ITEM 1: BUSINESS
UPBANCORP, INC.
Upbancorp, Inc. ("Upbancorp" or the "Company") is a multi-bank holding company organized in 1983 under the laws of the State of Delaware. Upbancorp owns all the outstanding common stock of Uptown National Bank of Chicago ("Uptown"), organized in 1929 and located in Chicago, Illinois, and Heritage Bank ("Heritage"), organized in 1977 and located in Phoenix, Arizona. (Uptown and Heritage are referred to as the "Subsidiary Banks".) Upbancorp does not engage in any activities other than providing administrative services and acting as a holding company for its Subsidiary Banks.
The Company is a banking company with total assets of $226 million at year- end 1996 and is headquartered in Chicago, Illinois. The majority of the operational responsibilities of each of the Subsidiary Banks rests with their Officers and Directors.
The Company and its Subsidiary Banks employed approximately 145 full-time equivalent employees at December 31, 1996.
SUBSIDIARY BANKS
The Company's affiliates consist of two full-service community banks, which operate five banking offices in northern Chicago and metropolitan Phoenix. Approximately 77% of its banking assets are related to Uptown with the remainder related to Heritage.
Both Subsidiary Banks are engaged in the general commercial banking business in addition to offering a complete range of retail banking services. The Subsidiary Banks conduct a general banking business which embraces all of the usual functions, both commercial and consumer, and which they may lawfully provide, including, but not limited to: the acceptance of deposits to demand, savings and time accounts and the servicing of such accounts; commercial, industrial, consumer and real estate lending; safe deposit box operations; and other banking services tailored for both commercial and retail clients.
Uptown has one wholly-owned subsidiary, Broadway Clark Building Corporation ("BCBC"), which is an Illinois corporation. BCBC owns all of the real estate that is used in connection with the operation of Uptown's business with the exception of one facility, which is leased.
SUPERVISION AND REGULATION
The Company and its Subsidiary Banks are subject to regulation and supervision by various governmental regulatory authorities including, but not limited to, the Federal Reserve Board (the "FRB"), the Office of the Comptroller of the Currency (the "OCC"), the Federal Deposit Insurance Corporation (the "FDIC"), the Arizona State Banking Department, the Securities and Exchange Commission (the "SEC"), the Internal Revenue Service and state taxing authorities. Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions, such as the Company and the Subsidiary Banks, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. This supervision and regulation is intended primarily for the protection of the FDIC's Bank Insurance Fund and the depositors, rather than the shareholders of financial institutions.
The Company is subject to supervision and regulation by the Board of Governors of the FRB, under the Bank Holding Company Act of 1956, as amended.
Uptown is chartered under the National Bank Act, as amended, and is subject to the examination, supervision, reporting and enforcement requirements of the OCC, as the chartering authority for national banks, and the FDIC as the administrator of the Bank Insurance Fund. The Bank is a member of the Federal Reserve System.
Heritage is chartered under the banking laws of Arizona and is subject to the examination, supervision, reporting and enforcement requirements of the Arizona State Banking Commission under the banking laws of Arizona and the FDIC under the Federal Deposit Insurance Act, as amended.
The deposits of the Subsidiary Banks are insured by the Bank Insurance Fund of the FDIC to the extent permitted by law.
The Company's common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Consequently, the Company is subject to the information proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Securities Exchange Act of 1934.
GOVERNMENTAL MONETARY POLICIES AND ECONOMIC CONDITIONS
The earnings of the Company are affected in important respects by general economic conditions and also by the fiscal and monetary policies of the federal government and its agencies. In particular, the FRB regulates the national supply of bank credit in order to achieve, among other things, maximum employment and a stable price level. Among the instruments of monetary policy used by the FRB to implement these objectives are: open market transactions in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and they may also affect interest rates charged on loans or paid for deposits.
Interest rate sensitivity has a major impact on the yields earned on assets of the Subsidiary Banks. As market rates change, yields earned on assets may not necessarily move to the same degree as rates paid on liabilities. For this reason, the Subsidiary Banks attempt to minimize earnings volatility related to fluctuations in interest rates through the use of formal asset/liability management programs which identifies imbalances between the repricing of earning assets and funding sources, among other things.
In addition to the FRB, the Company's earnings are also affected by the FDIC insurance premiums and the annual fees charged by the various regulatory authorities. The Company cannot fully predict the nature or the extent of any effect which such fiscal and monetary policies may have on its business and earnings.
COMPETITION
The principal methods of competition between commercial banks is generally expressed in terms of price, including interest rates paid on deposits and interest rates charged on borrowings, fees charged on fiduciary services, quality of services to customers, ease of access to services, and the offering of additional services. More recently, technological advances such as telebanking, point-of-sale debit cards and electronic data interchange have also resulted in intensified competition with traditional banking distribution systems.
Both Illinois and Arizona are highly competitive markets for banking and related financial services. Since these areas are the Company's primary focus markets, the Subsidiary Banks are exposed to varying types and levels of competition. In general, each Subsidiary Bank competes, anticipates and responds within each individual market area. Both Subsidiary Banks compete and rely heavily on the high level of quality service provided to our customers. The Company has seen the level of competition and number of competitors in its market places increase in recent years and expects a continuation of these competitive market conditions.
CAPITAL GUIDELINES
The FRB, the OCC and the FDIC have adopted risk-based capital guidelines which provide a framework for assessing the adequacy of the capital of banks and bank holding companies (collectively "banking institutions"). These guidelines apply to all banking institutions regardless of size and are used in the examination and supervisory process as well as in the analysis of applications to be acted upon by the regulatory authorities. These guidelines require banking institutions to maintain capital based on the credit risk of their operations.
The risk-based capital guidelines are designed to require the maintenance of capital commensurate with both on and off-balance sheet credit risks. The minimum ratios established by the guidelines are based on both tier 1 and total capital to total risk-based assets. Total risk-based assets are calculated by assigning each on-balance sheet asset and off-balance sheet item to one of four risk categories depending on the nature of each item. The amount of the items in each category is then multiplied by the risk-weight assigned to that category (0%, 20%, 50% or 100%). Total risk-based assets equals the sum of the resulting amounts. Tier 1 capital is generally defined as shareholders' equity less intangible assets and total capital is generally defined to include Tier 1 capital plus limited levels of the allowance for loan losses.
In addition to the risk-based capital requirements, the FRB, the OCC and the FDIC require institutions to maintain a minimum leveraged-capital ratio to supplement the risk-based capital guidelines. The leverage ratio is intended to ensure that adequate capital is maintained against risks other than credit risk.
The Company and the Subsidiary Banks exceed the minimum required capital guidelines for both risk-based capital ratios and the leverage ratio at December 31, 1996. A further discussion of the capital guidelines is included in the Capital Resources section under Item 7 of this Form 10-K.
DIVIDENDS
GENERAL
In addition to the capital guidelines provided in the discussion above, there are various national and state banking regulations which limit the ability of the Subsidiary Banks to pay dividends and thereby limiting the ability of the Company to pay dividends. Since the Company is a legal entity, separate and distinct from its affiliates, its dividends are not subject to such bank regulatory guidelines. The holders of the Company's common stock are entitled to receive such dividends as are declared by the Board of Directors. For a further discussion of dividends, see footnote 12 "Restrictions on Retained Earnings" in the Notes to Consolidated Financial Statements found elsewhere in this Form 10-K.
NATIONAL BANKING ASSOCIATION RESTRICTIONS
Uptown is a national banking association, and is limited with respect to the amount of dividends which they can pay to their shareholders under Sections 56 and 60 of the National Bank Act.
Section 56 restricts a national bank from paying dividends if it would impair the institution's capital by barring any payments in excess of "net profits then on hand". Section 56 further requires that a bank deduct losses and bad debts from "net profits then on hand". It also specifies that a portion of a bank's capital surplus account may be included as "net profits then on hand" to the extent that it represents earnings from prior periods.
Section 60 requires the OCC's approval if the total of all dividends declared in any calendar year will exceed the institution's net profits of that year combined with its retained net profits of the preceding two years, less any required transfers to surplus. In calculating its net profits under Section 60 a national bank may not add back provisions made to its allowance for loan losses nor deduct net charge-offs.
ARIZONA STATE-CHARTERED BANK RESTRICTIONS
Under the provisions of the Arizona Bank Code, dividends may not be declared by state-chartered banks unless they are made in compliance within the banking laws of Arizona. Additionally, the payment of dividends by a state- chartered bank whose deposits are insured by the Bank Insurance Fund, is affected by the requirement to maintain minimum capital pursuant to the capital adequacy guidelines issued by the FDIC.
ITEM 2:

