits.
Risk-Based Deposit Insurance Assessments
In addition, FDICIA required the FDIC to develop and implement a system to account for risks attributable to different categories and concentrations of assets and liabilities in assessing deposit insurance premiums. The FDIC adopted a risk-assessment system effective January 1, 1994. Under this system, each bank's deposit insurance premium assessment is calculated based on the level of risk that the Bank Insurance Fund will incur a loss if that bank fails and the amount of the loss if such failure occurs. This requirement, along with the increased emphasis on exceeding capital measures, may cause banks to adjust their asset mix in order to affect their deposit insurance premium and their ability to engage in activities.
Dividends Payable by the Bank to the Company
The Bank is a legal entity which is separate and distinct from the Company. Aside from raising capital on its own or borrowing funds for operating capital, it is anticipated that the Company may receive additional income through dividends paid by, and management fees charged to, the Bank. Subject to the regulatory restrictions described below, future cash dividends by the Bank will depend upon management's assessment of future capital requirements, contractual restrictions and other factors.
The power of the Board of Directors of a California chartered commercial bank to declare a cash dividend is subject to California law, which restricts the amount available for cash dividends to the lesser of the retained earnings or the bank's net income for its last three fiscal years (less any distributions to shareholders made during such period). Where the above test is not met, cash dividends may still be paid, with the prior approval of the Superintendent, in an amount not exceeding the greatest of (1) the retained earnings of the bank; (2) the net income of the bank for its last fiscal year; or (3) the net income of the bank for its current fiscal year. On December 31, 1996, the Bank was legally able to pay dividends.
Under the Federal Deposit Insurance Act, bank regulators also have authority to prohibit a bank from engaging in business practices which are considered to be unsafe or unsound. It is possible, depending upon the financial condition of the bank in question and other factors, that such regulators could assert that the payment of dividends or other payments might under certain circumstances be an unsafe or unsound practice, even if technically permissible.
California Law
The activities of the Bank are also regulated by state law. State law, for example, regulates certain loans to any officer of the Bank, directly or indirectly, or to any related corporation in which such officer is a stockholder, director, officer or employee.
California law permits California state-chartered banks to invest in the stock and equity securities of other corporations, to engage directly in or invest directly in subsidiaries which conduct real estate related activities (including property management and real estate appraisal), and to participate in management consulting and data processing services for third parties. FDICIA limits the powers, including investment authority and subsidiaries, of state banks to those activities that are either permitted to national banks, or activities that the FDIC finds do not pose a significant risk to the deposit insurance fund. As a result, state chartered banks in California may no longer engage in certain activities, such as real estate investment, that might otherwise be permitted under California law.
In 1996, the primary regulator of national banks, the Comptroller of the Currency, adopted regulations giving national banks the authority to engage in, directly or through subsidiaries, a wider range of activities outside of banking, and revised its application procedures to make obtaining permission easier for well-managed and strongly capitalized national banks. This created a potential disadvantage for California state-chartered banks in that such banks cannot engage on an expedited basis in an expanded national bank activity if it is not authorized under state laws and, under FDICIA, cannot engage in an activity expanded under state law if it is not authorized for national banks.
The California Superintendent of Banks has the authority to give state-chartered banks the powers and rights that national banks have, even if those powers and rights are inconsistent with state law, but this authority was amended in 1996, effective January 1, 1997, to provide that any regulation adopted by the Superintendent under this authority will expire at the end of the year after adoption, and cannot be reinstated. Therefore, state-chartered banks are still subject to a competitive disadvantage as compared to national banks, but the extent depends on whether the Superintendent adopts regulations to give to state-chartered banks the powers and rights that national banks have and whether those rights are granted by California legislation before regulatory authority expires.
Capital Regulations
The Federal Reserve Board requires bank holding companies to maintain adequate capital and has adopted capital leverage guidelines for evaluating the capital adequacy of bank holding companies. The FDIC has also adopted a similar minimum leverage regulation, requiring insured banks to maintain at least a minimum capital to asset ratio. The Board's guidelines and the FDIC's regulations require the banks and bank holding companies subject to them to achieve and maintain a Tier 1 capital to total asset ratio of at least three percent (3.0%) to five percent (5.0%), depending on the condition and rate of growth of the bank or holding company. Tier 1 or core capital is defined to consist primarily of common equity, retained earnings, and certain qualified perpetual preferred stock. These minimum leverage ratio requirements limit the ability of the banking industry, including the Bank, to leverage assets.
The Board also uses risk-based capital guidelines to evaluate the capital adequacy of member banks and bank holding companies. Under these guidelines, assets are categorized according to risk and the various categories are assigned risk weightings. Assets considered to present less risk than others require allocation of less capital. In addition, off-balance sheet and contingent liabilities and commitments must be categorized and included as assets for this purpose. Under these guidelines, when the Company's total assets equal or exceed $150 million it will be required to maintain total capital of at least 8.00% of risk-adjusted assets, and half of that minimum total capital must consist of Tier 1 capital as defined above. For bank holding companies with less than $150 million in total assets, the Board reviews the capital adequacy of the subsidiary bank of the holding company, instead of the consolidated entity.
The FDIC requires insured banks to maintain capital in proportion to risk-adjusted assets under capital guidelines that are similar to the Federal Reserve's risk-based capital guidelines. At this time, the Bank is required to maintain total capital of at least 8.00% of risk-adjusted assets.
The capital totals of the Bank as of December 31, 1996 and 1995 exceeded the amounts of capital required under the regulatory guidelines at those times. The following table shows the capital of the Bank, as a percentage of assets, and the capital that it is required to maintain under the capital regulations, as of December 31, 1996 and 1995:
RISK BASED CAPITAL COMPUTATION
(Note: Some totals may not foot or agree to financial statements or Management's Discussion by immaterial amounts due to averaging calculations and rounding)
The risk-based guidelines and the leverage ratio do not have a significant effect on the Company and the Bank at this time because the Bank meets its required ratios. The effect the requirements may have in the future is uncertain, but management does not believe they will have an adverse effect on the Company or the Bank. The risk-based capital guidelines may affect the allocation of the Bank's assets between various types of loans and investments. If the Bank continues to grow it may be required to raise additional capital.
As required by FDICIA, the Federal banking agencies now take credit risk concentrations and an individual institution's ability to manage such concentrations into account when they assess a bank's capital adequacy. Non-traditional investments and activities, such as the use of derivatives, are also taken into account in assessing capital requirements. The agencies can adjust the standards for risk-based capital on a case by case basis to take such risks into account, but there is no formula that a bank can use prior to evaluation by the agency to determine how credit concentration or nontraditional activities will affect its capital requirements.
The banking agencies adopted amendments to the risk-based capital rules in 1995 to take interest rate risk into account. Now, when the agencies assess the capital adequacy of a bank, they must take into account the effect on that bank's capital that would occur if interest rates moved up or down. The purpose of the amendment is to ensure that banks with high levels of interest rate risk have enough capital to cover the loss exposure.
Prompt Corrective Action
FDICIA requires the banking agencies to take corrective action against certain financial institutions, based upon the financial institutions' compliance with the various capital measurements. A financial institution is subject to corrective action if its total risk-based capital is less than 8%, or its Tier 1 risk-based capital ratio or leverage ratio is less than 4%. In addition, an institution having a total risk-based capital to assets ratio of less than 10%, a Tier 1 risk-based ratio of less than 6%, or a leverage ratio of less than 5% may be subject to corrective action if it receives a less-than- satisfactory rating for assets, management, earnings or liquidity in an examination or if such ratios fall significantly below such standards. These corrective actions become increasingly more severe as an institution becomes more and more undercapitalized. Ultimately, the federal regulator is required to seize an institution within 90 days of its becoming "critically undercapitalized," unless the regulator can document that another course of action will better achieve the purposes of this section of the law.
As discussed above, the Bank has capital ratios in excess of all such capital measurements, and is not subject to any corrective actions.
Impact of Monetary Policies
Banking is a business in which profitability depends on rate differentials. In general, the difference between the interest rate received by the Bank on loans extended to its customers and securities held in the Bank's investment portfolio and the interest rate paid by the Bank on its deposits and its other borrowings comprise the major portion of the Bank's earnings. To the extent that the Bank is not able to compensate for increases in the cost of deposits and other borrowings with greater income from loans, securities and fees, the net earnings of the Bank will be reduced. The interest rates paid and received by the Bank are highly sensitive to many factors which are beyond the control of the Bank, including the influence of domestic and foreign economic conditions.
The business of the Bank is also affected by the Board's regulations, which require the Bank to maintain cash reserve balances on transaction accounts and non-personal time deposits at the
Federal Reserve Bank. The average reserve requirement for the Bank for the year ended December 31, 1996 was approximately $578,000.
