ITEM 1. BUSINESS.
Background.
Pacific Mercantile Bancorp is a California corporation that owns all of the stock of Pacific Mercantile Bank (which, for convenience, will be referred to in this report as the "Bank" or "our Bank"). The Bank holds a California state banking chartered and operates a commercial banking business primarily in Orange County, California, approximately 60 miles south of Los Angeles. The Bank also is a member of the Federal Reserve System and its deposits are insured, to the maximum extent permitted by law, by the Federal Deposit Insurance Corporation (commonly known as the "FDIC"). The Bank commenced business in March 1999, with the opening of its first commercial banking office, located in Newport Beach, California and in April 1999 it launched its internet web site, at www.pmbank.com, where our customers are able to conduct many of their commercial banking transactions, more conveniently and less expensively, with us, 24 hours a day, 7 days a week. We have achieved rapid growth since then, opening a second banking office, located in San Clemente, California, in August 1999, and by December 31, 2000 our assets, net loans and total deposits had grown to $163 million, $98 million and $124 million, respectively. Additionally, as of that date we were serving a total of approximately 2,600 deposit customers, of which approximately 62% were conducting at least some of their banking transactions with us over the internet and business customers accounted for approximately 50% of our deposits. It is our plan to expand our operations into other areas of Southern California and, in furtherance of that plan, we recently received regulatory approvals to open two more commercial banking offices, one of which will be located in Costa Mesa, California, near the South Coast Plaza Shopping Center, and which is expected to open for business in the second quarter of 2001. The other office, which will be our first office in Los Angeles County, will be located in the heart of the Beverly Hills, California and is currently expected to open for business in the second quarter of 2001.
The capital stock of the Bank is our principal asset and substantially all of our business operations are conducted by the Bank which, as a result, accounts for substantially all of our revenues and income. As the owner of a commercial bank, Pacific Mercantile Bancorp is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act") and, as such, our operations are regulated by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board").
Pacific Mercantile Bancorp was organized by the Bank in January 2000 to become a bank holding company for the Bank. In June 2000, it did so, following receipt of required regulatory approvals, by acquiring all of the stock of the Bank in a merger in which (i) the shareholders of the Bank became the shareholders of Pacific Mercantile Bancorp, exchanging their shares of common stock of the Bank, on a one share-for-one share basis, for shares of Pacific Mercantile Bancorp common stock, and (ii) the Bank became our wholly-owned subsidiary. In June 2000, we completed an initial public offering of Pacific Mercantile Bancorp stock,
registered under the Securities Act of 1933. We sold a total of 2,611,608 shares of our common stock in that offering for a price of $8 per share. The net proceeds of that offering (after deducting underwriting commissions and offering expenses) totaled $18,527,200. See the Section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Capital Resources" in Part II of this Report for additional information regarding that public offering.
As a matter of convenience, we will be using the term "Company" or "us" to refer to Pacific Mercantile Bancorp, together with the Bank. In certain instances in this Report where we discuss Pacific Mercantile Bancorp as a corporation separate from the Bank, such as the discussion of regulatory requirements that are applicable to Pacific Mercantile Bancorp, but not to the Bank, we will refer to Pacific Mercantile Bancorp as the "Bancorp".
Our Commercial Banking Operations
Through our banking offices and by means of the Internet, we seek to meet the banking needs of small and medium size businesses, professional firms and individuals by providing:
. A broad range of banking and financial service products, more typical of larger banks, in order to gain a competitive advantage over independent or community banks that do not provide the same range or breadth of services that we are able to provide to our customers.
. A high level of personal service and responsiveness, more typical of independent and community banks, giving us a competitive advantage over large out-of-state and other large multi-regional banks that are unable or, due to the expense involved, are unwilling to provide that same level of personal service to this segment of the banking market.
. The added flexibility, convenience and efficiency of conducting banking transactions with us over the Internet, which further differentiates us from our competitors and will enable us to reduce the costs of providing service to our customers.
The specific products and services we offer include the following:
Deposit Products. We offer a number of different types of deposit accounts, including non-interest demand and interest bearing checking accounts, money market accounts, savings accounts and certificates of deposit. As of December 31, 2000, our deposits totaled $124,286,500. The following table sets forth, by type of deposit account, the average balances and total amounts of deposits maintained by customers at our Bank as of December 31, 2000:
- -------- (1) Includes money market accounts. Excludes $6,546,900 of money market deposits maintained at the Bank by Bancorp.
(2) Time certificates of deposit in varying denominations under and over $100,000. Excludes a $250,000 certificate of deposit maintained at the Bank by Bancorp.
Loan Products. We offer a diverse line of loan products, including commercial loans and credit lines, SBA guaranteed business loans, accounts receivable and inventory financing, real estate mortgage and construction loans and consumer loans. We also have established a mortgage banking division which originates
and purchases residential mortgages that, for the most part, qualify for resale to long-term investors in the secondary residential mortgage market. Our mortgage loan products include conforming and non-conforming agency-quality one-to-four family first mortgages, investor-quality home equity second mortgages and investor-quality home equity lines of credit secured by second trust deeds or mortgages. In most instances, we fund these loans at the time of origination and sell the loans to investors in the secondary market within 30 days of funding. We earn loan origination and processing fees and, prior to their resale, interest income on such qualifying mortgage loans.
The following table sets forth the types and amount of our loans that were outstanding as of December 31, 2000:
- -------- (1) These loans include approximately $23,673,800 of real estate loans purchased from an unrelated mortgage banking firm in the fourth quarter of 1999 and the first quarter of 2000.
(2) Excludes loans held for sale of $11,084,400 and deferred loan fees of $159,300.
Commercial Loans. The commercial loans we offer include short-term secured and unsecured loans with maturities ranging from 12 to 24 months; SBA guaranteed business loans with a term not to exceed 10 years; accounts receivable financing for terms not exceeding 12 months; and equipment and automobile loans and leases which generally amortize over a period not to exceed 7 years. The interest rates on these loans generally are adjustable and usually are indexed to The Wall Street Journal's prime rate. In order to mitigate the risk of borrower default, we generally require collateral to support the credit or personal guarantees from the owners of the borrowers, or both. In addition, all loans must have a well-defined primary and secondary source of repayment. Generally, lines of credit are granted for no more than a 12-month period and are subject to a more frequent periodic review.
We also offer asset-based lending products which involve a higher degree of risk in that the loan is designed for those borrowers who do not quality for unsecured lending. Typically, these borrowers consist of companies that are growing rapidly, are profitable but cannot internally fund their growth without borrowings. In addition, the collateral usually consists of accounts receivable. We control our risk by requiring loan-to-value ratios of not more than 80% and by closely and regularly monitoring the amount and value of the collateral in order to maintain that ratio.
Commercial loans, including accounts receivable financing, are generally made to businesses that have been in operation for at least three years. In addition, these companies have debt-to-worth ratios that generally do not exceed four-to-one. Operating cash flow of these borrowers must be sufficient to demonstrate the ability to pay obligations as they become due. The borrowers must also have good payment histories as evidenced by credit reports.
Real Estate Loans. Approximately 51% of our real estate loans outstanding as of December 31, 2000 were purchased from an unrelated mortgage banking firm. Most of these purchased loans are secured by multi-family dwellings. The remainder of the real estate portfolio consists primarily of nonresidential real estate loans, of which approximately 86% were secured by first trust deeds.
Loans secured by nonresidential real estate often involve loan balances to single borrowers or groups of related borrowers, and generally involve a greater risk of nonpayment, than do mortgage loans secured by single
and multi-family dwellings. Payments on these loans depend to a large degree on results of operations and dependable cash flows for the borrowers generated from a wide variety of businesses and industries. In addition, repayment of these loans may be affected adversely by changes in the economy in general or by the real estate market more specifically. Accordingly, the nature of this type of loan makes it more difficult to monitor and evaluate. Consequently, personal guarantees from the owners of the borrowers are typically required.