ITEM 2: PROPERTIES
The following table summarizes the Company and Subsidiary Banks' properties by location:
AFFILIATE PROPERTY TYPE/LOCATION OWNERSHIP SQUARE FOOTAGE
THE COMPANY 4753 N. Broadway - - Chicago, Illinois
UPTOWN Main Office: 4753 N. Broadway Owned 149,000 (Note 1) Chicago, Illinois
Banking Office: 6041 N. Clark Street Owned 2,100 (Note 1) Chicago, Illinois
Banking Office: 5345 N. Sheridan Road Leased 1,500 Chicago, Illinois
HERITAGE Main Office: 4222 E. Camelback Road Leased 4,000 Suite J200 Phoenix, Arizona
Banking Office: 4222 E. Camelback Road Leased 4,000 Suite J100 Phoenix, Arizona
Banking Office: 1333 W. Broadway Owned 13,900 (Note 2) Tempe, Arizona
Franklin Mortgage Office: 4222 E. Camelback Road Leased 1,641 Suite H200 Phoenix, Arizona
In addition to the banking locations listed above, the Subsidiary Banks own 12 automatic teller machines, strategically located within the subsidiaries' market places.
At December 31, 1996, the properties and equipment of the Company had an aggregate net book value of approximately $5.5 million.
Note 1: Uptown's locations are owned by its wholly-owned subsidiary, BCBC. Uptown utilizes approximately 49,000 square feet of its main office and the rest of the facility is leased out by BCBC to independent third parties.
Note 2: Heritage leases approximately 3,130 square feet of its Tempe location to an independent third party.
ITEM 3:

ITEM 3: LEGAL PROCEEDINGS
Neither the Company nor its Subsidiary Banks are party to any litigation, which in the judgment of management after consultation with counsel, would have a material effect on the financial position or results of operations of the Company or the Subsidiary Banks.
ITEM 4:

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no items submitted to a vote of security holders during the fourth quarter of 1996.
PART II
ITEM 5:

ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Over-The-Counter market under the symbol UPBN. As of December 31, 1996, there were 356 shareholders of record. The following table sets forth common stock information during each quarter of 1996 and 1995.
A discussion regarding the regulatory restrictions applicable to the Subsidiary Banks' ability to pay dividends is included in the Dividends Section under Item 1 of this Form 10-K and footnote 12 in the Notes to Consolidated Financial Statements found elsewhere in this Form 10-K.
ITEM 6:

ITEM 6: SELECTED FINANCIAL DATA
The following Selected Financial Data is not included by the report of independent public accountants and should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this Form 10-K. A more detailed discussion and analysis of factors affecting the Company's financial position and operating results is presented in Management's Discussion and Analysis of Financial Condition and Results of Operations found under Item 7

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The following management's discussion and analysis of financial condition and results of operations should be read in conjunction with the Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in Item 8

