UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-10198 The San Francisco Company (Exact name of Registrant as specified in its charter) Delaware 94-3071255 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 550 Montgomery Street, San Francisco, California 94111 (Address of principal executive office) (Zip Code) (415) 781-7810 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The Registrant had 31,723,782 shares of Class A Common Stock outstanding on October 31, 1997. page The San Francisco Company and Subsidiaries Quarterly Report on Form 10-Q Table of Contents Page Part I - Financial Information Item 1. Consolidated Statements of Financial Condition At September 30, 1997 and December 31, 1996 1 Consolidated Statements of Operations For the Three and Nine Months Ended September 30, 1997 and 1996 2 Consolidated Statements of Changes in Shareholders' Equity For the Nine Months Ended September 30, 1997 and 1996 3 Consolidated Statements of Cash Flows For the Three and Nine Months Ended September 30, 1997 and 1996 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 6 Part II - Other Information Item 1. Legal Proceedings 14 Item 2. Changes in Securities 14 Item 3. Defaults Upon Senior Securities 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Item 5. Other Information 14 Item 6. Exhibits and Reports on Form 8-K 14 Signatures 15 page The San Francisco Company and Subsidiaries Consolidated Statements of Financial Condition September 30, 1997 and December 31, 1996 (Unaudited) September 30, December 31, (Dollars in Thousands Except Per Share Data) 1997 1996 Assets: Cash and due from banks $ 3,200 $ 3,701 Federal funds sold 25,785 11,925 Cash and cash equivalents 28,985 15,626 Investment securities held-to-maturity, at cost (Market value: 1997 - $6,178; 1996 - $6,848) 6,225 6,943 Investment securities available-for-sale, at fair value 34,295 28,348 Federal Home Loan Bank stock, at par 701 670 Loans 37,308 43,762 Deferred loan fees (143) (190) Allowance for loan losses (5,991) (5,663) Loans, net 31,174 37,909 Other real estate owned, net 1,661 5,133 Premises and equipment, net 7,792 8,059 Interest receivable 625 758 Other assets 410 555 Total Assets $111,868 $104,001 Liabilities and Shareholders' Equity: Non-interest bearing deposits $ 21,760 $ 16,505 Interest bearing deposits 74,957 74,661 Total deposits 96,717 91,166 Other liabilities and interest payable 2,259 1,771 Total Liabilities 98,976 92,937 Shareholders' Equity: Preferred Stock (par value $0.01 per share) Series B - Authorized - 437,500 shares; Issued and outstanding - 15,869 111 111 Common stock (par value $0.01 per share) Class A - Authorized - 100,000,000 shares; Issued and outstanding - 1997 - 31,717,171 and 1996 - 28,775,995 317 288 Additional paid-in capital 78,812 77,841 Retained deficit (66,372) (67,099) Unrealized gain/(loss) on securities available-for-sale 24 (77) Total shareholders' equity 12,892 11,064 Total Liabilities and Shareholders' Equity $111,868 $104,001 See accompanying notes to unaudited consolidated financial statements. page 1 The San Francisco Company and Subsidiaries Consolidated Statements of Operations Three and Nine Months Ended September 30, 1997 and 1996 (Unaudited) Three Months Nine Months Ended September 30, Ended September 30, (Dollars in Thousands Except Per Share Data) 1997 1996 1997 1996 Interest income: Loans $ 1,234 $ 1,005 $ 3,473 $ 3,222 Investments 953 743 2,512 2,182 Dividends 10 11 31 28 Total interest income 2,197 1,759 6,016 5,432 Interest expense: Deposits 755 747 2,113 2,393 Other borrowings -- 1 -- 2 Total interest expense 755 748 2,113 2,395 Net interest income before provision for loan losses 1,442 1,011 3,903 3,037 Provision for loan losses -- -- -- -- Net interest income after provision for loan losses 1,442 1,011 3,903 3,037 Non-interest income: Stock option commissions and fees 440 196 1,069 866 Real estate rental income 179 272 658 756 Service charges and fees 198 113 437 337 Other income 39 2 94 3 Gain on sale of assets, net 32 204 260 659 Total non-interest income 888 787 2,518 2,621 Non-interest expense: Compensation and related benefits 1,134 762 2,968 2,480 Occupancy expense 288 263 903 872 Professional fees 146 156 361 450 Corporate insurance premiums 56 53 165 244 FDIC insurance premiums 10 91 89 215 Property taxes 22 26 87 81 Data processing 98 80 324 213 Other operating expenses 221 336 793 758 Total non-interest expense 1,975 1,767 5,690 5,313 Income before income taxes 355 31 731 345 Provision for income taxes (3) (272) 4 (262) Net Income $358 $303 $ 727 $ 607 Income per common share: Primary:Net income $ 0.01 $ 0.05 $0.02 $ 0.10 Weighted average shares outstanding 31,717,171 5,765,995 29,950,311 5,765,990 Fully diluted: Net income $ 0.01 $0.01 $0.02 $0.03 Weighted average shares outstanding 31,717,171 26,168,780 29,950,311 22,242,086 See accompanying notes to unaudited consolidated financial statements. page 2 The San Francisco Company and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity Nine Months Ended September 30, 1997 and 1996 (Unaudited) Unrealized Gain/ (Loss) on Total Additional Retained Securities Share- Preferred Common Paid-in Earnings Available- holders' (Dollars in Thousands) Stock Stock Capital (Deficit) for-Sale Equity Balances at January 1, 1996 $ 4,414 $ 58 $70,168 $(67,801) $ 41 $6,880 Proceeds on sale of stock 3,500 -- -- -- -- 3,500 Depreciation in market value of securities available-for-sale -- -- -- -- (156) (156) Conversion of Series B Preferred stock into Class A Common Stock (3) -- 3 -- -- -- Other 100 100 Net income (nine months) -- -- -- 607 -- 607 Balances at September 30, 1996 7,911 58 70,271 (67,194) (115) 10,931 Conversion of preferred stock to Class A Common Stock (7,800) 230 7,570 -- -- -- Appreciation in market value of securities available-for-sale -- -- -- -- 38 38 Net income (three months) -- -- -- 95 -- 95 Balances at December 31, 1996 111 288 77,841 (67,099) (77) 11,064 Proceeds from sale of common stock -- 29 971 -- -- 1,000 Appreciation in market value of securities available-for-sale -- -- -- -- 101 101 Net income (nine months) -- -- -- 727 -- 727 Balances at September 30, 1997 $ 111 $ 317 $78,812 $(66,372) $24 $12,892 See accompanying notes to unaudited consolidated financial statements. page 3 The San Francisco Company and Subsidiaries Consolidated Statements of Cash Flows Three and Nine Months Ended September 30, 1997 and 1996 (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, (Dollars in Thousands) 1997 1996 1997 1996 Cash Flows from Operating Activities: Net income $ 358 $ 303 $ 727 $ 607 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for loan losses -- -- -- -- Depreciation and amortization expense 135 145 412 530 Net loss on sale of investment securities available for sale -- -- 6 -- Net gain on sale of other real estate owned and real estate investment (37) (206) (271) (661) Provision of possible loss on other real estate owned -- -- 182 -- Decrease in interest receivable and other assets 131 344 278 361 Increase (decrease) in interest payable and other liabilities 388 73 487 (784) (Increase) decrease in deferred loan fees (114) (17) (47) 29 Net cash flows provided by operating activities 861 642 1,774 82 Cash Flows from Investing Activities: Proceeds from maturities of investment securities held-to-maturity 270 295 688 645 Proceeds from maturities of investment securities available-for-sale 2,791 169 3,517 4,232 Proceeds from the sale of investment securities available-for-sale -- -- 6,200 -- Purchase of investment securities held-to-maturity -- -- -- (7,815) Purchase of investment securities available-for-sale (5,595) (4,996) (15,569) (27,256) Net decrease in loans 3,376 4,357 6,453 12,625 Recoveries of loans previously charged off, net 48 135 329 279 (Purchases) sales of premises and equipment (49) 6 (145) (44) Sale of other real estate owned 93 572 3,533 3,708 Acquisition and capitalized cost of other real estate owned -- 150 28 236 Net cash provided by (used in) investing activities 934 688 5,034 (13,390) Cash Flows from Financing Activities: Net increase (decrease) in deposits 6,033 (4,485) 5,551 (18,032) Net increase in other borrowings -- -- -- 2,000 Net proceeds from sale of common stock -- -- 1,000 -- Net proceeds from sale of preferred stock -- 1,000 -- 3,500 Net cash provided by (used in) financing activities 6,033 (3,485) 6,551 (12,532) Increase (decrease) in cash and cash equivalents 7,828 (2,155) 13,359 (25,840) Cash and cash equivalents at beginning of period 21,157 19,129 15,626 42,814 Cash and cash equivalents at end of period $ 28,985 $16,974 $ 28,985 $16,974 Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest $ 736 $ 756 $ 2,125 $ 2,448 Payment of income taxes -- -- 2 3 Supplemental Schedule of Noncash Investing and Financing Activities: Net transfer of loans to other real estate owned -- -- -- 1,378 See accompanying notes to unaudited consolidated financial statements. page 4 The San Francisco Company and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note 1 - Organization The San Francisco Company (the "Company") is a Delaware corporation and a bank holding company registered under the Bank Holding Company Act of 1956. Bank of San Francisco (the "Bank"), a state chartered bank, was organized as a California banking corporation in 1978 and became a wholly owned subsidiary of the Company through a reorganization in 1982. Note 2 - Principles of Consolidation and Presentation The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q Quarterly Report and Articles 9 and 10 of Regulation S-X, and therefore, do not include all the information and footnotes necessary to present the consolidated financial condition, results of operations and cash flows of the Company in conformity with generally accepted accounting principles. The data as of September 30, 1997, and for the three and nine months ended September 30, 1997 and 1996 are unaudited, but in the opinion of management, reflect all accruals and adjustments of a recurring nature necessary for fair presentation of the Company's financial condition and results of operations. The results