Customers wishing to obtain a commercial real estate loan must have good payment records with a debt coverage ratio generally of at least 1.25 to 1. In addition, we require adequate insurance on the property to protect the collateral value. Generally, these types of loans are indexed to The Wall Street Journal prime rate and are written for maximum terms of 7 years with loan-to-value ratios of not more than 75%.
Residential Real Estate Loans. Generally, these loans are funded by our mortgage banking division at the time of origination and are sold to investors in the secondary market, usually within thirty days of funding. We earn loan origination and processing fees, and also interest income during the period from origination to sale. We also offer equity lines of credit secured by residential real estate which are tied to an outside index (such as The Wall Street Journal prime rate).
Generally, residential real estate loans must have loan-to-value ratios that do not exceed secondary market requirements. A borrower must demonstrate a good payment history as evidenced by credit reports. In accordance with investor criteria, the mortgage payment ratio may not exceed 28% of income and total debt of the borrower may not exceed 40% of income.
Consumer Loans. We offer a wide variety of products to consumers including personal installment loans, lines of credit and credit cards. We design these products to meet the needs of our customers and some are made at fixed rates of interest and others at adjustable rates. Consumer loans often entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. Further, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. Consumer loan collections are dependent on borrowers' ongoing financial stability. Furthermore, bankruptcy and insolvency laws may limit the amount which can be recovered on such loans. Consumer loans require a good payment record and, typically, debt ratios of not more than 40%.
Business Services. We offer various financial services directed primarily at our business banking customers, including:
. Merchant bankcard services to process credit card payments made by their customers;
. Automated clearinghouse origination services that enable any businesses that charge for their services or products on a monthly or other periodic basis to obtain payment from their customers through an automatic, pre-authorized debit from their customers' bank accounts anywhere in the United States;
. Electronic check origination and processing that allows businesses, including Internet retailers, to accept payment from their customers in the form of an electronic check that we are able to debit electronically from any bank in the United States; and
. Financial management tools, including multiple account control, account analysis, transaction security and verification, wire transfers, universal bill payment, payroll and lock box services.
Convenience Banking Services. We offer a number of services and products that make it more convenient to conduct banking transactions with us, such as our Internet banking system, ATM's, phone banking, night drop services and armored car services to order and receive cash without having to travel to our banking offices.
Automated Clearinghouse Origination Services. The Federal Reserve operates an automated or "electronic" clearing house system (which is commonly referred to as "ACH") which enables businesses, with
the authorization of their customers, to obtain payments of their charges by electronically debiting the banking accounts of their customers. ACH services enable businesses that sell products or services to customers to reduce their costs and improve their cash flow by:
. Eliminating the need to issue monthly invoices; and
. Substituting electronic checks, in place of conventional paper checks that must be prepared and mailed and then processed through the Federal Reserve's traditional clearing house system, thereby significantly shortening the time within which they can receive payments from their customers.
Typical businesses that use ACH services include insurance companies (to collect insurance premiums), lenders (to collect monthly mortgage or automobile payments) and health, fitness and other clubs (to collect monthly fees or dues).
However, for a business to be able to use ACH services, it must have a banking relationship with a bank that has the computer systems needed to be able, and that is authorized by the Federal Reserve, to originate ACH charges or "credits." While virtually all banks can receive ACH debits made against the accounts of their customers, there are a limited number of banks, particularly among independent and community banks, that have become authorized by the Federal Reserve, and have the computer systems necessary, to originate ACH debits for their business customers. The Bank has qualified with the Federal Reserve to do so and originates ACH transactions for a number of its customers.
We have also been retained to provide similar ACH services to clients of eFunds Corporation, which provides a number of automated collection services primarily to businesses that sell their products to consumers in person, by mail or over the Internet. Among the methods of collection that eFunds employs is an "electronic debit" process by which a consumer that buys products from any eFunds client may authorize the charges on a per transaction basis to be paid by means of an electronic debit or "electronic check" that can be transmitted electronically to and charged against the consumer's bank account at any U.S. based bank via a privately established automated clearing house system. Like the Federal Reserve's automated clearing house system, these automated payment services enable businesses to improve their cash flow and reduce expenses by reducing their dependence on conventional paper checks and credit cards for payment and enabling them to receive payments from their customers generally within two to three business days following the transactions which generate the electronic debits.
We act as an originating depository financial institution for a number of eFunds' clients, electronically debiting the bank accounts of and receiving the resulting payments from their customers and transferring those payments to banks designated by those eFunds clients who utilize this service. Neither eFunds' clients nor the consumers need to have accounts with us to avail themselves of this service and we generate interest earnings on the funds received as a result of the debits pending their electronic transmission to eFunds' clients. We believe that currently there are only about 30 banks in the United States that have qualified to participate as originating depository financial institutions in this program, most of which are much larger multi- regional and out-of-state banks. We are able to offer this service to our own business customers and, as a result, we believe that our investment in electronic information and processing systems enables us to offer a relatively unique service not provided by the independent and community banks with which we compete.
Internet Banking Services
Banking transactions that customers can conduct and banking products and services that customers can access at our Web site include:
. Establishing business and consumer checking and savings accounts;
. Purchasing and renewing certificates of deposit;
. Transferring funds between accounts;
. Printing bank statements;
. Viewing the front and back of their paid checks;
. Submitting loan applications;
. Transferring funds from credit lines to, and making loan payments from, their deposit accounts;
. Paying bills, payroll and taxes;
. Ordering cash through our Web site and having the funds delivered to them by armored car service;
. Utilizing business cash management services, including currency converters for international transactions and electronic wire transfers;
. Merchant banking services, including credit card processing, automated clearing house originations and electronic check processing; and
. A number of consumer and personal banking services, including financial planning for home buying and financing, retirement planning and discount brokerage services offered through a strategic alliance with UVest Financial Services Group, Inc., an online discount securities brokerage firm.
Opening an Account. Our customers can access our Web site and our Internet banking services through any Internet service provider by means of secure Web browsers such as Netscape's Navigator (Version 4.0 or higher) or Microsoft's Internet Explorer (Version 4.0 or higher). When customers access our menu of products and services at our Web site, they can open a new account, review the history and status of their existing accounts, and effectuate several different types of banking transactions.
To apply for a new account, a customer completes an online account application, prints out that application and mails it to us. A customer may also apply for a new account by calling our toll-free telephone number, which is 1-877-450-BANK.
Security. Our ability to provide our customers with secure financial services over the Internet is of paramount importance. We believe our Internet systems, services and software meet the highest standards of bank security. The following are among the security measures that are in place:
. Encrypted Transactions. All banking transactions and Internet communications are encrypted so that sensitive information is not available on the Internet in a form that can be read or easily deciphered.
. Secure Logon. To eliminate the possibility that a third party may download the Bank's or any customer's password file, user identification and passwords are stored behind a secure firewall on the Web server. Additionally, passwords are variable length strings of five to eight alphanumeric characters, which makes the chance that a password can be randomly guessed less than one in one trillion.
. Firewalls. All of our Internet banking services are routed from our Internet server through a firewall. The firewall is a combined software and hardware product that precisely defines, controls and limits access to "internal" computers from "outside" computers across a network. Use of this firewall means that only authenticated Bank customers or administrators may send or receive transactions through it, and the firewall itself is immune to penetration from the Internet. In other words, the firewall is a mechanism used to protect our computers from unauthorized access through the Internet by customers or by third parties.
. Physical Security. All servers and network computers reside in secure facilities. Currently, computer operations supporting our Internet operations are based in Newport Beach, California and at the offices of Fiserv, in Van Nuys, California where our mainframe computer is based. Only employees with proper identification may enter our primary server area. Access to our server console requires further password identification.