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF CONDITION
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOW
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.
UPBANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DOLLARS IN THOUSAND, EXCEPT PER SHARE DATA)
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS.
UPBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS:
Upbancorp, Inc. ("Upbancorp" or the "Company"), is a multi-bank holding company, organized in 1983 under the laws of the State of Delaware. The Company owns all of the outstanding common stock of Uptown National Bank of Chicago ("Uptown"), organized in 1929 and located in Chicago, Illinois and Heritage Bank ("Heritage"), organized in 1977 and located in Phoenix, Arizona. Upbancorp does not engage in any activities other than providing administrative services and acting as a holding company for its subsidiary banks.
The Company's affiliates consist of two full-service community banks, which operate five banking offices in northern Chicago and metropolitan Phoenix. Both Subsidiary Banks are engaged in the general commercial banking business in addition to offering a complete range of retail banking services. The Subsidiary Banks conduct general banking business which embraces all of the usual function, both commercial and consumer, and which they may lawfully provide, including, but not limited to: the acceptance of deposits to demand, savings, and time accounts and the servicing of such accounts; commercial, industrial, consumer and real estate lending; collections; safe deposit box operations; and other banking services tailored for both commercial and retail clients.
Uptown's wholly-owned subsidiary, Broadway Clark Building Corporation ("BCBC"), is an Illinois corporation and owns all of the real estate that is used in connection with the operation of Uptown's business with the exception of one facility.
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of Upbancorp and its wholly-owned subsidiaries Uptown (including its wholly-owned subsidiary BCBC) and Heritage after elimination of all intercompany balances and transactions.
BASIS OF FINANCIAL STATEMENT PRESENTATION:
The accounting and reporting policies of the Company conform to generally accepted accounting principles. In preparing the accompanying consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and the accompanying notes. Significant estimates which are particularly susceptible to change in a short period of time include the determination of the allowance for loan losses. Actual results could differ from those estimates.
Certain reclassifications have been made to the 1995 and 1994 consolidated financial statements to conform to the 1996 presentation.
SECURITIES HELD-TO-MATURITY:
Debt securities for which the Banks have both the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, is included in interest income.
SECURITIES AVAILABLE-FOR-SALE:
Securities classified as available-for-sale are those debt securities that the Banks intend to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Bank's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors.
Securities available-for-sale are reported at fair value with unrealized gains or losses reported as a separate component of shareholders' equity net of the related deferred tax effect. The amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, are recognized in interest income.
Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
Declines in the fair value of individual securities classified as either held-to-maturity or available-for-sale below their amortized cost that are determined to be other than temporary result in write-downs of the individual securities to their fair value with the resulting write-downs included in current earnings as realized losses.
MORTGAGES HELD-FOR-SALE:
The Company routinely sells to investors its originated residential mortgage loans and retains no servicing rights relating to these mortgages sold. Mortgage activity includes both mortgages held-for-sale with pre-purchase agreements, and loans sold directly into the secondary market. Mortgages held-for-sale are carried at cost with interest income recognized until sold. Mortgage banking fees are recorded at the date of sale. For purposes of this report, mortgages held-for-sale and mortgage banking fees relate only to these two types of mortgage activities; not to mortgages which are originated, booked and serviced by the Company. All sales are made without recourse.
LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES:
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances reduced by any charge-offs or specific valuation accounts and net of unearned discount, deferred loan fees and the allowance for loan losses.
Loan origination and commitment fees are deferred and the net amount is amortized as an adjustment of the loan yield over the contractual life of the related loans. Commitment fees based upon a percentage of a customer's unused line of credit and fees related to standby letters of credit are recognized over the commitment period.
Unearned interest on discounted loans is amortized to income over the life of the loans, using the sum-of-month's digits method which approximates the level yield method. For all other loans, interest is accrued daily on the outstanding balances. The accrual of interest is discontinued on loans past due 90 days or more. For impaired loans, accrual of interest is discontinued when management believes, after considering collection efforts and other factors, that the borrower's financial condition is such that collection of interest is doubtful. Interest income on these loans is recognized to the extent interest payments are received and the principal is considered fully collectible.
A loan is impaired when it is probable the Bank will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or at the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment, as well as any subsequent changes, is recorded through a valuation allowance included in the allowance for loan losses.
The Company considers consumer loans and residential real estate loans to be smaller homogeneous loans that are not considered as impaired loans. All other loan types are accounted for as impaired loans when they meet the above criteria.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb estimated losses on existing loans, based on an evaluation of the collectibility of loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, various regulatory agencies periodically review the allowance for loan losses based on their judgments of collectibility after reviewing the information available to them at the time of their examination.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed principally by the straight-line method over their estimated useful lives.
GOODWILL:
Goodwill arising from the acquisition of Heritage Bank is being amortized on a straight-line basis through 2002. As of December 31, 1996 and 1995, goodwill of $276 and $318, net of accumulated amortization, is included in other assets in the consolidation statements of condition.
INCOME TAXES:
Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD: The carrying amounts reported in the balance sheet for cash and due from banks and federal funds sold approximate their fair values.
SECURITIES HELD-TO-MATURITY AND AVAILABLE-FOR-SALE: Fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
LOANS AND MORTGAGES HELD-FOR-SALE: The fair values of the loan portfolio are estimated based upon discounted cash flow analyses that apply using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
DEPOSIT LIABILITIES: The fair values disclosed for deposits with no defined maturities is equal to their carrying amounts which represent the amount payable on demand. The carrying amounts for variable-rate, fixed- term money market accounts and certificates of deposit approximate their fair value at the reporting date. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
BORROWED FUNDS: The carrying amounts of borrowings under repurchase agreements and other short-term borrowings approximate their fair values.
ACCRUED INTEREST: The carrying amounts of accrued interest approximate their fair values.
OFF-BALANCE SHEET INSTRUMENTS: Fair values for the Company's off-balance sheet lending commitments (letters of credit and commitments to extend credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value for such committments is nominal.
EARNINGS PER COMMON SHARE:
Earnings per common share are determined on the basis of the weighted- average number of common shares outstanding.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES:
In June, 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 125 ("SFAS 125") "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities". SFAS 125 requires that an entity recognize only those assets that it controls and liabilities it has incurred. Assets should be recognized until control has been surrendered, and liabilities should be recognized until they have been extinguished. Recognition of financial assets and liabilities will not be affected by the sequence of the transactions unless the effect of the transactions is to maintain effective control over a transferred financial asset.
SFAS 125 is effective for transactions occurring after December 31, 1996, except for transactions relating to secured borrowings and collateral for which the effective date is December 31, 1997. The Company believes the adoption of SFAS 125 will not have a material impact on its consolidated financial statements.
NOTE 2. RESTRICTIONS ON CASH AND DUE FROM BANKS
The Banks are required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The total of these reserve balances was approximately $1,981 and $1,892 at December 31, 1996 and 1995.
NOTE 3. SECURITIES
The amortized cost and fair value of securities HELD-TO-MATURITY are as follows at December 31:
The amortized cost and fair value of securities AVAILABLE-FOR-SALE are as follows at December 31:
The amortized cost and fair value of securities AVAILABLE-FOR-SALE at December 31, 1996, by contractual maturity, are shown below. Expected maturities in mortgage-backed securities may differ from contractual maturities because the mortgages underlying the securities may be called or repaid with or without prepayment penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary.
Amoritzed Fair Cost Value ------------- ----------- Due in one year or less $ 13,740 $ 13,539 Due after one year through five years 19,278 19,001 Due after five years through ten years 3,427 3,462 Due after ten years 912 923 Equity securities 3,273 3,259 Mortgage-backed securities 26,191 25,672 ------------- ----------- Total $ 66,821 $ 65,856 ------------- ----------- ------------- -----------
Investment securities carried at approximately $22,976 and $11,061 at December 31, 1996 and 1995, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law.
During 1995, the Financial Accounting Standards Board decided to allow all enterprises to make a reassessment of the classifications of securities made under SFAS 115. The Company transferred the majority of its securities in the held-to-maturity classification to securities available-for-sale.
NOTE 4. LOANS Major classifications of loans are as follows at December 31:
The commerical loan maturities and sensitivity to changes in interest rates at December 31, 1996, are shown in the following table:
After on In one year through Over or less five years five years Total ----------- ---------- ----------- --------- Comemrical loan maturities $ 49,678 $ 31,933 $ 9,134 $ 90,745 ----------- ---------- ----------- --------- ----------- ---------- ----------- --------- Interest rate sensitivity: Fixed rate $ 11,238 $ 31,933 $ 9,134 $ 52,305 Variable rate 38,440 -- -- 38,440 ----------- ---------- ----------- --------- Total $ 49,678 $ 31,933 $ 9,134 $ 90,745 ----------- ---------- ----------- --------- ----------- ---------- ----------- ---------
Transactions in the allowance for loan losses account during the years ended December 31, 1996, 1995 and 1994 are summarized below:
December 31, -------------------------------- 1996 1995 1994 -------- -------- -------- Balance at beginning of year $ 1,402 $ 1,605 $ 1,421 Provision for loan losses 914 717 291 Loans charged-off (896) (948) (206) Recoveries on loans previously charged-off 65 28 99 ---------- ----------- --------- Balance at end of year $ 1,485 $ 1,402 $ 1,605 ---------- ----------- --------- ---------- ----------- ---------
As of December 31, 1996 and 1995, the Company's recorded investment in impaired loans and the related valuation allowance calculated under SFAS No. 114 and No. 118 are as follows:
1996 1995 -------------------- -------------------- Carrying Valuation Carrying Valuation Value Allowance Value Allowance -------- --------- ---------- --------- Impaired loans Valuation allowance required $ 411 $ 94 $ 1,581 $ 261 No valuation allowance required 400 - 788 - -------- --------- ---------- --------- Total Impaired Loans $ 811 $ 94 $ 2,369 $ 261 -------- --------- ---------- --------- -------- --------- ---------- ---------
The valuation allowance is included in the allowance for loan losses on the balance sheet. The average recorded investment in impaired loans for years-ended December 31, 1996 and 1995, was $1,878 and $4,025.
NOTE 5. PREMISES AND EQUIPMENT
The following is a summary of bank premises and equipment at December 31:
1996 1995 --------- --------- Land $ 1,106 $ 1,106 Buildings and improvements 11,629 10,852 Furniture, fixtures and equipment 5,532 5,751 --------- --------- Total cost 18,267 17,709 Accumulated depreciation (12,766) (11,929) --------- --------- Net book value $ 5,501 $ 5,780 --------- --------- --------- ---------
Depreciation expense on premises and equipment totaled $887, $924, and $972 for 1996, 1995 and 1994.
The buildings, in which the main facilities of each bank are located, have stores and offices which are rented. Gross rental receipts were $952 in 1996, $908 in 1995 and $858 in 1994 and are recorded as a reduction of net occupancy expense.
NOTE 6. DEPOSITS