of operations for the three and nine months ending September 30, 1997 are not necessarily indicative of the results to be expected for the entire year of 1997. This report should be read in conjunction with the Company's 1996 Annual Report on Form 10-K. The accompanying financial statements include the accounts of the Company, the Bank, and the Bank's wholly owned subsidiary, Bank of San Francisco Realty Investors (the "BSFRI"). All material intercompany transactions have been eliminated in consolidation. Certain amounts in the 1996 consolidated financial statements have been reclassified for comparative purposes. Note 3 - Income Per Common Share Primary income per common share is calculated using the weighted average number of Class A Common Shares, par value of $0.01 per share (the "Common Stock"), outstanding divided into net income. Fully diluted income per share is calculated using the weighted average number of shares outstanding assuming the conversion of the Series D Preferred Stock into Common Stock divided into net income. On December 31, 1996, all 390,000 outstanding shares of Series D Preferred Stock were converted into 23,010,000 shares of Common Stock. Note 4 - Dividend Restrictions The Company is subject to dividend restrictions under the Delaware General Corporation Law and regulations and policies of, and a Written Agreement dated December 14, 1994 (the "Agreement") with, the Federal Reserve Bank of San Francisco (the "FRB"). The Company's Series B Preferred Shares participate equally, share for share, in cash dividends paid on the Class A Common Shares in addition to receiving the cash dividends to which they are entitled. The Company has not paid any dividends on the Series B Preferred stock since the second quarter of 1991. The Board of Directors does not intend to declare dividends on any class of the Company's stock. Note 5 - Recent Accounting Pronouncements In February 1997, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards (the "SFAS") No. 128 "Earnings per Share" (the "SFAS No. 128"). Generally, SFAS No. page 5 128 establishes standards for computing and presenting earnings per share (the "EPS") for publicly held companies, replaces Primary EPS with Basic EPS, and specifies additional disclosure requirements regarding EPS. SFAS No. 128 is effective for financial statements issued for periods ending after December 15, 1997. Earlier application is not permitted. The adoption of SFAS No. 128 is not expected to have a material impact on the Company's present computation of primary and fully diluted EPS. In February 1997, the FASB also issued SFAS No. 129 "Disclosure of Information about Capital Structure" (the "SFAS No. 129"). Generally, SFAS No. 129 is effective for financial statements issued for periods ending after December 15, 1997. The adoption of SFAS No. 129 is not expected to have any impact on the Company's present disclosure of its capital structure. In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income". This statement establishes standards for reporting and displaying comprehensive income and its components in the financial statements. It requires that a company classify items of other comprehensive income, as defined by accounting standards, by their nature (e.g., unrealized gains or losses on securities) in a financial statement, but does not require a specific format for that statement. The Company is in the process of determining its preferred format. This statement is effective with the year-end 1998 financial statements; however, a total comprehensive income is required in the financial statements of the 1998 interim periods. Reclassification of financial statements for earlier periods is required. In June 1997, the FASB issued SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information". This statement requires that a public business enterprise report financial and descriptive information about its reportable operating segments on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments. This statement is effective with the year-end 1998 financial statements. The Securities and Exchange Commission (the "SEC") has approved rule amendments to clarify and expand existing disclosure requirements for derivative financial instruments. The amendments require enhanced disclosure of accounting policies for derivative financial instruments in the footnotes to the financial statements. In addition, the amendments expand existing disclosure requirements to include disclosure of quantitative and qualitative information about market risk inherent in market risk sensitive instruments outside of the financial statements and related notes thereto. The enhanced accounting policy disclosure requirements are effective for the quarterly period ended September 30, 1997. The rule amendments that require expanded disclosure of quantitative and qualitative information about market risk are effective with the 1997 Form 10-K. At September 30, 1997and 1996, the Company had no derivative financial instruments outstanding. Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations This document contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to, the Company's and Bank's ability to implement their respective long-term business plan, the economy in general and the condition of stock markets upon which the Company's stock brokerage business and fee income is dependent, the continued services of the Company's and Bank's key executives and managers, the real estate market in California and other factors beyond the Company's and the Bank's control. Such risks, uncertainties and factors, including those discussed herein, could cause actual results to differ materially from those indicated. Readers should not place undue reliance on forward-looking statements, which reflect management's views only as of the date hereof. The Company and the Bank undertake no obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. Readers are also encouraged to review the Company's publicly available filing with the SEC. page 6 Overview The principal activity of the Company is to serve as the holding company for the Bank with deposits insured by the Federal Deposit Insurance Corporation's (the "FDIC") Bank Insurance Fund. The information set forth in this report, including unaudited interim financial statements and related data, relates primarily to the Bank. The Company recorded net income of $358,000 and $727,000 for the three and nine months ended September 30, 1997, compared to a net income of $303,000 and $607,000 for the same periods in 1996. The increase in the Company's net income for the nine months ended September 30, 1997 of $120,000 compared to income for the same period in 1996 was primarily from an increase in net interest income and brokerage fees partially offset by an increase in operating costs in 1997 and lower gains on sale of other real estate owned in 1997 as compared to 1996. At September 30, 1997, total assets were $111.9 million, an increase of $7.9 million from $104.0 million at December 31, 1996. Total loans were $37.3 million, a decrease of $6.5 million, or 15% from $43.8 million at December 31, 1996. Total deposits were $96.7 million at September 30, 1997, an increase of $5.5 million compared to $91.2 million at December 31, 1996. Regulatory Directives Federal Reserve Board Written Agreement The Agreement prohibits the Company, without prior approval of the FRB, from: (a) paying any cash dividends to its shareholders; (b) directly or indirectly, acquiring or selling any interest in any entity, line of business, problem or other assets; (c) executing any new employment, service, or severance contracts, or renewing or modifying any existing contracts with any executive officer; (d) engaging in any transactions with the Bank that exceeds an aggregate of $20,000 per month; (e) engaging in any cash expenditures with any individual or entity that exceeds $25,000 per month; (f) increasing fees paid to any directors for attendance at board or committee meetings, or paying any bonuses to any executive officers; (g) incurring any new debt or increasing existing debt; and (h) repurchasing any outstanding stock of the Company. The Company is required to submit a progress report to the FRB on a quarterly basis. The Company was also required to submit to the FRB an acceptable written plan to improve and maintain an adequate capital position, a comprehensive business plan concerning current and proposed business activities, a comprehensive operating budget for the Bank and the consolidated Company. In addition, the Company's Board of Directors was required to submit an acceptable written plan designed to enhance their supervision of the operations and management of the consolidated organization. The Company has filed all of the required submissions with the FRB in accordance with the Agreement and management believes the Company continues to be in full compliance with the Agreement. Memorandum of Understanding On May 27, 1997, the FDIC and the California Department of Financial Institutions (formerly the State Banking Department) (the "DFI") terminated the Bank's Cease and Desist Orders and in lieu thereof entered into a Memorandum of Understanding with the Bank (the "MOU"). The MOU directs, among other things, that the Bank: (a) have and retain management acceptable to the Regional Director of the FDIC (the "Regional Director") and the Commissioner of the DFI (the "Commissioner"); (b) increase its capital by not less than $1.0 million; (c) maintain a 7% Leverage Capital ratio; (d) reduce assets classified "Substandard" as of September 30, 1996 (the date of the most recent full-scope FDIC and DFI Report of Examination of the Bank), to no more than $12.0 million by June 30, 1997, $10.0 million as of September 30, 1997, and $8.0 million as of December 31, 1997; (e) maintain an adequate reserve for loan losses; (f) develop and implement written policy recommendations outlined in the Report of Examination; (g) implement a policy which establishes a range for the Bank's volatile liabilities dependency ratio, and which ratio shall not