. Service Continuity. To avoid interruptions in our Internet banking services, we intend to install Internet servers at our other full service banking offices, such as in our San Clemente office, which can process Internet transactions not only from customers of that office, but also customers of our other offices, in the event the servers at those other offices become disabled. In the unlikely event that our customers are prevented from accessing their accounts over the Internet, they will retain access to their funds through a number of different means, including making in-person withdrawals at any of our branch banking offices or ATM's or by armored car; making deposits in person, by mail or at our ATM's and getting information and assistance from our employees by telephone. Additionally, Fiserv, which hosts our mainframe computer, has the ability to transfer data electronically to a second computer system located at a remote site, so that in the event of a natural disaster that affects Southern California, we will continue to be able to process banking transactions via our computer system without any significant interruptions. Additionally, we are working with Q-Up Systems, which provides Internet transaction processing software and services to us, to establish a second location equipped with Internet servers that can enable our customers to continue conducting Internet banking transactions with us in the event that our Internet servers in Southern California were to become disabled.
. Monitoring. All customer transactions on our Internet server in Newport Beach produce one or more entries into transactional logs. We recognize that it is critical to monitor these logs for unusual or fraudulent activity. Our personnel review these logs regularly to identify any abnormal or unusual activity and to take appropriate action. We believe that, ultimately, vigilant monitoring is the best defense against fraud.
We believe the risk of fraud presented by providing Internet banking services is not materially different from the risk of fraud inherent in any banking relationship. We believe that potential security breaches can arise from any of the following circumstances:
. misappropriation from the user of the user's account number or password;
. penetration of our server by an outside "hacker;"
. fraud committed by a new customer in completing his or her application with us; and
. fraud committed by an employee of ours or one of our service providers.
Both traditional banks and Internet banks are vulnerable to these types of fraud. By establishing the security measures described above, we believe we have minimized our vulnerability to the first three types of fraud. To counteract fraud by employees and service providers, we have established internal procedures and policies designed to ensure that, as in any bank, proper control and supervision is exercised over employees and service providers.
Additionally, the adequacy of our security measures is reviewed periodically by the Federal Reserve Board and the California Department of Financial Institutions, which are the federal and state government agencies with supervisory authority over the Bank. We also retain the services of third party computer security firms to conduct tests of our Internet banking and computer systems to identify potential threats to the security of our systems and to recommend additional actions that we can take to improve our security measures.
Measures to Deal with the California Electricity Crisis. California has recently encountered a tightening of electricity supplies from power generation companies and, although there have been few instances of power outages to date, it is expected that Southern California will experience so-called "rolling blackouts" due to electric power shortages during the summer months when electricity usage is at its peak. Moreover, the electric utilities that serve California have advised their customers that there may be unable to give much advance warning to their customers of the time and duration of these outages or "blackouts". To enable us to continue serving our customers and to minimize the potential disruptions that such blackouts would cause, we have developed contingency plans to deal with any power outages. These contingency plans include the use of
alternative energy generating equipment to provide power to essential systems and back up systems for effectuating banking transactions during the power outages. However, we do not know and cannot predict the frequency or duration of the power outages that may occur and, therefore, despite our contingency plans, such outages could adversely affect our future financial performance. Additionally, the electricity crisis will result in increases in the costs of the electricity we use. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Forward Looking Information and Uncertainties Regarding Future Financial Performance" in Part II of this Report.
Competition
Competitive Conditions in the Traditional Banking Environment. The banking business in California generally, and in our service area in particular, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of large multi-regional and large out-of-state banks which have offices operating over wide geographic areas. We compete for deposits and loans with such banks as well as other independent and community banks that are based or have branch offices in our market areas, and with savings and loan associations, credit unions, mortgage companies, money market and other mutual funds, stock brokerage firms, insurance companies, and other traditional and nontraditional financial institutions. We also compete for customers' funds with governmental and private entities issuing debt or equity securities or other forms of investments which may offer different and potentially higher yields than those available through bank deposits.
Major financial institutions that operate throughout California and that have offices in our service areas include Wells Fargo Bank, Bank of America, Union Bank, Sanwa Bank California, Washington Mutual Savings Bank, U. S. Bancorp, Comerica Bank and California Federal Savings. With the exception of Union Bank, all of these banks are now headquartered outside of California. Independent banks or financial institutions with offices in our service area include, among others, City National Bank, Imperial Bank, Manufacturers Bank, Downey Savings and Eldorado Bank.
The large banks and some of the independent institutions have the financial capability to conduct extensive advertising campaigns and to shift their resources to regions or activities of greater potential profitability. Many of them also offer diversified financial services which we do not presently offer directly. The larger banks also have substantially more capital and higher lending limits.
In order to compete with the financial institutions operating in our service areas, we rely on our independent status to provide flexible and greater personalized service to customers. We emphasize personal contacts with potential customers by our executive officers, directors and employees; develop local promotional activities; and seek to develop specialized or streamlined services for customers. To the extent customers desire loans in excess of our lending limit or services not offered by us, we attempt to assist customers in obtaining such loans or other services through participations with other banks or assistance from our correspondent banks or third party vendors.
Competitive Conditions in Internet Banking. The market for electronic banking services is rapidly evolving. There are a number of banks that offer services exclusively over the Internet, such as Net.B@nk and CompuBank, and others that are affiliated with existing banks, such as Wingspan.com, that market their services nationwide. There also are a large number of existing banks that are beginning to offer Internet banking services; however, we believe that few of these banks offer the comprehensiveness of Internet banking services that we are able to offer. However, many of the larger of these banks do have greater market presence and greater resources to market their Internet banking services than we do. Additionally, new competitors and competitive factors are likely to emerge, particularly in view of the rapid development of Internet commerce. Additionally, there have been recently published reports that the actual rate of growth in the use of the Internet banking services by consumers and business is lower than had been previously predicted, and that many customers continue to want to be able to access such services at traditional local banking offices. In recognition of these conditions, from the outset our strategy has been to offer our customers the benefits of both traditional and internet banking services.
We also compete for customer funds with the numerous and growing number of securities brokerage firms that offer online trading and investments, which provide an alternative to deposit products we offer. The Bank has entered into an agreement with UVEST Financial Services Group in order to offer online discount securities brokerage services to its customers via our Web site.
Existing and future state and federal legislation could significantly affect the cost of doing business, the range of permissible activities and competitive balance among major and smaller banks and other financial institutions. We cannot predict the impact such developments may have on commercial banking in general or on our business in particular. For additional information regarding these matters, see the discussion in below under the caption "Supervision and Regulation."
Supervision and Regulation
General. Both federal and state laws extensively regulate bank holding companies and banks. This regulation is intended primarily for the protection of depositors and the FDIC's deposit insurance fund and not for the benefit of our stockholders. Set forth below is a summary description of the material laws and regulations which affect or bear on our operations. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
In recent years, significant legislative proposals and reforms affecting the financial services industry have been discussed and evaluated by Congress and certain of these proposals have been adopted, including legislation that expands the insurance and other activities in which bank holding companies and their subsidiaries may engage. We cannot predict whether any other of these proposals, or any form of them, will be introduced in the current Congress and become law. Consequently, we cannot presently determine what effect, if any, those other proposals may have on us.
Pacific Mercantile Bancorp. Bancorp is a registered bank holding company subject to regulation under the Bank Holding Company Act. Bancorp is required to file with the Federal Reserve Board periodic reports pursuant to the Bank Holding Company Act, and is subject to Federal Reserve Board examinations.
Among the powers conferred on the Federal Reserve Board is the power to require any bank holding company to terminate an activity or terminate control of or liquidate or divest subsidiaries or affiliates that the Federal Reserve Board determines constitutes a significant risk to the financial safety, soundness or stability of the bank holding company or any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of a bank holding company's debt, including authority to impose interest ceilings and reserve requirements on such debt. Subject to certain exceptions, bank holding companies also are required to file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming the holding company's common stock or other equity securities.
Under the Bank Holding Company Act and related regulations adopted by the Federal Reserve Board, a bank holding company and its non-banking subsidiaries are prohibited from requiring tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Additionally, the Federal Reserve Board requires all bank holding companies to maintain capital at or above certain prescribed levels. See "Capital Standards" below. As a bank holding company, Bancorp must obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities, or of substantially all of the assets, of any bank or other bank holding company and for any merger of Bancorp with any other bank holding company.