The earnings and growth of the Bank are also affected by the monetary and fiscal policy of the United States and its agencies, particularly the Board. These agencies can and do implement national monetary policy, which is used in part to curb inflation and combat recession. Among the instruments of monetary policy used by these agencies are open market transactions in United States Government securities, changes in the discount rates of member bank borrowings and changes in reserve requirements. The actions of the Board have had a significant effect on lending by banks, investments and deposits, and such actions are expected to continue to have a substantial effect in the future. The nature and timing of any further changes in such polices and their impact on the Bank cannot be predicted.
Environmental Regulation
Federal, state and local regulations regarding the discharge of materials into the environment may have an impact on the Company and the Bank. Under Federal law, liability for environmental damage and the cost of cleanup may be imposed upon any person or entity who is an owner or operator of contaminated property. State law provisions, which were modeled after Federal law, impose substantially similar requirements. Both Federal and state laws were amended in 1996 to provide generally that a lender who is not actively involved in operating the contaminated property will not be liable to clean up the property, even if the lender has a security interest in the property or becomes an owner of the property through foreclosure.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the "Economic Growth Act"), discussed in more detail below, includes protection for lenders from liability under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"). The Economic Growth Act adds a new section to CERCLA to specify the actions a lender may take with respect to lending and foreclosure without incurring environmental clean-up liability or responsibility. Typical contractual provisions regarding environmental issues in the loan documentation and due diligence inspections will not lead to lender liability for clean-up, and a lender may foreclose on contaminated property, so long as it merely maintains the property and moves to divest it at the earliest possible time.
Under California law, a lender generally will not be liable to the State Attorney General for the cost associated with cleaning up contaminated property unless the lender realized some benefit from the property, failed to divest the property promptly, caused or contributed to the release of the hazardous materials or made the loan primarily for investment purposes. This amendment to California law became effective with respect to judicial proceedings filed and orders issued after January 1, 1997.
The extent of the protection provided by both the Federal and state lender protection statutes will depend on their interpretation by the administrative agencies and courts, and the Bank cannot predict whether it will be adequately protected for the types of loans it makes.
In addition, the Company and the Bank are still subject to the risks that a borrower's financial position will be impaired by liability under the environmental laws and that property securing a loan made by the Bank may be environmentally impaired and not provide adequate security for the Bank. California law provides some protection against the second risk, by establishing certain additional, alternative remedies for a lender in the situation where the property securing a loan is later found to be environmentally impaired. Primarily, the law permits the lender in such a case to pursue remedies against the borrower other than foreclosure under the deed of trust. To address the risk
that the borrower will be adversely affected by environmental liability, the Bank's Loan Policy calls for the Bank to study the history of the property and the uses of the property. When the Bank's review of the history of the property and the surrounding property indicates that there may be environmental issues, a Phase I environmental report is obtained for the property, and a Phase II report is obtained where its usefulness is indicated by the results of the Phase I environmental report.
Americans With Disabilities Act
The Americans With Disabilities Act ("ADA") enacted by Congress, in conjunction with similar California legislation, is having an impact on banks and their cost of doing business. The legislation requires employers with 15 of more employees and all businesses operating "commercial facilities" or "public accommodations" to accommodate disabled employees and customers. The ADA has two major objectives (1) to prevent discrimination against disabled job applicants, job candidates and employees and (2) to provide disabled persons with ready access to commercial facilities and public accommodations. Commercial facilities, such as the Bank, must ensure all new facilities are accessible to disabled persons, and in some instances may be required to adapt existing facilities to make them accessible, such as ATM's and bank premises.
New and Pending Legislation
Economic Growth and Regulatory Paperwork Reduction Act of 1996
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the "Economic Growth Act"), enacted on September 30, 1996, addresses the problems that arose from the disparity between the deposit insurance premiums payable by banks and savings associations, and includes a wide variety of regulatory relief measures for banks.
The crisis in the savings and loan industry during the late 1980's resulted in the dissolution of the Federal Savings and Loan Insurance Corporation and the insurance of thrift deposits through a separate fund of the FDIC called the Saving Association Insurance Fund ("SAIF") and the issuance of bonds by the Financing Corporation ("FICO") to cover some of the losses incurred by the failed savings association. As the banking industry in general has become more healthy since 1990, deposit insurance premiums for well-managed and strongly-capitalized BIF insured institutions have decreased to very low levels. However, because of the cost of carrying the FICO bonds and because the SAIF still needed to build reserves, deposit insurance premiums for SAIF insured institutions have not decreased. This created a large disparity between the cost of deposit insurance for healthy banks and similarly situated thrifts over the last several years. Many healthy thrifts have sought ways either to convert to BIF insurance or to obtain BIF insurance for some portions of their deposits, in order to remain competitive with banks. The migration of deposits increased the pressure on the remaining thrifts to build up reserves at the SAIF and pay the cost of servicing the FICO bonds.
Subtitle G of the Economic Growth Act required all remaining SAIF institutions (subject to certain exceptions) to pay a one-time deposit assessment of $.657 per $100 of insured deposits in 1996, in order to recapitalize the SAIF fund. The banking agencies are now required by law to take actions to prevent the migration of deposits from the SAIF to the BIF funds, until the year 2000. In addition, the cost of carrying the FICO bonds will now be allocated between BIF insurance institutions and SAIF insured institutions, with BIF insured institutions paying 1/5 the amount paid by SAIF insured institutions. The FDIC recently estimated that BIF institutions will pay an assessment of approximately $.0128 annually per $100 of insured deposits and SAIF institutions will pay approximately $.0644 annually per $100 of insured deposits. Starting in the year 2000, BIF and
SAIF institutions will share the FICO bond costs equally, with an estimated assessment of $.0243 annually per $100 of insured deposits.
This legislation will increase the Bank's premiums, as it will now be required to share in the cost of carrying the FICO bonds. The increase will be slight until the year 2000, at which time it will increase further.
The Economic Growth Act also included many regulatory relief provisions applicable to the Company and the Bank. The lending restrictions on directors and officers have been relaxed to permit loans having favorable terms under employee benefit plans. The Federal Reserve Board and the Department of Housing and Urban Development ("HUD") are required to simplify and improve their regulations with respect to disclosures relating to certain mortgage loans, and certain new exemptions from the disclosure requirements were added.
The Economic Growth Act also provides protection for lenders who self-test for compliance with the Equal Credit Opportunity Act (the "ECOA") and the Fair Housing Act ("FHA"). The ECOA and the FHA now provide that the results or reports generated or obtained by a bank from a self-test may not be obtained by an agency, department or applicant to be used with respect to any proceeding or civil action alleging a violation of the ECOA or the FHA, unless the bank releases the results of the test or otherwise waives the privilege. This change in the law protects the Bank against liability based on the results of internal tests done to enhance compliance with the law and encourages the Bank to use self-testing to evaluate its compliance with the ECOA and the FHA.
Section 2208 of the Economic Growth Act permits certain well-capitalized bank holding companies to engage (de novo or by acquisition) in activities previously approved by regulation without submitting an application. The Federal Reserve adopted interim regulations on November 1, 1996 to implement Section 2208. Under the new procedures, a bank holding company that qualifies may engage in new permitted new activities after providing advance notice to the Federal Reserve at least 12 business days in advance of engaging in the activity. In order to qualify, a bank holding company must be well-capitalized and have received a sufficiently high composite rating and management rating at its last examination.
Since the Federal Reserve did not have a regulatory definition of "well-capitalized," as applicable to a bank holding company, the interim rule defines well-capitalized for purposes of the new procedures. In general, in order for a bank holding company to be considered well capitalized, it must (1) have a total risk-based capital ratio of 10% or more, (2) have a Tier 1 risk-based capital ratio of 6% or more, (3) have either i) a Tier 1 leverage ratio of 4% or more or ii) a composite rating of 1 or uses a market risk adjustment to its risk-based capital ratio, and has a Tier 1 leverage ratio of 3% or more, and (4) not be subject to any written agreement, order or capital directive, issued by the Federal Reserve. This change in the law provides an advantage to a well-capitalized bank holding company, since such a bank holding company can engage in new activities more freely and quickly. The Company is considered well capitalized under the above definition.
State Regulatory Relief and Regulatory Agency Consolidation
Effective July 1, 1997, the California State Banking Department and the Department of Savings and Loan will be consolidated, and the new agency will be the Department of Financial Institutions (the "Department"). The Department will also have jurisdiction over credit unions and industrial loan companies, also known as thrift and loan companies. The legislation combining the agencies was sponsored by the State Banking Department, with the expectation that the effect of the legislation would be to reduce the cost of regulating the financial services industry, to promote reform of the regulatory climate for financial institutions and to encourage innovation. The various
types of financial institutions will continue to have separate charters and regulation, and the Bank, therefore, does not expect the consolidation to have a significant initial effect on the Bank. Over time, however, the Department may create more uniformity between the regulations governing banks and other types of financial institutions. This could create more competition between commercial banks and the other types of financial institutions. Also, the consolidation of the regulatory agencies may change the amount of the assessment the Bank pays each year to support the Department.
