Cathay General Bancorp Annual Report 2002

Plain-text annual report

2002 Annual Report taking off . . . and setting our sights on the next 40 years and beyond Financial Highlights (dollars in thousands, except per share data) 2002 2001 Amount Percentage Increase (Decrease) For the Year Net income Net income per common share Basic Diluted Cash dividends paid per common share At Year-End Securities Loans, net Assets Deposits Stockholders’ equity Book value per common share Proﬁtability Ratios Return on average assets Return on average stockholders’ equity Capital Ratios Tier 1 capital ratio Total capital ratio 1 Leverage ratio $ 48,700 $ 42,620 $ 6,080 14.27% 2.71 2.69 0.545 2.35 2.35 0.500 0.36 0.34 0.045 $ 707,725 1,848,078 2,753,998 2,314,643 287,961 16.00 $ 623,314 1,640,032 2,453,114 2,122,348 246,011 13.70 $ 84,411 208,046 300,884 192,295 41,950 2.30 15.32 14.47 9.00 13.54% 12.69 12.27 9.06 17.05 16.79 1.88% 18.30% 1.82% 18.36% 11.93% 13.01% 10.11% 11.15% 12.30% 9.48% 1 Total capital ratio represents Tier 1 capital plus the allowance for loan losses allowable as a percentage of risk-weighted assets. $49 > $43 $39 $30 $25 $179 $157 $288 > $246 $215 $2,754 > $2,453 $2,207 $1,996 $1,781 98 99 00 01 02 98 99 00 01 02 98 99 00 01 02 Net Income (in millions) Stockholders’ Equity (in millions) Total Assets (in millions) 1 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary Letter to Stockholders Dunson K. Cheng Chairman of the Board and President Dear Stockholders: 2002 was both a joyous and busy year for our company, having marked, as it did, the 40th year that Cathay Bank has been in business. During the intervening years since 1962, Cathay Bank has grown from a small, local organization with no more than $550,000 in capital, to a regional institution with stockholders’ equity totaling $288.0 million; from a single storefront of 1,000 square feet, to a bank with 24 branches, located in the states of California, New York and Texas, representative offices in Hong Kong and Shanghai, and an office for its subsidiary, Cathay Investment Company, in Taipei; from a work force of 7 to a current staff of approximately 600. Along the way, we have lived through the woes of several recessions, the distress of credits gone awry, and sadness at the departure of a number of colleagues. But, we have also experienced the joy of new branch openings, the satisfaction of meeting the needs of our customers, and the exhilaration of witnessing the extraordinary growth of our company. Through it all, we have felt privileged to work for a company that provides a reasonable return for its stockholders while simultaneously estab- lishing the opportunity for making a difference to our customers in their efforts to achieve financial success. So, in recognizing the 40th anniversary of Cathay Bank, the Board of Directors celebrated with all our stakeholders — with our stockholders, employees and customers, and, at large, with the community we serve. On March 22, 2002, the Board approved both a two-for-one stock split of the company’s common stock, and a 12% increase in the cash dividend, from 12.5 cents to 14 cents, on a post-stock split basis. It also invited all stockholders to join us on April 20, 2002, in an event to kick off a series of celebrations during the year. That event took place at Cathay Bank’s Los Angeles headquarters of the past 38 years, and was attended by over 1,000 stockholders, employ- ees, and guests. It brought together many long-time stockholders and retired colleagues for a pleasant and, at times, emotional reunion. On June 9, Cathay Bank hosted an outdoor dinner at the Bowers Museum in Santa Ana, California, for 300 of its valued cus- tomers in appreciation of their continued patronage. The day coincided with the opening of a special exhibition, the Symbols of Power, that included many treasures of the early emperors of the Qing Dynasty, all on loan from the Nanjing Museum. 2 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary On September 27 and November 22, the Board traveled to New York City and the northern California Bay Area, respec- tively, to participate in events commemorating the achievements of Cathay Bank over the past 40 years, and to thank our customers for their support, as well as our colleagues for the dedication they have shown in building Cathay Bank into the successful enterprise it is today. In addition to the many celebrations, Cathay Bank continued to move forward in 2002. As a complement to our exist- ing locations in Hong Kong and Taipei, we opened the Shanghai representative ofﬁce on April 20, and thereby expand- ed our overseas presence to the three largest commercial centers in the greater China region. These offices provide important linkage to our overseas clientele, and on-the-spot assistance to our trade finance cus- tomers that import from the region. Our third branch in the New York area opened for business on June 27 in Brooklyn, the borough with the third highest concentration of Asian-Americans. And, on September 9, we brought Cathay Bank to the capitol of California with the opening of the Sacramento office. Although there is little question these new facilities will add to our expenses in the short run, they will most assuredly expand our market reach, and should also help contribute to our future growth and profitability. Financially, our total assets increased this past year by 12%, to $2.75 billion; gross loans grew 13%, to $1.88 billion, and total deposits rose 9%, to $2.31 billion. For the ninth consecutive year, we posted double-digit growth in net income, to a record $48.7 million, an increase of 14% over 2001. Diluted earnings per share increased similarly, by 14%, to $2.69. Equally gratifying, the damage from the recession of 2001 was well-contained, and the company’s non- performing assets declined 24%, to $7.2 million, or 0.39% of gross loans plus other real estate owned. Our efﬁcien- cy ratio continued to improve, from 37% in 2001 to 36% in 2002, as a result of which the American Banker recently rated our institution the eighth most efﬁcient amongst the largest 500 bank holding companies in the nation. In 2002, the company paid out $9.8 million in dividends, repurchased 27,500 shares of its common stock, and retained $38.9 million as capital. As a result, total stockholders’ equity increased 17%, to $288.0 million, an amount fully 524 times greater than total capital at the time of our establishment 40 years ago. In closing, Cathay Bank has come a very long way in the past 40 years, and we thank you for your continued support through good times and bad. We believe we have a viable business model that will allow us to grow and to serve our community and our stockholders well into the future. > Dunson K. Cheng Chairman of the Board and President 3 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary 4 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary 5 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary strategicexpansion In April, Cathay Bank opened a representative ofﬁce in Shanghai, becoming one of a handful of pioneers providing valuable links for Chinese-American customers in China. Year in Review > Sacramento Shanghai Brooklyn In 2002, Cathay Bancorp, Inc. celebrated 40 years of bank- Growing Cathay’s Presence in the Marketplace Key to ing excellence by its subsidiary, Cathay Bank, and reported Cathay Bancorp's success has been its ability to assess the record earnings of $48.7 million, which is an increase of 14 potential of the marketplace intelligently and strategically, percent over 2001 and which marks the ninth consecutive year of double-digit earnings growth. Total assets grew 12 per- cent to $2.75 billion; total deposits increased 9 percent to $2.31 billion; and gross loans increased 13 percent to $1.88 billion. These results, achieved in a difﬁcult economic envi- ronment, are consistent with Cathay Bank’s long history of maintaining steady growth in good times and bad, and reﬂect visionary management and prudent business practices, as well as a dedication to customer service that is unsurpassed. Despite a reduction of 525 basis points in the target feder- and to target markets where its efforts have the potential to produce the best returns. As a result, it has been a leader among Chinese-American ﬁnancial institutions. It was the ﬁrst Chinese-American ﬁnancial institution to offer full banking services in all three of the largest Asian-American markets: California, New York, and Texas. In June, Cathay Bank opened a branch in Brooklyn, its third in New York. In September, Cathay Bank’s eighth Northern California branch opened for business in Sacramento. Both new branches made an encouraging start; by year end, they had attracted a total of $8.8 million in deposits. al funds rate by the Federal Reserve over the past two years, In addition, during the month of April, Cathay Bank opened Cathay Bancorp maintained a net interest margin above 4 a representative ofﬁce in Shanghai, thus becoming one of a percent throughout 2002. Its efﬁciency ratio improved from handful of pioneer institutions providing valuable links for 37 percent to 36 percent, making Cathay Bancorp the Chinese-American customers in China. eighth most efﬁcient bank holding company among the 500 largest in the U.S., based on a ratio of non-interest expense to total income minus interest expense. above, left to right: Cathay Bank’s new locations in Sacramento, Shanghai, and Brooklyn. 7 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary Cathay Bancorp reported record earnings of $48.7 million, which is an increase of 14 percent over 2001 and which marks the ninth consecutive year of double-digit earnings growth. steady growth Facilitating International Transactions These links have become increasingly important as the U.S. continues to develop its ties with China. In both countries, and in both directions, further development of these ties depends on the reliable transfer of monies. Cathay Bank’s China remittance service allows users to remit funds to China at a competitive rate. After targeting its promotions to heavy users, Cathay Bank has seen total fee income for China remittances surge to $2.1 million in 2002. Customers may now remit funds through any one of the 44,000 ofﬁces of the Agricultural Bank of China. With the rise of electronic commerce and the increasing use of electronic payment systems, wire transfers have become a preferred payment method. As a result of this trend, Cathay Bank increased its commercial international wire fee income from $981,000 in 2001 to $1.1 million in 2002, an increase of 14 percent. The corporate commercial loan department continues to provide various commercial ﬁnancing programs tailored to small- and medium-sized importers, exporters, and trading companies in California, New York, and Texas. Programs include lines of cred- it, equipment ﬁnancing, and short- or long-term working capital ﬁnancing to address trade cycle, working capital, expansion, and acquisition needs. In addition, in 2002, Cathay Bank consolidated its international ﬁnancing and corporate commercial loan departments. This consolidation resulted in enhanced operating efﬁciency and avenues for growth. During the year, Cathay Bank’s corporate com- mercial ﬁnancing grew 11 percent to $563.7 million in outstanding balances. 8 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary Servicing Homeowners With long-term interest rates at their lowest level in decades, Cathay Bank saw a marked increase in loan originations for residential real estate. In 2002, the number of loan originations increased 33 percent. The bal- ance of new loans jumped an astounding 51 percent and fees collected grew 25 percent. Low interest rates also spurred new activity in Cathay Bank’s home equity loan business. Consumers responded favorably to Cathay Bank’s competitive 3.88 percent introductory rate, resulting in a 21 percent increase to the outstanding balance total from $40.4 million in 2001 to $49.0 million in 2002. Electronic Banking It is not low interest rates alone, howev- er, that give Cathay Bank its competitive edge. Customers also come to Cathay Bank for outstanding customer service, the result of its comprehensive approach to building lifelong banking relationships. In addition to beneﬁting from Cathay Bank's friendly, capable, and efﬁcient branch ofﬁce facilities, Cathay Bank customers have increasingly been taking advan- tage of Cathay Bank's convenient Internet banking service. In 2002, signups soared 74 percent for eCashManagement and 84 percent for eBanking. > Financing Commercial Real Estate and Construction Domestically, one of the few bright spots of the 2002 econ- omy was a strong housing and construction sector. With its asset strength, agility, and focused services, Cathay Bank was well positioned to participate in this activity. In 2002, it continued to demonstrate steady growth in real estate and construction ﬁnancing. Total related outstanding balances increased by $161.4 million, or 18 percent. Cathay Bank’s major construction and ﬁnancing projects Rewarding Customer Loyalty In 2002, Cathay Bank inaugu- include the following: • $20.0 million for construction of a 198-unit apartment in Chula Vista, California • $17.0 million for reﬁnancing of a retail shopping center in Simi Valley, California rated a new customer service program to reward its top cus- tomers. The Premium Banking Program offers favorable rates, priority service, and customer telephone support that is available 24 hours a day, seven days a week. Many cus- tomers have expressed their appreciation of this program. Some have consolidated their ﬁnancial relationships so that • $9.6 million for construction of 29 planned development they all now reside at Cathay Bank. units in Redondo Beach, California • $7.3 million for reﬁnancing of 11 industrial buildings Strengthening the Communities We Serve Cathay Bank func- in Houston, Texas • $13.0 million for construction of a 158-room Sheraton tions as a vital part of the communities it serves, working to contribute to the whole and, in turn, beneﬁting from the wel- Four Points Hotel in Midtown Manhattan, New York coming and cooperative environment it helps to create. • $12.9 million for construction of four condo/apartment buildings in Flushing, New York • $13.0 million for ﬁnancing the purchase of a 21-story commercial building in the fashion district of Manhattan, New York Cathay Bank proactively seeks opportunities to support community projects and, in 2002, contributed $120,000 to deserving organizations. above: Total outstanding balance of commercial real estate and construction increased by $161.4 million, a jump of 18 percent. 9 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary stockholders, employees, and customers appreciation On April 20, 2002, Cathay Bancorp held a celebration at its Los Angeles headquarters to show its appreciation. > In September 2002, Cathay Bank received a $66,000 cash award from the U.S. Department of the Treasury for Community Reinvestment Act (CRA) activities that supported the Community Development Financial Institution program (CDFI) in the following ways: • In support of CDFI activities for distressed communities, Cathay Bank deposited $100,000 at the Northwest Community Federal Credit Union in San Francisco for ﬁve years at a zero percent interest rate. • Cathay Bank funded $500,000 as part of a syndication loan to the Community Financial Resource Center (CFRC); CFRC in turn uses these funds to make revolving loans to businesses in low- and moderate-income communities. Other CRA-related activities include: • Cathay Bank’s investment of $4.9 million in Lend Lease Institutional Tax Credit Fund XXIII for an affordable housing project called Scott Street Townhomes located in Houston, Texas. • Cathay Bank’s investment of $1.0 million in WNC Institutional Tax Credit Fund X-California to ﬁnance six affordable housing properties, representing 352 units, located in Sacramento and Southern California. • Cathay Bank’s investment of $2.0 million in WNC Institutional Tax Credit Fund X- New York, toward a total of $50 million needed to build nine affordable housing projects within the ﬁve boroughs of New York. Appreciating Stockholders and Employees Cathay Bancorp is grateful to the many loyal stockholders who have supported it over the years. There are thousands of companies in which they could invest their money, but they chose Cathay Bancorp. Cathay Bancorp, through its subsidiary, Cathay Bank, provides products and services that addresses the needs of real people and businesses — products and services created and provided by Cathay Bank’s able and dedicated employees. On April 20, 2002, Cathay Bancorp held a simple celebration at its Los Angeles headquarters to show its appreciation. More than 1,000 stockholders, customers, and employees attended. In addition, in September and November, Cathay Bancorp’s directors trav- eled to New York and Northern California to hold similar celebrations for customers and employees there. Customers, stockholders, and employees are all part of the Cathay global banking family. Through responsible management, strong ﬁnancial performance, and a commitment to innovation and excellence, Cathay Bancorp will strive to continue sup- porting these much-valued and cherished family members as they seek to achieve, and help others to achieve, the goals, hopes, and dreams that enrich and fulﬁll their lives. 10 2002 Annual Report Cathay Bancorp, Inc. and Subsidiary UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Ñscal year ended December 31, 2002 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ¥ n Commission Ñle number 0-18630 Cathay Bancorp, Inc. (Exact name of Registrant as speciÑed in its charter) Delaware (State or other jurisdiction of incorporation or organization) 777 North Broadway, Los Angeles, California (Address of principal executive oÇces) 95-4274680 (I.R.S. Employer IdentiÑcation No.) 90012 (Zip Code) Registrant's telephone number, including area code: (213) 625-4700 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $01 par value (Title of class) Preferred Stock Purchase Rights (Title of class) Indicate by check mark whether the registrant (1) has Ñled all reports required to be Ñled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to Ñle such reports), and (2) has been subject to such Ñling requirements for the past 90 days. Yes ¥ No n Indicate by check mark if disclosure of delinquent Ñlers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in deÑnitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¥ Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in rule 12b-2 of the Act). Yes ¥ No n The aggregate market value of the voting stock held by non-aÇliates of Registrant as of February 3, 2003 was $558,605,248 (computed on the basis of $37.75 per share, which was the closing price of our Common Stock reported by the Nasdaq National Market on February 3, 2003).* The aggregate market value of the voting stock held by non-aÇliates of the Registrant, computed by reference to the price at which the common equity was last sold as of the last business day of the Registrant's most recently completed second Ñscal quarter (June 28, 2002) was $603,555,500 The number of shares outstanding as of February 3, 2003: Common Stock, $.01 par value Ì 18,015,315 shares. DOCUMENTS INCORPORATED BY REFERENCE ‚ Portions of Registrant's deÑnitive proxy statement relating to Registrant's 2003 Annual Meeting of Stockholders to be held April 21, 2003, as Ñled, are incorporated by reference into Part I and Part III. * Estimated solely for the purposes of this cover page. The market value of shares held by Registrant's directors, executive officers, and Employee Stock Ownership Plan have been excluded. CATHAY BANCORP, INC. 2002 ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS PART I ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Items 1. Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Business of Bancorp ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OverviewÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Competition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Employees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Business of the BankÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ General ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset Quality ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Borrowings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Return on Equity and Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest Rates and DiÅerentials ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Analysis of Changes in Net Interest Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commitments and Letters of Credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subsidiaries of Cathay Bank ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expansion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Competition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Employees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Executive OÇcers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Regulation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Regulation of Bancorp and the Bank ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Regulatory EnvironmentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fiscal and Monetary Policies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Bank Holding Company Regulation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financial Services Modernization Legislation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ USA Patriot Act ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Banking Regulations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 2. Properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 3. Legal Proceedings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 4. Submission of Matters to a Vote of Security HoldersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PART IIÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ÏÏÏÏÏÏÏÏÏÏÏÏ Item 6. Selected Financial Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Selected Consolidated Financial Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Page 3 3 3 3 4 4 4 4 6 6 8 8 8 9 9 9 9 9 9 9 10 11 11 11 12 12 13 13 15 16 19 22 22 22 22 23 24 1 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ General ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Critical Accounting PoliciesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financial Events in 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Results of Operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Review of Financial ConditionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital Resources ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Risk Elements of the Loan Portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liquidity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recent Accounting PronouncementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Factors That May AÅect Future Results ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 7A. Quantitative and Qualitative Disclosures about Market Risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Market RiskÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Quantitative Information About Interest Rate Risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financial DerivativesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 8. Financial Statements and Supplementary Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PART III ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 10. Directors and Executive OÇcers of the Registrant ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 11. Executive Compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related Stockholder Matters ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 13. Certain Relationships and Related Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 14. Controls and ProceduresÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PART IV ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ SIGNATURES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CERTIFICATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Index to Consolidated Financial StatementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Page 25 25 25 26 26 36 47 48 58 58 61 64 64 67 67 68 68 68 68 69 69 69 69 69 69 71 73 77 2 In this annual report on Form 10-K, ""Bancorp'' refers to Cathay Bancorp, Inc. and the ""Bank'' refers to Cathay Bank. The terms ""Company,'' ""we,'' ""us,'' and ""our'' refer to Bancorp and the Bank collectively. The statements in this report include forward-looking statements regarding management's beliefs, projections, and assumptions concerning future results and events. These forward-looking statements may, but do not necessarily, also include words such as ""believes,'' ""expects,'' ""anticipates,'' ""intends,'' ""plans,'' ""estimates,'' ""may,'' ""will,'' ""should,'' ""could,'' ""predicts,'' ""potential,'' ""continue'' or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, or achievements to be materially diÅerent from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, adverse developments, or conditions related to or arising from: ‚ our expansion into new market areas; ‚ Öuctuations in interest rates; ‚ demographic changes; ‚ increases in competition; ‚ deterioration in asset or credit quality; ‚ changes in the availability of capital; ‚ adverse regulatory developments; ‚ changes in business strategy, including the formation of a real estate investment trust and the application to the Securities and Exchange Commission for deregistration of the registered investment company; ‚ general economic or business conditions; and ‚ other factors discussed in Part II Ì Item 7 Ì ""Factors that May AÅect Future Results.'' Actual results in any future period may also vary from the past results discussed in this report. Given these risks and uncertainties, we caution readers not to place undue reliance on any forward-looking statements, which speak as of the date of this report. We have no intention and undertake no obligation to update any forward-looking statement or to publicly announce the results of any revision of any forward- looking statement to reÖect future developments or events. PART I Items 1. Business Business of Bancorp Overview Cathay Bancorp, Inc. is a business corporation organized under the laws of the State of Delaware on March 1, 1990. Our only oÇce, and our principal place of business, is located at the main oÇce of Cathay Bank at 777 North Broadway, Los Angeles, California 90012. Our telephone number is (213) 625-4700. We are the holding company of Cathay Bank, a California state-chartered commercial bank. Our sole current business activity is to hold all of the outstanding stock of Cathay Bank. In the future, we may become an operating company or acquire savings institutions, banks, or companies engaged in bank-related activities and may engage in or acquire such other businesses, or activities as may be permitted by applicable law. We invite you to visit us at our Web site at www.cathaybank.com, to access free of charge our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, all of which are made available as soon as reasonably practicable after we electronically Ñle such material with or furnish it to the Securities and Exchange Commission. In addition, you can write to us to obtain a free copy of any of those reports at Cathay Bancorp Inc., 777 North Broadway, Los Angeles, California 90012, Attn: Investor Relations. 3 Competition Our primary business is the business of the Bank. Therefore, the competitive conditions to be faced by us are expected to include those faced by the Bank. See ""Business of the Bank Ì Competition.'' In addition, many banks and Ñnancial institutions have formed holding companies. It is likely that these holding companies will attempt to acquire other banks, thrift institutions, or companies engaged in bank-related activities. Thus, we may face increased competition in undertaking acquisitions of such institutions and in operating after any such acquisition. Employees Due to the limited nature of our activities, Bancorp currently does not employ any persons other than our management, which includes the President, the Chief Financial OÇcer, Secretary, Assistant Secretary, and the General Counsel. In the future, if we acquire other Ñnancial institutions or pursue other lines of business, we may hire additional employees. See ""Business of the Bank Ì Employees.'' Business of the Bank General The Bank was incorporated under the laws of the State of California on August 22, 1961, and was licensed by the Department of Financial Institutions (previously known as the California State Banking Department), and commenced operations as a California state-chartered bank on April 19, 1962. Cathay Bank is an insured bank under the Federal Deposit Insurance Act but, like most state-chartered banks of similar size in California, it is not a member of the Federal Reserve System. The Bank's main oÇce is located in the Chinatown area of Los Angeles, at 777 North Broadway, Los Angeles, California 90012. In addition, the Bank has the following branch oÇces: ‚ Southern California Ì Eleven branches located in the cities of: ‚ Alhambra (2 locations) ‚ Cerritos ‚ City of Industry (2 locations) ‚ Diamond Bar ‚ Irvine ‚ Monterey Park ‚ San Gabriel ‚ Torrance ‚ Westminster ‚ Northern California Ì Eight branches, located in the cities of: ‚ Cupertino ‚ Millbrae ‚ Milpitas ‚ Oakland ‚ Richmond ‚ Sacramento ‚ San Jose ‚ Union City 4 ‚ New York Ì Three branches, located in the cities of: ‚ Brooklyn ‚ Flushing ‚ New York City (Located in the Chinatown area) ‚ Texas Ì One branch located in the city of Houston ‚ Hong Kong Ì One representative oÇce ‚ Shanghai, China Ì One representative oÇce Our primary market area is deÑned by the Community Reinvestment Act delineation, which includes the contiguous areas surrounding each of the Bank's branch oÇces. It is the Bank's policy to reach out and actively oÅer services to low and moderate income groups in the delineated branch service areas. Many of the Bank's employees speak both English and one or more Chinese dialects or Vietnamese, and are thus able to serve the Bank's Chinese, Vietnamese, and English speaking customers. The Bank conducts substantially the same business operations as a typical commercial bank. It accepts checking, savings, and time deposits, and makes commercial, real estate, personal, home improvement, automobile, and other installment and term loans. From time to time, the Bank invests available funds in other interest-earning assets, such as U.S. Treasury securities, U.S. government agencies securities, state and municipal securities, mortgage-backed securities, asset-backed securities, corporate bonds, and venture capital investments. The Bank's services also include: ‚ letters of credit ‚ wire transfers ‚ forward currency, spot and forward contracts ‚ traveler's checks ‚ safe deposit ‚ night deposit ‚ Social Security payment deposit ‚ collection ‚ bank-by-mail ‚ drive-up and walk-up windows ‚ automatic teller machines (""ATM'') ‚ Internet banking services ‚ other customary bank services To accommodate those customers who cannot conduct banking business during normal banking hours, the Bank has extended its banking hours to include Saturday hours for most branches and Sunday hours at its New York branches. In addition, the operations of the drive-up and walk-up facilities are extended past normal banking hours. 5 Since its inception, the Bank's policy has been to attract business from, and to focus its primary services for the beneÑt of, individuals, professionals, and small to medium-sized businesses in the local markets in which its branches are located. The three general areas to which the Bank has directed its lendable assets are: ‚ residential mortgage loans, commercial mortgage loans, construction loans, mortgage warehousing loans, home equity lines loans; ‚ commercial loans, trade Ñnancing loans, Small Business Administration (""SBA'') loans; and ‚ installment loans to individuals for automobile, household, and other consumer expenditures. The Bank oÅers a program called Cathay Global Investment Services, which allows its customers to trade stocks online and to purchase mutual funds, annuities, equities, bonds, and short-term money market instruments, through UVest Financial Services Group, Inc. Securities The Bank's securities portfolio is managed by the First Vice President and Manager and the Company's Investment Committee, in accordance with a comprehensive written Investment Policy which addresses strategies, types, and levels of allowable investments, and which is reviewed and approved by our Board of Directors of the Company. Our investment portfolio is managed to meet our liquidity needs through proceeds from scheduled maturities and is also utilized for pledging requirements for deposits of state and local subdivisions, securities sold under repurchase agreements, and Federal Home Loan Bank (""FHLB'') advances. The portfolio is comprised of U.S. government agency securities, mortgage-backed securities, collateralized mortgage obliga- tions, obligations of states and political subdivisions, corporate debt instruments and equity securities. At December 31, 2002, the aggregate investment securities portfolio, with a carrying value of $707.73 million, was classiÑed as investment grade securities, except for our $4.06 million of non-rated venture capital investments. We do not include federal funds sold and certain other short-term securities as investment securities. These other investments are included in cash and cash equivalents. Information concerning the carrying value and the maturity distribution and yield analysis of the Company's securities available-for-sale and securities held-to-maturity portfolios is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations,'' and in ""Note 3 to the Consolidated Financial Statements.'' A summary of the amortized cost and estimated fair value of the Bank's securities by contractual maturity is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations,'' and in ""Note 3 to the Consolidated Financial Statements.'' Loans Our Board of Directors and senior management establish the basic lending policy for the Bank. Each loan is generally considered in terms of, among other things, character, repayment ability, Ñnancial condition of the borrower, secondary repayment source, collateral, capital, leverage capacity of the borrower, market conditions for the borrower's business or project, and prevailing economic trends and conditions. In the case of mortgage loans, our lending policy requires an independent appraisal on real estate property in accordance with applicable regulatory guidelines. Loan originations are obtained by a variety of sources, including existing customers, walk-in customers, referrals from brokers or existing customers, and advertising. In its present marketing eÅorts, the Bank emphasizes its community ties, customized personal service, competitive rates, and an eÇcient underwriting and approval process, with loan applications taken at all of the Bank's branch oÇces. The Bank's centralized documentation department supervises the obtaining of credit reports, appraisals, and other documentation involved with a loan. Commercial Mortgage Loans. These loans are typically secured by Ñrst deeds of trust on commercial properties, including primarily commercial retail properties, shopping centers and owner-occupied industrial facilities, and secondarily oÇce buildings, multiple-unit apartments, and multi-tenanted industrial properties. 6 In addition, the Bank provides medium-term commercial mortgage loans secured by commercial or industrial buildings where the owner either uses the property for business purposes or derives income from tenants. Commercial Loans. The Bank provides personalized Ñnancial services to diverse commercial and professional businesses in its market areas. Commercial loans consist primarily of short-term loans (normally with a maturity of up to one year) to support general business purposes, or to provide working capital to businesses in the form of lines of credit to Ñnance trade-Ñnance loans. The Bank continues to focus primarily on commercial lending to small-to-medium size businesses, within the Company's geographic market area. Commercial loan pricing is generally at a rate tied to the prime rate, as quoted in the Wall Street Journal, or the Banks' reference rate. Small Business Administration Loans. The Bank originates SBA loans in California, under the ""preferred lender'' status. Preferred lender status is granted to a lender which has made a certain number of SBA loans and which, in the opinion of the SBA, has staÅ who are qualiÑed and experienced in this area. As a preferred lender, the Bank's SBA Lending Group has the authority to make, on behalf of the SBA, the SBA guaranty on loans under the 7(a) program. This can represent a substantial savings in loan processing time to the customer. Under this program, the SBA delegates loan underwriting, closing, and most servicing and liquidation authority and responsibility to carefully selected lenders. The Bank utilizes both the 504 program, which is focused toward long-term Ñnancing of buildings and other long-term Ñxed assets, and the 7(a) program, which is the SBA's primary loan program, and which can be used for Ñnancing of a variety of general business purposes such as acquisition of land and buildings, equipment, inventory and working capital needs of eligible businesses generally over a 5- to 25-year term. The collateral position in the SBA loans is enhanced by the SBA guaranty in the case of 7(a) loans, and by lower loan-to-value ratios under the 504 program. During 2002, the Bank sold the guaranteed portion of certain of its SBA 7(a) loans in the secondary market. SBA loan pricing is generally at a rate tied to the prime rate, as quoted in the Wall Street Journal. Residential Mortgage Loans. The Bank originates single-family-residential mortgage loans, and home equity lines of credit. The single-family-residential mortgage loans are comprised of conforming, non- conforming, and jumbo residential mortgage loans, and are secured by Ñrst and subordinate liens on single (one-to-four units) family residential properties. The Bank's products include a Ñxed-rate residential mortgage loan, an adjustable-rate residential mortgage loan, and a variable-rate home equity line of credit loan. The pricing on our variable-rate home equity line of credit is generally at a rate tied to the prime rate, as quoted in the Wall Street Journal, or the Banks' reference rate. These mortgage loans are underwritten in accordance with the Bank's guidelines, on the basis of the borrower's Ñnancial strength, historical loan quality, and other qualiÑcations. The Bank's highest concentration of residential mortgage loans relates to properties in California. Real Estate Construction. The Bank's real estate construction loan activity focuses on providing short- term loans, typically ranging between approximately $1.0 million and $5.0 million, to individuals and developers with whom the Bank has established relationships for the construction primarily of multi-unit projects. Residential real estate construction loans are typically secured by Ñrst deeds of trust and guarantees of the borrower. The economic viability of the projects, the borrower's credit worthiness, and the borrower's and contractor's developmental experience are primary considerations in the loan underwriting decision. The Bank utilizes approved independent licensed appraisers. The Bank monitors projects during the construction phase through regular construction inspections and a disbursement program tied to the percentage of completion of each project. The Bank also occasionally makes unimproved property loans to borrowers who intend to construct a single-family-residence on the lot generally within twelve months. In addition, the Bank also makes commercial real estate construction loans to high net worth clients with adequate liquidity for construction of oÇce and warehouse properties. Such loans are typically secured by Ñrst deeds of trust and guarantees of the borrower. Installment Loans. The Bank's installment loan portfolio is divided between installment loans secured by automobiles and home improvement loans. Installment loans tend to be Ñxed rate and longer-term (one-to- 7 six year maturity). These consumer-oriented loans are funded primarily for the purpose of Ñnancing the purchase of automobiles and other personal uses of the borrower. Distribution and Maturity of Loans. Information concerning loan type and mix, distribution of loans and maturity of loans is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations,'' and in ""Note 4 to the Consolidated Financial Statements.'' Non-performing Loans and Allowance for Loan Losses. Information concerning non-performing loans, allowance for loan losses, loans charged-oÅ, loan recoveries, and other real estate owned is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations,'' and in ""Notes 4 and 5 to the Consolidated Financial Statements.'' Asset Quality The Bank monitors its asset quality with lending and credit policies, which require the regular review of its loan portfolio. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of the loan agreements. Such loans are placed under closer supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan losses, and (if appropriate) partial or full charge-oÅ. The Bank's policy is to place loans on a non-accrual status if interest and principal or either interest or principal is past due 90 days or more, or in cases where management deems the full collection of principal and interest unlikely. After a loan is placed on non-accrual status, any interest collected or accrued in the previous three months, is generally reversed against current income. Thereafter, any payment is generally Ñrst applied towards the principal balance. Depending on the circumstances, management may elect to continue the accrual of interest on certain past due loans if partial payment is received and/or the loan is well collateralized, and in the process of collection. The loan is generally returned to accrual status when the borrower has brought the past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled. Information concerning non-accrual, past due, and restructured loans is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations,'' and in ""Note 4 to the Consolidated Financial Statements.'' Deposits The Bank attempts to price its deposits in order to promote deposit growth and oÅers a wide array of deposit products in order to satisfy its customers' needs. The Bank's current deposit products include passbook accounts, checking accounts, money market deposit accounts, certiÑcates of deposit, individual retirement accounts, college certiÑcates of deposit, and public funds deposits. The Bank's deposits are generally obtained from residents within the Company's geographic market area. The Bank utilizes traditional marketing methods to attract new customers and deposits, by oÅering a wide variety of products and services and utilizing various forms of advertising media. Information concerning types of deposit accounts, average deposits and rates, and maturity of time deposits of $100,000 or more is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations.'' Borrowings Borrowings from time to time include securities sold under agreements to repurchase, the purchase of federal funds, and funds obtained as advances from the FHLB of San Francisco. Information concerning the types, amounts, and maturity of our borrowings is included in ""Note 8 to the Consolidated Financial Statements.'' 