The Bank Holding Company Act also prohibits any bank holding company from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries, except in statutorily permitted instances. However, we may, subject to the prior approval of the Federal Reserve Board, engage in, or acquire
shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Additionally, under statutory amendments adopted by Congress and enacted into law in 2000, subject to certain prior notice requirements bank holding companies may establish or acquire companies that engage in a number of financial service activities, including insurance brokerage services.
Under Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board's policy that, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both.
Bancorp also is a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, Bancorp is subject to examination by, and may be required to file reports with, the California Commissioner of Financial Institutions.
Our shares of common stock are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended and, therefore, we are subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Securities Exchange Act.
Pacific Mercantile Bank. As a California state chartered bank, the Bank is subject to primary supervision, periodic examination and regulation by the California Commissioner of Financial Institutions. As a member of the Federal Reserve Bank of San Francisco, the Bank also is subject to regulation by the Federal Reserve Board, which is its primary federal banking regulator. Because its deposits are insured by the FDIC, the Bank also is subject to regulations promulgated by the FDIC. If, as a result of an examination of the Bank, the Federal Reserve Board should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank's operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, the Federal Reserve Board has various remedies available. These remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate the Bank's deposit insurance, which would result in a revocation of the Bank's charter. The California Commissioner of Financial Institutions has many of the same remedial powers.
Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, the Bank is required to maintain capital at or above stated levels. See "Capital Standards" below.
Dividends and Other Transfers of Funds. In addition to cash generated from our initial public offering in June 2000, dividends from the Bank constitutes Bancorp's principal source of cash. Bancorp is a legal entity separate and distinct from the Bank and the Bank is subject to various statutory and regulatory restrictions on its ability to pay cash dividends to Bancorp. In addition, the California Commissioner of Financial Institutions and the Federal Reserve Board have the authority to prohibit the Bank from paying dividends, if either of them deem payment of dividends by the Bank to be an unsafe or unsound practice.
The Federal Reserve Board and the California Commissioner of Financial Institutions also have authority to prohibit the Bank from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the future financial condition of the Bank and other factors, that the Federal Reserve Board or the Commissioner could assert that the payment of dividends or other payments might, under some circumstances, constitute an unsafe or unsound practice. Additionally, the Federal Reserve Board has established guidelines with respect to the maintenance of appropriate levels of capital by banks and bank holding companies under its jurisdiction. Compliance with the standards set forth in those guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the Bank or Bancorp may pay. An insured depository institution is prohibited from paying management fees to any controlling persons or, with limited exceptions, paying dividend if, after the transaction, the institution would be undercapitalized. See "Prompt Corrective Action and Other Enforcement Mechanisms" and "Capital Standards" for a discussion of these additional restrictions on dividends.
The Bank is subject to restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, Bancorp or its other affiliates; the purchase of, or investments in, Bancorp stock or other Bancorp securities; and the taking of such securities as collateral for loans and the purchase of our assets or those of our other affiliates. Such restrictions prevent Bancorp's affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts, and such secured loans and investments by the Bank to or in Bancorp or any other Bancorp affiliates are limited, individually, to 10% of the Bank's capital and surplus (as defined by federal regulations) and, in the aggregate, to 20% of the Bank's capital and surplus. California law also imposes restrictions with respect to transactions involving Bancorp and other controlling persons of the Bank. Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law.
Capital Standards and Prompt Corrective Action.
Capital Standards. The Federal Reserve Board as well as other federal bank regulatory agencies, have adopted uniform risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjusted percentages, which range from zero percent for assets with low credit risk, such as U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as commercial loans.
The Federal Reserve Board, as well as other federal bank agencies, requires a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. As is usually the case with newly established banking organizations, as a condition of obtaining FDIC insurance for its deposits, the Bank agreed to maintain, during a period of three years following the commencement of its banking operations, which will end on February 28, 2002, a ratio of Tier 1 Capital to Average Assets of not less than 8%. Since the commencement of its operations, the Bank has been able to maintain that ratio well above 8%.
Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository
institutions, including; those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios:
. well capitalized;
. adequately capitalized;
. undercapitalized;
. significantly undercapitalized; and
. critically undercapitalized.
An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment.
The following table sets forth, as of December 31, 2000, the capital ratios of Bancorp and the Bank and compares those capital ratios to the federally established capital requirements that must be met for a bank holding company or a bank to be deemed adequately capitalized and to be deemed a "well capitalized institution" under the prompt corrective action regulations described below:
As the table indicates, at December 31, 2000 Bancorp and the Bank exceeded the capital ratios required for classification as adequately capitalized institutions, under federally mandated capital standards and as "well capitalized" institutions under the federally established prompt corrective action regulations.
In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines designed to identify and address potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to the following:
. internal controls, information systems and internal audit systems;
. loan documentation;
. credit underwriting;
. asset growth;
. earnings; and
. compensation, fees and benefits.
In addition, the federal banking agencies also have adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution is expected to:
. conduct periodic asset quality reviews to identify problem assets;
. estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses;
. compare problem asset totals to capital;
. take appropriate corrective action to resolve problem assets;
. consider the size and potential risks of material asset concentrations; and
. provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk.
These guidelines also establish standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves.
FDIC Deposit Insurance. The FDIC's Bank Insurance Fund insures the Bank's deposit accounts up to the maximum amount permitted by law. The FDIC may terminate insurance of deposits upon finding that an insured institution has engaged in unsafe or unsound practices, is in too unsafe or unsound a condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the institution's primary federal regulatory agency. California does not permit commercial banks to operate without FDIC insurance. As a result, termination of FDIC insurance of a California bank will result in its closure.
The Federal Deposit Insurance Corporation charges an annual assessment for the insurance of deposits, which as of December 31, 2000, ranged from [0 to 27] basis points per $100 of insured deposits, based on the risk a particular institution poses to its deposit insurance fund. The risk classification is based on an institution's capital group and supervisory subgroup assignment. Pursuant to the Economic Growth and Paperwork Reduction Act, banks pay, in addition to their normal deposit insurance premium as a member of the Bank Insurance Fund, an amount equal to approximately 1.3 basis points per $100 of insured deposits toward the retirement of the Financing Corporation bonds issued in the 1980s to assist in the recovery of the savings and loan industry.
Interstate Banking and Branching. The Bank Holding Company Act permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to conditions including nationwide- and state-imposed concentration limits. The Bank also has the ability, subject to certain restrictions, to acquire branches outside California either by acquisition from or a merger with another bank. The establishment by a state bank of new bank branches (often referred to as "de novo" branches) in other states is also possible in states with laws that expressly permit it. Interstate branches are subject to laws of the states in which they are located. Consolidations of and competition among banks has increased as banks have begun to branch across state lines and enter new markets.
Community Reinvestment Act and Fair Lending Developments. The Bank is subject to fair lending requirements and reporting obligations involving home mortgage lending operations and Community
Reinvestment Act activities. The Community Reinvestment Act generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods. A bank may be subject to substantial penalties and corrective measures for a violation of fair lending laws. The federal banking agencies may take compliance with those laws and Community Reinvestment Act obligations into account when regulating and supervising other activities.
A bank's compliance with its Community Reinvestment Act obligations is based on a performance-based evaluation system which bases Community Reinvestment Act ratings on an institution's lending service and investment performance. When a bank holding company applies for approval to acquire a bank or other bank holding company, the Federal Reserve Board will review the assessment of each subsidiary bank of the applicant bank holding company, and those records may be the basis for denying the application.