be more than 15%; (h) submit a strategic plan covering the period 1997 - 2002; (i) not pay cash dividends without prior written consent from the Regional Director and the Commissioner; and (j) report to the Regional Director and the Commissioner on a quarterly basis the form and manner of any actions taken to secure compliance with the MOU. page 7 The Bank has filed all of the required submissions with the FDIC and the FDI in accordance with the MOU, and management believes that the Bank is in full compliance with the requirements of the MOU. Capital Impairment Orders Under the California Financial Code as presently in effect, if a bank's deficit retained earnings exceeds 40% of its contributed capital, its capital is deemed to be impaired, and the bank may be required by the DFI to levy an assessment on its shares to correct the impairment (the "Capital Impairment Law"). The DFI has deemed the Bank's capital to be impaired, but has not required the Bank to levy any assessment on its shares. The Capital Impairment Law has been rescinded by the California Legislature, effective January 1, 1998. All assessment provisions shall terminate and the Bank may take expedited steps to remove all assessment provisions from its bylaws. Results of Operations Net Interest Income The Company's net interest income increased to $3.9 million in the first nine months of 1997 from $3.0 million in the same period in 1996, an increase of $866,000 or 29%. The net interest rate margin improved to 5.2% for the first nine months of 1997 from 4.3% for the same period in 1996 as a result of an increase in average earning assets of $6.0 million and an decrease in average interest bearing liabilities of $6.3 million. The increase in average earning assets was comprised of an increase in investment securities and Federal funds sold partially offset by a decline in loans. The weighted average yield on average interest-earning assets increased to 8.0% during the first nine months of 1997 from 7.7% during the same period in 1996 and the weighted average cost of funds on average deposits declined to 3.0% in 1997 from 3.3% in 1996. The increase in average earnings assets was primarily from a decline in the average non-performing assets of $5.9 million to $4.6 million as of September 30,1997 from $10.5 million as of December 31, 1996. The improvement in the yield on average earning assets was primarily the increase in the Fed Funds rate and the prime interest rate in 1997 compared to 1996. An increase in average non-interest bearing deposits resulted in the decline in the average cost of funds on total deposits. The decline in interest bearing deposits was primarily due to the maturity of higher costing time deposits. The Company's net interest income increased to $1.4 million in the third quarter from $1.0 million in the same quarter in 1996, an increase of $431,000 or 43%. The increase was the result of an increase in net interest rate margin, average earning assets, non-interest bearing liabilities and capital. The increase in the net interest rate margin of 87 basis points to 5.3% for the third quarter of 1997 from 4.4% for the same period in 1996 was primarily the result of an increase in the yield on loans and a decline in the cost of funds for the certificate of deposits. The increase in the yield on loans was primarily the result of the recognition of deferred loan fees upon the prepayment of related loans. The Bank's cost of funds declined primarily as a result of the reduction in higher costing money desk certificates of deposits from $20.8 million as of September 30, 1996 compared to $15.6 million as of September 30, 1997. Non-Interest Income Non-interest income decreased $103,000 for the first nine months of 1997 to $2.5 million compared to $2.6 million for the same period in 1996. The decline was primarily the result of a reduction in the sale of other real estate owned (the "OREO") for the first nine months of 1997 compared to the same period in 1996. The reduction in OREO resulted in fewer sales, which in turn resulted in a lower gain on sale of assets in 1997 of $260,000 compared to $659,000 in 1996. page 8 Non-interest income increased $101,000, for the third quarter of 1997 to $888,000 compared to $787,000 for the same period in 1996. The improvement was primarily the increase in transactions that generated the commissions, charges and fees related to increased activity of the exercise of the underlying stock options and discount brokerage transactions executed by the Bank's customers. Non-Interest Expense The Company's operating expenses increased by $377,000, or 7% during the first nine months of 1997 compared to the same period in 1996 primarily as a result of an increase in compensation and related benefits, data processing costs and other operating costs which were partially offset by declines in professional fees and insurance premiums. The increase in compensation and benefit costs was primarily the result of an increase in incentive related compensation accrued as a result of the Company's improved