FEDERAL DEPOSIT INSURANCE CORPORATION
Washington, D.C. 20429
FORM 10-K
Mark One
[x]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2005
or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ________.
PREFERRED BANK
(Exact name of registrant as specified in its charter)
California
(State or other jurisdiction of
incorporation or organization)
33539
(FDIC Certificate Number)
601 S. Figueroa Street, 20th Floor, Los Angeles, California
(Address of principal executive offices)
95-4340199
(I.R.S. Employer
Identification No.)
90017
(Zip Code)
Registrant’s telephone number, including area code: (213) 891-1188
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
NONE
Name of each exchange
on which registered
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [ ] No [x ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [x]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 or Regulation S-K is not contained
herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated
by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [x]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filed, or a non-accelerated
filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filed [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [x]
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant,
computed by reference to the price at which the common equity was last sold as of the last business day of the Registrant’s most
recently completed second fiscal quarter (June 30, 2005) was $167,262,011.
Number of shares of common stock of the Registrant outstanding as of March 29, 2006 was 6,706,304.
The following documents are incorporated by reference herein:
Document Incorporated By Reference
Part of Form 10-K
Into Which Incorporated
Definitive Proxy Statement for the Annual Meeting of Shareholders which will be filed
within 120 days of the fiscal year ended December 31, 2005............................................................
Part III
TABLE OF CONTENTS
Page
PART I 1
BUSINESS .............................................................................................................................. 1
PROPERTIES........................................................................................................................ 33
LEGAL PROCEEDINGS...................................................................................................... 33
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................... 34
PART II .................................................................................................................................................................... 35
ITEM 1.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS .............................................................................................. 35
SELECTED FINANCIAL DATA......................................................................................... 37
ITEM 6.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ............................................................. 39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISKS ............ 64
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ...................................... 64
ITEM 8.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ........................................................... 65
ITEM 9A. CONTROLS AND PROCEDURES...................................................................................... 65
ITEM 9B. OTHER INFORMATION ..................................................................................................... 65
PART III ................................................................................................................................................................. 66
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ............................ 66
ITEM 11. EXECUTIVE COMPENSATION......................................................................................... 66
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS .................................... 66
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS .................................. 66
PRINCIPAL ACCOUNTANT FEES AND SERVICES....................................................... 66
ITEM 14.
PART IV................................................................................................................................................................... 67
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES ................................................. 67
SIGNATURES ......................................................................................................................................................... 94
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PART I
Certain matters discussed in this Annual Report on Form 10-K may constitute forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the “1933 Act”) and Section 21E of
the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and as such, may involve risks and
uncertainties. These forward-looking statements relate to, among other things, expectations of the environment in
which the Bank operates and projections of future performance. The Bank’s actual results, performance, or
achievements may differ significantly from the results, performance, or achievements expected or implied in such
forward-looking statements. For discussion of some of the factors that might cause such differences, see “Item 1.
BUSINESS - Risk Factors That May Affect Future Results.”
ITEM 1. BUSINESS
General
We are one of the largest independent commercial banks in California focusing on the Chinese-American
market. We consider the Chinese-American market to encompass individuals born in the United States of Chinese
ancestry, ethnic Chinese who have immigrated to the United States and ethnic Chinese who live abroad but conduct
business in the United States.
We commenced operations in December 1991 in Los Angeles, California with initial capital of $20
million. At December 31, 2005, we had total assets of approximately $1.1 billion, loans and leases of approximately
$771.1 million, deposits of approximately $975.5 million and shareholders’ equity of approximately $123.8 million.
Net income per share on a diluted basis was $2.48 for the year ended December 31, 2005 as compared to $1.92 per
share for the year ended December 31, 2004.
We provide personalized deposit services as well as real estate finance, commercial loans and trade finance
to small and mid-sized businesses and their owners, entrepreneurs, real estate developers and investors,
professionals and high net worth individuals. We believe we have benefited, and will continue to benefit from the
significant migration to Southern California of ethnic Chinese from China and other areas of East Asia. We estimate
that at December 31, 2005, approximately 60% of our non-governmental deposits and 25% of our loans were with
customers from the Chinese-American market. While our business is not solely dependent on the Chinese-American
market, it represents an important element of our operating strategy, especially for our branch network and deposit
products and services.