Comprehensive Bank Reform Legislation. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act (the "Gramm Act"). The Gramm Act is expected to have a major impact on cross-industry mergers, customer privacy and lending to lower-income communities. The Gramm Act repeals the Glass Steagal Act of 1937, which separated commercial and investment banking, and eliminates the Bank Holding Company Act's prohibition on insurance underwriting activities. The Gramm Act allows both holding company subsidiaries and national bank operating subsidiaries to offer a wide range of new financial services, including insurance or securities sales. However, real estate development and insurance underwriting would be restricted to affiliates and cannot be performed by bank operating subsidiaries. State laws will govern insurance sales, but states cannot discriminate against national banks by preventing national banks from conducting insurance activities that non-banks may conduct. The Gramm Act bars a bank holding company from merging with insurance or securities firms, or embarking on new powers, if any of its banks earned less than a "satisfactory" Community Reinvestment Act rating in its most recent examination. The Gramm Act also provides that customers will have the right to prevent banks from sharing information with third parties. The Gramm Act is expected to further increase competition in providing financial services.
Employees
As of December 31, 2000, we employed 55 persons on a full-time equivalent basis. None of our employees is covered by a collective bargaining agreement. We believe our employee relations are good.
ITEM 2.
ITEM 2. PROPERTIES.
The Bank subleases approximately 9,500 square feet of ground floor office space, and leases approximately 4,300 square feet of upper floor office space, both from unaffiliated third parties, in Newport Beach, California, which is the current location of our headquarters and main banking office. Both leases expire on June 30, 2001. However, we have obtained a new 5-year lease from the master landlord for the ground floor office space which will continue to house our Newport Beach banking office. The Bank also subleases from an unaffiliated third party approximately 4,200 square feet of office space in San Clemente, California, which is the location of our southern Orange County banking office. The San Clemente sublease expires January 31, 2006.
The Bank has signed new leases, each for a term of 8 years, for approximately 3,000 square feet of ground floor office space, and for approximately 21,000 square feet of upper floor office space in the same building, which is located in Costa Mesa, California, across the street from the South Coast Plaza Shopping Mall. The ground floor space will house our new Costa Mesa branch banking office. We will be using the upper floor space for our headquarters offices which will be relocated from Newport Beach. We currently expect to open the banking office and to relocate our headquarters office to this new location in the second quarter of 2001.
The Bank has also signed a new lease for approximately 4,600 square feet of ground floor office space for a business banking office to be located in Beverly Hills, California, on Wilshire Boulevard near the intersection of McCarty street. The lease expires on April 30, 2006. We currently expect to open this new branch banking office, our first Los Angeles County location, in the second quarter of 2001.
We believe that these facilities are adequate to meet our needs for space during the next two to three years. However, we will continue to seek additional office space in Southern California at locations that we believe will be advantageous for new banking offices when opportunities to do so arise.
For additional information concerning properties, see Notes 5 and 12 of the Notes to the Consolidated Financial Statements included in Part II of this Report.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Bank is subject to legal actions that arise in the ordinary course of the banking business. At December 31, 2000, we had no pending legal proceedings that would be material to our financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
EXECUTIVE OFFICERS OF THE REGISTRANT.
The principal executive officers of the Bancorp and Bank are:
There is no family relationship among any of the above-named officers.
Mr. Dellerba has served as President, Chief Executive Officer and a Director of the Company and of the Bank since the respective dates of their inception. From February 1993 to June 1997, Mr. Dellerba served as the President, Chief Operating Officer and director of Eldorado Bank, and as Executive Vice President and a director of Eldorado Bancorp. Mr. Dellerba has more than 30 years of experience as a banking executive, primarily in Southern California and in Arizona.
John J. McCauley has served as Executive Vice President, Chief Operating Officer and a Director of the Company and of the Bank since the respective dates of their inception. From September 1991 to July 1997, Mr. McCauley served as Executive Vice President of Administration for Eldorado Bank.
Daniel L. Erickson, who is a certified public accountant, has been an Executive Vice President and the Chief Financial Officer of the Company and the Bank since the respective dates of their inception in 2000 and 1999, respectively. Prior to that, Mr. Erickson was Senior Vice President and Chief Financial Officer of Republic Bank from 1997 through 1998, and Senior Vice President and Chief Financial Officer of Marathon National Bank from 1993 to 1997.
John P. Cronin has served as the Chief Technology Officer for the Company and the Bank since the respective dates of their inception in 2000 and 1999, respectively. From 1996 to 1997, he was Executive Vice President-Retail Banking of CenFed Bank and President of CenFed Investments. From 1995 to 1996, he was Senior Vice President-Retail Banking of Eldorado Bank.
PART II
ITEM 5
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Trading Market for the Company's Shares.
Concurrently with the commencement of our initial public offering in June 2000, our shares were listed and have since been traded on the NASDAQ National Market System under the trading symbol "PMBC."
The following table presents the high and low sales prices for the Company's common stock, as reported by NASDAQ during each quarter since June 13, 2000. On March 15, 2001, the high and low sales prices of the our common stock, on the NASDAQ National Market System was $6.50 and $6.1875, respectively, and we had approximately 360 shareholders of record as of that date.
Dividend Policy. It is the policy of the Board of Directors to retain earnings to support future growth and, therefore, there are no current plans to pay cash dividends.
Restrictions on the Payment of Dividends. The principal source of funds available to the Company (in addition to the net proceeds retained by the Bancorp from its initial public stock offering), at least until such time, if any, as it may acquire or develop other businesses, will be cash dividends from the Bank. Therefore, government regulations, including the laws of the State of California, as they pertain to the payment of cash dividends by California state chartered banks, limit the amount of funds that will be available to us to pay cash dividends. California law places a statutory restriction on the amounts of cash dividends a bank may pay to its shareholders. Under that law, cash dividends by a California state chartered bank may not exceed, in any calendar year, the lesser of (i) net income of the bank for the year and retained net income from the preceding two years (after deducting all dividends paid during the period), or (ii) the bank's retained earnings. However, because the payment of cash dividends has the effect of reducing capital, capital requirements imposed on federally insured banks often operate, as a practical matter, to preclude the payment of cash dividends in amounts that might otherwise be permitted by California law; and the Federal bank regulatory agencies, as part of their supervisory powers, generally require insured banks to adopt dividend policies which limit the payment of cash dividends much more strictly than do applicable state laws.
In addition, Section 23(a) of the Federal Reserve Act restricts any bank subsidiary of a bank holding company, such as the Bancorp, from extending credit to the its bank holding company unless the loans are secured by specified obligations and are limited in amount to an aggregate of no more than 10% of the bank subsidiary's capital and retained earnings.
A more detailed discussion of those capital requirements and other restrictions is contained in the Section of Part I of this Report entitled "BUSINESS--Supervision and Regulation."
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA.
The following selected financial data for the periods presented is derived from our consolidated financial statements, including the accompanying notes, that have been audited by Grant Thornton LLP as of and for the 12 months ended December 31, 2000 and by Arthur Andersen LLP, independent public accountants, for the prior periods presented. Those financial statements are included as Item 8 of this Report. The selected financial data should be read together with those audited financial statements and the section of this Report entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations."
- -------- (1) For accounting purposes, the inception of the Company is deemed to have occurred in May 1998, when the organizers of the Bank established an organizing committee to file necessary applications for regulatory approvals and begin preparations for the opening of the Bank. Pursuant to those regulatory approvals, the Bank was incorporated in November 1998, received its charter, completed its initial sale of shares and commenced banking operations on March 1, 1999. As a result, no shares were outstanding and no revenues were generated from operations prior to March 1, 1999.
(2) Share and per share data have been retroactively adjusted for a 2-for-1 stock split effectuated in April 2000 and a 1.25-for-1 stock split effectuated in May 1999, as if both stock splits had occurred on March 1, 1999.
(3) Cash and cash equivalents include cash and due from other banks and federal funds sold.
(4) Includes loans held for sale of $11,084,400 and $2,700,000 at December 31, 2000 and 1999, respectively.