core operating performance for the first nine months of 1997 compared to the same period in 1996, including a one time accrual for a special one-time bonus that is likely to be payable to the Chief Executive Officer. The increase in data processing costs for the first nine months of 1997 compared to 1996 was the result of outsourcing certain data processing functions during the second quarter of 1996, which resulted in higher data processing costs beginning late in the second quarter of 1996. The increase in data processing costs was offset by reductions in data processing related compensation expenses. The increase in other operating costs was primarily related to a provision for possible loss on sale of OREO recorded as other operating expense in the second quarter of 1997. The decline in FDIC and corporate insurance premiums reflects improvement in the financial condition of the Company and the Bank in 1997 compared to 1996. The decline in professional fees reflects a reduction in the need for legal, and business and consulting services The Company's operating expenses increased by $208,000 during the third quarter of 1997 compared to the same period in 1996 primarily as a result of an increase in compensation and benefits related expenses partially offset by a reduction in other operating expenses for the reasons discussed above. Financial Condition Liquidity and Capital Resources Liquidity The Bank's liquid assets, which include cash and short term investments, totaled $29.0 million or 26% of total assets as of September 30, 1997 compared to $15.6 million, or 15% of total assets, at December 31, 1996. The increase was funded by a decline in net loans of $6.5 million and OREO of $3.5 million, and an increase in deposits of $5.6 million and capital of $1.8 million. As of September 30, 1997, the Bank had pledged loans and securities totaling $6.6 million enabling the Bank to borrow approximately $5.7 million from the Federal Home Loan Bank of San Francisco (the "FHLB"). The Bank did not draw on this lending facility during the first nine months of 1997. In the future, long and short-term borrowings from the FHLB may be used as an on-going source of liquidity and funding. As of September 30, 1997, the Bank had loans and securities pledged to the FRB totaling $1.9 million, which provide collateral to borrow up to $1.8 million from the FRB discount window. page 9 Capital At September 30, 1997, shareholders' equity was $12.9 million, compared to $11.1 million at December 31, 1996 primarily as a result of $727,000 in net income for the nine months then ended and a shareholder's capital investment of $1.0 million. The Company and the Bank are subject to general regulations issued by the FRB, FDIC, and DFI which require maintenance of certain levels of capital and the Bank is under specific capital requirements as a result of the MOU. As of September 30, 1997, the Company and the Bank are in compliance with all minimum capital ratio requirements including the minimum Leverage Capital ratio of 7% mandated by the MOU. The following table reflects both the Company's and the Bank's capital ratios with respect to minimum capital requirements in effect as of September 30, 1997: Minimum Capital Company Bank Requirement MOU(1) Leverage ratio 11.0% 10.8% 4.0% 7.0% Tier 1 risk-based capital 19.2 18.8 4.0 - Total risk-based capital 22.2 21.7 8.0 - (1) Bank only requirement On June 13, 1997, Mr. Putra Masagung, the record holder of a majority of the Company's Common Stock invested $1.0 million in capital pursuant to a February 26, 1996 agreement as consideration for issuance of 2,941,176 shares of the Company's Common Stock. Mr. Masagung recently advised the Company that PT Gunung Agung, an Indonesian company, beneficially acquired a majority ownership of the Company's Common Stock. See "Change in Beneficial Ownership" below for additional discussion. Investment Activities At September 30, 1997, the Company's investment securities, including Fed funds sold, totaled $67.0 million, or 60% of total assets, compared to $47.9 million, or 46.0% of total assets, at December 31, 1996. The increase in the investment portfolio of $19.1 million was funded by the disposition of $6.7 million in non-performing assets, reduction in performing loans of $3.3 million, a $1.8 million increase in capital, a $5.6 million increase in deposits and a net decrease in other assets and other liabilities of $1.7 million. The investment portfolio has included treasury and agency securities, fixed and adjustable rate mortgage backed securities, and to a limited extent collateralized mortgage backed securities. Generally, the Bank's investment securities held-to-maturity and available-for-sale have maturities or principal amortization of five years or less. At September 30, 1997, investment securities held-to-maturity totaled $6.2 million, compared to $6.9 million at December 31, 1996, and were carried at amortized cost. At September 30, 1997, the Company held $34.3 million in investment securities available-for-sale, compared