The aggregate amount of certificates of deposits of $100,000 or more totaled $12,584 and $11,910 at December 31, 1996 and 1995.
Maturities of time certificates of deposit are summarized as follows at December 31:
----------- 1997 $ 41,218 1998 8,739 1999 3,809 2000 790 2001 218 Thereafter - ----------- $ 54,774 ----------- -----------
NOTE 7. BORROWED FUNDS
Borrowed funds consisted of the following at December 31:
1996 1995 ----------- ---------- Federal Home Loan Bank borrowing, due July 1, 1996, variable rate $ - $ 5,000 Federal Home Loan Bank borrowing, due February 14, 1997, 5.83% fixed rate 2,000 - Federal Home Loan Bank borrowing, due July 1, 1998, variable rate 5,000 - Securities sold under agreements to repurchase and U.S. Treasury tax and loan note accounts 3,561 230 ----------- ---------- Total $ 10,561 $ 5,230 ----------- ---------- ----------- ----------
Uptown has an arrangement with the Federal Home Loan Bank of Chicago whereby the FHLB will make advances to the Bank with repayment terms from overnight to ten years. The Bank is eligible to obtain credit up to 20 times the member Bank's holding of Federal Home Loan Capital Stock; these eligible borrowings amount to $19,438. As required under the agreement, the advances can be collateralized by the following: qualifying 1-4 first mortgages, private mortgage-backed securities or U.S. Treasury and Agency obligations. Uptown has pledged a combination of U.S. Treasury and Agency mortgage-backed securities. Heritage has an arrangement with the Federal Home Loan Bank of San Francisco whereby the FHLB will make advances to the Bank with repayment terms from overnight to ten years but not to exceed the volume of its residential housing financial assets. The Bank is eligible to obtain credit up to 20 percent of the Bank's assets; these eligible borrowings amounted to $9,350 at December 31, 1996.
NOTE 8. PENSION PLAN
Uptown has a defined benefit plan covering substantially all employees in the Company. The plan is based on years of service and the employee's average compensation during all years of employment. The Company's funding policy is to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974 ("ERISA"), plus additional amounts as appropriate. The following table sets forth the Plan's funded status for the periods noted:
NOTE 9. INCOME TAXES
The provision for income taxes is comprised of the following amounts for the years ended December 31:
1996 1995 1994 ------- ------- ------- Current: Federal $ 470 $ 499 $ 307 State 60 81 - Deferred: 163 45 (61) ------- ------- ------- Total tax provision $ 693 $ 625 $ 246 ------- ------- ------- ------- ------- -------
The components of the net deferred tax assets are as follows:
The Bank has recorded a net deferred tax asset of $854, $887 and $1,279 as of December 31, 1996, 1995 and 1994, respectively, which is included in the balance sheet line item entitled "Other Assets."
Management has determined that a valuation allowance is not required at December 31, 1996 and 1995.
The following table reconciles the statutory Federal income tax rate with the effective income tax as a percent of pretax income.
1996 1995 1994 ------ ------- ------- Statutory income tax rate 34.0% 34.0% 34.0% Reduction/increase in taxes resulting from Tax-exempt interest (2.2%) (1.7%) (6.3%) State tax 2.1% 2.2% (1.3%) Non-deductible expenses 3.6% 3.5% (3.0%) ------ ------- ------- Effective income tax rate 37.5% 38.0% 23.4% ------ ------- ------- ------ ------- -------
NOTE 10. RELATED PARTIES
The Banks have entered into transactions with their directors and their affiliates (related parties). The aggregate amount of loans to such related parties at December 31, 1996 and 1995 was $2,716 and $2,925, respectively. During 1996, new loans and advances to such related parties amounted to $957 and repayments amounted to $1,166.
NOTE 11. COMMITMENTS, CONTINGENCIES AND CREDIT RISK
The Subsidiary Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement a bank has in particular classes of financial instruments.
The Banks' exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and standby and commercial letters of credit is presented by the contractual amount of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. 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 Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Banks upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, marketable securities, inventory, property, plant, and equipment, and income-producing commercial properties and residential properties.
Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Banks hold various types of collateral (primarily certificates of deposit) to support those commitments for which collateral is deemed necessary. Most of the letters of credit expire within twelve months.
Contract Amount ------------------------- Off - balance sheet assets 1996 1995 ---------- ---------- Commitments to extend credit $ 53,577 $ 33,589 Letters of credit: Standby 752 620 Commercial 358 950
Upbancorp leases certain office facilities and equipment under various operating lease agreements that provide for payment of taxes, insurance and maintenance costs. These leases generally include renewal options. The future minimum rental commitments at December 31, 1996 are as follows:
Premises Equipment Total ---------- ------------ ---------- 1997 $ 178 $ 74 $ 252 1998 181 -- 181 1999 179 -- 179 2000 161 -- 161 2001 162 -- 162 Thereafter 250 -- 250 ---------- ------------ ---------- Total minimum payments $ 1,111 $ 74 $ 1,185 ---------- ------------ ---------- ---------- ------------ ----------
In the ordinary course of business, the Banks have various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Company and the Banks are defendants in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company.
In addition to financial instruments with off-balance-sheet risk, the Company, to a certain extent, is exposed to varying risks associated with concentrations of credit. Concentrations of credit risk generally exist if a number of counterparties are engaged in similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by economic or other conditions.
The Company conducts substantially all of its lending activities throughout northeastern Illinois and the greater Phoenix metropolitan area. As of December 31, 1996, loans to customers in Arizona were approximately $44 million. Loans granted to businesses are primarily secured by business assets, owner-occupied real estate or personal assets of commercial borrowers. Loans to individuals are primarily secured by automobiles, residential real estate or other personal assets. Since the Company's borrowers and its loan collateral have geographic concentration in the greater Chicago and greater Phoenix metropolitan areas, the Company could have exposure to a decline in those local economies and real estate markets. However, management believes that the diversity of its customer base and local economies, its knowledge of the local markets, and its proximity to customers limits the risk of exposure to adverse economic conditions.
NOTE 12. RESTRICTIONS ON RETAINED EARNINGS
Uptown and Heritage are subject to certain restrictions on the amount of dividends that they may declare without prior regulatory approval. At December 31, 1996, approximately $1,249 of retained earnings of Uptown were available for dividend declaration without prior regulatory approval.
NOTE 13. REGULATORY MATTERS
The Company and the Banks are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - action by regulators that, if undertaken could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific capital guidelines that involve qualitative measures of the Company's and the Banks' assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Banks' 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 the Company and the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes the Company and the Banks meet all capital adequacy requirements to which they are subject to at December 31, 1996.
As of December 31, 1996, the most recent notification from the Office of the Comptroller of the Currency categorized Uptown as well capitalized and notification from the Federal Deposit Insurance Corporation categorized Heritage as adequately capitalized under the regulatory framework for prompt corrective action. As a result of this designation, Heritage is currently paying F.D.I.C. premiums at a rate of .04/$100 in deposits. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier 1 risk based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed either Banks' category.
The Company's ratios are presented in the following table:
NOTE 14. FINANCIAL INSTRUMENTS
The estimated fair values of the Banks' financial instruments were as follows at December 31,
NOTE 15. UPBANCORP, INC. - PARENT ONLY FINANCIAL STATEMENTS
The Parent Company's condensed financial information, which follows, conforms with the accounting policies described in the preceding notes:
STATEMENTS OF CONDITION
December 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1995 - ------------------------------------------------------------------------------- ASSETS Cash $ 381 $ 140 Investment in subsidiary banks 18,441 18,317 Other 155 100 ------- ------- TOTAL ASSETS $18,977 $18,557 ------- ------- ------- -------
LIABILITIES Dividend declared $ 110 $ 111 Other liabilities 11 12 ------- ------- TOTAL LIABILITIES $ 121 $ 123 ------- -------
SHAREHOLDERS' EQUITY Common stock - $10 par value $ 2,500 $ 2,500 Additional paid in capital 3,000 3,000 Retained earnings 15,425 14,714 Treasury stock (1,480) (1,394) Net unrealized loss on securities available-for-sale (589) (386) ------- ------- TOTAL SHAREHOLDERS' EQUITY $18,856 $18,434 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $18,977 $18,557 ------- ------- ------- -------
NOTE 15. UPBANCORP, INC. - PARENT ONLY FINANCIAL STATEMENTS (Continued)
STATEMENTS OF INCOME
Years ended December 31, (DOLLARS IN THOUSANDS) 1996 1995 1994 - ------------------------------------------------------------------------------- INCOME Dividends received from bank subsidiaries $ 1,411 $ 125 $ 600 Interest on short term investments 9 8 23 -------- -------- -------- Total Income 1,420 133 623 -------- -------- -------- EXPENSE Salaries and employee benefits 333 343 339 Other expense 122 35 90 -------- -------- -------- Total Expense 455 378 429 -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAXES AND UNDISTRIBUTED INCOME (LOSS) OF SUBSIDIARIES 965 (245) 194 Income tax benefit 112 94 81 -------- -------- -------- INCOME (LOSS) BEFORE UNDISTRIBUTED INCOME (LOSS) OF SUBSIDIARIES 1,077 (151) 275 Undistributed income of subsidiaries 77 1,169 531 -------- -------- -------- NET INCOME $ 1,154 $ 1,018 $ 806 -------- -------- -------- -------- -------- --------
REPORT OF MANAGEMENT ON RESPONSIBILITY FOR FINANCIAL REPORTING UPBANCORP, INC. AND SUBSIDIARIES
To the Shareholders of Upbancorp, Inc.:
The accompanying consolidated financial statements were prepared by Management, who is responsible for the integrity and objectivity of the data presented. In the opinion of Management, the financial statements, which necessarily include amounts based on Management's best estimates and judgments, have been prepared in conformity with generally accepted accounting principles appropriate to the circumstances.
Management depends upon the Company's system of internal controls in meeting its responsibilities for reliable financial statements. This system is designed to provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with Management's authorization. Judgments are required to assess and balance the relative cost and the expected benefits of these controls. As an integral part of the system of internal controls, the Bank Subsidiaries contract with a professional staff of Independent Internal Auditors who conduct operational, financial, and special audits, and coordinate audit coverage with the Independent Auditors.
The consolidated financial statements have been audited by our Independent Auditors, McGladrey & Pullen LLP, who render an independent professional opinion on Management's financial statements.
The Audit Committee of Upbancorp, Inc.'s Board of Directors, composed solely of outside directors, meets regularly with the Independent Internal Auditors, the Independent Auditors and Management to assess the scope of the annual examination plan and to discuss audit, internal control and financial reporting issues, including major changes in accounting policies and reporting practices. The Independent Internal Auditors and the Independent Auditors have free access to the Audit Committee, without Management present, to discuss the results of their audit work and their evaluations of the adequacy of internal controls and the quality of financial reporting.
Sincerely,
/s/Richard K. Ostrom - ------------------------------------- Richard K. Ostrom President and Chief Executive Officer
/s/Kathleen L. Harris - ------------------------------------- Kathleen L. Harris Vice President & Chief Financial Officer
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of Upbancorp, Inc.:
We have audited the accompanying consolidated statements of condition of Upbancorp, Inc. and subsidiaries as of December 31, 1996 and the related consolidated statements of income, cash flows and changes in shareholders' equity 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Upbancorp, Inc. and subsidiaries as of December 31, 1996 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.
/s/McGladrey & Pullen LLP ------------------------- McGladrey & Pullen LLP
Schaumburg, Illinois February 21, 1997
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of Upbancorp, Inc.:
We have audited the accompanying consolidated statements of condition of Upbancorp, Inc. and subsidiaries as of December 31, 1995 and the related consolidated statements of income, cash flows and changes in shareholders' equity for each of the two years in the period ended December 31, 1995. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Upbancorp, Inc. and subsidiaries as of December 31, 1995 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP ----------------------- Arthur Andersen LLP
Chicago, Illinois February 23, 1996
ITEM 9:

ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
The Company's Board of Directors approved the selection of McGladrey & Pullen, LLP as new independent accountants upon the recommendation of the Company's Audit Committee. This change was effective August 5, 1996. Further information concerning this change can be found in the Proxy Statement for the 1997 Annual Meeting of Shareholders of the Company to be held April 15, 1997, which is incorporated herein by reference.
PART III
ITEM 10:

ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Directors and Executive Officers of the Company, their family relationships and their business experience is contained in the "Information about Directors and Nominees" and "Executive Officers" sections of the Proxy Statement for the 1997 Annual Meeting of Shareholders of the Company to be held on April 15, 1997, which is incorporated herein by reference.
ITEM 11:

ITEM 11: EXECUTIVE COMPENSATION
Information regarding compensation of the Executive Officers of the Company is contained in the "Executive Compensation" section of the Proxy Statement for the 1997 Annual Meeting of Shareholders of the Company to be held on April 15, 1997, which is incorporated herein by reference.
ITEM 12:

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and management is contained in the "Security Ownership of Certain Beneficial Owners and Management" section of the Proxy Statement for the 1997 Annual Meeting of Shareholders of the Company to be held on April 15, 1997, which is incorporated herein by reference.
ITEM 13:

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions of the Company is contained in the "Certain Relationships and Related Transactions" section of the Proxy Statement for the 1997 Annual Meeting of Shareholders of the Company to be held on April 15, 1997, which is incorporated herein by reference. Further information with respect to loans to the Directors and Executive Officers of the Company is provided in Note 10 to the Consolidated Financial Statements located elsewhere in this Form 10-K.
PART IV
ITEM 14:

ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following exhibits, financial statements and financial statement schedules are filed as part of this report:
FINANCIAL STATEMENTS
Consolidated Statements of Condition - December 31, 1996 and 1995
Consolidated Statements of Income - Years ended December 31, 1996, 1995, and 1994
Consolidated Statements of Cash Flows - Years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
Report of Independent Public Accountants
FINANCIAL STATEMENT SCHEDULES
All schedules normally required by Form 10-K are omitted since they are either not applicable or the required information is shown in the financial statements or notes thereto.
EXHIBITS
(3) By-laws as amended by the Company's Board of Directors on December 15, 1995.
(b) REPORTS ON FORM 8-K - No reports on Form 8-K were filed during the fourth quarter of 1996.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Date: February 21, 1997 UPBANCORP, INC. --------------- (The Registrant)
/s/ Richard K. Ostrom --------------------- Richard K. Ostrom President and Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THEIR CAPACITIES ON FEBRUARY 21, 1997.
/s/ Roger P. Eklund Chairman of the Board February 21, 1997 - -------------------------------- Roger P. Eklund
/s/ Stephen W. Edwards, CLU Director February 21, 1997 - -------------------------------- Stephen W. Edwards, CLU
/s/ Delbert R. Ellis Director February 21, 1997 - -------------------------------- Delbert R. Ellis
/s/ John E. Fahrendorf, Jr. Director February 21, 1997 - -------------------------------- John E. Fahrendorf, Jr.
/s/ Alfred E. Hackbarth, Jr. Director February 21, 1997 - -------------------------------- Alfred E. Hackbarth, Jr.
/s/ James E. Heraty Director February 21, 1997 - -------------------------------- James E. Heraty
/s/ Marvin L. Kocian Director February 21, 1997 - -------------------------------- Marvin L. Kocian
/s/ Richard K. Ostrom Director February 21, 1997 - -------------------------------- Richard K. Ostrom
/s/ B. Arthur Russell Director February 21, 1997 - -------------------------------- B. Arthur Russell