ITEM 7
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Background. The following discussion presents information about the consolidated results of operations, financial condition, liquidity and capital resources of the Company. Substantially all of the Company's operations are conducted by the Bank and the Bank accounts for substantially all of the Company's revenues. This information should be read in conjunction with the Company's audited Consolidated Financial Statements thereto included in Item 8
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors Pacific Mercantile Bancorp and Subsidiary:
We have audited the accompanying consolidated statement of financial condition of Pacific Mercantile Bancorp and Subsidiary as of December 31, 2000, and the related consolidated statements of operations, stockholders' 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.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 Pacific Mercantile Bancorp and Subsidiary as of December 31, 2000 and the consolidated results of operations, stockholders' equity and cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
Irvine, California February 9, 2001
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Pacific Mercantile Bancorp:
We have audited the accompanying consolidated statement of financial condition of Pacific Mercantile Bancorp and subsidiary (the Company) as of December 31, 1999, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for the year ended December 31, 1999 and the period from inception (May 29, 1998) to December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pacific Mercantile Bancorp and subsidiary as of December 31, 1999, and the results of their operations and their cash flows for the year ended December 31, 1999 and for the period from inception (May 29, 1998) to December 31, 1998 in conformity with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Irvine, California January 28, 2000 (except with respect to the reorganization discussed in Note 1 as to which the date is June 12, 2000)
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
The accompanying notes are an integral part of these financial statements.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Period from Inception (May 29, 1998) to December 31, 1998 and for the Years Ended December 31, 1999 and 2000
The accompanying notes are an integral part of these financial statements.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2000 and 1999 and the Period from Inception (May 29, 1998) to December 31, 1998
The accompanying notes are an integral part of these financial statements.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business and Significant Accounting Policies
Organization
The consolidated financial statements include the accounts of Pacific Mercantile Bancorp ("Bancorp") and Pacific Mercantile Bank (the "Bank"). Bancorp is a bank holding company which was incorporated on January 7, 2000 in the State of California. Pacific Mercantile Bank is a banking company which was formed on May 29, 1998, incorporated November 18, 1998 in the State of California and commenced operations on March 1, 1999. The Bank is chartered by the California Department of Financial Institutions (DFI) and is a member of the Federal Reserve Bank of San Francisco ("FRB"). In addition, its customers' deposit accounts are insured by the Federal Deposit Insurance Corporation ("FDIC') up to the maximum amount allowed by Federal Regulations.
On June 12, 2000 Bancorp acquired the Bank by means of a merger which resulted in the Bank becoming a wholly-owned subsidiary of Bancorp and the Bank's shareholders became Bancorp shareholders, owning the same number and percentage of Bancorp shares as they had owned in the Bank (the "Reorganization"). Prior to the Reorganization, Bancorp had only nominal assets and had not conducted any business. All financial information included herein has been restated as if the holding company reorganization was effective for all periods presented. Additionally, the number of common shares outstanding gives retroactive effect to a two-for-one stock split of the Bank's outstanding shares that became effective on April 14, 2000, and a 1.25 for 1.00 stock split that became effective May 21, 1999.
The Bank provides a full range of banking services to small and medium size businesses, professionals and the general public throughout Orange County and is subject to competition from other financial institutions. The operating results of the Bank may be significantly affected by changes in market interest rates and by fluctuations in real estate values in the Bank's primary service area. The Bank is regulated by the DFI, FRB and FDIC and undergoes periodic examinations by those regulatory authorities.
Use of Estimates
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of Bancorp and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
For purposes of the statements of cash flow, cash and cash equivalents consist of cash on hand and due from banks and federal funds sold. Generally, federal funds are sold for a one-day period.
Interest Bearing Deposits with Financial Institutions
Interest bearing deposits with financial institutions mature within one year and are carried at cost.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Securities Available for Sale
Securities available for sale are those that management intends to hold for an indefinite period of time and that may be sold in response to changes in liquidity needs, changes in interest rates, changes in prepayment risks and other similar factors. The securities are recorded at fair value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income or loss, respectively.
Purchased premiums and discounts are recognized as interest income using the interest method over the term of the securities. Declines in the fair value of securities available for sale below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Loans Held for Sale
Loans intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Loans and Allowance for Loan Losses
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are stated at principal amounts outstanding, net of unearned income. Interest is accrued daily as earned, except where reasonable doubt exists as to collectibility, in which case accrual of interest is discontinued and the loan is placed on nonaccrual status. Loans are generally classified as impaired and placed on nonaccrual status when, in management's opinion, such principal or interest will not be collectible in accordance with the contractual terms of the loan agreement. Loans with principal or interest that is 90 days or more past due are placed on nonaccrual status. Management may elect to continue the accrual of interest when the estimated net realizable value of the collateral is sufficient to recover both principal and accrued interest balances and such balances are in the process of collection. Generally, interest payments received on nonaccrual loans are applied to principal. Once all principal has been received, additional interest payments are recognized as interest income on a cash basis.
The allowance for loan losses is established through a provision for loan losses. Loans are charged against the allowance for loan losses when management believes that the collection of the carrying amount is unlikely. Because the Bank commenced operations in early 1999, management has no prior loss experience with its loan portfolio. Consequently, during the initial stages of operation, the allowance is being maintained at a level of 1.3% of outstanding loan balances. This allowance is intended to reflect losses based upon historical industry loan losses and management's evaluation of the Bank's loan portfolio quality. As management develops more history with the Bank's loan portfolio, it will maintain an allowance for loan losses based on evaluations of the collectibility of loans taking into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, review of specific problem loans, prior loan loss experience and current economic conditions that may affect the borrowers' ability to pay.
The allowance 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. Management believes that the allowance for loan losses is adequate as of December 31, 2000 and 1999. In addition, the FRB and the DFI, as an integral part of their examination processes, periodically review the Bank's allowance for loan losses. The agencies may require the Bank to recognize additions to the allowance based on their judgments given the information available at the time of their examinations.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Bank also evaluates loans for impairment, where principal and interest is not expected to be collected in accordance with the contractual terms of the loan agreement. The Bank measures and reserves for impairment on a loan by loan basis using either the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if the loan is collateral dependent. As of December 31, 2000 and 1999, the Bank has no loans classified as impaired. The Bank excludes from its impairment calculations smaller, homogeneous loans such as consumer installment loans and lines of credit. Also, loans that experience insignificant payment delays or payment shortfalls are generally not considered impaired.
Loan Origination Fees and Costs
All origination fees and related direct costs are deferred and amortized to interest income as an adjustment to yield over the respective lives of the loans using the effective interest method. As of December 31, 2000 and 1999, approximately $159,300 and $62,200, respectively, of net deferred loan costs were included in the related loan totals in the accompanying statements of financial condition.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization which is charged to expense on a straight-line basis over the estimated useful lives of the assets or, in the case of leasehold improvements, over the term of the leases, whichever is shorter. Maintenance and repairs are charged directly to expense as incurred. Improvements to premises and equipment that extend the useful lives of the assets are capitalized.
When assets are disposed of, the applicable costs and accumulated depreciation thereon are removed from the accounts and any resulting gain or loss is included in current operations. Rates of depreciation and amortization are based on the following estimated useful lives:
Income Taxes
Deferred income taxes and liabilities are determined using the asset and liability method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
Income (Loss) Per Share
Basic income (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of Bancorp. The weighted average number of shares used in the income or loss per share computation for the years ended December 31, 2000 and 1999 was 5,098,796 and 2,466,114, respectively. No shares were outstanding for the period from inception (May 29, 1998) to December 31, 1998. Common stock equivalents are excluded from the income (loss) per share calculation for fiscal 1999 because the effect would be antidilutive.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Option Plan
Bancorp accounts for stock-based employee compensation as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," and has adopted the disclosure provisions of Statements of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation (SFAS 123)." SFAS No. 123 requires pro-forma disclosures of net income (loss) and net income (loss) per share as if the fair value based method of accounting for stock based awards had been applied. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period.
