Hanmi Financial Annual Report 2004

Plain-text annual report

hanmi financial Annual Report 2004 the essentials of real success talent commitment resources opportunity Hanmi Bank is a wholly owned subsidiary of Hanmi Financial Corporation (Nasdaq: HAFC). A leading Korean-American bank headquartered in Los Angeles, Hanmi Bank provides high quality individual, corporate and institutional ﬁnancial services in regional markets.Throughout its history, Hanmi has produced long-term proﬁtable growth while adapting to changing market conditions.We credit this success to practicing sound and prudent risk management techniques and to building enduring relationships with you – our shareholders, customers and employees. At year-end 2004, your bank had total assets of nearly $3.1 billion and 22 full-service ofﬁces in Los Angeles, Orange, San Francisco, Santa Clara and San Diego counties. Hanmi Financial Financial Highlights (amounts in thousands, except per-share amounts) 2004 2003 2002 2001 2000 For the year Net interest income Service charges and fee income Other operating income Non-interest expenses Net income At year end Total assets Net loans Total deposits Shareholders’ equity Per Common Share Net income (diluted) Cash dividends declared Book value Financial Ratios Net interest margin Nonperforming loans to total gross loans Allowance for loan losses to total gross loans Efﬁciency ratio Tier 1 capital to average total assets* Total capital to total risk-weighted assets* Return on average assets Return on average equity *Hanmi Bank ratio $ 101,550 $ 21,823 $ 5,775 $ 66,566 $ 36,700 $ 56,327 $ 15,691 $ 4,625 $ 39,325 $ 19,213 $ 47,971 $ 13,485 $ 7,719 $ 38,333 $ 17,030 $ 43,688 $ 12,799 $ 4,454 $ 32,028 $ 16,810 $ 41,355 $ 12,288 $ 2,714 $ 27,796 $ 15,523 $ 3,104,188 $2,234,842 $2,528,807 $ 399,910 $ 1,787,139 $1,248,399 $1,445,835 $ 139,467 $1,457,313 $ 975,154 $1,283,979 $ 124,468 $ 1,159,416 $ 781,718 $1,042,353 $ 104,873 $1,035,310 $ 621,222 $ 934,581 $ 86,396 $ 0.84 $ 0.20 $ 8.11 $ 0.67 $ 0.20 $ 4.92 $ 0.60 $ 0.57 $ 0.60 $ – $ – $ – $ 3.17 $ 3.83 $ 4.47 4.29% 3.69% 3.96% 4.29% 5.23% 0.27% 0.68% 0.65% 0.63% 0.40% 1.00% 51.54% 1.06% 51.31% 1.14% 55.41% 1.19% 52.40% 1.78% 49.32% 8.78% 7.75% 8.34% 8.76% 8.39% 11.80% 1.37% 12.51% 11.09% 1.18% 14.51% 11.94% 1.30% 15.08% 12.75% 1.53% 17.56% 12.27% 1.68% 19.81% 3,104.2 36.7 2,528.8 2,234.8 1,787.1 1,457.3 19.2 16.8 17.0 15.5 1,159.4 1,035.3 1,445.8 1,284.0 1,042.4 934.6 1,248.4 975.2 781.7 621.2 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 Total Assets Dollars in millions Net Income Dollars in millions Total Deposits Dollars in millions Net Loans Dollars in millions page 1 To our shareholders Last year was the most successful in Hanmi’s twenty-two-year history. At December 31, 2004, assets were a record $3.1 billion, compared to $1.8 billion at the end of 2003. Net income for the year was a record $36.7 million, up from $19.2 million in 2003. Even more telling, perhaps, was the year-over-year improvement of sixty basis points in our net interest margin, to 4.29 percent in ﬁscal 2004. These results reﬂect the strength of our core business and our merger with Paciﬁc Union Bank, completed last April. The merger was the single most important event in Hanmi’s history and, with the full integration of the two institutions now essentially complete, we expect to achieve further operating efﬁciencies in 2005. With the merger, we now have the foundation on which to build a truly regional ﬁnancial institution. As the largest Korean-American bank in the country, we are in an enviable position vis-à-vis our competitors. Our ﬁnancial resources — and our twenty-two branch ofﬁces — give us inherent advantages in attracting deposits, funding loans, and realizing the sort of cost savings that can sustain bottom-line growth. To be sure, we face any number of challenges in the months and years ahead, not least of which is the intensely competitive nature of our business. As important as size, then, is quality of service — the ability to anticipate and satisfy each customer’s speciﬁc ﬁnancial needs. It encompasses everything from new product development to welcoming a new customer at a branch ofﬁce. Superior service generates superior returns to our shareholders. Financial service is built on personal relationships, and without our loyal customers and dedicated employees we could not succeed. Our continuing success requires that we diligently attend to our customers’ ongoing needs while relentlessly pursuing new customers who can further contribute to our growing balance sheet. Superior service is possible only with the enthusiastic participation of our employees. They will participate more actively in ensuring that no stone goes unturned when it comes to recognizing and addressing customers’ needs. In pursuing that goal, they will soon be able to draw upon a variety of new products designed to appeal to a demographic base that is increasingly diverse – and increasingly sophisticated in terms of what it demands of a ﬁnancial services institution. Hanmi Financial 2004 Annual Report S u n g W o n S o h n , i P r e s i d e n t a n d C h e f E x e c u t i v e O f ﬁ c e r w i l l d r a w o n a s t e a d f a s t c o m m i t m e n t t o u n s u r p a s s e d c u s t o m e r s e r v i c e . ” “ H a n m i ’ s t r a n s i t i o n f r o m c o m m u n i t y b a n k t o r e g o n a l i ﬁ n a n c i a l i n s t i t u t i o n page 2 Hanmi Financial 2004 Annual Report In order to improve sales and customer satisfaction, we are designing a program that will enable us to identify and track cross-selling opportunities at the branch level. We will also put in place an incentive- based compensation package that rewards those employees, from tellers to executives, who meet or exceed their goals. Even though our primary focus is organic growth through excellent sales and service, we will pursue, as opportunities present themselves, the sort of M&A activities that culminated in last year’s merger with Paciﬁc Union Bank. We will continue to concentrate on the Korean-American community, with the goal of further expanding our market share. But we will also look for opportunities beyond the Korean-American community. In fact, nearly half our lending activity already comes from non-Korean-Americans. The attractive valuation of our shares compared to other banks reﬂects in part the exceptionally attractive demographics of our marketplace and the fact that we have served a particularly enterprising ethnic group. It also reﬂects our ability to meet the growing needs of other ethnic groups. We believe we are particularly well positioned to meet the ﬁnancial needs of an ever more multi-ethnic society. In 2004, the price of our stock appreciated more than 80 percent. However, the market rewards past performance only to the extent that it provides a window on the future. A company’s current valuation — and its ability to attract new investors and new capital — rests on management’s ability to devise and articulate a strategy that can produce sustainable bottom-line growth. We are fortunate to be headquartered in one of the world’s most vibrant and ethnically diverse markets, a market ideally suited to support the further growth of Hanmi’s business. We face 2005 with considerable optimism. We thank you for your continuing support, and we look forward to keeping you apprised of our progress. Sincerely, Joon Hyung Lee Chairman of the Board of Directors Sung Won Sohn President and Chief Executive Ofﬁcer page 3 real talent Employees are our most important asset. Hanmi Financial 2004 Annual Report Essential 1. Our employees are among the most talented in the market. Of the four ingredients necessary to the success of any business, talent is perhaps the hardest to measure. But without it no enterprise can hope to thrive. As a longstanding leader among Korean-American banks, and with excellent training programs and a wide range of career opportunities, Hanmi has been able to attract and retain a wealth of talent. Our senior managers have the imagination and creativity to devise new When the talents of an individual are presented in concert with those of many others, solutions to old problems, and they are adept at guiding the operations of the whole becomes greater than the sum of its parts. a major ﬁnancial institution. Our branch managers, many of whom have been with us for decades, do an outstanding job of cultivating the strengths of our employees, from loan ofﬁcer to teller, who are typically the ﬁrst point of contact with our customers. r e c ﬁ f O n o i t a r t s i n m d A i i f e h C , m K i . W d i v a D i ” . s p h s n o i t a l e r l a n o s r e p n o l l a e v o b a h c a e f o s d e e n r a l u c i t r a p e h t g n i s s e r d d a r o f t n e m t i m m o c d n a t n e l a t a h t i W “ t l i u b s i g n i k n a b l u f s s e c c u s t a h t n o i t c i v n o c r u o t c e ﬂ e r l s e e y o p m e s ’ i m n a H , r e m o t s u c page 5 real commitment Strong customer relationships are the foundation of our business. Hanmi Financial 2004 Annual Report Essential 2. A commitment to excellence underlies all that we do. Talent is ill-served without an underlying commitment to one’s customers. Without it one cannot build and maintain the long-term relationships that are essential to success. We are committed to serving those who are unfamiliar with the country’s banking and business traditions. From special installment savings plans to sophisticated currency-linked invest- ment vehicles, we are dedicated to ensuring that our products and services are tailored to the needs and sensibilities of the people we serve. The achievement of new heights requires As one of the most active participants in California’s low-income housing dedication and commitment to a course of action, program, we support all our constituents. We are committed to addressing no matter how arduous the task. the interests of all our stakeholders — customers, investors, and the community at large. We are committed to the idea that the success of our business rests fundamentally on loyalty, conﬁdence, and trust. , l a u d i v i d n i t n a t r o p m i n a s a r e m o t s u c y r e v e t a e r t o t e r i s e d r u O “ p l e h l l i w , e v r e s e w s e i t i n u m m o c e h t g n i t r o p p u s o t t n e m t i m m o c r e d a o r b r u o e k i l r e c ﬁ f O e v i t u c e x E l i a n o g e R , a m a y a r u M . H i k u S ” . y t i r e p s o r p r i e h t n i e r a h s e w t a h t e r u s n e page 7 real resources Providing Hanmi with a strong competitive advantage. Hanmi Financial 2004 Annual Report Essential 3. Unsurpassed resources will continue to support our growth. Talent and commitment alone will not ensure success. In addition to our intellectual capital — our dedicated employees — we have the resources and infra- structure, notably $3 billion in assets and a network of twenty-two branch ofﬁces, that give us a signiﬁcant competitive advantage over our peers. Resources are effectively the raw materials We have a balance sheet that enables us to fund the development of the new that provide the foundation and structure of an products and new internal systems that are necessary to support continu- undertaking, supporting its continuing growth. r e c ﬁ f O l a i c n a n i F f e h C i , i k s r a n W i i . J l e a h c i M ” . n o i t u t i t s n i l a i c n a n ﬁ d e t n e i r o y l l a c i n h t e ing growth. Our ready access to the capital markets will further support our growth through mergers or acquisitions, as opportunities present themselves. We have as well a wealth of credibility and goodwill — the result of two decades of service to our Southern California constituents — that will stand us in good stead as we pursue new customer relationships. e h t e v a h e w , s e c ﬁ f o h c n a r b f o k r o w t e n e v i s n e t x e n a d n a l a t i p a c e l p m a h t i W “ i g n d a e l s ’ a i n r o f i l a C n r e h t u o S s a g n d n a t s i s ’ i m n a H e c n a h n e r e h t r u f o t s e c r u o s e r page 9 real opportunity Growing in partnership with our customers. Hanmi Financial 2004 Annual Report Essential 4. We embrace the opportunity to prosper with the communities we serve. A business must have a receptive marketplace. We are fortunate to be headquartered in one of the world’s most vibrant and ethnically diverse economies, and the opportunities are enormous. As the economy grows, so, too, does the net worth and sophistication of our customers. r a e l c a h t i w i m n a H s e d i v o r p k n a B n o n U c ﬁ i c a P h t i i w r e g r e m s ’ r a e y t s a L “ Successfully exploiting an opportunity often requires Through the introduction of new products and services designed to meet the courage to embark upon a journey whose course the needs of an increasingly multi-ethnic constituency, and with the is clear but whose outcome is not assured. opening of additional branch ofﬁces, we can grow in partnership with the individuals and the businesses of the communities we serve. California’s growing multi-ethnic population gives us the occasion to use our proven relationship-building skills to expand our demographic reach well beyond the Korean-American community. In this endeavor, we look forward to establishing Hanmi as a truly regional ﬁnancial institution. r e c ﬁ f O t i d e r C f e h C g n i t c A i , m i L . U e c i n u E i ” . n o g e r e h t t u o h g u o r h t h c a e r c i h p a r g o m e d s t i d n e t x e r e h t r u f o t y t i n u t r o p p o page 11 Hanmi Financial 2004 Annual Report Corporate Information Ofﬁcers Dr. Sung Won Sohn President and Chief Executive Ofﬁcer Michael J. Winiarski Senior Vice President and Chief Financial Ofﬁcer David W. Kim Senior Vice President and Chief Administration Ofﬁcer Eunice U. Lim Senior Vice President and Acting Chief Credit Ofﬁcer Suki H. Murayama Senior Vice President and Regional Executive Ofﬁcer Board of Directors Joon Hyung Lee Chairman of the Board President Root-3 Corporation M. Christian Mitchell Former Partner Deloitte & Touche I Joon Ahn Former Chairman of the Board Chang Kyu Park Former Chairman of the Board Principal Pharmacist Serrano Medical Center Pharmacy Stuart S. Ahn President Sunnyland Development, Inc. Joseph K. Rho Former Chairman of the Board Principal J & S Investment Ung Kyun Ahn Former Chairman of the Board President Ahn’s Music Inc. William J. Ruh Executive Vice President Castle Creek Capital LLC Kraig Kupiec Managing Member Shoreline Trading Group Won R. Yoon Former Chairman of the Board Chief Surgeon Olympic Medical Center Richard B.C. Lee President B.C. Textiles, Inc. Independent Public Accountants KPMG, LLP Los Angeles, California Registrar and Transfer Agent U.S. Stock Transfer Corporation Glendale, California Website www.hanmiﬁnancial.com Stock Listing Nasdaq Ticker symbol for common stock “HAFC” Left to right: Won R. Yoon I Joon Ahn Joseph K. Rho Kraig Kupiec Sung Won Sohn M. Christian Mitchell Joon Hyung Lee Stuart S. Ahn Ung Kyun Ahn Richard B. C. Lee Chang Kyu Park page 12 Table of Contents Selected Consolidated Financial Data Management’s Discussion & Analysis of Results of Operations and Financial Condition Management’s Report on Internal Control Over Financial Reporting Reports of Independent Registered Public Accounting Firm Consolidated Statements of Financial Condition Consolidated Statements of Income Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 14 16 38 39 41 42 43 44 46 Hanmi Financial 2004 Annual Report page 13 Hanmi Financial Selected Consolidated Financial Data The following table presents selected historical ﬁ nancial information, including per share information as adjusted for the stock dividends and stock splits declared by the Company. This selected historical ﬁ nancial data should be read in conjunction with the ﬁ nancial statements of the Company and the notes thereto appearing elsewhere in this statement and the information contained in “Management’s Discussion and Analysis of Results of Operations and Financial Condition.” The selected historical ﬁ nancial data as of and for each of the years in the ﬁ ve years ended December 31, 2004 is derived from the Company’s audited ﬁ nancial statements. In the opinion of management of the Company, the information presented reﬂ ects all adjust- ments, including normal and recurring accruals, considered necessary for a fair presentation of the results of such periods. (Dollars in Thousands, Except for Per Share Data) 2004 2003 2002 2001 2000 As of and for the Year Ended December 31, Summary Statement of Income Data: Interest income Interest expense Net interest income before provision for credit losses Provision for credit losses Non- interest income Non- interest expenses Income before provision for income taxes Provision for income taxes Net income Summary Statement of Financial Condition Data: Cash and cash equivalents Total securities Net loans Total assets Total deposits Total liabilities Total shareholders’ equity Average net loans Average securities Average interest- earning assets Average total assets Average deposits Average interest- bearing liabilities Average shareholders’ equity Average tangible equity Per Share Data: Earnings per share – basic (1) Earnings per share – diluted (1) Book value per share – basic (1) Cash dividends per share Common shares outstanding Selected Performance Ratios: Return on average assets (2) Return on average equity (3) Return on average tangible equity (4) Net interest spread (5) Net interest margin (6) Average shareholders’ equity to average total assets $ 134,167 32,617 $ 77,123 20,796 $ 69,316 21,345 $ 76,678 32,990 $ 72,246 30,891 101,550 2,907 27,598 66,566 59,675 22,975 $ 36,700 $ 127,164 418,973 2,234,842 3,104,188 2,528,807 2,704,278 399,910 1,912,534 425,537 2,366,185 2,670,701 2,129,724 1,687,688 293,313 143,262 56,327 5,680 20,316 39,325 31,638 12,425 47,971 4,800 21,204 38,333 26,042 9,012 43,688 1,400 17,253 32,028 27,513 10,703 41,355 2,250 15,002 27,796 26,311 10,788 $ 19,213 $ 17,030 $ 16,810 $ 15,523 $ 62,595 414,616 1,248,399 1,787,139 1,445,835 1,647,672 139,467 1,103,765 379,635 1,525,633 1,623,214 1,416,564 1,057,249 132,369 130,252 $ 122,772 279,548 975,154 1,457,313 1,283,979 1,332,845 124,468 882,625 244,675 1,211,553 1,308,885 1,164,562 854,858 112,927 110,762 $ 81,205 213,179 781,718 1,159,416 1,042,353 1,054,543 104,873 701,714 235,034 1,017,422 1,100,182 988,392 736,947 95,740 93,427 $ 176,107 205,994 621,222 1,035,310 934,581 948,914 86,396 555,045 180,470 791,105 925,608 873,044 569,544 78,363 75,802 $ 0.87 $ 0.84 $ 8.11 $ 0.20 49,330,704 $ 0.68 $ 0.67 $ 4.92 $ 0.20 28,326,820 $ 0.62 $ 0.60 $ 4.47 $ — 27,830,866 $ 0.61 $ 0.60 $ 3.83 $ — 27,385,660 $ 0.57 $ 0.57 $ 3.17 $ — 27,228,248 1.37% 12.51% 25.62% 3.74% 4.29% 1.18% 14.51% 14.75% 3.09% 3.69% 1.30% 15.08% 15.38% 3.22% 3.96% 1.53% 17.56% 17.99% 3.06% 4.29% 1.68% 19.81% 20.48% 3.71% 5.23% 10.98% 8.15% 8.63% 8.70% 8.47% page 14 (Dollars in Thousands, Except for Per Share Data) 2004 2003 2002 2001 2000 As of and for the Year Ended December 31, Selected Capital Ratios: Tier 1 capital to average total assets: Hanmi Financial Hanmi Bank Tier 1 capital to total risk- weighted assets: Hanmi Financial Hanmi Bank Total capital to total risk- weighted assets: Hanmi Financial Hanmi Bank Selected Asset Quality Ratios: Non- performing loans to total gross loans (7) Non- performing assets to total assets (8) Net charge- offs to average total gross loans Allowance for loan losses to total gross loans Allowance for loan losses to non- performing loans Efﬁ ciency ratio (9) Dividend payout ratio (10) 8.93% 8.78% 10.93% 10.75% 11.98% 11.80% 0.27% 0.19% 0.19% 1.00% 377.49% 51.54% 22.99% (1) Restated for a 100% stock dividend declared in January 2005, a 9% stock dividend declared in 2002, a 12% stock dividend declared in 2001 and a 3- for- 2 stock split in 2001. (2) Net income divided by average total assets. (3) Net income divided by average shareholders’ equity. (4) Net income divided by average tangible equity. (5) Represents the average rate earned on interest- earning assets less the average rate paid on interest- bearing liabilities. 