8 Return on Equity and Assets Information concerning the return on average assets, return on average stockholders' equity, the average equity to assets ratio and the dividend payout ratio is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations.'' Interest Rates and DiÅerentials Information concerning the interest-earning asset mix, average interest-earning assets, average interest- bearing liabilities and the yields on interest-earning assets and interest-bearing liabilities is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations.'' Analysis of Changes in Net Interest Income An analysis of changes in net interest income due to changes in rate and volume is included in Part II Ì Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operations.'' Commitments and Letters of Credit Information concerning the Bank's outstanding loan commitments and letters of credit is included in ""Note 11 to the Consolidated Financial Statements.'' Subsidiaries of Cathay Bank Cathay Investment Company. Cathay Investment Company is a wholly-owned subsidiary of the Bank that was formed in 1984 to invest in real property. In 1987, Cathay Investment Company opened an oÇce in Taipei, Taiwan to promote Taiwanese real estate investments in Southern California. The oÇce in Taipei is located at Sixth Floor, Suite 3, 146 Sung Chiang Road, Taipei, Taiwan. Cathay Securities Fund, Inc. Cathay Securities Fund, Inc. is a registered investment company and a wholly-owned subsidiary of the Bank. It was formed in 2000 to engage in the business of investing in, owning, and holding loans and securities. Its oÇce is located at 777 North Broadway, Los Angeles, California 90012. The Company has applied to the Securities and Exchange Commission to deregister this registered investment company. See discussion below in the section entitled ""Factors That May AÅect Future Results'' of this Annual Report on Form 10-K. Expansion Management of the Bank continues to look for opportunities to expand the Bank's branch network by seeking new branch locations and/or by acquiring other Ñnancial institutions to diversify its customer base in order to compete for new deposits and loans, and to be able to serve its customers more eÅectively. On June 27, 2002, the Bank opened a new branch in Brooklyn, New York, and on September 9, 2002, the Bank opened a new branch in Sacramento, Northern California. In addition, with China's accession into the World Trade Organization and its increasing importance in the world economy, the Bank opened a representative oÇce in Shanghai, China, on April 20, 2002. Competition The banking business in California, and speciÑcally in the market areas served by most of the Bank's branch oÇces, is highly competitive. The Bank competes for deposits and loans with other commercial banks, savings and thrift institutions, brokerage houses, insurance companies, mortgage companies, credit unions, credit card companies and other Ñnancial and non-Ñnancial institutions and entities. In addition, the Bank also competes with other entities (both governmental and private industry) that are seeking to raise capital through the issuance and sale of debt and equity securities. Many of these institutions and entities oÅer 9 services that are not oÅered directly by the Bank and have substantially greater Ñnancial resources than does the Bank. The direction of federal legislation in recent years seems to favor increased competition between diÅerent types of Ñnancial institutions and to foster new entrants into the Ñnancial services market. Competitive conditions are expected to continue to intensify as legislation is enacted which has the eÅect of dissolving historical barriers that limit participation in certain markets, increasing the cost of doing business for banks, or aÅecting the competitive balance between banks and other Ñnancial and non-Ñnancial institutions and entities. Technological factors, such as on-line banking and brokerage services, and economic factors can also be expected to have an ongoing impact on increasingly competitive conditions. To compete with other Ñnancial institutions in its primary service areas, the Bank relies principally upon the following: ‚ local promotional activities ‚ personal contacts by its oÇcers, directors, employees, and stockholders ‚ extended hours on weekdays, Saturday banking, and Sunday banking in certain locations ‚ Internet banking ‚ an Internet website, located at www.cathaybank.com ‚ certain other specialized services For customers whose loan demands exceed the Bank's lending limit, the Bank has attempted in the past, and intends in the future, to arrange for such loans on a participation basis with correspondent banks. The Bank also assists customers requiring other services not oÅered by the Bank to obtain such services from its correspondent banks. In Southern California, at least three other Chinese-American banks of comparable size provide particular competition for loans and deposits with the Bank and at least two super-regional banks provide such competition for deposits. In Northern California, one of these Chinese-American banks provide particular competition for loans and deposits with the Bank and the same two super-regional banks provide such competition for deposits as well. In addition, there are many other Chinese-American banks in both Southern and Northern California. Banks from the PaciÑc Rim countries, such as Taiwan, Hong Kong, and China also continue to open branches in the Los Angeles area, thus increasing competition in the Bank's primary markets. Employees As of December 31, 2002, Bancorp and Bank (including subsidiaries) employed approximately 581 per- sons, including 131 oÇcers. None of the employees are represented by a union. Management believes that its relations with employees are excellent. 10 Executive OÇcers The table below sets forth the names, ages, and positions of all executive oÇcers of the Company. See Part III, Item 10 Ì ""Directors and Executive OÇcers of the Registrant,'' below for further information regarding the executive oÇcers of Bancorp and Cathay Bank. Name Age Present Position and Principal Occupation During the Past Five Years Dunson K. Cheng ÏÏÏÏÏÏÏÏÏÏÏÏÏ Anthony M. Tang ÏÏÏÏÏÏÏÏÏÏÏÏÏ Irwin Wong ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Elena Chan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58 Chairman of the Board of Directors of Bancorp, Cathay Bank and Cathay Investment Company since 1994; President of Bancorp since 1990. President of Cathay Bank since 1985 and director of Cathay Bank since 1982. President of Cathay Investment Company since 1999; Chief Executive OÇcer of Cathay Investment Company since 1995 and director of Cathay Investment Company since 1984. Chairman of the Board of Directors and President of Cathay Securities Fund, Inc. since July 2000. Trustee and President of Cathay Real Estate Investment Trust since February 2003. 49 Executive Vice President of Bancorp since 1994; Assistant Secretary of Bancorp from 1991 to April 2001; Chief Financial OÇcer and Treasurer of Bancorp since 1990; and Senior Vice President of Bancorp from 1990 until 1994. Chief Lending OÇcer of Cathay Bank since 1985; director of Cathay Bank since 1986; Assistant Secretary of Cathay Bank from 1994 to April 2001; Senior Executive Vice President of Cathay Bank since December 1998; Executive Vice President of Cathay Bank from 1994 to December 1998; and Senior Vice President of Cathay Bank from 1990 until 1994. Vice President, Chief Financial OÇcer, and director of Cathay Securities Fund, Inc. since July 2000. Trustee and Vice President of Cathay Real Estate Investment Trust since February 2003. 54 Executive Vice President-Branch Administration for Cathay Bank since 1999; Senior Vice President Ì Branch Administration of Cathay Bank from 1989 until 1999; and Vice President Ì Branch Administration for Cathay Bank from 1988 until 1989. Treasurer of Cathay Real Estate Investment Trust since February 2003. 52 Senior Vice President and Chief Financial OÇcer of Cathay Bank since 1992; Internal Auditor of Cathay Bank from 1985 to 1992. Secretary of Cathay Securities Fund, Inc. since July 2000. Secretary of Cathay Real Estate Investment Trust since February 2003. Regulation Regulation of Bancorp and the Bank As a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended and as revised by the Gramm-Leach-Bliley Act of 1999, Bancorp's primary regulatory authority is the Federal Reserve System (the ""Federal Reserve''). The Bank Holding Company Act requires Bancorp to Ñle annual reports of its operations with the Federal Reserve. Bancorp is also subject to examination by the Federal Reserve. 11 The Bank, as a California state-chartered commercial bank, is regulated by the Federal Deposit Insurance Corporation (or FDIC), and by the California Department of Financial Institutions. The Bank's deposits are insured up to the legal maximum by the FDIC. Although not a member of the Federal Reserve, the Bank is subject to Federal and State rules and regulations. Regulatory authorities review key operational areas of Bancorp and the Bank, including asset quality, capital adequacy, liquidity, management and administrative ability, compliance with consumer protection laws and security of conÑdential customer information. Applicable law and regulations also limit the business activities in which Bancorp, the Bank, and its subsidiaries may be engaged. See also, ""Other Banking Regulations Ì Interstate Banking'' and ""Federal Limits on the Activities and Investments of State-Chartered Banks'' below. Bancorp also Ñles periodic reports, proxy statements, and other information with the Securities and Exchange Commission, and is subject to federal and state securities laws, including the Sarbanes-Oxley Act of 2002, which contains provisions dealing with corporate governance and management, disclosure, oversight of the accounting profession, and auditor independence. The following summary describes some of the more signiÑcant laws, regulations, and policies that aÅect our operations. It is not a complete listing of all laws that apply to Bancorp and the Bank. To the extent that the information in this Section, ""Regulation of Bancorp, and the Bank,'' describes statutory or regulatory provisions, it is qualiÑed in its entirety by reference to such provisions. Regulatory Environment The banking and Ñnancial services industry is heavily regulated. Regulations, statutes, and policies aÅecting the industry are frequently under review by Congress, state legislatures, and the federal and state agencies charged with supervisory and examination authority over banking institutions. This regulatory framework is intended primarily to protect the Bank's depositors, the federal deposit insurance fund, and the safety and soundness of the regulated Ñnancial institutions. Generally, the regulatory framework is not intended to protect our stockholders. We expect that changes in the banking and Ñnancial services industry will continue to occur in the future. Some of the changes may create opportunities for us to compete in Ñnancial markets with less regulation. However, these changes also may create new competitors in geographic and product markets which have historically been limited by law to banking institutions, such as the Bank. We cannot predict how changes in regulations, statutes, or policies will impact us. These changes may have a material adverse eÅect on our business and earnings. Fiscal and Monetary Policies The operations of bank holding companies and their subsidiaries are aÅected by the Ñscal and monetary policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit. The Federal Reserve uses the following instruments of monetary policy, among others, as a means to implement its objectives: ‚ open market purchases and sales of U.S. government securities; ‚ changes in the discount rate on bank borrowings; and ‚ changes in reserve requirements on bank deposits and borrowings by banks and their aÇliates. The Federal Reserve uses these instruments of monetary policy in varying combinations to seek to inÖuence the overall level of bank loans, investments and deposits; the interest rates charged on loans and paid for deposits; the price of the dollar in foreign exchange markets; and the level of inÖation. The Federal Reserve's Ñscal and monetary policies will continue to have a signiÑcant eÅect on Bancorp and the Bank. 12 Bank Holding Company Regulation As a bank holding company, Bancorp is subject to regulation, supervision, and examination by the Federal Reserve. It is required to Ñle reports with the Federal Reserve and furnish such other information as may be required by the Federal Reserve under the Bank Holding Company Act. The Federal Reserve has a policy that bank holding companies must serve as a source of Ñnancial and managerial strength to their subsidiary banks and may not conduct their operations in an unsafe or unsound manner. It is the Federal Reserve's position that bank holding companies should stand ready to use their available resources to provide adequate capital to their subsidiary banks during periods of Ñnancial stress or adversity. Bank holding companies should also maintain the Ñnancial Öexibility and capital-raising capacity to obtain additional resources for assisting their subsidiary banks. If a bank holding company fails in these requirements, the Federal Reserve will generally consider such failure to be an unsafe and unsound banking practice or a violation of the Federal Reserve's regulations or both. The Federal Reserve also has the authority to regulate bank holding company debt, including the authority to impose interest rate ceilings and reserve requirements on such debt. Under certain circumstances, the Federal Reserve may require Bancorp to Ñle written notice and obtain its approval prior to purchasing or redeeming Bancorp's equity securities. Bancorp must also obtain the prior approval of the Federal Reserve if it acquires more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of a bank or bank holding company. The Federal Reserve must also give prior approval to any merger or consolidation with another bank holding company. In addition, under the Bank Holding Company Act, Bancorp cannot acquire direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company. It cannot engage directly or indirectly in activities other than banking, managing or controlling banks or furnishing services to its subsidiaries. However, there are some statutory exceptions. Subject to prior approval of the Federal Reserve, Bancorp can acquire shares of companies engaged in activities that the Federal Reserve deems to be closely related to banking or managing or controlling banks. In addition, as discussed below under ""Financial Services Modernization Legislation,'' if Bancorp becomes a ""Financial Holding Company,'' certain restrictions on acquiring ownership or control of certain non-banking companies will no longer apply. Financial Services Modernization Legislation On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 (referred to in this report as the Modernization Act), which among other things revised the Bank Holding Company Act. EÅective March 12, 2000, the Modernization Act repealed the two aÇliation provisions of the Glass-Steagall Act that restricted banks and securities Ñrms from aÇliating. The Modernization Act repealed: ‚ Section 20 of the Glass-Steagall Act, which restricted the aÇliation of Federal Reserve member banks with Ñrms ""engaged principally'' in speciÑed securities activities, and ‚ Section 33 of the Glass-Steagall Act, which restricted oÇcer, director, or employee interlocks between a member bank and any company or person ""primarily engaged'' in speciÑed securities activities. In addition, the Modernization Act expressly preempted any state law restricting the establishment of Ñnancial aÇliations, primarily related to insurance. The law established a comprehensive framework to permit aÇliations among commercial banks, insurance companies, securities Ñrms, and other Ñnancial service providers. The Modernization Act revised and expanded the Bank Holding Company Act framework and permitted a bank holding company to engage in additional types of Ñnancial activities provided that it became a ""Financial Holding Company'' under the Modernization Act. 13 Such Ñnancial activities include banking, insurance, securities activities, merchant banking, and addi- tional activities incidental to such Ñnancial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the Ñnancial system generally. To aÇliate with other Ñnancial service providers, we would have to become a ""Financial Holding Company.'' We would have to Ñle a declaration with the Federal Reserve, electing to engage in activities permissible for Financial Holding Companies and certify that we are eligible to do so because the Bank is ""well-capitalized'' and ""well-managed.'' The Federal Reserve must also determine that the Bank, as the insured depository institution subsidiary, has at least a ""satisfactory'' rating under the Community Reinvest- ment Act. We have not sought to become a Financial Holding Company. We will continue to monitor our strategic business plan, market conditions, and other factors to determine whether we will elect to become a Financial Holding Company and take advantage of the expanded powers provided in the Modernization Act. Under the Modernization Act, securities Ñrms and insurance companies that become Financial Holding Companies may acquire banks and other Ñnancial institutions. No regulatory approval will be required for a Financial Holding Company to acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are Ñnancial in nature or incidental to activities that are Ñnancial in nature, as determined by the Federal Reserve. Prior Federal Reserve approval is required before a Financial Holding Company acquires the beneÑcial ownership or control of more than 5% of the voting shares of a bank holding company, bank or savings association. To the extent that the Modernization Act permits banks, securities Ñrms, and insurance companies to aÇliate, the Ñnancial services industry may experience further consolidation. The Modernization Act also added a new section to the Federal Deposit Insurance Act. The new section allows subsidiaries of state banks to engage in ""activities as principal that would only be permissible'' for a national bank to conduct in a Ñnancial subsidiary. It expressly preserved a state bank's right to retain all existing subsidiaries. California permits state-chartered commercial banks to engage in any activity permissi- ble for national banks. Under the Modernization Act, a national bank subsidiary may engage in any Ñnancial activity which may be conducted through a Financial Holding Company subsidiary, except for insurance underwriting, insurance investments, real estate investment or development or merchant banking. Therefore, the Bank can form subsidiaries to engage in the activities authorized by the Modernization Act to the same extent as a national bank. To form a Ñnancial subsidiary, the Bank must be ""well-capitalized'' and meet other regulatory requirements. See ""Other Banking Regulations Ì Federal Limits on the Activities and Invest- ments of State-Chartered Banks'' below. The Modernization Act may have the result of increasing the amount of competition that Bancorp and the Bank face from larger institutions and other types of companies oÅering Ñnancial products, many of which may have substantially more Ñnancial resources than Bancorp and the Bank. Privacy. The Modernization Act provides consumers with new protections against the transfer and use of their nonpublic personal information by Ñnancial institutions. The OÇce of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corporation and the OÇce of Thrift Supervision issued Ñnal rules on June 1, 2000. Under the rules, Ñnancial institutions must provide among other things: ‚ initial notices to customers about their privacy policies (including a description of the conditions under which they may disclose nonpublic personal information to nonaÇliated third parties and aÇliates); ‚ annual notices of such privacy policies to current customers; and ‚ subject to certain exceptions, a reasonable method for customers to ""opt out'' of disclosure to nonaÇliated third parties. These federal privacy protections do not prohibit state governments from imposing more protective rules. Consumer Protection Rules Ì Sale of Insurance Products. On December 4, 2000, the federal bank and thrift regulatory agencies adopted consumer protection rules for the sale of insurance products by depository 14 institutions as required by the Modernization Act. The eÅective date was originally April 1, 2001, but on March 19, 2001, the federal agencies postponed the eÅective date until October 1, 2001. The rules apply to any depository institution or any person selling, soliciting, advertising, or oÅering insurance products or annuities to a customer at an oÇce of the institution or on behalf of the institution. The rule requires oral and written disclosure, before the completion of the sale of an insurance product or annuity, that such product: ‚ is not a deposit or other obligation of, or guaranteed by, the depository institution or its aÇliate; ‚ is not insured by the FDIC or any other agency of the United States, the depository institution or its aÇliates; and ‚ has certain risks of investment, including possible loss of value. Finally, the depository institution may not condition an extension of credit on the consumer's purchase of an insurance product or annuity from the depository institution or from any of its aÇliates; on the consumer's agreement not to obtain an insurance product or annuity from an unaÇliated entity; or by prohibiting a consumer from obtaining an insurance product or annuity from an unaÇliated entity. The disclosure must be understandable and the customer must acknowledge receipt of such disclosure. In addition, to the extent practicable, a depository institution must keep insurance and annuity activities physically segregated from the areas where retail deposits are routinely accepted from the general public. Safeguarding ConÑdential Customer Information. In February 2001, the federal bank and thrift regulatory agencies published guidelines requiring Ñnancial institutions to establish an information security program to: ‚ identify and assess the risks that may threaten customer information; ‚ develop a written plan containing policies and procedures to manage and control these risks; ‚ implement and test the plan; and ‚ adjust the plan on a continuing basis to account for changes in technology, the sensitivity of customer information, and internal or external threats to information security. Each institution may implement a security program appropriate to its size and complexity and the nature and scope of its operations. The guidelines outline speciÑc security measures that institutions should consider in implementing a security program. A Ñnancial institution must adopt those security measures determined to be appropriate. The guidelines require the Board of Directors to oversee an institution's eÅorts to develop, implement, and maintain an eÅective information security program and approve written information security policies and programs. The guidelines became eÅective July 1, 2001. The precise impact of the Modernization Act on Bancorp and the Bank will not be fully known until the last of the Modernization Act's phased eÅective dates occurs on November 12, 2004, and until regulatory agencies promulgate all the administrative regulations implementing many portions of the Act. It can be expected that state regulatory authorities and/or legislatures may act in response to the Modernization Act. USA Patriot Act On October 26, 2001, in response to the tragic events of September 11, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the ""Patriot Act''). The Patriot Act is directed at the prevention, detection, and prosecution of international money laundering and Ñnancing of terrorism and, among other things, requires or will require Ñnancial institutions to do the following (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures, and controls with respect to private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and 15 (iii) avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, foreign banks that do not have a physical presence in any country. The Company is not yet able to determine the impact of the Patriot Act on its Ñnancial condition or results of operations. Other Banking Regulations As a California state-chartered commercial bank, the Bank is subject to primary supervision, periodic examination, and regulation by the FDIC and by the California Department of Financial Institutions. The Bank's deposits are insured by the FDIC up to the legal maximum and the Bank is subject to FDIC rules applicable to insured banks. Although not a member of the Federal Reserve, the Bank is subject to Federal and State rules and regulations. Capital Requirements. The Federal Reserve and the FDIC have established risk-based minimum capital guidelines that seek to ensure that banking organizations are appropriately capitalized. The guidelines are intended to provide a measure of capital that reÖects the degree of risk associated with a banking organization's operations for transactions reported on the balance sheet as assets, and transactions which are recorded as oÅ-balance sheet items, such as letters of credit or recourse arrangements. Under these guidelines, the nominal dollar amounts of assets and the credit equivalent amounts of oÅ-balance sheet items are multiplied by one of several risk-adjusted percentages. The risk-adjusted percentages range from 0% for assets with low credit risk, such as U.S. Treasury securities, to 100% for assets with high credit risk, such as commercial loans. The federal regulators require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% (10% to be well capitalized) and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4% (6% to be well capitalized). In addition, the federal regulators require a minimum Tier 1 leverage ratio of 4% (5% to be well capitalized). The Company was well capitalized as of December 31, 2002, with a total risk-based capital ratio of 13.01%, a Tier 1 risk-based capital ratio of 11.93% and Tier 1 leverage ratio of 10.11%. The tables presenting our risk-based capital and leverage ratios as of December 31, 2002, are included in Note 10 to the Consolidated Financial Statements of Bancorp, which are included in this Annual Report on Form 10-K. Prompt Corrective Action. In December 1991, the Federal Deposit Insurance Corporation Improve- ment Act of 1991 (or FDICIA) was enacted into law. FDICIA provided for the recapitalization of the Bank Insurance Fund and improved examinations of insured depository institutions. It required each federal banking regulatory agency to revise its risk-based capital standards and to specify levels at which regulated institutions are considered ""well capitalized,'' ""adequately capitalized,'' ""undercapitalized,'' ""signiÑcantly undercapital- ized'' or ""critically undercapitalized.'' It prescribes standards for safety and soundness of all insured depository institutions. FDICIA requires each federal banking agency and the FDIC to take ""prompt corrective action'' against those institutions that fail to satisfy their minimum capital requirements. As of December 31, 2002, the Bank was well capitalized for these regulatory purposes. An institution that, based on its capital levels, is classiÑed as well capitalized, adequately capitalized or undercapitalized may be treated as though it were in the next lower capital category, if the appropriate federal banking agency determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. The aÅected institution must receive proper notice and have an opportunity for a hearing. At each successive lower capital category, an insured bank is subject to more restrictions, including restrictions on the bank's activities, operational practices, and ability to pay dividends. In addition to measures taken under the prompt corrective action provision, commercial banking organizations may be subject to potential enforcement actions by federal regulators for, among other things, unsafe or unsound practices in conducting their businesses, or violations of any law, rule, regulation, or any condition imposed in writing by the relevant regulatory agency or any written agreement with a regulatory agency. 16 Premiums for Deposit Insurance. The Bank's deposit accounts are insured by the Bank Insurance Fund, as administered by the FDIC, up to the maximum permitted by law. The amount of FDIC assessments paid by each Bank Insurance Fund member institution is based on its capitalization risk level and its supervisory subgroup category. The supervisory subgroup category is based on the FDIC's assessment of the Ñnancial condition of the institution and the probability that FDIC intervention or other corrective action will be required. The Bank Insurance Fund assessment rate as of December 31, 2002, ranged from zero to 27 basis points per $100 of insured deposits. At December 31, 2002, the Bank's assessment rate was zero. The FDIC may increase or decrease the assessment rate schedule on a semiannual basis. An increase in the Bank Insurance Fund assessment rate could have a material adverse eÅect on our earnings. The FDIC is authorized to terminate a depository institution's deposit insurance if it Ñnds among other things that: ‚ the institution's condition is unsafe or unsound; ‚ the institution has engaged in unsafe or unsound practices; and ‚ the institution has violated any applicable law, rule, regulation, order or condition imposed in writing by the relevant regulating agency or any written agreement with a regulating agency. Under the Economic Growth and Regulatory Paperwork Reduction Act of 1996, on January 1, 1997, banks began paying an annual assessment towards the retirement of U.S. government issued Financing Corporation bonds. The bonds were issued in the 1980s to capitalize the Federal Savings and Loan Insurance Corporation to assist in the recovery of the savings and loan industry. FDIC-insured institutions paid approximately 1.71 cents per $100 of Bank Insurance Fund-assessable deposits in 2002. Dividends. As a California corporation and a state-chartered bank, the Bank may not pay dividends to Bancorp in excess of certain statutory and regulatory limits. As of December 31, 2002, the maximum dividend that the Bank could have declared, subject to regulatory approval, was $103,076,000. The California Commissioner of Financial Institutions and the Federal Reserve may also prohibit a bank from paying dividends to its bank holding company if they determine that such payment would constitute an unsafe or unsound banking practice. In addition, if the Bank fails to comply with its minimum capital requirements, its regulators may restrict its ability to pay dividends using prompt corrective action or other enforcement powers. Community Reinvestment Act and Fair Lending. The Bank is subject to certain fair lending require- ments and reporting obligations involving its home mortgage lending operations and Community Reinvest- ment Act activities. Under the Community Reinvestment Act, a bank is obligated to help meet the credit needs of its entire community, including low and moderate income neighborhoods, consistent with safe and sound operation. The Community Reinvestment Act does not establish speciÑc lending requirements or programs, nor does it limit a bank's discretion to develop the types of products and services that it believes are best suited to its community. However, the Community Reinvestment Act does require that federal regulators, when examining an institution, assess the institution's record of meeting the credit needs of its community and take such record into account in evaluating certain applications, including an application to become a Financial Holding Company under the Modernization Act. Federal regulators are required to provide a written examination of an institution's Community Reinvestment Act performance. The regulators rate an institution's performance using a four tiered rating system. The ratings are: outstanding record of meeting community credit needs; satisfactory record of meeting community credit needs; needs to improve record of meeting community credit needs; and substantial noncompliance of meeting community credit needs. The ratings are available to the public. Based upon the last Community Reinvestment Act examination by the FDIC in January 2001, the Bank's Community Reinvestment Act rating was ""satisfactory'' in meeting community credit needs. The Bank is also subject to other fair lending requirements and reporting obligations related to its home mortgage lending operations. The Equal Credit Opportunity Act and Fair Housing Act prohibit discrimination 17 on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract). A bank can become subject to substantial penalties and corrective measures for violations of fair lending laws. Federal Limits on the Activities and Investments of State-Chartered Banks. Federal restrictions on the direct and indirect activities and investments of state-chartered or licensed depository institutions exist if the institution either carries federal deposit insurance or is involved in activities with foreign banks. The FDIC is the regulatory agency with the authority to determine federal restrictions on all direct and indirect activities and investments. Prior to 1999, subject to a number of grandfathering provisions and a few exceptions, there were three rules which limited the activities and investments of state-chartered banks. 1. A state-chartered bank could not engage as principal in any type of activity that was prohibited for a national bank, unless the FDIC determined the activity posed no signiÑcant risk to the aÅected deposit insurance fund and the institution met its fully phased in capital requirements. 2. A state-chartered bank could not make or retain an equity investment of a type or in an amount that was prohibited for a national bank; and, divestiture of such an investment was required by 1996. 3. A state-chartered bank could retain an equity investment in the form of a majority-owned subsidiary engaged as principal in activities prohibited for a national bank subsidiary, but only if the FDIC had made the same determinations respecting risk to the insurance fund and capital compliance by the bank. The Modernization Act added a new section to the Federal Deposit Insurance Act to provide that an insured state bank may control or hold an interest in a subsidiary engaged as principal in activities that would be permissible for a national bank to conduct through a Ñnancial subsidiary, subject to certain conditions. Under the Modernization Act, in January 2001, the FDIC adopted Ñnal rules to streamline the certiÑcation process. State nonmember banks may self-certify that they meet the requirements necessary to qualify for conducting non-agency activities. The insured state bank must certify that: it is ""well managed;'' it is ""well capitalized;'' it will deduct the aggregate amount of its outstanding equity investment in all Ñnancial subsidiaries that engage in activities as principal from the bank's total assets and tangible equity; and it will deduct such equity investment in such Ñnancial subsidiaries from its total risk-based capital. In addition, the bank must have received a Community Reinvestment Act rating of ""satisfactory'' in meeting community credit needs in its most recent examination. Additional requirements must be satisÑed in order for a Ñnancial subsidiary of a state nonmember insured bank to conduct securities underwriting. Securities activities are subject to a variety of general and speciÑc safety and soundness restrictions. Further, state banks wishing to engage in activities prohibited to national banks, such as real estate development or investment, must continue to seek FDIC consent by Ñling a notice or application, as was the procedure before the Modernization Act. Interstate Banking. The Federal Riegle-Neal Interstate Banking and Branching EÇciency Act of 1994 was signed into law on September 29, 1994. The Riegle-Neal Act signiÑcantly relaxed or eliminated many restrictions on interstate banking. EÅective September 29, 1995, the Riegle-Neal Act permitted a bank holding company to acquire banks in states other than its ""home state,'' even if applicable state law would not permit that acquisition. Such acquisitions continue to require Federal Reserve approval and remain subject to certain state laws. EÅective June 1, 1997, the Riegle-Neal Act permitted interstate mergers of banks, thereby allowing a single merged bank to operate branches in multiple states. The Riegle-Neal Act allowed each state to adopt legislation to ""opt-out'' of these interstate merger provisions. Conversely, the Riegle-Neal Act permitted states to ""opt in'' to the merger provisions of the Act prior to their stated eÅective date, to permit interstate mergers in that state prior to June 1, 1997. The enactment of the California Interstate Banking and Branching Act of 1995 provided for interstate banking and branching in California. This early opt-in legislation became eÅective on October 2, 1995. It required out-of-state institutions, which did not own a California bank to acquire an 18 existing whole Ñve-year old bank before establishing a California branch. De novo interstate branching was not permitted. This act revised much of the original California interstate banking law Ñrst enacted in 1986 that permitted interstate banking with other states on a reciprocal basis. Banks and bank holding companies contemplating acquisitions must comply with the following Acts, as applicable: ‚ the competitive standards of the Bank Holding Company Act; ‚ the Change in Bank Control Act; and ‚ the Bank Merger Act. The crucial test under each Act is whether the proposed acquisition will ""result in a monopoly'' or will ""substantially'' lessen competition in the relevant geographic market. Both the Bank Holding Company Act and the Bank Merger Act preclude granting regulatory approval for any transaction that will ""result in'' a monopoly or is in furtherance of a plan to create a monopoly. However, where a proposed transaction is likely to cause a substantial reduction in competition, or tends to create a monopoly or otherwise restrain trade, these Acts permit the granting of regulatory approval under certain circumstances. The applicable regulator may approve the transaction if it concludes that the perceived anti-competitive eÅects are clearly outweighed by the probable beneÑcial eÅects of the transaction in meeting the convenience and needs of the community to be served. We seek to expand our market areas by acquiring other Ñnancial institutions or establishing de novo branches in or outside of California as permitted by applicable laws, whenever suitable opportunities present themselves. The Riegle-Neal Act may have the eÅect of increasing competition by facilitating entry into the California banking market by out of state banks and bank holding companies. Federal Home Loan Bank. The Federal Home Loan Bank System consists of twelve district banks and is supervised by the Federal Housing Finance Board. Commercial banks, credit unions, savings associations, and certain other insured depository institutions making long-term home mortgage loans are eligible to become members of the Federal Home Loan Bank System. In January 1993, the Bank became a member and stockholder of the Federal Home Loan Bank in San Francisco. As a member and stockholder, the Bank has access to a source of low-cost liquidity. The level of stock ownership is currently governed by the Federal Home Loan Bank Act, and the amount of borrowing is deÑned by the amount of stock purchased. Stock is purchased and redeemed at par. The Bank's investment in Federal Home Loan Bank stock totaled 55,606 shares or $5,560,600 as of December 31, 2002. All credit extended by the district bank requires full collateralization. Eligible collateral includes the following: ‚ residential Ñrst mortgage loans on single and multi-family projects ‚ U.S. government and agency securities ‚ deposits in district banks ‚ certain other real estate related assets permitted by law Item 2. Properties Cathay Bancorp. The Bancorp currently neither owns nor leases any real or personal property. We use the premises, equipment, and furniture of the Bank without the payment of any rental fees to the Bank. 19 Cathay Bank. The Bank's main corporate oÇce and headquarters branch is located in the Chinatown area of Los Angeles. The oÇces are in a three-story structure containing 26,527 square feet and constructed of glass and concrete. The Bank owns both the building and the land upon which the building is situated. ‚ The main Öoor currently accommodates: ‚ a platform area for consumer loans and certain commercial and commercial mortgage loans ‚ a platform area for Cathay Global Investments Services ‚ a new account area ‚ teller stations ‚ pneumatic drive-up teller stations ‚ walk-up teller station ‚ an operations area ‚ a vault area ‚ The second Öoor contains executive oÇces and the Bank's Board Room ‚ The third Öoor houses the Bank's corporate lending department. Parking for approximately 126 automobiles is provided on three lots adjacent to the Bank's building, two of which are owned by the Bank. The third lot is leased under a 55-year term with a 30-year option commencing in January 1987 at a current monthly rent of approximately $16,031. Furthermore, the Bank owns its branch oÇces in the following cities: ‚ Monterey Park ‚ Alhambra ‚ Westminster ‚ San Gabriel ‚ Torrance ‚ Cerritos ‚ City of Industry ‚ Cupertino ‚ Flushing, New York 20 In addition to the bank-owned properties, the parking lot lease, and the lease for the Cathay Investment Company's Taipei oÇce described below, the Bank leases certain other premises. The following table lists the location, square footage, purpose, and lease term of each lease. Location Sq. Ft. Purpose Lease Term 767 N. Hill StreetÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Los Angeles, CA (Rm 305-306, 308-309, 313-315, 320)* 767 N. Hill StreetÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Los Angeles, CA (Rm 301-302) 16025 E. Gale Ave., Ste B-1ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ City of Industry, CA 2010 Tully Road** ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ San Jose, CA 710 Webster Street ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oakland, CA 1759 N. Milpitas Blvd ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Milpitas, CA 15323 Culver DriveÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Irvine, CA 1095 El Camino RealÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Millbrae, CA 800 N. Hill StreetÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Los Angeles, CA 43 E. Valley Blvd ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Alhambra, CA 3288 Pierce Street, Suite D-101 ÏÏÏÏÏÏÏÏÏÏÏ Richmond, CA 1195 S. Diamond Bar Blvd ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diamond Bar, CA 1701 Decoto Road ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Union City, CA 5591 Sky Parkway ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Suite 411-415 Sacramento, CA 45 E. BroadwayÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ New York, NY 10375 Richmond Avenue, Suite 1600*** ÏÏÏ Houston, TX 5402 Eight Avenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Brooklyn, NY Room 902-3, 9/F ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Printing House 6 Duddell Street, Central Hong Kong Unit 1808 Shanghai Kerry Centre, ÏÏÏÏÏÏÏÏÏ 1515 Nanjing Road West Shanghai, 200040 People's Republic of China 8,912 Administrative oÇces 2/01 Ó 1/04 1,800 Administrative oÇces 2/01 Ó 1/04 4,483 Hacienda Heights branch oÇce San Jose branch oÇce 4,800 5,000 Oakland branch oÇce 3,121 Milpitas branch oÇce 4,450 Irvine branch oÇce 3,441 Millbrae branch oÇce 8,707 Administrative oÇces 1,976 2,535 2,500 Valley/Stoneman branch oÇce Berkeley/Richmond branch oÇce Diamond Bar branch oÇce 7/99 Ó 6/04 with one 5-year option 3/96 Ó 4/06 with two 5-year options 9/01 Ó 9/06 with one 5-year option 10/00 Ó 10/05 with two 5-year options 10/94 Ó 4/09 with two 5-year options 1/00Ó 12/04 with one 5-year option 2/99 Ó 2/04 11/01 Ó 11/06 with three 5-year options 10/97 Ó 10/03 with two 5-year options 9/99 Ó 9/07 2,100 Union City branch 04/01 Ó 04/06 3,235 oÇce Sacramento branch oÇce 06/2002 Ó 06/2007 6,450 New York Chinatown branch oÇce 1,797 Houston branch oÇce 1/97 Ó 12/06 with two 5-year options 5/02 Ó 4/03 2,700 Brooklyn branch oÇce 740 Hong Kong representative oÇce 09/01 Ó 08/11 with one 5-year option 1/03 Ó 1/05 726 Shanghai representative oÇce 4/02 Ó 4/05 21 * The lease is between the Bank and T.C. Realty, Inc., a California corporation owned by the spouse of Mr. Patrick Lee. Mr. Lee is a director of Bancorp and the Bank. Management believes that the lease is on terms at least as favorable to the Bank as would have existed in a transaction with an unrelated third party. ** Cathay Bank has a one-time right to cancel the lease after the Ñfth year upon the payment of $55,500 in consideration. *** The Houston branch oÇce lease is being renegotiated for a term of one additional year. The Bank currently operates 24 domestic branch oÇces, one branch oÇce of Cathay Investment Company in Taiwan, one representative oÇce in Hong Kong, and one representative oÇce in Shanghai, China. Each branch oÇce has loan approval rights subject to the branch manager's authorized lending limits. Activities of Cathay Investment Company's Taiwan oÇce and the Hong Kong and Shanghai representative oÇces are limited to coordinating the transportation of documents to the Bank's headquarters oÇce and performing liaison services. As of December 31, 2002, the Bank's investment in premises and equipment totaled $29,788,000. See also Note 7 to the Consolidated Financial Statements of Cathay Bancorp, which is included in this Annual Report on Form 10-K. Cathay Investment Company. The oÇce in Taipei is located at Sixth Floor, Suite 3, 146 Sung Chiang Road, Taipei, Taiwan, and consists of 1,806 square feet. The lease was renewed for one year from October 5, 2002 to October 4, 2003. The lease contains an option to renew the lease for an additional period ranging from one to three years, after October 4, 2003. As of December 31, 2002, Cathay Investment Company did not own any properties. Cathay Securities Fund, Inc. Its oÇce is located at 777 North Broadway, Los Angeles, California 90012. The Company has applied to the Securities and Exchange Commission to deregister this registered investment company. See discussion below in the section entitled ""Factors That May AÅect Future Results'' of this Annual Report on Form 10-K. Item 3. Legal Proceedings Management is not currently aware of any litigation that is expected to have material adverse impact on our consolidated Ñnancial condition or the results of operations. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of 2002. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters (a) Market Information Cathay Bancorp trades on the Nasdaq National Market under the symbol ""CATY.'' The closing price of the Company's common stock on February 3, 2003 was $37.75 per share, as reported by the Nasdaq National Market. The Company does not represent that the outstanding shares may be either bought or sold at a certain price. 