1. Summary Of Significant Accounting And Reporting Policies

Reclassification - Certain amounts in the 1995 and 1996 financial statements have been reclassified to conform to the 1997 presentation.

Use of Estimates in the Preparation of Financial Statements - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents - Cash and cash equivalents are reported in the Balance Sheet as Cash and due from banks, and Federal funds sold. Bank of Commerce (the "Bank") considers all liquid investments purchased with an original maturity of three months or less to be cash equivalents.

The Bank has certain reserve requirements at the Federal Reserve Bank. At December 31, 1997 and 1996, the required reserves were $11,362 and $5,905, respectively. Cash on hand held by the Bank is eligible for meeting reserve requirements. Balances of cash on hand were $3,008 at December 31, 1997, and $1,444 at December 31, 1996. Reserve requirements over and above cash on hand are kept in non-interest bearing deposits with the Federal Reserve Bank.

The Bank is liable for letters of credit issued on its behalf under a credit facility administered by another independent bank. The administrating bank retains some secondary recourse. Under the terms of the facility, Bank of Commerce maintains a $50 compensating balance in a non-interest bearing deposit account, and another $125 in an interest bearing time deposit pledged against the Bank's obligations under the facility. These balances are reported in Cash and due from banks. The Bank has no other investments in interest bearing deposits.

Investment Securities - The Bank accounts for investment securities in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This statement requires that only debt securities that the Bank has the positive intent and ability to hold to maturity be classified as held to maturity and reported at amortized cost; all other debt securities are reported at fair value. SFAS No. 115 further requires that realized and unrealized gains and losses on securities classified as trading account assets shall be recognized in current operations. Securities not classified as held to maturity or trading are classified as available for sale.

Held to maturity investment securities are carried at cost, adjusted for the amortization of premiums and the accretion of discounts. Premiums and discounts are amortized and accreted to operations using the straight-line method, adjusted for prepayments, as applicable. Management has the intent and the Bank has the ability to hold these assets as long-term investments until their maturities.

In the event management was to sell a held to maturity investment, or reclassify the investment to available for sale, under SFAS No. 115, the Bank would be required to reclassify the entire held to maturity portfolio to available for sale, and would be precluded from classifying any investments as held to maturity in the future. Under certain circumstances (including the significant deterioration of the issuer's creditworthiness or a significant change in tax-exempt status, regulatory requirements, or statutory requirements), securities held to maturity may be sold or transferred to another portfolio, without triggering these provisions of SFAS No. 115.

Available for sale investment securities are carried at fair value. Unrealized gains and losses are excluded from earnings and reported, net of tax, as a separate component of shareholders' equity. Securities within the available for sale portfolio may be used as part of the Bank's asset/liability strategy and may be sold in response to changes in interest rate risk, prepayment risk, or other similar economic factors. The specific identification method is used to compute gains or losses on the sale of these securities.

Loans and Loan Origination Fees - Loans are stated at the amount of recorded investment. Loan origination fees and certain direct loan origination costs are deferred and recognized over the estimated expected life of the related loan as an adjustment to yield by the interest method.

Interest on loans is credited to income daily as earned. The accrual of interest on loans is discontinued when, in management's judgment, a reasonable doubt exists as to the collectibility of the amounts due.

Nonperforming Loans and Past Due Loans - Included in the nonperforming loan category are loans which have been placed on nonaccrual by management because collection of interest is doubtful and loans which have been restructured to provide a reduction in the interest rate or some other concession in terms to the benefit of the borrower.

When the payment of principal or interest on a loan is delinquent for 90 days, or earlier in some cases, the loan is placed on nonaccrual. When a loan is placed on nonaccrual, interest accrued during the current year prior to the judgment of uncollectibility is charged to operations. Generally, any payments received on nonaccrual loans are first applied to outstanding loan amounts and then to the recovery of amounts charged-off. Any excess is treated as recovery of lost interest.

Restructured loans are those loans on which concessions in terms have been granted because of a borrower's financial difficulty. Interest is generally accrued on these loans in accordance with the new terms. These restructured loans are reported as nonperforming until the borrower demonstrates satisfactory performance under the new terms for a period of one year.

In certain circumstances, an exception to nonaccrual status is given for loans delinquent 90 days. These loans are in the process of collection and the underlying collateral fully supports the carrying value of the loan. When this exception is made, the loans are monitored on a monthly basis to confirm that the accruing status is warranted. Past due and accruing loans are generally classified together with other nonperforming loans due to their delinquency.

Impaired Loans - Loans are classified as impaired under SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", when management believes it is probable that the Bank will be unable to collect all amounts due under the terms of the loan agreement. This determination is generally made before the loans meet the traditional definition of nonperforming and usually involve special circumstances beyond the criteria for nonperforming status. As a result, the Bank's impaired loans will generally include nonperforming loans and loans expected to become nonperforming in the foreseeable near term. The specific allowance for credit loss is evaluated on a loan by loan basis for impaired loans.