In addition to regulatory consolidation, the California legislature enacted regulatory relief applicable to state chartered banks. Specifically, applications are no longer required in order for a bank to establish a new ATM, a state-chartered bank no longer needs the prior approval of the Department to amend its bylaws, and only a notice is now required (instead of an application) to close a branch. These changes will reduce the Bank's cost of establishing new ATMs, and may reduce its other costs of doing business, in the event it determines to make any of the other changes affected by the new legislation.
New OCC Corporate Activities and Transaction Regulations
On November 26, 1996, the OCC completely revised its rules to simplify and streamline corporate applications and notices by national banks, including such diverse issues as branch applications, fiduciary powers applications, change in bank control, and changes in capital. The amendments became effective on December 31, 1996. The OCC also amended its rules during 1996 with respect to the types of activities in which a national bank can engage, to expand those activities and simply the application process for national banks that are well-capitalized and have strong management. See, Bank Regulation, California Law, above.
Although the Bank is not currently intending to enter into any new type of business, either relating to banking or that is not currently permitted for a bank, this regulation could affect the Bank if any of its national bank competitors to expand their operations in the future. The extent of this depends on the extent to which the OCC permits banks to engage in new lines of business, whether the State Banking Department or the new Department of Financial Institutions adopts parity regulations for state-chartered banks, and whether the Bank qualifies to expand its business at such time as it might decide to expand.
ATM Fee Legislation
In April of 1996, two of the larger ATM networks lifted their prior restriction prohibiting ATM operators from directly surcharging the users of the ATMs, which triggered a series of legislative proposals and hearings with respect to whether the fees charged by the operators of ATM machines should be regulated. The lifting of the prior restriction on surcharges was controversial in part because customer may be required to pay two charges for a single transaction, one to the bank issuing the ATM card and another to the operator of the ATM being used. See, Proposed Legislation and Regulation, below.
Currently, Federal law requires a bank at which a depositor has an account to disclose to its own customers the amount of fees it charges, and California law requires an ATM operator to disclose to users of the ATM machine who are using an ATM card issued by someone other than the ATM operator that a fee will be charged. California law was amended in 1996, effective July 1, 1997, to require the operators of ATMs in California to disclose to all users of its ATMs any surcharge or fee that the operator of the machine will charge, including charges for mini-statements and other services. The disclosure must be displayed on the machine itself or shown electronically, on the ATM screen. The Bank has taken action, both in signs and electronic display, to be in the
opinion of management to be in early compliance with the pending legislation. The cost of such compliance is not material.
Interstate Banking and Branching
The Caldera, Weggeland and Killea California Interstate Banking and Branching Act of 1995 ("Interstate Banking Act") became effective October 2, 1995. The Interstate Banking Act implements in California a limited form of interstate branching. A bank from outside of California may now acquire a whole bank in California and merge the California bank into the out-of-state bank. The effect of such merger is that the out-of-state bank will have full branch offices in California. Federal law authorizing these mergers was passed in 1994 and became effective September 30, 1995.
Out-of-state banks may not establish branch offices in California by opening a new branch or acquiring one or more (but less than all) of the branches of a California bank. They may only acquire a whole bank that has been in existence for at least five years. As a result of the Interstate Banking Act, California banks may now be permitted to branch into other states that have also adopted early opt-in legislation. Although the Bank has not experienced a significant impact to date, there may be increased competition from large interstate banks.
The Interstate Banking Act also authorizes California state-chartered banks to appoint unaffiliated banks in other states to act as an agent of the California state-chartered bank. The agent can accept deposits and evaluate loan applications on behalf of the principal bank. National banks may establish agency relationships only with affiliated banks. This expanded authority for state-chartered banks may place national banks in California at a disadvantage if many state-chartered bank use agency relationships with unaffiliated entities to increase their business.
New Community Reinvestment Act Regulations.
The Federal banking agencies amended substantially their Community Reinvestment Act ("CRA") regulations in 1995, and issued guidelines and explanations of the new regulations in 1996. CRA requires banks to help meet the credit needs of their entire communities, including minorities and low and moderate income groups.
Under the revised CRA regulations, the agencies determine a bank's rating under the CRA by evaluating its performance on lending, service and investment tests, with the lending test as the most important. The tests are to be applied in an "assessment context" that is developed by the agency for the particular institution. The assessment context takes into account demographic data about the community, the community's characteristics and needs, the institution's capacities and constraints, the institution's product offerings and business strategy, the institution's prior performance, and data on similarly situated lenders. Since the assessment context is developed by the regulatory agencies, a particular bank will not know until it is examined whether its CRA programs and efforts have been sufficient.
Larger institutions are required under the revised regulations to compile and report certain data on their lending activities in order to measure performance. Some of this data is already required under other laws, such as the Equal Credit Opportunity Act.
Small institutions (with less than $250 million in assets) are now being examined on a "streamlined assessment method." The streamlined method focuses on the institution's loan to deposit ratio, degree of local lending, record of lending to borrowers and neighborhoods of differing income levels, and record of responding to complaints. The Federal regulators who are
implementing the new regulations have reported that the time spent at the banks during CRA examination is reduced under the new regulations, and the banks spend less time on paperwork evidencing compliance.
On March 8, 1996, the Federal banking agencies issued joint examination procedures applicable to compliance examination under the new CRA regulations. On October 21, 1996, the Consumer Compliance Task Force of the Federal Financial Institutions Examination Council issued additional guidelines about for CRA compliance. Starting on July 1, 1997, the new procedures and guidelines will apply to larger institutions.
Large and small institutions have the option of being evaluated for CRA purposes in relation to their own pre-approved strategic plan. Such a strategic plan must be submitted to the institution's regulator three months before its effective date and be published for public comment.
The Bank is currently considered a small institution under the CRA regulations and it will be a small institution until it has assets of greater than $250 million at the ends of two years in a row. The initial impact of this amendment on the business of the Bank will be less than the impact when the Bank no longer qualifies as a small institution. At that time, the new regulations will increase the amount of reports the Bank is required to prepare and submit, and it could cause the Bank to change its asset mix, in order to meet the performance standards. At this time, the new regulations have increased the uncertainty of the Bank's business, both as the rating and examination procedures changes and as the Bank grows and may no longer qualify as a small institution.
Safety and Soundness Guidelines.
The Federal banking agencies issued final safety and soundness guidelines in 1995, as required by FDICIA. The guidelines contain operational and managerial standards and prohibit certain compensation practices. In 1996, the agencies adopted guidelines for asset quality and earnings. The effect of the guidelines is to require general standards of safe and sound business and banking practices with respect to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, compensation, asset quality and earnings. The banking agencies have indicated that the standards are the same as the agencies previously applied in their examinations of institutions, so the adoption should not affect individual institutions that comply with the regulations. If an agency determines that an institution is not in compliance with the guidelines, the institution must submit a plan to come into compliance to the regulator within 30 days of notification.
The effect of these guidelines on the Bank depends on how they are implemented by the Bank's primary regulator, the FDIC. The Bank expects that the guidelines may increase the Bank's cost of doing business, since it now must document its compliance with all the requirements in the guidelines. The new guidelines, in the areas of monitoring asset quality and the quality and quantity of earnings, require the Bank to document that certain reports have been made, and that it is monitoring the required items at the required times.
Proposed Legislation and Regulation.
Certain legislative and regulatory proposals that could affect the Company, the Bank and the banking business in general are pending or may be introduced, before the United States Congress, the California State Legislature, and Federal and state government agencies. Bills have been introduced in the Congress and the California legislature to regulate the amount of ATM fees that operators of ATMs may charge, and to further regulate the disclosure of such fees. A recently introduced bill in the California Assembly will, of adopted as proposed, prohibit the operator of an
ATM completely from charging fees for the use of the ATM. If this legislation is adopted as proposed by the California Legislature and signed by the Governor, the Bank's income from its ATM network would be severely reduced to the amount the Bank receives from interchange fees. The department could not cover its expenses at that level of revenue.
Other proposals to permit banks to engage in related financial services, and to permit other financial services companies to offer banking-related services are pending and, if adopted, would increase competition to the Bank. For example, the Economic Growth Act anticipates that the types of financial institution charters may be consolidated before the year 2000, especially that the charters of national banks and federal savings associations may be combined. This would also increase competition for the Bank, if federal savings associations' charters are modified to include the powers of national banks.
It is not known to what extent, if any, these proposals will be enacted and what effect such legislation would have on the structure, regulation and competitive relationship of financial institutions. It is likely, however, that many of these proposals would subject the Company and the Bank to increased regulation, disclosure and reporting requirements and would increase competition to the Bank and its cost of doing business.
In addition to pending legislative changes, the various banking regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. It cannot be predicted whether or in what form any such legislation or regulations will be enacted or the effect that such legislation may have on the Bank's business.
Item 2.

Item 2. Properties
The Company's and the Bank's principal offices are located in a modern, six-story building at 900 Veterans Boulevard, Redwood City, which provides approximately 8,300 square feet of ground floor interior space. In June of 1995 the Bank executed a lease for 7.5 years (90 months) with a seven year option to renew. The new lease was made at essentially the same terms as the previous lease. The current monthly cost for this space (which includes an allocation of certain operating expenses) is approximately $20,700 per month or approximately $2.49 per square foot. The rental amounts are subject to further adjustments annually based on the Consumer Price Index and the allocation of property taxes and operating expenses. This building was acquired in September of 1992 by Nine-C Corporation, which is owned by Mr. James Burney, a major shareholder of the Company and a Director Emeritus of the Company and the Bank.