22 The following table sets forth the high and low closing prices as reported on the Nasdaq National Market, as adjusted to reÖect a two-for-one stock split in the form of a 100 percent stock dividend, eÅective May 9, 2002: Year Ended December 31, 2002 2001 High Low High Low First quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $36.74 48.30 45.46 44.00 $30.71 35.73 33.32 31.90 $32.25 29.86 29.00 33.47 $22.57 21.82 22.83 26.40 (b) Holders As of February 3, 2003, there were approximately 1,640 holders of record of our Common Stock. (c) Dividends The cash dividends declared by quarter, as adjusted to reÖect a two-for-one stock split eÅective May 9, 2002, were as follows: Year Ended December 31, 2002 2001 First quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $0.125 0.140 0.140 0.140 $0.125 0.125 0.125 0.125 Item 6. Selected Financial Data The following table presents selected historical consolidated Ñnancial data for the Bancorp, and is derived in part from the audited consolidated financial statements of the Company. The selected historical consolidated Ñnancial data should be read in conjunction with the Consolidated Financial Statements of Cathay Bancorp and the Notes thereto, which are included in this Annual Report on Form 10-K. 23 Selected Consolidated Financial Data 2002 Year Ended December 31, 2000 (Dollars in thousands, except share and per share data)(3) 1999 2001 1998 Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,991,333 18,115,119 Income Statement(1) Interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income before provision for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for loan losses ÏÏÏÏÏÏÏÏÏÏ Securities gains (losses) ÏÏÏÏÏÏÏÏÏÏ Other non-interest income ÏÏÏÏÏÏÏÏ Non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income tax expense Income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income per common share Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash dividends paid per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average common shares Statement of Condition Securities available-for-saleÏÏÏÏÏÏÏÏ Securities held-to-maturity ÏÏÏÏÏÏÏÏ Net loans(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DepositsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchaseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Advances from the Federal Home Loan Bank ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common Stock Data Shares of common stock outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Book value per common share ÏÏÏÏÏ ProÑtability Ratios Return on average assetsÏÏÏÏÏÏÏÏÏÏ Return on average stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividend payout ratio ÏÏÏÏÏÏÏÏÏÏÏÏ Average equity to average assets ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÇciency ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 144,061 39,920 $ 159,352 66,153 $ 164,553 74,156 $ 133,046 57,408 $ 123,309 57,225 104,141 6,000 1,926 14,245 43,317 70,995 22,295 48,700 2.71 2.69 0.545 $ $ $ $ $ 248,273 459,452 1,848,078 2,753,998 2,314,643 93,199 6,373 2,157 12,622 40,165 61,440 18,820 42,620 2.35 2.35 0.500 18,107,790 18,165,260 248,958 374,356 1,640,032 2,453,114 2,122,348 $ $ $ $ $ 90,397 4,200 1,085 11,671 38,504 60,449 21,862 38,587 2.13 2.13 0.440 18,113,502 18,147,770 177,796 387,200 1,437,307 2,206,834 1,876,447 $ $ $ $ $ $ $ $ $ $ 75,638 4,200 (3) 8,858 30,282 50,011 19,720 30,291 1.68 1.68 0.405 18,026,856 18,035,520 160,991 426,332 1,245,585 1,995,924 1,721,736 66,084 3,600 43 8,093 30,065 40,555 15,976 24,579 1.37 1.37 0.350 17,934,376 17,936,460 239,928 418,156 961,876 1,780,898 1,560,402 $ $ $ $ $ 28,500 22,114 68,173 46,990 16,436 50,000 287,961 30,000 246,011 10,000 214,787 30,000 179,109 30,000 156,652 17,999,955 16.00 $ 17,957,738 13.70 $ 18,148,730 11.83 $ 18,067,166 9.91 $ 17,977,520 8.71 $ 1.88% 1.82% 1.81% 1.63% 1.44% 18.30 20.11 10.27 36.00 18.36 21.23 9.03 37.20 20.09 20.66 9.03 37.33 18.31 23.95 8.89 35.84 17.00 25.55 8.47 40.51 (1) Includes the operating results and the selected assets and assumed deposits and liabilities of Golden City Commercial Bank subsequent to the December 10, 1999, their acquisition date. (2) Net loans represents gross loans net of loan participations sold, allowance for loan losses and unamortized deferred loan fees. (3) Shares and per share data have been adjusted to reÖect a two-for-one stock split in the form of a 100 percent stock dividend, eÅective May 9, 2002. 24 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations General The following discussion is intended to provide information to facilitate the understanding and assessment of the consolidated Ñnancial condition of Cathay Bancorp, Inc. (""Bancorp'') and its subsidiary, Cathay Bank (the ""Bank'' and together the ""Company'' or ""we'', ""us'' or ""our'') and their consolidated results of operations. It should be read in conjunction with the audited consolidated Ñnancial statements and footnotes appearing elsewhere in this report. The Bank oÅers a wide range of Ñnancial services. The Bank now operates twelve branches in Southern California, eight branches in Northern California, three branches in New York State, one branch in Houston, Texas, and two representative oÇces, one in Hong Kong and one in Shanghai, China. In addition, the Bank's subsidiary, Cathay Investment Company, maintains an oÇce in Taiwan. The Bank is a commercial bank, servicing primarily the individuals, professionals, and small to medium-sized businesses in the local markets in which its branches are located. The following discussion and other sections of this report include forward-looking statements regarding management's beliefs, projections, and assumptions concerning future results and events. These forward- looking statements may, but do not necessarily, also include words such as ""believes,'' ""expects,'' ""antici- pates,'' ""intends,'' ""plans,'' ""estimates,'' ""may,'' ""will,'' ""should,'' ""could,'' ""predicts,'' ""potential,'' ""continue'' or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, or achievements to be materially diÅerent from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, adverse developments, or conditions related to or arising from: ‚ our expansion into new market areas; ‚ fluctuations in interest rates; ‚ demographic changes; ‚ increases in competition; ‚ deterioration in asset or credit quality; ‚ changes in the availability of capital; ‚ adverse regulatory developments; ‚ changes in business strategy, including the formation of a real estate investment trust and the application to the Securities and Exchange Commission for deregistration of the registered investment company; ‚ general economic or business conditions; and ‚ other factors discussed in the section entitled ""Factors that May AÅect Future Results'' later in this report. Actual results in any future period may also vary from the past results discussed in this report. Given these risks and uncertainties, we caution readers not to place undue reliance on any forward-looking statements, which speak as of the date hereof. We have no intention and undertake no obligation to update any forward-looking statement or to publicly announce the results of any revision of any forward-looking statement to reÖect future developments or events. The Ñnancial information presented herein includes the accounts of the Company, the Bank, and the Bank's wholly-owned subsidiaries. All material transactions between these entities are eliminated. Critical Accounting Policies The discussion and analysis of our Ñnancial condition and results of operations are based upon our consolidated Ñnancial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated Ñnancial statements requires management to make estimates and judgments that aÅect the reported amounts of assets 25 and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our Ñnancial statements. Actual results may diÅer from these estimates under diÅerence assumptions or conditions. Accounting for the allowance for loan losses involves signiÑcant judgments and assumptions by management, which has a material impact on the carrying value of net loans; management considers this accounting policy to be a critical accounting policy. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances as described under the heading ""Allowance for Loan Losses.'' Financial Events in 2002 New branches and representative oÇce The Bank opened two new branches and one overseas representative oÇce during the year. The Sacramento Branch opened for business on September 9, 2002. The Brooklyn Branch opened for business on June 27, 2002, and became our third branch in the New York area. On April 20, 2002, we opened a representative oÇce in Shanghai, China. Acquisition of deposit accounts of the New York branch of CITIC International Financial Holdings Limited On November 27, 2002, the Bank entered into a deposit account purchase agreement with CITIC International Financial Holdings Limited, a limited company incorporated in Hong Kong, to purchase and assume certain deposit accounts with an aggregate value not to exceed $10 million, and for a total premium not to exceed $60,000. This transaction is pending regulatory approval. Two-for-one stock split On March 22, 2002, the Bancorp announced that its Board of Directors approved a two-for-one split of the Company's common stock, in the form of a 100% stock dividend, payable May 9, 2002, to stockholders of record on April 19, 2002. Stockholders received one additional share for every one share of Cathay Bancorp common stock held on the record date. The Company common stock had been trading at or near its historic closing highs, and to commemorate the 40th Anniversary of the Bank, the Board of Directors approved the splitting of the Company's common stock to help make it more accessible to a wider range of investors and improve its liquidity. Increase to common stock dividend On March 22, 2002, the Board of Directors of the Bancorp approved a quarterly cash dividend of 14 cents per share on a post-split basis payable April 16, 2002, to stockholders of record on April 1, 2002. This dividend represented a 12 percent increase from the 12.5 cents per share dividend paid on a post-split basis in the previous quarter. Repurchase of common stock In 2002, the Company repurchased a total of 27,500 shares of common stock at an average price of $34.37. At December 31, 2002, the Company is still authorized to purchase an additional $6.71 million under the $15.00 million repurchase program adopted by the Board of Directors in April 2001. Cumulatively through December 31, 2002, the Company has repurchased 305,300 shares of our common stock for $8.29 million. Results of Operations Summary For the year 2002, the Company reported a record consolidated net income of $48.70 million or $2.69 per diluted share, a 14.27% increase in net income compared with net income of $42.62 million or $2.35 per 26 diluted share for 2001, and an increase of 26.21% in net income, when compared with net income of $38.59 million or $2.13 per diluted share for 2000. An increase of $29.34 million in the excess of average interest-earning assets over average deposits and borrowings coupled with changes in the mix of average interest-earning assets and in the mix of average deposits and borrowings, were the main drivers of the total $6.08 million increase to net income between 2002 and 2001. These changes increased our net interest income before provision for loan losses by 11.74%, or $10.94 million, between 2002 and 2001. Net interest income before provision for loan losses for 2002 totaled $104.14 million compared to $93.20 million for 2001. During the same period, non-interest income increased by $1.39 million, reÖecting increases in wire transfer fee income, safe deposit fee income, loan related fee income, and gains on sale of SBA loans. Although we were able to improve our eÇciency ratio to 36.00% in 2002 compared to 37.20% in 2001, the Company's non-interest expense increased by $3.15 million between 2002 and 2001 to $43.32 million, as a result of increases in year-end bonuses and in annual salary adjustments. Net income and key Ñnancial performance ratios are presented below for the three years indicated: 2002 2001 (In thousands, except share and per share data) 2000 Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Return on average assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Return on average stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total average assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total average stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÇciency ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅective income tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ $ $ 48,700 2.71 2.69 1.88% 18.30% $ $ $ 42,620 2.35 2.35 1.82% 18.36% 38,587 2.13 2.13 1.81% 20.09% $2,590,837 $ 266,136 $2,339,669 $ 232,105 $2,126,853 $ 192,117 36.00% 31.40% 37.20% 30.63% 37.33% 36.17% Year 2002 compared to Year 2001 Taxable-Equivalent Interest Income During 2002, we experienced compression to our taxable-equivalent net interest margin due to the declining interest rate environment on a balance sheet that is asset sensitive. During 2001, the Federal Open Market Committee (""FOMC''), lowered the target federal funds rate by 475 basis points in rapid succession during the year. In November 2002, an additional reduction of 50 basis points was approved by the FOMC, bringing the total decrease to 525 basis points during the past two years. As a commercial bank, most of our loans are variable-rate, and reprice each time there is a change in the target Federal funds rate. In response to these conditions, we made eÅorts to manage our interest-earning assets by increasing average loans, which yield higher than other types of investments, and made eÅorts to obtain lower cost core deposits, thus optimizing the mix of our deposit portfolios. The impact of these eÅorts allowed us to maintain our taxable- equivalent margin well above the 4.00% mark during 2002, and increased our taxable-equivalent net interest income by $11.04 million to $106.29 million compared with $95.25 million for 2001. On a combined basis, these changes to our balance sheet should position us to slightly reduce our exposure to declining interest rates, while also eÅectively allowing us to take advantage of market interest rates in the event they move upward. The increase of $11.04 million to taxable-equivalent interest income was due to a combination of the following: ‚ Increase in volume: Average interest-earning assets increased $252.52 million, to $2.42 billion in 2002, an increase of 11.66% over interest-earning assets of $2.17 billion in 2001. The increase in total interest-earning assets contributed an additional $17.35 million to taxable-equivalent interest income between 2002 and 2001. 27 ‚ Decrease in rate: As mentioned above, the rapidly declining interest rate environment was the main factor behind our decrease in taxable-equivalent interest income in 2002, resulting in a $32.54 million decrease to taxable-equivalent interest income due to rate changes. The taxable-equivalent yield on interest-earning assets decreased 141 basis points from 7.45% in 2001 to 6.04% in 2002. ‚ Change in the mix of interest earning assets: Average net loans of $1.72 billion, which yield higher than other types of investments, increased by $205.25 million in 2002 and comprised 71.30% of total average interest-bearing assets compared with 70.14% in 2001. Conversely, total average investment securities as a percentage of total average interest-earning assets declined to 26.63% in 2002 compared to 28.21% in 2001, and equaled $644.27 million in 2002 compared with $611.21 million in 2001. Interest Expense Interest expense decreased by $26.23 million to $39.92 million in 2002 compared with $66.15 million in 2001. The reason for the decrease was a combination of the repricing of deposits in a lower interest rate environment, and a change in the mix of these deposits, partially oÅset by increases in volume, more particularly described as follows: ‚ Increase in volume: Average interest-bearing liabilities increased $178.16 million in 2002, and added $5.53 million of additional interest expense in 2002. ‚ Decrease in rate: As a result of the lower interest rate environment during 2002, the average cost of interest-bearing liabilities decreased 162 basis points to 1.98% in 2002 compared with 3.60% in 2001, decreasing interest expense by $31.77 million. The average cost of funds on total deposits and borrowings, which includes non-interest-bearing demand deposits, decreased by 146 basis points to 1.74% in 2002 compared with 3.20% in 2001. ‚ Change in the mix of deposits and borrowings: As a percentage of total average deposits and borrowings, average time deposits of $100,000 or more decreased to 41.35% for 2002 compared with 42.39% during 2001. For the year 2002, total average deposits and borrowings increased by $223.18 million, of which 57.58% or $128.49 million of the total increase was comprised of average core deposits, while the remaining 42.18% or $94.65 million was comprised of average time deposits of $100,000 or more and borrowings. Taxable-Equivalent Net Interest Margin The excess of average interest-earning assets over average deposits and borrowings increased by $29.34 million in 2002 to $126.96 million compared with $97.63 million in 2001. The taxable-equivalent net interest margin, deÑned as taxable-equivalent net interest income to average interest-earning assets decreased one basis point from 4.40% in 2001 to 4.39% in 2002. Year 2001 compared to Year 2000 Taxable-Equivalent Interest Income Taxable-equivalent interest income decreased $4.89 million or 2.94% to $161.40 million in 2001, largely as a result of actions taken by the Federal Open Market Committee (""FOMC''), which lowered the target federal funds rate by 475 basis points during the year. The $4.89 million decrease in taxable-equivalent interest income was due to a combination of the following: ‚ Increase in volume: Average interest-earning assets increased $239.83 million, to $2.17 billion in 2001, an increase of 12.45% over interest-earning assets of $1.93 billion in 2000. The increase in volume was primarily attributable to the increase in average net loans of $206.37 million, which contributed an additional $18.12 million to interest income. ‚ Decrease in rate: The taxable-equivalent yield on interest-earning assets decreased 118 basis points from 8.63% in 2000 to 7.45% in 2001. As a result of the lower interest rate environment, the interest yield earned on average net loans decreased 168 basis points from 9.62% to 7.94%, decreasing interest 28 income on net loans by $23.87 million. The decrease in yield of average interest-earning assets was primarily due to eleven consecutive drops in interest rates by the FOMC. ‚ Change in the mix of interest earning assets: Average net loans of $1.52 billion, which yield higher than other types of investments, increased by $206.37 million in 2001 and comprised 70.14% of total average interest-bearing assets compared with 68.16% in 2000. Conversely, total average securities increased by $9.97 million and comprised 28.21% of total average interest-earning assets in 2001 compared with 31.21% in 2000. Interest Expense Interest expense decreased by $8.00 million to $66.15 million in 2001 compared with $74.16 million in 2000, primarily due to a combination of the following: ‚ Increase in volume: Average interest-bearing liabilities increased $149.05 million in 2001, and added $6.76 million of additional interest expense in 2001. ‚ Decrease in rate: As a result of the lower interest rate environment during 2001, the average cost of interest-bearing liabilities decreased 79 basis points to 3.60% in 2001 compared with 4.39% in 2000, decreasing interest expense by $14.76 million. The average cost of funds on deposits and borrowings, which includes non-interest-bearing demand deposits, decreased by 70 basis points to 3.20% in 2001 compared with 3.90% in 2000. ‚ Change in the mix of deposits and borrowings: Average time deposits of $1.29 billion increased by $169.62 million and comprised 62.21% of total deposits and borrowings in 2001 compared to 58.74% of total deposits and borrowings in 2000. Other borrowed funds decreased by $41.22 million to $3.08 million in 2001. Average savings deposits, which include savings accounts, NOW accounts and money market accounts increased by $33.25 million to $496.94 million in 2001, average non-interest- bearing demand deposits increased by $17.62 million to $229.59 million in 2001 compared with $211.98 million in 2000, and securities sold under agreements to repurchase decreased by $7.49 million to $32.34 million in 2001. Taxable-Equivalent Net Interest Margin As a result of the eleven interest rates cuts by the FOMC during 2001, the Company's taxable-equivalent net interest margin, deÑned as taxable-equivalent net interest income to average interest-earning assets, decreased 38 basis points from 4.78% in 2000 to 4.40% in 2001. The Company was asset sensitive in the short- term scenario, which resulted in lower yielding assets and lagging time deposits in 2001. Net interest income before provision for loan losses for 2002, 2001, and 2000 are summarized below: Net interest income before provision for loan lossesÏÏÏÏÏÏÏÏÏÏÏ Taxable-equivalent net interest income before provision for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 $104,141 2001 (In thousands) $93,199 2000 $90,397 $106,294 $95,250 $92,132 29 Taxable-Equivalent Net Interest Income Ì Changes Due to Rate and Volume(1) 2002-2001 Increase (Decrease) in Net Interest Income Due to: Changes in Rate Total Change Changes in Volume 2001-2000 Increase (Decrease) in Net Interest Income Due to: Changes in Rate Changes in Volume Total Change Interest-Earning Assets Federal funds sold and securities purchased under agreements to resellÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities available-for-sale (In thousands) $ 488 $ (991) $ (503) $ 938 $ (308) $ 630 (Taxable)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,127 (1,977) 1,150 (12) (487) (499) Securities available-for-sale (Nontaxable)(2)ÏÏÏÏÏÏÏÏÏÏÏ (37) 2 (35) 14 (3) 11 Securities held-to-maturity (Taxable)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,515) (1,437) (2,952) (371) 34 (337) Securities held-to-maturity (Nontaxable)(2)ÏÏÏÏÏÏÏÏÏÏÏ Agency preferred stock(2)ÏÏÏÏÏ Deposits with other banks ÏÏÏÏÏ Loans(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total increase (decrease) in 32 320 (59) 14,996 98 (377) 35 (27,894) 130 (57) (24) (12,898) (29) 1,169 45 18,119 (7) (93) (29) (23,865) (36) 1,076 16 (5,746) interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,352 (32,541) (15,189) 19,873 (24,758) (4,885) Interest-Bearing Liabilities Savings deposits, NOW accounts, and others ÏÏÏÏÏÏÏÏ Time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase ÏÏÏÏ Other borrowed funds ÏÏÏÏÏÏÏÏÏ Advances from the Federal Home Loan Bank ÏÏÏÏÏÏÏÏÏÏ Mortgage indebtedness ÏÏÏÏÏÏÏÏ Total increase (decrease) in 690 3,672 (2,945) (28,542) (2,255) (24,870) 524 8,441 (2,700) (10,346) (2,176) (1,905) (172) 23 (50) (101) (222) (78) (564) (1,379) (423) (1,361) (987) (2,740) 1,319 (127) 1,192 (251) (14) 70 Ì (181) (14) interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,532 (31,765) (26,233) 6,757 (14,760) (8,003) Changes in net interest income ÏÏÏ $11,820 $ (776) $ 11,044 $13,116 $ (9,998) $ 3,118 (1) Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated proportionately to changes due to volume and changes due to rate. (2) The amount of interest earned on certain securities of states and political subdivisions and other securities held have been adjusted to a fully taxable-equivalent basis, using eÅective federal income tax rate of 35%. (3) Amounts are net of allowance for loan losses of $24,543,000 in 2002, $23,973,000 in 2001, and $21,967,000 in 2000, and net of unamortized deferred loan fees of $4,606,000 in 2002, $3,900,000 in 2001, and $4,139,000 in 2000. 30 The following table sets forth information concerning average interest-earning assets, average interest- bearing liabilities, and the yields and rates paid on those assets and liabilities. Average outstanding amounts included in the table are daily averages. Interest-Earning Assets and Interest-Bearing Liabilities 2002 Year Ended December 31, 2001 (Dollars in thousands) 2000 Interest-Earnings Assets Federal Funds Sold and Securities Purchased Under Agreements to Resell Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ 48,966 1.66% 813 $ $ 32,397 4.06% 1,316 $ $ 11,053 6.21% 686 Securities Available-for-Sale, Taxable Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities Available-for-Sale, Nontaxable Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities Held-to-Maturity, Taxable Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities Held-to-Maturity, Nontaxable Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Agency Preferred Stock Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deposits with Other Banks Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans(1) Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 250,197 $ 196,934 $ 197,004 5.54% 13,867 226 7.96% 18 6.46% 12,717 693 7.65% 53 6.71% 13,216 510 8.24% 42 $ $ $ $ $ $ $ $ $ $ 299,398 $ 324,760 $ 330,841 5.75% 17,215 69,529 7.54% 5,243 24,923 5.35% 1,333 894 3.58% 32 $ $ $ $ $ $ $ 6.21% 20,167 69,096 7.40% 5,113 19,722 7.05% 1,390 3,264 1.72% 56 $ $ $ $ $ $ $ 6.20% 20,504 69,478 7.41% 5,149 3,398 9.24% 314 1,124 3.56% 40 $ $ $ $ $ $ $ $1,724,796 $1,519,548 $1,313,177 6.24% 7.94% 9.62% $ 107,693 $ 120,591 $ 126,337 31 Total Interest-Earning Assets Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average yield(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest earned(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-Bearing Liabilities Savings Deposits(3) Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest paid or accrued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Time Deposits Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest paid or accrued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities Sold Under Agreements to Repurchase Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest paid or accrued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Borrowed Funds Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest paid or accrued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Advances from the Federal Home Loan Bank Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest paid or accrued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage Indebtedness Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paid(6)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest paid or accrued(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Interest-Bearing Liabilities Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount of interest paid or accrued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-Interest-Bearing Demand Deposits Average outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 Year Ended December 31, 2001 (Dollars in thousands) 2000 $2,418,929 $2,166,414 $1,926,585 6.04% 7.45% 8.63% $ 146,214 $ 161,403 $ 166,288 $ 565,289 $ 496,942 $ 463,695 0.59% 3,330 $ 1.12% 5,585 $ 1.67% 7,761 $ $1,372,854 $1,286,973 $1,117,350 2.43% 33,409 27,173 3.33% 906 3,680 1.58% 58 48,356 4.58% 2,217 $ $ $ $ $ $ $ 4.53% 58,279 32,342 3.49% 1,128 3,075 4.42% 136 19,863 5.16% 1,025 $ $ $ $ $ $ $ 5.39% 60,184 39,831 5.31% 2,115 44,297 6.49% 2,876 24,809 4.86% 1,206 Ì $ Ì% Ì $ Ì $ Ì% Ì $ 160 8.75% 14 $ $ $ $ $ $ $ $ $ $2,017,352 $1,839,195 $1,690,142 1.98% 3.60% 4.39% $ 39,920 $ 66,153 $ 74,156 $ 274,614 $ 229,592 $ 211,975 Total deposits and borrowed fundsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average rate paid on deposits and borrowed funds ÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,291,966 $2,068,787 $1,902,117 1.74% 3.20% 3.90% 32 Net Interest Income(7)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest rate spread(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest margin on interest-earning assets(4)(7) ÏÏÏÏÏÏÏÏÏÏÏ 2002 Year Ended December 31, 2001 (Dollars in thousands) $ 95,250 $ $ 106,294 4.30% 4.39% 4.25% 4.40% 2000 92,132 4.73% 4.78% (1) Non-accrual loans are included in the average balance. (2) The average yield has been adjusted to a fully taxable-equivalent basis for certain securities of states and political subdivisions and other securities held using an eÅective Federal income tax rate of 35%. (3) Savings deposits include NOW accounts and money market accounts. (4) Calculated by dividing net interest income by average outstanding interest-earning assets. (5) Yields and amounts of interest earned include loan fees. (6) Yield and amount of interest paid or accrued include interest paid on senior debts of other real estate owned, either to bring the loans current or to pay oÅ the loans when the Company obtained title to the properties and thereafter. (7) Net interest income, interest rate spread and net interest margin on interest-earning assets have been adjusted to a fully taxable-equivalent basis using an eÅective Federal income tax rate of 35%. The following table highlights the change in the composition of interest-earning asset mix as of December 31, 2002, and 2001: Interest-Earning Asset Mix As of December 31, 2002 As of December 31, 2001 Percentage of Total Interest- Earning Assets Amount Percentage of Total Interest- Earning Assets Amount (Dollars in thousands) Amount Changed From 2001 to 2002 Percentage Changed From 2001 to 2002 Types of Interest-Earning Assets Federal funds sold and Securities purchased under agreements to resell ÏÏÏÏÏÏÏ Securities available-for-saleÏÏÏ Securities held-to-maturity ÏÏÏ Deposits with other banks ÏÏÏÏ Loans (net of allowance for loans losses and unamortized deferred loan fees) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 19,000 248,273 459,452 370 0.74% 9.64 17.84 0.01 $ 13,000 248,958 374,356 1,399 0.57% 10.93 16.44 0.06 $ 6,000 (685) 85,096 (1,029) 46.15% (0.28) 22.73 (73.55) Total interest-earning assets ÏÏ $2,575,173 100.00% $2,277,745 100.00% $297,428 1,848,078 71.77 1,640,032 72.00 208,046 12.69 13.06% Year 2002 compared to Year 2001 Provision for Loan Losses The provision for loan losses represents the charge against current earnings that is determined by management, through a credit review process, as the amount needed to maintain an allowance that management believes is suÇcient to absorb loan losses inherent in the Company's loan portfolio. The provision for loan losses was $6.00 million in 2002 compared with $6.37 million in 2001. For the year 2002, net charge- oÅs equaled $5.43 million or 0.31% of average net loans, primarily as a result of one credit totaling $3.62 million, which Ñled for Chapter 7 protection and was charged-oÅ during the second quarter of 2002. The comparable numbers for the year 2001 were net charge-oÅs of $4.37 million or 0.29% of average net loans, 33 principally to recognize deterioration in two credits that were partially charged-oÅ in the 4th quarter 2001. Also, see ""Allowance for Loan Losses'' in this 2002 Annual Report on Form 10-K. Non-interest Income Securities gains and losses, depository service fees, letters of credit commissions, gains and losses on loan sales, and a wide range of fee-based services provided non-interest income. These fee-based services include among other things wire transfer fees, safe deposit fees, fees on loan related activities, fee income from our Global Investment Services unit, and foreign exchange fees. Non-interest income from all of these activities totaled $16.17 million in 2002 compared with $14.78 million in 2001. The increase of $1.39 million or 9.42% from 2001 to 2002, was primarily due to the following items: ‚ an increase of $658,000 in depository service fee income, an increase of 12.91%, to $5.76 million compared with $5.10 million in 2001. The increase in depository service fees during 2002 was predominantly due to an increase in service charges on deposit accounts, and an increase in investment services fee income from our Global Investment Services unit; ‚ an increase of $1.17 million in other operating income, which includes primarily loan fees, wire transfer fees, safe deposit fees, foreign exchange fees and gain on sale of loans, and which totaled $6.54 million in 2002, compared with $5.37 million in 2001. The increase in other operating income was primarily due to increases in commercial and commercial real estate loan fees, gain on sale of SBA and residential mortgage loans, an increase in wire transfer service fees, and an increase in service fee income from the rental of our safe deposit boxes; ‚ a decrease of $231,000 in securities gains. During the third quarter of 2002, due to our increasing loan demand, and also to take advantage of the lower interest rate environment, we sold investment securities with a carrying value of $20.14 million resulting in gains on sale totaling $1.89 million. In addition, during 2002, investment securities calls and write-downs on venture capital investments resulted in a net gain of $32,000, bringing the total of securities gains to $1.93 million for 2002. The comparable numbers for 2001 were sales of investment securities totaling $21.12 million, resulting in gains of $1.06 million, a gain of $851,000 on a forward rate agreement (""FRA''), and securities calls and write-downs on venture capital investments resulting in a net gain of $251,000, for a total of $2.16 million in securities gains during 2001; and ‚ letters of credit commissions decreased by $205,000 or 9.53%, to $1.95 million in 2002, likely as a result of a continuing uncertainty over the outlook for the U.S. economy from the point of view of some of our importing customers. Non-interest Expense Non-interest expense totaled $43.32 million in 2002, compared with $40.17 million in 2001. The increase of $3.15 million or 7.85% in non-interest expense in 2002 was primarily a combination of the following: ‚ an increase of $2.03 million in salaries and employee beneÑts. Annual salary adjustments, increases in year-end bonuses, and additional employees and salary expense to accommodate our new branches in Union City Ì California, which opened for business on October 2001, Brooklyn Ì New York, which opened for business in June 2002, Sacramento Ì California, which opened for business in September 2002, and our new representative oÇce in Shanghai Ì China, which opened for business in April 2002, drove the increase of $2.03 million in salaries and employee beneÑts in 2002; ‚ an increase of $605,000 in occupancy expense and computer and equipment expense, as a result of our three new branches and our representative oÇce in Shanghai, China; ‚ a decrease of $44,000 in marketing expenses, primarily due to a $250,000 donation towards the establishment of the 911 Healing Hands non-proÑt organization in 2001; 34 ‚ a decrease of $1.36 million in professional services. During 2001, professional services fees in connection with litigation, the formation of the registered investment company of the Bank, and other corporate matters drove the increase of $1.36 million to $5.40 million for 2001 compared with $4.04 million in 2002; and ‚ a decrease of $3.24 million in real estate operations. During the fourth quarter of 2001, non-interest expenses were lowered by a $3.2 million gain on the sale of one other real estate owned commercial property. Despite the $3.15 million increase in non-interest expense during 2002, the eÇciency ratio, deÑned as non-interest expense divided by net interest income before provision for loan losses plus non-interest income, decreased to 36.00% in 2002 compared with 37.20% in 2001. The decrease in the eÇciency ratio for 2002 was primarily the result of the increase in our net interest income before provision for loan losses, coupled with the increase in non-interest income. Income Tax Expense The provision for income taxes was $22.30 million or an eÅective income tax rate of 31.40% for 2002 compared with $18.82 million or an eÅective income tax rate of 30.63% in 2001, and compared with $21.86 million or an eÅective income tax rate of 36.17% in 2000. The eÅective income tax rate during 2002 and 2001 reÖected the income tax beneÑts of a registered investment company subsidiary of the Bank, which provided Öexibility to raise additional capital in a tax eÇcient manner, and additional tax credits earned from qualiÑed low income housing investments. See discussion below in the section entitled ""Factors That May AÅect Future Results'' of this Annual Report on Form 10-K. Year 2001 compared to Year 2000 Provision for Loan Losses The provision for loan losses was $6.37 million in 2001 compared with $4.20 million in 2000. The increase of $2.17 million in 2001 compared with 2000 was primarily due two credits that were partially charged-oÅ in the fourth quarter of 2001. Net charge-oÅs for 2001 were $4.37 million or 0.29% of average net loans compared with charge-oÅs of $1.74 million or 0.13% of average net loans during 2000. Non-interest Income The increase of $2.02 million or 15.86% from 2000 to 2001, was primarily due to the following items: ‚ An increase of $539,000 in depository service fee income, up 11.83%, to $5.10 million in 2001 compared with $4.56 million in 2000; ‚ An increase of $1.07 million in securities gains. The increase was the result of a gain of $1.06 million on investment securities sold during the third quarter 2001. These securities were sold during the third quarter of 2001 and were either callable or scheduled to mature within the 21 months following the end of the third quarter of 2001. In addition, we had a gain of $851,000 on a forward rate agreement (""FRA''). The FRA settled on March 5, 2001; ‚ Letters of credit commissions decreased by $287,000 or 11.77%, to $2.15 million in 2001, as a result of a slowdown of overseas purchases from some of our importing customers; and ‚ Other operating income, which includes primarily loan fees, wire transfer fees, safe deposit fees, and foreign exchange fees were $5.37 million, up $699,000, compared with $4.67 million in 2000. 35 Non-interest Expense Non-interest expense totaled $40.17 million in 2001, compared with $38.50 million in 2000. The increase of $1.66 million or 4.31% in non-interest expense in 2001, was primarily a combination of the following: ‚ an increase of $954,000 in salaries and employee beneÑts, primarily due to annual salary adjustments for the Bank's employees; ‚ an increase of $277,000 in marketing expenses, primarily due to a $250,000 donation towards the establishment of the 911 Healing Hands non-proÑt organization and fund to help with relief eÅorts in response to the terrible events of September 11, 2001; ‚ an increase of $1.77 million in professional services, primarily due to legal fees in connection with litigation, and corporate matters; ‚ an increase of $1.57 million in investments in real estate, primarily due to operational losses from low income housing investments that qualify for investment tax credits; and ‚ a decrease of $3.40 million in real estate operations, primarily due to a $3.38 million gain on the sale of other real estate owned. The eÇciency ratio, deÑned as non-interest expense divided by net interest income before provision for loan losses plus non-interest income, improved to 37.20% in 2001 compared with 37.33% in 2000. The improvement in our eÇciency ratio for 2001 was primarily the result of the increase in our net interest income before provision for loan losses, coupled with the increase in non-interest income. Income Tax Expense The eÅective tax rate in 2001 was 30.63% compared with 36.17% in 2000. The decline in the eÅective tax rate in 2001 was the result of a registered investment company subsidiary of the Bank, which provided Öexibility to raise additional capital in a tax eÇcient manner, and additional tax credits earned from qualiÑed low income housing investments. See discussion below in the section entitled ""Factors That May AÅect Future Results'' of this Annual Report on Form 10-K. Review of Financial Condition Total assets increased $300.88 million or 12.27% to $2.75 billion at December 31, 2002, compared with total assets of $2.45 billion at December 31, 2001. The major changes in the Consolidated Statements of Condition during 2002 are listed below: ‚ Total net loans grew $208.05 million or 12.69% to $1.85 billion, based on strong net growth in commercial mortgage loans and commercial loans. ‚ Total securities increased $84.41 million or 13.54% to $707.73 million. ‚ Total deposits increased by $192.30 million or 9.06% to $2.31 billion. The majority of the growth in deposits or 66.65% was achieved from a strong growth in lower-cost core deposits. ‚ Federal Home Loan Bank (""FHLB'') borrowings and securities sold under agreements to repurchase increased 50.63% to $78.50 million. ‚ Other liabilities increased by $42.4 million primarily as a result of the purchase of $33.55 million of securities in December 2002, which did not settle until January 2003. ‚ Stockholders' equity rose 17.05% to $287.96 million. 36 Securities Under our investment policy, we classify the Company's investment securities portfolio as follows: ‚ Those securities for which we have the positive intent and ability to hold until maturity, are classiÑed as securities held-to-maturity, and carried at amortized cost. ‚ Those securities which could be sold in response to changes in interest rates, changes in prepayment risk, increases in loan demand, the need to increase regulatory capital, general liquidity needs, or other similar factors are classiÑed as securities available-for-sale, and carried at estimated fair value, with unrealized gains or losses, net of deferred taxes, reÖected in stockholders' equity. ‚ Securities held-to-maturity are transferred to the available-for-sale category when those securities are within 90 days to maturity, to further enhance the Company's liquidity. Securities available-for-sale represented 11.38% of average interest-earning assets for 2002 compared with 10.03% for 2001. The fair value of securities available-for-sale (""AFS'') at December 31, 2002, was $248.27 million compared with $248.96 million at December 31, 2001. The portfolio is comprised primarily of U.S. government agency securities, corporate bonds, agency preferred equity securities, and venture capital investments. Securities available-for-sale are carried at fair value and had a net unrealized gain of $9.53 million at December 31, 2002, compared with $7.17 million at December 31, 2001. The increase in unrealized holding gains from year-end 2001 resulted from the Öattening of the yield curve during 2002, as a result of the decreasing interest rate environment, uncertainties regarding general economic conditions, and war and terrorism. These unrealized gains do not impact net income and are recorded as adjustments to stockholders' equity, net of related deferred income taxes. Also, see Note 3 to the Consolidated Statements of Condition. During 2002, the Bank sold AFS securities with a net book value of $20.14 million. These AFS securities sales resulted in gains of $1.89 million, exclusive of gains on calls of securities of $359,000 and $341,000 in write-downs on AFS venture capital investments. The gain on sale from AFS securities was related to the sale of U.S. government agency notes and corporate bonds. The Company's AFS venture capital investments include investments in private equity funds, and at December 31, 2002, had a fair value of $4.06 million. During 2002, $341,000 in write-downs were recorded compared to write-downs of $65,000 in 2001. These write-downs were necessitated by the continued weakness in the economy and capital markets. Management's assessment of the fair value of AFS venture capital investments is based on several factors including: available information about the funds, the general partners' fair value assessments, current economic conditions, available market comparables, eÅectiveness of the funds' management teams, and other factors. Accordingly, the fair value estimates could diÅer signiÑcantly among parties using diÅerent assumptions or judgments, and may not necessarily represent amounts that will ultimately be realized. Securities held-to-maturity (""HTM'') represented 15.25% of average interest-earning assets for 2002 compared with 18.18% for 2001. HTM securities at December 31, 2002 increased by $85.10 million to $459.45 million compared with $374.36 million at December 31, 2001. The increase in HTM securities during 2002 was primarily the result of purchases of collateralized mortgage obligations during the fourth quarter of 2002, of which $33.55 million settled in January 2003. The portfolio is comprised primarily of U.S. agencies mortgage-backed-securities, corporate bonds, state and municipal securities, U.S. government agency securi- ties, and collateralized mortgage obligations. HTM securities are carried at cost, and at December 31, 2002, had a fair value of $477.78 million. The average taxable-equivalent yield on our total investment securities dropped 60 basis points to 5.85% in 2002, compared with 6.45% in 2001 as some matured or call securities were replaced at lower prevailing interest rates. 