7.80% 7.75% 10.05% 10.00% 11.13% 11.09% 0.68% 0.48% 0.29% 1.06% 154.13% 51.31% 29.41% 8.50% 8.34% 11.01% 10.81% 12.14% 11.94% 0.65% 0.44% 0.28% 1.14% 8.86% 8.76% 11.71% 11.59% 12.87% 12.75% 0.63% 0.43% 0.45% 1.19% 8.46% 8.39% 11.11% 11.02% 12.37% 12.27% 0.40% 0.25% 0.16% 1.78% 173.81% 55.41% — 188.12% 52.40% — 441.68% 49.32% — (6) Represents net interest income before provision for credit losses as a percentage of average interest- earning assets. (7) Non- performing loans consist of non- accrual loans, loans past due 90 days or more and restructured loans. (8) Non- performing assets consist of non- performing loans (see footnote (7) above) and other real estate owned. (9) The efﬁ ciency ratio is calculated as the ratio of total non- interest expenses to the sum of net interest income before provision for credit losses and total non- interest income including securities gains and losses. (10) Dividends declared per share divided by basic earnings per share. page 15 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition This discussion presents management’s analysis of the results of operations and ﬁ nancial con- dition of the Company as of and for the years ended December 31, 2004, 2003 and 2002. The discussion should be read in conjunction with the ﬁ nancial statements of the Company and the notes related thereto presented elsewhere in this report. This discussion and analysis contains forward- looking statements that involve risks and uncer- tainties. The Company’s actual results could differ materially from those anticipated in such forward- looking statements as a result of certain factors discussed elsewhere in this report. Critical Accounting Policies We have established various accounting policies that govern the application of accounting prin- ciples generally accepted in the United States of America in the preparation of our ﬁ nancial statements. Our signiﬁ cant accounting policies are described in the “Notes to Consolidated Financial Statements.” Certain accounting policies require us to make signiﬁ cant estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities, and we consider these to be critical accounting policies. The estimates and assump- tions we use are based on historical experience and other factors, which we believe to be reason- able under the circumstances. Actual results could differ signiﬁ cantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods. Management has discussed the development and selection of these critical accounting policies with the Audit Committee of Hanmi Financial’s Board of Directors. During the year ended December 31, 2004, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” (“SFAS No. 141”), the purchase of Paciﬁ c Union Bank (“PUB”) required signiﬁ cant estimates and assumptions. We engaged outside experts, including apprais- ers, to assist in estimating the fair values of certain assets acquired, particularly the loan portfolio, core deposit intangible asset and ﬁ xed assets. The Bank used market data regard- ing securities market prices and interest rates to estimate the fair values of ﬁ nancial assets, including the securities portfolio, deposits and borrowings. We also evaluated long- lived assets for impairment and recorded any neces- sary adjustments. In accordance with Emerging Issues Task Force Issue No. 95- 3, “Recognition of Liabilities in Connection With a Purchase Business Combination,” we recognized liabilities assumed for costs to involuntarily terminate employees of PUB and costs to exit activities of PUB under an exit plan approved by Hanmi Bank’s Board of Directors. We believe the allowance for loan losses and reserve for credit losses are critical accounting policies that require signiﬁ cant estimates and assumptions that are particularly susceptible to signiﬁ cant change in the preparation of our ﬁ nancial statements. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Financial Condition – Allowance for Loan Losses,” “Results of Operations – Provision for Credit Losses” and “Notes to Consolidated Financial Statements, Note 1 – Summary of Signiﬁ cant Accounting Policies” for a description of the methodology used to determine the allowance for loan losses and reserve for credit losses. Overview Over the last three years, the Company has experienced signiﬁ cant growth in assets and deposits. Total assets increased to $3,104.2 million at December 31, 2004 from $1,787.1 million and $1,456.3 million at December 31, 2003 and 2002, respectively. Total net loans increased to $2,234.9 million at December 31, 2004 from $1,248.4 million and $975.1 million at December 31, 2003 and 2002, respectively. Total deposits increased to $2,528.8 million as of December 31, 2004 from $1,445.8 million and $1,284.0 million at December 31, 2003 and 2002, respectively. The Company’s asset growth was mainly due to the acquisition of PUB, which had assets of $1.2 billion, and also attributable to loan production during the period. page 16 competitive conditions, mergers and acquisi- tions of other ﬁnancial institutions within the Company’s market area, changes in interest rates, government policies and actions of regulatory agencies. The Company’s provision for credit losses was $2.9 million, $5.7 million, and $4.8 million in 2004, 2003 and 2002, respectively, reﬂecting changes in the balance and credit quality of its loan portfolio. The Company also generated substantial non- interest income from service charges on deposit accounts, charges and fees generated from international trade ﬁnance, and gains on sales of loans. The Company’s non-interest expenses consist primarily of employee compensation and beneﬁts, occupancy and equipment expenses and other operating expenses. For the year ended December 31, 2004, non-interest income was $27.6 million, an increase of $7.4 million, or 35.8%, over 2003 non-interest income of $20.3 million. The increase was primarily a result of the merger with PUB. For the year ended December 31, 2003, non- interest income was $20.3 million, a decrease of $888,000, or 4.2%, from 2002 non- interest income. The decrease reﬂected a decreased amount of gain on sales of securities, which decreased $2.2 million from $3.3 million in 2002 to $1.1 million in 2003. Non-interest income other than gain on sales of securities increased $1.8 million, or 10.5%, from $7.4 million in 2002 to $19.2 million in 2003, reﬂecting the expansion in the Bank’s average loan and deposit portfolios. The efﬁciency ratio increased slightly, to 51.54%, in 2004 compared to 51.31% in 2003 as a result of non-recurring expenses associated with the merger with PUB. In 2003, the efﬁciency ratio improved to 51.31% from 55.41% in 2002 as a result of greater efﬁciencies associated with the expansion of its average loan and deposit port- folios, which increased 25.1% and 19.3%, respectively, while non-interest expenses increased 2.6% year over year. Non-interest expenses in 2002 include a charge of $4.4 million for certain securities held by the Bank. Exclusive of this charge, non-interest expenses increased 15.9% from 2002 to 2003. For the year ended December 31, 2004, net income was $36.7 million, representing an increase of $17.5 million, or 91.0%, from $19.2 million for the year ended December 31, 2003. This resulted in basic earnings per share of $0.87 and $0.68 for the years ended December 31, 2004 and 2003, respectively, and diluted earnings per share of $0.84 and $0.67 for the same years. The Company’s primary source of revenue is net interest income, which is the difference between interest and fees derived from earning assets and interest paid on liabilities incurred to fund those assets. The Company’s net interest income is affected by changes in the volume of interest-earning assets and interest-bearing liabilities. It also is affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabili- ties. The increase in net income for 2004 was attributable to increases in net interest margin and average interest-earning assets. Net interest income increased due to a 78.8% increase in volume of net loans. The average interest rate paid decreased by four basis points while the average interest rate earned increased by 61 basis points. As a result, net interest spread increased by 65 basis points from 3.09% in 2003 to 3.74% in 2004. For the year ended December 31, 2003, net income was $19.2 million, representing an increase of $2.2 million, or 12.8%, from $17.0 million for the year ended December 31, 2002. This resulted in basic earnings per share of $0.68 and $0.62 for the years ended December 31, 2003 and 2002, respectively, and diluted earnings per share of $0.67 and $0.60 for the same years. Despite a decrease in the net inter- est margin, net income increased in 2003, largely attributable to a 26% increase in average interest-earning assets. Net interest income increased due primarily to a higher volume of gross loans. The interest rate paid decreased by 53 basis points while the interest rate earned decreased by 65 basis points. As a result, net interest spread decreased by 12 basis points, from 3.25% in 2002 to 3.13% in 2003. The Company’s results of operations are signif- icantly affected by its provision for credit losses. Results of operations may also be affected by other factors, including general economic and page 17 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition Results of Operations Net Interest Income and Net Interest Margin The Company’s earnings depend largely upon the difference between the interest income received from its loan portfolio and other interest- earning assets and the interest paid on deposits and borrowings. The difference is “net interest income.” Net interest income, when expressed as a percentage of average total interest- earning assets, is referred to as the net interest margin. The Company’s net interest income is affected by the change in the level and mix of interest- earning assets and interest- bearing liabilities, referred to as volume changes. The Company’s net interest income also is affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes. Interest rates charged on the Company’s loans are affected principally by the demand for such loans, the supply of money available for lending purposes and competitive factors. Those factors are, in turn, affected by general economic conditions and other factors beyond the Company’s control, such as Federal eco- nomic policies, the general supply of money in the economy, income tax policies, govern- mental budgetary matters and the actions of the Federal Reserve Bank. For the years ended December 31, 2004 and 2003, the Company’s net interest income was $101.6 million and $56.3 million, respectively. The net interest spread and net interest margin for the year ended December 31, 2004 were 3.74% and 4.29%, respectively, compared to 3.09% and 3.69%, respectively, for the year ended December 31, 2003. For the years ended December 31, 2003 and 2002, the Company’s net interest income was $56.3 million and $48.0 million, respectively. The net interest spread and net interest margin for the year ended December 31, 2003 were 3.09% and 3.69%, respectively, compared to 3.22% and 3.96%, respectively, for the year ended December 31, 2002. Average interest- earning assets increased 55.1% to $2,366.2 million in 2004 from $1,525.6 million in 2003. Average net loans increased 73.3% to $1,912.5 million in 2004 from $1,103.8 million in 2003 and average investment securi- ties increased 12.1% to $425.5 million in 2004 from $379.6 million in 2003. Total loan inter- est income increased by 81.6% in 2004 on an annual basis due to the increase in average net loans outstanding and the increase in average yields on net loans from 5.82% in 2003 to 6.10% in 2004. The average interest rate charged on loans increased reﬂ ecting the average WSJ Prime rate increase of 22 basis points from 4.12% in 2003 to 4.34% in 2004. The yield on interest- earning assets increased from 5.06% in 2003 to 5.67% in 2004, an increase of 0.61%, reﬂ ecting a shift in the mix of interest- earning assets from 72.3% loans, 24.9% securities and 2.8% other interest- earning assets in 2003 to 80.8% loans, 18.0% securities and 1.2% other interest- earning assets. The majority of interest- earning assets growth was funded by a $713.2 million or 50.3% increase in average total deposits. Total average interest- bearing liabilities grew by 59.6% to $1,687.7 million in 2004 compared to $1,057.2 million in 2003. The average interest rate the Company paid for interest- bearing liabilities decreased by four basis points from 1.97% in 2003 to 1.93% in 2004. As a result, the net interest spread increased to 3.74% in 2004 compared to 3.09% in 2003. page 18 The following tables show the Company’s aver- age balances of assets, liabilities and sharehold- ers’ equity; the amount of interest income or interest expense; the average yield or rate for each category of interest-earning assets and interest-bearing liabilities; and the net interest spread and the net interest margin for the peri- ods indicated. 2004 Interest Income/ Expense Average Yield/ Rate Average Balance 2003 Interest Income/ Expense Average Yield/ Rate Average Balance For the Year Ended December 31, 2002 Interest Income/ Expense Average Yield/ Rate Average Balance $ 1,912,534 $116,612 3,015 70,372 6.10% $1,103,765 $64,211 1,421 33,596 6.59% 5.82% $ 882,625 $56,398 29,699 6.97% 6.39% 1,300 6.44% 90,336 264,829 15,041 12,772 — — 301 3,374 10,261 716 183 — — 6 3.73% 3.87% 4.76% 1.43% — — 1.99% 70,465 275,574 6,003 21,844 14,370 — 16 2,395 3.40% 3.02% 8,321 4.55% 273 1.27% 277 1.57% 225 — — — — 29,204 185,772 3,767 51,456 28,693 288 49 1,340 4.59% 8,507 4.58% 5.50% 207 925 1.80% 630 2.20% 2.68% 2.51% 8 1 2,366,185 134,167 5.67% 1,525,633 77,123 5.06% 1,211,553 69,316 5.72% (Dollars in Thousands) Assets Interest-earning assets: Net loans (1) Municipal securities (2) Obligations of other U.S. government agencies Other debt securities Equity securities Federal funds sold Term federal funds sold Commercial paper Interest-earning deposits Total interest- earning assets Non-interest-earning assets: Cash and cash equivalents Premises and equipment, net Accrued interest receivable Other assets 76,064 15,733 9,387 203,332 Total non-interest- earning assets Total assets 304,516 $2,670,701 52,067 8,496 6,049 30,969 54,496 7,638 5,264 29,934 97,581 $1,623,214 97,332 $1,308,885 Liabilities and Shareholders' Equity Interest-bearing liabilities: Deposits: Money market checking Savings Time deposits of $100,000 or more Other time deposits Other borrowed funds Total interest-bearing liabilities $ 466,880 131,589 8,098 1,790 1.73% $ 207,689 97,070 1.36% 2,584 1,894 1.24% $ 176,089 92,835 1.95% 3,036 2,632 1.72% 2.84% 611,555 10,966 5,414 253,884 6,349 223,780 1.79% 2.13% 2.84% 386,701 302,651 63,138 7,415 7,354 1,549 1.92% 2.43% 2.45% 312,618 251,469 21,847 7,838 2.51% 7,034 2.80% 3.68% 805 1,687,688 32,617 1.93% 1,057,249 20,796 1.97% 854,858 21,345 2.50% Non-interest-bearing liabilities: Demand deposits Other liabilities 665,816 23,884 Total non-interest- bearing liabilities Total liabilities Shareholders’ equity 689,700 2,377,388 293,313 Total liabilities and 422,453 11,143 433,596 1,490,845 132,369 331,551 9,549 341,100 1,195,958 112,927 shareholders’ equity $2,670,701 $1,623,214 $1,308,885 Net interest income Net interest spread (3) Net interest margin (4) $101,550 $56,327 $ 47,971 3.74% 4.29% 3.09% 3.69% 3.22% 3.96% (1) Loans are net of the allowance for loan losses, deferred fees and related direct costs. Loan fees have been included in the calculation of interest income. Loan fees were $6.0 million, $3.2 million and $2.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. (2) Yields on tax-exempt income have been computed on a tax-equivalent basis, using an effective marginal rate of 35%. (3) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities. (4) Represents net interest income as a percentage of average interest- earning assets. page 19 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition The following table sets forth, for the periods indicated, the dollar amount of changes in interest earned and paid for interest- earning assets and interest- bearing liabilities and the amount of change attributable to changes in average daily balances (volume) or changes in average daily interest rates (rate). The variances attributable to both the volume and rate changes have been allocated to volume and rate changes in proportion to the relationship of the abso- lute dollar amount of the changes in each: (In Thousands) Interest income: Net loans Municipal securities Obligations of other U.S. Government agencies Other debt securities Equity securities Federal funds sold Term federal funds sold Commercial paper Interest- earning deposits Total interest income Interest expense: Money market checking Savings Time deposits of $100,000 or more Other time deposits Other borrowed funds Total interest expense Change in net interest income 2004 vs. 2003 Increases (Decreases) Due to Change in For the Year Ended December 31, 2003 vs. 2002 Increases (Decreases) Due to Change in Volume Rate Total Volume Rate Total $49,174 1,576 $3,227 $52,401 1,594 18 $ 13,199 $(5,386) $ 7,813 121 (45) 166 725 (335) 429 (126) (112) — 6 254 2,275 14 32 (113) — — 979 1,940 443 (94) (225) — 6 1,478 3,292 107 (429) (257) (4) — (423) (3,478) (41) (219) (148) (4) (1) 1,055 (186) 66 (648) (405) (8) (1) 51,337 5,707 57,044 17,552 (9,745) 7,807 4,191 564 4,060 (1,103) 4,522 1,323 (668) (509) (837) 278 5,514 (104) 3,551 (1,940) 4,800 485 115 1,639 1,318 1,089 (937) (853) (2,062) (998) (345) (452) (738) (423) 320 744 (549) 12,234 $39,103 (413) 11,821 4,646 (5,195) $6,120 $45,223 $12,906 $(4,550) $8,356 Provision for Credit Losses For the year ended December 31, 2004, the provision for credit losses was $2.9 million, compared to $5.7 million for the year ended December 31, 2003, a decrease of 48.8%. While the Company’s loan volume increased, the allowance for loan losses decreased to 1.00% of total gross loans from 1.06% in 2003 (with- out the change in accounting that separated the reserve for credit losses from the allowance for loan losses, the ratio was 1.08% at December 31, 2004). This decrease in the ratio of the allowance for loan losses to total gross loans was primarily due to the overall decrease of historical loss factors on pass grade loans. Since the year 2001, the Company has reﬁ ned its credit man- agement process and instituted a more compre- hensive risk rating system. For the year ended December 31, 2003, the provision for credit losses was $5.7 million, compared to $4.8 million for the year ended December 31, 2002, an increase of 18.3%. Provisions to the allowance for loan losses are made quarterly, in anticipation of probable loan losses. The quarterly provision is based on the allowance need, which is calculated using a formula designed to provide adequate allowances for anticipated losses. The formula is composed of various components. The allowance is determined by assigning speciﬁ c allowances for all classiﬁ ed loans. All loans that are not classiﬁ ed are then given certain alloca- tions according to type with larger percentages applied to loans deemed to be of a higher risk. page 20 These percentages are determined based on the Company’s prior loss history by type of loan, adjusted for current economic factors. (In Thousands) Allowance for Loan Losses Applicable to 2004 2003 2002 2001 2000 Allowance Amount Total Allowance Amount Loans Total Allowance Amount Loans Total Allowance Amount Loans Total Allowance Amount Loans Total Loans Real estate loans: Construction $ 349 Commercial property 1,854 Residential property 155 Total real estate loans 2,358 Commercial and Industrial loans (1) Consumer loans Unallocated Total allowance for loan losses 19,051 1,293 — $92,521 $ 427 $ 43,047 $ 267 $ 39,237 $ 163 $ 33,618 $ 68 $ 8,543 147,810 783,539 48,192 80,786 337 284,465 47,891 149 397,853 58,477 198,336 49,526 1,108 258 1,311 262 374 191 956,846 992 499,377 753 371,593 1,529 281,480 1,641 204,545 1,214,419 87,526 — 11,376 846 135 685,557 54,878 — 9,773 560,370 44,416 — 652 76 7,072 738 69 457,973 38,645 — 5,473 378,247 38,486 — 571 3,591 $22,702 $2,258,791 $13,349 $1,239,812 $11,254 $976,379 $9,408 $778,098 $11,276 $621,278 (1) Loans held for sale excluded. The allowance is based on estimates, and ultimate future losses may vary from current estimates. Underlying trends in the economic cycle, particularly in Southern California, which management cannot completely predict, will inﬂuence credit quality. It is always possible that future economic or other factors may adversely affect Hanmi Bank’s borrowers. As a result, the Company may sustain loan losses in any particular period that are sizable in relation to the allowance, or exceed the allowance. In addition, the Company’s asset quality may deteriorate through a number of possible factors, including: • rapid growth; • failure to maintain or enforce appropriate underwriting standards; • failure to maintain an adequate number of qualiﬁed loan personnel; and • failure to identify and monitor potential problem loans. As a result of these and other factors, loan losses may be substantial in relation to the allowance or exceed the allowance. page 21 Non-Interest Income The following table sets forth the various com- ponents of the Company’s non-interest income for the years indicated: (In Thousands) Service charges on deposit accounts Trade ﬁnance fees Remittance fees Other service charges and fees Bank-owned life insurance income Increase in fair value of derivatives Other income Gain on sales of loans Gain on sales of securities available for sale Total non-interest income For the Year Ended December 31, 2002 2003 2004 $14,441 $10,339 $ 9,195 2,410 2,887 786 952 4,044 1,653 1,685 1,513 1,094 731 499 552 232 1,681 2,997 35 840 2,157 1,368 659 1,875 134 1,094 3,265 $27,598 $20,316 $21,204 The Company earns non-interest income from four major sources: service charges on deposit accounts, fees generated from international trade ﬁnance, gain on sales of loans, and gain on sales of securities available for sale. Non-interest income has become a signiﬁcant part of the Company’s revenue in the past several years. For the year ended December 31, 2004, non-interest income was $27.6 million, an increase of 35.8% from $20.3 million for the year ended December 31, 2003. This increase was mainly due to increases in service charges on deposit accounts and trade ﬁnance fees. Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition The service charges on deposit accounts increased by $4.1 million or 39.7% for the year 2004 compared to 2003. Service charge income on deposit accounts increased with the higher deposit volume and number of accounts as a result of the PUB merger. Average deposits increased by 50.3% from $1.4 million in 2003 to $2.1 million in 2004. The Company constantly reviews service charges to maximize service charge income while still maintaining its competitive position. Fees generated from international trade ﬁ nance increased by 40.1% from $2.9 million in 2003 to $4.0 million during 2004. The increase was primarily due to the PUB merger. Average trade ﬁ nance loans increased by $29.8 million or 60.9% from $48.9 million in 2003 to $78.7 million in 2004. Gain on sales of loans was $3.0 million in 2004, compared to $2.2 million and $1.9 million in 2003 and 2002, respectively, representing increases of 38.9% and 15.0% for the years ended December 31, 2004 and 2003, respec- tively. The increase in gain on sales of loans resulted from the Company’s increased sales activity in SBA loans, which was primarily due to the acquisition of PUB. The Company sells the guaranteed portion of SBA loans in the secondary markets, while retaining servicing rights. During the year 2004, the Company sold $35.4 million of SBA loans. Gain on sales of securities available for sale decreased by 87.8% from $1.1 million in 2003 to $0.1 million during 2004. The Company sold $54.2 million of securities, recognizing premiums of 1.91% over the carrying value of such securities. The ability to generate such gains in the future is not assured since any gains are dependent on market interest rates. The increase in other income in 2004 com- pared to 2003 is mainly due to an increase in credit card fee income and sales commission from mutual funds and insurance products. For the year ended December 31, 2003, non- interest income was $20.3 million, a decrease of $0.9 million or 4.2% from $21.2 million for the year ended December 31, 2002. This decrease was largely attributable to the $2.2 million decrease in gain on sales of securities available for sale and a $1.3 million decrease in the change in fair value of interest rate swaps. The large increase in service charges on deposit accounts and trade ﬁ nance fees offsets this decrease and resulted in a comparatively small overall decrease in non- interest income of $0.9 million. As a part of its continuing effort to expand non- interest income, the Company introduced non- depository products, such as life insurance, mutual funds and annuities, to customers in December 2001. During the year 2004, the Company generated income of $427,000 from this activity, which represented an 87.3% increase from $228,000 earned in 2003. Non- Interest Expenses The following table sets forth the breakdown of non- interest expenses for the years indicated: (In Thousands) Salaries and employee beneﬁ ts Occupancy and equipment Data processing Advertising and promotional expense Supplies and communications Professional fees Amortization of core deposit intangible Impairment of investment securities Other operating expense Merger- related expenses Total non- interest expenses For the Year Ended December 31, 2004 2003 2002 $33,540 $ 21,214 $ 17,931 4,330 2,784 5,198 3,080 8,098 4,540 3,001 2,433 2,068 1,635 1,496 1,167 1,523 1,466 1,003 1,872 121 8 — 8,961 2,053 — 5,414 — 4,416 4,872 — $66,566 $39,325 $38,333 For the year ended December 31, 2004, non- interest expenses were $66.6 million, an increase of $27.2 million or 69.3% from $39.3 million for the year ended December 31, 2003. This increase was primarily due to the PUB merger, which closed on April 30, 2004. Salaries and employee beneﬁ ts expenses for 2004 increased $12.3 million, or 58.1%, to $33.5 million from $21.2 million for 2003, due primarily to a 45% increase in the number of employees following the acquisition of PUB. page 22 Occupancy and equipment expenses for 2004 increased $2.9 million, or 55.8%, to $8.1 mil- lion compared to $5.2 million for 2003. This increase was mainly due to the acquisition of 12 former PUB branches. Data processing expense for 2004 increased $1.5 million, or 47.4%, to $4.5 million from $3.1 million for 2003. Additional expense was incurred mainly due to an increase in loans and deposits volume related to the acquisition and conversion of the Bank’s core data processing systems. Supplies and communication expenses also increased $0.9 million, or 62.6%, to $2.4 million from $1.5 million for 2003. Professional fees were $2.1 million for 2004, representing an increase of $0.9 million, or 77.2%, compared to $1.2 million for 2003. The increase was caused primarily by consulting fees related to the integration with PUB and data processing system conversions. Professional fees for the year ended December 31, 2004 include $537,000 of integration costs paid to outside consultants. Advertising and promotional expense increased from $1.6 million for 2003 to $3.0 million for 2004, an increase of $1.4 million, or 83.5%. In 2004, Hanmi Bank conducted print, radio and television campaigns and distributed various promotional items to publicize its merger with PUB and attract and retain customers. During the year ended December 31, 2004, the Company recorded restructuring charges totaling $2.1 million in connection with the acquisition of PUB, consisting of employee severance and retention bonuses, leasehold termination costs, and ﬁxed asset impairment charges associated with planned branch closures. In 2004, the Company recognized $975,000 of restructuring costs related to retention bonuses paid to former PUB employees. Such costs are treated as period costs and are recognized in the period services are rendered. Core deposit premium amortization increased to $1.9 million for 2004, compared to $121,000 for 2003, an increase of $1.8 million. The increase is attributable to the acquisition of PUB. Other operating expenses were $7.4 million for 2004, compared to $4.5 million for 2003, representing an increase of $2.9 million, or 64.9%. The increases are primarily attributable to additional operating expenses associated with the acquisition of PUB. For the year ended December 31, 2003, total non-interest expenses increased by $1.0 million or 2.6%. This increase in 2003 was relatively minor due to the charges made for impairment of investment securities during 2002, when the Company recorded an impairment charge of $4.4 million on corporate bonds issued by WorldCom, Inc. (“WorldCom”). The $5.0 million bond was purchased in January 2001 and WorldCom defaulted on it in January 2002. As of December 31, 2003, the remaining $1.0 million par value was carried at $119,000 and had a market value of $335,000. During 2003, the Company sold $4.0 million par value of that bond and recognized a gain of $782,000. In 2004, the Company sold its remaining WorldCom securities, recognizing a gain of $100,000. Excluding the impairment charges during 2002, total non-interest expenses would have increased by $5.4 million or 15.9% to $39.3 million in 2003 from $33.9 million in 2002. The increase was primarily due to the expan- sion of the Company’s branch network, which caused increases in salaries, occupancy and data processing expenses. Two full branches were added to the Company’s network in 2003, which required an increase in staff (salaries and employee beneﬁts), as well as additional rent for the new locations. The business generated by the new branches also created the need for additional data processing expenses to support the larger customer base and volume. page 23 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition Provision for Income Taxes For the year ended December 31, 2004, the Company recognized a provision for income taxes of $23.0 million on pre- tax income of $59.7 million, representing an effective tax rate of 38.5%, compared to a provision of $12.4 million on pre- tax income of $31.6 million, representing an effective tax rate of 39.3%, for 2003. The Company made investments in various tax credit funds totaling $5.3 million and recognized $1.0 million of income tax credits earned from qualiﬁ ed low- income housing investments in 2004. The Company recognized an income tax credit of $382,000 for the tax year 2003 from $4.1 million in such investments. The Company intends to continue to make such investments as part of an effort to lower its effective tax rate and to receive credit under the Community Reinvestment Act. For the year ended December 31, 2003, the Company recognized a provision for income taxes of $12.4 million on pre- tax income $31.6 million, representing an effective tax rate of 39.3%, compared to a provision of $9.0 mil- lion on pre- tax income of $26.0 million, representing an effective tax rate of 34.6%, for 2002. As indicated in “Notes to Consolidated Financial Statements, Note 10 — Income Taxes,” income tax expense is the sum of two compo- nents: current tax expense and deferred tax expense (beneﬁ t). Current tax expense is the result of applying the current tax rate to taxable income. The deferred portion is intended to account for the fact that income on which taxes are paid differs from ﬁ nancial statement pre- tax income because certain items of income and expense are recognized in different years for income tax purposes than in the ﬁ nancial statements. These differences in the years that income and expenses are recognized cause “temporary differences.” Most of the Company’s temporary differences involve recognizing more expenses in its ﬁ nan- cial statements than it has been allowed to deduct for taxes, and therefore the Company normally has a net deferred tax asset. At December 31, 2004, the Company had net deferred tax assets of $5.0 million. Financial Condition Loan Portfolio Total gross loans increased by $997.4 million or 78.8% in 2004. Total gross loans represented 72.9% of total assets at December 31, 2004 compared with 70.8% and 69.9% at December 31, 2003 and 2002, respectively. The table below sets forth the composition of the Company’s loan portfolio by major category. Commercial and industrial loans made up the largest portion of the total loan portfolio, representing 53.8% of total loans at December 31, 2004, as compared with 56.2% and 57.9% of total loans at December 31, 2003 and 2002, respectively. Commercial loans include term loans and revolving lines of credit. Term loans typically have a maturity of three to ﬁ ve years and are extended to ﬁ nance the purchase of business entities, owner- occupied commercial property, business equipment, leasehold improvements or for permanent working capital. SBA guaranteed loans usually have a longer maturity (5 to 20 years). Lines of credit, in general, are extended on an annual basis to businesses that need tem- porary working capital and/or import/ export ﬁ nancing. These borrowers are well diversiﬁ ed as to industry, location and their current and target markets. The Company manages its port- folio to avoid concentration in any of the areas mentioned. The commercial loan portfolio also includes SBA loans held for sale, which totaled $3.9 million and $25.5 million at December 31, 2004 and 2003, respectively. Real estate loans were $956.8 million and $499.4 million at December 31, 2004 and 2003, respectively, representing 42.3% and 39.5%, respectively, of the total loan portfolio. Real estate loans are extended to ﬁ nance the purchase and/or improvement of commercial real estate and residential property. The proper- ties generally are investor- owned, but may be for user- owned purposes. Underwriting guidelines include, among other things, review of appraised value, limitations on loan- to- value ratios, and minimum cash ﬂ ow requirements to service debt. The majority of the properties taken as collateral are located in Southern California. page 24 The following table sets forth the amount of total loans outstanding in each category as of the dates indicated: (In Thousands) 2004 2003 2002 2001 2000 Amount Outstanding as of December 31, Real estate loans: Commercial property Construction Residential property Total real estate loans Commercial and industrial loans (1) Consumer loans Total gross loans $ 783,539 92,521 80,786 956,846 1,218,269 87,526 $2,262,641 $ 397,853 43,047 58,477 499,377 711,011 54,878 $284,465 39,237 47,891 371,593 572,910 44,416 $ 198,336 33,618 49,526 281,480 472,920 38,645 $ 147,810 8,543 48,192 204,545 391,093 38,486 $1,265,266 $ 988,919 $793,045 $634,124 (1) Loans held for sale were included at the lower of cost or market. The following table sets forth the percentage distribution of loans in each category as of the dates indicated: (In Thousands) 2004 2003 2002 2001 2000 Percentage Distribution of Loans as of December 31, Real estate loans: Commercial property Construction Residential property Total real estate loans Commercial and industrial loans Consumer loans Total gross loans 34.63% 4.09% 3.57% 42.29% 53.84% 3.87% 31.44% 3.40% 4.62% 39.46% 56.20% 4.34% 28.77% 3.97% 4.84% 37.58% 57.93% 4.49% 25.01% 4.24% 6.25% 35.50% 59.63% 4.87% 23.31% 1.35% 7.60% 32.26% 61.67% 6.07% 100.00% 100.00% 100.00% 100.00% 100.00% The following table shows the distribution of the Company’s undisbursed loan commitments as of the dates indicated: (In Thousands) Commitments to extend credit Standby letters of credit Commercial letters of credit Unused credit card lines Total undisbursed loan commitments December 31, 2004 2003 $367,708 47,901 49,699 14,324 $253,722 34,434 34,261 3,801 $479,632 $326,218 page 25 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition The table below shows the maturity distribution and repricing intervals of the Company’s out- standing loans as of December 31, 2004. In addition, the table shows the distribution of such loans between those with variable or ﬂ oat- ing interest rates and those with ﬁ xed or pre- determined interest rates. The table includes non- accrual loans of $5.8 million. (In Thousands) Real estate loans: Commercial property Construction Residential property Total real estate loans Commercial and industrial loans Consumer loans Total gross loans Loans with predetermined interest rates Loans with variable interest rates Non- Performing Assets Non- performing assets consist of loans on non- accrual status, loans 90 days or more past due and still accruing interest, loans restruc- tured where the terms of repayment have been renegotiated resulting in a reduction or deferral of interest or principal, and other real estate owned (“OREO”). Loans are generally placed on non- accrual status when they become 90 days past due unless management believes the loan is adequately collateralized and in the process of collection. Loans may be restructured by man- agement when a borrower has experienced some change in ﬁ nancial status, causing an inability to meet the original repayment terms, and where the Company believes the borrower eventually will overcome those circumstances and repay the loan in full. OREO consists of properties acquired by foreclosure or similar means that management intends to offer for sale. Management’s classiﬁ cation of a loan as non- accrual is an indication that there is reasonable doubt as to the full collectibility of principal or interest on the loan; at this point, the Company stops recognizing income from the interest on the loan and reverses any uncollected interest that had been accrued but unpaid. These loans may or may not be collateralized, but collection efforts are continuously pursued. After One But Within One Year Within Five Years After Five Years Total $ 745,229 92,521 26,729 864,479 1,172,277 51,112 $ 25,549 — 32,990 58,539 33,079 36,414 $ 12,761 — 21,067 33,828 12,913 — $ 783,539 92,521 80,786 956,846 1,218,269 87,526 $2,087,868 $128,032 $46,741 $2,262,641 $ 69,950 $ 2,017,918 $ 110,678 $ 17,354 $46,741 $ — $ 227,369 $2,035,272 The Company’s non- performing loans were $6.0 million at December 31, 2004, compared to $8.7 million and $6.5 million at December 31, 2003 and 2002, respectively, representing a 31% decrease in 2004 and a 34% increase in 2003. As of December 31, 2004, 2003 and 2002, total non- performing assets were the same as non- performing loans. During these same periods, total loans increased by 78.8% in 2004 from 2003, and 27.9% in 2003 from 2002. As a result, the ratio of non- performing assets to total loans and OREO decreased to 0.27% at December 31, 2004, from 0.68% at December 31, 2003 and 0.65% at December 31, 2002. As of December 31, 2004 and 2003, the Company had no OREO. Except for non- performing loans set forth below and loans disclosed as impaired, the Company’s management is not aware of any loans as of December 31, 2004 for which known credit problems of the borrower would cause serious doubts as to the ability of such borrow- ers to comply with their present loan repayment terms, or any known events that would result in the loan being designated as non- performing at some future date. The Company’s management cannot, however, predict the extent to which a deterioration in general economic conditions, real estate values, increases in general rates of interest, or changes in the ﬁ nancial condition or business of borrower may adversely affect a borrower’s ability to pay. page 26 The following table provides information with respect to the components of the Company’s non-performing assets as of December 31 of the years indicated: (Dollars in Thousands) 2004 2003 2002 2001 2000 Non-accrual loans: Real estate loans: Commercial property Residential property Commercial and industrial loans Consumer loans Total non-accrual loans Loans 90 days or more past due and still accruing (as to principal or interest): Real estate loans: Commercial property Residential property Commercial and industrial loans Consumer loans Total loans 90 days or more past due and still accruing (as to principal or interest) Total non-performing loans Other real estate owned Total non-performing assets Non-performing loans as a percentage of total gross loans Non-performing assets as a percentage of total assets $ — 112 5,510 184 5,806 — — 169 39 208 6,014 — $6,014 0.27% 0.19% Allowance for Loan Losses and Reserve for Credit Losses The allowance for loan losses and reserve for credit losses are maintained at levels that are believed to be adequate by management to absorb estimated probable loan losses inher- ent in the loan portfolio. The adequacy of the allowance and the reserve is determined through periodic evaluations of the Company’s portfolio and other pertinent factors, which are inherently subjective as the process calls for various signiﬁcant estimates and assumptions. Among others, the estimates involve the amounts and timing of expected future cash ﬂows and fair value of collateral on impaired loans, estimated losses on loans based on historical loss experience, various qualitative factors, and uncertainties in estimating losses and inherent risks in the various credit portfo- lios, which may be subject to substantial change. On a quarterly basis, the Company utilizes a classiﬁcation migration model and individual loan review analysis tools, as a starting point for determining the allowance for loan loss and reserve for credit loss adequacy. The Company’s page 27 $ 527 1,126 6,398 53 8,104 557 — — — 557 8,661 — $ — 287 5,522 49 5,858 356 261 — — 617 6,475 — $ 1,183 730 2,275 94 4,282 602 117 — — 719 5,001 — $8,661 $6,475 $5,001 $ 516 649 923 71 2,159 391 3 — — 394 2,553 — $2,553 0.68% 0.65% 0.63% 0.40% 0.48% 0.44% 0.43% 0.25% loss migration analysis tracks twelve quarters of loan losses to determine historical loss experi- ence in every classiﬁcation category (i.e., pass, special mention, substandard and doubtful) for each loan type, except consumer loans (auto, mortgage and credit cards), which are analyzed as homogeneous loan pools. These calculated loss factors are then applied to outstanding loan balances, unused commitments and off-balance sheet exposures, such as letters of credit. The individual loan review analysis is the other part of the allowance allocation process, applying speciﬁc monitoring policies and procedures in analyzing the existing loan portfolios. Further assignments are made based on general and speciﬁc economic conditions, as well as perfor- mance trends within speciﬁc portfolio segments and individual concentrations of credit. The allowance for loan losses was $22.7 million at December 31, 2004, compared to $13.3 million at December 31, 2003. The increase in the allowance for loan losses in 2004 was due primarily to the PUB merger. The ratio of the allowance for loan losses to total gross loans decreased from 1.06% to 1.00%, primarily due Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition to the overall decrease of historical loss factors on pass grade loans. The loan loss estimation, based on historical losses, and speciﬁ c alloca- tions of the allowance are performed on a quarterly basis. The reserve for credit losses was $1.8 million at December 31, 2004, compared to $1.4 million at December 31, 2003. Adjust- ments to allowance allocations for speciﬁ c segments of the loan portfolio may be made as a result thereof, based on the accuracy of forecasted loss amounts and other loan- or policy- related issues. The Company determines the appropriate overall allowance for loan losses and reserve for credit losses based on the foregoing analysis, taking into account management’s judgment. Allowance methodology is reviewed on a peri- odic basis and modiﬁ ed as appropriate. Based on this analysis, including the aforementioned factors, the Company believes that the allowance for loan losses and reserve for credit losses are adequate as of December 31, 2004. (Dollars in Thousands) 2004 2003 2002 2001 2000 As of and for the Year Ended December 31, Allowance for loan losses: Balance at beginning of year Allowance for loan losses – PUB acquisition Actual charge- offs: Real estate loans: Commercial property Commercial and industrial loans Consumer loans Total charge- offs Recoveries on loans previously charged off: Real estate loans: Construction Commercial property Residential property Commercial and industrial loans Consumer loans Total recoveries Net loan charge- offs Provision charged to operating expenses Balance at end of year Reserve for credit losses: Balance at beginning of year Provision charged to operating expenses Balance at end of year $ 13,349 10,566 $ 11,254 — $ 9,408 — $ 11,276 — $ 10,624 — — 5,004 481 5,485 — — — 1,702 78 1,780 3,705 2,492 $ 22,702 198 3,687 538 4,423 — 21 6 859 322 1,208 3,215 5,310 — 3,213 358 3,571 — — — 871 105 976 2,595 4,441 — 3,782 324 4,106 — 273 — 307 214 794 3,312 1,444 — 1,383 399 1,782 30 — — 691 163 884 898 1,550 $ 13,349 $ 11,254 $ 9,408 $ 11,276 $ 1,385 415 $ 1,800 $ 1,015 370 $ 656 359 $ 700 (44) $ 1,385 $ 1,015 $ 656 $ — 700 $ 700 Ratios: Net loan charge- offs to average total gross loans Net loan charge- offs to total gross loans at end of period Allowance for loan losses to average total gross loans Allowance for loan losses to total gross loans at end of period Net loan charge- offs to allowance for loan losses Net loan charge- offs to provision charged to operating expenses Allowance for loan losses to non- performing loans Balances: Average