Allowance for Credit Losses - The allowance for credit losses is a valuation allowance established for estimated future losses on loans. All losses are charged to the allowance when the loss actually occurs or when a determination is made that a loss is likely to occur. Recoveries are credited to the allowance at the time of recovery.

Throughout the year, management estimates the likely level of future losses to determine whether the allowance for credit losses is adequate for the existing portfolio. Based on these estimates, an amount is charged to the provision for credit losses and credited to the allowance to adjust the allowance to a level determined to be adequate.

Management's judgment as to the level of losses on existing loans involves the consideration of current and anticipated economic conditions and their potential effects on specific borrowers, an evaluation of the existing relationships among loans, potential credit losses and the present level of the allowance, results of examinations of the loan portfolio by regulatory agencies, and management's internal review of the loan portfolio. In determining the collectibility of certain loans, management also considers the fair value of any underlying collateral. The amounts ultimately realized may differ from the carrying value of these assets due to economic, operating, or other conditions beyond the Bank's control.

It should be understood that estimates of credit losses involve judgment. While it is possible that in particular periods the Bank may sustain losses which are substantial relative to the allowance for credit losses, in management's judgment, the allowance for credit losses reflected in the balance sheets is adequate to absorb estimated losses which may exist in the current loan portfolio.

Premises and Equipment - Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation expense is computed using the straight-line method over the estimated useful lives of the assets, which range from 3 to 40 years. Leasehold improvements are amortized straight-line over the periods of the leases or the estimated useful lives, whichever is shorter.

Real Estate Acquired Through Foreclosure - Real estate acquired through foreclosure is recorded at the lesser of the Bank's carrying value of the loan, or the Bank's interest in the net realizable value of the property. Write-downs of the loan carrying value are charged to the allowance for credit losses at the date of the foreclosure sale, and the remaining carrying value is reclassified to real estate owned.

Write-downs of real estate owned after acquisition due to a decline in the net realizable value, if any, are charged to operations in the period in which the decline occurred. Required developmental costs associated with foreclosed property under construction are capitalized, as long as the write-up does not cause book value to exceed net realizable value. Operating expenses of real estate owned, net of related income, and the net gain or loss on the disposition of the property, are included in other expense.

Gain on Sale of Loans - The Bank originates loans guaranteed by the U.S. Small Business Administration ("SBA"). These loans have maturities of up to 25 years. The SBA will guarantee the repayment of up to 75% of the loan's principal and accrued interest. A ready market exists for the guaranteed portion of the loan, and the Bank may sell the guaranteed portion into this secondary market while retaining the unguaranteed portion in portfolio. The Bank executes all SBA loan sales on a servicing retained basis, where the Bank retains the rights and obligations to service the loans.

The standard loan sale structure provides for the Bank to keep a portion of the cash flows from the interest payments on the loan. This cash flow is commonly known as a "servicing spread." Under SBA regulations, the Bank is required to keep at least 100 basis points in servicing spread with the sale of a guaranteed portion of a loan.

The Bank may structure a loan sale to provide a cash premium in addition to a servicing spread. If the cash premium exceeds 10% of the principal balance sold, the Bank is required to share the amount of the premium over 10% with the SBA.

In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," to be effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. This statement provides consistent accounting and reporting standards for transfers and servicing of financial assets, extinguishments of liabilities, and for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The statement amends and extends to all servicing assets and liabilities, the accounting standards for mortgage servicing rights in SFAS No. 65 "Accounting for Certain Mortgage Banking Activities," and supersedes SFAS No. 122, "Accounting for Mortgage Servicing Rights."

The statement requires that servicing assets and other retained interests in transferred assets be measured by allocating the previous carrying amount between the assets sold and the retained interests based on their relative fair values at the date of transfer. The maximum gain that can be recognized at the date of transfer is the difference between the fair value of the assets sold and the reallocated carrying amount of the assets sold. The Bank followed a similar allocation process under the previous accounting treatment afforded SBA loan sales under Emerging Issues Task Force ("EITF") Issue No. 88-11, "Allocation of Recorded Investment when a Loan or Part of a Loan is Sold." Most of the principles and valuation techniques practiced under EITF No. 88-11 have continued under SFAS No. 125.

Under SFAS No. 125, the servicing spread is recognized as a "servicing asset" to the extent the contractual servicing fee in the loan sale agreement exceeds "adequate compensation" for the servicing. For SBA loans, adequate compensation has been determined to be 40 basis points. Servicing spread in excess of the contractual fee, formerly know as "excess servicing," is now recognized as an "interest only strip" ("IO" strip) under SFAS No. 125. The interest only strip is treated as a financial asset in substance, similar to an available for sale security under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Differences between the fair value of the strip and its amortized carrying value are recorded as unrealized gains or losses, and recorded net of the related tax effect in a separate component of shareholders' equity. (See Note 2.)