37 The following table summarizes the carrying value of our portfolio of securities for each of the past three years: 2002 As of December 31, 2001 (In thousands) 2000 Securities Available-for-Sale: U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset-backed securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Money market fund ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $170,183 100 6,147 847 10,510 Ì 33,069 27,417 $118,324 Ì 8,543 2,705 10,395 20,000 60,334 28,657 $ 78,317 1,277 13,207 5,804 10,370 Ì 60,370 8,451 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $248,273 $248,958 $177,796 Securities Held-to-Maturity U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset-backed securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 49,996 72,770 66,135 168,055 9,999 72,611 19,886 $ 50,017 69,906 110,342 50,282 920 73,031 19,858 $ 64,689 68,820 135,494 48,694 13,156 56,347 Ì Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $459,452 $374,356 $387,200 38 The scheduled maturities and taxable-equivalent yields by security type are presented in the following tables: Securities Available-for-Sale Portfolio Maturity Distribution and Yield Analysis: One Year or Less After One Year to Five Years As of December 31, 2002 After Five Years to Ten Years (Dollars in thousands) Over Ten Years Total Maturity Distribution: U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations(1) ÏÏÏÏÏÏÏ Asset-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì $150,154 Ì 90 847 10,510 17,027 Ì 100 Ì Ì Ì 10,201 27,417 $20,029 Ì 1,033 Ì Ì 5,841 Ì $ Ì $170,183 100 6,147 847 10,510 33,069 27,417 Ì 5,024 Ì Ì Ì Ì Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $37,718 $178,628 $26,903 $5,024 $248,273 Weighted-Average Yield: U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations(1) ÏÏÏÏÏÏÏ Asset-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity securities(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì% 7.60 Ì Ì Ì 7.85 3.88 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.03% 4.90% Ì 5.69 5.86 5.69 5.48 Ì 5.01% 4.01% Ì 6.56 Ì Ì 7.61 Ì 4.80% Ì% Ì 7.12 Ì Ì Ì Ì 7.12% 4.79% 7.60 7.00 5.86 5.69 6.60 3.88 5.03% (1) Securities reÖect stated maturities and not anticipated prepayments. (2) Average yield has been adjusted to a fully-taxable equivalent basis. 39 Securities Held-to-Maturity Portfolio Maturity Distribution and Yield Analysis One Year or Less After One Year to Five Years As of December 31, 2002 After Five Years to Ten Years (Dollars in thousands) Over Ten Years Total Maturity Distribution: U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities(2)ÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations(1) ÏÏÏÏÏ Asset-backed securities(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì $ 49,996 11,998 5,782 2,243 9,999 32,638 9,986 725 Ì Ì Ì 18,987 Ì $ Ì $ 25,073 39,023 48,508 Ì 20,986 9,900 Ì $ 49,996 72,770 66,135 168,055 9,999 72,611 19,886 34,974 21,330 117,304 Ì Ì Ì Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $19,712 $122,642 $143,490 $173,608 $459,452 Weighted-Average Yield: U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities(2)ÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations(1) ÏÏÏÏÏ Asset-backed securities(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì% 11.37 Ì Ì Ì 5.82 Ì Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.03% 5.47% 8.30 4.89 7.31 4.27 5.94 4.86 5.73% Ì% Ì% 7.54 6.03 4.94 Ì 6.70 5.70 7.00 7.10 4.19 Ì Ì Ì 6.00% 5.10% 5.47% 7.46 6.25 4.45 4.27 6.13 5.28 5.59% (1) Securities reÖect stated maturities and not anticipated prepayments. (2) Average yield has been adjusted to a fully-taxable equivalent basis. Loans Loans, net of deferred loan fees, represented 72.27% of average interest-earning assets during 2002 compared with 71.22% during 2001. Gross loans, exclusive of deferred loan fees, increased by $209.32 million, an increase of 12.55%, to $1.88 billion at year-end 2002 compared with $1.67 billion at year-end 2001. The growth was primarily attributable to the following: ‚ Commercial mortgage loans are typically secured by Ñrst deeds of trust on commercial properties, including primarily commercial retail properties, shopping centers and owner-occupied industrial facilities, and secondarily oÇce buildings, multiple-unit apartments, and multi-tenanted industrial properties. In addition, the Bank provides medium-term commercial real estate loans secured by commercial or industrial buildings where the owner either uses the property for business purposes or derives income from tenants. Commercial mortgage loans increased $205.01 million or 27.77% to $943.39 million at year-end 2002, compared to $738.38 million at year-end 2001. Total commercial mortgage loans accounted for 50.25% of gross loans at year-end 2002 compared to 44.27% at year-end 2001. ‚ Commercial loans consist primarily of short-term loans (normally with a maturity of up to one year) to support general business purposes, or to provide working capital to businesses in the form of lines of credit to Ñnance trade-Ñnance loans, and SBA loans. Commercial loans were up $57.55 million or 11.37% to $563.68 million at December 31, 2002, compared to $506.13 at December 31, 2001. The Company is continuing to focus primarily on commercial lending to small-to-medium size businesses, 40 within the Company's geographic market area. The third quarter of 2002 brought an additional challenge, as an unresolved labor dispute forced all of the PaciÑc Coast ports to close for approximately one week. This disruption to international trade did not have a material impact to the Bank's trade- Ñnance loan portfolio. The portfolio of SBA loans at December 31, 2002, equaled $19.37 million compared with $17.56 million at December 31, 2001. During 2002, the Bank sold $7.75 million of SBA loans, resulting in a gain on sale of loans of $411,000. ‚ Real estate construction loans decreased $43.64 million or 26.23% to $122.77 million at year-end 2002 compared to $166.42 million at year-end 2001. Our construction loan projects are located primarily in California, Texas, Nevada, and New York. Due to the recessionary economy, projects requiring construction Ñnancing declined during 2002. ‚ Residential mortgage loans decreased by $4.54 million or 1.93% to $231.37 million at year-end 2002, compared to $235.91 million at year-end 2001. Included with our residential mortgage loans are our home equity line of credit loans. At December 31, 2002, the portfolio of home equity lines of credit was $48.96 million, an increase of 21.32%, from $40.35 million at year-end 2001. The portfolio of residential mortgage loans, excluding the home equity line of credit loan portfolio, decreased by $13.15 million to $182.41 million at year-end 2002. New loan originations and reÑnances total $79.19 million in 2002, which was partially oÅset by loan sales in 2002 totaling $7.05 million, and payments and payoÅs during the year totaling $85.29 million. Residential mortgage loans sold in 2002, excluding home equity lines of credit, totaled $7.05 million, and resulted in a gain on sale of loans of $22,400. ‚ Installment loans decreased $4.75 million, down 23.38% to $15.57 million at December 31, 2002, compared to $20.32 million at December 31, 2001. These consumer-oriented loans are funded primarily for the purpose of Ñnancing the purchase of automobiles and other personal use of the borrower. The classiÑcation of loans by type as of December 31 for each of the past Ñve years, as well as the changes in loan portfolio composition for the past two years and the contractual maturity of the loan portfolio as of December 31, 2002 are presented below: Loan Type and Mix 2002 Amount Outstanding as of December 31, 2000 1999 (In thousands) 2001 1998 Type of Loans: Commercial loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Residential mortgage loans ÏÏÏÏÏÏÏÏÏÏ Commercial mortgage loans ÏÏÏÏÏÏÏÏÏ Real estate construction loans ÏÏÏÏÏÏÏÏ Installment loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 563,675 231,371 943,391 122,773 15,570 447 $ 506,128 235,914 738,379 166,417 20,322 745 $ 442,181 220,720 630,662 142,048 27,329 473 $ 395,138 207,725 577,384 62,516 25,498 419 $370,539 184,158 356,608 40,738 29,165 269 Gross loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,877,227 1,667,905 1,463,413 1,268,680 981,477 Less: Allowance for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏ Unamortized deferred loan feesÏÏÏÏÏÏÏ (24,543) (4,606) (23,973) (3,900) (21,967) (4,139) (19,502) (3,593) (15,970) (3,631) Net loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,848,078 $1,640,032 $1,437,307 $1,245,585 $961,876 41 Changes in Loan Portfolio Composition As of December 31, 2002 As of December 31, 2001 Amount Percentage of Total Loans Amount (Dollars in thousands) Percentage of Total Loans Percentage Increase (Decrease) Type of Loans: Commercial loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Residential mortgage loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial mortgage loansÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate construction loans ÏÏÏÏÏÏÏÏÏÏÏ Installment loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Allowance for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unamortized deferred loan fees ÏÏÏÏÏÏÏÏÏÏ $ 563,675 231,371 943,391 122,773 15,570 447 (24,543) (4,606) 30.50% $ 506,128 235,914 12.52 738,379 51.05 166,417 6.64 20,322 0.84 745 0.02 (23,973) (1.32) (3,900) (0.25) 30.86% 14.38 45.02 10.15 1.24 0.05 (1.46) (0.24) 11.37% (1.93) 27.77 (26.23) (23.38) (40.00) 2.38 18.10 Net loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,848,078 100.00% $1,640,032 100.00% 12.69% Contractual Maturity of Loan Portfolio(1),(2) Within One Year One to Five Years Over Five Years Total (In thousands) Commercial Loans Floating rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Residential Mortgage Loans Floating rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial Mortgage Loans Floating rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real Estate Construction Loans Floating rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Installment Loans Floating rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $338,783 104,173 $ 66,923 5,675 $ 40,291 7,346 $ 445,997 117,194 1,104 6,546 231,855 63,416 11,017 Ì Ì 7,956 56,085 166,938 424,196 144,293 Ì Ì Ì Ì 57,303 173,512 725,140 215,303 112,371 9,784 Ì 15,570 114 28 69,089 7,594 101,354 9,784 Ì 7,614 42 Within One Year One to Five Years Over Five Years Total (In thousands) Other Loans Floating rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 446 Total loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $638,979 Floating rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $509,340 129,639 Total loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $638,979 Allowance for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì $394,492 $310,899 83,593 $394,492 Ì 1 Ì 447 $839,150 $1,872,621 $520,572 318,578 $1,340,811 531,810 $839,150 $1,872,621 (24,543) $1,848,078 (1) In the normal course of business, loans are renewed, extended, or prepaid from time to time; therefore, the above should not be viewed as an indication of future cash Öows. (2) Loans are net of unamortized deferred loan fees. Other Real Estate Owned Other Real Estate Owned, net of a valuation allowance of $131,000, decreased to $653,000 at December 31, 2002, compared with $1.56 million at year-end 2001. As of December 31, 2002, there were two outstanding owned properties, which included one parcel of land, and one commercial building. Both properties are located in California. During 2002, we acquired two single-family residential (""SFR'') properties, and sold Ñve SFR properties, two of which were the two properties acquired in 2002. The carrying value of the Ñve properties sold was approximately $1.31 million, and the sales resulted in gains on sale of $395,000. To reduce the carrying value of other real estate owned to the estimated fair value of the properties, we maintain a valuation allowance for owned properties. We perform periodic evaluations on each property and make corresponding adjustments to the valuation allowance, if necessary. Any decline in value is recognized by a corresponding increase to the valuation allowance, which is included in other real estate owned expense, in the current period. Management did not make any additional provision for losses in 2002. We recognized net operating income of $349,000 from operating owned properties in 2002 compared to net operating income of $3.59 million in 2001, and net operating income of $185,000 in 2000. Operating income declined from $348,000 in 2001 to $166,000 in 2002. Although the California real estate market continued to show strength in 2002, the future performance of the market is unpredictable. See ""Factors That May AÅect Future Results'' below for a discussion of some of the factors that may aÅect the matters discussed in this Section. The following table shows the components of other real estate owned expense (income) for the years ended: Other Real Estate Owned Expense (Income) by Type 2002 Net operating expense (income)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net gains on disposal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 46 Ì (395) 2001 (In thousands) $ (213) Ì (3,376) 2000 $ 7 71 (263) Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(349) $(3,589) $(185) 43 Investments in Real Estate As of December 31, 2002, our investments in real estate were comprised of seven limited partnerships, three of which were acquired in 2002. We acquired an interest in the Lend Lease ITC XXIII in March 2002 for $4.87 million, an interest in the WNC Institutional Tax Credit Fund X New York Ì Series 3 in August 2002 with an initial commitment of $577,000, and an interest in the WNC Institutional Tax Credit California Fund X Ì Series 2, with an initial contribution of $415,000 in September 2002, and an additional contribution of $122,000 in October 2002. The limited partnerships are formed for the purpose of investing in low income housing projects, which qualify for federal and/or state low income housing tax credits. As of December 31, 2002, investments in real estate increased $3.95 million to $21.68 million from $17.73 million at year-end 2001. During 2002, we recognized $2.04 million in net operating losses from the limited partnerships, compared to $2.26 million in net operating losses in 2001. The following table summarizes the composition of our investments in real estate as of the dates indicated: Percentage of Ownership Acquisition Date (Dollars in thousands) December 31, 2002 December 31, 2001 Carrying Amount Las Brisas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Los Robles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ California Corporate Tax Credit Fund III ÏÏ Wilshire CourtyardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Lend Lease ITC XXIII ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WNC Institutional Tax Credit Fund X New York Ì Series 3 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WNC Institutional Tax Credit Fund X 49.5% 99.0% 32.5% 99.9% 4.5% December 1993 August 1995 March 1999 May 1999 March 2002 4.2% August 2002 California Ì Series 2 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.0% September 2002 $ Ì 386 11,128 4,568 4,546 529 521 $ Ì 386 12,426 4,915 Ì Ì Ì $21,678 $17,727 Deposits The Bank uses primarily customer deposits to fund its operations, and to a lesser extent borrowings in the form of securities sold under agreements to repurchase, and advances from the Federal Home Loan Bank. The Bank deposits are generally obtained from residents within the Bank's geographic market area. The Bank utilizes traditional marketing methods to attract new customers and deposits, by oÅering a wide variety of products and services and utilizing various forms of advertising media. Although the Bank's vast majority of the Bank's deposits are retail in nature, the Bank does engage in certain wholesale activities, primarily accepting time deposits from political subdivisions and public agencies. The Bank considers wholesale deposits to be an alternative borrowing source rather than a customer relationship, and as such, their levels are determined by management's decisions as to the most economic funding sources. At December 31, 2002, the Bank had no brokered-deposits, and public deposits totaled $90.31 million or 3.90% of total deposits. ‚ The Bank's total deposits increased $192.30 million or 9.06% from $2.12 billion at year-end 2001 to $2.31 billion at December 31, 2002. ‚ Core deposits increased $128.16 million or 10.68%. The increase in core deposits, deÑned as total deposits less time deposits of $100,000 or more, was attributable to increases of $42.40 million in non- interest bearing demand deposits, up 16.28%, to $302.83 million at year-end 2002 compared with $260.43 million at year-end 2001, NOW accounts and money market accounts, which increased by 13.66% or $37.21 million to $309.67 million at December 31, 2002, compared with $272.46 million at year-end 2001, savings accounts, which increased by $37.90 million to $290.23 million compared with 44 $252.32 million at year-end 2001, and time deposits under $100,000, which increased by 2.57% or $10.65 million to $425.14 million compared with $414.49 million at year-end 2001. ‚ Time deposits of $100,000 or more (""Jumbo CDs'') increased $64.13 million or 6.95% to $986.79 mil- lion in 2002 compared with $922.65 million in 2001. The following table displays the deposit mix for the past three years: Deposit Mix 2002 Amount Percentage Year Ended December 31, 2001 Amount (Dollars in thousands) Percentage 2000 Amount Percentage $ 302,828 148,085 161,580 290,226 425,138 13.08% $ 260,427 135,650 6.40 136,806 6.98 252,322 12.54 414,490 18.37 12.27% $ 221,805 125,647 119,805 231,761 379,809 6.39 6.45 11.89 19.53 11.82% 6.70 6.38 12.35 20.24 986,786 42.63 922,653 43.47 797,620 42.51 Demand ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOW accounts ÏÏÏÏÏÏÏÏÏÏÏ Money market accounts ÏÏÏÏ Savings depositsÏÏÏÏÏÏÏÏÏÏÏ Time deposits under $100 ÏÏ Time deposits of $100 or more ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,314,643 100.00% $2,122,348 100.00% $1,876,447 100.00% Average total deposits grew $199.20 million or 9.89% to $2.21 billion during 2002 compared with average total deposits of $2.01 billion in 2001. ‚ Average core deposits increased $128.49 million or 11.31%. ‚ Average Jumbo CDs increased $70.76 million or 8.07%. The following table displays average deposits and rates for the past Ñve years: Average Deposits and Rates 2002 2001 2000 1999 1998 Amount % Amount % Amount % Amount % Amount % (Dollars in thousands) Demand ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 274,568 Ì% $ 229,592 Ì% $ 211,975 Ì% $ 169,013 Ì% $ 166,657 Ì% NOW accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Money market accountsÏÏÏÏÏÏÏ Savings deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏ 139,589 154,414 271,286 Time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,372,854 0.30 0.99 0.51 2.43 128,973 129,629 238,340 1,286,973 0.75 1.74 0.99 4.53 122,851 112,817 228,027 1,117,350 1.20 2.32 1.61 5.39 117,374 99,628 207,498 1,001,878 1.22 1.59 1.54 4.69 111,900 99,833 205,372 900,441 1.42 2.11 2.10 5.11 TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,212,711 1.66% $2,013,507 3.17% $1,793,020 3.79% $1,595,391 3.33% $1,484,203 3.58% As interest rate spreads broadened between Jumbo CDs and other types of interest-bearing deposits under the prevailing interest rate environment, our Jumbo CD portfolio maintained faster growth than other types of deposits. Nevertheless, management considers our Jumbo CDs generally less volatile primarily due to the following reasons: ‚ approximately 68.48% of the Bank's Jumbo CDs have stayed with the Bank for more than two years; ‚ the Jumbo CD portfolio continued to be diversiÑed with 4,684 individual accounts averaging approximately $192,000 per account owned by 3,266 individual depositors as of January 14, 2003; and 45 ‚ this phenomenon of having a relatively higher percentage of Jumbo CDs to total deposits exists in most of the Asian American banks in our California market due to the fact that the customers in this market tend to have a higher savings rate. Management continues to monitor the Jumbo CD portfolio to identify any changes in the deposit behavior in the market and of the patrons the Bank is servicing. To discourage the concentration in Jumbo CDs, management has continued to make eÅorts in the following areas: ‚ to oÅer only retail interest rates on Jumbo CDs; ‚ to oÅer new transaction-based products, such as the tiered money market deposits; ‚ to promote transaction-based products from time to time, such as demand deposits; and ‚ to seek to diversify the customer base by branch expansion and/or acquisition as opportunities arise. Almost 87.94% of our Jumbo CDs mature within one year as of year-end 2002. The following tables display time deposits of $100,000 or more by maturity and time deposits with remaining term of more than one year at December 31, 2002: Time Deposits of $100,000 or More by Maturity Less than three months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Three to six months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Six to twelve months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Over one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ At December 31, 2002 (In thousands) $393,032 270,500 204,249 119,005 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $986,786 Maturities of Time Deposits with a Remaining Term of More Than One Year for Each of the Five Years Following December 31, 2002 (In thousands) 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $146,464 78,779 616 402 82 Borrowings Borrowings include securities sold under agreements to repurchase (""reverse repurchase agreements''), federal funds purchased, and funds obtained as advances from the Federal Home Loan Bank (""FHLB'') of San Francisco. Securities sold under agreements to repurchase at December 31, 2002, equaled $28.50 million, an increase of $6.39 million or 28.88% from $22.11 million at December 31, 2001. The weighted-average interest rate during 2002 was 3.08% compared to 3.51% during 2001. The underlying collateral pledged for the repurchase agreement consists of a U.S. government agency security with a carrying value of $29,972,000, and a fair value of $31,172,000 as of December 31, 2002, which is held by a custodian, and maintained under the Company's control. The $28.50 million balance at year-end was comprised of a reverse repurchase agreement 46 obtained in January 2002, which is long-term, and will mature in January 2004. The table below provides comparative data for securities sold under agreements to repurchase: Average amount outstanding during the year(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏ Maximum amount outstanding at month-end(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏ Balances, December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rate at year-end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average interest rate for the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 $30,784 48,150 28,500 December 31, 2001 (In thousands) $34,799 55,412 22,114 2000 $ 70,701 110,145 68,173 3.29% 3.08% 1.01% 3.51% 6.09% 6.25% (1) Average balances were computed using daily averages. (2) Highest month-end balances were January in 2002, February 2001, and October 2000. Advances from the Federal Home Loan Bank of San Francisco (""FHLB'') amounted to $50.00 million at December 31, 2002, and $30.00 million at December 31, 2001. Of the Bank's $50.00 million in FHLB advances outstanding at December 31, 2002, $10.00 million bearing interest at 4.90% was obtained in 1998 and matures on October 28, 2003, $20.00 million bearing interest at 3.48% was obtained in 2002 and matures on February 27, 2004, and $20.00 million bearing interest at 5.45% was obtained in 2001 and matures on March 21, 2005. These advances are non-callable with Ñxed interest rates. Capital Resources Stockholders' Equity We obtain capital primarily from retained earnings and to a lesser extent, the issuance of additional common stock through our Dividend Reinvestment Plan and options exercised. Stockholders' equity of $287.96 million was up $41.95 million or 17.05% compared to $246.01 million at December 31, 2001. Our stockholders' equity equaled 10.46% of total assets at December 31, 2002, compared 10.03% of total assets at year-end 2001. The increase of $41.95 million or 17.05% in stockholders' equity was due to the following: ‚ an addition of $48.70 million from net income less payments of dividends on common stock of $9.80 million; ‚ an increase of $2.34 million from issuance of additional common shares through the Dividend Reinvestment Plan and proceeds from exercise of stock options less the purchase of 27,500 shares of treasury stock during 2002, at an average price of $34.37, totaling $945,000; ‚ an increase of $1.66 million in accumulated other comprehensive income, including: ‚ a favorable diÅerence of $1.33 million in the net unrealized holding gains on securities available-for- sale, net of tax; and ‚ an increase of $326,000 from unrealized gains on cash Öow hedging derivatives, net of tax. On March 22, 2002, our Board of Directors approved and announced a two-for-one stock split of the Company's common stock, in the form of a 100% stock dividend, payable May 9, 2002, to stockholders of record on April 19, 2002. The Board of Directors also approved a 12% increase in the quarterly cash dividend from 12.5 cents per share to 14 cents per share on a post-split basis, payable April 16, 2002, to stockholders of record on April 1, 2002. On a post-split basis, we declared cash dividends of 12.5 cents per common share in January 2002 on 17,957,736 shares outstanding, cash dividends of 14 cents in April 2002 on 17,973,720 shares outstanding, cash dividends of 14 cents in July 2002 on 18,001,002 shares outstanding, and cash dividends of 14 cents in October 2002 on 18,006,544 shares outstanding. Total cash dividends paid in 2002 amounted to $9.80 million. 47 On April 6, 2001, the Board of Directors approved a stock repurchase program of up to $15 million of our common stock. The Company intends to repurchase shares under the program, from time to time, in the open market or through negotiated purchases, under conditions which allow such repurchases to be accretive to earnings, while maintaining capital ratios that exceed the guidelines for a ""well capitalized'' Ñnancial institution. During 2002 and on a post-split basis, the Company repurchased 27,500 shares at an average price of $34.37 per share. On a post-split basis, cumulatively through December 31, 2002, the Company has repurchased 305,300 shares of our common stock for $8.29 million. On February 19, 1998, our Board of Directors adopted an ""Equity Incentive Plan'' (""the Plan'') which was approved by stockholders at the April 20, 1998, Annual Meeting of Stockholders. The Plan will expire on February 18, 2008. The following information is provided on a post-split basis: ‚ On September 17, 1998, we granted 90,000 shares of common stock options with an exercise price of $16.50 per share to eligible senior oÇcers and directors. ‚ On January 20, 2000, we granted 110,000 shares of common stock options with an exercise price of $21.25 per share to eligible oÇcers and directors. ‚ On January 18, 2001, we granted 111,000 shares, and on March 15, 2001, we granted 1,800 shares of common stock options with an exercise price of $30.10 per share to eligible oÇcers and directors. ‚ On February 21, 2002, we granted 113,440 shares of common stock options with an exercise price of $32.55 per share to eligible oÇcers and directors. ‚ On January, 16, 2003, we granted 215,000 shares of common stock options with an exercise price of $39.85 per share to eligible oÇcers and directors. Management seeks to retain the Company's capital at a level suÇcient to support future growth, to protect depositors and stockholders, to absorb any unanticipated losses and to comply with various regulatory requirements. Under California State banking law, the Bank may not pay a cash dividend, without regulatory approval, which exceeds the lesser of the Bank's retained earnings or its net income for the last three Ñscal years, less any cash distributions made during that period. The amount of retained earnings available for cash dividends as of December 31, 2002, is restricted to approximately $103,076,000 under this regulation. Capital Adequacy Management seeks to retain the Company's capital at a level suÇcient to support future growth, protect depositors and stockholders, and comply with various regulatory requirements. The primary measure of capital adequacy is based on the ratio of risk-based capital to risk-weighted assets. At year-end 2002, Tier 1 risk-based capital ratio of 11.93%, total risk-based capital ratio of 13.01%, and Tier 1 leverage capital ratio of 10.11%, continued to place the Company in the ""well capitalized'' category, which is deÑned as institutions with Tier 1 risk-based capital ratio equal to or greater than six percent, Tier 1 leverage capital ratio equal to or greater than Ñve percent, and total risk-based capital ratio equal to or greater than ten percent. The comparable ratios for 2001 were Tier 1 risk-based capital ratio of 11.15%, total risk- based capital ratio of 12.30%, and Tier 1 leverage capital ratio of 9.48%. A table displaying the Company and the Bank's capital and leverage ratios at year-end 2002 and 2001 is included in Note 10 to the Consolidated Financial Statements. Risk Elements of the Loan Portfolio Non-performing Assets Non-performing assets include loans past due 90 days or more and still accruing interest, non-accrual loans, and other real estate owned. The Company's policy is to place loans on a non-accrual status if interest and principal or either interest or principal is past due 90 days or more, or in cases where management deems 48 the full collection of principal and interest unlikely. After a loan is placed on non-accrual status, any interest accrued in the previous three months is generally reversed against current income. Thereafter, any payment is generally Ñrst applied towards the principal balance. Depending on the circumstances, management may elect to continue the accrual of interest on certain past due loans if partial payment is received and/or the loan is well collateralized and in the process of collection. The loan is generally returned to accrual status when the borrower has brought the past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled. Management reviews the loan portfolio regularly for problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of the loan agreements. Such loans are placed under closer supervision with consideration given to placing the loan on non-accrual status, the need for an additional allowance for loan losses, and (if appropriate) partial or full charge-oÅ. Our non-performing assets decreased $2.24 million or 23.59% to $7.25 million at year-end 2002 compared to $9.48 million at year-end 2001. The decrease was due to a combination of the following: ‚ An increase of $1.78 million in loans past due 90 days or more and still accruing interest; ‚ A decrease of $3.11 million in non-accrual loans; and ‚ A decrease of $902,000 in other real estate owned. As a percentage of gross loans plus other real estate owned, our non-performing assets decreased to 0.39% at year-end 2002 from 0.57% at year-end 2001. The non-performing loan coverage ratio, deÑned as the allowance for loan losses to non-performing loans, increased to 372.31% at year-end 2002, which was higher than that of 302.42% at year-end 2001. The increase was primarily due to the reduction of $3.11 million in non-accrual loans. On January 3, 2003, one accruing commercial mortgage loan past due 90 days or more, in the amount of $1.10 million was paid oÅ, and on January 31, 2003, one non-accrual construction loan in the amount of $1.66 million was paid oÅ. 49 The following table presents the breakdown of total non-accrual, past due, and restructured loans for the past Ñve years: Non-accrual, Past Due and Restructured Loans 2002 2001 1999 1998 December 31, 2000 (Dollars in thousands) Accruing loans past due 90 days or more ÏÏÏÏÏÏÏÏÏ Non-accrual loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,468 4,124 $ Total non-performing loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,592 Real estate acquired in foreclosure ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 653 689 7,238 7,927 1,555 $ 589 14,696 $ 3,724 13,696 $ 4,683 13,090 15,285 17,420 5,174 4,337 17,773 10,454 Total non-performing assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,245 $ 9,482 $20,459 $21,757 $28,227 Troubled debt restructurings(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-performing assets as a percentage of gross $ 5,266 $ 4,474 $ 4,531 $ 4,581 $ 4,642 loans and other real estate owned at year-endÏÏÏÏ 0.39% 0.57% 1.39% 1.71% 2.85% Allowance for loan losses as a percentage of non- performing loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 372.31% 302.42% 143.72% 111.95% 89.86% (1) Troubled debt restructurings are accruing interest at their restructured terms. The eÅect of non-accrual loans and troubled debt restructurings on interest income for the past Ñve years is presented below: Non-accrual Loans Contractual interest due ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest recognized ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $321 34 Net interest foregone ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $287 $823 96 $727 $1,408 627 $1,396 234 $1,395 112 $ 781 $1,162 $1,283 2002 2001 2000 1999 1998 (In thousands) Troubled Debt Restructurings Contractual interest due ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest recognized ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $338 258 Net interest foregone ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 80 $409 370 $ 39 $ 422 407 $ 429 414 $ 421 412 $ 15 $ 15 $ 9 2002 2001 2000 1999 1998 (In thousands) Non-accrual loans Non-accrual loans were $4.12 million at year-end 2002 and $7.24 million at year-end 2001. Non-accrual loans at December 31, 2002, consisted mainly of thirteen commercial loans totaling $1.93 million, one construction loan totaling $1.66 million, two commercial mortgage loans totaling $254,000, and three residential mortgage loans totaling $264,000. The comparable numbers for 2001 were $4.85 million in sixteen commercial loans, $1.82 million on one construction loan, $374,000 in two commercial mortgage loans, and $189,000 in two residential mortgage loans. On January 31, 2003, one non-accrual construction loan in the amount of $1.66 million was paid oÅ. 50 The following tables present the type of properties securing the loans and the type of businesses the borrowers engaged in under commercial mortgage and commercial non-accrual loan categories as of the dates indicated: December 31, 2002 December 31, 2001 Real Estate(1) Commercial Real Estate(1) Other (In thousands) Commercial Other Type of Collateral Single/multi-family residence ÏÏÏÏÏÏÏÏÏ Commercial real estate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LandÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ UCCÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unsecured ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 386 132 1,658 Ì Ì Ì TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,176 $ 117 1,099 425 278 Ì 9 $1,928 $Ì Ì Ì Ì 17 3 $20 $ 441 122 1,821 Ì Ì Ì $2,384 $ 266 839 Ì 3,647 Ì 102 $4,854 $Ì Ì Ì Ì Ì Ì $Ì (1) Real estate includes commercial mortgage loans, real estate construction loans, and residential mortgage loans. December 31, 2002 December 31, 2001 Real Estate(1) Commercial Real Estate(1) Other (In thousands) Commercial Other Type of Business Real estate development ÏÏÏÏÏÏÏÏÏÏÏÏÏ Wholesale/Retail ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Food/RestaurantÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Import ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,658 Ì Ì Ì Ì 518 $ 96 1,557 13 127 Ì 135 TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,176 $1,928 $Ì Ì Ì Ì Ì 20 $20 $1,821 122 Ì Ì Ì 441 $2,384 $ 27 3,421 701 400 Ì 305 $4,854 $Ì Ì Ì Ì Ì Ì $Ì (1) Real estate includes commercial mortgage loans, real estate construction loans, and residential mortgage loans. Commercial mortgage, real estate construction, and residential mortgage non-accrual loans ‚ $1.66 million of the balance represented one credit secured by Ñrst trust deed on land, which paid oÅ on January 31, 2003. ‚ The remaining balance of $518,000 consisted of two credits secured by Ñrst trust deeds on one single- family-residence and on one commercial property. Commercial non-accrual loans ‚ UCC-1 Ñlings, mainly accounts receivable and inventories, secured Ñve loans totaling $278,000. ‚ The balance of $1.65 million consisted of six credits secured primarily by Ñrst trust deeds on multi- family-residences or commercial buildings and warehouses, and one unsecured credit. 51 Troubled debt restructurings A troubled debt restructuring is a formal restructure of a loan when the lender, for economic or legal reasons related to the borrower's Ñnancial diÇculties, grants a concession to the borrower. The concessions may be granted in various forms, including reduction in the stated interest rate, reduction in the loan balance or accrued interest, and extension of the maturity date. Troubled debt restructurings, including those on non-accrual status, increased $1.93 million to $6.40 mil- lion at December 31, 2002, compared to $4.47 million at December 31, 2001. At December 31, 2002, all trouble debt restructured loans were performing under their revised terms, except for two credits totaling $1.13 million, which were not delinquent, but management choose to placed both credits on non-accrual status, due to credit concerns. These two credits are included with other non-accrual loans. The increase from year-end 2001 was primarily due two credits totaling $5.35 million that were restructured during the year, partially oÅset by credits that paid-oÅ during the year or were performing for an extended period of time and removed from troubled debt restructured classiÑcation. Impaired loans A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement based on current circumstances and events. We consider all loans classiÑed and restructured in our evaluation of loan impairment. The classiÑed loans are stratiÑed by size, and loans less than our deÑned selection criteria are treated as a homogeneous portfolio. If loans meeting the deÑned criteria are not collateral dependent, we measure the impairment based on the present value of the expected future cash Öows discounted at the loan's eÅective interest rate. If loans meeting the deÑned criteria are collateral dependent, we measure the impairment by using the loan's observable market price or the fair value of the collateral. If the measurement of the impaired loan is less than the recorded amount of the loan, we then recognize impairment by creating or adjusting an existing valuation allowance with a corresponding charge to the provision for loan losses. We identiÑed impaired loans with a recorded investment of $19.59 million at year-end 2002, compared to $19.35 million at year-end 2001. The average balance of impaired loans was $24.76 million in 2002 and $23.47 million in 2001. Interest collected on impaired loans totaled $1.22 million in 2002, and $959,000 in 2001. On January 31, 2003, one impaired construction loan on non-accrual status, with a recorded investment of $1.66 million, was paid oÅ. The following tables present a breakdown of impaired loans and the related allowances as of the dates indicated: At December 31, 2002 At December 31, 2001 Recorded Investment Allowance Commercial ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real Estate(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,883 15,707 1 $ 629 2,356 1 Net Balance Recorded Investment (In thousands) $ 3,254 13,351 Ì $ 6,924 12,426 Ì Allowance Net Balance $2,143 1,764 Ì $ 4,781 10,662 Ì TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $19,591 $2,986 $16,605 $19,350 $3,907 $15,443 (1) Real Estate includes commercial mortgage loans, real estate construction loans, and residential mortgage loans. In addition, accruing loans past due 90 days or more had an outstanding balance of $2.50 million at year- end 2002 compared with $689,000 at year-end 2001. On January 3, 2003, one accruing commercial mortgage loan past due 90 days or more, with a recorded investment of $1.10 million, was paid oÅ. 52 Loan Concentration We experienced no loan concentrations to multiple borrowers in similar activities which exceeded 10% of total loans as of December 31, 2002. See ""Factors That May AÅect Future Results'' below for a discussion of some of the factors that may aÅect the matters discussed in this Section. Allowance for Loan Losses The Bank's management is committed to managing the risk in its loan portfolio by maintaining the allowance for loan losses at a level that is considered to be equal to the estimated and known risks in the loan portfolio. With a risk management objective, the Bank's management has an established monitoring system that is designed to identify impaired and potential problem loans, and to permit periodic evaluation of impairment and the adequacy level of the allowance for loan losses in a timely manner. In addition, our Board of Directors has established a written loan policy that includes an eÅective loan review and control system to ensure that the Bank maintains an adequate allowance for loan losses. The Board of Directors provides oversight for the allowance evaluation process, including quarterly evaluations, and judge that it is adequate to absorb estimated losses in the loan portfolio. The determination of the amounts of the allowance for loan losses and the provision for loan losses is based on management's current judgment about the credit quality of the loan portfolio and takes into consideration known relevant internal and external factors that aÅect collectibility when determining the appropriate level for the allowance for loan losses. The nature of the process by which the Bank determines the appropriate allowance for loan losses requires the exercise of considerable judgment. Additions to the allowance for loan losses are increased by charges to the provision for loan losses. IdentiÑed credit exposures that are determined to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged oÅ amounts, if any, are credited to the allowance for loan losses. A sustained weakness or further weakening of the economy or other factors that adversely aÅect asset quality could result in an increase in the number of delinquencies, bankruptcies, or defaults, and a higher level of non-performing assets, net charge-oÅs, and provision for loan losses in future periods. See ""Factors That May AÅect Future Results,'' in this Annual Report on Form 10-K, for additional factors that could cause actual results to diÅer materially from forward-looking statements or historical performance. 53 The following table sets forth the information relating to the allowance for loan losses, charge-oÅs, and recoveries for the past Ñve years: Allowance for Loan Losses 2002 Amount Outstanding as of December 31, 2000 1999 (Dollars in thousands) 2001 1998 Balance at beginning of year ÏÏÏÏÏÏÏÏÏ Provision for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans charged-oÅ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries of charged-oÅ loansÏÏÏÏÏÏÏ $ $ $ 23,973 6,000 (5,976) 546 21,967 6,373 (4,663) 296 19,502 4,200 (1,905) 170 $ 15,970 4,200 (1,731) 1,063 $ 15,379 3,600 (3,519) 510 Balance at end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 24,543 $ 23,973 $ 21,967 $ 19,502 $ 15,970 Average net loans outstanding during year ended ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ratio of net charge-oÅs to average net loans outstanding during the year ÏÏÏ Provision for loan losses to average net loans outstanding during the year ÏÏÏ Allowance to non-performing loans at year-end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Allowance to gross loans at year-end ÏÏ $1,724,796 $1,519,548 $1,313,177 $1,088,578 $907,639 0.31% 0.29% 0.13% 0.06% 0.33% 0.35% 0.42% 0.32% 0.39% 0.40% 372.31% 1.31% 302.42% 1.44% 143.72% 1.50% 111.95% 1.54% 89.86% 1.63% Commercial loans accounted for $5.66 million in charge-oÅs during 2002, primarily as a result of one credit totaling $3.62 million that was identiÑed and reported as a non-accrual loan during the Ñrst quarter 2002. The charge-oÅ of this credit was a direct result of the borrower's Ñling a petition for protection under a Chapter 7 Bankruptcy. During 2002, total charge-oÅs equaled $5.98 million, an increase of $1.31 million or 28.16% over total charge-oÅs of $4.66 million in 2001. Net charge-oÅs for 2002 amounted to $5.43 million or 0.31% of average net loans outstanding at December 31, 2002. By comparison, the total net charge-oÅs for 2001 were $4.37 million, or 0.29% of average net loans outstanding. The following tables summarizes loan charge-oÅ and recovery activity by loan type in the allowance for loan losses for the years indicated: Loan Charged-oÅ by Loan Type Commercial loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Percentage of total commercial loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 $5,663 2001 Year Ended December 31, 2000 (Dollars in thousands) $ 537 1999 $1,116 $3,465 1998 $2,394 1.00% 0.68% 0.12% 0.28% 0.65% Real estate loans(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Percentage of total real estate loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 163 $1,080 $1,066 $ 388 $ 873 0.01% 0.09% 0.11% 0.05% 0.15% Installment and other loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Percentage of total installment and other loans(1)ÏÏÏÏÏÏÏ $ 150 $ 118 $ 302 $ 227 $ 252 0.94% 0.56% 1.09% 0.88% 0.86% Total loans charged-oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,976 $4,663 $1,905 $1,731 $3,519 (1) Percentages were calculated based on year-end balances. (2) Real estate loans include commercial mortgage loans, real estate construction loans, and residential mortgage loans. 