total gross loans outstanding during period Total gross loans outstanding at end of period Non- performing loans at end of period 0.19% 0.29% 0.29% 0.46% 0.16% 0.25% 0.26% 0.42% 1.17% 1.19% 1.26% 1.32% 1.00% 1.06% 1.14% 1.19% 0.16% 0.14% 1.99% 1.78% 16.32% 24.08% 23.06% 35.20% 7.96% 148.68% 60.55% 58.43% 229.36% 57.94% 377.55% 154.13% 173.81% 188.12% 441.68% $1,938,422 $ 1,119,860 $895,394 $ 715,050 $ 567,195 $2,262,641 $1,265,266 $ 988,919 $793,045 $634,124 $ 6,014 $ 8,661 $ 6,475 $ 5,001 $ 2,553 page 28 The Company concentrates the majority of its earning assets in loans. In all forms of lending, there are inherent risks. The Company concen- trates the preponderance of its loan portfolio in either commercial loans or real estate loans. A small part of the portfolio is represented by installment loans primarily for the purchase of automobiles. While the Company believes that its underwrit- ing criteria are prudent, outside factors can adversely impact credit quality. A portion of the portfolio is represented by loans guaranteed by the SBA, which further reduces the Company’s potential for loss. The Company also utilizes credit review in an effort to maintain loan quality. Loans are reviewed throughout the year with new loans and those that are classiﬁed special mention and worse. In addition to the Company’s internal grading system, loans criticized by this credit review are downgraded with appropriate allowance added if required. As indicated above, the Company formally assesses the adequacy of the allowance on a quarterly basis by: • reviewing the adversely graded, delinquent or otherwise questionable loans; • generating an estimate of the loss potential in each such loan; • adding a risk factor for industry, economic or other external factors; and • evaluating the present status of each loan. Although management believes the allowance is adequate to absorb losses as they arise, no assurance can be given that the Company will not sustain losses in any given period, which could be substantial in relation to the size of the allowance. Investment Portfolio The investment portfolio maintained by the Company as of December 31, 2004 was com- posed of collateralized mortgage obligations, mortgage-backed securities, U.S. Government agency securities (“Agencies”), municipal bonds and corporate bonds. Investment securities available for sale were 99.7% of the total investment portfolio as of December 31, 2004 and 2003. Most of the securities held by the Company carried ﬁxed interest rates. Other than holdings of Agencies, there were no investments in securities of any one issuer exceeding 10% of the Company’s shareholders’ equity as of December 31, 2004, 2003 or 2002. The following table summarizes the amortized cost, fair value and distribution of the Company’s investment securities as of the dates indicated: 2004 2003 2002 Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Investment Portfolio as of December 31, $ 691 $ 691 402 — 399 — $ 690 $ 689 645 — 638 — $ 1,088 $ 1,126 1,487 4,983 1,457 4,997 $ 1,090 $ 1,093 $ 1,328 $ 1,334 $ 7,542 $ 7,596 $148,706 $149,174 92,539 89,677 73,616 8,444 4,433 93,172 89,345 71,771 8,380 4,437 $ 117,139 $ 117,484 124,096 125,491 81,426 80,845 61,403 60,741 13,903 13,641 14,976 15,055 $ 78,112 $ 79,173 102,877 53,901 18,237 1,188 16,630 102,212 53,408 17,810 594 16,630 $ 415,811 $417,883 $412,912 $413,288 $268,766 $272,006 (In Thousands) Held to maturity: Municipal bonds Mortgage-backed securities Corporate bonds Total held to maturity Available for sale: Mortgage-backed securities Collateralized mortgage obligations U.S. Government agency securities Municipal bonds Corporate bonds Other Total available for sale page 29 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition The following table summarizes the maturity and/or repricing schedule for the Company’s investment securities and their weighted- average yield as of December 31, 2004: WithinOne Year After One But Within Five Years After Five But Within Ten Years After Ten Years (Dollars in Thousands) Amount Yield Amount Yield Amount Yield Amount Yield Collateralized mortgage obligations (1) Mortgage- backed securities (1) Obligations of other U.S. government agencies Obligations of state and local political subdivisions (2) Corporate bonds Other securities $ 16,255 71,525 2.67% $ 64,923 3.22% 44,086 4.25% $ 11,361 27,664 4.20% 4.46% $ — 6,298 4.30% — 5.14% 40,074 3.95% 34,633 3.24% 14,970 4.20% — — 267 — 4,433 7.07% — 6.69% 692 5,946 — 6.76% 4.21% — 5,275 2,498 — 5.40% 4.76% — 68,073 — — 6.56% — — $132,554 3.50% $150,280 4.01% $61,768 4.42% $ 74,371 6.44% (1) Collateralized mortgage obligations and mortgage- backed securities have contractual maturities through 2034. The above table is based on the expected prepayment schedule. (2) The yield on obligations of state and local political subdivisions has been computed on a tax- equivalent basis, using an effective marginal rate of 35%. Deposits Total deposits at December 31, 2004, 2003 and 2002 were $2,528.8 million, $1,445.8 million and $1,284.0 million, respectively, representing an increase of $1,083.0 million or 74.9% in 2004 and $161.8 million or 12.6% in 2003. The growth of deposit volume in 2004 is primarily attributable to the acquisi- tion of PUB on April 30, 2004. At December 31, 2004, 2003 and 2002, the total time deposits outstanding were $1,031.7 million, $667.8 million and $583.5 million, respec- tively, representing 40.8%, 46.2% and 45.4%, respectively, of total deposits. Demand depos- its and money market accounts increased by $662.1 million or 97.2% in 2004 and $78.8 million or 13.1% in 2003. At December 31, 2004, non- interest- bearing demand deposits represented 28.9% of total deposits compared to 32.9% at December 31, 2003. Average deposits for the years ended December 31, 2004, 2003 and 2002 were $2,129.7 million, $1,416.6 million and $1,164.6 million, respec- tively. Average deposits, therefore, grew by 50.3% in 2004 and 21.6% in 2003. Core deposits (deﬁ ned as demand, money mar- ket, and savings deposits) grew $719.1 million, or 92.4%, to $1.50 billion as of December 31, 2004 compared to $778 million as December 31, 2003. The overall deposit increase and the change in deposit composition was mainly due to an expansion of the branch network through the merger with PUB. The Company accepts brokered deposits on a selective basis at prudent interest rates to augment deposit growth. There were $40.0 million of brokered deposits as of December 31, 2004. The Company also had $200.0 million of state time deposits over $100,000 with an average interest rate of 2.08% as of December 31, 2004. page 30 The table below summarizes the distribution of average daily deposits and the average daily rates paid for the periods indicated: (Dollars in Thousands) 2004 Average Balance Average Rate 2003 Average Balance Average Rate Demand, non-interest-bearing Money market checking Savings Time deposits of $100,000 or more Other time deposits Total deposits $ 665,816 466,880 131,589 611,555 253,884 $2,129,724 1.73% 1.36% 1.79% 2.13% $ 422,453 207,689 97,070 386,701 302,651 $1,416,564 1.24% 1.95% 1.92% 2.43% For the Year Ended December 31, 2002 Average Balance Average Rate $ 331,551 176,089 92,835 312,618 251,469 $1,164,562 1.72% 2.84% 2.51% 2.80% The table below summarizes the maturity of the Company’s time deposits in denominations of $100,000 or greater at December 31 of the years indicated: December 31, (Dollars in Thousands) 2004 2003 2002 Three months or less Over three months through six months Over six months through twelve months Over twelve months $378,205 $ 261,274 $ 231,410 232,231 57,034 46,470 131,775 14,369 52,815 17,821 40,520 5,144 $756,580 $388,944 $323,544 Borrowings The Company’s borrowings mostly take the form of advances from the Federal Home Loan Bank of San Francisco (“FHLB”), overnight Federal funds, and junior subordinated debt associated with trust preferred securities. At December 31, 2004, advances from the FHLB were $66.4 million, a decrease of $82.0 million, or 55.3%, from the December 31, 2003 balance of $148.4 million. As of December 31, 2004, there were no overnight Federal funds purchased compared to $31.5 million as of December 31, 2004. During the ﬁrst half of 2004, the Company issued two junior subordinated notes bearing interest at three-month London InterBank Offered Rate (“LIBOR”) plus 2.90% totaling $61.8 million and one junior subordinated note bearing interest at three-month LIBOR plus 2.63% totaling $20.6 million. The Company’s outstanding subordinated deben- tures related to these offerings, the proceeds of which were used to ﬁnance the purchase of PUB, totaled $82.4 million at December 31, 2003. Interest Rate Risk Management Interest rate risk indicates the Company’s expo- sure to market interest rate ﬂuctuations. The movement of interest rates directly and inversely affects the economic value of ﬁxed-income assets, which is the present value of future cash ﬂow discounted by the current interest rate; under the same conditions, the higher the cur- rent interest rate, the higher the denominator of discounting. Interest rate risk management is intended to decrease or increase the level of the Company’s exposure to market interest rate. The level of interest rate risk can be man- aged through the changing of gap positions and the volume of ﬁxed-income assets and so forth. For successful management of interest rate risk, the Company uses various methods with which to measure existing and future interest rate risk exposures. In addition to regular reports used in business operations, repricing gap analysis, stress testing and simulation modeling are the main measurement techniques used to quantify interest rate risk exposure. page 31 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition The following table shows the most recent status of the Company’s gap position. (Dollars in Thousands) Within After Three Months After One Year But Within Five Years Three Months But Within One Year After Five Years Non-Interest- Sensitive Total $ — — $ — — $ — — $ 54,505 — $ 54,505 62,659 — — 38,703 716 34,070 10,800 — — — 21,868 — — 150,280 47,827 110,678 17,384 — — 79,800 — — 21,961 136,139 7,857 46,741 — — — — — — 10,000 21,961 352,728 66,245 — — 5,806 227,369 2,029,466 5,806 — — — (27,799) — 279,380 (27,799) — 301,248 $ 106,157 $ 405,969 $212,698 $ 311,892 $ 3,104,188 $ 191,176 46,680 202,950 $ 398,702 78,391 260,304 $ 66,176 10,868 68,626 $ — — — $ 729,583 153,862 613,662 10,000 — Assets: Cash (non- interest- earning) $ — Cash (interest- earning) 62,659 Securities purchased under agreements to resell FRB and FHLB stock Securities: Fixed rate Floating rate Loans: Fixed rate Floating rate Non- accrual Unearned income, allowance for loan losses and discount Derivatives Other assets Total assets — (79,800) — $2,067,472 35,880 2,001,282 — 27,606 9,845 $ 73,529 17,923 81,782 Liabilities Deposits: Demand deposits Savings Money market checking Time deposits of $100,000 or more Other time deposits Other borrowed funds Junior subordinated debentures Other liabilities Shareholders’ equity Total liabilities and shareholders’ equity 378,205 156,190 2,930 82,406 — — 364,006 99,676 25,000 — — — 14,269 19,181 36,000 — — — 100 73 5,363 — — — — — — — 23,772 399,910 756,580 275,120 69,293 82,406 23,772 399,910 $ 792,965 $929,488 $ 806,847 $151,206 $423,682 $ 3,104,188 Repricing gap Cumulative repricing gap Cumulative repricing gap as a percentage of total assets Cumulative repricing gap as a percentage of interest- earning assets $ 1,274,507 $ 1,274,507 $(823,331) $ 451,176 $(400,878) $50,298 $ 61,492 $ 111,790 $ (111,790) $ — 41.06% 14.53% 1.62% 3.60% 46.00% 16.29% 1.82% 4.04% — — The repricing gap analysis measures the static timing of repricing risk of assets and liabilities, i.e., a point- in- time analysis measuring the difference between assets maturing or repricing in a period and liabilities maturing or repricing within the same time period. Assets are assigned to maturity and repricing categories based on their expected repayment or repricing dates, and liabilities are assigned based on their repricing or maturity dates. Core deposits that have no maturity dates (demand deposits, savings and money market checking) are assigned to categories based on expected decay rates. On December 31, 2004, the cumulative repricing gap as a percentage of interest- earning assets in the less- than- three month period was 46.00%. This was a large increase page 32 from the previous year’s ﬁgure of 24.33%. The increase was caused by an increase in ﬂoating rate loans. Derivatives of $79.8 million lessened the gap impact in the period. The cumulative repricing percentage in the three to twelve- month period also moved higher, reaching 16.29%. In terms of ﬁxed and ﬂoating gap (Dollars in Thousands) Cumulative repricing gap Percentage of total assets Percentage of interest-earning assets The spread between interest income on interest- earning assets and interest expense on interest- bearing liabilities is the principal component of net interest income, and interest rate changes substantially affect the Company’s ﬁnancial performance. The Company emphasizes capital protection through stable earnings rather than maximizing yield. In order to achieve stable earnings, the Company prudently manages its assets and liabilities and closely monitors the percentage changes in net interest income and equity value in relation to limits established within the Company’s guidelines. positions, which are used internally to control repricing risk, the accumulated ﬁxed gap posi- tion between assets and liabilities as a percentage of interest-earning assets was (20.01)%. The ﬂoating gap position in the less-than-one year period was 19.30%. The following table summarizes the status of the Company’s gap position as of the dates indicated. Less than Three Months December 31, Three to Twelve Months December 31, 2004 2003 2004 2003 $1,274,507 41.06% 46.00% $412,826 23.12% 24.33% $451,176 14.53% 16.29% $116,705 6.54% 6.88% To supplement traditional gap analysis, the Company performs simulation modeling to estimate the potential effects of interest rate changes. The following table summarizes one of the stress simulations performed by the Company to forecast the impact of changing interest rates on net interest income and the market value of interest-earning assets and interest-bearing liabilities reﬂected on the Company’s balance sheet. This sensitivity anal- ysis is compared to policy limits, which specify the maximum tolerance level for net inter- est income exposure over a one-year horizon, given the basis point adjustment in interest rates reﬂected below. Hypothetical Changes in Interest Rates (Dollars in Thousands) Change in Interest Rate (bps) 200 100 0 (100) (200) Projected Changes (%) Projected Net Interest Income 10.98 % 5.49 % 0.00 % (5.62)% (11.36)% Projected Economic Value of Equity (5.13)% (2.75)% 0.00 % 3.22 % 6.94 % December 31, 2004 Change in Amount Net Interest Income $ 12,097 $ 6,046 $ — $ (6,198) $(12,521) Economic Value of Equity $(21,582) $ (11,598) $ — $ 13,557 $29,204 In the above stress simulation, for a 100 basis point decline in interest rates, the Company may be exposed to a 5.62% decline in net interest income and a 3.22% increase in the economic value of equity. For a 100 basis point increase in interest rates, net interest income may increase by 5.49%, but the economic value of equity may decrease by 2.75%. For a 200 basis point increase in interest rates, net interest income may increase by 10.98%, but economic value of equity may decrease by 5.13%. page 33 Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition Liquidity and Capital Resources Liquidity Measures For a 200 basis point decrease in interest rates, net interest income may decrease by 11.36%, but economic value of equity may increase by 6.94%. All projected changes remained well within internal policy guidelines. The estimated sensitivity does not necessarily represent a Company forecast and the results may not be indicative of actual change to the Company’s net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape, prepay- ments on loans and securities, pricing strategies on loans and deposits, and replacement of asset and liability cash ﬂ ows. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions, including how customer preferences or competitor inﬂ uences might change. Liquidity of the Bank is deﬁ ned as the ability to supply cash as quickly as needed without causing a severe deterioration in its proﬁ tability. The Bank’s major liquidity on the asset side stems from available cash positions, Federal funds sold and short- term investments catego- rized as trading and/or available for sale securities, which can be disposed of without signiﬁ cant capital losses in the ordinary business cycle. Liquidity sources on the liability side come from borrowing capacities, which include Federal funds lines, repurchase agreements, FRB discount window, and Federal Home Loan Bank advances. Thus, maintenance of high quality loans and securities that can be used for collateral in repurchase agreements or other secured borrowings is another important feature of liquidity management. Liquidity risk may occur when the Bank has few short- duration securities available for sale and/or is not capable of raising funds as quickly as necessary at accept- able rates in the capital or money markets. Also, a heavy and sudden increase in cash demands for loans and/or deposits can tighten the liquidity position. Several ratios are reviewed on a daily, monthly and quarterly basis to manage the liquidity position and to preempt any liquidity crisis. Six speciﬁ c statistics, which include the loans- to- assets ratio, off- balance sheet items and dependence on non- core deposits, foreign deposits, lines of credit and liquid assets, are reviewed quarterly for liquid- ity management purposes. Heavy loan demand and limited liquid assets increased pressure for liquidity in 2004, but the Company still had sufﬁ cient liquid assets to meet loan demand. Liquidity Ratios and Trends December 31, Short- term investments/ total assets Core deposits/ total assets Short- term non- core funding/ total assets Short- term investments/ short- term non- core funding dependence Net loans/ total assets Investments/ deposits Loans and investments/ deposits Off- balance sheet items/ total assets 2004 2003 2002 5% 41% 6% 40% 12% 45% 33% 45% 40% 23% 20% 30% December 31, 2003 70% 30% 2002 67% 29% 2004 72% 20% 109% 116% 105% 15% 18% 17% The net loans to total assets ratio increased to 72% in 2004. Despite ﬂ uctuations during the year, net loans grew faster than assets during the year. During the year, the ratio of net loans to total assets ranged primarily from 70% to 72%. The investments to deposits ratio decreased to 20% in 2004. The loans and investments to deposits ratio decreased to 109%. Off- balance sheet items as a percentage of total assets decreased in 2004 to 15% from 18% in 2003. The total amount increased to $479.6 million at December 31, 2004 from $326.2 million at December 31, 2003. The increase was primar- ily due to a $114.0 million increase in unused commitments. During the year, the percentage of off- balance sheet items to total assets ranged page 34 primarily from 13% to 16%. The ratios of short-term non-core funding to total assets and short-term investments to short-term non-core funding dependence were 33% and 23%, respectively, at December 31, 2004, compared to 45% and 20%, respectively, at December 31, 2003. Foreign deposit risk deals with dependency on foreign deposits that could adversely affect the Bank’s liquidity. These liabilities are assumed to be volatile in accordance with the variability of social, political and environmental condi- tions in foreign countries. On a quarterly basis, the Bank monitors foreign deposits and Brazilian deposits separately, and exposures to both categories remained well within the Bank’s internal guidelines. There were increases to the lines of credit secured by the Company to meet its liquidity needs. The Company maintained a total of $85.0 million in credit lines. In addition, the Company maintained eight master repurchase agreements, all of which can furnish liquidity to the Company in consideration of bond collateral. The Company also can meet its liquidity needs through borrowings from the FHLB. The Company is eligible to borrow up of 25% of its total assets from the FHLB. As of December 31, 2004, the Company had no material commitments for capital expenditures. The Company raises capital in the form of deposits, borrowings (primarily FHLB advances and junior subordinated debentures) and equity, and expects to continue to rely upon deposits as the primary source of capital. Factors That May Affect Future Results of Operations In addition to other factors set forth herein, below is a discussion of certain factors that may affect the Company’s ﬁnancial operations and should be considered in evaluating the Company. page 35 Our Southern California business focus and economic conditions in Southern California could adversely affect our operations. Hanmi Bank’s operations are primarily located in Los Angeles and Orange counties. As a result of this geographic concen- tration, the Company’s results depend largely upon economic conditions in these areas. A deterioration in economic condition in Hanmi Bank’s market area, or a signiﬁcant natural or manmade disaster in these market areas, could have a material adverse effect on the quality of Hanmi Bank’s loan portfolio, the demand for its products and services and on its overall ﬁnancial condition and results of operations. Our concentrations in commercial real estate loans located primarily in Southern California could have adverse effects on credit quality. Approximately 34.6% of the Bank’s loan portfolio consists of commer- cial real estate loans, primarily in Southern California. As a result of this concentration, a deterioration of the Southern California commercial real estate market could have adverse consequences for the Bank. Among the factors that could contribute to such a decline are general economic conditions in Southern California, interest rates and local market construction and sales activity. The Company’s earnings are affected by changing interest rates. Changes in interest rates affect the level of loans, deposits and investments, the credit proﬁle of existing loans, the rates received on loans and securities and the rates paid on deposits and borrowings. Signiﬁcant ﬂuctu- ations in interest rates may have a material adverse effect on the Company’s ﬁnancial condition and results of operations. Hanmi may fail to realize the anticipated beneﬁts of the merger with PUB. The success of the merger will depend on, among other things, Hanmi’s ability to realize anticipated cost savings and revenue enhancements and to combine the businesses of its subsidiary Hanmi Bank and PUB in a manner that permits growth oppor- tunities to occur and that does not materially disrupt the existing customer relationships of PUB or result in decreased revenues resulting from any loss of customers. If Hanmi is not able to successfully achieve these objectives, the anticipated beneﬁts of the merger may not be realized fully, or at all, or may take longer to realize than expected. Hanmi Financial Management’s Discussion & Analysis of Results of Operations and Financial Condition We are subject to government regulations that could limit or restrict our activities, which in turn could adversely affect our operations. The ﬁ nancial services industry is subject to extensive Federal and state super- vision and regulation. Signiﬁ cant new laws, changes in existing laws, or repeals of existing laws may cause the Company’s results to differ materially. Further, Federal monetary policy, particularly as implemented through the Federal Reserve System, signiﬁ cantly affects credit conditions for the Company, and a material change in these conditions could have a material adverse affect on the Company’s ﬁ nancial condition and results of operations. Competition may adversely affect our performance. The banking and ﬁ nancial services businesses in the Company’s market areas are highly competitive. The Company faces competition in attracting deposits and in making loans. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems, and the pace of consolidation among ﬁ nancial services providers. The results of the Company in the future may differ depend- ing upon the nature and level of competition. If a signiﬁ cant number of borrowers, guarantors or related parties fail to perform as required by the terms of their loans, we could sustain losses. A signiﬁ cant source of risk arises from the possibility that losses will be sustained because borrowers, guaran- tors or related parties may fail to perform in accordance with the terms of their loans. The Company has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Company’s credit portfolio. These policies and procedures, however, may not prevent unex- pected losses that could have a material adverse effect on the Company’s ﬁ nancial condition and results of operations. Off- Balance Sheet Arrangements For a discussion of off- balance sheet arrange- ments, see “Item 1. Business – Small Business Administration Guaranteed Loans” and “Item 1. Business – Off- Balance Sheet Commitments,” in the Company's Annual Report on Form 10-K for the year ended December 31, 2004. Contractual Obligations The Company’s contractual obligations as of December 31, 2004 are as follows: (In Thousands) Contractual Obligations Time deposits Long- term debt obligations Operating lease obligations Total contractual obligations Less Than One Year More Than One More Than Three Years and Less Than Five Years Year and Less Than Three Years $ 998,077 — 2,614 $1,000,691 $ 24,770 30,000 6,600 $ 61,370 $ 8,680 6,000 7,657 $22,337 More Than Five Years $ 173 87,967 6,545 Total $1,031,700 123,967 23,416 $94,685 $ 1,179,083 page 36 Recently Issued Accounting Standards In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R (revised 2004), “Share-Based Payment.” SFAS No. 123R addresses the accounting for share- based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using the intrinsic method that is currently used and requires that such transactions be accounted for using a fair value-based method and recognized as expense in the Consolidated Statement of Income. The effective date of SFAS No. 123R is for interim and annual periods beginning after June 15, 2005. The Company has been providing pro forma disclosures under SFAS No. 123. See “Notes to Consolidated Financial Statements, Note 1 – Summary of Signiﬁcant Accounting Policies.” In March 2004, the FASB issued Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF No. 03-1”). This EITF describes a model involving three steps: (1) determine whether an invest- ment is impaired; (2) determine whether the impairment is other-than-temporary; and (3) recognize any impairment loss in earnings. The EITF also requires several additional disclosures for cost-method investments. In September 2004, the FASB approved the deferral of the effective date for EITF No. 03-1 pending reconsideration of implementation guidance relating to debt securities that are impaired solely due to market interest rate ﬂuctuation. Adoption is not expected to have a material impact on our ﬁnancial position or results of operations. In December 2003, the American Institute of Certiﬁed Public Accountants (“AICPA”) released Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”). SOP 03-3 addresses accounting for differences between contractual cash ﬂows and cash ﬂows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. SOP 03-3 is effective for loans acquired in ﬁscal years beginning after December 15, 2004. Adoption is not expected to have a material impact on our ﬁnancial position or results of operations. In December 2004, the FASB issued SFAS No. 153, “Exchange of Non-Monetary Assets, an Amendment of APB Opinion No. 29, ‘Accounting for Non-Monetary Transactions.’” SFAS No. 153 is based on the principle that exchange of non-monetary assets should be measured based on the fair market value of the assets exchanged. SFAS No. 153 eliminates the exception of non- monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS No. 153 is effective for non-monetary asset exchanges in ﬁscal periods beginning after June 15, 2005. The Company is currently assessing the provi- sions of SFAS No. 153 and its impact on its consolidated ﬁnancial statements. Quantitative and Qualitative Disclosures About Market Risk For quantitative and qualitative disclosures regarding market risks in Hanmi Bank’s port- folio, see “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations – Interest Rate Risk Management” and “– Liquidity and Capital Resources.” page 37 Hanmi Financial Management’s Report on Internal Control Over Financial Reporting Management of Hanmi Financial Corporation (“Hanmi”) is responsible for establishing and maintaining adequate internal control over ﬁ nancial reporting pursuant to the rules and regulations of the Securities and Exchange Commission. Hanmi’s internal control over ﬁ nancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁ nancial reporting and the prepa- ration of consolidated ﬁ nancial statements for external purposes in accordance with U.S. gen- erally accepted accounting principles. Internal control over ﬁ nancial reporting includes those written policies and procedures that: • pertain to the maintenance of records that in reasonable detail accurately and fairly reﬂ ect the transactions and dispositions of the assets of the company; • provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁ nancial statements in accordance with generally accepted accounting principles; • provide reasonable assurance that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and • provide reasonable assurance regarding pre- vention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the consolidated ﬁ nancial statements. Because of its inherent limitations, internal control over ﬁ nancial reporting may not pre- vent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in con- ditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of Hanmi’s internal control over ﬁ nancial report- ing as of December 31, 2004. Management based this assessment on criteria for effective internal control over ﬁ nancial reporting described in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of Hanmi’s internal control over ﬁ nancial reporting and testing of the operational effectiveness of its internal control over ﬁ nancial reporting. Management reviewed the results of its assess- ment with the Audit Committee of our Board of Directors. Based on this assessment, management deter- mined that, as of December 31, 2004, Hanmi maintained effective internal control over ﬁ nancial reporting. KPMG LLP, the independent registered pub- lic accounting ﬁ rm who audited and reported on the consolidated ﬁ nancial statements of Hanmi, have issued a report on management’s assessment of Hanmi’s internal control over ﬁ nancial reporting as of December 31, 2004. The report expresses unqualiﬁ ed opinions on management’s assessment and on the effective- ness of Hanmi’s internal control over ﬁ nancial reporting as of December 31, 2004. March 16, 2005 page 38 Hanmi Financial Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Hanmi Financial Corporation: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Hanmi Financial Corporation and subsidiary maintained effective internal control over ﬁ nancial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Hanmi Financial Corporation’s management is respon- sible for maintaining effective internal control over ﬁ nancial reporting and for its assessment of the effectiveness of internal control over ﬁ nancial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of Hanmi Financial Corporation’s internal control over ﬁ nancial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Account- ing Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁ nancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over ﬁ nancial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit pro- vides a reasonable basis for our opinion. A company’s internal control over ﬁ nancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁ nancial reporting and the preparation of ﬁ nancial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁ nancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂ ect the transactions and disposi- tions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁ nancial statements in accordance with gener- ally accepted accounting principles, and that receipts and expenditures of the company are page 39 being made only in accordance with authori- zations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the ﬁ nancial statements. Because of its inherent limitations, internal control over ﬁ nancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that the Hanmi Financial Corporation maintained effective internal control over ﬁ nancial report- ing as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Hanmi Financial Corporation maintained, in all material respects, effective internal control over ﬁ nancial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consoli- dated statements of ﬁ nancial condition of Hanmi Financial Corporation and subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in shareholders’ equity and compre- hensive income, and cash ﬂ ows for each of the years in the three-year period ended December 31, 2004, and our report dated March 16, 2005 expressed an unqualiﬁ ed opinion on those consolidated ﬁ nancial statements. Los Angeles, California March 16, 2005 Hanmi Financial Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Hanmi Financial Corporation: We have audited the accompanying consolidated statements of ﬁ nancial condition of Hanmi Financial Corporation and subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and cash ﬂ ows for each of the years in the three- year period ended December 31, 2004. These consolidated ﬁ nancial statements are the respon- sibility of the Hanmi Financial Corporation’s management. Our responsibility is to express an opinion on these consolidated ﬁ nancial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assur- ance about whether the ﬁ nancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁ nancial statements. An audit also includes assessing the accounting principles used and signiﬁ cant estimates made by management, as well as evaluating the overall ﬁ nancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated ﬁ nancial statements referred to above present fairly, in all material respects, the ﬁ nancial position of Hanmi Financial Corporation and subsidiary as of December 31, 2004 and 2003, and the results of their operations and their cash ﬂ ows for each of the years in the three- year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effective- ness of Hanmi Financial Corporation’s internal control over ﬁ nancial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2005 expressed an unqualiﬁ ed opinion on management’s assessment of, and the effective operation of, internal control over ﬁ nancial reporting. Los Angeles, California March 16, 2005 page 40 Hanmi Financial Consolidated Statements of Financial Condition (Dollars in Thousands) Assets Cash and due from banks Federal funds sold and securities purchased under agreements to resell Cash and cash equivalents Federal Reserve Bank stock Federal Home Loan Bank stock Securities held to maturity, at amortized cost (fair value: 2004 — $1,093; 2003 — $1,334) Securities available for sale, at fair value Loans receivable, net of allowance for loan losses of $22,702 and $13,349 at December 31, 2004 and 2003, respectively Loans held for sale, at the lower of cost or fair value Customers’ liability on acceptances Premises and equipment, net Accrued interest receivable Deferred income taxes Servicing asset Goodwill Core deposit intangible Bank-owned life insurance — cash surrender value Other assets Total assets Liabilities and Shareholders’ Equity Liabilities: Deposits: Non-interest-bearing Interest-bearing: Savings Money market checking Time deposits of $100,000 or more Other time deposits Total deposits Accrued interest payable Acceptances outstanding Other borrowed funds Junior subordinated debentures Other liabilities Total liabilities Commitments and contingencies (Notes 16 and 17) Shareholders’ equity Common stock, $.001 par value; authorized 200,000,000 shares; issued and outstanding, 49,330,704 shares and 28,326,820 shares at December 31, 2004 and 2003, respectively Additional paid-in capital Accumulated other comprehensive income — unrealized gain on securities available for sale and interest rate swaps, net of income taxes of $744 and $220 at December 31, 2004 and 2003, respectively Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying notes to consolidated ﬁ nancial statements page 41 2004 December 31, 2003 $ 55,164 $ 62,595 72,000 127,164 12,099 9,862 1,090 417,883 2,230,992 3,850 4,579 19,691 10,029 5,009 3,846 209,643 11,476 21,868 15,107 $3,104,188 — 62,595 2,935 7,420 1,328 413,288 1,222,945 25,454 3,930 8,435 6,686 7,207 2,364 1,831 212 11,137 9,372 $1,787,139 $ 729,583 $ 475,100 153,862 613,662 756,580 275,120 2,528,807 7,100 4,579 69,293 82,406 12,093 2,704,278 96,869 206,086 388,944 278,836 1,445,835 4,403 3,930 182,999 — 10,505 1,647,672 49 334,932 14 103,082 1,035 63,894 399,910 $3,104,188 386 35,985 139,467 $1,787,139 Hanmi Financial Consolidated Statements of Income (Dollars in Thousands, Except Per Share Data) Interest income: Interest and fees on loans Interest on investments Interest on term federal funds sold Interest on federal funds sold Total interest income Interest expense Net interest income before provision for credit losses Provision for credit losses Net interest income after provision for credit losses Non-interest income: Service charges on deposit accounts Trade ﬁ nance fees Remittance fees Other service charges and fees Bank-owned life insurance income Increase in fair value of derivatives Other income Gain on sales of loans Gain on sales of securities available for sale Total non-interest income Non-interest expenses: Salaries and employee beneﬁ ts Occupancy and equipment Data processing Advertising and promotional expense Supplies and communication Professional fees Amortization of core deposit intangible Impairment of securities Other operating expense Merger-related expenses Total non-interest expenses Income before provision for income taxes Provision for income taxes Net income Earnings per share: Basic Diluted Weighted-average shares outstanding: Basic Diluted See accompanying notes to consolidated ﬁ nancial statements 2004 2003 2002 Years Ended December 31, $ 116,612 17,372 — 183 134,167 32,617 101,550 2,907 98,643 14,441 4,044 1,653 1,685 731 232 1,681 2,997 134 27,598 33,540 8,098 4,540 3,001 2,433 2,068 1,872 — 8,961 2,053 66,566 59,675 22,975 $36,700 $ 0.87 $ 0.84 $ 64,211 12,410 225 277 77,123 20,796 56,327 5,680 50,647 10,339 2,887 952 1,513 499 35 840 2,157 1,094 20,316 21,214 5,198 3,080 1,635 1,496 1,167 121 — 5,414 — 39,325 31,638 12,425 $ 19,213 $ 0.68 $ 0.67 $56,398 11,363 630 925 69,316 21,345 47,971 4,800 43,171 9,195 2,410 786 1,094 552 1,368 659 1,875 3,265 21,204 17,931 4,330 2,784 1,523 1,466 1,003 8 4,416 4,872 — 38,333 26,042 9,012 $17,030 $ 0.62 $ 0.60 42,268,964 43,517,257 28,092,708 28,662,026 27,647,570 28,306,492 page 42 Hanmi Financial Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income Years Ended December 31, 2004, 2003 and 2002 (Dollars in Thousands) Balance, December 31, 2001 Stock options exercised Stock dividends Cash paid for fractional shares Comprehensive income: Net income Change in unrealized gain on securities available for sale, net of tax Total comprehensive income Balance, December 31, 2002 Stock options exercised Cash dividends Comprehensive income: Net income Change in unrealized gain on securities available for sale and interest rate swaps, net of tax Total comprehensive income Balance, December 31, 2003 Stock options exercised Warrants exercised Stock issued through private placement Stock issued in PUB acquisition Cash dividends Comprehensive income: Net income Change in unrealized gain on securities available for sale and interest rate swaps, net of tax Total comprehensive income Number of Shares Outstanding 25,124,458 444,044 2,262,364 — — — 27,830,866 495,954 — — — 28,326,820 670,576 20,000 7,894,654 12,418,654 — — — Additional Accumulated Other Common Paid-In Comprehensive Stock Capital Income $25 $ 81,078 1,468 17,381 — Total Retained Shareholders’ Earnings Equity $1,003 $ 22,767 $104,873 1,469 1 (7) — (17,382) (7) — — — 1 2 — — — 28 — — — — — — 99,927 3,141 — — 17,030 17,030 1,102 — 1,102 18,132 2,105 22,408 124,468 3,141 (5,636) — (5,636) — — — — 19,213 19,213 — (1,719) — (1,719) 17,494 28 103,068 3,234 190 1 — 386 35,985 139,467 3,235 190 — — — — 8 12 — — — 71,702 156,738 — — — — — 71,710 — 156,750 (8,791) (8,791) — — — 36,700 36,700 649 — 649 37,349 Balance, December 31, 2004 49,330,704 $49 $334,932 $1,035 $63,894 $399,910 See accompanying notes to consolidated ﬁ nancial statements page 43 Hanmi Financial Consolidated Statements of Cash Flows (In Thousands) Cash ﬂ ows from operating activities: Net income Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities: Depreciation and amortization of premises and equipment Amortization of premiums and discounts on investments Amortization of core deposit intangible Provision for credit losses Federal Reserve Bank stock and Federal Home Loan Bank stock dividend Gain on sales of securities available for sale Change in fair value of derivatives Impairment loss on investment security held to maturity Gain on sales of loans Gain on sales of other real estate owned Loss on sales of premises and equipment Deferred tax provision (beneﬁ t) Origination of loans held for sale Proceeds from sales of loans held for sale Change in: Decrease (increase) in accrued interest receivable Increase in cash surrender value of bank-owned life insurance Decrease (increase) in other assets (Decrease) increase in accrued interest payable (Decrease) increase in other liabilities Net cash and cash equivalents provided by operating activities Cash ﬂ ows from investing activities: Proceeds from matured term federal funds sold Proceeds from sale of Federal Home Loan Bank stock Proceeds from matured or called securities 2004 2003 2002 Years Ended December 31, $ 36,700 $ 19,213 $ 17,030 2,447 3,246 1,872 2,907 (497) (134) (232) — (2,997) — 15 6,573 (53,855) 54,311 155 (731) 1,149 (444) (12,751) 1,559 121 212 5,680 (107) (1,094) (35) — (2,157) (82) 67 (2,069) (45,858) 35,100 (1,153) (500) (1,832) 1,018 5,506 1,397 22 8 4,800 (895) (3,265) (1,368) 4,416 (1,875) — — (469) (33,226) 37,508 (125) (634) (2,045) (1,341) 1,011 37,733 13,588 20,949 — 5,031 30,000 — — — available for sale 120,389 170,346 105,245 Proceeds from matured or called securities held to maturity Proceeds from sale of securities available for sale Proceeds from termination of interest rate swap Proceeds from sale of other real estate owned Net increase in loans receivable Purchase of Federal Reserve Bank stock and Federal Home Loan Bank stock Purchases of securities available for sale Purchases of bank-owned life insurance Purchases of premises and equipment, net Acquisition of PUB, net of cash acquired Net cash and cash equivalents used in investing activities 239 53,063 — — (120,651) (9,884) (22,384) (10,000) (2,049) (63,498) 6,214 45,051 — 204 (265,641) (5,669) (358,218) — (2,031) — 10,012 102,343 1,368 — (190,284) (522) (283,726) — (1,832) — (49,743) (379,744) (257,396) page 44 (In Thousands) 2004 2003 2002 Years Ended December 31,s in Cash ﬂows from ﬁnancing activities: Increase in deposits Issuance