In addition to the 8,300 square feet the Company leases for its primary operations, an additional 2,100 square feet was leased in the same building in 1993 for the Bank's Mortgage and Construction Lending Department. With the closing of the Mortgage department in February of 1997, the Bank expects to utilize the portion of the space vacated for other purposes. The current cost for this additional space (which includes an allocation of certain operating expenses) is approximately $3,900 per month or $1.86 per square foot. The lease expired in December 1995 and was renewed for a three year period with a three year option to renew. This lease is also subject to adjustment annually based on the Consumer Price Index and the allocation of property taxes and operating expenses.
The Company leases additional premises for its data processing, accounting and centralized operations departments in Redwood City. These premises are located in a building owned by Mr. Alan Miller, a major shareholder and Director Emeritus of the Company and the Bank. The lease covers total space of approximately 5,200 square feet. On May of 1991, the Company executed a three year lease with Mr. Alan Miller. This lease has been extended to March 31, 1999 with an
additional three year option to renew. The current monthly cost under the lease (which includes an allocation and adjustments for certain operating expenses) is approximately $4,750 per month, or $.91 per square foot. The monthly rent payment is subject to annual adjustment based on the cost of living index as published by the U.S. Department of Labor, Bureau of Labor Statistics. In addition to monthly rent payments, the Company is also responsible for its pro rata share of the building's operating expenses (i.e., taxes, utilities, insurance, landscaping, security).
The Company's leases were reviewed by management and the Board of Directors and found to be equitable and competitive with other leases within the immediate market area.
The Company owns leasehold improvements and furniture, fixtures and equipment located at the above locations, all of which are used in the banking business.
Item 3.

Item 3. Legal Proceedings.
As of December 31, 1996, neither the Company nor the Bank was a party to, nor is any of their property the subject of any material pending legal proceedings, nor are any such proceedings known to be contemplated by governmental authorities. At the same date, the Bank was involved as a party in employment litigation with two former employees of the Bank as described below. This litigation is considered by the Bank to be ordinary routine litigation incidental to the Bank's business and is not considered to be financially material.
In December 1996, a former employee, Harry Clancy, filed two lawsuits, one in the San Mateo Superior Court and another in Federal District Court for the Northern District of California. The Superior Court action has been removed to the Federal district Court for the Northern District of California and coordinated with the other action pending there. The suits seek damages claiming that Mr. Clancy was wrongfully terminated and that he was wrongfully excluded from the Bank's 401(k) program.
In March 1996, a former employee, Sandra Smith, filed a lawsuit in Federal District Court for the Northern District of California. The suit seeks damages for back pay, claiming alleged violations of the Americans With Disabilities Act.
In response to the foregoing lawsuits, the Bank denies the claims in their entirety and intends to vigorously defend them. The Bank's counsel believes that an award of damages is unlikely and any unexpected award would not have a material impact on the financial condition of the Bank.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted, through the solicitation of proxies or otherwise, to a vote of security holders during the fourth quarter of the fiscal year covered by this Form 10-K.
PART II
Item 5.

Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.
The Company's Common Stock is not listed on any exchange nor is it listed on the NASDAQ system. U.S. Stock Transfer Corporation acts as transfer agent and registrar for trades. Hoeffer & Arnett, Inc., Sutro & Company, and Van Kasper and Company handle transactions in the Company's stock. At March 15, 1997 the Company had approximately 380 shareholders of common stock.
The following table indicates the range of high and low bid prices, not including broker's commissions, for the periods shown, based upon information provided by Hoeffer & Arnett, Inc., Van Kasper and Company, and Sutro & Company. The table does not include transactions made privately by individuals. The prices listed below are inter-dealer prices, and do not necessarily represent actual transactions and do not include retail mark-up, mark-downs or commissions.
The following table sets forth the Company's cash dividend history from 1991 to the date this report is filed.
Continuation of future cash dividend payments by the Company is contingent upon the Board of Directors' assessment of the Company's current financial position as well as their expectation of future results. The Board also considers, among other factors, the current capital position of both the Company and the Bank as well as the need for cash and capital in the future.
For a discussion of the legal and other restrictions on the Company's ability to pay dividends, see "(f) Supervision and Regulation --Bank Holding Company Regulation-Dividends Payable by the Company" and "Bank Regulation" under the heading "Item 1. Business" above.
Item 6.

Item 6. Selected Financial Data.
The selected consolidated financial information for the Company and its subsidiaries presented below for the five years ended December 31, 1996 should be read in conjunction with the Company's consolidated financial statements and the notes thereto which are included in the Annual Report on this Form 10-K. All are amounts are in thousands except per share data.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included as part of Item 8

Item 8. Financial Statements and Supplementary Data.
Audited consolidated balance sheets as of the last two fiscal years and audited consolidated statements of operations, changes in shareholders' equity and cash flows for each of the last three fiscal years, appear commencing on page 56 of this Annual Report on Form 10-K and are incorporated by reference. Supplementary data are not required.
Item 9.

Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
This information is provided in the Company's Current Report on Form 8-K filed with the SEC on September 19, 1996.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant.
The following table provides certain information regarding the Board of Directors of the Company and the Bank.
None of the directors of the Company or the Bank were selected pursuant to any arrangement or understanding other than the directors and officers of the Company and the Bank acting in their capacities as such. There are no family relationships between any two or more of the directors or officers.
Set forth below are brief summaries of the background and business experience, including the principal occupation, of the Company's and Bank's directors. Except for the Bank, no corporation or organization discussed below is an affiliate or a subsidiary of the Company.
FRANK M. BARTALDO, JR. Mr. Bartaldo has been with Bay Area Bank since 1986. He currently serves as Executive Vice President and Senior Banking Officer of the Bank. In February 1996, Mr. Bartaldo was elected to serve as a director of the company's sole subsidiary, Bay Area Bank. Before his employment at Bay Area Bank, Mr. Bartaldo was a partner in a mortgage banking business and prior to that he was employed for eight years at Wells Fargo Bank. Mr. Bartaldo received his BS in Business Administration from California State University at Chico in 1971. Mr. Bartaldo is President of the Redwood City-San Mateo County Chamber of Commerce.
MARIO BIAGI: Presently a rancher/consultant, Mr. Biagi owned and operated Ethan Allen Furniture Store in Belmont for 15 years and Biagi Interiors in Redwood City for 10 years. From 1976 to 1984, Mr. Biagi served as a councilman for Redwood City and from 1980 to 1982, as the City's mayor. He currently serves on the Advisory Board of Kainos having served as a board member for 8 years. In addition to other active involvement in the community, he acted as Interim President of the Bank from December 1984 to May 1985, and as the Chairman of the Board from 1981 to 1991. In May 1995 Mr. Biagi was once again elected to the position of Chairman of the Board of Bay Area Bank.
JOHN O. BROOKS: Mr. Brooks began his position as President/Chief Executive Officer and Director of Bay Area Bank and Chief Operating Officer of Bay Area Bancshares on November 2, 1992. On June 27, 1995 Mr. Brooks was appointed a Director of Bay Area Bancshares. He has more than 30 years of experience in the banking industry. From 1990 to 1992, he was President/CEO of Heritage Oaks Bank in Paso Robles. From 1987 to 1990, he was President/CEO at the Bank of Pleasanton and from 1980 to 1987, he held the same position at Foothill Bank in Mountain View, Ca. Mr. Brooks is currently involved in local Rotary groups, the San Carlos Youth Center Foundation, serves on the Board of Directors of the Mid-Peninsula YMCA and the Peninsula Outreach Program and is a member of the honor society, Beta Gamma Sigma.
GARY S. GOSS: A Certified Public Accountant since 1961, Mr. Goss is the principal in the accounting firm of Gary S. Goss, San Carlos, California. Currently a member of the Redwood City, San Carlos and Foster City Chambers of Commerce and the San Carlos Rotary. Mr. Goss has been president of the San Carlos Chamber and served on the Board of Directors of the Half Moon Bay Chamber of Commerce. He also served as president of the YMCA.
ROBERT R. HAIGHT: Mr. Haight is the owner and founder of Woodside Road Insurance Agency in Redwood City. He is also a licensed insurance broker and agent. Mr. Haight graduated from Redwood City's Sequoia High School, having lived in Redwood City since 1942. He is a past president and director of the Redwood City Chamber of Commerce, the Redwood City Independent Insurance Agents Association, and San Mateo County Independent Agents Association. Currently, Mr. Haight is Director of the Redwood City Independent Insurance Agents Association and a member of the Sequoia Club. Mr. Haight was elected Chairman of the Board, President and Chief Executive Officer of Bay Area Bancshares in 1991.