54 Recoveries by Loan Type Commercial loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Installment and other loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 $242 268 36 Year Ended December 31, 2000 1999 2001 (In thousands) $ 74 3 93 $ 761 181 121 $196 11 89 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $546 $296 $170 $1,063 1998 $188 280 42 $510 (1) Real estate loans include commercial mortgage loans, real estate construction loans, and residential mortgage loans. Our allowance for loan losses consists of the following: ‚ SpeciÑc allowance: For impaired loans, we provide speciÑc allowances based on an evaluation of impairment, and for each criticized loan, we allocate a portion of the general allowance to each loan based on a loss percentage assigned. The percentage assigned depends on a number of factors including loan classiÑcation, the current Ñnancial condition of the borrowers and guarantors, the prevailing value of the underlying collateral, charge-oÅ history, management's knowledge of the portfolio and general economic conditions. ‚ General allowance: The unclassiÑed portfolio is segmented on a group basis. Segmentation is determined by loan type and by identifying risk characteristics that are common to the groups of loans. The allowance is provided to each segmented group based on the group's historical loan loss experience, the trends in delinquency, and non-accrual, and other signiÑcant factors, such as national and local economy, trends and conditions, strength of management and loan staÅ, underwriting standards and the concentration of credit. The total allowance for loan losses consists of the above two components: speciÑc and general. To determine the adequacy of the allowance in each of these two components, the Bank employs two primary methodologies, the classiÑcation migration and the individual loan review analysis methodology. These methodologies support the basis for determining allocations between the various loan categories and the overall adequacy of the Bank's allowance to provide for probable losses inherent in the loan portfolio. These methodologies are further supported by additional analysis of relevant factors such as the historical losses in the portfolio, trends in the non-performing/non-accrual loans, loan delinquencies, the volume of the portfolio, peer group comparisons, and federal regulatory policy for loan and lease losses. Other signiÑcant factors of portfolio analysis include changes in lending policies/underwriting standards, portfolio composition, and concentrations of credit, and trends in the national and local economy. With these above methodologies, the speciÑc allowance is for those loans internally classiÑed and risk graded as Special Mention, Substandard, Doubtful, or Loss. Additionally, the Bank's management allocates a speciÑc allowance for ""Impaired Credits,'' in accordance with SFAS No. 114 ""Accounting by Creditors for Impairment of a Loan.'' The level of the general allowance is established to provide coverage for management's estimate of the credit risk in the loan portfolio by various loan segments not covered by the speciÑc allowance. 55 The table set forth below reÖects management's allocation of the allowance for loan losses by loan category and the ratio of each loan category to the total loans as of the dates indicated: Allocation of Allowance for Loan Losses As of December 31, 2002 2001 2000 1999 1998 Percentage of Loans in Each Category to Average Amount Gross Loans Amount Gross Loans Amount Gross Loans Amount Gross Loans Amount Gross Loans Percentage of Loans in Each Category to Average Percentage of Loans in Each Category to Average Percentage of Loans in Each Category to Average Percentage of Loans in Each Category to Average Type of Loans: Commercial (Dollars in thousands) loans ÏÏÏÏÏÏÏÏ $11,812 29.73% $11,504 29.61% $10,231 30.00% $ 8,546 35.06% $ 7,468 38.58% Residential mortgage loans 1,466 13.26 2,181 14.86 808 15.61 1,743 18.15 1,901 18.46 Commercial mortgage loans 8,458 47.25 7,702 42.19 8,564 45.25 7,781 39.95 5,815 35.16 Real estate construction loans ÏÏÏÏÏÏÏÏ Installment loans Other loans ÏÏÏÏ 2,610 181 16 8.80 0.92 0.04 2,386 11.73 1,855 197 3 1.57 0.04 380 129 7.11 1.99 0.04 843 464 125 4.30 2.46 0.08 365 414 7 4.77 2.98 0.05 Total ÏÏÏÏÏÏÏÏ $24,543 100.00% $23,973 100.00% $21,967 100.00% $19,502 100.00% $15,970 100.00% Total commercial loans have grown from $506.13 million at year-end 2001 to $563.68 million at year-end 2002, with the large portion of this growth being in asset-based lending category, including the issuance of letters of credit through the Bank's International Department. While this segment has been steadily growing (with the exception of the Ñrst quarter of 2002), the growth rate has been slower during the fourth quarter with a continued sluggish economic recovery as evidenced by an $11.39 million increase during the fourth quarter of 2002 compared with $21.68 million growth during the third quarter of 2002. Delinquencies over 90 days in this segment correspondingly peaked in the fourth quarter of 2001, at $15.28 million, before trending downward to $9.44 million by year-end 2002, as the growth rate subsided. Allocated allowances increased slightly from $11.50 million at year-end 2001, to $11.81 million at year-end 2002, after applying loan charge-oÅs of $5.66 million during 2002. However, in view of the recent losses experienced by the Bank in the asset-based lending category, management has deemed it prudent to increase the minimum loss rate allocation to 2.25% as compared to the 2.20% on September 30, 2002, since there is a certain degree of continued economic sluggishness and uncertainty in the direction of the economy. Residential mortgage loans decreased to $231.37 million at December 31, 2002, from $235.91 million at year-end 2001, after rising to $232.22 million at September 30, 2002, based on a 1% growth level in originations, and based on usually low interest rates during the third quarter and fourth quarter from rate sensitive borrowers. While delinquencies over 90 days have been trending downward from the fourth quarter of 2001, rising unemployment in a sluggish early stage economic recovery in the fourth quarter of 2002, has caused a corresponding $1.53 million rise in delinquency in the fourth quarter of 2002, compared with $880,000 at the end of the third quarter 2002. Even though actual charge-oÅs have not occurred in this segment over the last year, management has nevertheless determined that it is prudent to allocate an allowance for $1.47 million at year-end 2002 in this loan category, in view of the current origination volume and the rise in credit risks associated with increases in unemployment during a sluggish recovery in the economy. Commercial mortgage loans grew 27.77% or $205.01 million during 2002 while the allowance allocation increased $756,000 or approximately 9.82% to a level of $8.46 million from $7.70 million in 2001. Most of the growth in this loan segment during 2002 took place in the third and fourth quarters, and was primarily a direct result of unusually low interest rates to rate sensitive borrowers. Although the volume has increased, 56 there has been no concentration of hotels or motels, but has consisted primarily of shopping centers, commercial oÇce buildings, warehouses, apartment structures, and represents approximately 50.25% of the Bank's gross loans. Delinquencies over 90 days in this loan segment have ranged from a high of $11.19 million in the Ñrst quarter of 2002, to a low of $3.33 million in the second quarter of 2002, with an average delinquent amount of $7.26 million. Total delinquency in this segment rose to $9.73 million in the fourth quarter 2002, but was 8.87% below the year-end 2001 total of $10.68 million. Within this delinquency aggregate, 90° day delinquent accounts have fallen from $2.83 million at March 31, 2002, to $443,000 at December 31, 2002, a substantial decrease, while non-accrual loans have also decreased from $374,000 at year-end 2001, to $254,000 by the end of 2002. Loan losses have been nominal during the last nine quarters despite the variance in delinquencies. However, management expects that the debt service capability of borrowers during 2003 will depend to some degree on the direction of the economy, which, thus far, has shown only a gradual recovery from the recent recession. Because of the increased volume in this loan segment coupled with a sluggish recovery, and an uncertain degree of impact on the real estate variables (such as appreciation, rate sensitivity, debt service capability, and long-term proÑtability) that drive these types of loans, management has reached the conclusion to increase the allowance in this segment by a prevailing minimum risk factor allocation rate. Unlike the commercial mortgage loans, the outstanding construction loans have continued to decrease in 2002, and as of the fourth quarter the balance of this segment was $122.77 million compared to $166.42 mil- lion at year-end 2001. Delinquency over 90 days in this segment has correspondingly decreased from $11.49 million at year-end 2001, to $3.97 million by the fourth quarter 2002, with the reduction in loan volume and the resolution of two of four major delinquent loans. Non-accrual loans also moved downward from the 2001 level of $1.82 million to $1.66 million. However, even though the loan volume and delinquency have decreased, the allocated allowances have remained approximately $2.61 million for the last two consecutive quarters of 2002. While the allowance has decreased from the Ñrst quarter of 2002, the Bank believes it to be prudent to hold the present level of allocation based on the inherent risk nature in this loan segment. More speciÑcally, the primary rationale by the Bank's management for not correspondingly decreasing the allowances as of year-end 2002 in this loan segment is based upon the longer-term higher risk nature of construction projects that have the potential of exceeding the projected interest reserves. Thus far, manage- ment has not observed borrowers encountering above normal diÇculty in obtaining permanent takeout Ñnancing, sizable concentration of commercial oÇce building loans, and an increased number of extensions to the borrower for completion of construction. Management believes that the risk allocation for the construction portfolio should be viewed from a longer economic view given the current weak leasing market for oÇce buildings in Southern and Northern California. Allocated allowances for installment and consumer loans have been gradually declining as the total loan volume in this segment has declined from $20.32 million at year-end 2001 to $15.57 million at year-end 2002. The Bank has not actively competed for this type of loan, but has provided such loans, when necessary, as an accommodation to Bank customers. Delinquencies over 90 days have moved downward nominally from $122,000 at year-end 2001 to $22,000 at year-end 2002. Loans delinquent over 90 days have been eliminated for the last two quarters of 2002. Loans on non-accrual have been nominal throughout 2001 and 2002. Similarly, the charged-oÅ loans have also been nominal with the decreasing loan volume. Management has therefore correspondingly continued to move the allocated allowances downward with the decrease in loan volume from $197,000 at year-end 2001 to the present level of $181,000 at year-end 2002. Allowances for other risks of probable loan losses that amounted to $2.06 million as of December 31, 2002, compared to $1.67 million as of December 31, 2001 have been included in the allocations above. The components of the other risks that have a potential of aÅecting the Bank's portfolio are comprised of two basic elements. First, the Bank has set aside funds to cover the risk factors of a recessionary state of the national economy and the uncertain economic forecast in the short-run. Thus far, the government's eÅorts to stimulate the economy through various monetary policies such as tax cuts and aggressive lowering of interest rates over the last one and three-quarter years have only resulted in the early stage of a sluggishly uncertain recovery as evidenced by eroding consumer conÑdence, weak demand for non-durables, and the lack of business investment. The September 11th event and the current corporate scandals in various large companies and discussions of probable war against Iraq have clouded the economic outlook instead of giving clear visibility to 57 the direction of the economy. The economy could experience a second downturn and companies will not be able to avoid further substantial short falls in sales and earnings, business closures and downsizing, which will result in increased risk to the Bank's portfolio. The second component of other portfolio risk is the potential errors in loan classiÑcation and review methodologies. Based on these two above components of other risks, management has increased the allocation of the allowance. Also, see ""Factors That May AÅect Future Results,'' in this Annual Report on Form 10-K, for additional factors that could cause actual results to diÅer materially from forward-looking statements, or historical performance. Liquidity Liquidity is our ability to maintain suÇcient cash Öow to meet maturing Ñnancial obligations and customer credit needs, and to take advantage of investment opportunities as they are presented in the marketplace. Our principal sources of liquidity are growth in deposits, proceeds from the maturity or sale of securities and other Ñnancial instruments, repayments from securities and loans, federal funds purchased and securities sold under agreements to repurchase and advances from FHLB. At year-end 2002, our liquidity ratio (deÑned as net cash, short-term and marketable securities to net deposits and short-term liabilities) decreased slightly to 29.14%, compared to 30.76% at year-end 2001. To supplement its liquidity needs, the Bank maintains a total credit line of $52.50 million for federal funds with three correspondent banks, and master agreements with six brokerage Ñrms whereby up to $280.00 million would be available through the sale of securities subject to repurchase. The Bank is also a shareholder of the FHLB, which enables the Bank to have access to lower cost FHLB Ñnancing when necessary. At December 31, 2002, the Bank had a total approved credit line with the FHLB of San Francisco totaling $643.63 million. The total credit outstanding with the FHLB of San Francisco at December 31, 2002, was $50.00 million. These advances are non-callable and bear Ñxed interest rates, with $10.00 million maturing in 2003, $20.00 million maturing in 2004, and $20.00 million maturing in 2005. These borrowings are secured by residential mortgages. ""See Note 8 to the Consolidated Financial Statements.'' Liquidity can also be provided through the sale of liquid assets, which consist of federal funds sold, securities sold under agreements to repurchase and securities available-for-sale. At December 31, 2002, such assets at fair value totaled $267.27 million, with $105.91 million pledged as collateral for borrowings and other commitments. The remaining $161.36 million was available as additional liquidity, of which $142.36 was AFS securities, available to be pledged as collateral for additional borrowings. We had a significant portion of our time deposits maturing within one year or less as of December 31, 2002. Management anticipates that there may be some outflow of these deposits upon maturity due to the keen competition in the Bank's marketplace. However, based on our historical runoff experience, we expect the outflow will be minimal and can be replenished through our normal growth in deposits. Management believes all the above-mentioned sources will provide adequate liquidity to the Bank to meet its daily operating needs. The Bancorp obtains funding for its activities primarily through dividend income contributed by the Bank and proceeds from investments in the Dividend Reinvestment Plan and exercise of stock options. Dividends paid to Bancorp by the Bank are subject to regulatory limitations. The business activities of Bancorp consist primarily of the operation of the Bank with limited activities in other investments. Management believes Bancorp's liquidity generated from its prevailing sources are suÇcient to meet its operational needs. Also, see Note 11 Commitments and Contingencies of the Notes to Consolidated Financial Statements, in this Annual Report on Form 10-K. Recent Accounting Pronouncements EÅective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (""SFAS'') No. 142, ""Goodwill and Other Intangible Assets.'' SFAS No. 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed annually for impairment. Upon adoption of SFAS No. 142, the Company was required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the 58 Ñrst interim period. In addition, to the extent an intangible asset is identiÑed as having an indeÑnite useful life, the Company was required to test the intangible asset for impairment in accordance with the provisions of SFAS No. 142. Any impairment loss is measured as of the date of adoption and recognized as the cumulative eÅect of a change in accounting principle in the Ñrst interim period. The Company adopted SFAS No. 142 eÅective January 1, 2002. Upon adoption, the Company discontinued the amortization of goodwill and reclassiÑed $2.33 million from goodwill to core deposit intangible, which is classiÑed under other assets in the Statements of Financial Condition. The Company also reassessed the useful lives and residual value of all intangible assets acquired in purchase business combinations, and tested goodwill for impairment, and found no impairment. In August 2001, the Financial Accounting Standards Board (""FASB'') issued SFAS No. 144, ""Accounting for the Impairment or Disposal of Long-Lived Assets.'' For long-lived assets to be held and used, SFAS No. 144 retains the requirements of SFAS No. 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash Öows and (b) measure an impairment loss as the diÅerence between the carrying amount and fair value. Further, SFAS No. 144 eliminates the requirement to allocate goodwill to long-lived assets to be tested for impairment, describes a probability-weighted cash Öow estimation approach to deal with situations in which alternative courses of action to recover the carrying amount of a long-lived asset are under consideration or a range is estimated for the amount of possible future cash Öows, and establishes a ""primary-asset'' approach to determine the cash Öow estimation period. For long-lived assets to be disposed of by sale, SFAS No. 144 retains the requirements of SFAS No. 121 to measure a long-lived asset classiÑed as held-for-sale at the lower of its carrying amount or fair value less cost to sell and to cease depreciation. Discontinued operations are no longer measured on a net realizable value basis, and future operating losses are no longer recognized before they occur. SFAS No. 144 broadens the presentation of discontinued operations to include a component of an entity, establishes criteria to determine when a long-lived asset is held-for-sale, prohibits retroactive reclassiÑcation of the asset as held- for-sale at the balance sheet date if the criteria are met after the balance sheet date but before issuance of the Ñnancial statements, and provides accounting guidance for the reclassiÑcation of an asset from ""held-for-sale'' to ""held-and-used.'' The provisions of SFAS No. 144 are eÅective for Ñscal years beginning after Decem- ber 15, 2001. The Company adopted SFAS No. 144 eÅective January 1, 2002. Adoption of SFAS No. 144 did not have any impact on the results of operations or Ñnancial condition of the Company. In April 2002, the FASB issued SFAS No. 145, ""Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.'' SFAS No. 145 rescinds the SFAS No. 4 requirement that all gains and losses from extinguishment of debt be aggregated and, if material, classiÑed as an extraordinary item, net of the related income tax eÅect. Henceforth, those gains and losses from extinguishment of debt are to be classiÑed in accordance with the criteria in APB Opinion No. 30, ""Reporting the Results of Operations Ì Reporting the EÅects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.'' SFAS No. 64, which amended SFAS No. 4, is no longer necessary with the rescission of SFAS No. 4. SFAS No. 44 was issued to establish accounting requirements for the eÅects of transition to the provisions of the Motor Carrier Act of 1980. Since the transition has been completed, SFAS No. 44 is no longer necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease modiÑcations that have economic eÅects similar to sale-leaseback transactions to be accounted for in the same manner as sale-leaseback transactions. SFAS No. 145 is eÅective for Ñnancial statements for periods beginning after May 15, 2002, and earlier adoption is recommended. The Company adopted SFAS No. 145 eÅective May 15, 2002. Adoption of SFAS No. 145 did not have any impact on the results of operations or Ñnancial condition of the Company. In July 2002, FASB issued SFAS No. 146, ""Accounting for Costs Associated with Exit or Disposal Activities''. SFAS No. 146 applies to costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities or personnel. Under SFAS No. 146, a company will record a liability for a cost associated with an exit or disposal activity when that liability is incurred and can be measured at fair value. A liability is incurred when an event leaves the company little or no discretion to avoid transferring or using the assets in the future. Previous accounting guidance was provided by the Emerging 59 Issues Task Force (""EITF'') Issue No. 94-3, ""Liability Recognition for Certain Employee Termination BeneÑts and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).'' SFAS No. 146 is eÅective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 did have a material impact on the Company's results of operations or Ñnancial condition. In October 2002, the FASB issued SFAS No. 147, ""Acquisitions of Certain Financial Institutions.'' SFAS No. 147 is an amendment of FASB statements No. 72 and 144 and FASB Interpretation No. 9. The Statement addresses the Ñnancial accounting and reporting for the acquisition of all or part of a Ñnancial institution. It also provides guidance on the accounting for the impairment or disposal of acquired long-term customer relationship intangible assets. The provisions in paragraph 5 of this Statement are eÅective for acquisitions for which the date of acquisition is on or after October 1, 2002. The adoption of this statement had no impact on the Company. In December 2002, the FASB issued SFAS No. 148, ""Accounting for Stock-Based Compensation Ì Transition and Disclosure,'' an amendment of FASB Statement No. 123. This Statement amends FASB Statement No. 123, ""Accounting for Stock-Based Compensation,'' to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim Ñnancial statements. Certain of the disclosure modiÑcations are required for Ñscal years ending after December 15, 2002, and are included in the notes to the consolidated Ñnancial statements. In November 2002, the FASB issued Interpretation No. 45, ""Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34.'' This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual Ñnancial statements about its obligations under guarantees issued. The Interpretation also clariÑes that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modiÑed after December 31, 2002, and are not expected to have a material eÅect on the Company's Ñnancial statements. The disclosure requirements are eÅective for Ñnancial statements of interim and annual periods ending after December 15, 2002. In January 2003, the FASB issued Interpretation No. 46, ""Consolidation of Variable Interest Entities,'' an interpretation of Accounting Research Bulletin No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as deÑned in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For public enterprises, such as the Company, with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation applies no later than the beginning of the Ñrst interim or annual reporting period beginning after June 15, 2003. The application of this Interpretation is not expected to have a material eÅect on the Company's Ñnancial statements. The Interpretation requires certain disclosures in Ñnancial statements issued after January 31, 2003 if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes eÅective. As of December 31, 2002, the Company owned interests in two limited partnerships, for which it is reasonably possible that the limited partnerships may be construed to be variable interest entities subject to consolidation under Interpretation No. 46. Both of these investments were formed for the purpose of investing in low-income housing projects, which qualify for federal low-income housing tax credits and/or California tax credits, and at December 31, 2002, the carrying amount of those investments in real estate was $4.95 million. As of December 31, 2002, the Company had fully satisÑed all capital commitments required under these two investments in real estate, and in addition, under the terms of both limited partnership agreements, the Company is not liable for the debts, liabilities, contracts, or any other obligation of these limited partnerships. Application of Interpretation No. 46 for the Company will be the third quarter of 2003. The Company has not 60 completed its analysis to determine the impact to the Company in adopting the application of Interpretation No. 46. However, the Company expects that the adoption will not have a material impact on the Company's results of operations or Ñnancial position. Factors That May AÅect Future Results The Allowance for Loan Losses is an Estimate of Estimable and Probable Loan Losses. Actual Loan Losses in Excess of the Estimate Could Adversely AÅect Our Net Income and Capital. The allowance for loan losses is based on management's estimate of the estimable and probable losses from our loan portfolio. If actual losses exceed the estimate, the excess losses could adversely aÅect our net income and capital. Such excess could also lead to larger allowances for loan losses in future periods, which could in turn adversely aÅect net income and capital in those periods. Management believes that the allowance for loan losses at December 31, 2002, is adequate to cover estimable and probable losses from its loan portfolio as of that date. If economic conditions diÅer substantially from the assumptions used in the estimate or adverse developments arise with respect to our loans, future losses may occur, and increases in the allowance may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of our allowance. These agencies may require us to establish additional allowances based on their judgment of the information available at the time of their examinations. No assurance can be given that we will not sustain loan losses in excess of present or future levels of the allowance for loan losses. Fluctuations in Interest Rates Could Adversely AÅect Our Business. The interest rate risk inherent in our lending, investing, and deposit taking activities is a signiÑcant market risk to us and our business. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be aÅected uniformly by Öuctuations in interest rates. The magnitude and duration of changes in interest rates, events over which we have no control, may have an adverse eÅect on net interest income. Prepayment and early withdrawal levels, which are also impacted by changes in interest rates, can signiÑcantly aÅect our assets and liabilities. Increases in interest rates may adversely aÅect the ability of our Öoating rate borrowers to meet their higher payment obligations, which could in turn lead to an increase in non-performing assets and net charge-oÅs. Generally, the interest rates on interest-earning assets and interest-bearing liabilities of the Company do not change at the same rate, to the same extent, or on the same basis. Even assets and liabilities with similar maturities or periods of repricing may react in diÅerent degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may Öuctuate in advance of changes in general market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. Certain assets, such as Ñxed and adjustable rate mortgage loans, have features that limit changes in interest rates on a short-term basis and over the life of the asset. We seek to minimize the adverse eÅects of changes in interest rates by structuring our asset-liability composition to obtain the maximum spread. We use interest rate sensitivity analysis and a simulation model to assist us in estimating the optimal asset-liability composition. However, such management tools have inherent limitations that impair their eÅectiveness. There can be no assurance that we will be successful in minimizing the adverse eÅects of changes in interest rates. See also ""Risks Elements of the Loan Portfolio'' and ""Market Risk.'' InÖation May Adversely AÅect Our Financial Performance. The consolidated Ñnancial statements and related Ñnancial data presented in this report have been prepared in accordance with accounting principles generally accepted in the United States. These principles require the measurement of Ñnancial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inÖation. The primary impact of inÖation on the operations of the Company is reÖected in increased operating costs. Virtually all of our assets and liabilities are monetary in nature. As a result, interest rates have a more signiÑcant impact on our 61 performance than the general levels of inÖation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services. As We Expand Our Business Outside of California Markets, We Will Encounter Risks That Could Adversely AÅect Us. We primarily operate in California markets with a concentration of Chinese American individuals and businesses; however, one of our strategies is to expand beyond California into other domestic markets that have concentrations of Chinese American individuals and businesses. We began this expansion with the acquisition of certain assets and assumptions of certain liabilities from Golden City Commercial Bank in New York in 1999 and the opening of the Houston loan production oÇce in Texas, which was subsequently converted into a full-service branch in 2000. In addition, on October 5, 2001, we opened a new branch in Union City, Northern California. In 2002, we opened a new branch in Brooklyn, New York City, and one in Sacramento, California. In addition, with China's accession into the World Trade Organization and its increasing importance in the world economy, we opened a representative oÇce in Shanghai, China. In the course of this expansion, we will encounter signiÑcant risks and uncertainties that could have a material adverse eÅect on our operations. These risks and uncertainties include increased operational diÇculties arising from, among other things, our ability to attract suÇcient business in new markets, to manage operations in noncontiguous market areas, and to anticipate events or diÅerences in markets in which we have no current experience. To the extent that we expand through acquisitions, such acquisitions may also adversely harm our business, if we fail to adequately address the Ñnancial and operational risks associated with such acquisitions. For example, risks can include diÇculties in assimilating the operations, technology and personnel of the acquired company; diversion of management's attention from other business concerns; inability to maintain uniform standards, controls, procedures and policies; potentially dilutive issuances of equity securities; incurrence of additional debt and contingent liabilities; use of cash resources; large write-oÅs; and amortiza- tion expenses related to other intangible assets with Ñnite lives. The Company Could Be Adversely AÅected by Potential Changes in California Tax Law and Delays in Implementation of Its Strategy. Our eÅective income tax rate was lower in 2002, 2001, and 2000 due in large part to income tax beneÑts derived from a registered investment company subsidiary of the Bank. We had relied on the California tax law related to registered investment companies and on an outside tax opinion. In January 2002, a change to that law was proposed that would have denied these tax beneÑts retroactively for the earlier years, as well as prospectively for future years. This proposed change was not enacted, but another proposal was recently introduced in the California Legislature, which would deny such tax beneÑts from and after January 1, 2003. In December, 2002, we decided to deregister the registered investment company and, in January, 2003, we applied to the Securities and Exchange Commission for such deregistration. Also in January, 2003, as an alternative to the registered investment company, we applied for regulatory approval to create a real estate investment trust. We received such regulatory approval in February, 2003, and have started operating the real estate investment trust and building up its assets. While the real estate investment trust should provide some tax beneÑts in 2003, our eÅective income tax rate for 2003 is expected to be higher than the rate in the past few years. The actual rate for 2003 will depend to some extent on the timing of the build up in the asset levels of the trust, as well as on the interest rate and regulatory environment. Adverse Economic Conditions in California and Other Regions Where the Bank Has Operations, Could Cause Us to Incur Losses. Our banking operations are concentrated primarily in Southern and Northern California, and secondarily in Nevada, Texas, and New York. Adverse economic conditions in these regions could impair borrowers' ability to service their loans, decrease the level and duration of deposits by customers, and erode the value of loan collateral, such as, the currently unknown impact of the California budged deÑcit. These events could 62 increase the amount of our non-performing assets and have an adverse eÅect on our eÅorts to collect our non- performing loans or otherwise liquidate our non-performing assets (including other real estate owned) on terms favorable to us. Real estate securing our lending activities is also principally located in Southern and Northern California, and to a lesser extent, in Houston, Texas, and New York City. The value of such collateral depends upon conditions in the relevant real estate markets. These include general or local economic conditions and neighborhood characteristics, real estate tax rates, the cost of operating the properties, governmental regulations and Ñscal policies, acts of nature including earthquakes, Öood and hurricanes (which may result in uninsured losses), and other factors beyond our control. The Risks Inherent in Construction Lending May Adversely AÅect Our Net Income. The risk inherent in construction lending may adversely aÅect our net income. Such risks include, among other things, the possibility that contractors may fail to complete, or complete on a timely basis, construction of the relevant properties; substantial cost overruns in excess of original estimates and Ñnancing; market deterioration during construction; and lack of permanent take-out Ñnancing. Loans secured by such properties also involve additional risk because such properties have no operating history. In these loans, loan funds are advanced upon the security of the project under construction, which is of uncertain value prior to completion of construction, and the estimated operating cash Öow to be generated by the completed project. There is no assurance that such properties will be sold or leased so as to generate the cash Öow anticipated by the borrower. Such consideration can aÅect the borrowers' ability to repay their obligations to us and the value of our security interest in collateral. Our Use of Appraisals in Deciding Whether to Make a Loan on or Secured by Real Property Does Not Insure the Value of the Real Property Collateral. In considering whether to make a loan on or secured by real property, we generally require an appraisal of such property. However, the appraisal is only an estimate of the value of the property at the time the appraisal is made. If the appraisal does not reÖect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. We Face Substantial Competition From Larger Competitors. We face substantial competition for deposits and loans, as well as other banking services, throughout our market area from the major banks and Ñnancial institutions that dominate the commercial banking industry. This may cause our cost of funds to exceed that of our competitors. Such banks and Ñnancial institutions have greater resources than us, including the ability to Ñnance advertising campaigns and allocate their investment assets to regions of higher yield and demand. By virtue of their larger capital bases, such institutions have substantially greater lending limits than us and perform certain functions, including trust services, which are not presently oÅered by us. We also compete for loans and deposits, as well as other banking services, with savings and loan associations, Ñnance companies, money market funds, brokerage houses, credit unions and non-Ñnancial institutions. Adverse EÅects of Banking Regulations or Changes in Banking Regulations Could Adversely AÅect Our Business. We are governed by signiÑcant federal and state regulation and supervision, which is primarily for the beneÑt and protection of our customers and not for the beneÑt of our stockholders. In the past, our business has been materially aÅected by such regulation and supervision. This trend is likely to continue in the future. Laws, regulations, or policies currently aÅecting us may change at any time. Regulatory authorities may also change their interpretation of existing laws and regulations. Such changes may, among other things, increase the cost of doing business, limit permissible activities, or aÅect the competitive balance between banks and other Ñnancial institutions. It is impossible to predict the competitive impact that any such changes would have on commercial banking in general or on our business in particular. 63 Adverse Economic Conditions in Asia Could Cause Us to Incur Losses. It is diÇcult to predict the behavior of the Asian economy. The U.S. economic policies, military tensions, and an unfavorable global economic condition may adversely impact the Asian economy. If the Asian economic conditions should deteriorate, we could be exposed to economic and transfer risk, and could experience an outÖow of deposits by our Asian-American customers. Transfer risk may result when an entity is unable to obtain the foreign exchange needed to meet its obligations or to provide liquidity. This may adversely impact the recoverability of investments with or loans made to such entities. Adverse economic conditions may also negatively impact asset values and the proÑtability and liquidity of companies operating in this region. Statutory Restrictions on Dividends and Other Distributions From the Bank May Adversely Impact Us. A substantial portion of our cash Öow comes from dividends that the Bank pays to us. Various statutory provisions restrict the amount of dividends that the Bank can pay without regulatory approval. In addition, if the Bank were to liquidate, the Bank's creditors would be entitled to receive distributions from the assets of the Bank to satisfy their claims against the Bank before we, as a holder of an equity interest in the Bank, would be entitled to receive any of the assets of the Bank. Our Need to Continue to Adapt to Our Information Technology Systems to Allow Us to Provide New and Expanded Services Could Present Operational Issues and Require SigniÑcant Capital Spending. As we begin to oÅer internet banking and other on-line services to our customers, and continue to expand our existing conventional banking services, we will need to adapt our information technology systems to handle these changes in a way that meets constantly changing industry standards. This can be very expensive and may require signiÑcant capital expenditures. In addition, our success will depend, among other things, on our ability to provide secure and reliable services, anticipate changes in technology and eÇciently develop and introduce services that are accepted by our customers and cost eÅective for us to provide. Systems failures, delays, breaches of conÑdentiality and other problems could harm our reputation and business. Certain Provisions of Our Charter, Bylaws and Rights Agreement Could Make the Acquisition of Our Company More DiÇcult. Certain provisions of our Charter, Bylaws, and Rights Agreement between us and American Stock Transfer and Trust Company, as Rights Agent, could make the acquisition of our company more diÇcult. These provisions include authorized but unissued shares of preferred and common stock that may be issued without stockholder approval; three classes of directors serving staggered terms; preferred share purchase rights that generally become exercisable if a person or group acquires 15% or more of our common stock or announces a tender oÅer for 15% or more of our common stock; special requirements for stockholder proposals and nominations for director; and super-majority voting requirements in certain situations including certain types of business combinations. Terrorist Attacks. The impact of September 11th terrorist attacks or any future terrorist attacks and responses to such activities cannot be predicted at this time with respect to severity or duration. The impact could adversely aÅect the Company in a number of ways, including, among others, an increase in delinquencies, bankruptcies or defaults that could result in a higher level of non-performing assets, net charge-oÅs, and provision for loan losses. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Market Risk Market risk is the risk of loss from adverse changes in market prices and rates. The principal market risk to the Company is the interest rate risk inherent in our lending, investing, and deposit taking activities, due to 64 the fact that interest-earning assets and interest-bearing liabilities do not reprice at the same rate, to the same extent, or on the same basis. We actively monitor and manage our interest rate risk through analyzing the repricing characteristics of our loans, securities, and deposits on an on-going basis. The primary objective is to minimize the adverse eÅects of changes in interest rates on our earnings, and ultimately the underlying market value of equity, while structuring our asset-liability composition to obtain the maximum spread. Management uses certain basic measurement tools in conjunction with established risk limits to regulate its interest rate exposure. Due to the limitation inherent in any individual risk management tool, we use both an interest rate sensitivity analysis and a simulation model to measure and quantify the impact to our proÑtability or the market value of our assets and liabilities. The interest rate sensitivity analysis details the expected maturity and repricing opportunities, mismatch or sensitivity gap between interest-earning assets and interest-bearing liabilities over a speciÑed time frame. A positive gap exists when rate sensitive assets which reprice over a given time period exceed rate sensitive liabilities. During periods of increasing interest rates, net interest margin may be enhanced with a positive gap. A negative gap exists when rate sensitive liabilities which reprice over a given time period exceed rate sensitive assets. During periods of increasing interest rates, net interest margin may be impaired with a negative gap. The following table indicates the maturity or repricing and rate sensitivity of our interest-earning assets and interest-bearing liabilities as of December 31, 2002. Our exposure as reÖected in the table, represents the estimated diÅerence between the amount of interest-earning assets and interest-bearing liabilities repricing during future periods based on certain assumptions. The interest rate sensitivity of our assets and liabilities presented in the table may vary if diÅerent assumptions were used or if actual experience diÅers from the assumptions used. As reÖected in the table below, we were asset sensitive with a cumulative gap ratio of a positive 28.99% within three months and 4.40% within one year at year-end 2002, compared with a positive 18.67% within three months and a negative 5.18% within one year at year-end 2001. Interest Rate Sensitivity December 31, 2002 Interest Rate Sensitivity Period Within 3 Months Over 3 Months To 1 Year Over 1 Year to 5 Years Over 5 Years Non-interest Sensitive Total (Dollars in thousands) Interest-Earning Assets: Cash and due from banks ÏÏÏÏÏÏÏÏÏÏÏÏÏ Federal funds sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏ Securities held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏ Loans receivable Commercial loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Residential mortgage loans ÏÏÏÏÏÏÏÏÏÏ Commercial mortgage loans ÏÏÏÏÏÏÏÏÏ Real estate construction loansÏÏÏÏÏÏÏÏ Installment loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total loans, gross(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest-earning assets, net ÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 553 19,000 27,517 Ì 492,768 57,329 728,867 117,237 2,641 443 1,399,285 Ì $1,446,355 Interest-bearing Liabilities Deposits: Demand ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Money market and NOW(2) ÏÏÏÏÏÏÏÏ Savings(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TCDs under $100 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TCDs $100 and over ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì 13,660 11,717 227,460 395,102 647,939 $ Ì Ì 10,201 19,712 55,917 29 5,823 3,878 4,965 Ì 70,612 Ì $ 100,525 $ Ì 47,938 62,679 183,964 473,247 767,828 65 $ Ì Ì 178,628 122,642 5,696 6,470 63,593 Ì 7,947 Ì 83,706 Ì $384,976 $ Ì 124,871 144,401 13,714 118,437 401,423 $ Ì Ì 31,927 317,098 7,366 167,279 144,854 Ì Ì 1 319,500 Ì $668,525 $ Ì 123,196 71,429 Ì Ì 194,625 $ 70,224 Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì 83,393 $ 153,617 $ 302,828 Ì Ì Ì Ì 302,828 $ 70,777 19,000 248,273 459,452 561,747 231,107 943,137 121,115 15,553 444 1,873,103 83,393 $2,753,998 $ 302,828 309,665 290,226 425,138 986,786 2,314,643 December 31, 2002 Interest Rate Sensitivity Period Within 3 Months Over 3 Months To 1 Year Over 1 Year to 5 Years Over 5 Years Non-interest Sensitive Total (Dollars in thousands) Securities sold under agreements to repurchase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Advances from Federal Home Loan BankÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest-bearing other liabilities ÏÏÏÏ Stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and stockholders' equity Interest sensitivity gap ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative interest sensitivity gap ÏÏÏÏÏÏÏÏ Gap ratio (% of total assets)ÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative gap ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 28,500 Ì Ì 28,500 Ì Ì Ì $ 647,939 $ 798,416 $ 798,416 28.99% 28.99% 10,000 Ì Ì $ 777,828 $(677,303) $ 121,113 (24.59)% 4.40% 40,000 Ì Ì $469,923 $(84,947) $ 36,166 Ì Ì Ì $194,625 $473,900 $510,066 (3.08)% 1.31% 17.21% 18.52% Ì 72,894 287,961 $ 663,683 $(510,066) Ì $ (18.52)% Ì% 50,000 72,894 287,961 $2,753,998 Ì Ì Ì Ì (1) Loans are gross of the allowance for loan losses and unamortized deferred loan fees. Non-accrual loans are included in non-earning assets. Adjustable loans are included in the ""within three months'' category, as they are subject to an interest adjustment depending upon terms on the loan. (2) The Company's own historical experience and decay factor are used to estimate the money market and NOW, and savings deposit runoÅ. Since interest rate sensitivity analysis does not measure the timing diÅerences in the repricing of assets and liabilities, we use a net interest income simulation model to measure the extent of the diÅerences in the behavior of the lending and funding rates to changing interest rates, so as to project future earnings or market values under alternative interest rate scenarios. Interest rate risk arises primarily through the Company's traditional business activities of extending loans and accepting deposits. Many factors, including economic and Ñnancial conditions, movements in interest rates and consumer preferences aÅect the spread between interest earned on assets and interest paid on liabilities. The net interest income simulation model is designed to measure the volatility of net interest income and net portfolio value, deÑned as net present value of assets and liabilities, under immediate rising or falling interest rate scenarios in 100 basis points increments. Although the modeling is very helpful in managing interest rate risk, it does require signiÑcant assumptions for the projection of loan prepayment rates on mortgage related assets, loan volumes and pricing, and deposit and borrowing volume and pricing, that might prove inaccurate. Because these assumptions are inherently uncertain, the model cannot precisely estimate net interest income, or precisely predict the eÅect of higher or lower interest rates on net interest income. Actual results will diÅer from simulated results due to the timing, magnitude, and frequency of interest rates changes, the diÅerences between actual experience and the assumed volume, changes in market conditions, and management strategies among other factors. The Company monitors its interest rate sensitivity and attempts to reduce the risk of a signiÑcant decrease in net interest income caused by a change in interest rates. We establish a tolerance level in our policy to deÑne and limit interest income volatility to a change of plus or minus 30% when the hypothetical rate change is plus or minus 200 basis points. When the net interest rate simulation projects that our tolerance level will be met or exceeded, we seek corrective action after considering, among other things, market conditions, customer reaction, and the estimated impact on proÑtability. At December 31, 2002, if interest rates were to increase instantaneously by 100 basis points, the simulation indicated that our net interest income over the next twelve months would increase by 7.00%, and if interest rates were to increase instantaneously by 200 basis points, the simulation indicated that our net interest income over the next twelve months would increase by 12.72%. Conversely, if interest rates were to decrease instantaneously by 100 basis points, the simulation indicated that our net interest income over the next twelve months would decrease by 7.54%, and if interest rates were to decrease instantaneously by 200 basis points, the simulation indicated that our net interest income over the next twelve months would decrease by 16.19%. 66 The Company's simulation model also projects the net economic value of our portfolio of assets and liabilities. We have established a tolerance level to value the net economic value of our portfolio of assets and liabilities in our policy to a change of plus or minus 30% when the hypothetical rate change is plus or minus 200 basis points. At December 31, 2002, if interest rates were to increase instantaneously by 200 basis points, the simulation indicated that the net economic value of our portfolio of assets and liabilities would decrease by 16.56%, and conversely, if interest rates were to decrease instantaneously by 200 basis points, the simulation indicated that the net economic value of our assets and liabilities would increase by 10.59%. Quantitative Information About Interest Rate Risk The following table shows our Ñnancial instruments that are sensitive to changes in interest rates, categorized by expected maturity, and the instruments' fair values at December 31, 2002, and 2001. For assets, expected maturities are based on contractual maturity. For liabilities, we use our historical experience and decay factors to estimate the deposit runoÅs of interest-bearing transactional deposits. We use certain assumptions to estimate fair values and expected maturities. OÅ-balance sheet commitments to extend credit, letters of credit, and bill of lading guarantees represent the contractual unfunded amounts. OÅ-balance sheet Ñnancial instruments represent fair values. The results presented may vary if diÅerent assumptions are used or if actual experience diÅers from the assumptions used. Average Interest Rate Expected Maturity Date at December 31, 2003 2004 2005 2006 2007 Thereafter Total (Dollars in thousands) As of December 31, 2002 2001 Fair Value Total Fair Value 1.23% $ 19,000 $ Ì $ Ì $ Ì $ Ì $ Ì $ 19,000 $ 19,000 $ 13,000 $ 13,000 Interest-Sensitive Assets: Federal funds sold and securities purchased under agreements to resellÏÏÏÏÏÏ Mortgage-backed securities and collateralized mortgage obligations ÏÏÏÏÏ Investment securitiesÏÏÏÏÏÏÏ Loans Commercial ÏÏÏÏÏÏÏÏÏÏÏÏ Residential mortgageÏÏÏÏÏ Commercial mortgageÏÏÏÏ Real estate construction ÏÏ Installment & others ÏÏÏÏÏ 5.64 5.34 4.34 6.39 5.81 5.17 6.16 Ì 1,282 Ì 4,590 3,090 232,222 57,430 28,336 92,174 74,371 97,427 116,803 241,184 466,541 246,019 480,036 171,872 451,442 175,184 456,588 433,666 29,639 14,774 15,443 11,219 46,639 142 365 2,204 1,818 3,214 221,606 75,993 88,029 44,340 49,435 110,812 563,376 108,763 10,781 Ì Ì 7,961 3,389 2,557 1,395 Ì 517 Ì Ì 1 Ì 551,380 229,349 931,985 119,544 15,820 2,568 552,070 239,157 944,882 119,784 15,847 2,568 498,280 231,755 725,643 163,591 20,763 1,928 498,486 234,002 726,234 163,906 20,831 1,928 Interest rate swap ÏÏÏÏÏÏÏÏÏ Ì Ì Ì 2,568 Ì Interest-Sensitive Liabilities: Other interest-bearing deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Time depositsÏÏÏÏÏÏÏÏÏÏÏÏÏ 0.40 1.97 Securities sold under 135,994 97,061 74,255 57,210 40,746 194,625 599,891 599,912 524,778 524,805 1,265,461 67,685 78,163 214 319 82 1,411,924 1,419,816 1,337,143 1,343,618 agreements to repurchase 3.29 Ì 28,500 Ì Advances from the Federal Home Loan Bank ÏÏÏÏÏÏÏ 4.55 10,000 20,000 20,000 OÅ-Balance Sheet Financial Instruments: Commitments to extend credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Standby letters of credit ÏÏÏÏ Other letters of credit ÏÏÏÏÏÏ Bill of lading guaranteeÏÏÏÏÏ Financial Derivatives 606,704 56,358 1,634 15,004 36,667 10,608 225 Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì 28,500 29,043 22,114 22,114 50,000 52,251 30,000 30,937 180 60,148 725,024 (424) 676,513 (349) Ì Ì Ì Ì Ì Ì 15,229 36,667 10,608 (54) (196) (71) 17,595 26,923 12,729 (64) (91) (72) It is the policy of the Company not to speculate on the future direction of interest rates. However, the Company enters into Ñnancial derivatives in order to seek mitigation of exposure to interest rate risks related to our interest-earning assets and interest-bearing liabilities. We believe that these transactions, when properly 67 structured and managed, may provide a hedge against inherent interest rate risk in the Company's assets or liabilities and against risk in speciÑc transactions. In such instances, the Company may protect its position through the purchase or sale of interest rate futures contracts for a speciÑc cash or interest rate risk position. Other hedge transactions may be implemented using interest rate swaps, interest rate caps, Öoors, Ñnancial futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, we seek to analyze the costs and beneÑts of the hedge in comparison to other viable alternative strategies. All hedges will require an assessment of basis risk and must be approved by the Bank's Investment Committee. For periods prior to January 1, 2001, for those qualifying Ñnancial derivatives that altered the interest rate characteristics of assets or liabilities, the net diÅerential to be paid or received on the Ñnancial derivative was treated as an adjustment to the yield on the underlying assets or liabilities. Interest rate Ñnancial derivatives that did not qualify for the accrual method, were recorded at fair value, with gains and losses recorded in earnings. EÅective January 1, 2001, the Company adopted SFAS No. 133, ""Accounting for Derivative Instruments and Hedging Activities,'' as amended by SFAS No. 137 and No. 138. SFAS No. 133 establishes accounting and reporting standards for Ñnancial derivatives, including certain Ñnancial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all Ñnancial derivatives as assets or liabilities in the Company's statement of Ñnancial condition and measurement of those Ñnancial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a Ñnancial derivative is designated as a hedge and if so, the type of hedge. Upon adoption of SFAS No. 133, the Company recognizes all derivatives on the balance sheet at fair value. Fair value is based on dealer quotes, or quoted prices from instruments with similar characteristics. The Company uses Ñnancial derivatives designated for hedging activities as cash Öow hedges. For derivatives designated as cash Öow hedges, changes in fair value are recognized in other comprehensive income until the hedged item is recognized in earnings. On March 21, 2000, we entered into an interest rate swap agreement with a major Ñnancial institution in the notional amount of $20.00 million for a period of Ñve years. The interest rate swap was for the purpose of hedging the cash Öows from a portion of our Öoating rate loans against declining interest rates. The purpose of the hedge is to provide a measure of stability in the future cash receipts from such loans over the term of the swap agreement, which at December 31, 2002, was approximately nine quarters. At December 31, 2002, the fair value of the interest rate swap was $2.27 million, exclusive of accrued interest, or $1.19 million net of tax compared to $1.68 million, exclusive of accrued interest, or $869,000 net of tax, at December 31, 2001. For the twelve months ended December 31, 2002, net amounts totaling $1.06 million were reclassiÑed into earnings. The estimated net amount of the existing gains within accumulated other comprehensive income that are expected to reclassify into earnings within the next 12 months is approximately $1.16 million. Item 8. Financial Statements and Supplementary Data For Ñnancial statements, see ""Index to Consolidated Financial Statements'' on page 77. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not Applicable. Item 10. Directors and Executive OÇcers of the Registrant PART III The information under the caption ""Election of Directors'' in our deÑnitive Proxy Statement relating to our 2003 Annual Meeting of Stockholders (the ""Proxy Statement'') is incorporated herein by reference. The term of oÇce of each oÇcer is from the time of appointment until the next annual organizational meeting of the Board of Directors of Bancorp or Cathay Bank (or action in lieu of a meeting) and until the 68 appointment of his or her successor unless, before that time, the oÇcer resigns or is removed or is otherwise disqualiÑed from serving as an oÇcer of Bancorp or Cathay Bank. The information under the caption ""Section 16(a) BeneÑcial Ownership Reporting Compliance'' in our Proxy Statement is incorporated herein by reference. Item 11. Executive Compensation The information under the captions ""Compensation of Directors'', ""Management Compensation'', ""Compensation Committee Interlocks and Insider Participation'' and ""Compensation Committee Report on Executive Compensation'' in our Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related Stockholder Matters The information set forth under the captions ""Principal Holders of Securities,'' ""Equity Compensation Plan Information,'' and ""Election of Directors'' in our Proxy Statement is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information under the captions ""Election of Directors'' and ""Certain Transactions'' in our Proxy Statement is incorporated herein by reference. Item 14. Controls and Procedures The Company's principal executive oÇcer and principal Ñnancial oÇcer have evaluated the eÅectiveness of the Company's ""disclosure controls and procedures,'' as such term is deÑned in Rule 13a-14(c) of the Securities Exchange Act of 1934, as amended, (the ""Exchange Act'') within 90 days of the Ñling date of this Annual Report on Form 10-K. Based upon their evaluation, the principal executive oÇcer and principal Ñnancial oÇcer have concluded that the Company's disclosure controls and procedures are eÅective to ensure that information required to be disclosed by the Company in the reports Ñled or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods speciÑed in the SEC's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company's management, including its principal executive oÇcer and principal Ñnancial oÇcer, as appropriate to allow timely decisions regarding required disclosure. There were no signiÑcant changes in the Company's internal controls or in other factors that could signiÑcantly aÅect these controls subsequent to the date of such evaluation. PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Documents Filed as Part of this Report (a)(1) Financial Statements See Index to Consolidated Financial Statements on page 77. (a)(2) Financial Statement Schedules Schedules have been omitted since they are not applicable, they are not required, or the information required to be set forth in the schedules is included in the Consolidated Financial Statements or Notes thereto. (a)(3) Exhibits 69 3.1 Restated CertiÑcate of Incorporation. Previously Ñled with the Securities and Exchange Commis- sion as an exhibit to Registration Statement No. 33-33767 and reÑled herein. 3.2 Restated Bylaws. Previously Ñled with the Securities and Exchange Commission as an exhibit to Bancorp's Annual Report on Form 10-K for the year ended December 31, 2001, and incorporated herein by reference. 3.3 CertiÑcate of Designation of Series A Junior Participating Preferred Stock. Previously Ñled with the Securities and Exchange Commission as an exhibit to Bancorp's Annual Report on Form 10-K for the year ended December 31, 2001, and incorporated herein by reference. 4.1 Rights Agreement. Previously Ñled with the Securities and Exchange Commission as an exhibit to Bancorp's Registration Statement on Form 8-A on December 20, 2000 and incorporated herein by reference. 10.1 Form of Indemnity Agreements between Bancorp and its directors and certain oÇcers. Previously Ñled with the Securities and Exchange Commission as an exhibit to Registration Statement No. 33-33767 and incorporated herein by reference. 10.2 Amended and Restated Cathay Bank Employee Stock Ownership Plan eÅective January 1, 1997. Previously Ñled with the Securities and Exchange Commission as an exhibit to Bancorp's Registra- tion Statement on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. 10.3 Dividend Reinvestment Plan of Bancorp. Previously Ñled with the Securities and Exchange Commission as an exhibit to Registration Statement No. 33-33767 and incorporated herein by reference. 10.4 Equity Incentive Plan of Bancorp. Previously Ñled with the Securities and Exchange Commission as an exhibit to Bancorp's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 and incorporated herein by reference.* 22.1 Subsidiaries of Bancorp. Previously Ñled with the Securities and Exchange Commission as an exhibit to Bancorp's Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. 23.1 Consent of Independent Auditors 99.1 CEO CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSU- ANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 99.2 CFO CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 * Management compensatory plan (b) Reports on Form 8-K The Company did not Ñle any reports on Form 8-K during the last quarter of 2002. 70 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. SIGNATURES Cathay Bancorp, Inc. By: /s/ DUNSON K. CHENG Dunson K. Cheng Chairman and President Date: February 28, 2003 Powers of Attorney KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dunson K. Cheng and Anthony M. Tang, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K and to Ñle the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and conÑrming all that each of said attorneys- in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date /s/ DUNSON K. CHENG Dunson K. Cheng /s/ ANTHONY M. TANG Anthony M. Tang President, Chairman of the Board and Director (principal executive oÇcer) Executive Vice President, Chief Financial OÇcer/ Treasurer and Director (principal Ñnancial oÇcer) (principal accounting oÇcer) February 28, 2003 February 28, 2003 /s/ RALPH ROY BUON-CRISTIANI Ralph Roy Buon-Cristiani Director February 28, 2003 /s/ KELLY L. CHAN Kelly L. Chan /s/ MICHAEL M.Y. CHANG Michael M.Y. Chang /s/ GEORGE T.M. CHING George T.M. Ching Director February 28, 2003 Director February 28, 2003 Director February 28, 2003 71 Signature Title Date /s/ WING K. FAT Wing K. Fat /s/ PATRICK S.D. LEE Patrick S.D. Lee /s/ JOSEPH C.H. POON Joseph C.H. Poon /s/ THOMAS G. TARTAGLIA Thomas G. Tartaglia /s/ WILBUR K. WOO Wilbur K. Woo Director February 28, 2003 Director February 28, 2003 Director February 28, 2003 Director February 28, 2003 Director February 28, 2003 72 I, Dunson K. Cheng, certify that: CERTIFICATIONS 1. I have reviewed this annual report on Form 10-K of Cathay Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in this annual report, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying oÇcers and I are responsible for establishing and maintaining disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the Ñling date of this annual report (the ""Evaluation Date''); and c) presented in this annual report our conclusions about the eÅectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying oÇcers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all signiÑcant deÑciencies in the design or operation of internal controls which could adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial data and have identiÑed for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a signiÑcant role in the registrant's internal controls; and 6. The registrant's other certifying oÇcers and I have indicated in this annual report whether or not there were signiÑcant changes in internal controls or in other factors that could signiÑcantly aÅect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to signiÑcant deÑciencies and material weaknesses. Date: February 28, 2003 By /s/ DUNSON K. CHENG Dunson K. Cheng Chairman and President 73 I, Anthony M. Tang, certify that: 1. I have reviewed this annual report on Form 10-K of Cathay Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in this annual report, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying oÇcers and I are responsible for establishing and maintaining disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the Ñling date of this annual report (the ""Evaluation Date''); and c) presented in this annual report our conclusions about the eÅectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying oÇcers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all signiÑcant deÑciencies in the design or operation of internal controls which could adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial data and have identiÑed for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a signiÑcant role in the registrant's internal controls; and 6. The registrant's other certifying oÇcers and I have indicated in this annual report whether or not there were signiÑcant changes in internal controls or in other factors that could signiÑcantly aÅect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to signiÑcant deÑciencies and material weaknesses. Date: February 28, 2003 By /s/ ANTHONY M. TANG Anthony M. Tang Chief Financial OÇcer 74 Exhibit 99.1 CEO CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Cathay Bancorp, Inc., and Subsidiary (the ""Company'') on Form 10-K for the period ended December 31, 2002 as Ñled with the Securities and Exchange Commission on the date hereof (the ""Report''), I, Dunson K. Cheng, chief executive oÇcer of the Company, certify, pursuant to 18 U.S.C. Û 1350, as adopted pursuant to Û 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the Ñnancial condition and results of operations of the Company. Date: February 28, 2003 By /s/ DUNSON K. CHENG Dunson K. Cheng Chairman and President 75 Exhibit 99.2 CFO CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Cathay Bancorp, Inc., and Subsidiary (the ""Company'') on Form 10-K for the period ended December 31, 2002 as Ñled with the Securities and Exchange Commission on the date hereof (the ""Report''), I, Anthony M. Tang, chief Ñnancial oÇcer of the Company, certify, pursuant to 18 U.S.C. Û 1350, as adopted pursuant to Û 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the Ñnancial condition and results of operations of the Company. Date: February 28, 2003 By /s/ ANTHONY M. TANG Anthony M. Tang Chief Financial OÇcer 76 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Independent Auditors' Report ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Condition at December 31, 2002 and 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Income and Comprehensive Income for each of the years ended December 31, 2002, 2001 and 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Changes in Stockholders' Equity for each of the years ended December 31, 2002, 2001 and 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 ÏÏÏÏ Notes to Consolidated Financial Statements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Parent-only condensed Ñnancial information of Cathay Bancorp, Inc. as of December 31, 2002, 2001 and 2000 is included in Note 15 to the Consolidated Financial Statements in this Annual Report on Form 10-K ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Page 78 79 80 81 82 83 109 77 The Stockholders and the Board of Directors of Cathay Bancorp, Inc.: INDEPENDENT AUDITORS' REPORT We have audited the accompanying consolidated statements of condition of Cathay Bancorp, Inc. and subsidiary (the Company) as of December 31, 2002 and 2001, and the related consolidated statements of income and comprehensive income, changes in stockholders' equity and cash Öows for each of the years in the three-year period ended December 31, 2002. These consolidated Ñnancial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated Ñnancial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Ñnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements. An audit also includes assessing the accounting principles used and signiÑcant estimates made by management, as well as evaluating the overall Ñnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated Ñnancial statements referred to above present fairly, in all material respects, the Ñnancial position of Cathay Bancorp, Inc. and subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash Öows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated Ñnancial statements, the Company changed its method of accounting for goodwill and other intangible assets in 2002. Los Angeles, California January 15, 2003 KPMG LLP 78 CONSOLIDATED STATEMENTS OF CONDITION As of December 31, 2002 2001 (In thousands, except share and per share data) ASSETS Cash and due from banks ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Federal funds sold and securities purchased under agreements to resell ÏÏÏÏÏÏÏÏ Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities available-for-sale (amortized cost of $238,740 in 2002 and $241,788 $ 70,777 19,000 89,777 $ 73,514 13,000 86,514 in 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 248,273 248,958 Securities held-to-maturity (estimated fair value of $477,782 in 2002 and $382,814 in 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LoansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Allowance for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unamortized deferred loan fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other real estate owned, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments in real estate, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Premises and equipment, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Customers' liability on acceptances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued interest receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Goodwill ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 459,452 1,877,227 (24,543) (4,606) 1,848,078 653 21,678 29,788 10,608 14,453 6,552 24,686 $2,753,998 374,356 1,667,905 (23,973) (3,900) 1,640,032 1,555 17,727 29,403 12,729 14,545 6,552 20,743 $2,453,114 Deposits LIABILITIES AND STOCKHOLDERS' EQUITY Non-interest-bearing demand depositsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-bearing accounts: NOW accountsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Money market accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Savings accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Time deposits under $100 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Time deposits of $100 or moreÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Advances from the Federal Home Loan Bank ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Acceptances outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equity Preferred stock, $0.01 par value; 10,000,000 shares authorized, none issued ÏÏ Common stock, $0.01 par value; 25,000,000 shares authorized, 18,305,255 issued and 17,999,955 outstanding in 2002, and 18,235,538 issued and 17,957,738 outstanding in 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Treasury stock, at cost (305,300 shares in 2002, and 277,800 shares in 2001) Additional paid-in-capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated other comprehensive income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 302,828 $ 260,427 148,085 161,580 290,226 425,138 986,786 2,314,643 28,500 50,000 10,608 62,286 2,466,037 135,650 136,806 252,322 414,490 922,653 2,122,348 22,114 30,000 12,729 19,912 2,207,103 Ì Ì 183 (8,287) 70,857 6,719 218,489 287,961 $2,753,998 182 (7,342) 68,517 5,063 179,591 246,011 $2,453,114 See accompanying notes to consolidated Ñnancial statements. 79 CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Year Ended December 31, 2001 (In thousands, except share and per share data) 2000 2002 INTEREST INCOME Interest on loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest on securities available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest on securities held-to-maturityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest on federal funds sold and securities purchased under agreements to resell ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest on deposits with banks ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ INTEREST EXPENSE Time deposits of $100 or moreÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other borrowed funds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income before provision for loan losses ÏÏÏÏÏÏÏ Provision for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income after provision for loan losses ÏÏÏÏÏÏÏÏ NON-INTEREST INCOME Securities gainsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Letters of credit commissions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depository service fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other operating incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NON-INTEREST EXPENSE Salaries and employee beneÑts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Occupancy expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Computer and equipment expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Professional services expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FDIC and State assessments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Marketing expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other real estate owned (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Operations of investments in real estate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other operating expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other comprehensive income, net of tax: Unrealized holding gains arising during the year ÏÏÏÏÏÏÏÏÏÏ Cumulative adjustment upon adoption of SFAS No. 133ÏÏÏ Unrealized gains on cash Öow hedge derivatives ÏÏÏÏÏÏÏÏÏÏ Less: reclassiÑcation adjustments included in net incomeÏÏÏ Total other comprehensive income, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏ Total comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 107,693 14,847 20,676 813 32 144,061 23,351 13,388 3,181 39,920 104,141 6,000 98,141 1,926 1,947 5,755 6,543 16,171 25,716 3,730 3,225 4,036 501 1,405 (349) 2,038 3,015 43,317 70,995 22,295 48,700 3,290 Ì 326 1,960 1,656 50,356 $ $ 120,591 13,762 23,627 1,316 56 159,352 40,005 23,859 2,289 66,153 93,199 6,373 86,826 2,157 2,152 5,097 5,373 14,779 23,689 3,422 2,928 5,395 475 1,449 (3,589) 2,257 4,139 40,165 61,440 18,820 42,620 2,408 566 303 517 2,760 45,380 Net income per common share Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic average common shares outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted average common shares outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ 2.71 2.69 17,991,333 18,115,119 $ $ 2.35 2.35 18,107,790 18,165,260 See accompanying notes to consolidated Ñnancial statements. 80 $ 126,337 13,473 24,017 686 40 164,553 41,431 26,514 6,211 74,156 90,397 4,200 86,197 1,085 2,439 4,558 4,674 12,756 22,735 3,242 2,773 3,625 462 1,172 (185) 683 3,997 38,504 60,449 21,862 38,587 3,084 Ì Ì (225) 3,309 41,896 $ $ $ 2.13 2.13 18,113,502 18,147,770 Ì Ì Ì Ì Ì Ì Ì 1,691 48 8 (7,965) 3,309 38,587 214,787 1,811 347 85 (7,342) (9,057) 2,760 42,620 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Years Ended December 31, 2002, 2001 and 2000 Common Stock Number of Shares Amount Accumulated Other Comprehensive Income (Loss) (In thousands, except share and per share amounts) Additional Paid-in- Capital Retained Earnings Treasury Stock Total Stockholders' Equity 18,067,166 $180 $64,529 $(1,006) $115,406 $ Ì $179,109 Balance at December 31, 1999ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Issuances of common stock Ì Dividend Reinvestment Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock options exercised ÏÏÏÏÏÏ Tax beneÑts from stock plans Cash dividends of $0.440 per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in other comprehensive income ÏÏÏÏ Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance at December 31, 78,660 2,904 Ì Ì Ì Ì 1 Ì Ì Ì Ì Ì 1,690 48 8 Ì Ì Ì Ì Ì Ì Ì 3,309 Ì Ì Ì Ì (7,965) Ì 38,587 2000ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18,148,730 181 66,275 2,303 146,028 Issuances of common stock Ì Dividend Reinvestment Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock options exercised ÏÏÏÏÏÏ Tax beneÑts from stock plans Purchases of treasury stockÏÏÏ Cash dividends of $0.500 per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in other comprehensive income ÏÏÏÏ Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance at December 31, 69,314 17,494 Ì (277,800) Ì Ì Ì 1 Ì Ì Ì Ì Ì Ì 1,810 347 85 Ì Ì Ì Ì Ì Ì Ì Ì Ì 2,760 Ì Ì Ì Ì Ì Ì Ì Ì (7,342) (9,057) Ì 42,620 Ì Ì Ì 2001ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,957,738 182 68,517 5,063 179,591 (7,342) 246,011 Issuances of common stock Ì Dividend Reinvestment Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock options exercised ÏÏÏÏÏÏ Tax beneÑt from stock plans Purchases of treasury stockÏÏÏ Cash dividends of $0.545 per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in other comprehensive income ÏÏÏÏ Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance at December 31, 54,515 15,202 Ì (27,500) Ì Ì Ì 1 Ì Ì Ì Ì Ì Ì 1,897 294 149 Ì Ì Ì Ì Ì Ì Ì Ì Ì 1,656 Ì Ì Ì Ì Ì (9,802) Ì 48,700 Ì Ì Ì (945) Ì Ì Ì 1,898 294 149 (945) (9,802) 1,656 48,700 2002ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,999,955 $183 $70,857 $ 6,719 $218,489 $(8,287) $287,961 See accompanying notes to consolidated Ñnancial statements. 81 CONSOLIDATED STATEMENTS OF CASH FLOWS 2002 Year Ended December 31, 2001 (In thousands) 2000 Cash Flows from Operating Activities Net Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan lossesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for losses on other real estate owned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax (beneÑt) liability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net gains on sale of loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net gain on sale of other real estate owned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gain on sales and calls of securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Write-downs on venture capital investmentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of investment security premiums, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of intangibles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax beneÑts from stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Increase (decrease) in deferred loan fees, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Decrease (increase) in accrued interest receivableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Increase) decrease in other assets, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Increase in other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Flows from Investing Activities Purchase of investment securities available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from maturity and call of investment securities available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from sale of investment securities available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchase of mortgage-backed securities available-for-saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from repayment and sale of mortgage-backed securities available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchase of investment securities held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from maturity and call of investment securities held-to-maturityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchase of mortgage-backed securities held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from repayment of mortgage-backed securities held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from sale of loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net increase in loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchase of premises and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from sale of other real estate owned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net increase in investments in real estate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 48,700 $ 42,620 $ 38,587 6,000 Ì (1,087) 1,596 (433) (395) (2,267) 341 773 198 149 706 92 (4,780) 43,461 44,354 93,054 6,373 Ì (2,361) 1,472 Ì (3,376) (2,222) 65 575 864 85 (239) 1,088 2,200 2,840 7,364 49,984 4,200 71 637 1,500 Ì (263) (1,085) Ì (926) 815 8 544 (2,483) (1,372) 9,666 11,312 49,899 (232,361) 221,792 22,036 Ì 4,425 (36,103) 13,226 (140,958) 66,980 15,347 (230,073) (1,981) 1,704 (3,951) (952,258) 865,867 22,179 Ì 8,421 (82,313) 60,295 (40,052) 63,155 Ì (204,516) (1,152) 6,995 (379) (660,275) 678,368 21,443 (949) 6,955 (47,824) 17,519 (29,604) 38,802 Ì (200,298) (5,924) 3,187 (361) Net cash used in investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (299,917) (253,758) (178,961) Cash Flows from Financing Activities Net increase in demand deposits, NOW accounts, Money market and savings depositsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net increase in time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net (decrease) increase in federal funds purchased and securities sold under agreements to repurchaseÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Increase (decrease) in borrowing from Federal Home Loan Bank ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from shares issued to Dividend Reinvestment Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from exercise of stock optionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchase of treasury stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 117,514 74,781 6,386 20,000 (9,802) 1,898 294 (945) Net cash provided by Ñnancing activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 210,126 Increase in cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents, beginning of the yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,263 86,514 86,187 159,714 (46,059) 20,000 (9,057) 1,811 347 (7,342) 205,601 1,827 84,687 47,899 106,812 21,183 (20,000) (7,965) 1,691 48 Ì 149,668 20,606 64,081 Cash and cash equivalents, end of the yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 89,777 $ 86,514 $ 84,687 Supplemental disclosure of cash Öow information Cash paid during the year for: InterestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-cash investing activities: Transfer to investment securities available-for-sale within 90 days of maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net change in unrealized holding gain on securities available-for-sale, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative adjustment upon adoption of SFAS No. 133, net of taxÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net change in unrealized gains on cash Öow hedge derivatives, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers to other real estate ownedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans to facilitate the sale of other real estate owned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ $ $ $ $ 40,440 17,046 $ $ 68,020 5,561 10,964 1,330 $ $ Ì $ $ 326 $ 407 Ì $ 11,722 1,891 566 303 1,057 5,400 $ $ $ $ $ $ $ $ 72,644 17,411 59,858 3,309 Ì Ì 5,347 1,515 See accompanying notes to consolidated Ñnancial statements. 