of junior subordinated debentures Proceeds from exercise of stock options Proceeds from exercise of stock warrants Stock issued through private placement Cash dividends paid (Decrease) increase in proceeds from other borrowed funds Cash paid for fractional shares on dividends Net cash and cash equivalents provided by ﬁnancing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental disclosures of cash ﬂow information: Interest paid Income taxes paid Supplemental schedule of non-cash investing and ﬁnancing activities: 146,273 82,406 3,235 190 71,710 (7,740) 161,856 — 3,141 — — (4,220) (219,495) — 145,202 — 76,579 64,569 62,595 $ 127,164 305,979 (60,177) 122,772 $ 62,595 241,626 — 1,469 — — — 34,925 (7) 278,013 41,566 81,206 $122,772 $ 29,920 $ 25,400 $ 19,778 $ 9,469 $ 22,686 $ 9,125 Transfer of loans to other real estate owned Transfer of retained earnings to common stock and additional paid-in capital for stock dividend $ — $ 2,467 Accrued dividend $ — $ 122 $ — $ — $ 1,416 $ 17,382 $ — Reconciliation of acquisition of PUB, net of cash acquired: Fair value of assets acquired Cash and cash equivalents acquired Non-cash ﬁnancing of purchase price and liabilities assumed: Issuance of common stock Liabilities assumed Acquisition of PUB, net of cash acquired See accompanying notes to consolidated ﬁnancial statements $1,383,782 (104,383) $ — — $ — — (156,750) (1,059,151) $ 63,498 — — $ — — — $ — page 45 Hanmi Financial Notes to Consolidated Financial Statements Note 1 – Summary of Signiﬁ cant Accounting Policies The accounting and reporting policies of Hanmi Financial Corporation and subsidiary conform to accounting principles generally accepted in the United States of America and to prevailing practices within the banking industry. A summary of the signiﬁ cant accounting policies consistently applied in the preparation of the accompanying consolidated ﬁ nancial statements follows. Principles of Consolidation The consolidated ﬁ nancial statements include the accounts of Hanmi Financial Corporation (the “Company”) and its wholly owned subsid- iary, Hanmi Bank (the “Bank”), after elimina- tion of all material intercompany transactions and balances. The Company was formed as a holding company of the Bank and registered with the Securities and Exchange Commission under the Securities Act of 1933 on March 17, 2001. Subsequent to the formation of the Company, each of the Bank’s shares was exchanged for one share of the Company with an equal value. The Company’s primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through operation of the Bank. Hanmi Bank is a community bank conducting general business banking with its primary market encompassing the multi- ethnic population of Los Angeles, Orange, San Diego, San Francisco and Santa Clara counties. Hanmi Bank’s full- service ofﬁ ces are located in business areas where many of the businesses are run by immigrants and other minority groups. Hanmi Bank’s client base reﬂ ects the multi- ethnic composition of these communities. The Bank is a California state- chartered, FDIC- insured ﬁ nancial institution. On April 30, 2004, the Company completed its acquisition of Paciﬁ c Union Bank (“PUB”), a $1.2 billion (assets) commercial bank head- quartered in Los Angeles that, like Hanmi, served primarily the Korean- American community. As of December 31, 2004, the Bank maintained a branch network of 23 locations, serving indi- viduals and small- to medium- sized businesses in Los Angeles and surrounding areas. Cash and Cash Equivalents Cash and cash equivalents include cash and due from banks, Federal funds sold and securities purchased under resale agreements, all of which have maturities of less than 90 days. Securities Securities are classiﬁ ed into three categories and accounted for as follows: 1. Securities that the Company has the positive intent and ability to hold to maturity are classiﬁ ed as “held- to- maturity” and reported at amortized cost; 2. Securities that are bought and held principally for the purpose of selling them in the near future are classiﬁ ed as “trading securities” and reported at fair value. Unrealized gains and losses are recognized in earnings; and 3. Securities not classiﬁ ed as held- to- maturity or trading securities are classiﬁ ed as “available for sale” and reported at fair value. Unrealized gains and losses are reported as a separate component of share- holders’ equity as accumulated other comprehensive income, net of deferred income taxes. Accreted discounts and amortized premiums on investment securities are included in interest income using the effective interest method, and unrealized and realized gains or losses related to holding or selling of securities are calculated using the speciﬁ c- identiﬁ cation method. To the extent there is an impairment of value deemed other than temporary for a security held to maturity or available for sale, a loss is recognized in earnings and a new cost basis established for the security. The Company also has a minority investment of 4.99% in a non- publicly traded company, Paciﬁ c International Bank. The investment is included in Other Assets on the Company’s consolidated balance sheet and is carried at cost. The Company monitors the investment for impairment and makes appropriate reduc- tions in carrying value when necessary. page 46 Derivative Instruments The Company accounts for derivatives in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This standard requires the Company to record all derivatives at fair value and per- mits the Company to designate derivative instruments as being used to hedge changes in fair value or changes in cash ﬂows. Changes in the fair value of derivatives that offset changes in cash ﬂows of the hedged item are recorded initially in Other Comprehensive Income. Amounts recorded in Other Comprehensive Income are subsequently reclassiﬁed into earnings during the same period in which the hedged item affects earnings. If a derivative qualiﬁes as a fair value hedge, then changes in the fair value of the hedging derivative are recorded in earnings and are offset by changes in fair value attributable to the hedged risk of the hedged item. Any portion of the changes in the fair value of derivatives designated as a hedge that is deemed ineffective is recorded in earnings along with changes in the fair value of derivatives with no hedge designation. Loans The Company originates loans for investment, with such designation made at the time of origi- nation. Loans are recorded at the contractual amounts due from borrowers, adjusted for unamortized discounts and premiums, undis- bursed funds, net deferred loan fees and origi- nation costs, and the allowance for loan losses. Certain Small Business Administration (“SBA”) loans that may be sold prior to matu- rity have been designated as held for sale at origination and are recorded at the lower of cost or fair value, determined on an aggregate basis. A valuation allowance is established if the market value of such loans is lower than their cost, and operations are charged or credited for valuation adjustments. Upon sales of such loans, the Company receives a fee for servicing the loans. The servicing asset is recorded based on the present value of the contractually speci- ﬁed servicing fee, net of adequate compensation, for the estimated life of the loan, discounted by a rate in the range of 11% to 12% and a con- stant prepayment rate ranging from 6% to 16%. The servicing asset is amortized in proportion to and over the period of estimated servicing page 47 income. The Company capitalized $2,172,000 and $652,000 of servicing assets during 2004 and 2003, respectively, and amortized $690,000 and $352,000 during the years ended December 31, 2004 and 2003, respectively. Management periodically evaluates the servicing asset for impairment. Impairment, if it occurs, is recognized in a valuation allowance in the period of impairment. Interest-only strips are recorded based on the present value of the excess of total servicing fee over the contractually speciﬁed servicing fee for the estimated life of the loan, calculated using the same assumptions as noted above. Such interest-only strips are accounted for at their estimated fair value, with unrealized gains or losses recorded as adjustments to earnings. Loans Held for Sale Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Loan Interest Income and Fees Interest on loans is credited to income as earned and is accrued only if deemed collect- ible. Direct loan origination costs are offset by loan origination fees with the net amount deferred and recognized over the contractual lives of the loans in interest income as a yield adjustment using the effective interest method. Discounts or premiums associated with purchased loans are accreted or amortized to interest income using the interest method over the contractual lives of the loans, adjusted for prepayments. Accretion of discounts and deferred loan fees is discontinued when loans are placed on non-accrual status. Loans are placed on non-accrual status when, in the opinion of management, the full timely collection of principal or interest is in doubt. As a general rule, the accrual of interest is dis- continued when principal or interest payments become more than 90 days past due. However, in certain instances, the Company may place a particular loan on non-accrual status earlier, depending upon the individual circumstances surrounding the loan’s delinquency. When an asset is placed on non-accrual status, previously accrued but unpaid interest is reversed against Hanmi Financial Notes to Consolidated Financial Statements current income. Subsequent collections of cash are applied as principal reductions when received, except when the ultimate collectibility of principal is probable, in which case interest payments are credited to income. Non- accrual assets may be restored to accrual status when principal and interest become current and full repayment is expected. Interest income is recognized on the accrual basis for impaired loans not meeting the criteria for non- accrual. Allowance for Loan Losses Management believes that, as of December 31, 2004, the allowance for loan losses is adequate to provide for probable losses inherent in the loan portfolio. However, the allowance is an estimate that is inherently uncertain and depends on the outcome of future events. Management’s estimates are based on previous loan loss experience; volume, growth and composition of the loan portfolio; the value of collateral; and current economic conditions. The Company’s lending is concentrated in consumer, commercial, construction and real estate loans in the greater Los Angeles/ Orange County area. Although management believes the level of the allowance as of December 31, 2004 is adequate to absorb probable losses inherent in the loan portfolio, a decline in the local economy may result in increasing losses that cannot reasonably be predicted at this date. Loan losses are charged, and recoveries are credited, to the allowance account. Additions to the allowance account are charged to the provision for credit losses. The allowance for loan losses is maintained at a level considered adequate by management to absorb probable losses in the loan portfolio. The adequacy of the allowance is determined by management based upon an evaluation and review of the loan portfolio, consideration of historical loan loss experience, current economic conditions, changes in the composition of the loan port- folio, analysis of collateral values and other pertinent factors. Loans are measured for impairment when it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agree ment. The amount of impairment and any subsequent changes are recorded through the provision for credit losses as an adjustment to the allowance for loan losses. Accounting standards require that an impaired loan be measured based on: 1. the present value of the expected future cash ﬂ ows, discounted at the loan’s effective interest rate; or 2. the loan’s observable fair value; or 3. the fair value of the collateral, if the loan is collateral- dependent. The Company evaluates installment loans for impairment on a pooled basis. These loans are considered to be smaller balance, homogeneous loans and are evaluated on a portfolio basis considering the projected net realizable value of the portfolio compared to the net carrying value of the portfolio. Premises and Equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation on furniture, ﬁ xtures and equip- ment is computed on the straight- line method over the estimated useful lives of the related assets, which range from three to 30 years. Leasehold improvements are capitalized and amortized using the straight- line method over the term of the lease or the estimated useful lives of the improvements, whichever is shorter. Goodwill and Intangible Assets Goodwill, which represents the excess of pur- chase price over fair value of net assets acquired, amounted to $209.6 million and $1.8 million as of December 31, 2004 and 2003, respectively. The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), effec- tive January 1, 2002. SFAS No. 142 required that goodwill be recorded at the reporting unit level. Reporting units are deﬁ ned as an operating segment. We have identiﬁ ed one reporting unit – our banking operations. SFAS No. 142 pro- hibits the amortization of goodwill but requires that it be tested for impairment at least annually, or earlier if events have occurred that might indicate impairment. The Company ceased amortization of goodwill as of January 1, 2002. The Company’s impairment test is performed in two phases. The ﬁ rst step involves comparing the fair value of the reporting unit with its carry- ing amount, including goodwill. Fair value of the reporting unit is estimated using two page 48 Stock-Based Compensation Compensation cost for stock options is mea- sured as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. Pro forma disclosure of net income and earnings per share is provided as if the fair value-based method had been applied. Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant dates for awards under the Plan consistent with the fair value method of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net income and earnings per share for the years ended December 31, 2004, 2003 and 2002 would have been reduced to the pro forma amounts indicated below: (Dollars in Thousands, Except Per Share Data) 2004 2003 2002 Net income: As reported Compensation expense Pro forma Earnings per share: As reported: Basic Diluted Pro forma: Basic Diluted $36,700 $ 19,213 $17,030 791 408 521 $ 36,292 $18,692 $ 16,239 $ 0.87 $ 0.68 $ 0.62 $ 0.84 $ 0.67 $ 0.60 $ 0.86 $ 0.67 $ 0.59 $ 0.83 $ 0.65 $ 0.57 The estimated weighted-average fair value of options granted was $3.94 per share in 2004, $3.30 per share in 2003 and $2.52 per share in 2002. The weighted-average fair value of options granted under the Company’s ﬁxed stock option plan was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: dividend yield of 1.40%, 0.00% and 0.00% in 2004, 2003 and 2002, respec- tively; expected volatility of 32.4%, 31.0% and 37.0% in 2004, 2003 and 2002; respectively; expected lives of 4.2 years, 4.5 years and 4.5 years in 2004, 2003 and 2002, respectively; and risk-free interest rates of 2.90%, 1.87% and 2.39% in 2004, 2003 and 2002, respectively. different valuation techniques: (a) discounted earnings cash ﬂow and (b) average market price to earnings multiple using a management selected peer group. If the fair value of the reporting unit exceeds its fair value an addi- tional procedure must be performed. That additional procedure involves comparing the implied fair value of the reporting unit good- will with the carrying amount of that goodwill. An impairment loss is recorded through earnings to the extent the carrying amount of goodwill exceeds its implied fair value. As of December 31, 2004, management is unaware of any circumstances that would indicate a potential impairment of goodwill. The Company amortizes core deposit intan- gible (“CDI”) balances using the straight-line method over ﬁve years. As required upon adoption of SFAS No. 142, the Bank evaluated the useful lives assigned to the CDI assets and determined that no change was necessary and amortization expense was not adjusted for the year ended December 31, 2004. As required by SFAS No. 142, the CDI balance is assessed for impairment or recoverability whenever events or changes in circumstances indicate the carry- ing amount may not be recoverable. The CDI recoverability analysis is consistent with the Company’s policy for assessing impairment or disposal of long-lived assets. As of and for the year ended December 31, 2004, management is not aware of any circumstances that would indicate impairment of the CDI assets, and no impairment charges were recorded through earnings in 2004. Income Taxes The Company provides for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between ﬁnancial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those tem- porary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. page 49 Hanmi Financial Notes to Consolidated Financial Statements Stock Split On January 20, 2005, the Company’s Board of Directors declared a two- for- one stock split, to be effected in the form of a 100 percent common stock dividend. The new shares were distributed on February 15, 2005 to share- holders of record on the close of business on January 31, 2005. All share and per share amounts have been restated to reﬂ ect the stock split for all periods presented. Earnings Per Share Basic earnings per share (“EPS”) is computed by dividing earnings available to common shareholders by the weighted- average number of common shares outstanding for the period. Diluted EPS reﬂ ects the potential dilution of securities that could share in the earnings. Impairment of Long- Lived Assets The Company accounts for long- lived assets in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long- Lived Assets.” This Statement requires that long- lived assets and certain identiﬁ able intan- gibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash ﬂ ows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Use of Estimates in the Preparation of Financial Statements The preparation of ﬁ nancial statements in conformity with accounting principles gener- ally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of con- tingent assets and liabilities at the date of the ﬁ nancial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Recently Issued Accounting Standards In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R (revised 2004), “Share- Based Payment.” SFAS No. 123R addresses the accounting for share- based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instru- ments. SFAS No. 123R eliminates the ability to account for share- based compensation transactions using the intrinsic method that is currently used and requires that such transac- tions be accounted for using a fair value- based method and recognized as expense in the Consolidated Statement of Income. The effective date of SFAS No. 123R is for interim and annual periods beginning after June 15, 2005. The Company has been providing pro forma disclosures under SFAS No. 123, which are included in “Note 1 — Stock- Based Compensation.” In March 2004, the FASB issued Emerging Issues Task Force (“EITF”) Issue No. 03- 1, “The Meaning of Other- Than- Temporary Impairment and Its Application to Certain Investments” (“EITF No. 03- 1”). This EITF describes a model involving three steps: (1) determine whether an invest- ment is impaired; (2) determine whether the impairment is other- than- temporary; and (3) recognize any impairment loss in earnings. The EITF also requires several additional disclosures for cost- method investments. In September 2004, the FASB approved the deferral of the effective date for EITF No. 03- 1 pending reconsideration of implementation guidance relating to debt securities that are impaired solely due to market interest rate ﬂ uctuation. Adoption is not expected to have a material impact on our ﬁ nancial position or results of operations. In December 2003, the American Institute of Certiﬁ ed Public Accountants (“AICPA”) released Statement of Position 03- 3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” page 50 (“SOP 03-3”). SOP 03-3 addresses accounting for differences between contractual cash ﬂows and cash ﬂows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. SOP 03-3 is effective for loans acquired in ﬁscal years beginning after December 15, 2004. Adoption in 2005 did not have a material impact on our ﬁnancial position or results of operations. In December 2004, the FASB issued SFAS No. 153, “Exchange of Non-Monetary Assets, an Amendment of APB Opinion No. 29, ‘Accounting for Non-Monetary Transactions.’” SFAS No. 153 is based on the principle that exchange of non-monetary assets should be measured based on the fair market value of the assets exchanged. SFAS No. 153 eliminates the exception of non- monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS No. 153 is effective for non-monetary asset exchanges in ﬁscal periods beginning after June 15, 2005. The Company is currently assessing the provi- sions of SFAS No. 153 and its impact on its consolidated ﬁnancial statements. Reclassiﬁcations – Certain reclassiﬁcations were made to the prior year’s presentation to con- form to the current year’s presentation. Note 2 – Business Combination On April 30, 2004, the Company completed its acquisition of PUB and merged PUB with Hanmi Bank. The Company paid $164.5 mil- lion in cash to acquire 5,537,431 of the PUB shares owned by Korea Exchange Bank. All of the remaining PUB shares were converted in the acquisition into shares of the Company’s common stock based on an exchange ratio of 2.312 Hanmi shares for each PUB share. In addition, all outstanding PUB employee stock options were converted into 137,414 options