STANLEY A. KANGAS: Mr. Kangas recently retired as chairman of the Board of Brian Kangas Foulk (BKF), a civil engineering firm in Redwood City. Mr. Kangas was President of BKF from 1975 to 1995. He has over 35 years of experience in all aspects of civil engineering and land surveying. Mr. Kangas has provided engineering consulting services to Stanford University, its Medical Center and Research/Industrial Park and the Stanford Shopping Center. He served as Principal-In-Charge for many of BKF's large scale projects including the 1,200 acre Redwood Shores community in Redwood City. He also serves as District Engineer for the Belmont County Water District. Professional affiliations include the American Society of Civil Engineers, American Water Works Association, Bay Counties Civil Engineers and Land Surveyors Association, Consulting Engineers and Land Surveyors of California, Peninsula Association of Contractors and Engineers, Peninsula Chapter of Civil Engineers and Land Surveyors, San Mateo County Economic Development
Association, Northern California Surveyors Joint Apprenticeship Committee and the Northern California Surveyors Trust. Mr. Kangas is currently involved in many local community programs and non-profit groups including the Redwood City-San Mateo County Chamber of Commerce, Kainos, the Sequoia Hospital Foundation, San Carlos Youth Center Foundation and the Boys and Girls Club of the Peninsula. Mr. Kangas and BKF were recently honored with the Sequoia Award for civic service by a Redwood City business. Mr. Kangas was appointed to the Board of Directors of Bay Area Bank and Bay Area Bancshares on February 20, 1996.
DAVID J. MACDONALD: A real estate developer and syndicator, Mr. Macdonald is owner and broker of David J. Macdonald Real Estate Company in San Carlos. Mr. Macdonald is a member of the San Mateo County Sheriff's Air Squadron and Search and Rescue.
THORWALD A. MADSEN: Retired since 1989, Mr. Madsen was Manager of Bay Counties Builders Escrow from 1972 to 1989, and Executive Director of the Peninsula Builder's Exchange from 1972 to 1984. Prior to assuming dual responsibilities at PBE, he ran his own company, Thor Madsen Plumbing and Heating from 1944 to 1970. Always an active member of the community, Mr. Madsen served as Mayor of San Carlos in 1974 and served on the city council from 1972 to 1976. He was on the San Carlos Park & Recreation Commission for 12 years, serving as Chairman five times. Currently Mr. Madsen is an active participant in the San Carlos Lions Club, PACE Engineers Club, San Mateo Men's Garden Club, and served as President of the San Carlos Branch of Sons in Retirement in 1990.
DENNIS W. ROYER. Mr. Royer is a partner in his family-owned and operated business, Royer Realty in Redwood City, which his father began in 1954. Upon receiving his MBA from the University of Santa Clara in 1967, Mr. Royer began his career as a residential real estate broker. He is a former board member of the Redwood City/San Carlos Association of Realtors and the Peninsula Golf and Country Club. Mr. Royer was appointed to the Board of Directors of Bay Area Bank and Bay Area Bancshares on June 6, 1995.
Executive Officers of the Registrant
The information required herein is incorporated by reference from Item 1(b), herein.
Item 11.

Item 11. Executive Compensation.
The following table sets forth the cash compensation paid to or allocated for the Chief Executive Officer of the Company and the Bank and those executive officers whose cash compensation exceeded $100,000 for services rendered in 1996, 1995, and 1994.
Executive Salary Continuation Plan
The Board of Directors of the Bank entered into a Salary Continuation Plan for John Brooks effective January 1, 1995 by which he will receive salary continuation benefits in accordance with the terms and conditions of a written agreement. This could result in a maximum benefit of annual payments to Mr. Brooks of $80,000 per year for a period of up to 15 years from 2006 through 2020. Each such annual payment is to consist of a basic benefit of $2,000 and a target benefit of $78,000.
The target benefit accrues proportionately for each calendar year from 1995 through 2005 in which Mr. Brooks remains as chief executive officer of the Bank and in which the Bank achieves certain performance standards. If the performance standards are not achieved in a particular year, the proportion of the target benefit does not vest. The payment of the annual payments to the extent they are vested will commence in 2006 and continue for up to 15 years through 2020 if certain conditions are met.
The following table sets forth certain information regarding the Salary Continuation Plan:
Profit Sharing Plan
The Bank instituted a capital accumulation and profit-sharing plan (the "Plan") for eligible employees of the Bank effective January 1, 1985 which was last amended November 1, 1987. The Plan is intended to provide benefits to the Bank's employees at retirement or upon death or disability. To be eligible for participation in the Plan, an employee must complete one half year of service and not be included in a collective bargaining unit.
Benefits are provided through the Bank's discretionary profit-sharing contributions as well as from salary saving contributions ("401(k) contributions") made by the employee. 401(k) contributions are made with before-tax dollars thereby reducing the employee's taxable income. The Bank may contribute a matching amount equal to a percentage of the employee's 401(k) contribution up to a maximum of 5% of the employee's earnings determined prior to the 401(k) contribution. The amount of the Bank's matching contribution, if any, is determined each year by the Bank's Board of Directors; however, contributions by the Bank are not allowed until the Company has achieved certain predefined performance standards. The Bank is not required to make a matching contribution even if such performance standards are achieved.
An employee's 401(k) contribution may be in an amount from 1% to 15% of the employee's earnings. If the employee contributes more than 5% of his earnings each year, no more than 5% will be matched by the Bank in the event the Bank determines it will make a discretionary contribution. The amount of the Bank's discretionary contribution, if any, is determined on a yearly basis.
Following two years of service, the Bank's contributions begin to vest, with 100% vesting occurring after four years of service. For the years ending December 31, 1996, 1995 and 1994, the Bank contributed $72,000, $64,000, and $64,000 and respectively, to the Plan.
Stock Option Plan
The Company adopted a Qualified Stock Option Plan (the "1993 Plan") in 1993, which was approved by the shareholders at the 1993 Annual Meeting. The 1993 Plan provides for the issuance of incentive and non-incentive stock options to directors, key full-time employees and officers and
consultants of the Company and the Bank. The 1993 Plan initially covered 231,431 shares of the Company's Common Stock, no par value, for which such options could be granted. As of March 15, 1997, 174,469 shares were subject to outstanding options and 9,558 shares remained available for future grant under the plan.
The Plan provides that all options be granted at an exercise price of not less than 100% of fair market value on the date of grant in the case of incentive stock options or not less than 85% of fair market value on the date of grant in the case of other stock options. The Board of Directors of the Company may issue options which become vested in the future based upon achieving certain longevity requirements and/or performance standards. Within three months following termination of employment for any reason other than death or disability, an optionee (other than a director- optionee) may exercise his or her option to the extent such option was exercisable on the date of termination, subject to earlier termination by reason of expiration of the option. In the event of the death or disability of an optionee (other than a director-optionee), the option is exercisable for a period of six months after that event, which is also subject to earlier termination if the option expires. Director-optionees may exercise their options for a period of five years following retirement, death or disability, subject to earlier termination of the options.
The following table sets forth the value realized by the exercise of options during 1996 and the value of outstanding stock options held by the executive officers named in the Summary Compensation Table at December 31, 1996, pursuant to the 1993 Plan. In addition, in February of 1997, Mr. Brooks exercised options for 2,000 shares, with an exercise price of $4.75.
SAR PLAN
In 1996, the Board of Directors of Bay Area Bancshares adopted a Stock Appreciation Right Plan, by which full-time employees of the Company and the Bank may be awarded stock appreciation rights (SARs). An employee to whom a SAR is awarded may choose to exercise the SAR and receive the difference between the base price of the SAR (which is equal to the fair market value of the stock at the time the SAR is awarded) and the fair market value at the time the SAR is
exercised. The following table sets forth the SARs awarded in 1996 to those officers named in the Summary Compensation Table.
Employment Agreement
On September 2, 1992, Bank President and Chief Executive Officer John O. Brooks entered into an employment agreement with the Bank. The agreement has no term and Mr. Brooks' employment is "at will" thus it may be terminated at any time. The agreement primarily outlines Mr. Brooks' base salary (currently $150,000 annually), auto allowance ($500 per month), performance requirements for bonuses (annual bonus payments not to exceed 4.5% of Bank pretax income), maximum severance benefits (six months if the Bank is sold or merged before September 1997; after five years employment six months salary if terminated without cause and nine months salary if the bank is sold or merged), authorities and responsibilities, and other miscellaneous benefits.
Compensation of Directors
In 1996, non-officer directors of the Company received $200 per Company Board meeting. The Chairman of the Company's Board received an additional $100 per meeting. Each non-officer director received $650 per Bank Board meeting and the Chairman of the Bank's Board received an additional $200 per monthly meeting. Each non-officer director receives $150 per monthly committee meeting and also $550 per month for health insurance premiums. Total compensation for the seven non-officer directors in 1996 was $193,000, which does not include the health insurance.