ITEM 1. BUSINESS
THE COMPANY
GENERAL
Storage Trust Realty (the "Company") was formed as a Maryland real estate investment trust ("REIT") on July 12, 1994 to continue the self-storage business of Burnam Holding Companies Co. ("BHC") and certain of its affiliates (collectively, the "Predecessor Company") in owning, operating and managing self-storage facilities. The Company and its subsidiaries commenced operations effective with the completion of the Company's initial public offering (the "IPO") on November 16, 1994. As of December 31, 1996, the Company owned 165 self-storage facilities in 18 states and was a partner in two joint ventures that owned one operating self-storage facility and one self-storage facility under development.
Substantially all of the Company's assets and interest in self-storage facilities are held by, and all of its operations are conducted through, Storage Trust Properties, L.P. (the "Operating Partnership"). The Company is the sole general partner of, and thereby controls the operations of, the Operating Partnership, holding a 93.61% ownership interest therein as of December 31, 1996. The remaining ownership interests in the Operating Partnership (the "Units") are held by certain owners of the Predecessor Company, including BHC, and certain former owners of assets acquired by the Operating Partnership subsequent to the IPO.
Storage Realty Management Co. (the "Management Company") manages self-storage facilities owned by unrelated third parties and conducts other business, such as the sale of locks, the processing of customer property insurance and the rental of trucks, at various facilities. Through its ownership of the preferred stock of the Management Company, the Operating Partnership receives substantially all of the economic benefits of the business carried on by the Management Company.
The Company derives its revenue principally from the Operating Partnership, which is generated primarily by (a) the Operating Partnership's rental of self-storage units at its facilities, (b) revenues (for financial reporting purposes) of the Management Company, and (c) earnings from joint ventures.
The Company believes that it is the fifth largest operator of self-storage facilities in the United States, based on the number of facilities operated. As of December 31, 1996, the Company (through its interest in the Operating Partnership) owned 165 self-storage facilities in 18 states in the Southern, Mid-Atlantic, Midwest and Western regions of the United States, including South Carolina (22), Texas (22), Missouri (20), Florida (18), Tennessee (18), Georgia (17), North Carolina (11), Colorado (8), Kansas (6), Illinois (5), Kentucky (5), Alabama (4), Mississippi (3), Wisconsin (2), Oklahoma (1), Louisiana (1), Ohio (1) and Virginia (1). The Operating Partnership, through joint ventures, has a 15% ownership interest in an operating self-storage facility in Louisiana and a 25% ownership interest in a self-storage facility under development in Missouri. Additionally, the Management Company manages ten facilities for unaffiliated third parties. The facilities which the Operating Partnership owns or in which the Operating Partnership owns a joint venture interest, together with the facilities managed for unrelated third parties by the Management Company are referred to herein as the "Facilities".
In 1996, the Company acquired 46 self-storage facilities for a combined purchase price of $116.6 million. The Company acquired facilities in Florida (7), Texas (5), Kansas (5), Missouri (5), Tennessee (4), Kentucky (4), Georgia (3), Colorado (3), South Carolina (2), Wisconsin (2), Alabama (1), Illinois (1), Oklahoma (1), North Carolina (1), Virginia (1) and Ohio (1). In 1996, the Company exchanged two of its facilities in Oklahoma with a publicly-held self-storage REIT for its facility in Florida (included in the acquisition totals above).
The Company is self-administered and self-managed. The Company has elected and expects to continue to qualify as a real estate investment trust for federal income tax purposes.
BUSINESS OBJECTIVES AND OPERATING STRATEGIES
Business Objectives
The Company's primary objectives are to increase cash available for distribution and enhance shareholder value. These objectives are accomplished by (a) managing the Facilities and expanding them where economically feasible, (b) acquiring existing self-storage facilities, (c) converting other commercial real estate into self-storage facilities, and (d) developing new self-storage facilities. The Company's strategies for accomplishing these objectives are:
Internal Growth Strategies
The Company's internal growth strategy is to increase cash flow at the Facilities (and any additional facilities hereafter acquired) by (a) aggressively increasing rents on a regular basis, (b) containing costs and improving operating leverage, and (c) selectively expanding the Facilities, which includes the addition of climate controlled space.
* Increasing Rents - Revenues are increased through the use of sales and marketing programs that are customized for each location and an aggressive leasing program. The Company pursues an objective of being a price leader in its local markets and will attempt to increase rents at all of the Facilities throughout the year. The Company has a general policy that, as occupancy of all same-size units at a particular Facility nears 90%, it will consider increasing rents applicable to these units. The Company plans to continue this strategy at the Facilities and to implement it at facilities that may be acquired or developed in the future.
* Containing Costs and Improving Operating Leverage - The Company seeks to increase cash flow by containing facility operating expenses and spreading corporate overhead expense over an increasing number of facilities. The Company believes that new facilities can be added to the portfolio with very little additional overhead expense because of the Company's operating procedures, decentralized regional managers and management information systems. Through the use of area managers and regional managers, the Company operates with only one level of management between on-site managers and senior management.
* Expanding the Facilities - Many of the Facilities maintain levels of occupancy that when combined with local demand may make it economically feasible to expand existing storage space. In 1996, the Company completed the expansion of four Facilities that totaled 58,050 square feet. Additionally, in several of the Company's markets, there is increasing demand for climate controlled space which the Company currently rents for a premium over non-climate controlled space. In 1996, the Company completed climate-controlled conversions at six Facilities that totaled 18,450 square feet. The Company is exploring opportunities to add new climate controlled space or convert existing space to climate controlled space at the Facilities and other facilities that may be acquired in the future.
External Growth Strategies
The Company's external growth strategy focuses on (a) selectively acquiring additional self-storage facilities, (b) converting other real estate properties into self-storage facilities, and (c) developing new facilities. The Company's management consists of experienced acquisition, development, operations and finance personnel who, when evaluating potential opportunities for acquisition, development and conversion, analyze employment, population and income trends, proximity to major transportation arteries, retail centers and commercial services, visibility and other market data. However, certain potential financing techniques to support acquisition, development or conversion, such as incurrence of debt or issuance of additional equity securities, involve potential leveraging of the Company or dilution to existing shareholders.
* Acquiring Existing Facilities - The Company intends to acquire self-storage facilities that are (a) in the Company's geographic regions of operations where the Company can achieve greater market penetration and economies of scale or in attractive new markets and in new geographic regions where the Company can acquire sufficient facilities to achieve economies of scale, (b) available at attractive prices or currently underperforming and (c) capable of enhanced performance through the application of the Company's management expertise. The Company focuses on acquisitions of Facilities of sufficient size to provide attractive operating efficiencies. The Company believes attractive opportunities exist to acquire self-storage facilities because of the fragmented ownership throughout the industry and the shortage of skilled operators. By actively targeting underperforming facilities or facilities where the Company can apply its proven management techniques, the Company believes that it will be able to enhance its yields by maximizing cash flows at such properties. In addition, the Company believes it has the ability to attract potential sellers of self-storage properties by offering Units in exchange for such properties, thus allowing the sellers to defer taxes which would otherwise be payable upon a profitable sale of property. In 1996, the consideration for ten of the facilities acquired by the Company included 406,759 Units valued at $8,743,000.
* Converting Other Real Estate into Self-Storage Facilities - The Company also has the ability to perform complex conversions of other real estate buildings into self-storage facilities, especially in metropolitan markets where new development or acquisitions may not be economically feasible. The Company believes that in certain markets the costs relating to conversion or redevelopment can be substantially less than those of acquisition or development. Additionally, the Company believes that conversions can simultaneously provide rapid in-fill of current regions of the Company's markets at attractive capitalization rates. Previously completed conversion projects include an automobile dealership in St. Louis, Missouri, and a hotel in New Orleans, Louisiana, and a 68,000 square foot former shoe warehouse in Atlanta, Georgia that commenced operations in March 1996.
* Developing New Facilities - The Company intends to develop self-storage facilities in certain of its markets where there are favorable demographics and where suitable acquisitions may not be available. New development may be done by the Company or by joint ventures in which the Company has an interest. The Company's management (through BHC) developed 36 self-storage facilities between 1974 and the IPO. This development capability will allow the Company the opportunity to grow when acquisition opportunities are not plentiful or economically attractive. In making its decision to develop a facility, the Company obtains information such as census data for the relevant market with respect to population density, income levels and the relative proportions of rental, commercial and residential space. In addition, the Company weighs the costs of acquisition, as measured by recent market sales or bids, versus the costs of development, including construction, land acquisition and site preparation. The Company intends to develop self-storage facilities where it believes there are strong barriers to entry, such as a limited number of suitable sites with the requisite zoning. The Company also intends to focus on development of facilities of sufficient size to provide attractive operating efficiencies.
DISPOSITIONS AND EXCHANGES
Management constantly reviews the Facilities comprising the Company's portfolio. The Company has no current intention to dispose of any of the Facilities, but may do so in the future. Any decision to dispose of a particular Facility would be based on a variety of factors, including, but not limited to, (a) the strategic fit with the rest of the Company's portfolio, (b) the potential to continue to increase cash flow and value in the particular market, (c) the current market value and (d) alternate uses of capital.
The Company may dispose of Facilities for cash or other consideration or may exchange Facilities with other entities, including other publicly-held self-storage REITs. During 1996, the Company exchanged two of its facilities in Oklahoma City, Oklahoma and $1,400,000 in additional consideration with Storage USA, Inc. for its facility in Jacksonville, Florida.
CAPITAL STRATEGY
Mortgages and Notes Payable:
The Company intends to maintain a conservative capital strategy and currently has a policy of limiting the amount of debt related to the Facilities as reflected on the Company's consolidated balance sheet, including debt of joint ventures in which the Company owns an interest, ("Company Debt") to less than 50% of the market value of the issued and outstanding Common Shares (including interests exchangeable for Common Shares) plus Company Debt ("Total Market Capitalization"). At December 31, 1996, the Company's Debt-to-Total Market Capitalization was 15.4%. The Company does not believe that this limit will restrict its operations or have a material adverse effect on its financial condition or results of operations, although there can be no assurance that it will not do so in the future. The Board of Trustees can change the policy at any time in light of then current economic conditions and other relevant factors.
The expansion of existing facilities, the acquisition, conversion and development of additional self-storage facilities, and the repayment of indebtedness, including amounts outstanding on the revolving line of credit, represent the Company's principal liquidity requirements.
The Company expects to meet its short-term liquidity requirements by using (a) net cash provided by operating activities, (b) any portion of net cash flow not currently distributed, (c) borrowings under the revolving line of credit and (d) the second funding under the Senior Notes (as described below). The Company intends to meet its long-term liquidity requirements primarily through (a) borrowings under the revolving line of credit, (b) the issuance of new debt and (c) the sale of Common Shares. The Company believes that its future net cash flow will be adequate to meet operating requirements and provide for payment of distributions by the Company in accordance with tax requirements relating to a REIT in the short-term and in the long-term.
The Company has a $100 million unsecured revolving line of credit that may be used to fund the acquisition, development or conversion of additional facilities. The credit line expires in January 1998, with a one-year extension at the Company's option upon satisfaction of certain conditions, and bears interest at a floating rate of LIBOR plus 162.5 basis points (7.267% at December 31, 1996).
CAPITAL STRATEGY (continued)
MORTGAGES AND NOTES PAYABLE: (continued)
In December 1996, the Company received commitments from various institutional investors for the private placement of $100 million of unsecured Senior Notes. The Company funded $75 million of the Senior Notes on January 22, 1997, and the remaining $25 million is expected to be funded during April 1997. The fixed rate debt has two separate series - Series A Senior Notes totaling $44 million with a final maturity of seven years, an average maturity of six years and a fixed interest rate of 7.47% (125 basis points over comparable Treasuries) and Series B Senior Notes totaling $56 million with a final maturity of ten years, an average maturity of eight years and a fixed interest rate of 7.66% (135 basis points over comparable Treasuries). The proceeds of the financing are being utilized to repay indebtedness under the revolving line of credit, to finance the acquisition of additional self-storage facilities and for general corporate purposes.
Issuance of Common Shares and Units:
On November 16, 1994, the Company completed the IPO with the public offering of 5,760,000 Common Shares at $17.50 per Common Share. Net of underwriting discounts and offering costs, the Company received $92,051,000 from the IPO. Concurrent with the IPO, the Original Investors transferred their interests in the Predecessor Company, the management business of BHC and other assets, to the Operating Partnership as set forth in the registration statement on Form S-11 relating to the IPO. Additionally, the Predecessor Company purchased 50,000 Common Shares pursuant to a concurrent private placement. Accordingly, the Original Investors received a 1.7% interest in the Company and 4.7% interest in the Operating Partnership.