On February 17, 2005, we completed initial public offering (“IPO”) of 2,438,000 shares of our common
stock at $38.00 per share in a firm commitment underwritten offering. The number of shares sold included 318,000
shares sold pursuant to the underwriters’ exercise of their over-allotment option. Of the 2,438,000 shares sold,
Preferred Bank sold 985,622 shares and 1,452,378 shares were sold by certain selling shareholders. The net
proceeds to us from our IPO of common stock were approximately $35 million (before expenses).
We had used the net proceeds from this offering for general corporate purposes, working capital, financing
internal growth, and expanding of new branches and loan portfolios.
Our main office is located at 601 S. Figueroa Street, 20th Floor, Los Angeles, CA 90017 and our telephone
number is (213) 891-1188. Our internet address is www.preferredbank.com. On our Investor Relations website,
which can be accessed through www.preferredbank.com, we post the following filings as soon as reasonably
practicable after they are filed with or furnished to the Federal Deposit Insurance Corporation: our annual report on
Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, our proxy statement related to
our annual stockholders’ meeting and any amendments to those reports or statements filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings on our Investor Relations website
are available free of charge. The reference to our website address does not constitute incorporation by reference of
the information contained in the website and should not be considered part of this document. A copy of our Code of
Personal and Business Conduct, including any amendments thereto or waivers thereof and Board Committee
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Charters can also be accessed on our website. We will provide, at no cost, a copy of our Code of Personal and
Business Conduct and Board Committee Charters upon request by phone or in writing at the above phone number
or address, attention: Chris Chan, Senior Vice President and Chief Financial Officer.
Our Customers
We provide a range of deposit and loan products and services to customers primarily within the following
categories:
• Real Estate Finance—consisting of investors and developers within the real estate industry and of
owner-occupied properties in Southern California. We provide construction loans and mini-perm loans
for residential, commercial, industrial and other income producing properties. A portion of our real
estate loans are to borrowers who are also international trade finance customers.
• Middle Market Business—consisting of manufacturing, service and distribution companies with
annual sales of approximately $5 million to $100 million and with borrowing requirements of up to
approximately $12 million. We offer a range of lending products to customers in this market,
including working capital loans, equipment financing and commercial real estate loans. Additionally,
we provide a full range of deposit products and related services including safe deposit boxes, account
reconciliation, courier service and cash management services.
•
International Trade Finance—consisting of importers and exporters based in the U.S. requiring both
borrowing and operational products. We offer a full range of products to international trade finance
customers, including commercial and standby letters of credit, acceptance financing, documentary
collections, foreign draft collections, international wires and foreign exchange.
• Private Banking—consisting of wealthy individuals residing in the Pacific Rim area with residences,
real estate investments or businesses in Southern California. We offer all of our banking products and
services to this segment through our multi-lingual team of professionals knowledgeable in the business
environment and financial affairs of Pacific Rim countries. We believe our language capabilities
provide us with a competitive advantage.
• Professionals—consisting generally of physicians, accountants, attorneys, business managers and
talent agents and other professionals associated with the entertainment industry. We provide
specialized personal banking services to customers in this segment including courier service, several
types of specialized deposit accounts and personal and business loans as well as lines of credit.
Our Market
From our main office in downtown Los Angeles, California and full-service branch banking offices in Los
Angeles and Orange Counties, we market our services and conduct our business primarily in Los Angeles, Orange,
Ventura, Riverside and San Bernardino counties, focusing on the areas with growing Chinese-American
communities.
We believe that Chinese-Americans continue to be the largest Asian ethnic group in Los Angeles County.
According to the U.S. Census 2000, between 1990 and 2000, the Chinese-American population in the United States
grew by approximately 48% with 40% of all Chinese-Americans living in California. During this same period, it is
estimated that the Chinese-American population in Los Angeles grew by 34%. According to the U.S. Census
Bureau, as of 2003, 364,469 or approximately 30% of Asian-Americans living in Los Angeles County were
Chinese-Americans (excluding Taiwanese).
As of 2003, Asian-Americans have attractive demographics with a higher nationwide median household
income than all other groups ($55,262 vs. $43,318). According to the Bureau of Labor Statistics, in 2003, Asian-
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Americans have the highest percentage of college education of any group and the lowest unemployment rate of any
ethnic group at 6.0%.
We believe that continuing consolidation of banks generally in Southern California, and among the banks
serving the Chinese-American market in particular, has created an underserved market of small and mid-sized
businesses, real estate developers and investors and high net worth depositors that we can continue to attract as
customers.