to $28.3 million at December 31, 1996. The increase in investment securities available-for-sale of $6.0 million was primarily investments in fixed rate balloon mortgage-backed securities and discounted callable agency securities with a weighted average term to maturity of approximately two years. The investment securities available-for-sale were accounted for at fair value. Unrealized gains and losses are recorded as an adjustment to equity and are not reflected in the current earnings of the Company. As of September 30, 1997, the investment securities available-for-sale had an unrealized gain of $24,000 that is included as a separate component of shareholder's equity to reflect the current market value of these securities. page 10 Loans During the first nine months of 1997, total loans decreased by $6.5 million, from $43.8 million at December 31, 1996 to $37.3 million at September 30, 1997, primarily as a result of loan repayments. The composition of the Bank's loan portfolio at September 30, 1997 and December 31, 1996 is summarized as follows: September 30, December 31, (Dollars in Thousands) 1997 1996 Real estate mortgage $ 25,219 $ 28,022 Secured commercial and financial 4,413 6,229 Unsecured 5,968 7,800 Other 1,708 1,711 37,308 43,762 Deferred fees and discounts, net (143) (190) Allowance for possible loan losses (5,991) (5,663) Total loans, net $31,174 $ 37,909 Classified Assets and Impaired Loans Classified assets include non-accrual loans, OREO and performing loans that exhibit well-defined credit quality weaknesses. The table below outlines the Bank's classified assets at September 30, 1997 and December 31, 1996: September 30, December 31, (Dollars in Thousands) 1997 1996 Loans - performing $ 3,166 $10,391 Non-accrual loans 207 3,400 OREO 1,661 5,133 Total classified assets $ 5,034 $ 18,924 Classified assets declined by 74% to $5.0 million as of September 30, 1997 compared to $18.9 million at December 31, 1996. The decrease was primarily the result of loan payoffs, sale of OREO, and loan upgrades. As of September 30, 1997 and December 31, 1996, all OREO were classified. As of September 30, 1997, the Bank did not have any loans that were between 31 and 89 days delinquent and still accruing. The Company identifies loans with weak credit quality characteristics for review in accordance with SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" (SFAS No. 114) as amended by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures". As of September 30, 1997 and December 31, 1996, the Company had impaired loans totaling $207,000 and $3.4 million, respectively. The impairment was measured using the collateral value method. The collateral value method uses an appraisal or other market valuation to determine the value of the loans underlying collateral in addition to other collection criteria to determine overall collectability. The interest income recognized on impaired loans during the first nine months of 1997 and 1996 was $43,000 and $60,000, respectively. page 11 There can be no assurances that the Bank will continue to experience declines in the amount of its classified assets or not experience losses in attempting to collect the classified loans or otherwise liquidate the non-performing assets which are presently reflected on the Company's statement of financial condition. The Bank expects that to the extent that non-performing assets continue to decline, it will be able to reduce the costs incurred for managing and carrying those assets. Allowance for Loan Losses The Bank charges current earnings with provisions for estimated losses on loans receivable. The provisions take into consideration specifically identified problem loans, the financial condition of the borrowers, the fair value of the collateral, recourse to guarantors and other factors compared to the total allowance for loan losses. Generally, a charge to current earnings is required when the total allowance for loan losses is less than the specific loss allowances, which are determined as described below. Specific loss allowances are established based on the asset classification and credit quality grade. Specific loss allowances are utilized to ensure that the allowance is allocated based on the credit quality including the present value of the expected future cash flows, the terms and structure of the loan, the financial condition of the borrower, and the fair value of underlying collateral. As of September 30, 1997, $31,000 in the allowance of loan losses was allocable to impaired loans, as identified in accordance with SFAS No. 114, which had an outstanding principal balance totaling $207,000. In addition, the Bank carries an "unallocated" loan loss allowance to provide for losses that may occur in the future in loans that are not presently classified, based on present economic conditions, trends, and related uncertainties. The following table summarizes the loan loss experience of the Bank for the nine months ended September 30, 1997: September 30, (Dollars in Thousands) 1997 Beginning balance of allowance for