During June and July 1995, the Company completed a public offering of 2,875,000 Common Shares at $20.00 per Common Share. Net of underwriting discounts and offering costs, the Company received $53,561,000 from this offering. The net proceeds have been used to repay indebtedness under the revolving line of credit, which was incurred in connection with the acquisition of facilities, and to acquire additional self-storage facilities.
During July 1996, the Company completed a public offering of 4,140,000 Common Shares at $20.25 per Common Share. Net of underwriting discounts and offering costs, the Company received $78,894,000 from this offering. The net proceeds were used to repay indebtedness under the revolving line of credit and a short-term acquisition loan, which was incurred in connection with the acquisition of facilities.
In November 1996, the Company filed a shelf registration statement covering $150,000,000 of equity securities. This registration statement has been declared effective and should permit the Company to access the equity markets efficiently when it deems appropriate. However, no assurance can be given that market conditions will be favorable for such an offering.
In connection with the acquisition of Facilities during 1995, the Company issued 183,774 Units valued at $3,652,000. In connection with the acquisition of Facilities during 1996, the Company issued 406,759 Units valued at $8,743,000.
The Units in the Operating Partnership not held by the Company can be exchanged for Common Shares of the Company on a one-for-one basis or redeemed in cash at the Company's option. As of December 31, 1996, no Units had been converted to Common Shares or redeemed for cash.
COMPETITION
All of the Facilities are located in developed areas that include other self-storage facilities. The number of competitive self-storage facilities in a particular area could have a material effect on the Company's ability to lease self-storage units at the Facilities or at any newly developed or acquired facilities and on the rents charged. The Company may be competing with others that have greater resources than the Company and whose officers and directors have more experience than the Company's officers and Trustees. In addition, other forms of storage properties, warehouses and single-family housing provide alternatives to potential customers of self-storage facilities.
REGULATION
Environmental Matters
The Company is subject to federal, state, and local environmental laws, ordinances and regulations that apply to the development of real property, including construction activities, the ownership of real property, and the operation of self-storage facilities.
In developing properties and constructing facilities, the Company utilizes environmental consultants to determine whether there are any flood plains or wetlands or environmentally sensitive areas that are part of the property to be developed. If flood plains are identified, development and construction are planned so that flood plain areas are preserved or alternative flood plain capacity is created in conformance with federal and local flood plain management requirements.
Stormwater discharge from a construction facility is evaluated in connection with the requirements for stormwater permits under the Clean Water Act. This is an evolving program in most states. It is anticipated that general stormwater permits will be applicable to the Company's activities, and individual permits will not be required for existing or new development.
Under various federal, state and local laws, ordinances and regulations, an owner or operator of real property may become liable for the costs of removal or remediation of certain hazardous or toxic substances on, under or in such property. Such laws, ordinances and regulations often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. The presence of hazardous or toxic substances, or the failure to properly remediate such substances, when released, may adversely affect the owner's ability to sell or lease such real estate or to borrow using such real estate as collateral, and may cause the property owner to incur substantial remediation costs. In addition to claims for cleanup costs, the presence of hazardous substances on a property could result in a claim by a private party for personal injury or a claim by an adjacent property for property damage.
The Company has not been notified by any governmental authority of any material noncompliance, claim, or liability in connection with any of the Facilities. The Company has not been notified of a claim for personal injury or property damage by a private party in connection with any of the Facilities in connection with environmental conditions.
A Phase I environmental assessment for each of the Facilities has been prepared by an independent environmental consultant. The purpose of each such report was to identify, to the extent reasonably possible and based on reasonably available information, whether the environmental quality of the Facility had been affected by hazardous or toxic substances, including petroleum products and asbestos.
REGULATION (continued)
Environmental Matters (continued)
The scope of the Phase I environmental assessment for each such Facility generally included: (a) a review of reasonably available maps, aerial photographs and other public information to analyze the past and present uses of the site; (b) limited inquiries of federal, state and local agencies having jurisdiction over certain environmental matters; and (c) an on-site assessment of the Facility to inspect for evidence of past or present on-site waste disposal, visible surface contamination, above-surface and subsurface storage tanks, drums, barrels and other storage containers, current waste streams and management practices, ACMs, and PCB transformers. In addition, as part of the Phase I environmental assessment, abutting properties and nearby sources of potential contamination were identified and evaluated for potential impact to the Facility, to the extent reasonably possible.
In connection with the acquisition of 25 facilities (the "Balcor/Colonial Facilities") from Balcor/Colonial Storage Income Fund - 86 (the "Seller") in May 1996, the Seller had a Phase I environmental assessment for each of the Balcor/Colonial Facilities prepared by an independent environmental consultant. The purpose and scope of such assessments was generally the same as set forth above with respect to Phase I environmental assessments of the other Facilities. None of these Phase I environmental assessments recommended any further investigation (except, in one instance, to confirm radon test results which was subsequently confirmed) at any of the Balcor/Colonial Facilities. However, based on the historical use of two of the sites, the Company engaged environmental consultants to conduct a limited subsurface soil and groundwater investigation to confirm the opinions expressed in the Phase I assessments of these sites. The results of such investigations indicated the presence of certain substances, the presence of which may require monitoring, reporting or remediation. Based on the investigations, remedial action plans were prepared based on the maximum remediation effort that could be required under the appropriate state law. The Seller had placed $250,000 into escrow to be used towards a portion of the cost of remediation of these sites. Based on the remedial action plans, the Company received the full $250,000 held in escrow. Based upon the information which the Company has obtained and the receipt of the escrowed funds, the Company does not currently expect the aggregate cost of the remedying environmental conditions at these two Balcor/Colonial Facilities to have a material adverse effect on the financial condition or results of operations of the Company, although there can be no assurance that this will be the case.
The environmental assessments, and in certain circumstances further investigation, have not revealed, nor is the Company aware of, any environmental condition with respect to the Facilities that is expected to have a material adverse effect on the Company's financial condition or results of operations. No assurances can be given, however, that (a) the environmental assessments and further investigation which have been conducted with respect to the Facilities or which will be conducted with respect to the facilities that may be acquired or developed in the future, have revealed, or will reveal, all potential environmental liabilities, (b) any prior owner or operator of the real property on which the Facilities are located did not create any material environmental condition not known to the Company, or (c) an environmental condition does not otherwise exist as to any one or more of the Facilities, which liabilities or conditions could have a material adverse effect upon the financial condition or results of operations of the Company.
Americans with Disability Act
Under the Americans with Disability Act ("ADA"), all public accommodations are required to meet certain federal requirements related to physical access and use by disabled persons. While the Company believe that the Facilities comply in all material respects with these physical requirements (or would be eligible for applicable exemptions from material requirements because of adaptive assistance provided), a determination that the Company is not in compliance with the ADA could result in the imposition of fines, injunctive relief, damages or attorney's fees. If the Company were required to make modifications to comply with the ADA, the Company's ability to make expected distributions to its shareholders could be adversely affected; however, management believes that such effect would be minimal.
REGULATION (continued)
Local Regulation
As with all real property, self-storage facilities must conform to local zoning ordinances. The Facilities' operations have not been subjected to any material zoning complaints. Typically, self-storage facilities are not a permitted use within the commercial and retail areas desired by the Company for the development of a new facility. Therefore, the Company must generally obtain a variance to undertake the development of a new facility. The zoning classifications for self-storage have been narrowed repeatedly so that new self-storage development within major metropolitan areas is becoming increasingly difficult. The restrictive zoning regulations may keep the industry restricted to all but those who have the expertise to show the benefits of self-storage to a community and have the credentials necessary to persuade zoning boards to rezone or grant variances.
INSURANCE
Management believes that each of the Facilities is covered by adequate fire, flood and property insurance provided by reputable companies and with commercially reasonable deductibles and limits. The Company maintains comprehensive liability, all-risk property insurance coverage with respect to the Facilities with policy specifications, limits and deductibles customarily carried for similar properties. In addition, the Company maintains a policy insuring against environmental liabilities resulting from tenant storage on terms customary and standard for the industry. The Company also has obtained or continued existing title insurance insuring fee title to each of the Facilities owned by the Company in an aggregate amount which the Company believes to be adequate.
EMPLOYEES
As of February 14, 1997, the Company (through the Operating Partnership and the Management Company) employed a total of 506 persons of which (a) 460 work at the Facilities, (b) nine work in the regional offices and (c) 37 work at the home office. The Company believes that relations with their employees are good.
STORAGE REALTY MANAGEMENT CO.
The Management Company manages ten Facilities owned by unrelated third parties. The managed Facilities contain approximately 470,000 net rentable square feet and are located in the following seven states: Florida (4), North Carolina (1), Georgia (1), Alabama (1), Missouri (1), Kansas (1) and Virginia (1). While the Management Company does not intend to actively expand this aspect of its operations, management of additional facilities in the future may be considered as a precursor to acquisition by the Operating Partnership or in order for the Company to become familiar with an attractive new market. Additionally, the Management Company conducts various other businesses, such as the sale of locks, the processing of customer property insurance and the rental of trucks, at various Facilities.
BHC owns 95% of the voting common stock of the Management Company, which is generally entitled to dividends equal to 4.75% of all distributions. The remaining 5% of the voting common stock, entitled to .25% of all distributions, is owned by the Operating Partnership. The Operating Partnership owns 100% of the nonvoting preferred stock of the Management Company. The nonvoting preferred stock is entitled to dividends equal to 95% of all distributions of the Management Company. The charter of the Management Company requires the quarterly distribution as dividends of its net cash flow, subject to the discretion of the board of directors that there are funds legally available therefor. Such provision may not be changed without the consent of the holder of the preferred stock. Accordingly, the Operating Partnership expects to receive substantially all of the available net cash flow from the Management Company through ownership of the preferred stock and thereby will receive substantially all of the economic benefit of the operations carried on by the Management Company.
THE INDUSTRY
The self-storage industry is an integral part of the commercial and residential real estate markets, serving the storage needs of businesses and consumers. Initially developed in the early 1960s in the southwestern portion of the United States, self-storage facilities were built in response to the growing need for low-cost accessible storage. A number of factors have accelerated the demand for storage facilities including, among others, a more mobile society, with individuals moving to new homes and new cities needing short-term storage for their belongings, the increasing cost of residential housing (resulting in smaller houses), the increased popularity of apartments and condominiums, more individuals with growing discretionary income (resulting in the accumulation of more possessions and the purchase of items such as boats and recreational vehicles which cannot be stored at residences), the growing number of small businesses and the escalating cost of other storage alternatives. In addition to traditional use by consumers, many retail stores and other businesses use self-storage facilities to store goods received from warehouses or, in some instances, directly from manufacturers, through just-in-time delivery systems. Self-storage facilities serve as additional storage capacity for households acquiring goods or businesses building inventory or producing storable items, such as new products or records.
In addition to providing affordable, accessible storage space for personal and business use, many facilities offer climate controlled units as well as outside storage pads for vehicles and boats. With the advent of resident managers, storing goods became a far more convenient process for customers (i.e. tenants renting self-storage space), resulting in increased customer awareness and appreciation. Rental units are usually secured by customer locks and only the customer has the key, thus ensuring controlled access. Facilities are generally fenced, have locked gates and are lighted at night. Computerized access gates for self-storage have made the overall storage process more convenient for the customer.
The successful development of self-storage facilities is becoming increasingly sophisticated. Specialized skills in areas such as site selection, design and unit mix are critical to the development of successful new self-storage projects on a cost efficient basis. Furthermore, new development in self-storage has become more difficult due to the lack of available capital, pressure from zoning boards and municipalities, and increases in building costs as new facilities are required to meet rigorous landscaping and other aesthetically oriented standards.
ITEM 2.