82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of SigniÑcant Accounting Policies The accompanying consolidated Ñnancial statements include the accounts of Cathay Bancorp, Inc. (""Bancorp''), a Delaware corporation, and its wholly-owned subsidiary, Cathay Bank (""Bank''), a California state-chartered bank (together, the ""Company''). All signiÑcant inter-company transactions and balances have been eliminated in consolidation. The consolidated Ñnancial statements of the Company are prepared in conformity with accounting principles generally accepted in the United States of America (""GAAP'') and general practices within the banking industry. Organization and Background. The business activities of Bancorp consist primarily of the operations of the Bank and its wholly-owned subsidiaries, Cathay Investment Company (""CIC'') and Cathay Securities Fund, Inc., a registered investment company of the Bank. The Company has applied to the Securities and Exchange Commission to deregister this registered investment company. There are no operating business activities currently at Bancorp. The Bank is a commercial bank, servicing primarily the individuals, professionals, and small to medium-sized businesses in the local markets in which its branches are located. Its operations include the acceptance of checking, savings, and time deposits, and the making of commercial, real estate and consumer loans. The Bank also oÅers trade Ñnancing, letter of credit, wire transfer, spot and forward contracts, internet banking, investment services, and other customary banking services to its customers. Use of Estimates. The preparation of the consolidated Ñnancial statements in accordance with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated Ñnancial statements and the reported amounts of revenues and expenses during the period. Actual results could diÅer from those estimates. The most signiÑcant estimate subject to change relates to the allowance for loan losses. Certain reclassiÑcations have been made to the prior years' Ñnancial statements to conform to the 2002 presentation. The following are descriptions of the more signiÑcant of these policies. Securities. Securities are classiÑed as held-to-maturity when management has the ability and intent to hold these securities until maturity. Securities are classiÑed as available-for-sale when management intends to hold the securities for an indeÑnite period of time, or when the securities may be utilized for tactical asset/ liability purposes, and may be sold from time to time to manage interest rate exposure and resultant prepayment risk and liquidity needs. Securities purchased are designated as held-to-maturity or available-for- sale at the time of acquisition. Securities held-to-maturity are stated at cost, adjusted for the amortization of premiums and the accretion of discounts on a level-yield basis. The carrying value of these assets is not adjusted for temporary declines in fair value since the Company has the positive intent and ability to hold them to maturity. Securities available-for-sale are carried at fair value, and any unrealized holding gains or losses are excluded from earnings and reported as a separate component of stockholders' equity, net of tax, in accumulated other comprehensive income until realized. Realized gains or losses are determined on the speciÑc identiÑcation method. Premium and discounts are amortized or accreted as adjustment of yield on a level-yield basis. The cost basis of an individual security is written down, if the decline in its fair value below the amortized cost basis is other than temporary. The write-down is accounted for as a realized loss, and is included in net income. The new cost basis is not changed for subsequent recoveries in fair value. Loans. Loans are carried at amounts advanced, less principal payments collected and net deferred loan fees. Interest is accrued and earned daily on an actual or 360-day basis. Interest accruals on business loans and non-residential real estate loans are generally discontinued whenever the payment of interest or principal is 90 days or more past due. Such loans are placed on non-accrual status, unless the loan is well secured, and there is a high probability of recovery in full, as determined by management. When loans are placed on a non- accrual status, previously accrued but unpaid interest is reversed and charged against current period income, and interest is subsequently recognized only to the extent cash is received. Interest collected on non-accrual 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) loans is applied to the outstanding principal balance unless the loan is returned to accrual status. In order to be returned to accrual status, all past due payments must be received and the loan must be paying in accordance with its payment terms. Loan origination fees and commitment fees, oÅset by certain direct loan origination costs, are deferred and recognized over the contractual life of the loan as a yield adjustment. If a loan is placed on non-accrual status, the amortization of the loan fees and the accretion of discounts discontinue until such time when the loan is reverted back to accruing status. Allowance for Loan Losses. Management believes the allowance for loan losses is being maintained at a level considered adequate to provide for estimable and probable losses. Additions to the allowance for loan losses are made monthly by charges to operating expense in the form of a provision for loan losses. All loans judged to be un-collectible are charged against the allowance while any recoveries are credited to the allowance. Management monitors changing economic conditions, the loan mix by category, the industry segregation, and geographic distribution of the portfolio and the type of borrowers in determining the adequacy of the allowance for loan losses. Management also closely reviews its past, present and expected overall net loan losses in comparison to the existing level of the allowance. In addition, the Bank's regulators, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to make additions to its allowance for loan losses based on the judgments of the information available to them at the time of their examination. Impaired Loans. A loan is considered impaired when it is ""probable'' that the Bank will be unable to collect all amounts due (i.e. both principal and interest) according to the contractual terms of the loan agreement. The measurement of impairment may be based on (1) the present value of the expected future cash Öows of the impaired loan discounted at the loan's original eÅective interest rate, (2) the observable market price of the impaired loan or (3) the fair value of the collateral of a collateral-dependent loan. The amount by which the recorded investment in the loan exceeds the measure of the impaired loan is recognized by recording a valuation allowance with a corresponding charge to the provision for loan losses. The Company stratiÑes its loan portfolio by size and treats smaller performing loans with an outstanding balance less than the Company's deÑned criteria as a homogenous portfolio. For loans with a balance in excess of $750,000, the Company conducts a periodic review of each loan in order to test for impairment. The Company recognizes interest income on impaired loans based on its existing method of recognizing interest income on non-accrual loans. Letter of Credit Fees. Issuance and commitment fees received for the issuance of commercial or standby letters of credit are recognized over the term of the instruments. Premises and Equipment. Premises and equipment are carried at cost, less accumulated depreciation. Depreciation is computed on the straight-line method based on the following estimated useful lives of the assets: Type Estimated Useful Life Buildings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Building improvementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Furniture, Ñxtures and equipmentÏÏÏÏÏÏÏÏÏÏÏÏ Leasehold improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Shorter of useful lives or the terms of the lease 15 to 45 years 5 to 20 years 3 to 25 years Improvements are capitalized and amortized to occupancy expense based on the above table. Other Real Estate Owned. Real estate acquired in the settlement of loans is initially recorded and subsequently is carried at fair value, less estimated costs to sell. SpeciÑc valuation allowances on other real estate owned are recorded through charges to operations to recognize declines in fair value subsequent to foreclosure. Gains on sales are recognized when certain criteria relating to the buyer's initial and continuing investment in the property are met. 84 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Investments in Real Estate. At December 31, 2002, the Company is a limited partner in seven diÅerent partnerships that invest in low-income housing projects that qualify for Federal and/or State income tax credits. As further discussed in Note 6, the partnership interests are accounted for utilizing the equity method of accounting. The costs related directly to the development or the improvement of real estate are capitalized. Gains on sales are recognized when certain criteria relating to the buyer's initial and continuing investment in the property are met. Goodwill. Goodwill represents the excess of costs over fair value of assets of businesses acquired. EÅective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (""SFAS'') No. 142, ""Goodwill and Other Intangible Assets.'' Goodwill and intangible assets acquired in a purchase business combination and determined to have an indeÑnite useful life are not amortized, but instead are tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, ""Accounting for Impairment or Disposal of Long-Lived Assets.'' Upon adoption of SFAS No. 142, the Company was required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the Ñrst interim period. In addition, to the extent an intangible asset was identiÑed as having an indeÑnite useful life, the Company was required to test the intangible asset for impairment in accordance with the provisions of SFAS No. 142. Any impairment loss is measured as of the date of adoption and recognized as the cumulative eÅect of a change in accounting principle in the Ñrst interim period. The Company adopted SFAS No. 142 eÅective January 1, 2002. Upon adoption, the Company discontinued the amortization of goodwill and reclassiÑed $2.33 million from goodwill to core deposit intangible, which is classiÑed under other assets in the Statements of Financial Condition. The Company also reassessed the useful lives and residual value of all intangible assets acquired in purchase business combinations, and tested goodwill for impairment, and found no impairment. Prior to 2002, goodwill, was amortized on a straight-line basis over the expected periods to be beneÑted (generally 15 years). Amortization expense related to goodwill was $661,000 for the year ended December 31, 2001. The following table reconciles previously reported net income as if the provisions of SFAS No. 142 were in eÅect during the past three years. 2002 2001 (In thousands, except per share data) 2000 Net income As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Add back goodwill amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $48,700 - $42,620 661 $38,587 661 Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $48,700 $43,281 $39,248 Basic net income per share As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2.71 2.71 Diluted net income per share As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.69 2.69 $2.35 2.39 2.35 2.38 $2.13 2.17 2.13 2.16 Core Deposit Premium. Core deposit premium, which represents the purchase price over the fair value of the deposits acquired from other Ñnancial institutions, is amortized on a straight-line basis over the expected periods to be beneÑted (generally 15 years). The Company assesses the recoverability of this 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) intangible asset by determining whether the amortization of the premium balance over its remaining life can be recovered through the remaining deposit portfolio. At December 31, 2002, the unamortized balance of core deposit premium was $2.13 million. Aggregate amortization expense for core deposit premium for the year ended December 31, 2002, was $198,000. Estimated amortization expense for the next Ñve years is: $188,000 in 2003, $188,000 in 2004, $188,000 in 2005, $176,000 in 2006, and $176,000 in 2007. Stock-Based Compensation. The Company applies the intrinsic value method to account for stock- based compensation whereby expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Pro forma net income and pro forma net income per share disclosures for employee stock option grants are based on the recognition as expense, over the vesting period, of the fair value on the date of grant of all stock-based awards. The Company estimated the fair value of options granted in 2002, 2001, and 2000 using the Black- Scholes option-pricing model with following assumptions: (i) an expected life of the option of four years, (ii) a stock price volatility of 35.80% in 2002 and 2001, and 33.88% in 2000 based on daily market prices for the preceding four-year period, (iii) an expected dividend yield of 3.07% per share per annum in 2002, 1.66% per share per annum in 2001, and 2.1% per share per annum in 2000, and (iv) a risk-free interest rate of 2.34% in 2002, 3.89% in 2001, and 5.1% in 2000. The fair value of the options was calculated to be $7.75 per share for options granted in 2002 at the date of grant, $8.78 per share for options granted in 2001 at the date of grant, and $6.03 per share for options granted in 2000 at the date of grant, on a split-adjusted basis. If the compensation cost for the Company's stock option plan had been determined with the fair value at the grant dates, computed using the assumptions above, for awards under the Plan consistent with the method of SFAS No. 123, ""Accounting for Stock-Based Compensation,'' the Company's net income and earnings per share for 2002, 2001, and 2000 would have been reduced to the pro forma amounts indicated below. 2002 2001 (In thousands, except per share data) 2000 Net income As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $48,700 48,490 $42,620 42,276 $38,587 38,457 Basic net income per share As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted net income per share As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.71 2.70 2.69 2.68 2.35 2.34 2.35 2.33 2.13 2.13 2.13 2.12 Stock Split. Earnings per share, dividends per share and average shares outstanding have been restated for periods prior to the stock split distributed on May 9, 2002, to stockholders of record on April 19, 2002. The par value of additional shares was capitalized by a transfer from retained earnings to common stock. Derivative Financial Instruments. It is the policy of the Company not to speculate on the future direction of interest rates. However, the Company enters into Ñnancial derivatives in order to seek mitigation of exposure to interest rate risks related to our interest-earning assets and interest-bearing liabilities. We believe that these transactions, when properly structured and managed, may provide a hedge against inherent interest rate risk in the Company's assets or liabilities and against risk in speciÑc transactions. In such instances, the Company may protect its position through the purchase or sale of interest rate futures contracts for a speciÑc cash or interest rate risk position. Other hedge transactions may be implemented using interest rate swaps, interest rate caps, Öoors, Ñnancial futures, forward rate agreements, and options on futures or 86 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) bonds. Prior to considering any hedging activities, we seek to analyze the costs and beneÑts of the hedge in comparison to other viable alternative strategies. All hedges require an assessment of basis risk and must be approved by the Bank's Investment Committee. For periods prior to January 1, 2001, for those qualifying Ñnancial derivatives that altered the interest rate characteristics of assets or liabilities, the net diÅerential to be paid or received on the Ñnancial derivative was treated as an adjustment to the yield on the underlying assets or liabilities. Interest rate Ñnancial derivatives that did not qualify for the accrual method, were recorded at fair value, with gains and losses recorded in earnings. EÅective January 1, 2001, the Company adopted SFAS No. 133, ""Accounting for Derivative Instruments and Hedging Activities'' (""SFAS No. 133''), as amended by SFAS No. 137 and No. 138. SFAS No. 133 establishes accounting and reporting standards for Ñnancial derivatives, including certain Ñnancial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all Ñnancial derivatives as assets or liabilities in the Company's statement of Ñnancial condition and measurement of those Ñnancial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a Ñnancial derivative is designated as a hedge and if so, the type of hedge. On the date a derivative contract is entered into, the Company designates the derivative as either a hedge of the fair value of a recognized asset or liability or of an unrecognized Ñrm commitment (fair value hedge), a hedge of a forecasted transaction or the variability of cash Öows to be received or paid related to a recognized asset or liability (cash Öow hedge), a foreign-currency fair-value or cash-Öow hedge (foreign currency hedge), or a hedge of a net investment in a foreign operation. For all hedging relationships, the Company formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the item, the nature of the risk being hedged, how the hedging instrument's eÅectiveness in oÅsetting the hedged risk will be assessed, and a description of the method of measuring ineÅectiveness. This process includes linking all derivatives that are designated as fair-value, cash-Öow, or foreign-currency hedges to speciÑc assets and liabilities on the statement of condition or to speciÑc Ñrm commitments or forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly eÅective in oÅsetting changes in fair values or cash Öows of hedged items. When it is determined that a derivative is not highly eÅective as a hedge or that it has ceased to be a highly eÅective hedge, the Company discontinues hedge accounting prospectively. Upon adoption of SFAS No. 133, the Company recognizes all derivatives on the balance sheet at fair value. Fair value is based on dealer quotes, or quoted prices from instruments with similar characteristics. The Company uses Ñnancial derivatives designated for hedging activities as cash Öow hedges. For derivatives designated as cash Öow hedges, changes in fair value are recognized in other comprehensive income until the hedged item is recognized in earnings. Income Taxes. The provision for income taxes is based on income reported for Ñnancial statement purposes, and diÅers from the amount of taxes currently payable, since certain income and expense items are reported for Ñnancial statement purposes in diÅerent periods than those for tax reporting purposes. The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary diÅerences between the Ñnancial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in eÅect when such amounts are realized or settled. A valuation allowance is established for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. A valuation allowance is established, when necessary, to reduce the deferred tax assets to the amount that is more likely than not to be realized. Comprehensive Income. Comprehensive income is deÑned as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income generally includes net income, foreign items, minimum pension liability adjustments, unrealized gains and losses on investments in securities available-for-sale, and cash Öow hedges. Comprehensive income and its components 87 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) are reported and displayed in the Company's consolidated statements of income and comprehensive income. Comprehensive income is a Ñnancial reporting concept and does not aÅect the Company's Ñnancial position or results of operations. Net Income per Common Share. Earnings per share (""EPS'') is computed on a basic and diluted basis. Basic EPS excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reÖects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shares in the earnings of the Company. Amounts and share and per share data have been adjusted to reÖect a two-for-one stock split in the form of a 100 percent stock dividend, eÅective May 9, 2002. Statement of Cash Flows. Cash and cash equivalents include short-term, highly-liquid investments that generally have an original maturity of three months or less. Segment Information and Disclosures. Accounting principles generally accepted in the United States of America establish standards to report information about operating segments in annual Ñnancial statements and requires reporting of selected information about operating segments in interim reports to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company has concluded it has one segment. Recent Accounting Pronouncements In August 2001, the Financial Accounting Standards Board (""FASB'') issued SFAS No. 144, ""Accounting for the Impairment or Disposal of Long-Lived Assets.'' For long-lived assets to be held and used, SFAS No. 144 retains the requirements of SFAS No. 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash Öows and (b) measure an impairment loss as the diÅerence between the carrying amount and fair value. Further, SFAS No. 144 eliminates the requirement to allocate goodwill to long-lived assets to be tested for impairment, describes a probability-weighted cash Öow estimation approach to deal with situations in which alternative courses of action to recover the carrying amount of a long-lived asset are under consideration or a range is estimated for the amount of possible future cash Öows, and establishes a ""primary-asset'' approach to determine the cash Öow estimation period. For long-lived assets to be disposed of by sale, SFAS No. 144 retains the requirements of SFAS No. 121 to measure a long-lived asset classiÑed as held-for-sale at the lower of its carrying amount or fair value less cost to sell and to cease depreciation. Discontinued operations are no longer measured on a net realizable value basis, and future operating losses no longer are recognized before they occur. SFAS No. 144 broadens the presentation of discontinued operations to include a component of an entity, establishes criteria to determine when a long-lived asset is held-for-sale, prohibits retroactive reclassiÑcation of the asset as held- for-sale at the balance sheet date if the criteria are met after the balance sheet date but before issuance of the Ñnancial statements, and provides accounting guidance for the reclassiÑcation of an asset from ""held-for-sale'' to ""held-and-used.'' The provisions of SFAS No. 144 are eÅective for Ñscal years beginning after Decem- ber 15, 2001. The Company adopted SFAS No. 144 eÅective January 1, 2002. Adoption of SFAS No. 144 did not have any impact on the results of operations or Ñnancial condition of the Company. In April 2002, the FASB issued SFAS No. 145, ""Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.'' SFAS No. 145 rescinds the SFAS No. 4 requirement that all gains and losses from extinguishment of debt be aggregated and, if material, classiÑed as an extraordinary item, net of the related income tax eÅect. Henceforth, those gains and losses from extinguishment of debt are to be classiÑed in accordance with the criteria in APB Opinion No. 30, ""Reporting the Results of Operations Ì Reporting the EÅects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.'' SFAS No. 64, which amended SFAS No. 4, is no longer necessary with the rescission of SFAS No. 4. SFAS No. 44 was issued to establish accounting requirements for the eÅects of transition to the provisions of the Motor Carrier Act of 1980. Since 88 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) the transition has been completed, SFAS No. 44 is no longer necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease modiÑcations that have economic eÅects similar to sale-leaseback transactions to be accounted for in the same manner as sale-leaseback transactions. SFAS No. 145 is eÅective for Ñnancial statements for periods beginning after May 15, 2002, and earlier adoption is recommended. The Company adopted SFAS No. 145 eÅective May 15, 2002. Adoption of SFAS No. 145 did not have any impact on the results of operations or Ñnancial condition of the Company. In July 2002, FASB issued SFAS No. 146, ""Accounting for Costs Associated with Exit or Disposal Activities''. SFAS No. 146 applies to costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities or personnel. Under SFAS No. 146, a company will record a liability for a cost associated with an exit or disposal activity when that liability is incurred and can be measured at fair value. A liability is incurred when an event leaves the company little or no discretion to avoid transferring or using the assets in the future. Previous accounting guidance was provided by the Emerging Issues Task Force (""EITF'') Issue No. 94-3, ""Liability Recognition for Certain Employee Termination BeneÑts and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).'' SFAS No. 146 is eÅective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 did have a material impact on the Company's results of operations or Ñnancial condition. In October 2002, the FASB issued SFAS No. 147, ""Acquisitions of Certain Financial Institutions.'' SFAS No. 147 is an amendment of FASB statements No. 72 and 144 and FASB Interpretation No. 9. The Statement addresses the Ñnancial accounting and reporting for the acquisition of all or part of a Ñnancial institution. It also provides guidance on the accounting for the impairment or disposal of acquired long-term customer relationship intangible assets. The provisions in paragraph 5 of this Statement are eÅective for acquisitions for which the date of acquisition is on or after October 1, 2002. The adoption of this statement had no impact on the Company. In December 2002, the FASB issued SFAS No. 148, ""Accounting for Stock-Based Compensation Ì Transition and Disclosure,'' an amendment of FASB Statement No. 123. This Statement amends FASB Statement No. 123, ""Accounting for Stock-Based Compensation,'' to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim Ñnancial statements. Certain of the disclosure modiÑcations are required for Ñscal years ending after December 15, 2002, and are included in the notes to these consolidated Ñnancial statements. In November 2002, the FASB issued Interpretation No. 45, ""Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34.'' This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual Ñnancial statements about its obligations under guarantees issued. The Interpretation also clariÑes that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modiÑed after December 31, 2002, and are not expected to have a material eÅect on the Company's Ñnancial statements. The disclosure requirements are eÅective for Ñnancial statements of interim and annual periods ending after December 15, 2002. In January 2003, the FASB issued Interpretation No. 46, ""Consolidation of Variable Interest Entities,'' an interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as deÑned in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For public enterprises, such as the Company, with a variable interest 89 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) in a variable interest entity created before February 1, 2003, the Interpretation applies no later than the beginning of the Ñrst interim or annual reporting period beginning after June 15, 2003. The application of this Interpretation is not expected to have a material eÅect on the Company's Ñnancial statements. The Interpretation requires certain disclosures in Ñnancial statements issued after January 31, 2003, if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes eÅective. As of December 31, 2002, the Company owned interests in two limited partnerships, for which it is reasonably possible that the limited partnerships may be construed to be variable interest entities subject to consolidation under Interpretation No. 46. Both of these investments were formed for the purpose of investing in low-income housing projects, which qualify for federal low-income housing tax credits and/or California tax credits, and at December 31, 2002, the carrying amount of those investments in real estate was $4.95 million. As of December 31, 2002, the Company had fully satisÑed all capital commitments required under these two investments in real estate, and in addition, under the terms of both limited partnership agreements, the Company is not liable for the debts, liabilities, contracts, or any other obligation of these limited partnerships. Application of Interpretation No. 46 for the Company will be the third quarter of 2003. The Company has not completed its analysis to determine the impact to the Company in adopting the application of Interpretation No. 46. However, the Company expects that the adoption will not have a material impact on the Company's results of operations or Ñnancial position. 2. Cash and Cash Equivalents The Company manages its cash and cash equivalents, which consist of cash on hand, amounts due from banks, federal funds sold, securities purchased under agreements to resell, and money market accounts, based upon the Company's operating, investment and Ñnancing activities. For the purpose of reporting cash Öows, these same accounts are included in cash and cash equivalents. The Company is required to maintain reserves with the Federal Reserve. Reserve requirements are based on a percentage of deposit liabilities. The average reserve balances required were $5,874,000 for 2002 and $3,288,000 for 2001. Securities purchased under agreements to resell are collateralized by U.S. government agency and mortgaged-backed securities at December 31, 2002 and 2001. These agreements generally mature in one business day. The counter-parties to these agreements are nationally recognized investment banking Ñrms that meet credit requirements of the Company and with whom a master repurchase agreement has been duly executed. The following table sets forth information with respect to securities purchased under resale agreements. 2002 2001 (In thousands) Balance, December 31ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Annualized weighted-average interest rate, December 31ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average amount outstanding during the year(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average interest rate for the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Maximum amount outstanding at any month end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14,000 $ Ì 1.33% Ì% $42,573 $27,897 1.70% 4.12% $52,000 $36,000 (1) Average balance were computed using daily averages. For those securities obtained under the resale agreements, the collateral is either held by a third party custodian or by the counter-party and segregated under written agreements that recognize the Company's interest in the securities. Interest income associated with securities purchased under resale agreements totaled $724,000 for 2002, $1,149,000 for 2001, and $513,000 for 2000. 90 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The following table sets forth information with respect to federal funds sold. Balance, December 31ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Annualized weighted-average interest rate, December 31ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average amount outstanding during the year(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average interest rate for the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Maximum amount outstanding at any month end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,000 $13,000 1.01% 1.01% $ 6,393 $ 4,500 1.40% 3.70% $22,000 $13,000 2002 2001 (In thousands) (1) Average balance were computed using daily averages. 3. Securities Securities Available-for-Sale. The following table reÖects the amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities available-for-sale as of December 31, 2002 and 2001: Available-For-Sale 2002 U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipals securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortized Cost $162,287 100 5,767 808 9,997 30,755 29,026 Gross Unrealized Gains Gross Unrealized Losses (In thousands) Fair Value $ 7,896 Ì 380 39 513 2,314 Ì $ Ì $170,183 100 6,147 847 10,510 33,069 27,417 Ì Ì Ì Ì Ì 1,609 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $238,740 $11,142 $1,609 $248,273 2001 U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $113,873 8,336 2,658 9,994 20,000 57,973 28,954 $ 4,500 213 47 401 Ì 2,532 34 $ 49 6 Ì Ì Ì 171 331 $118,324 8,543 2,705 10,395 20,000 60,334 28,657 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $241,788 $ 7,727 $ 557 $248,958 The amortized cost and fair value of securities available-for-sale, except for mortgage-backed securities, collateralized mortgage obligations and venture capital investments, at December 31, 2002, by contractual maturities are shown below. Actual maturities may diÅer from contractual maturities because borrowers may have the right to call or repay obligations with or without call or repayment penalties. 91 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Amortized Cost Fair Value (In thousands) Due in one year or less(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after one year through Ñve years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after Ñve years through ten yearsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities and collateralized mortgage obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 39,124 168,177 24,864 6,575 $ 37,718 177,691 25,870 6,994 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $238,740 $248,273 (1) Equity securities are reported in this category. Proceeds from sales and repayments of securities available-for-sale were $26,461,000 during 2002 and $30,600,000 during 2001. Proceeds from maturities and calls of securities available-for-sale were $221,792,000 during 2002 and $865,867,000 during 2001. Gains realized on securities available-for-sale were $2,252,000, and losses realized were $341,000 in 2002 compared with $1,057,000 in gains and $65,000 in losses realized in 2001. There were no gains in 2000, and losses realized in 2000 were $18,000. Securities Held-to-Maturity. The carrying value, gross unrealized gains, gross unrealized losses and estimated fair values of securities held-to-maturity are as follows at December 31, 2002 and 2001: Held-To-Maturity Carrying Value Gross Unrealized Gains Gross Unrealized Losses (In thousands) 2002 U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 49,996 72,770 66,135 168,055 9,999 72,611 19,886 $ 2,032 5,392 3,231 1,664 349 4,471 1,510 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $459,452 $18,649 2001 U.S. government agencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and municipal securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Collateralized mortgage obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 50,017 69,906 110,342 50,282 920 73,031 19,858 $ 1,251 2,049 2,726 657 1 1,822 484 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $374,356 $ 8,990 $ Ì 6 Ì 60 Ì 253 Ì $319 $ Ì 380 14 57 Ì 81 Ì $532 Estimated Fair Value $ 52,028 78,156 69,366 169,659 10,348 76,829 21,396 $477,782 $ 51,268 71,575 113,054 50,882 921 74,772 20,342 $382,814 The carrying value and estimated fair value of securities held-to-maturity, except for mortgage-backed securities and collateralized mortgage obligations, at December 31, 2002, by contractual maturities are shown 92 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) below. Actual maturities may diÅer from contractual maturities because borrowers may have the right to call or repay obligations with or without call or repayment penalties. Amortized Cost Fair Value (In thousands) Due in one year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after one year through Ñve years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after Ñve years through ten yearsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after ten years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-backed securities and collateralized mortgage obligations ÏÏÏÏÏÏ $ 19,712 114,617 55,959 34,974 234,190 $ 20,172 119,146 62,073 37,366 239,025 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $459,452 $477,782 Proceeds from repayment of securities held-to-maturity were $66,980,000 during 2002 and $63,155,000 during 2001. Proceeds from the maturities and calls of securities held-to-maturity were $13,226,000 during 2002 and $60,295,000 during 2001. The Company realized gross gains of $14,000 for 2002, $314,000 for 2001, and less than $1,000 for 2000, on call of securities. No losses were realized for 2002, 2001, or 2000. Securities having a carrying value of $153,138,000 at December 31, 2002, and $125,250,000 at December 31, 2001, were pledged to secure public deposits, treasury tax and loan, and securities sold under agreements to repurchase. Federal Home Loan Bank (""FHLB'') stock is carried at cost, and included in other assets in the Consolidated Statements of Condition. The carrying amount of the FHLB stock at December 31, 2002, was $5.56 million compared to $5.64 million at December 31, 2001. The Federal Home Loan Bank Act currently governs the level of stock ownership, and the stock is purchased and redeemed at par. The amount of Federal Home Loan Bank stock required is based on the member's year-end outstanding mortgage-backed securities, residential mortgages, and advances from the FHLB. 4. Loans Most of the Company's business activity is with customers located in the predominantly Asian areas of Southern and Northern California, New York City, and Houston, Texas. The Company has no speciÑc industry concentration, and generally its loans are collateralized with real property or other pledged collateral of the borrowers. Loans are generally expected to be paid-oÅ from the operating proÑts of the borrowers, 93 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) reÑnancing by another lender or through sale by the borrowers of the secured collateral. The components of loans in the consolidated statements of condition as of December 31, 2002 and 2001, were as follows: Type of Loans: Commercial loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Residential mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity linesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate construction loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Installment loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 2001 (In thousands) $ 563,675 182,414 943,391 48,957 122,773 15,570 447 $ 506,128 195,562 738,379 40,352 166,417 20,322 745 Gross loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,877,227 1,667,905 Less Allowance for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unamortized deferred loan fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (24,543) (4,606) (23,973) (3,900) Net loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,848,078 $1,640,032 The Company previously sold participations in certain residential mortgage loans to buyers in the secondary market. These participations covered substantially all of the loan balances and were sold without recourse. As of December 31, 2002, the Company had $8,211,000 of these loans in its servicing portfolio, which included loans sold in 2002, totaling $7,045,000. There were no loan sales in 2001. There were no loans held for sale as of December 31, 2002 and 2001. The Company pledged approximately $81,183,000 of its residential mortgage loans as of December 31, 2002, and $96,413,000 as of December 31, 2001, to secure a line of credit with the Federal Home Loan Bank. The allowance for loan losses is a signiÑcant estimate that can and does change based on management's process in analyzing the loan portfolio and on management's assumptions about speciÑc borrowers and applicable economic and environmental conditions, among other factors. An analysis of the activity in the allowance for loan losses for the years ended December 31, 2002, 2001, and 2000 is as follows: Balance at beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans charged-oÅ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries of charged-oÅ loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $23,973 6,000 (5,976) 546 2002 2001 (In thousands) $21,967 6,373 (4,663) 296 2000 $19,502 4,200 (1,905) 170 Balance at end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $24,543 $23,973 $21,967 The Company had identiÑed impaired loans with a recorded investment to be approximately $19,591,000 as of December 31, 2002, and $19,350,000 as of December 31, 2001. The average balances of impaired loans were $24,763,000 for 2002, $23,465,000 for 2001, and $29,516,000 for 2000. Interest collected on impaired loans totaled $1,223,000 in 2002, $959,000 in 2001, and $2,120,000 in 2000. The Bank recognizes interest 94 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) income on impaired loans based on its existing method of recognizing interest income on non-accrual loans. The following table is a breakdown of impaired loans and the related speciÑc allowance: Recorded Investment Allocated Net Balance Allowance (In thousands) 2002 CommercialÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,883 15,707 1 TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $19,591 2001 CommercialÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,924 12,426 TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $19,350 $ 629 2,356 1 $2,986 $2,143 1,764 $3,907 $ 3,254 13,351 Ì $16,605 $ 4,781 10,662 $15,443 (1) Real Estate includes commercial mortgage loans, construction loans, and residential mortgage loans In addition, accruing loans past due 90 days or more had outstanding balances of $2.50 million at year- end 2002 compared with $689,000 at year-end 2001. On January 3, 2003, one accruing commercial mortgage loan past due 90 days or more, with a recorded investment of $1.10 million was paid-oÅ. The Company has entered into transactions with its directors, signiÑcant stockholders, and their aÇliates (""Related Parties''). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers. In management's opinion, these transactions did not involve more than normal credit risk or present other unfavorable features. All loans to Related Parties were current as of December 31, 2002. An analysis of the activity with respect to loans to Related Parties is as follows: Balance at December 31, 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional loans made ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payments receivedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance at December 31, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional loans made(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payments received(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (In thousands) $ 12,899 21,060 (15,147) 18,812 81,095 (67,730) Balance at December 31, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 32,177 (1) The increase loans made to and payments received from related parties is primarily attributable to two lines of credit made to the spouse of one director, in the amount of $10 million each. Each line is secured by a separate time deposit of $10 million each. The purpose of the lines is for business investment. The director is not a party to either credit relationship. 95 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The following is a summary of non-accrual loans and troubled debt restructurings as of December 31, 2002, 2001, and 2000 and the related net interest foregone for the years then ended: Non-accrual Loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,124 2002 2001 (In thousands) $7,238 Contractual interest due ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest recognized ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 321 34 $ 823 96 2000 $14,696 $ 1,408 627 Net interest foregone ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 287 $ 727 $ 781 Troubled Debt Restructurings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,266 $4,726 $ 4,531 Contractual interest due ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest recognized ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 338 258 $ 409 370 Net interest foregone ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 80 $ 39 $ $ 422 407 15 As of December 31, 2002, there were no commitments to lend additional funds to those borrowers whose loans have been restructured, impaired, or in non-accrual status. 5. Other Real Estate Owned The balance of other real estate owned at December 31, 2002, was $653,000 and at December 31, 2001, was $1,555,000. The valuation allowance was $131,000 at December 31, 2002, and December 31, 2001. The following table presents the components of other real estate owned expense (income) for the year ended: Operating expense (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net gain on disposal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 46 Ì (395) 2002 2001 (In thousands) $ (213) Ì (3,376) 2000 $ 7 71 (263) Total other real estate owned (income)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(349) $(3,589) $(185) An analysis of the activity in the allowance for other real estate losses for the years ended December 31, 2002, 2001, and 2000 is as follows: 2002 2001 2000 Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for lossesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs on disposal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $131 Ì Ì Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $131 $131 Ì Ì $131 $ 614 71 (554) $ 131 6. Investments in Real Estate The Company's investments in real estate were $21,678,000 as of December 31, 2002, and $17,727,000 as of December 31, 2001, consisting of seven investments in limited partnerships formed for the purpose of investing in low income housing projects, qualiÑed for Federal low income housing tax credits. The limited partnerships are expected to generate tax credits over a weighted-average remaining period of approximately eleven years. In addition to the Federal tax credits, the California Corporate Tax Credit Fund, the WNC Institutional Tax Credit Fund California Ì Series 2, and the WNC Institutional Tax Credit Fund New York Ì Series 3, also qualiÑed for State tax credits. See Note 9 of the notes to consolidated Ñnancial statements for income tax eÅects. In 2002, the Company acquired an interest in three additional real estate 96 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) investment as follows: an interest in Lend Lease ITC XXIII with a contribution of $4,874,000, an interest in WNC Institutional Tax Credit Fund X New York Ì Series 3, with an initial contribution of $577,000, and an interest in the WNC Institutional Tax Credit Fund X California Ì Series 2, with an initial contribution of $415,000, and an additional contribution of $122,000 in October 2002. The following table presents the details of the seven projects as of December 31, 2002 and 2001: The following table summarizes the composition of our investments in real estate as of the dates indicated: Percentage of Ownership Acquisition Date (Dollars in thousands) December 31, 2002 December 31, 2001 Carrying Amount Las Brisas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Los Robles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ California Corporate Tax Credit Fund III ÏÏ Wilshire CourtyardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Lend Lease ITC XXIII ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WNC Institutional Tax Credit Fund X New York Ì Series 3 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WNC Institutional Tax Credit Fund X 49.5% 99.0% 32.5% 99.9% 4.5% December 1993 August 1995 March 1999 May 1999 March 2002 4.2% August 2002 California Ì Series 2 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.0% September 2002 $ Ì 386 11,128 4,568 4,546 529 521 $ Ì 386 12,426 4,915 Ì Ì Ì $21,678 $17,727 The Company's 99.00% and 99.90% interests in the Los Robles and Wilshire Courtyard limited partnerships were not consolidated as of December 31, 2002 and 2001, because the Company did not have control over the operation of these limited partnerships. The Company's investments are accounted for by using the equity method of accounting. The Company recognized a net loss of approximately $2,038,000 in 2002, $2,257,000 in 2001, and $683,000 in 2000, from the limited partnerships' operations. 7. Premises and Equipment Premises and equipment consisted of the following at December 31, 2002, and 2001: Land and land improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Building and building improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Furniture, Ñxtures and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Construction in process ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Accumulated depreciationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 2001 (In thousands) $11,953 17,687 15,536 3,404 70 48,650 18,862 $11,800 17,685 14,414 2,512 291 46,702 17,299 Premises and equipment, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $29,788 $29,403 The amount of depreciation included in operating expense was $1,596,000 in 2002, $1,472,000 in 2001, and $1,500,000 in 2000. 97 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 8. Borrowings Securities Sold under Agreements to Repurchase. The underlying collateral pledged for the repurchase agreements consists of U.S. government agency security with a carrying value of $29,972,000 and a fair value of $31,172,000 as of December 31, 2002, and is held by a custodian and maintained under the Company's control. In 2001 and 2000, these borrowings generally matured in less than 30 days, however, at December 31, 2002, the $28.50 million balance at year-end was comprised of a long-term reverse repurchase agreement obtained in January 2002, which will mature in January 2004. The table below provides comparative data for securities sold under agreements to repurchase: Average amount outstanding during the year(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Maximum amount outstanding at month-end(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balances, December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rate at year-end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average interest rate for the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 $30,784 48,150 28,500 December 31, 2001 (In thousands) $34,799 55,412 22,114 2000 $70,701 110,145 68,173 3.29% 3.08% 1.01% 3.51% 6.09% 6.25% (1) Average balances were computed using daily averages. (2) Highest month-end balances were January 2002, February 2001, and October 2000. Advances from the Federal Home Loan Bank. Advances from the Federal Home Loan Bank of San Francisco (""FHLB'') amounted to $50.00 million at December 31, 2002, and $30.00 million at December 31, 2001. Of the Bank's $50.00 million in FHLB advances outstanding at December 31, 2002, $10.00 million bearing interest at 4.90% was obtained in 1998 and matures on October 28, 2003, $20.00 million bearing interest at 3.48% was obtained in 2002 and matures on February 27, 2004, and $20.00 million bearing interest at 5.45% was obtained in 2001 and matures on March 21, 2005. These advances are non-callable with Ñxed interest rates. 