Under SFAS No. 125, previously recognized excess servicing for loan sales before January 1, 1997 must conform to the new presentation. At December 31, 1996, the Bank had $11,693 capitalized as the present value of excess servicing income. Effective January 1, 1997 the Bank reclassified $8,077 of this asset into the SFAS No. 125 interest only strip classification.

The Bank measures the fair value of the guaranteed portion sold by the market sales price, estimates the fair value of the unguaranteed portion of the loan retained with representative market values, and uses discounted cash flow methods to measure the fair value of the servicing assets and interest only strips. The process of reallocating the carrying value under SFAS No. 125 causes a valuation discount to be recognized on the unguaranteed portion of the loan retained. This discount on the retained portion of the loan is recognized when the loan sale is recorded. The gain recorded in earnings is net of the discount recognized on the portion of the loan retained.

In the past, the application of EITF No.88-11 produced a similar valuation discount on the unguaranteed portion of the loan retained. The Bank's portfolio of unguaranteed SBA loans retained is significantly discounted as a result of this accounting treatment. (See Notes 3 and 4.)

Income Taxes - Amounts provided for income taxes are based on income reported for financial statement purposes at current tax rates. Such amounts include taxes deferred into future periods resulting from temporary differences caused by the recognition of certain types of income and expense in different accounting periods for tax and financial reporting purposes. This income and expense is mainly gains from SBA loan sales, provisions for credit losses, and depreciation.

Earnings Per Share and Capital Structure - In March 1997, the Bank's Board of Directors declared a 5 for 2 stock split which was issued May 5, 1997. In September 1997, the Board declared another stock split, 2 for 1, which was issued December 10, 1997. Earnings per share calculations for the 1995 and 1996 periods have been restated to reflect both 1997 stock splits.

In February 1997, the FASB issued SFAS No. 128, "Earnings per Share," effective for financial statements issued for periods ending after December 15, 1997. This statement specifies the computation, presentation, and disclosure requirement for earnings per share for entities with publicly held common stock. Earnings per share calculations are simplified and are presented in a manner comparable to international standards. SFAS No. 128 supersedes Accounting Principles Board ("APB") Opinion No. 15, "Earnings per Share." All earnings per share calculation for all periods presented are restated to conform with SFAS No. 128 presentation.

Under SFAS No. 128, the Primary and Fully Diluted earnings per share disclosures made under APB Opinion No. 15 are replaced by "Basic" and "Diluted" earnings per share. Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of actual common shares outstanding for the period. Diluted earnings per share includes the potential dilution from common stock equivalent securities following the treasury stock method using the average price of the common stock for the period.

The tables below reconcile the net income available to common stockholders, basic and diluted shares, and earnings per share for the periods presented in the Statements of Income.

Earnings per Share
(whole dollars)

In September 1995 the Bank completed an equity offering, raising $5.25 million in new capital. The offering consisted of 250,000 units, each unit representing two shares of convertible preferred stock, one "C" common stock purchase warrant, and one "D" common stock purchase warrant. The "C" warrants expired on July 25, 1997. The "D" warrants represent the right to purchase five shares of the Bank's common stock at $2.80 per share and expire July 25, 1999.

In 1997 the Bank issued 96,448 common shares for the exercise of stock options by Bank officers. Shares issued for the exercise of C and D warrants in 1997 were 1,190,125 and 249,562, respectively. At December 31, 1997, D warrants representing the right to purchase 966,373 shares remain outstanding. In 1996, the Bank issued 60,730 shares for the exercise of stock options, 57,010 shares for the exercise of C warrants, and 34,065 shares for the exercise of D warrants. In 1995, the Bank issued 62,500 shares for the exercise of stock options. No C or D warrants were exercised in 1995.

The preferred stock was called for redemption at its stated value of $10.75 per share in September 1996. The preferred stock was convertible into the Bank's common stock on a one for one basis, and all of the preferred shareholders exercised the conversion privilege. As of November 15, 1996, all of the Bank's outstanding preferred shares were converted into common shares. The Bank declared $376 and $162 in dividends on the preferred stock in 1996 and 1995, respectively.

In 1996, the Bank's authorized number of common shares under the articles of incorporation were increased to 50,000,000 shares from 5,000,000.

Recent accounting pronouncements - In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 130 establishes standards for the presentation of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 131 establishes standards of reporting for publicly held companies and requires the disclosure of information about operating segments in annual financial statements and interim financial reports issued to shareholders. Both of these pronouncements are effective for fiscal years beginning after December 15, 1997. The Bank has not yet determined the effects of adopting these standards, but since both of these standards address matters of financial statement disclosure, the Bank does not expect any materially adverse effect on its financial position or results of operations from their adoption.