ITEM 2. PROPERTIES
As of December 31, 1996, the Facilities owned by the Company consisted of 165 self-storage facilities located in 18 states containing approximately 8,491,000 net rentable square feet and 71,000 units. For these Facilities, the average net rentable square footage per property was approximately 51,500 and the average number of units per property was approximately 430. As of December 31, 1996, the weighted-average occupancy in these owned Facilities on a square footage basis was approximately 86%.
As of December 31, 1996, the Company, through joint ventures, had a 15% ownership interest in an operating self-storage facility and a 25% ownership interest in a self-storage facility under development.
As of December 31, 1996, the Facilities managed by the Management Company consisted of ten self-storage facilities located in seven states containing approximately 470,000 rentable square feet.
The table on the following pages sets forth the location of and other information relating to the Company's portfolio of owned Facilities and those Facilities in which the Company has a joint venture interest. The table does not include those Facilities managed by the Management Company.
FACILITIES OWNED BY OPERATING PARTNERSHIP:
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are not subject to any pending material legal proceedings. The Company and its subsidiaries are parties to a variety of legal proceedings arising in the ordinary course of their business. It is management's opinion that the ultimate resolution of these matters will not have a material adverse impact on the financial condition, results of operations or liquidity of the Company.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to the Company's shareholders for a vote since the last annual meeting of shareholders held on May 8, 1996.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The information required by this item is hereby incorporated by reference to the material appearing on page 25 of the Company's 1996 Annual Report (the "Annual Report") under the caption "Shareholder and Investor Information."
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is hereby incorporated by reference to the data appearing on the inside front cover of the Annual Report under the caption "Selected Financial Data."
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this item is hereby incorporated by reference to the material appearing on pages 9 through 12 of the Annual Report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is hereby incorporated by reference to the "Report of Independent Auditors," "Storage Trust Realty Consolidated Balance Sheets as of December 31, 1996 and 1995," "Storage Trust Realty and Predecessor Company Consolidated and Combined Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994," "Storage Trust Realty and Predecessor Company Consolidated and Combined Statements of Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994," "Storage Trust Realty and Predecessor Company Consolidated and Combined Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994" and "Storage Trust Realty and Predecessor Company Notes to Consolidated and Combined Financial Statements" appearing in the Annual Report on pages 13 through 23.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is hereby incorporated by reference to the material appearing on pages 2 through 4 of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on May 7, 1997 (the "Proxy Statement"), under the captions "Election of Trustees" and "Management - Trustees and Executive Officers" and page 14 of the Proxy Statement under the caption "Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is hereby incorporated by reference to the material appearing on pages 6 through 11 of the Proxy Statement under the captions "Executive Compensation - Summary Compensation Table," " - Option Grants," " - Aggregated Option Exercises in 1996 and Year-End Option Values," " - Option Plan," " - Incentive Compensation," " - Retirement Savings Plan," " - Compensation of Trustees," " - Non-competition Agreements and Termination of Employment," "Compensation Committee Interlocks and Insider Participation," " - Executive Compensation Committee Report on Executive Compensation" and " - Performance Graph."
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is hereby incorporated by reference to the material appearing on pages 13 and 14 of the Proxy Statement under the caption "Security Ownership."
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is hereby incorporated by reference to the material appearing on page 12 of the Proxy Statement under the caption "Certain Relationships and Related Transactions."
PART IV
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.
STORAGE TRUST REALTY
Date: February 27, 1997 By /s/ Michael G. Burnam ---------------------------------- Michael G. Burnam Chief Executive Officer and Trustee
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Trustees of Storage Trust Realty
We have audited the consolidated balance sheets of Storage Trust Realty (the "Company") as of December 31, 1996 and 1995, and the related consolidated and combined statements of operations, shareholders' equity and cash flows of Storage Trust Realty and Predecessor Company for each of the three years in the period ended December 31, 1996, and have issued our report thereon dated January 22, 1997 (except for Note 9, as to which the date is January 31, 1997); such consolidated and combined financial statements and report are included in the Company's 1996 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Storage Trust Realty listed in Item 14.