Directors are also eligible to receive options and have received options under the 1993 Plan and the prior plan of the Company. In 1996, directors exercised options for 13,000 shares of stock, by which those directors realized $99,500. As of March 15, 1997 the directors of the Company
have options exercisable for a total of 99,577 shares. The value of those exercisable options as of March 15, 1997 was approximately $1,170,030, which value is estimated based on fair market value of Common Stock at March 15, 1997 ($16.50 estimated bid price) less the exercise price of those options.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
Security Ownership of Management
The following table sets forth information as of March 15, 1997, pertaining to beneficial ownership of the Company's Common Stock by current directors of the Company and the Bank and all directors and executive officers1 of the Company as a group. The information contained herein has been obtained from the Company's records and from information furnished directly by the individual or entity to the Company.
The table should be read with the understanding that more than one person may be the beneficial owner or possess certain attributes of beneficial ownership with respect to the same securities. Therefore, careful attention should be given to the footnote references set forth in the column entitled "Amount Held and Nature of Holdings." In addition, shares issuable pursuant to options which may be exercised within 60 days of March 15, 1997 are deemed to be issued and outstanding and have been treated as outstanding in calculating the percentage ownership of those individuals possessing such interest, but not for any other individuals. Thus, the total number of shares considered to be outstanding for the purposes of this table may vary depending upon the individual's particular circumstance.
Major Shareholders
The following sets forth information as of March 15, 1997, pertaining to beneficial ownership of the Company's Common Stock by persons, other than management, known to the Company to own 5% or more of the Company's common stock. This information was obtained through the Company's stock transfer agent and registrar.
Item 13.

Item 13. Certain Relationships and Related Transactions.
Buildings Leases with Major Shareholders
The Company's and the Bank's principal offices are located in a modern, six-story building at 900 Veterans Boulevard, Redwood City, which provides approximately 8,300 square feet of ground floor interior space. In June of 1995 the Bank executed a lease for 7.5 years (90 months) with a seven year option to renew. The new lease was made at essentially the same terms as the previous lease. The current monthly cost for this space (which includes an allocation of certain operating expenses) is approximately $20,700 per month or approximately $2.49 per square foot. The rental amounts are subject to further adjustments annually based on the Consumer Price Index and the allocation of property taxes and operating expenses. This building was acquired in September of 1992 by Nine-C Corporation, which is owned by Mr. James Burney, a major shareholder of the Company and a Director Emeritus of the Company and the Bank.
In addition to the 8,300 square feet the Company leases for its primary operations, an additional 2,100 square feet was leased in the same building in 1993 for the Bank's Mortgage and Construction Lending Department. With the closing of the Mortgage department in February of 1997, the Bank expects to utilize the portion of the space vacated for other purposes. The current cost for this additional space (which includes an allocation of certain operating expenses) is approximately $3,900 per month or $1.86 per square foot. The lease expired in December 1995 and was renewed for a three year period with a three year option to renew. This lease is also subject to adjustment annually based on the Consumer Price Index and the allocation of property taxes and operating expenses.
The Company leases additional premises for its data processing, accounting and centralized operations departments in Redwood City. These premises are located in a building owned by Mr. Alan Miller, a major shareholder and Director Emeritus of the Company and the Bank. The lease covers total space of approximately 5,200 square feet. On May of 1991, the Company executed a three year lease with Mr. Alan Miller. This lease has been extended to March 31, 1999 with a three year option to renew. The current monthly cost under the lease (which includes an allocation and adjustments for certain operating expenses) is $4,750 per month, or $.91 per square foot. The monthly rent payment is subject to annual adjustment based on the cost of living index as published by the U.S. Department of Labor, Bureau of Labor Statistics. In addition to monthly rent payments, the Company is also responsible for operating expenses (i.e., taxes, utilities, insurance, landscaping, security) of the building based on the Company's proportionate share of the building's square footage (29%).
The Company's leases were reviewed by management and the Board of Directors and found to be equitable and competitive with other leases within the immediate market area.
The Company owns leasehold improvements and furniture, fixtures and equipment located at the above locations, all of which are used in the banking business.
Indebtedness of Management
Some of the Company's directors and executive officers, as well as their immediate family and associates, are customers of, and have had banking transactions with the Bank in the ordinary course of the Bank's business and the Bank expects to have such ordinary banking transactions with these persons in the future. In the opinion of management of the Bank, all loans and commitments to lend included in such transactions were made in compliance with applicable laws, and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons of similar creditworthiness, and did not involve more than a normal risk of collectibility or present other unfavorable features. The aggregate amount the Bank can lend to directors and officers as a group is limited to 100% of the Bank's capital. Loans to individual directors and officers must comply with the Bank's respective lending policies and statutory lending limits, and prior approval of the Bank's Board of Directors is required for most of these loans. Total loans outstanding at December 31, 1996 to current directors and executive officers, and their associates was $1,549,000 or approximately 16.70% of the Bank's capital.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Financial Statements.
Reference Page
Report of Independent Auditors: Coopers & Lybrand.................................................. 59
Consolidated Financial Statements of Bay Area Bancshares and Subsidiaries: .............................56
Consolidated Balance Sheets as of December 31, 1996 and 1995: .....................................56
Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994: ..................................57
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995, and 1994.......... ............59
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995, and 1994: .................................58
Notes to Consolidated Financial Statements:.........................60
2. Financial Statement Schedules. In accordance with the rules of Regulation S-X, schedules are not submitted because (a) they are not applicable to or required of the Company, or (b) the information required to be set forth therein is included in the financial statements or footnotes thereto.
3. Exhibits. Management contracts and compensation plans are identified with a number sign ("#").
Exhibit Number
3.1 Restated Articles of Incorporation of Company1
3.2 Amendment to Restated Articles of Incorporation2
3.3 Bylaws of Company, as amended2
3.4 Amendment to Bylaws of Company2
4.1 Certificate of Determination of Preferred Stock4
10.3 Lease Entered Into By and Between Alan B. Miller and Bay Area Bank5
10.4 # Employment Agreement Between John O. Brooks, Bay Area Bancshares and Bay Area Bank dated as of September 2, 19926
10.8 # 1993 Stock Option Plan6
10.9 # Forms of Stock Option Agreements6
10.11 #Director Emeritus Agreement Bay Area Bank and James E. Burney dated March 21, 19957
10.12 #Director Emeritus Agreement Bay Area Bank and Alan Miller dated May 16, 19957
10.13 Commercial Lease between Nine C Corporation dated June 30, 1995 for the Bank's primary facility7
10.14 Commercial Lease between Nine C Corporation dated November 30,
for the Bank's Mortgage Department7
10.15 #Salary Continuation Agreement between John O. Brooks and Bay Area Bank dated January 1, 1995.
10.16 #1996 Stock Appreciation Rights Plan, Amendment No. 1 to the SAR Plan and forms of SAR Agreement.
22 The only significant subsidiary of the Company is Bay Area Bank --100%-owned subsidiary incorporated in the State of California. Bay Area Bank owns 100% of Bay Counties Builders Escrow, Inc., an inactive California corporation.
23 Consent of Coopers & Lybrand LLP
27 Financial Data Schedule - -------------------
1 Filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988.
2 Filed as Exhibit 3.2 Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.
3 Filed as Exhibits 3.2, and 3.3, respectively, to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.
4 Filed as Exhibit 4.1, to the Company's Current Report on Form 8-K filed September 15, 1988.
5 Filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.
6 Filed as Exhibits 10.4, 10.8 and 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
7 Filed as Exhibits 10.11, 10.12, 10.13 and 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the fourth quarter.
Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act.
The Registrant's proxy material for its 1996 Annual Meeting of Shareholders and its Annual Report to Shareholders covering Registrant's last fiscal year is to be furnished to security holders subsequent to the filing of this Annual Report on Form 10-K. The Registrant shall furnish copies of such material to the Commission when it is sent to security holders.
See accompanying notes.
See accompanying notes.
See accompanying notes.