Comprehensive Income
Components of comprehensive income include non-ownership related revenues, expenses, gains, and losses that under generally accepted accounting principles are included in equity but excluded from net income. The Bank had no components of comprehensive income in the period ended December 31, 1998.
Segment Disclosures
Based on the internal reporting of financial information, management currently believes that it operates with only one operating segment and has not included any segment disclosures herein.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which was subsequently amended by SFAS No. 137 to defer the effective date of the pronouncement from fiscal years beginning June 15, 1999 to fiscal years beginning June 30, 2000. SFAS No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the purpose of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. Management believes that the adoption of SFAS No. 133 will not have a material impact on the Bank's financial condition or results of operations.
Reclassifications
Certain reclassifications have been made to prior years' balances to conform to the December 31, 2000 presentation.
2. Interest Bearing Deposits with Financial Institutions
The Bank had interest bearing deposits with financial institutions of $1,188,000 and $1,386,000 at December 31, 2000 and 1999, respectively. The weighted average percentage yield of these deposits at December 31, 2000 and 1999, was 6.57 % and 5.70%, respectively.
Interest bearing deposits with financial institutions at December 31, 2000 are scheduled to mature within one year.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3.Securities Available For Sale
The following is a summary of the major components of securities available for sale and a comparison of amortized cost, estimated fair market values, gross unrealized gains and losses and maturities at December 31, 2000 and 1999:
At December 31, 2000, U.S. Government securities and U.S. Agency securities with a fair market value of $2,204,300 and $3,228,800, respectively, were pledged to secure a discount line at the Federal Reserve Bank and securities sold with agreements to repurchase.
4.Loans and Allowance for Loan Losses
The loan portfolio consisted of the following at December 31:
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of the Bank's transactions in the allowance for loan losses for the year ended December 31 is as follows:
At December 31, 2000 and 1999, the Bank had no nonaccrual loans, no restructured loans, no loans with principal balances more than 90 days past due, and no loans that were considered impaired.
5.Premises and Equipment
The major classes of premises and equipment at December 31 are as follows:
The amount of depreciation and amortization included in operating expense was $419,000 and $202,100 for the years ended December 31, 2000 and 1999, respectively. There was no depreciation for the period from inception (May 29, 1998) through December 31, 1998.
6.Deposits
The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2000 and 1999 was $17,212,900 and $21,782,100, respectively.
At December 31, 2000, the scheduled maturities of time deposits of $100,000 or more are as follows:
7.Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase, which are classified as secured borrowings, mature within one day from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The Bank monitors the fair value of the underlying securities on a daily basis.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8.Related Parties
The executive officers and directors of the Bank, and the companies with which they are associated, have banking transactions with the Bank in the ordinary course of business. All loans and commitments to loan included in such transactions have been made in accordance with applicable laws and on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with persons of similar creditworthiness that are not affiliated with the Bank, and only if such loans do not present any undue risk of collectibility.
The following is a summary of loan transactions with executive officers and directors of the Bank for the year ended December 31:
9.Income Taxes
The components of the net deferred tax asset are as follows:
The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows:
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Bank has established a valuation allowance of $1,161,100, $1,134,700 and $109,500 at December 31, 2000, 1999 and 1998, respectively. The valuation allowance has been established due to the Bank's limited operating history and management's inability to determine whether or not the deferred tax asset will be realizable in the future.
The Bank has a net operating loss carryforward of approximately $1,596,000 for federal income tax purposes which expires through 2020. In addition, the Bank has a net operating loss carryforward of approximately $1,514,000 for state franchise tax purposes which expires through 2006. During 2000, the Bank had an "ownership change" as defined under Internal Revenue Code Section 382. Under Section 382, which has also been adopted under California law, if during any three-year period there is more than a 50% change in ownership of the Bank, then the future use of any pre-change net operating losses or built-in losses of the Bank would be subject to an annual percentage limitation based on the value of the Bank at the ownership change date. The current annual limitation under Section 382 is approximately $1,700,000.
10.Net Income (Loss) Per Share
The following data shows a reconciliation of the numerators and the denominators used in computing income (loss) per share and the weighted average number of shares of potential dilutive common stock.
Stock options of 380,106 were not included in computing diluted income (loss) per share for the year ended December 31, 1999 because their effects were antidilutive. No shares were outstanding for the period from inception (May 29, 1988) to December 31, 1998.
11.Stockholders' Equity
On March 1, 1999, the Bank sold 2,090,620 shares of its common stock that raised approximately $8,298,300 through an initial public offering, net of approximately $64,200 in related expense. Concurrent with the completion of the offering, the Bank received final approval from the California Department of Financial Institutions ("DFI") to commence operations and from the FDIC on its application for the insurance of its customers' deposit accounts. The Bank commenced operations on March 1, 1999.
In November 1999, the Bank completed a second offering in which it sold 1,629,542 shares of its common stock that raised approximately $10,720,900, net of approximately $278,500 in related expense. In addition, in conjunction with the June 12, 2000 merger and reorganization described in Note 1 between Bancorp and the
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Bank, Bancorp sold 2,611,608 shares of its common stock in a public offering registered under the Securities Act of 1933. Proceeds of this public offering, net of underwriting discounts, commissions and other expenses of $2,365,700, totaled $18,527,200. In addition, Bancorp issued warrants to the underwriter to purchase 250,000 shares of common stock at an exercise price of $9.60 per share.
On April 20, 1999, the Bank's Board of Directors authorized a 1.25 for 1.00 stock split which became effective on May 21, 1999. Additionally, the Bank's Board of Directors authorized a two-for-one stock split which became effective on April 14, 2000. Share and per share data have been adjusted herein to give effect to both stock splits.
Under California law, the directors of the Bank may declare distributions to stockholders subject to the restriction that the amount available for the payment of cash dividends shall be the lesser of retained earnings of the Bank or the Bank's net income for its last three fiscal years (less the amount of any distributions to stockholders made during such period). If the above test is not met, distributions to stockholders may be made only with the prior approval of the Commissioner of the California Department of Financial Institutions ("Commissioner") and in an amount not exceeding the greatest of the Bank's retained earnings, the Bank's net income for its last fiscal year or the Bank's net income for its current fiscal year. If the Commissioner finds that the stockholders' equity of the Bank is not adequate, or that the making by the Bank of a distribution to stockholders would be unsafe or unsound for the Bank, the Commissioner can order the Bank not to make any distribution to stockholders.
The ability of the Bank to pay dividends is further restricted under the Federal Deposit Insurance Corporation Improvement Act of 1991 which prohibits a bank from paying dividends if, after making such payment, the bank would fail to meet any of its minimum capital requirements. Under the Financial Institutions Supervisory Act and Federal Financial Institutions Reform, Recovery and Enforcement Act of 1989, federal banking regulators also have authority to prohibit financial institutions from engaging in business practices which are considered to be unsafe or unsound. It is possible, depending upon the financial condition of the Bank and other factors, that regulators could assert that the payment of dividends in some circumstances might constitute unsafe or unsound practices. Therefore, the Bank's federal regulatory agency might prohibit the payment of dividends even though such payments would otherwise be technically permissible.
12. Commitments and Contingencies
The Bank leases certain facilities and equipment under various non- cancelable operating leases. Rent expense for the years ended December 31, 2000 and 1999 and for the period from inception (May 29, 1998) through December 31, 1998 was $432,400, $171,300 and $20,800, respectively.
Future minimum non-cancelable lease commitments are as follows:
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In order to meet the financing needs of its customers in the normal course of business, the Bank is party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. At December 31, 2000, the Bank was committed to fund certain loans amounting to approximately $41,761,000. The contractual amounts of credit-related financial instruments such as commitments to extend credit, credit-card arrangements, and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless.
The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Commitments generally have fixed expiration dates; however, since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Bank upon extension of credit is based on management's credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, residential real estate and income-producing commercial properties.