9. Income Taxes For the years ended December 31, 2002, 2001, and 2000, the current and deferred amounts of the income tax expense are summarized as follows: 2002 2001 (In thousands) 2000 Current Federal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $21,561 1,821 $19,367 1,814 $19,321 1,904 23,382 21,181 21,225 Deferred Federal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,196) 109 (1,350) (1,011) (1,087) (2,361) 479 158 637 Total income tax expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $22,295 $18,820 $21,862 98 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Temporary diÅerences between the amounts reported in the Ñnancial statements and the tax basis of assets and liabilities give rise to deferred taxes. Deferred tax assets and liabilities at December 31, 2002 and 2001 are as follows: 2002 2001 (In thousands) Deferred Tax Assets DiÅerence between provisions for loan losses for tax and Ñnancial reporting purposes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,865 $ 9,275 DiÅerence between provisions for other real estate owned losses for tax and Ñnancial reporting purposesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State income tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 55 1,185 515 71 705 676 Gross deferred tax assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,620 10,727 Deferred Tax Liabilities Use of accelerated depreciation for tax purposes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred loan fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHLB stock dividend ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized holding gain on securities available-for-sale, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gain on cash Öow hedge derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,411) (1,025) (4,009) (956) (163) (1,312) Ì (1,115) (3,043) (706) (368) Gross deferred tax liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (7,564) (6,544) Net deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,056 $ 4,183 Amounts for the current year are based upon estimates and assumptions as of the date of this report and could vary from amounts shown on the tax returns as Ñled. Accordingly, the variances from the amounts previously reported for 2001 are primarily the result of adjustments to conform to the tax returns as Ñled. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary diÅerences become deductible. Management considers the projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize all beneÑts related to these deductible temporary diÅerences. Included in other assets in the statements of condition, at December 31, 2002 and 2001, were net deferred tax assets of $4,056,000 in 2002, and $4,183,000 for 2001. Other assets as of December 31, 2002 and 2001 included a current income tax receivable of $35,000 for 2002 and $996,000 for 2001. Other liabilities as of December 31, 2002 and 2001 include a current income tax payable $24,745,000 for 2002 and $19,370,000 for 2001. 99 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Income tax expense results in eÅective tax rates that diÅer from the statutory Federal income tax rate for the years indicated as follows: Tax provision at Federal statutory rate ÏÏÏÏÏÏÏÏ State income taxes, net of Federal income tax 2002 2001 (In thousands) 2000 $24,848 35.00% $21,504 35.00% $21,157 35.00% beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,255 1.77 522 0.85 1,340 2.22 Interest on obligations of state and political subdivisions, which are exempt from Federal taxation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Low income housing tax creditsÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-deductible expense Ì Amortization of goodwillÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (141) (2,732) (0.20) (3.85) (72) (2,294) (0.12) (3.73) (1,240) (947) (2.05) (1.57) Ì (935) Ì (1.32) 236 (1,076) 0.38 (1.75) 231 1,321 0.38 2.19 Total income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $22,295 31.40% $18,820 30.63% $21,862 36.17% 10. Stockholders' Equity and Earnings per Share As a bank holding company, Bancorp's ability to pay dividends will depend upon the dividends it receives from the Bank and on the income it may generate from any other activities in which Bancorp may engage, either directly or through other subsidiaries. Currently, since Bancorp does not have any other signiÑcant business activities outside the Bank's operations, its ability to pay dividends will depend solely on dividends received from the Bank. Under California State banking law, the Bank may not pay a cash dividend, without regulatory approval, which exceeds the lesser of the Bank's retained earnings or its net income for the last three Ñscal years, less any cash distributions made during that period. The amount of retained earnings available for cash dividends as of December 31, 2002, is restricted to approximately $103,076,000 under this regulation. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory Ì and possibly additional discretionary Ì actions by regulators that, if undertaken, could have a direct material eÅect on the Bank's Ñnancial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet speciÑc capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain oÅ-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classiÑcation are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Federal Deposit Insurance Corporation has established Ñve capital ratio categories: ""well capital- ized'', ""adequately capitalized'', ""undercapitalized'', ""signiÑcantly undercapitalized'' and ""critically under- capitalized.'' A well capitalized institution must have a Tier 1 capital ratio of at least 6%, a total risk-based capital ratio of at least 10% and a leverage ratio of at least 5%. At December 31, 2002, the Bank was in compliance with the minimum capital requirements and is considered well capitalized. 100 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The Company's and the Bank's capital and leverage ratios as of December 31, 2002, and 2001 are presented in the tables below: Company Bank Company Bank Balance As of December 31, 2002 Percentage Balance Percentage (Dollars in thousands) Balance As of December 31, 2001 Percentage Balance Percentage Tier I Capital (to risk- weighted assets) ÏÏÏÏ $ 271,613(1) 11.93% $ 262,874(1) 11.57% $ 231,916(2) 11.15% $ 224,239(2) 10.80% Tier I Capital minimum requirement ÏÏÏÏÏÏÏÏ 91,043 4.00 90,876 4.00 83,231 4.00 83,064 ExcessÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 180,570 7.93% $ 171,998 7.57% $ 148,685 7.15% $ 141,175 4.00 6.80% Total capital (to risk- weighted assets) ÏÏÏÏ $ 296,156(1) 13.01% $ 287,417(1) 12.65% $ 255,904(2) 12.30% $ 248,227(2) 11.95% Total Capital minimum requirement ÏÏÏÏÏÏÏÏ 182,085 8.00 181,752 8.00 166,462 8.00 166,129 ExcessÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 114,071 5.01% $ 105,665 4.65% $ 89,442 4.30% $ 82,098 8.00 3.95% Risk-weighted assets ÏÏÏ $2,276,063 $2,271,902 $2,080,776 $2,076,608 Tier I Capital (to average assets) Leverage ratio ÏÏÏÏÏÏ Minimum leverage $ 271,613(1) 10.11% $ 262,874(1) 9.80% $ 231,916(2) 9.48% $ 224,239(2) 9.18% requirement ÏÏÏÏÏÏÏÏ 107,439 4.00 107,258 4.00 97,843 4.00 97,665 ExcessÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 164,174 6.11% $ 155,616 5.80% $ 134,073 5.48% $ 126,574 4.00 5.18% Total average assets ÏÏÏ $2,685,983(3) $2,681,438(3) $2,446,084(3) $2,441,623(3) (1) Excluding accumulated other comprehensive income of $6,719,000 and intangibles of $8,682,000. (2) Excluding accumulated other comprehensive income of $5,063,000 and intangibles of $8,880,000. (3) Average assets represent average balances for the fourth quarter of 2002 and the fourth quarter of 2001. The Board of Directors of Bancorp is authorized to issue preferred stock in one or more series and to Ñx the voting powers, designations, preferences or other rights of the shares of each such class or series and the qualiÑcations, limitations, and restrictions thereon. Any preferred stock issued by Bancorp may rank prior to Bancorp common stock as to dividend rights, liquidation preferences, or both, may have full or limited voting rights, and may be convertible into shares of Bancorp common stock. No preferred stock has been issued as of December 31, 2002. On November 16, 2000, Bancorp's Board of Directors adopted a Rights Agreement between Bancorp and American Stock Transfer and Trust Company, as Rights Agent, and declared a dividend of one preferred share purchase right for each outstanding share of Bancorp common stock. The dividend was payable on January 19, 2001, to stockholders of record at the close of business on the record date, December 20, 2000. Each preferred share purchase right entitles the registered holder to purchase from Bancorp one one- thousandth of a share of Bancorp's series A junior participating preferred stock at a price of $200, subject to adjustment. In general, the rights become exercisable if, after December 20, 2000, a person or group acquires 15% or more of Bancorp's common stock or announces a tender oÅer for 15% or more of the common stock. The Board of Directors is entitled to redeem the rights at one cent per right at any time before any such person acquires 15% or more of the outstanding common stock. The rights will expire in ten years. The complete terms and conditions of the rights are contained in the Rights Agreement, between Bancorp and the Rights Agent, which was Ñled as an exhibit to Bancorp's Form 8-A on December 20, 2000. The Rights Agreement is a successor to Bancorp's prior rights agreement, which expired at the close of business on December 20, 2000. 101 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The following is the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the years as indicated: Year Ended December 31, 2002 Year Ended December 31, 2001 Year Ended December 31, 2000 Income (Numerator) Per Share (Denominator) Amount Shares Income (Numerator) Per Shares Share (Denominator) Amount Income (Numerator) Per Share (Denominator) Amount Shares Net Income ÏÏÏ $48,700 $42,620 $38,587 (In thousands, except share and per share data) Basic EPS income available to common stockholders EÅect of dilutive stock options ÏÏÏÏÏ Diluted EPS income available to common stockholders $48,700 17,991,333 $2.71 $42,620 18,107,790 $2.35 $38,587 18,113,502 $2.13 123,786 57,470 34,268 $48,700 18,115,119 $2.69 $42,620 18,165,260 $2.35 $38,587 18,147,770 $2.13 For the years ended December 31, 2002 and 2000, all outstanding options had a dilutive eÅect and were included in the computation of diluted earnings per share. Options to purchase an additional 51,635 shares of common stock were outstanding at December 31, 2001, and were not included in the computation of diluted earnings per share because their inclusion would have had an antidilutive eÅect. 11. Commitments and Contingencies Litigation. The Company is involved in various litigation concerning transactions entered into during the normal course of business. Management, after consultation with legal counsel, does not believe that the resolution of such litigation will have a material eÅect upon its Ñnancial statements taken as a whole. Lending. In the normal course of business, the Company becomes a party to Ñnancial instruments with oÅ-balance sheet risk to meet the Ñnancing needs of its customers. These Ñnancial instruments included commitments to extend credit in the form of loans or through commercial or standby letters of credit and Ñnancial guarantees. Those instruments represent varying degrees of exposure to risk in excess of the amounts included in the accompanying consolidated statements of condition. The contractual or notional amount of these instruments indicates a level of activity associated with a particular class of Ñnancial instrument and is not a reÖection of the level of expected losses, if any. The Company's exposure to credit loss in the event of non-performance by the other party to the Ñnancial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support Ñnancial instruments with credit risk. 102 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Financial instruments whose contract amounts represent the amount of credit risk include the following: Commitments to extend credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Standby letters of credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other letters of credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Bill of lading guarantee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $725,000 15,000 37,000 11,000 $676,000 18,000 27,000 13,000 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $788,000 $734,000 2002 2001 (In thousands) Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the commitment agreement. These commitments generally have Ñxed expiration dates and are expected to expire without being drawn upon. The total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by- case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation of the borrowers. As of December 31, 2002, the Company does not have Ñxed-rate or variable-rate commitments with characteristics similar to options, which provide the holder, for a premium paid at inception to the Company, the beneÑts of favorable movements in the price of an underlying asset or index with limited or no exposure to losses from unfavorable price movements. The Company's exposure to credit risk from this Ñnancial guarantee is essentially the same as if the Company was the owner of the corporation debt. At December 31, 2002, the Company has no outstanding Ñnancial guarantees. Letters of credit and bill of lading guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in making loans to customers. As of December 31, 2002, the Company had available credit lines with other Ñnancial institutions in the amount of $332,500,000. Derivative Financial Instruments. The Company entered into a forward rate agreement with a notional amount of $100 million that was recorded at fair value, with gains recorded as securities gains in the accompanying consolidated statements of income and comprehensive income. The agreement expired in March 2001. On March 21, 2000, the Company entered into an interest rate swap agreement with a major Ñnancial institution in the notional amount of $20.00 million for a period of Ñve years. The interest rate swap was for the purpose of hedging the cash Öows from a portion of our Öoating rate loans against declining interest rates. The purpose of the hedge is to provide a measure of stability in the future cash receipts from such loans over the term of the swap agreement, which at December 31, 2002, was approximately two and an one quarter years. At December 31, 2002, the fair value of the interest rate swap was $2.27 million, exclusive of accrued interest or $1.19 million, net of tax compared to $1.68 million, exclusive of accrued interest, or $869,000 net of tax, at December 31, 2001. For the twelve months ended December 31, 2002, net amounts totaling $1.06 million were reclassiÑed into earnings. The estimated net amount of the existing gains within accumulated other comprehensive income that are expected to reclassify into earnings within the next 12 months is approximately $1.16 million. Leases. The Company is obligated under a number of operating leases for premises and equipment with terms ranging from 1 to 55 years, many of which provide for periodic adjustment of rentals based on changes in various economic indicators. Rental expense was $2,507,000 for 2002, $2,269,000 for 2001 and $2,200,000 103 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) for 2000. The following table shows future minimum payments under operating leases with terms in excess of one year as of December 31, 2002. Year Ended December 31, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commitments (In thousands) $ 1,772(1) 1,562 1,499 1,488 1,148 11,719 Total minimum lease paymentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $19,188 (1) Includes the annual lease payment of approximately $107,000 to be made to T.C. Realty, Inc., a corporation owned by Mr. Patrick Lee's spouse. Mr. Lee is a director of the Bancorp and the Bank. The 3-year lease is due to expire in 2003. Rental income was $515,000 for 2002, $450,000 for 2001, and $437,000 for 2000. The following table shows future rental payments to be received under operating leases with terms in excess of one year as of December 31, 2002: Year Ended December 31, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commitments (In thousands) $ 468 322 124 59 43 66 Total minimum lease payments to be received ÏÏÏÏÏÏÏÏÏÏÏÏ $1,082 12. Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of Ñnancial instruments. Cash and Short-term Instruments. For cash and short-term instruments, the carrying amount was assumed to be a reasonable estimate of fair value. Investment Securities. For securities (which include securities available-for-sale, and securities held-to- maturity), fair values were based on quoted market prices at the reporting date. If a quoted market price was not available, fair value was estimated using quoted market prices for similar securities. Loans. Fair values were estimated for portfolios of loans with similar Ñnancial characteristics. Each loan category was further segmented into Ñxed and adjustable rate interest terms and by performing and non- performing categories. The fair value of performing loans was calculated by discounting scheduled cash Öows through the estimated maturity using estimated market discount rates that reÖect the credit and interest rate risk inherent in the loan. 104 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Fair value for non-performing real estate loans was based on recent external appraisals of the underlying collateral of the loan. If appraisals were not available, estimated cash Öows are discounted using a rate commensurate with the risk associated with the estimated cash Öows. Assumptions regarding credit risk, cash Öows, and discount rates are determined judgmentally using available market information and speciÑc borrower information. Deposit Liabilities. The fair value of demand deposits, savings accounts, and certain money market deposits was assumed to be the amount payable on demand at the reporting date. The fair value of Ñxed- maturity certiÑcates of deposit was estimated using the rates currently oÅered for deposits with similar remaining maturities. Other Borrowings. This category includes federal funds purchased and securities sold under repurchase agreements, and other short-term borrowings. The carrying amount is a reasonable estimate of fair value because of the relatively short period of time between the origination of the instrument and its expected realization. Advances from Federal Home Loan Bank. The fair value of the advances is estimated by discounting the projected cash Öows using the U.S. Treasury curve adjusted to approximate current entry-value interest rates applicable and similar obligations issued by the Bank. OÅ-Balance-Sheet Financial Instruments. The fair value of commitments to extend credit, standby letters of credit, and Ñnancial guarantees written were estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthi- ness of the counter-parties. The fair value of guarantees and letters of credit was based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter-parties at the reporting date. Derivative Financial Instruments. The fair value of interest rate swap was quoted market prices at the reporting date. If a quoted market price was not available, fair value was estimated using quoted market prices for similar securities. Fair value estimates were made at speciÑc points in time, based on relevant market information and information about the Ñnancial instrument. These estimates do not reÖect any premium or discount that could result from oÅering for sale at one time the Bank's entire holdings of a particular Ñnancial instrument. Because no market exists for a signiÑcant portion of the Bank's Ñnancial instruments, fair value estimates were based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various Ñnancial instruments, and other factors. These estimates were subjective in nature and involved uncertainties and matters of signiÑcant judgment and therefore cannot be determined with precision. Changes in assumptions could signiÑcantly aÅect the estimates. 105 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Fair Value of Financial Instruments Financial Assets Cash and due from banks ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Federal funds sold and securities purchased under agreements to resell ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities available-for-saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest rate swapÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financial Liabilities As of December 31, 2002 Carrying Amount Fair Value As of December 31, 2001 Carrying Amount Fair Value (In thousands) $ 70,777 $ 70,777 $ 73,514 $ 73,514 19,000 248,273 459,452 1,848,078 2,568 19,000 248,273 477,782 1,871,740 2,568 13,000 248,958 374,356 1,640,032 1,928 13,000 248,958 382,814 1,643,459 1,928 DepositsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase Advances from Federal Home Loan Bank ÏÏÏÏÏ 2,314,643 28,500 50,000 2,322,556 28,939 52,364 2,122,348 22,114 30,000 2,128,850 22,114 30,397 As of December 31, 2002 Fair Notional Value Amount (In thousands) As of December 31, 2001 Notional Amount Fair Value OÅ-Balance Sheet Financial Instruments Commitments to extend credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Standby letters of credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other letters of credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Bill of lading guarantee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $725,024 15,229 36,667 10,608 $(424) (54) (196) (71) $676,513 17,595 26,923 12,729 $(349) (64) (91) (72) 13. Employee BeneÑt Plans Employee Stock Ownership Plan. Under the Company's Amended and Restated Cathay Bank Em- ployee Stock Ownership Plan (""ESOP''), the Company makes annual contributions to a trust in the form of either cash or common stock of the Company for the beneÑt of eligible employees. Employees are eligible to participate in the ESOP after completing two years of service for salaried full-time employees or 1,000 hours for each of two consecutive years for salaried part-time employees. The amount of the annual contribution is discretionary except that it must be suÇcient to enable the trust to meet its current obligations. The Company also pays for the administration of this plan and of the trust. The ESOP purchased 50,453 shares in 2002, 28,918 shares in 2001, and 37,510 shares in 2000, of the Bancorp's stock at an aggregate cost of $1,694,078 in 2002, $773,163 in 2001, and $812,359 in 2000. The shares purchased in 2002 included 34,200 shares bought on the open market and 16,253 shares bought through the Dividend Reinvestment Plan. The shares purchased in 2001 included 8,400 shares bought on the open market and 20,518 shares bought through the Dividend Reinvestment Plan. The shares purchased in 2000 included 15,000 shares bought on the open market and 22,510 shares bought through the Dividend Reinvestment Plan. The Company contributed $694,000 in 2002, $598,500 in 2001, and $564,800 in 2000 to the trust. The expense was charged to salaries and employee beneÑts in the accompanying consolidated statements of income and comprehensive income. In 2002, distribution of beneÑts to participants totaled 112,821 shares. As of December 31, 2002, the ESOP owned 982,120 shares or 5.46% of the Company's outstanding common stock. Cathay Bancorp, Inc. 401(k) Plan. In 1997, the Board approved the Cathay Bancorp, Inc. 401(k) ProÑt Sharing Plan, which began on March 1, 1997. Salaried employees who have completed three months of 106 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) service and have attained the age of 21 are eligible to participate. Enrollment dates are on January 1st, April 1st, July 1st and October 1st of each year. Participants may contribute up to 15% of their compensation for the year but not to exceed the dollar limit set by the Internal Revenue Code. Participants may change their contribution election on the enrollment dates. The Company matches 50% of the participants' contribution up to 4% of their compensation after one year of service. The vesting schedule for the matching contribution is 0% for less than two years of service, 25% after two years of service and from then on, at an increment of 25% each year until 100% vested after Ñve years of service. The Company's contribution amounted to $247,400 in 2002, $227,900 in 2001, and $198,100 in 2000. The Plan allows participants to withdraw all or part of their vested amount in the Plan due to certain Ñnancial hardship as set forth in the Internal Revenue Code and Treasury Regulation. Participants may also borrow up to 50% of the vested amount, up to a maximum of $50,000. The minimum loan amount is $1,000. 14. Equity Incentive Plans In 1998, the Board adopted the Cathay Bancorp, Inc. Equity Incentive Plan. Under the Equity Incentive Plan, directors and eligible employees may be granted incentive or non-statutory stock options, or awarded restricted stock, for up to 2,150,000 shares of the Company's common stock on a split adjusted basis. The Equity Incentive Plan currently expires on February 2008. The Company granted non-statutory stock options to selected bank oÇcers and non-employee directors in 2000 to purchase a total of 110,000 shares, in 2001 to purchase a total of 112,800 shares, and in 2002 to purchase a total of 113,440 shares of the Company's common stock. The exercise price per share of these non- statutory stock options is equal to the fair market value of a share of the Company's common stock on the date of grant. Such options have a maximum ten-year term and vest in 20% annual increments (subject to early termination in certain events). If such options expire or terminate without having been exercised, any shares not purchased will again be available for future grants or awards. Balance, December 31, 1999 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Shares 89,400 110,000 (2,904) (840) Balance, December 31, 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 195,656 Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 112,800 (17,494) (23,740) Weighted-Average Exercise Price $16.50 21.25 16.50 21.25 $19.15 30.10 17.55 24.94 Balance, December 31, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 267,222 $23.36 Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 113,440 (15,202) (1,640) 32.55 19.37 28.71 Balance, December 31, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 363,820 $26.37 107 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The following table shows stock options outstanding and exercisable as of December 31, 2002, the corresponding exercise prices and the weighted-average contractual life remaining. Exercise Price $16.50 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21.25 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30.10 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32.55 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Shares 63,600 86,816 100,684 112,720 363,820 Outstanding Weighted-Average Remaining Contractual Life (in Years) 5.8 7.1 8.1 9.2 7.8 Exercisable Shares 50,512 27,000 13,716 Ì 91,228 No compensation cost has been recognized for its stock option plans in the consolidated Ñnancial statements. 108 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 15. Condensed Financial Information of Cathay Bancorp, Inc. (Unaudited) The condensed Ñnancial information of Cathay Bancorp, Inc. as of December 31, 2002 and 2001 and for the years ended December 31, 2002, 2001, and 2000 were as follows: Statements of Condition Year Ended December 31, 2002 2001 (In thousands, except share and per share data) Assets Cash ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investment securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investment in subsidiary Ì Cathay Bank ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,249 4,058 279,222 500 $ 3,248 3,999 238,335 500 Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $288,029 $246,082 Liabilities Accrued expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equity Preferred stock, $0.01 par value; 10,000,000 shares authorized, none issuedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock, $0.01 par value; 25,000,000 shares authorized, 18,305,255 issued and 17,999,955 outstanding in 2002, and 18,235,538 issued and 17,957,738 outstanding in 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏ Treasury stock, at cost (305,300 shares in 2002 and 277,800 shares in 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional paid-in-capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated other comprehensive income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 68 68 Ì 71 71 Ì 183 182 (8,287) 70,857 6,719 218,489 (7,342) 68,517 5,063 179,591 Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 287,961 246,011 Total liabilities and stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $288,029 $246,082 109 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Statements of Income and Comprehensive Income 2002 Year Ended December 31, 2001 (In thousands) $14,058 (469) $ 9,801 (573) 2000 $ 7,965 (280) Cash dividends from Cathay Bank ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before undistributed earnings of subsidiary ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,228 241 9,469 Equity in undistributed earnings of subsidiary ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 39,231 Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 48,700 Other comprehensive income, net of tax: Unrealized holding gains arising during the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative adjustment upon adoption of SFAS No. 133 ÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains on cash Öow hedge derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: reclassiÑcation adjustments included in net income ÏÏÏÏÏÏÏÏÏÏÏ Total other comprehensive income, net of taxÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,290 Ì 326 1,960 1,656 13,589 196 13,785 28,835 42,620 2,408 566 303 517 2,760 7,685 118 7,803 30,784 38,587 3,084 Ì Ì (225) 3,309 Total comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $50,356 $45,380 $41,896 110 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Statements of Cash Flows 2002 Year Ended December 31, 2001 (In thousands) 2000 Cash Öows from Operating Activities Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile net income to net cash provided by operating activities: $ 48,700 $ 42,620 $ 38,587 Equity in undistributed earnings of subsidiary ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Decrease) increase in accrued expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Write-downs on venture capital investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (39,231) (3) 341 Ì (28,835) (30,784) 8 65 (500) 22 Ì Ì Net cash provided by operating activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,807 13,358 7,825 Cash Flows from Investing Activities Purchase of investment securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash used in investing activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Flows from Financing Activities Cash dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from shares issued under the Dividend Reinvestment Plan ÏÏÏ Proceeds from exercise of stock options and tax beneÑts from stock plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchase of treasury stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (400) (400) (655) (655) (3,410) (3,410) (9,802) 1,898 (9,057) 1,811 (7,965) 1,691 443 (945) 432 (7,342) 56 Ì Net cash used in Ñnancing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (8,406) (14,156) (6,218) Increase (decrease) in cash and cash equivalentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,001 3,248 (1,453) 4,701 (1,803) 6,504 Cash and cash equivalents, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,249 $ 3,248 $ 4,701 Supplemental disclosure of cash Öow information Cash paid during the year for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-cash investing activities: Net change in unrealized holding gains on securities available-for- sale, net of taxÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative adjustment upon adoption of SFAS No. 133, net of taxÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net change in unrealized gains on cash Öow hedge derivatives, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ 150 $ 150 1,330 $ 1,891 Ì $ 566 326 $ 303 $ $ $ $ 150 3,309 Ì Ì 16. Dividend Reinvestment Plan The Company has a dividend reinvestment plan which allows for participants' reinvestment of cash dividends and certain additional optional investments in the Company's common stock. Shares issued under the plan and the consideration received on a post-split stock basis were 54,515 for $1,896,000 in 2002, 69,314 for $1,811,000 in 2001, and 78,660 for $1,691,000 in 2000. 111 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 17. Quarterly Results of Operations (Unaudited) The following table sets forth selected unaudited quarterly Ñnancial data: Summary of Operations 2002 2001 Fourth Quarter Third Quarter Second Quarter First Quarter Fourth Quarter Third Quarter Second Quarter First Quarter (In thousands, except per share data) Interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏ $36,224 9,340 $36,304 10,062 $35,267 9,835 $36,266 10,683 $36,608 13,121 $39,977 15,965 $40,721 17,660 $42,046 19,407 Net interest income ÏÏÏÏÏÏÏÏÏ Provision for loan lossesÏÏÏÏÏÏ 26,884 1,500 26,242 1,500 25,432 1,500 25,583 1,500 23,487 2,773 24,012 1,200 23,061 1,200 22,639 1,200 Net interest income after provision for loan losses ÏÏÏÏ 25,384 24,742 23,932 24,083 20,714 22,812 21,861 21,439 Non-interest income ÏÏÏÏÏÏÏÏ Non-interest expense ÏÏÏÏÏÏÏÏ 3,630 11,560 5,185 10,891 4,022 10,214 3,334 10,652 3,721 8,461 4,154 10,253 3,052 10,340 3,852 11,111 Income before income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax expense ÏÏÏÏÏÏÏÏÏ 17,454 5,385 19,036 6,031 17,740 5,502 16,765 5,377 15,974 4,437 16,713 5,208 14,573 4,375 14,180 4,800 Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,069 13,005 12,238 11,388 11,537 11,505 10,198 9,380 Other comprehensive income (loss), net of tax: Unrealized holding gains (losses) arising during the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative adjustment upon adoption of SFAS No. 133 Unrealized gains (losses) on cash Öow hedge derivatives Less: reclassiÑcation adjustments included in net incomeÏÏÏÏÏÏÏÏÏÏÏÏ Total other comprehensive 159 1,939 3,527 (2,334) (811) 2,201 (730) 1,748 Ì Ì (166) 417 Ì 141 Ì Ì Ì Ì (66) (316) 511 (148) 566 256 499 550 718 194 127 287 79 24 income (loss), net of taxÏÏÏ (506) 1,806 2,950 (2,594) (1,254) 2,425 (957) 2,546 Total comprehensive incomeÏÏ $11,563 $14,811 $15,188 $ 8,794 $10,283 $13,930 $ 9,241 $11,926 Basic net income per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted net income per common shareÏÏÏÏÏÏÏÏÏÏÏÏ $ $ 0.67 0.67 $ $ 0.72 0.72 $ $ 0.68 0.67 $ $ 0.63 0.63 $ $ 0.64 0.64 $ $ 0.63 0.63 $ $ 0.56 0.56 $ $ 0.52 0.52 112 administrative information > Board of Directors Front Row (left to right) George T. M. Ching Vice Chairman of the Board Cathay Bancorp, Inc. Dunson K. Cheng Chairman of the Board and President Cathay Bancorp, Inc. Wilbur K. Woo Vice Chairman of the Board Cathay Bancorp, Inc. Back Row (left to right) Joseph C. H. Poon President Edward Properties, Inc. Michael M. Y. Chang Secretary Cathay Bancorp, Inc. Ralph Roy Buon-Cristiani Retired Veterinarian Anthony M. Tang Executive Vice President Cathay Bancorp, Inc. Thomas G. Tartaglia Director Cathay Bancorp, Inc. Kelly L. Chan CPA Vice President Phoenix Bakery Patrick S. D. Lee Retired Real Estate Developer Wing K. Fat President Frank Fat, Inc. Officers Cathay Bancorp, Inc. Cathay Bank Dunson K. Cheng Chairman of the Board and President George T. M. Ching Vice Chairman of the Board Wilbur K. Woo Vice Chairman of the Board Michael M.Y. Chang Secretary Anthony M. Tang Executive Vice President and Chief Financial Officer/ Treasurer/Assistant Secretary Perry P. Oei General Counsel Dunson K. Cheng Chairman of the Board and President George T. M. Ching Vice Chairman of the Board Wilbur K. Woo Vice Chairman of the Board Michael M.Y. Chang Secretary Anthony M. Tang Senior Executive Vice President and Chief Lending Officer Irwin Wong Executive Vice President Branch Administration James Brewer Senior Vice President Credit Administration Elena Chan Senior Vice President and Chief Financial Officer James P. Lin Senior Vice President and Manager Corporate Commercial Loan and International Banking Perry P. Oei General Counsel Tina Chao First Vice President and Team Manager Corporate Commercial Loan Oliver Chen First Vice President and Team Manager Corporate Commercial Loan Chingying Chu First Vice President and Manager Small Business Administration Loan Angela Hui First Vice President and Loan Officer Commercial Real Estate Loan Dennis Kwok First Vice President and Manager Cathay Portfolio Management and Cathay Global Investment Services Pin Tai General Manager New York Region Wilson Tang Regional Vice President Branch Administration Jack Tweedy First Vice President Credit Administration Edward Alvarado Vice President and Loan Officer Commercial Real Estate Loan Weston Barkwill Chief Internal Auditor Peggy Chan Vice President and Loan Officer New York Region Jay Cheng Vice President and Loan Officer Corporate Commercial Loan John M. Fox Vice President and Manager Collateral Control Scott Kleinert Vice President and Manager Information Systems Margaret Li Vice President and Manager Mortgage Loan Tony Moya Vice President Bank Operations Administration Javier G. Otoya Vice President and Controller Francine Paxson Vice President Loan Operations Louisa Ting Vice President Branch Operations Administration New York Region Susan Yang Vice President and Loan Officer Corporate Commercial Loan Offices Corporate Office: 777 North Broadway Los Angeles, CA 90012 (213) 625-4700 Tel: Fax: (213) 625-1368 Branch Offices: California Los Angeles 777 North Broadway Los Angeles, CA 90012 Tel: (213) 625-4700 Fax: (213) 625-1368 Kenneth Chan Assistant Vice President and Manager Monterey Park 250 South Atlantic Boulevard Monterey Park, CA 91754 Tel: (626) 281-8808 Fax: (626) 281-2956 Frank Chen Regional Vice President and Manager Alhambra 601 North Atlantic Boulevard Alhambra, CA 91801 Tel: (626) 284-6556 Fax: (626) 282-3496 Frank Chen Regional Vice President and Manager Hacienda Heights 16025 East Gale Avenue City of Industry, CA 91745 Tel: (626) 333-8533 Fax: (626) 336-4227 Shu Lee Regional Vice President and Manager Westminster 9121 Bolsa Avenue Westminster, CA 92683 Tel: (714) 890-7118 Fax: (714) 898-9267 Allen Vi Vice President and Manager San Jose 2010 Tully Road San Jose, CA 95122 Tel: (408) 238-8880 Fax: (408) 238-2302 Edward Wong Vice President and Manager San Gabriel 825 East Valley Boulevard San Gabriel, CA 91776 Tel: (626) 573-1000 Fax: (626) 573-0983 Jack Sun Vice President and Manager Torrance 23228 Hawthorne Boulevard Torrance, CA 90505 (310) 791-8700 Tel: Fax: (310) 791-1862 Allen Lin Assistant Vice President and Manager Oakland 710 Webster Street Oakland, CA 94607 Tel: (510) 208-3700 Fax: (510) 208-3727 Claudia Wong Assistant Vice President and Manager Cerritos 11355 South Street Cerritos, CA 90701 (562) 860-7300 Tel: Fax: (562) 860-2296 Henry Yoh Assistant Vice President and Manager City of Industry 1250 South Fullerton Road City of Industry, CA 91748 Tel: (626) 810-1088 Fax: (626) 810-2188 Shu Lee Regional Vice President and Manager Cupertino 10480 South De Anza Boulevard Cupertino, CA 95014 Tel: (408) 255-8300 Fax: (408) 255-8373 David Lin Vice President and Manager Milpitas 1759 North Milpitas Boulevard Milpitas, CA 95035 Tel: (408) 262-0280 Fax: (408) 262-0780 Tony Wen Vice President and Manager Irvine 15323 Culver Drive Irvine, CA 92604 Tel: (949) 559-7500 Fax: (949) 559-7508 Linda Kuo Vice President and Manager Millbrae Millbrae Plaza 1095 El Camino Real Millbrae, CA 94030 Tel: (650) 652-0188 Fax: (650) 652-0180 Stanley Wong Vice President and Manager Valley-Stoneman 43 East Valley Boulevard Alhambra, CA 91801 Tel: (626) 576-7600 Fax: (626) 576-5831 Claudia My Lu Vice President and Manager Berkeley-Richmond 3288 Pierce Street Richmond, CA 94804 (510) 526-8898 Tel: Fax: (510) 526-0639 Sumiko Wu Assistant Vice President and Manager Diamond Bar 1195 South Diamond Bar Boulevard Diamond Bar, CA 91765 Tel: (909) 860-8299 Fax: (909) 861-0920 Shu Lee Regional Vice President and Manager Union City 1701 Decoto Road Union City, CA 94587 Tel: (510) 675-9190 Fax: (510) 675-9312 Tony Wen Vice President and Manager Sacramento 5591 Sky Parkway Sacramento, CA 95823 Tel: (916) 428-4890 Fax: (916) 428-4966 Alice Palecek Assistant Manager New York Flushing 40-14/16 Main Street Flushing, NY 11354 Tel: (718) 886-5225 Fax: (718) 961-7680 New York Chinatown 45 East Broadway New York, NY 10002 Tel: (212) 732-0200 Fax: (212) 732-7389 Francis Wong Vice President and Manager Brooklyn 5402 Eighth Avenue Brooklyn, NY 11220 Tel: (718) 435-0800 Fax: (718) 633-0128 Francis Wong Vice President and Manager Texas Houston 10375 Richmond Avenue #1600 Houston, TX 77042 Tel: (713) 278-9599 Fax: (713) 278-9699 Shu Mak Vice President and Acting Manager Overseas Representative Offices: Hong Kong Room 902-3, 9/F Printing House 6 Duddell Street Central, Hong Kong (852) 2522-0071 Tel: Fax: (852) 2810-1652 Winnie Lau Representative Shanghai Unit 1808, Shanghai Kerry Centre 1515 Nanjing Road West Shanghai 200040 People’s Republic of China Miranda So Chief Representative Subsidiary: Cathay Investment Company Los Angeles 777 North Broadway Los Angeles, CA 90012 Tel: (213) 625-4700 Fax: (213) 625-1368 Dunson K. Cheng Chief Executive Officer and President Taipei Sixth Floor, Suite 3 146 Sung Chiang Road Taipei, Taiwan, R.O.C. (886) (2) 2537-5057 Tel: Fax: (886) (2) 2537-5059 Li Sung Representative and Manager Additional Information: Market Makers The following ﬁrms make a market in Cathay Bancorp, Inc. stock: Hoefer & Arnett, Inc. Knight Securities Wedbush Morgan Securities Registrar and Transfer Agent American Stock Transfer and Trust Company 59 Maiden Lane New York, NY 10038 (800) 937-5449 Tel: Cathay Service Hotline (800) 9 CATHAY / 922-8429 Cathay Bank Web Site www.cathaybank.com m o c . n g i s e d g m c . w w w A C , a n e d a s a P , . c n I n g i s e D g M C : n g i s e D FORWARD-LOOKING STATEMENTS This Annual Report contains forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may include, but are not limited to, such words as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminolo- gy or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance, or achievements, of Cathay Bancorp, Inc. to be materially different from any future results, performance, or achievements, expressed or implied by such forward-looking statements. Such risks and uncertainties and other factors include, but are not limited to adverse developments, or conditions related to or arising from: our expansion into new market areas; ﬂuctuations in interest rates; demographic changes; increases in competition; deterioration in asset or credit quality; changes in the availability of capital; adverse regulatory developments; changes in business strategy, including the formation of a real estate investment trust and the application to the Securities and Exchange Commission for deregistration of the registered investment company; general economic or business conditions. These and other factors are further described in Cathay Bancorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2002, contained in this Annual Report, its Quarterly Reports on Form 10-Q, and other ﬁlings it makes with the Securities and Exchange Commission from time to time. Actual results in any future period may also vary from the past results discussed in this Annual Report. Given these risks and uncertainties, we caution readers not to place undue reliance on any forward- looking statements, which speak as of the date of this Annual Report. Cathay Bancorp, Inc. has no intention and undertakes no obligation to update any forward-looking statement or to publicly announce the results of any revision of any forward-looking statement to reﬂect future developments or events. Member of Federal Deposit Insurance Corporation This annual report has not been reviewed, or conﬁrmed for accuracy or relevance, by the Federal Deposit Insurance Corporation. 777 North Broadway Los Angeles, California 90012 T: (213) 625-4700 F: (213) 625-1368 www.cathaybank.com

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