to purchase Hanmi stock valued at $1.1 million in total. Based on Hanmi’s average price of $12.53 for the ﬁve-day trading period from April 28 through May 4, 2004, the total consideration paid for PUB was $324.6 million and resulted in the recognition of goodwill aggregating $207.8 million. Purchase Price and Acquisition Costs For purposes of the accompanying pro forma combined ﬁnancial data, the purchase price has been estimated as follows (dollars in thousands, except share prices): (Dollars in Thousands; Except Share Prices) Common stock: Number of shares of PUB stock outstanding as of April 30, 2004 Less shares acquired for cash Number of shares of PUB stock to be exchange for Hanmi stock Exchange ratio Stock issued in PUB acquisition Multiplied by Hanmi’s average stock price for the period two days before and two days after the April 29, 2004 pricing of the merger agreement Stock options: Estimated fair value of 137,414 Hanmi stock options to be issued in exchange for 59,443 PUB outstanding stock options, calculated using the Black-Scholes option pricing model, modiﬁed for dividends, with model assumptions estimated as of April 30, 2004 and a Hanmi stock price of $12.53, the average stock price for the period two days before through two days after the April 29, 2004 pricing of the merger agreement Cash Transaction costs: Cash Stock warrants Total estimated purchase price 10,908,821 (5,537,431) 5,371,390 2.312 12,418,654 $ 12.53 155,606 1,063 164,562 3,320 145 $ 324,696 page 51 Hanmi Financial Notes to Consolidated Financial Statements For the purposes of these pro forma condensed combined ﬁ nancial statements, the purchase price estimated above has been allocated based on estimates of the fair values of the assets acquired and liabilities assumed. The ﬁ nal val- uation of net assets acquired will be completed as soon as possible but no later than one year from the acquisition date. To the extent estimates need to be adjusted, they will be adjusted. (Dollars in Thousands) Book value of net assets acquired Adjustments: Adjustment to record acquired securities at estimated fair value Adjustment to record acquired loans at estimated fair value Adjustment to record acquired ﬁ xed assets at estimated fair value Adjustment to record core deposit intangible asset Adjustment to record various other assets at estimated fair value Adjustment to record interest- bearing deposits at fair value Adjustment to record other borrowings at fair value Adjustment to record severance beneﬁ ts associated with the elimination of positions, termination of certain contractual obligations of PUB and other miscellaneous adjustments Adjustment to record deferred tax liability Adjustment to record goodwill associated with the acquisition of PUB Total estimated purchase price $ 110,683 (1,489) 376 5,459 13,137 15 (264) (789) (4,512) (7,948) 210,028 $324,696 The fair value of PUB net assets acquired was as follows: (In Thousands) Assets: Cash and due from banks Federal fund sold Federal Home Loan Bank stock Securities available for sale Loans receivable, net of allowance for loan losses Premises and equipment Accrued interest receivable Goodwill Core deposit intangible Other assets Total assets Liabilities: Deposits Borrowings Other liabilities Total liabilities Net assets acquired $ 27,483 76,900 6,256 157,905 865,743 11,668 3,498 207,812 13,136 13,381 $1,383,782 $ 936,699 105,789 16,663 $ 1,059,151 $ 324,631 The core deposit intangible is being amortized over its estimated useful life of ﬁ ve years. None of the goodwill balance is expected to be deduc- tible for income tax purposes. Merger- related costs recognized as expenses during 2004 consist of employee retention bonuses, the costs of vacating duplicative branches within Hanmi’s existing network and the impairment of ﬁ xed assets (primarily leasehold improvements) associated with such branches. Of the $2,053,000 provided, $777,000 was utilized and charged against the related liability in the 2004. The remaining balance of $1,276,000 is anticipated to be uti- lized by the end of 2005, excluding certain lease commitments that may continue into 2006. Certain costs (primarily PUB employee sever- ance, data processing contract termination costs, and the costs of vacating duplicative branches within PUB’s network) were recognized as lia- bilities assumed in the business combination or impairments of ﬁ xed assets associated with such branches. Accordingly, they have been considered part of the purchase price of PUB and recorded as an increase in the balance of goodwill. Of the $4,515,000 provided, $2,444,000 was utilized and charged against the related liability in 2004. The remaining balance of $2,071,000 is anticipated to be utilized by the end of 2005, excluding certain lease commit- ments that may continue into 2009. page 52 Note 3 – Securities Purchased Under Agreements to Resell The Company purchases government agency securities and/or whole loans under agreements to resell the same securities (reverse repurchase agreements) with primary dealers. Amounts advanced under these agreements represent short-term invested cash. Securities subject to the reverse repurchase agreements are held in the name of the Company by dealers who arrange the transactions. In the event that the fair value of the securi- ties decreases below the carrying amount of the related reverse repurchase agreement, the counterparties are required to designate an equivalent value of additional securities in the name of the Company. The following is a summary of the securi- ties purchased under agreements to resell at December 31, 2004: (Dollars in Thousands) Balance at year-end Average balance outstanding during the year Maximum amount outstanding at any month-end during the year Weighted-average interest rate during the year $10,000 $ 55 $10,000 2.33% The Company incurred the following merger- related costs through December 31, 2004. (In Thousands) Merger-related costs: Employee termination costs Contract termination costs Leasehold termination costs Asset impairments Total merger-related costs Included in Cost of Expensed Acquisition $ 1,364 — 348 341 $1,425 1,828 1,262 — $2,053 $4,515 Pro Forma Combined Financial Data Reﬂecting the PUB Acquisition The Pro Forma Combined Income Statements presented below give effect to the acquisition of PUB as if it had been consummated as of January 1, 2003. The pro forma information is not necessarily indicative of the results of operations that would have resulted had the acquisition been completed as of January 1, 2003, nor is it necessarily indicative of future results of operations. (Dollars in Thousands; Except Per Share Data) 2004 Net interest income Provision for credit losses Non-interest income Non-interest expenses Provision for income taxes Net income Weighted-average shares outstanding: Basic Diluted Earnings per share: Basic Diluted $121,259 3,307 33,366 86,029 25,110 $ 40,179 2003 $90,819 7,580 33,399 70,726 18,190 $27,722 48,928,260 49,760,374 48,406,100 49,557,118 $ 0.82 $ 0.81 $ 0.57 $ 0.56 Note 4 – Securities The following is a summary of the securities held to maturity at December 31: (In Thousands) 2004 Municipal bonds Mortgage-backed securities 2003 Municipal bonds Mortgage-backed securities page 53 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value $ 691 399 $1,090 $ 690 638 $ 1,328 $ – 3 $ 3 $ – 7 $ 7 $ – – $ – $ 1 – $ 1 $ 691 402 $1,093 $ 689 645 $1,334 Hanmi Financial Notes to Consolidated Financial Statements The following is a summary of securities avail- able for sale at December 31: (In Thousands) 2004 Mortgage- backed securities Collateralized mortgage obligations U.S. Government agencies Municipal bonds Corporate bonds Other 2003 Mortgage- backed securities Collateralized mortgage obligations U.S. Government agencies Municipal bonds Corporate bonds Other Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value $148,706 93,172 89,345 71,771 8,380 4,437 $ 415,811 $ 117,139 125,491 80,845 60,741 13,641 15,055 $ 412,912 $ 1,014 236 381 1,938 76 34 $3,679 $ 830 274 606 910 309 — $2,929 $ 546 869 49 93 12 38 $1,607 $ 485 1,669 25 248 47 79 $2,553 $ 149,174 92,539 89,677 73,616 8,444 4,433 $417,883 $ 117,484 124,096 81,426 61,403 13,903 14,976 $413,288 The amortized cost and estimated fair value of investment securities at December 31, 2004, by contractual maturity, are shown below. Although mortgage- backed securities and collateralized mortgage obligations have contractual maturities through 2034, expected maturities may differ from contractual maturi- ties because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. (In Thousands) Within one year Over one year through ﬁ ve years Over ﬁ ve years through ten years Over ten years Mortgage- backed securities Collateralized mortgage obligations Asset- backed securities Available for Sale Held to Maturity Amortized Cost $ 4,261 71,120 32,450 65,664 173,495 148,706 93,172 438 242,316 Estimated Fair Value $ 4,261 71,340 32,749 67,382 175,732 149,174 92,539 438 242,151 Amortized Cost $ — — — 691 691 399 — — 399 Estimated Fair Value $ — — — 691 691 402 — — 402 $ 415,811 $417,883 $1,090 $1,093 Gross unrealized losses on investment securi- ties and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows as of December 31, 2004: (In Thousands) Available for sale: Mortgage- backed securities Collateralized mortgage obligations U.S. Government agency securities Municipal bonds Corporate bonds Other Less than 12 Months 12 Months or More Total Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value $ 135 264 49 — 12 — $460 $22,747 13,780 14,883 — 3,103 — $54,513 $ 411 605 — 93 — 38 $37,428 39,824 — 3,775 — 1,962 $ 546 869 49 93 12 38 $ 60,175 53,604 14,883 3,775 3,103 1,962 $1,147 $82,989 $1,607 $137,502 page 54 the year and were included in comprehensive income and $167,000 ($122,000 net of tax) of previously unrealized losses were realized in earnings. In 2003, $1.8 million ($1.3 million net of tax) of unrealized losses arose during the year and were included in comprehensive income and $1.1 million ($692,000 net of tax) of previously unrealized gains were realized in earnings. In 2002, $2.5 million ($1.7 million net of tax) of unrealized gains arose during the year and were included in comprehensive income and $882,000 ($574,000 net of tax) of previously unrealized gains were realized in earnings. Note 5 – Loans Receivable and Allowance for Loan Losses Loans receivable consisted of the following at December 31: (In Thousands) 2004 2003 Real estate loans: Commercial property Construction Residential property Total real estate loans Commercial and industrial loans Consumer loans Total gross loans Allowance for loans losses Deferred loan fees Loans receivable, net $ 783,539 $ 397,853 43,047 58,477 92,521 80,786 956,846 1,214,419 87,526 499,377 685,557 54,878 2,258,791 (22,702) (5,097) 1,239,812 (13,349) (3,518) $2,230,992 $1,222,945 At December 31, 2004 and 2003, the Company serviced loans sold to unafﬁliated parties in the amounts of $173.7 million and $97.9 million, respectively. Changes in loan servicing rights, net of amorti- zation, were as follows: (In Thousands) Balance, beginning of year Additions Amortization Balance, end of year December 31, 2004 2003 $2,364 2,172 (690) $3,846 $2,064 652 (352) $2,364 All individual securities that have been in a continuous unrealized loss position for 12 months or longer at December 31, 2004 had investment grade ratings upon purchase. The issuers of these securities have not, to our knowledge, established any cause for default on these securities and the various rating agencies have reafﬁrmed these securities’ long-term investment grade status at December 31, 2004. These securities have ﬂuctuated in value since their purchase dates as market interest rates have ﬂuctuated. However, the Company has the ability, and management intends to hold these securities until their fair values recover to cost. Therefore, in management’s opinion, all secu- rities that have been in a continuous unrealized loss position for the past 12 months or longer as of December 31, 2004 are not other-than- temporarily impaired, and therefore, no impairment charges as of December 31, 2004 are warranted. Securities with carrying values of $307.5 million and $278.5 million as of December 31, 2004 and 2003, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. At December 31, 2003, the Company held a WorldCom, Inc. (“WorldCom”) corporate bond in its available for sale portfolio with an amortized carrying value of $119,000. On January 15, 2003, such investment matured and WorldCom defaulted on the repayment. The Company wrote down its cost basis in the invest- ment to fair value, recognizing a loss of $4.4 million during the year ended December 31, 2002, as the Company’s management consid- ered such decline in market value an other than temporary condition. In 2003, the Company sold $4.0 million par value of this bond and recognized gains of $782,000. In 2004, the Company sold its remaining WorldCom securi- ties, recognizing a gain of $100,000. There were $0.1 million, $1.1 million and $3.3 million in net realized gains on sales of securities available for sale during the years ended December 31, 2004, 2003 and 2002, respectively. During 2004, $983,000 ($713,000 net of tax) of unrealized losses arose during page 55 Hanmi Financial Notes to Consolidated Financial Statements Activity in the allowance for loan losses and reserve for credit losses was as follows: (In Thousands) Balance, beginning of year Allowance for loan losses acquired in PUB acquisition Provision charged to operating expense Loans charged off Recoveries, net of charge- offs Balance, end of year 2004 2003 2002 Allowance for Reserve for Loan Losses Credit Losses Allowance for Reserve for Loan Losses Credit Losses Total Allowance for Reserve for Loan Losses Credit Losses Total Total $ 13,349 $ 1,385 $ 14,734 $ 11,254 $ 1,015 $12,269 $ 9,408 $ 656 $10,064 As of and for the Years Ended December 31, 10,566 — 10,566 — — — — — — 2,492 (5,485) 415 — 2,907 (5,485) 5,310 (4,423) 370 — 5,680 (4,423) 4,441 (3,571) 359 4,800 (3,571) — 1,780 — 1,780 1,208 — 1,208 976 — 976 $22,702 $1,800 $24,502 $13,349 $1,385 $14,734 $11,254 $1,015 $ 12,269 The following is a summary of the investment in impaired loans and the related allowance for loan losses: (In Thousands) Recorded investment in impaired loans Related allowance for loan losses Impaired loans without speciﬁ c allowances December 31, 2004 2003 $ 7,653 $3,039 $6,285 $2,972 $3,262 $ 392 The average recorded investment in impaired loans during the years ended December 31, 2004, 2003 and 2002 was $9.9 million, $6.4 million and $4.8 million, respectively. Interest income of $350,000, $204,000 and $273,000 was recognized on impaired loans during the years ended December 31, 2004, 2003 and 2002, respectively. Loans on non- accrual status totaled $5.8 million and $8.1 million at December 31, 2004 and 2003, respectively. If interest on non- accrual loans had been recognized at the origi- nal interest rates, interest income would have increased $678,000, $362,000 and $203,000 during the years ended December 31, 2004, 2003 and 2002, respectively. The Company is not committed to lend additional funds to debtors whose loans are impaired. Loans past due 90 days or more and still accruing interest totaled $208,000 and $557,000 at December 31, 2004 and 2003, respectively. Restructured loans totaled $2.6 million and $640,000 at December 31, 2004 and 2003, respectively. The following is an analysis of all loans to ofﬁ cers and directors of the Company and their afﬁ liates. In the opinion of management, all such loans were made under terms that are consistent with the Company’s normal lending policies. (In Thousands) December 31, 2004 2003 Outstanding balance, beginning of year $ 885 Credit granted, including renewals 951 Repayments (284) $1,552 Outstanding balance, end of year $2,645 127 (1,887) $ 885 Income from these loans totaled $70,000 and $153,000 for the years ended December 31, 2004 and 2003, respectively, and is reﬂ ected in the accompanying Consolidated Statements of Income. Note 6 – Premises and Equipment The following is a summary of the major components of premises and equipment: (In Thousands) Land Buildings and improvements Furniture and equipment Leasehold improvements December 31, 2004 2003 $ 6,120 7,354 11,116 7,845 $ 1,820 3,034 8,052 5,826 32,435 18,732 Accumulated depreciation and amortization (12,744) Total premises and equipment, net $ 19,691 (10,297) $ 8,435 Note 7 – Deposits Time deposits by maturity were as follows: (In Thousands) December 31, 2004 2003 Less than three months After three months to six months After six months to twelve months After twelve months Total time deposits $ 534,394 289,134 174,548 33,624 $1,031,700 $ 429,129 116,983 99,094 22,574 $667,780 page 56 A summary of interest expense on deposits was as follows for the years ended December 31, 2004, 2003 and 2002: (In Thousands) 2004 2003 2002 Money market checking Savings Time deposits of $100,000 or more Other time deposits Total interest expense on deposits $ 8,098 $ 2,584 $ 3,036 2,632 1,894 1,790 10,966 5,414 7,415 7,354 7,838 7,034 $26,268 $19,247 $20,540 Note 8 – Other Borrowed Funds Other borrowed funds consisted of the following: (In Thousands) December 31, 2004 2003 FHLB advances Note issued to U.S. Treasury Federal funds purchased and securities sold under agreements to resell $66,363 2,930 $148,400 3,104 — 31,495 Total other borrowed funds $69,293 $ 182,999 FHLB advances represent collateralized obliga- tions with the FHLB of San Francisco, and are summarized by contractual maturity as follows: (In Thousands) Year 2005 2006 2007 2008 2009 Thereafter Amount $25,000 10,000 20,000 — 6,000 5,363 $ 66,363 The Company has pledged investment securities available for sale with a carrying value of $68.8 million as collateral with the FHLB for this borrowing facility. The total borrowing capacity available from the collateral that has been pledged is $757.1 million, of which $690.7 mil- lion remained available as of December 31, 2004. For the years ended December 31, 2004, 2003 and 2002, interest expense on other borrowed funds totaled $3,305,000, $1,549,000 and $805,000, respectively, and the weighted- average interest rates were 2.14%, 2.45% and 3.68%, respectively. In 2004, the Company obtained additional lines of credit of $18.0 million. Total credit lines for borrowing amounted to $85.0 million at December 31, 2004. page 57 Note 9 – Junior Subordinated Debentures During the ﬁrst half of 2004, the Company issued two junior subordinated notes bearing interest at three-month London InterBank Offered Rate (“LIBOR”) plus 2.90% total- ing $61.8 million and one junior subordi- nated note bearing interest at three-month LIBOR plus 2.63% totaling $20.6 million. The Company’s outstanding subordinated deben- tures related to these offerings, the proceeds of which were used to ﬁnance the purchase of PUB, totaled $82.4 million at December 31, 2004. For the year ended December 31, 2004, interest expense on the junior subor- dinated debentures totaled $3,044,000 with a weighted-average interest rate of 4.41%. Note 10 – Income Taxes A summary of income tax provision for the years ended December 31, 2004, 2003 and 2002 follows: (In Thousands) Current: Federal State Deferred: Federal State 2004 2003 2002 $16,010 $10,852 3,642 6,271 $8,410 1,071 22,281 14,494 9,481 1,032 (338) (1,732) (337) 694 (2,069) (390) (79) (469) Provision for income taxes $22,975 $12,425 $9,012 As of December 31, 2004 and 2003, the Federal and state deferred tax assets are as follows: (In Thousands) Deferred tax assets: Credit loss provision Depreciation State taxes Other Total deferred tax assets Deferred tax liabilities: Purchase accounting Unrealized gain on securities available for sale and interest rate swaps Other Total deferred tax liabilities Valuation allowance Net deferred tax assets December 31, 2004 2003 $11,232 816 1,475 42 13,565 $6,754 667 895 31 8,347 (7,022) (142) (744) (790) (8,556) — (220) (98) (460) (680) $5,009 $7,207 Management believes that it is more likely than not that the results of future operations will generate sufﬁcient taxable income to realize the deferred tax assets, net of the valuation allowance. Hanmi Financial Notes to Consolidated Financial Statements A reconciliation of the difference between the Federal statutory income tax rate and the effec- tive tax rate as of December 31 is shown in the following table: Statutory tax rate State taxes, net of federal tax beneﬁ ts Tax- exempt municipal securities Reversal of valuation allowance Other Effective tax rate 2004 2003 2002 35.0% 35.0% 35.0% 6.5% 6.6% 2.4% (1.8%) (1.5%) (1.1%) (0.7%) (0.5%) — (0.8%) — (1.7%) 38.5% 39.3% 34.6% At December 31, 2004, net current taxes receivable of $2.4 million were included in Other Assets in the Consolidated Statements of Financial Condition. At December 31, 2003, net current taxes payable of $5.0 million were included in Other Liabilities in the Consolidated Statements of Financial Condition. Note 11 – Shareholders’ Equity Stock Options The Bank adopted a Stock Option Plan in 1992, which was replaced by the Hanmi Financial Corporation Year 2000 Stock Option Plan (the “Plan”), under which options to purchase shares of the Company’s common stock may be granted to key employees and directors. The Plan provides that the option price shall not be less than the fair value of the Company’s stock on the effective date of the grant. Generally, options will vest over ﬁ ve years. No option may be granted with a term of more than ten years. The following is a summary of the transactions under the stock option plan described above: 2004 2003 2002 Weighted- Number Average Exercise Price Per Share of Shares Weighted- Number Average Exercise Price Per Share of Shares Weighted- Number Average Exercise Price Per Share of Shares Options outstanding, beginning of year Options granted Options assumed in PUB acquisition