Report of Independent Accountants
To the Shareholders and the Board of Directors of Bay Area Bancshares: We have audited the accompanying consolidated balance sheet of BAY AREA BANCSHARES (the Company) as of December 31, 1996 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements as of December 31, 1995 and for the years ended December 31, 1995 and 1994 were audited by other auditors whose report dated January 19, 1996 expressed an unqualified opinion.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bay Area Bancshares at December 31, 1996 and the consolidated results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand
San Francisco, California February 8, 1997
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 1-Summary of Significant Accounting Policies The consolidated financial statements of Bay Area Bancshares (the Company), and its wholly owned subsidiary, Bay Area Bank (the Bank), have been prepared in conformity with generally accepted accounting principles and general practice within the banking industry. The Company's significant accounting policies are as follows:
a. Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation. All dollar amounts are shown in thousands except per share data.
b. Use of Estimates in the Preparation of Financial Statements The preparation of the consolidated financial statements of the Company requires management to make estimates and assumptions that affect reported amounts. These estimates are based on information available as of the date of the financial statements. Therefore, actual results could differ from those estimates.
c. Cash and Cash Equivalents The Company considers cash and due from banks and federal funds sold to be cash and cash equivalents.
d. Investment Securities Held to Maturity and Available for Sale The amortized cost of debt securities classified as held-to-maturity or available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization is included in interest income from investments. Interest and dividends are included in interest income from investments. Realized gains and losses, and declines in value judged to be other-than-temporary are included in net securities gains (losses). The cost of securities sold is based on the specific identification method. Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity.
e. Loans Loans are stated at the amount of principal outstanding at the balance sheet date. Interest on commercial, installment and real estate loans is accrued daily on a simple interest basis on the amount of principal outstanding. The Bank's policy is to place loans on nonaccrual status if either principal or interest has become past due for 90 days or more, or when payment in full of principal or interest is not expected. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current period income. Bank management may waive nonaccrual status and the previously accrued interest may not be reversed if a loan is well secured and in the process of collection. Cash received on non-accrual loans is applied to reduce the principal balance.
f. Loans Held for Sale Loans held for sale in the normal course of business consist of residential real estate loans that were originated or acquired with the intent to sell. These loans are recorded at the lower of cost or fair value and are originated through the Bank's Mortgage Department.
g. Allowance for Possible Loan Losses The allowance for possible loan losses is maintained at a level considered by management as adequate to provide for losses that are inherent in the loan portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The Bank makes periodic credit reviews of the loan portfolio and considers current economic conditions, historical loan loss experience and other factors in determining the adequacy of the allowance. The allowance for possible loan losses is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.
h. Premises and Equipment Premises and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets, which are generally three to five years for furniture and equipment. Leasehold improvements are amortized over the term of the respective lease or the estimated useful life of the property, whichever is shorter.
i. Real Estate Owned Real estate owned is carried at the lower of cost or fair value. When the property is acquired through foreclosure, any excess of the related loan balance over the fair value is charged to the reserve for possible loan losses. Subsequent write-downs, operating expense, and losses upon sale, if any, are charged to operating expenses.
j. Earnings per Share Earnings per common and common equivalent shares are computed by dividing net income by the weighted average number of common shares and common equivalent shares outstanding which include dilutive and anti-dilutive stock options, preferred stock and a corresponding adjustment of net interest income net of income taxes. The computation of common equivalent shares for primary earnings per share is based on the weighted average market price of the Company's common stock throughout the period. The computation of common equivalent shares for fully diluted earnings per share is based on the market price of the Company's common stock at the end of the period.
k. Reclassifications Certain reclassifications have been made to prior years' amounts to conform with the current year presentation. These reclassifications have no effect on previously reported net income.
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 2-Nature of operations The Company, through its subsidiary bank, provides a wide range of commercial banking services to individuals, professionals and small to medium sized businesses. The services provided include those typically offered by commercial banks, such as: interest-bearing and noninterest bearing checking accounts, savings and time deposits, business and personal loans, collection services, safe depository facilities, funds transfer, the issuance of money orders, cashiers checks, and the sale of travelers' checks. The Bank also operates a network of off-site Automated Teller Machines (ATM's), and a Mortgage Department (which was closed in February 1997), which generally sold the loans it originated in the secondary mortgage market.
Note 3--Investment Securities The amortized cost and approximate market value of investment securities as of December 31, 1996 and 1995 are as follows:
The amortized cost and aggregate fair value of investment securities at December 31, 1996 by type and maturity are shown below. Mortgage-backed securities are shown at final contractual maturity. The expected maturities of mortgage backed securities will differ from contractual maturities because borrowers have the right to prepay obligations without prepayment penalties.
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 3--Investment Securities (Continued) In 1995, the Company sold a security with a par value of $500 from its available for sale portfolio. As a result of this transaction, the Company realized a loss of $16. The Company did not sell any securities in 1996.
The net adjustment to unrealized gain on investment securities available for sale, included as a separate component of shareholders' equity, was $15 between December 31, 1995 and December 31, 1996. The Financial Accounting Standards Board allowed companies to revisit the designations of their held to maturity and held for sale securities in the fourth quarter of 1995. In December of 1995, the Company elected to transfer a security from its held to maturity portfolio to its held for sale portfolio in anticipation that it may be sold prior to maturity. The security had an amortized cost of $595 and an unrealized loss of $13 at the time of transfer. As of December 31, 1996 and 1995, investment securities with an amortized cost of $2,057 and $1,590 respectively, were pledged to secure public deposits and other borrowings as required by law.
Note 4--Loans and allowance for Possible Loan Losses Loan balances as of December 31, 1996 and 1995 were as follows:
The changes in the allowance for possible loan losses for the years ended December 31, 1996, 1995 and 1994 were as follows:
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, effective January 1, 1995. As a result of applying the new rules, certain impaired loans are reported at the present value of expected future cash flows using the loan's effective interest rate, or as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. If the estimated value of the loan is less than the carrying value of the loan, the impairment is recorded through a valuation allowance. The valuation allowance for impaired loans at December 31, 1996 and 1995 under SFAS No. 114 was $258 and $185 which is included in the Company's allowance for loan loss.
The Company considers all nonaccrual loans to be impaired loans. At December 31, 1996 and 1995 there were loans totaling approximately $1,431 and $470 respectively, on nonaccrual status. Interest earned but not recorded on all loans that were on nonaccrual status during the years ended December 31, 1996, 1995, and 1994 was approximately $127, $43 and $60, respectively.
The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, executive officers, principal shareholders and their associates. These transactions, including loans and deposits, are granted on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with others and do not involve more than the normal risk of collectability or present other unfavorable features. The loan activity with respect to these related parties during 1996 is summarized below:
Loans to directors, executive officers, principal shareholders and their associates
Balance at January 1, 1996 1995
$945 $1,024 Additions 888 -- Paydowns or Retirements 284 79 ................................................................................ Balance at December 31, $1,549 $945
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 4--Loans and allowance for Possible Loan Losses (Continued)
The Bank's business activity is with customers primarily located within San Mateo County. The Bank grants real estate, commercial, and installment loans to these customers. Although the Bank has a diversified loan portfolio, a significant portion of its customers' ability to repay the loans is dependent upon the real estate economic sector. Generally, the loans are secured by assets or stock. Loans are based on the borrowers' established integrity, historical cash flow, and their willingness and ability to perform on commitments. The Bank's policy is to secure collateral where deemed necessary to protect the soundness of the loan. In the event of loan default, the Bank's means of recovery is through judicial procedures.
Note 5--Premises and Equipment
Note 6--Deposits and Interest on Deposits As of December 31, 1996 and 1995, the Bank had time certificates of deposit in denominations of $100 or more totaling approximately $9,959 and $7,850, respectively. Interest paid on these deposits was approximately $494 in 1996, $347 in 1995 and $333 in 1994.
Note 7--available credit As of December 31, 1996 and 1995, the Bank had in place $9,000 in unsecured liquidity lines of credit. These funds were available through its correspondent banks. The Bank is a member of the Federal Home Loan Bank of San Francisco (FHLB). The Bank may borrow up to 25% of its assets subject to collateral and FHLB stock purchase requirements. At December 31, 1996 the Bank held $294 in FHLB stock and was able to borrow up to approximately $2,058. There were no borrowings at December 31, 1996 or 1995.
Note 8--Regulatory capital requirements The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material affect on the Bank's financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier Icapital (as defined) to average assets (as defined). Management believes, as of December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject.
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 8--Regulatory capital requirements (Continued) As of December 31, 1996, the Bank was categorized as "well- capitalized" under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratio as set forth in the table, and not be subject to a capital directive.
The retained earnings of the Company include undistributed earnings of the Bank. Dividends by the Bank to the Company are restricted under California law to the lesser of the Bank's retained earnings, or the Bank's net income for the latest three fiscal years, less dividends previously declared during that period, or with the approval of the California Superintendent of Banks, to the greater of the retained earnings of the Bank, the net income of the Bank for its last fiscal year or the net income of the Bank for its current fiscal year. As of December 31, 1996, the Bank had retained earnings available for dividend distribution of $3,774.
Additionally, the Federal Reserve Act generally restricts loans, advances and investments by the Bank, in or to the Company, to 10% of the shareholders' equity of the Bank.
Note 9--Commitments and Contingent Liabilities The Company is obligated for rental payments under certain operating leases and contract agreements. Rental expense included in occupancy expense and equipment expense was approximately $378, $359 and $315 for the years ended December 31, 1996, 1995 and 1994, respectively.