Bancorp and the Bank are subject to legal actions normally associated with financial institutions. At December 31, 2000, neither Bancorp nor the Bank had any pending contingencies that would be material to the financial condition or results of operations of either Bancorp or the Bank.
The Bank is required to purchase stock in the Federal Reserve Bank in an amount equal to 6% of its capital, one-half of which must be paid currently with the balance due upon request.
13.Stock Option Plan
Effective March 2, 1999, the Board of Directors adopted a stock option plan (the "Plan"). The Plan provides for the granting of options to directors, officers and other key employees, entitling them to purchase shares of common stock of Bancorp at a price per share equal to or above the fair market value of Bancorp's shares on the date the option is granted. Options vest over five year periods and expire 10 years after the grant date. The Plan further provides that if Bancorp sells or issues any additional shares of common stock (other than pursuant to the exercise of options under the Plan), the number of shares issuable pursuant to the Plan will be automatically increased by a number equal to 20% of the additional shares that are sold or issued. As such, Bancorp's current year stock issuance of 2,611,608 shares increased the number of shares issuable under the Option Plan by 522,322. The Plan provides that the total number of shares for which options may be granted under the Option Plan shall be 1,248,230 shares.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following tables summarize information concerning currently outstanding and exercisable stock options:
Shares exercisable at December 31, 2000 were 330,632 at an option price of between $4.00 and $12.13 per share.
Bancorp continues to account for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," under which no compensation cost for stock options is recognized for stock option awards granted at or above fair market value. Had compensation expense for Bancorp's Plan been determined based upon the fair value at the grant date for awards under the Plan in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," Bancorp's net income (loss) and income (loss) per share would have been reduced (increased) to the pro forma amounts indicated below:
The fair value of these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions for the years ending December 31, 2000 and 1999, respectively: no dividend yield, expected volatility of 50 and 0 percent, risk-free interest rates ranging from 5.90% to 6.63% and 5.27% to 5.81%, and an expected option life of 5 years.
14.Employee Benefit Plans
The Bank has a 401(k) plan that covers substantially all full-time employees. It permits voluntary contributions by employees, a portion of which are matched by the Bank. The Bank's expenses relating to its contributions to the 401(k) plan for the years ended December 31, 2000 and 1999, and for the period from inception (May 29, 1998) through December 31, 1998, were $114,200, $25,300, and none, respectively.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15.Regulatory Matters and Capital/Operating Plans
Bancorp and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Bancorp's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancorp and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Bancorp and Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2000, that Bancorp and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2000, based on the regulations, Bancorp and the Bank are categorized as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," Bancorp and the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following tables. There are no conditions or events that management believes have changed Bancorp or the Bank's category.
The actual capital amounts and ratios of Bancorp and the Bank at December 31, 2000 are presented in the following table:
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The actual capital amounts and ratios of the Bank at December 31, 1999 are presented in the following table:
16. Parent Company Only Information
The following Condensed Financial Statements of Bancorp are presented as if the merger and reorganization described in Note 1 was effective on January 1, 2000.
Condensed Statement of Financial Condition
Condensed Statement of Operations
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Condensed Statement of Cash Flows
17. Fair Value of Financial Instruments
Fair value estimates are made at a discreet point in time based on relevant market information and information about the financial instruments. Because no active market exists for a significant portion of the Bank's financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments, prepayment assumptions, future expected loss experience and other such factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
In addition, the fair value estimates are based on existing on and off- balance sheet financial instruments without attempting to estimate the value of existing and anticipated future customer relationships and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include other real estate owned and premises and equipment.
The following methods and assumptions were used to estimate the fair value of financial instruments.
Cash and Cash Equivalents
The fair value of cash and cash equivalents approximates its carrying value.
Interest Bearing Deposits with Financial Institutions
The fair value of interest bearing deposits maturing within ninety days approximate their carrying values.
Securities Available for Sale
For investment securities, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Loans Held for Sale
The fair value of loans held for sale is based on commitments on hand from investors or prevailing market prices.
Loans
The fair value for loans with variable interest rates is the carrying amount. The fair value of fixed rate loans is derived by calculating the discounted value of future cash flows expected to be received by the various homogeneous categories of loans. All loans have been adjusted to reflect changes in credit risk.
Securities Sold Under Agreements to Repurchase
The fair value of securities sold under agreements to repurchase is the carrying amount and mature on a daily basis.
Deposits
The fair value of demand deposits, savings deposits, and money market deposits is defined as the amounts payable on demand at year-end. The fair value of fixed maturity certificates of deposit is estimated based on the discounted value of the future cash flows expected to be paid on the deposits.
Commitments to Extend Credit and Standby Letters of Credit
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the parties involved. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and committed rates. The fair value of these unrecorded financial instruments is estimated to approximate the notional amounts at December 31, 2000 and 1999.
The estimated fair values and related carrying amounts of the Bank's financial instruments at December 31, 2000 and 1999 are as follows:
In all cases, the estimated fair values of the Bank's financial instruments are equal to their respective book values at December 31, 1998.
PACIFIC MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
18. Subsequent Events
Subsequent to December 31, 2000, the Bank signed three lease agreements for approximately 36,100 square feet of office space for the new corporate headquarters, the Newport Beach branch, a new Costa Mesa branch and a new Beverly Hills branch. The lease agreements are for a period of five to eight years.
Future minimum non-cancelable lease commitments for the above leases are as follows:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
As reported in a Current Report on Form 8-K dated October 23, 2000, the Company dismissed Arthur Anderson LLP as its independent public accountants and selected Grant Thornton LLP as its new independent public accountants. The Current Report also stated, and it was confirmed in a letter from Arthur Andersen LLP, that there had never been (i) any disagreements between the Company and Arthur Andersen LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedures or (ii) any "reportable events" (as defined in Paragraph (a)(v) of Item 304 of Regulation S-K as promulgated by the Securities and Exchange Commission).
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except for information regarding the Registrant's executive officers which is included in Part I of this Report, the information called for by Item 10 is incorporated herein by reference from the Company's definitive proxy statement which is scheduled to be filed with the Commission on or before April 30, 2001 for the Company's 2001 annual meeting of stockholders.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference from the Company's definitive proxy statement which is scheduled to be filed with the Commission on or before April 30, 2001 for the Company's 2001 annual meeting of stockholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference from the Company's definitive proxy statement which is scheduled to be filed with the Commission on or before April 30, 2001 for the Company's 2001 annual meeting of stockholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference from the Company's definitive proxy statement which is scheduled to be filed with the Commission on or before April 30, 2001 for the Company's 2001 annual meeting of stockholders.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this Form 10-K:
(1) Financial Statements:
See Index to Consolidated Financial Statements in Item 8 on Page 31 of this Report.
(2) Financial Statement Schedules:
All schedules are omitted as the information is not required, is not material or is otherwise furnished.
(3) Exhibits:
See Index to Exhibits on Page E-1 of this Form 10-K.
(4) Reports on Form 8-K:
As described in Item 9 of this Report, during the fourth quarter of 2000, the Company filed a Current Report on Form 8-K dated October 17, 2000, and an Amendment to that Form 8-K, to report the dismissal of Arthur Andersen LLP as the Company's independent accountants and the selection of Grant Thornton LLP as its new independent accountants.
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, on the 30th day of March 2001.
PACIFIC MERCANTILE BANCORP
/s/ Raymond E. Dellerba By: _________________________________ Raymond E. Dellerba President and Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes Raymond E. Dellerba, John J. McCauley and Daniel L. Erickson, and each of them individually, as his or her attorney-in-fact, to sign in his or her behalf and in each capacity stated below, and to file, all amendments and/or supplements to this Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following officers and directors of the Registrant in the capacities indicated on March 30, 2001.
EXHIBIT INDEX
- -------- + Incorporated by reference to the same numbered exhibit to the Company's Registration Statement on Form S-1 filed with the Commission on June 14, 2000.
**Incorporated by reference to the Exhibit 1.2 to the above referenced S-1 Registration Statement.
E-1