Options exercised Options cancelled/ expired Options outstanding, end of year Options exercisable at year- end 1,500,064 1,141,000 137,414 (670,576) (139,066) 1,968,836 487,242 $ 5.52 $14.63 $ 5.11 $ 4.82 $ 9.61 $10.72 $ 6.10 2,137,012 80,000 — (495,954) (220,994) 1,500,064 655,154 $5.32 $8.75 $ — $4.53 $6.99 $5.52 $5.26 2,612,846 80,000 — (444,044) (111,790) 2,137,012 771,368 $6.41 $7.75 $ — $ 3.31 $ 7.01 $5.32 $4.66 Exercise Prices $2.76 $3.27 $3.89 $4.10 $4.36 $7.04 $7.52 $7.92 $8.75 $10.44 $12.85 $13.35 $13.52 $15.56 $17.17 Options Outstanding Options Exercisable Weighted- Average Remaining Contractual Life 0.8 years 5.8 years 5.7 years 1.4 years 1.6 years 6.6 years 2.7 years 4.0 years 8.5 years 4.2 years 9.4 years 9.5 years 9.2 years 9.8 years 9.8 years Number Outstanding 35,462 28,482 292,992 4,272 4,102 407,542 11,328 18,032 80,000 4,624 14,000 20,000 694,000 4,000 350,000 1,968,836 Number Outstanding 35,462 28,482 109,872 4,272 4,102 191,068 11,328 18,032 80,000 4,624 — — — — — 487,242 The number and price per share of outstanding options have been adjusted to reﬂ ect the stock dividends in January 2005 and 2002. Stock Warrants In 2004, the Company issued stock warrants to afﬁ liates of Castle Creek Financial LLC (“Castle Creek”) for services rendered in connection with the placement of the Company’s equity securities. Under the terms of the warrants, the warrant holders can purchase a total of 508,558 shares of common stock at an exercise price of $9.50 per share. The warrants were immediately exercisable and expire after ﬁ ve years. During 2004, 20,000 shares of common stock were issued for the exercise of stock warrants. page 58 Note 12 – Regulatory Matters The Company and the Bank are subject to various regulatory capital requirements administered by the Federal banking regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the Company’s con- solidated ﬁnancial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet speciﬁc capital guidelines that involve quantitative measures of the assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classiﬁcation are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum ratios (set forth in the table below) of total and Tier 1 capital (as deﬁned in the regulations) to risk- weighted assets (as deﬁned), and of Tier 1 capital (as deﬁned) to average assets (as deﬁned). Management believes that, as of December 31, 2004 and 2003, the Company and the Bank met all capital adequacy requirements to which they were subject. As of December 31, 2004, the most recent notiﬁcation from the Federal Reserve Board categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized” the Bank must maintain minimum total risk- based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notiﬁcation which management believes have changed the institution’s category. The capital ratios of the Company and the Bank at December 31 were as follows: (Dollars in Thousands) December 31, 2004 Total capital (to risk-weighted assets): Company Bank Tier 1 capital (to risk-weighted assets): Company Bank Tier 1 capital (to average assets): Company Bank December 31, 2003 Total capital (to risk-weighted assets): Company Bank Tier 1 capital (to risk-weighted assets): Company Bank Tier 1 capital (to average assets): Company Bank Amount Actual Ratio Minimum Regulatory Requirement Ratio Amount Minimum to Be Categorized as “Well Capitalized” Ratio Amount $281,684 $277,075 11.98% 11.80% $ 188,173 $ 187,921 8.00% 8.00% N/A $ 234,901 N/A 10.00% $ 257,182 $252,573 10.93% 10.75% $ 94,087 $ 93,960 4.00% 4.00% N/A $140,940 $257,182 $252,573 8.93% 8.78% $ 115,235 $ 115,055 4.00% 4.00% N/A $ 143,818 N/A 6.00% N/A 5.00% $151,336 $150,547 11.13% 11.09% $ 108,757 $108,630 8.00% 8.00% N/A $ 135,788 N/A 10.00% $136,602 $135,813 10.05% 10.00% $ 54,379 $ 54,315 4.00% 4.00% N/A $ 81,473 $136,602 $ 135,813 7.80% 7.75% $ 70,088 $ 70,067 4.00% 4.00% N/A $ 87,584 N/A 6.00% N/A 5.00% The average reserve balance required to be maintained with the Federal Reserve Bank was $1.5 million as of December 31, 2004 and 2003. page 59 Hanmi Financial Notes to Consolidated Financial Statements Note 13 – Earnings Per Share The Company declared a 100% stock dividend on January 20, 2005 and a 9% stock dividend on February 20, 2002. 2004: Basic EPS – income available to common shareholders Effect of dilutive securities – options and warrants Diluted EPS – income available to common shareholders 2003: Basic EPS – income available to common shareholders Effect of dilutive securities – options Diluted EPS – income available to common shareholders 2002: Basic EPS – income available to common shareholders Effect of dilutive securities – options Diluted EPS – income available to common shareholders Note 14 – Employee Beneﬁ ts The Company has proﬁ t sharing and section 401(k) plans for the beneﬁ t of substantially all of its employees. Contributions to the proﬁ t sharing plan are determined by the board of directors. No contributions were made to the proﬁ t sharing plan in 2004, 2003 or 2002. The Company matches 75% of participant contributions to the 401(k) plan up to 8% of each 401(k) plan participant’s annual compen- sation. The Company made contributions to the 401(k) plan for the years ended December 31, 2004, 2003 and 2002 of $858,000, $553,000 and $524,000, respectively. In 2001 and 2004, the Company purchased single premium life insurance policies covering certain ofﬁ cers of the Company. The Company is the beneﬁ ciary under the policy. In the event of the death of a covered ofﬁ cer, the Company will receive the speciﬁ ed insurance beneﬁ t. The following is a reconciliation of the numer- ators and denominators (adjusted for the 100% stock dividend in January 2005 and the 9% stock dividend in 2002) of the basic and diluted per share computations for the years ended December 31, 2004, 2003 and 2002: Income (Numerator) Weighted-Average Shares (Denominator) Per Share Amount $36,700 — $36,700 $ 19,213 — $ 19,213 $ 17,030 — $ 17,030 42,268,964 1,248,293 43,517,257 28,092,708 569,318 28,662,026 27,647,570 658,922 28,306,492 $ 0.87 (0.03) $ 0.84 $ 0.68 (0.01) $ 0.67 $ 0.62 (0.02) $ 0.60 Note 15 – Derivative Financial Instruments During 2004, the Company entered into one interest rate swap agreement, wherein the Company received a ﬁ xed rate of 7.29%, at quarterly intervals, and paid Prime- based ﬂ oating rates, at quarterly intervals, on a total notional amount of $10.0 million. This swap agreement matures in 2009 and was designated as a cash ﬂ ow hedge for accounting purposes. The total notional amount of interest rate swaps was $70.0 million as of December 31, 2004. During 2003, the Company entered into four interest rate swap agreements, wherein the Company received ﬁ xed rates of 5.77%, 6.37%, 6.51% and 6.76%, at quarterly intervals, and paid Prime- based ﬂ oating rates, at quar- terly intervals, on a total notional amount of $60.0 million. All four of the swap agreements mature in 2008. These swaps were designated as hedges for accounting purposes. As of December 31, 2004, the fair value of the interest rate swaps was in an unfavorable posi- tion of $293,000. A total of ($170,000), net of tax, was included in Other Comprehensive Income. As of December 31, 2003, the fair value of the interest rate swaps was in a favorable position of $253,000. A total of $165,000, net of tax, was included in Other Comprehensive Income. Income of $19,000 and $35,000 related to hedge ineffectiveness was recognized in 2004 and 2003, respectively. page 60 Rental expenses recorded under such leases in 2004, 2003 and 2002 amounted to $3.2 mil- lion, $2.0 million and $1.8 million, respectively. In the normal course of business, the Company is involved in various legal claims. Management has reviewed all legal claims against the Company with in-house or outside legal counsel and has taken into consideration the views of such counsel as to the outcome of the claims. In management’s opinion, the ﬁnal disposition of all such claims will not have a material adverse effect on the ﬁnancial position and results of operations of the Company. Note 17 – Off-Balance Sheet Commitments The Company is a party to ﬁnancial instruments with off-balance sheet risk in the normal course of business to meet the ﬁnancing needs of its customers. These ﬁnancial instruments include commitments to extend credit and standby let- ters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of ﬁnancial condi- tion. The Bank’s exposure to credit losses in the event of non-performance by the other party to commitments to extend credit and standby let- ters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for extending loan facilities to customers. The Bank evaluates each customer’s creditwor- thiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on man- agement’s credit evaluation of the counterparty. In 2004, the Bank offered a certiﬁcate of deposit (“CD”) product that pays interest tied to the movement in the Standard & Poors 500 Index. The economic characteristics and risks of the embedded option are not clearly and closely related to the CD. Therefore, the embedded option is separated from the CD and accounted for separately in liabilities. As of December 31, 2004, the fair value of the embedded option was $1,396,000 and the change in the liability during 2004 was $242,000. The change was recognized in earnings. To economically hedge the interest risk, the Bank entered into an agreement to purchase an equity swap. As of December 31, 2004, the fair value of the equity swap was $212,000, which was also equal to the change during the year. The change was recognized in earnings. Note 16 – Commitments and Contingencies The Company leases its premises under non- cancelable operating leases. At December 31, 2004, future minimum annual rental commit- ments under these non-cancelable operating leases, with initial or remaining terms of one year or more, are as follows for the years ended December 31: Amount $ 2,614 2,567 2,286 1,747 1,112 6,545 $16,871 (In Thousands) Year 2005 2006 2007 2008 2009 Thereafter page 61 Hanmi Financial Notes to Consolidated Financial Statements Collateral held varies but may include accounts receivable; inventory; property, plant and equipment; and income- producing or borrower- occupied properties. The following table shows the distribution of the Company’s undisbursed loan commitments as of the dates indicated: (In Thousands) Commitments to extend credit Standby letters of credit Commercial letters of credit Unused credit card lines Total undisbursed loan commitments December 31, 2004 2003 $367,708 47,901 49,699 14,324 $253,722 34,434 34,261 3,801 $479,632 $326,218 Note 18 – Fair Value of Financial Instruments The estimated fair value of ﬁ nancial instru- ments has been determined by the Company using available market information and appro- priate valuation methodologies. However, considerable judgment is required to interpret market data in order to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assump- tions and/or estimation methodologies may have a material effect on the estimated fair value amounts: (In Thousands) Assets: Cash and cash equivalents Federal Reserve Bank stock Federal Home Loan Bank stock Securities held to maturity Securities available for sale Loans receivable, net Loans held for sale Accrued interest receivable Interest rate swaps Equity swap Liabilities: Non- interest- bearing deposits Interest- bearing deposits Other borrowed funds and junior subordinated debentures Accrued interest payable Embedded derivative December 31, 2004 Carrying Amount Estimated Fair Value December 31, 2003 Carrying Amount Estimated Fair Value $ 127,164 12,099 9,862 1,090 417,883 2,230,992 3,850 10,029 (293) 212 $ 127,164 12,099 9,862 1,093 417,883 2,229,096 4,026 10,029 (293) 212 729,853 1,799,224 151,699 7,100 1,396 729,853 1,799,224 153,541 7,100 1,396 $ 62,595 2,935 7,420 1,328 413,288 1,222,945 25,454 6,686 253 — 475,100 970,735 182,999 4,403 — $ 62,595 2,935 7,420 1,334 413,288 1,226,300 25,501 6,686 253 — 475,100 977,670 184,497 4,403 — page 62 The methods and assumptions used to estimate the fair value of each class of ﬁnancial instru- ments for which it is practicable to estimate that value are explained below: currently being offered by the Bank on com- parable deposits as to amount and term. The carrying amount of accrued interest payable approximates its fair value. (g) Other Borrowed Funds – Discounted cash ﬂows have been used to value other borrowed funds. (h) Loan Commitments and Standby Letters of Credit – The fair value of loan commitments and standby letters of credit is based upon the dif- ference between the current value of similar loans and the price at which the Bank has com- mitted to make the loans. The fair value of loan commitments and standby letters of credit is immaterial at December 31, 2004 and 2003. Note 19 – Condensed Financial Information of Parent Company Statements of Financial Condition December 31, 2004 2003 (In Thousands) Assets: Cash Receivable from Hanmi Bank Investment in Hanmi Bank Investment in unconsolidated subsidiaries Other assets Total assets $ 5,376 455 475,302 2,986 1,799 $485,918 Liabilities and shareholders’ equity: Liabilities: Junior subordinated debentures $ 82,406 Other liabilities 3,602 Shareholders’ equity 399,910 Total liabilities and shareholders’ equity $485,918 Statements of Income $ 1,454 231 138,678 511 1,081 $141,955 $ — 2,488 139,467 $141,955 (In Thousands) 2004 2003 2002 Years ended December 31, Equity in earnings of Hanmi Bank Other expenses, net Income tax beneﬁt Net income $ 39,574 $19,578 $ 17,371 (521) 180 (4,673) 1,799 (602) 237 $36,700 $ 19,213 $17,030 (a) Cash and Cash Equivalents – The carrying amounts approximate fair value due to the short-term nature of these instruments. (b) Federal Reserve Bank Stock and Federal Home Loan Bank Stock – The carrying amounts approximate fair value as the stock may be resold to the issuer at carrying value. (c) Securities – The fair value of securities is generally obtained from market bids for similar or identical securities or obtained from inde- pendent securities brokers or dealers. (d) Loans – Fair values are estimated for portfo- lios of loans with similar ﬁnancial characteris- tics, primarily ﬁxed and adjustable rate interest terms. The fair values of ﬁxed rate mortgage loans are based on discounted cash ﬂows utiliz- ing applicable risk-adjusted spreads relative to the current pricing of similar ﬁxed rate loans, as well as anticipated repayment schedules. The fair value of adjustable rate commercial loans is based on the estimated discounted cash ﬂows utilizing the discount rates that approximate the pricing of loans collateralized by similar commercial properties. The fair value of non- performing loans at December 31, 2004 and 2003 was not estimated because it is not practi- cable to reasonably assess the credit adjustment that would be applied in the marketplace for such loans. The estimated fair value is net of allowance for loan losses. (e) Accrued Interest Receivable – The carrying amount of accrued interest receivable approxi- mates its fair value. (f) Deposits – The fair value of non-maturity deposits is the amount payable on demand at the reporting date. Non-maturity deposits include non-interest-bearing demand deposits, savings accounts and money market checking. Discounted cash ﬂows have been used to value term deposits such as certiﬁcates of deposit. The discount rate used is based on interest rates page 63 Hanmi Financial Notes to Consolidated Financial Statements Statements of Cash Flows (In Thousands) Cash ﬂ ows from operating activities: Net income Adjustments to reconcile net income to net cash (used in) provided by operating activities: Earnings of Hanmi Bank (Increase) decrease in receivable from Hanmi Bank Increase in other assets Increase in other liabilities Net cash (used in) provided by operating activities Cash ﬂ ows from investing activities: Dividends received from Hanmi Bank Capital contribution to Hanmi Bank Acquisition of Paciﬁ c Union Bank Purchase of investment in unconsolidated subsidiaries Net cash (used in) provided by investing activities Cash ﬂ ows from ﬁ nancing activities: Issuance of junior subordinated debentures Proceeds from exercise of stock options Stock issued through private placement Cash dividends paid Net cash provided by (used in) ﬁ nancing activities Net increase (decrease) in cash Cash, beginning of year Cash, end of year Note 20 – Quarterly Financial Data (Unaudited) Summarized quarterly ﬁ nancial data follows: 2004 Net interest income Provision for credit losses Net income Basic earnings per share Diluted earnings per share 2003 Net interest income Provision for credit losses Net income Basic earnings per share Diluted earnings per share Years Ended December 31, 2004 2003 2002 $ 36,700 $ 19,213 $17,030 (39,574) (224) (718) 132 (3,684) 11,990 (80,000) (71,710) (2,475) (142,195) 82,406 3,425 71,710 (7,740) 149,801 3,922 1,454 (19,578) (231) (1,968) 1,065 (1,499) 2,300 — — (161) 2,139 — 3,141 — (4,220) (1,079) (439) 1,893 (17,371) 368 (11) 6 22 — — — — — — 1,469 — (7) 1,462 1,484 409 $ 5,376 $ 1,454 $ 1,893 March 31 June 30 September 30 December 31 $16,828 $ 900 $ 6,386 $ 0.23 $ 0.22 $12,058 $ 1,180 $ 4,240 $ 0.15 $ 0.15 $23,974 $ 850 $ 7,545 $ 0.18 $ 0.18 $13,680 $ 1,500 $ 4,953 $ 0.18 $ 0.18 $ 29,815 $ — $ 11,069 $ 0.23 $ 0.22 $14,290 $ 1,700 $ 4,945 $ 0.18 $ 0.17 $30,933 $ 1,157 $ 11,700 $ 0.24 $ 0.23 $ 16,298 $ 1,300 $ 5,075 $ 0.18 $ 0.18 page 64 Hanmi Financial Offices Corporate Headquarters 3660 Wilshire Boulevard Penthouse Suite A Los Angeles, California 90010 (213) 382-2200 Cerritos Ofﬁce 11754 East Artesia Boulevard Artesia, California 90701 (562) 924-8001 Woo Young Choung First Vice President & Manager South Cerritos Ofﬁce 11900 South Street, Suite 109 Cerritos, California 90703 (562) 924-0700 Ho Il Min First Vice President & Manager Downtown Ofﬁce 950 South Los Angeles Street Los Angeles, California 90015 (213) 347-6051 Ae Cha Kim Senior Vice President & Manager Fashion District Ofﬁce 726 E. 12th Street, Suite 211 Los Angeles, California 90021 (213) 743-5850 Judy Lee First Vice President & Manager Garden Grove Ofﬁce 9820 Garden Grove Boulevard Garden Grove, California 92844 (714) 537-4040 Ine Ja Kim Senior Vice President & Manager West Garden Grove Ofﬁce 9122 Garden Grove Boulevard Garden Grove, California 92844 (714) 537-4111 Ine Ja Kim Senior Vice President & Manager Gardena Ofﬁce 2001 West Redondo Beach Boulevard Gardena, California 90247 (310) 965-9400 Thomas Oh Senior Vice President & Manager Rowland Heights Ofﬁce 18720 East Colima Road Rowland Heights, California 91748 (626) 854-1000 Sook Ran Park Senior Vice President & Manager Irvine Ofﬁce 14474 Culver Drive, Suite D Irvine, California 92604 (949) 262-2500 Silicon Valley Ofﬁce 2765 El Camino Real Santa Clara, California 95051 (408) 260-3400 Dong In Kim First Vice President & Manager Philip Whang First Vice President & Manager Koreatown Galleria Ofﬁce 3250 West Olympic Boulevard Suite 200 Los Angeles, California 90006 (323) 730-4830 Kyoung Ae Roe First Vice President & Manager Koreatown Plaza Ofﬁce 928 S. Western Avenue Suite 260 Los Angeles, California 90006 (213) 252-6360 Elaine Chung Senior Vice President & Manager Olympic Ofﬁce 3737 West Olympic Boulevard Los Angeles, California 90019 (323) 735-3737 Helen Kim Senior Vice President & Manager Mid-Olympic Ofﬁce 3099 West Olympic Boulevard Los Angeles, California 90006 (213) 252-6340 Thomas J. Kim First Vice President & Manager San Diego Ofﬁce 4637 Convoy Street, Suite 101 San Diego, California 92111 (858) 467-4800 Young Hoon Oh First Vice President & Manager San Francisco Ofﬁce 1491 Webster Street San Francisco, California 94115 (415) 776-3003 Torrance Ofﬁce 2370 Crenshaw Boulevard Suite H Torrance, California 90501 (310) 781-1200 Sun Young Park First Vice President & Manager West Torrance Ofﬁce 21838 Hawthorne Boulevard Torrance, California 90503 (310) 214-4280 Suk Jin Yoon First Vice President & Manager Van Nuys Ofﬁce 14427 Sherman Way Van Nuys, California 91405 (818) 779-3120 Kyung Mi Choi First Vice President & Manager Vermont Ofﬁce 933 S. Vermont Avenue Los Angeles, California 90006 (213) 252-6380 Jung Hak Son Senior Vice President & Manager Western Ofﬁce 120 South Western Avenue Los Angeles, California 90004 (213) 388-2200 Jennifer Yun First Vice President & Manager Wilshire Ofﬁce 3660 Wilshire Boulevard Suite 103 Los Angeles, California 90010 (213) 427-5757 Philip Whang First Vice President & Manager Susanna H. Rivera Senior Vice President & Manager Seattle Loan Production Ofﬁce 33110 Paciﬁc Hwy South Suite 4 Federal Way, Washington 98003 (253) 952-7766 Myung Joon Kim First Vice President & Manager Capital Markets Group 3660 Wilshire Boulevard Penthouse Suite A Los Angeles, California 90010 (213) 427-5616 Dong Wook Kim Senior Vice President & Manager Commercial Loan Department 3660 Wilshire Boulevard Suite 103 Los Angeles, California 90010 (213) 427-5626 Hassan Bouayad Senior Vice President & Manager Consumer Loan Center 3099 West Olympic Boulevard Los Angeles, California 90006 (213) 252-6400 Jennifer Nam First Vice President & Manager International Trade Finance Department 3660 Wilshire Boulevard Suite 103 Los Angeles, California 90010 (213) 427-5680 Seong Hoon Hong Vice President & Manager Residential Mortgage Center 928 S. Western Avenue Suite 260 Los Angeles, California 90006 (213) 252-6490 Janette K. Mah First Vice President & Manager SBA Department 3327 Wilshire Boulevard Los Angeles, California 90010 (213) 427-5761 James Kim First Vice President & Manager Special Industries Department 3660 Wilshire Boulevard Suite 1050 Los Angeles, California 90010 (213) 637-4792 Hassan Bouayad Senior Vice President & Manager Design: bloch+coulter Design Group www.blochcoulter.com Corporate Headquarters 3660 Wilshire Boulevard Penthouse Suite A Los Angeles, California 90010 (213) 382-2200 www.hanmiﬁnancial.com

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