At December 31, 1996, the approximate future lease rentals payable under operating leases for premises were as follows:
1997 $330 1998 330 1999 249 2000 231 2001 231 Thereafter 231 ......................................................................... Total Minimum Lease Payments $1,602
The Company's primary location (900 Veterans Blvd.) was acquired by a former director in October of 1992. The lease for approximately 8,300 square feet, which was negotiated with the previous lessor, a non-related party, was renewed for a seven year term in June of 1996 with an additional seven and one-half year option. An additional lease for approximately 2,100 square feet for the Bank's Mortgage Department was negotiated with the former director and renewed for a three year term in December of 1996 with an additional three year option. Total rent paid in 1996 for all space leased at 900 Veterans Blvd was $276. In 1996 the Company executed a three year extension of its data processing center with a three year option with a former director. Total rent paid in 1996 for the data processing center was approximately $53. In the opinion of management, the terms of the leases are no less favorable than terms which could have been obtained from unrelated parties. The Bank is required to maintain reserves with the Federal Reserve Bank (FRB) of San Francisco. Reserve requirements are primarily based on a percentage of deposit liabilities. At December 31, 1996 and 1995 the Bank had balances of $964 and $310 respectively with the FRB. In the normal course of business, the Company is at times subject to pending and threatened legal actions and proceedings. After reviewing pending and threatened actions and proceedings with counsel, management believes that the outcome of such actions or proceedings will not have a material adverse effect on the consolidated financial condition of the Company.
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 10--Off-Balance Sheet Instruments With Risk In the ordinary course of business, the Bank enters into various types of transactions which involve financial instruments with off-balance sheet risk. These instruments include commitments to extend credit and standby letters of credit and are not reflected in the accompanying balance sheets. These transactions may involve, to varying degrees, credit and interest rate risk in excess of the amount, if any, recognized in the balance sheets. Management does not anticipate any loss to result from these commitments. The Bank's off-balance sheet credit risk exposure is the contractual amount of commitments to extend credit and standby letters of credit. The Bank applies the same credit standards to these contracts as it uses in its lending process.
Commitments to extend credit are agreements to lend to customers. These commitments have specified interest rates and generally have fixed expiration dates but may be terminated by the Bank if certain conditions of the contract are violated. Although currently subject to drawdown, many of these commitments are expected to expire or terminate without funding. Therefore, the total commitment amounts do not necessarily represent future cash requirements. Collateral held relating to these commitments varies, but may include cash, securities and real estate. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Credit risk arises in these transactions from the possibility that a customer may not be able to repay the Bank upon default of performance. Collateral held for standby letters of credit is based on an individual evaluation of each customer's creditworthiness, but may include cash and securities.
Note 11--Profit Sharing and salary continuation PlanS The Bank has a qualified profit sharing plan for most full-time employees. Employer contributions are to be made from current-year profits, predicated on the performance of the Bank based on a formula approved annually by the Bank's Board of Directors. Participants in the plan are allowed to make contributions in accordance with the plan agreement. The Bank matches the participants' contributions up to 5% of their annual salary so long as certain Bank profitability goals are met. Full vesting of the Bank's contribution to the employee occurs after five years of employment. The Bank provided for contribution expense of $72, $64 and $64 during 1996, 1995 and 1994, respectively. During 1996, the Company implemented a salary continuation plan for the Bank's Chief Executive Officer. Under the plan, the Company is obligated to provide the officer or his beneficiaries, during a period of 15 years after retirement, an annual benefit of $80. The officer vests in the benefits of the plan equally each year and fully vests in 2005 if certain bank performance standards are met and if he reaches normal retirement age while working for the Bank. The costs of these benefits accrue over the remaining expected service life of the officer based on the estimated present value of the related benefits. Salary continuation expense was $57 and $81 in 1996 and 1995, respectively. The Bank has elected to fund its obligation under the plan described above with a life insurance contract. The Bank is the beneficiary of a life insurance policy with a current cash surrender value of $129 which is included in other assets at December 31, 1996. The Company made a premium payment of $89 to this policy in both 1996 and 1995 and anticipates making additional premium payments of $89 for the next two fiscal years to the policy.
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 12--Employee Stock Option Plan and rights The Company has a stock option plan for full-time, salaried officers and directors and employees who have substantial responsibility for the successful operation of the Company. Options are granted at no less than the fair market value of the stock at the date of the grant. Options vest over a period of 0 to 5 years and have a maximum term of 10 years. The options may be granted in accordance with terms determined by the Board of Directors until the expiration of the plan. At December 31, 1996, 9,558 shares were available for grant. The following table summarizes the option activity for the years ended December 31, 1996, 1995, 1994 and 1993 (all share amounts are in thousands):
On January 1, 1996, the Bank adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS 123). As permitted by SFAS 123, the Bank has chosen to apply APBOpinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its Plans. Accordingly, no compensation cost has been recognized for options granted under the Plan. Had compensation cost for the Bank's Plan been determined based on the fair value at the grant dates for awards under the Plan consistent with the method of SFAS 123, the Bank's net income and net income per share would have been reduced to the pro forma amounts indicated below:
The fair value of each option grant is estimated on the date of grant using a method that approximates the Black-Scholes option-pricing model with the following weighted-average assumptions used for grant in 1996 and 1995; expected volatility of 15%, risk-free interest rates of 6.00% and expected lives of 10 years.
The following table summarizes information about the Plan's stock options at December 31, 1996:
Options Outstanding ................................................................................ Number Outstanding Number Excercisable Exercise Rate ............................................................................... $4.75 158 158 $5.23 10 10 $7.25 2 2 $12.50 10 10 Total 180 180 ............................................................................... Weighted average exercise price $5.24 $5.24
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 13--Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets are set forth below:
The current and deferred amounts of the tax provision (benefit) for the years ended December 31, 1996, 1995 and 1994 were as follows:
The provisions for income taxes differ from the amounts computed by applying the statutory federal income tax rates to income before taxes as follows:
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 14-FAIR VALUE OF FINANCIAL INSTRUMENTS In accordance with Statement of Financial Accounting No. 107 "Disclosures about Fair Value of Financial Instruments" (SFAS 107), the estimated fair value of the Company's financial instruments are disclosed below. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent or affect the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating its fair value disclosure for financial instruments: Cash and Cash Equivalents: Cash and cash equivalents, which includes federal funds sold, is carried at an amount that approximates fair value. Time Deposits With Other Financial Institutions: Time deposits are carried at an amount that approximates fair value. Investment Securities: Fair value is based on quoted market prices, where available or quoted market prices of comparable instruments. If not material, the carrying value of investment securities approximates fair value. Loans and Loans Held for Sale: Most adjustable rate loans are valued at the carrying amount. All fixed and adjustable rate loans with interest rate caps and floors are valued by loan type. To determine the fair value, the interest rate used to discount the cash flows is the current market rate for a like class of loans. Additionally, the allowance for loan losses was applied against the estimated fair value to recognize future defaults of contractual cash flows. Interest Receivable: Interest receivable is carried at an amount that approximates fair value. Deposits: The fair values disclosed for demand (interest bearing transaction and savings deposits) are equal to the amount payable on demand at the reporting date (carrying amount). Fair value for time deposits (fixed-rate certificate of deposits) are estimated using a discounted cash flow calculation that applies interest rates currently offered on deposits of similar remaining maturities. Interest Payable: Interest payable is carried at an amount that approximates fair value. Fed Funds Purchased: Fed funds purchased are carried at an amount that approximates fair value. Off-Balance-Sheet Instruments: The fair value of commitments to extend credit were not significant.
The estimated fair values of the Company's financial instruments are as follows:
Notes to Consolidated Financial Statements (Dollar amounts in thousands, except per share data)
Note 15--Condensed Financial Information of the Parent Company Condensed balance sheets, statements of income, and cash flows for Bay Area Bancshares (parent company only) are presented below:
Bay Area Bancshares (Parent) Balance Sheets at December 31, 1996 and 1995
Bay Area Bancshares (Parent) Statements of Income For the Years Ended December 31, 1996, 1995 and 1994
Bay Area Bancshares (Parent) Statements of Cash Flows For the Years Ended December 31, 1996, 1995 and 1994
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DATE: March 26, 1997 BAY AREA BANCSHARES
By /s/ Robert R. Haight Robert R. Haight, Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)
By /s/ John O. Brooks John O. Brooks, Director, Executive Vice President Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE: DATE:
/s/ Mario A. Biagi March 26, 1997 MARIO A. BIAGI, Director
/s/ John O. Brooks March 26, 1997 JOHN O. BROOKS, Director
/s/ Gary S. Goss March 26, 1997 GARY S. GOSS, Director
/s/ Robert R. Haight March 26, 1997 ROBERT R. HAIGHT, Chairman of the Board of Directors, President and Chief Executive Officer
/s/ Stanley A. Kangas March 26, 1997 STANLEY A. KANGAS, Director
/s/ David J. Macdonald March 26, 1997 DAVID J. MACDONALD, Director
/s/ Thorwald A. Madsen March 26, 1997 THORWALD A. MADSEN, Director
/s/ Dennis W. Royer March 26, 1997 DENNIS W. ROYER, Director
/s/ Anthony J. Gould March 26, 1997 ANTHONY J. GOULD, Vice President Chief Accounting Officer
Exhibit Index
10.15 Salary Continuation Agreement between John O Brooks and Bay Area Bank dated January 1, 1995
10.16 #1996 Stock Apreciation Rights Plan, Amendment No. 1 to SAR Plan and forms of Agreement
23 Consent of Coopers & Lybrand L.L.P.
27 Financial Data Schedule