loan losses at December 31, 1996 $ 5,663 Charge-offs -- Recoveries 328 Provision -- Ending balance of allowance for loan losses $ 5,991 The unallocated portion of the allowance for loan loss totaled $3.7 million at September 30, 1997 compared to $2.4 million at December 31, 1996. The increase in the unallocated allowance was primarily the result of recoveries and the reduction in classified loans that require a higher allocation of reserves. page 12 Deposits The Bank had total deposits of $96.7 million at September 30, 1997, compared to $91.2 million at December 31, 1996, an increase of $5.5 million. A summary of deposits at September 30, 1997 and December 31, 1996 is as follows: September 30, December 31, (Dollars in Thousands) 1997 1996 Demand deposits $ 21,760 $ 16,505 NOW 16,075 18,295 Money market 16,779 17,376 Savings 1,329 1,343 Total deposits with no stated maturity 55,943 53,519 Time deposits: Less than $100,000 24,008 29,154 $100,000 and greater 16,766 8,493 Total time deposits 40,774 37,647 Total deposits $ 96,717 $ 91,166 The Bank's private and business banking customer's deposits totaled $36.2 million, or 37.5% of total deposits, at September 30, 1997, compared to $36.4 million, or 40.0% of total deposits, at December 31, 1996. Deposits of the Bank's Association Bank Services clients totaled $17.1 million, or 17.7% of total deposits at September 30, 1997, compared to $18.2 million, or 21.8% of total deposits at December 31, 1996. Deposits acquired through the money desk operations totaled $15.6 million, or 16.1% of total deposits at September 30, 1997, compared to $20.1 million, or 23.0% of total deposits at December 31, 1996. Escrow customer's deposits totaled $19.8 million, or 20.5% of total deposits at September 30, 1997 compared to $10.0 million or 11.0% of total deposits as of December 31, 1996. Concentrations of deposits acquired through the money desk operations and certificates of deposit of $100,000 and more have been classified by bank regulators as volatile liabilities associated with certain risks, including the risks of reduced liquidity if a bank is unable to retain such deposits and of reduced margins if interest costs are increased by a bank in order to retain such deposits. As a result of the MOU, the Bank is required to maintain a volatile liability dependency ratio of not more than 15%, which the Bank was in compliance with as of September 30, 1997. Change in Beneficial Ownership Mr. Putra Masagung, the record holder of 97.8% of the Company's Common Stock, has advised the Company that a majority ownership of the Company's Common Stock was beneficially acquired by PT Gunung Agung (the "GA"), an Indonesian company, in a series of transactions from 1992 to 1995. This acquisition of a majority ownership occurred without the required prior approval of the state and federal regulatory authorities. The Company believes that without such regulatory approval, GA will be prevented from exercising its rights as a shareholder. The Company advised the appropriate regulatory authorities of these events. Representatives of both GA and Mr. Masagung have initiated discussions with the regulatory agencies to determine the appropriate steps to be taken under the circumstances. Based on the facts known at this time, management of the Company does not believe this development will have a material impact on the operations or the current financial condition of the Company or the Bank. This development is not expected to materially reduce the net operating loss carryforwards that the Company may use to reduce any future income tax liability. However, any future change in control could materially reduce the net present value of net operating loss carryforwards. page 13 PART II - OTHER INFORMATION Item 1 - Legal Proceedings Because of the nature of its business, the Company and its subsidiaries, including the Bank, are from time-to-time parties to legal actions. Based on information available to the Company and the Bank, and its review of such outstanding claims to date, management believes the liability relating to such claims, if any, will not have a material adverse effect on the Company's liquidity, consolidated financial condition or results of operations. Item 2 - Changes in Securities See "Financial Condition - Liquidity and Capital Resources". Item 3 - Defaults Upon Senior Securities None Item 4 - Submission of Matters to a Vote of Security Holders None Item 5 - Other Information None Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits None (b) Report on Form 8-K A Report on Form 8-K, filed on August 8, 1997, regarding a change in beneficial ownership is incorporated by reference. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Change in Beneficial Ownership". page 14 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The San Francisco Company (Registrant) Date: November 12, 1997 /s/ James E. Gilleran James E. Gilleran Chairman of the Board and Chief Executive Officer Date: November 12, 1997 /s/ Keary L. Colwell Keary L. Colwell Chief Financial Officer page 15