We believe we are well positioned to compete effectively with the smaller Chinese-American community
banks, the larger commercial banks and major publicly listed and foreign bank-owned Chinese banks operating in
Southern California by offering the following:
•
•
•
deposit and cash management services to high net worth depositors with a high degree of personal
service and responsiveness;
experienced, multi-lingual management team and staff who we believe can provide sophisticated credit
solutions faster and more efficiently and with a higher degree of personal service than what is
provided by our competition; and
loan products to customers requiring credit of a size in excess of what can be provided by our
competitors.
Our Strategy
We strive to continue operating as a high performing community bank for the long-term benefit of our
shareholders, customers and employees. The key elements of our growth and operating strategy are to:
Growth Strategies
• Continue to grow our real estate lending activities by providing competitive commercial real estate
loans, construction loans and other real estate loans. With the additional capital provided by this
offering, we will have the ability to originate larger loans to new and existing customers.
• Expand our franchise by establishing new branches in Southern California. We may open additional
branches by the end of 2006.
• Expand our commercial lending relationships in an effort to increase our noninterest bearing deposit
accounts and our noninterest income. We expect to enhance our commercial loan portfolio by
expanding existing customer relationships, as well as by devoting additional marketing resources to
the Chinese-American business community in Southern California.
• Expand our portfolio of products and services to high net worth customers who we believe prefer to
address their deposit and credit needs in a personal manner with experienced, efficient and service-
oriented bank officers.
• Hire and retain experienced and qualified employees to support our planned expansion of our business
activities.
Operating Strategies
• Maintain high asset quality independent of production goals by continuing to utilize rigorous loan
underwriting standards and credit risk management policies.
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• Access capital markets as needed and enhance our equity-based compensation programs through the
increased liquidity provided by being a public company.
•
•
•
•
•
•
Increase revenue opportunities by increasing our investments in higher yielding floating rate loans and
investment securities and reducing the percentage of our investments in federal funds sold and other
overnight investments.
Increase our operating leverage by:
increasing our loan to deposit ratio by growing our loan portfolio;
expanding sources of funding in addition to deposits to fund our loan and securities portfolios, such as
borrowings from the Federal Home Loan Bank system;
changing the mix of our securities and loan portfolios to reduce the effect of regulatory asset risk
weighting consistent with our yield parameters to permit additional asset growth without requiring
additional capital; and
potentially reorganizing our corporate structure to form a bank holding company so that we may have
greater access to the capital markets and benefit from the incremental operating flexibility provided by
a bank holding company structure.
Our Lending Activities
We originate a variety of types of loans, most of which fall into the following four categories:
• Real estate mini-perm loans;
• Real estate construction loans;
• Commercial loans; and
• Trade finance.
In addition to these loan types, we make a small amount of consumer loans principally as an
accommodation to our business customers. We also utilize our relationships within the banking industry to purchase
and sell participations in syndicated loans that meet our underwriting criteria. During the year ended December 31,
2005, we purchased $120.4 million and sold $13.8 million in non-recourse loan participations. We manage our loan
portfolio to provide for an adequate return, but also to provide a diversification of risk.
We originate our loans from our eleven banking offices in Los Angeles, Orange, and San Bernardino
counties. For mini-perm and construction loans, we rely on referrals from existing clients who are real estate
investors and developers as well as our network of loan brokers. For our commercial and trade finance lending, we
seek referrals from existing banking clients as well as referrals from professionals, such as certified public
accountants, attorneys and business managers.
At December 31, 2005, 89% of our loans carried interest rates that adjust with changes in the Prime Rate,
9% carried interest rates tied to LIBOR or other indices and 2% carried a fixed rate. At December 31, 2005, we had
no loan at interest rate floors.
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The following table sets forth information regarding our four major loan categories:
At December 31, 2005
(Do lla rs in tho us a nds )
Real Estate Mini-Perm
Portfolio size
Number of loans
Average loan size
Average LTV(1)
Average DCR(2)
Weighted average rate
Real Estate Construction
Portfolio size
Number of loans
Average loan size
Average LTV(1)
Weighted average rate
Commercial Loans
Portfolio size
Number of loans
Average loan size
Weighted average rate
Trade Finance
Portfolio size
Number of loans
Average loan size
Weighted average rate
$372,251
225
$1,654
58.23 %
1.74 %
7.87 %
$171,646
86
$1,996
59.02 %
8.32 %
$149,428
513
$291
7.25 %
$76,700
152
$505
7.57 %
(1) Average loan-to-value, or LTV, is calculated based upon a weighted average of outstanding principal loan balances (for mini-perm loans) or commitment (for
construction loans) divided by the most recent third party appraisal reports. Third party appraisal reports are only an estimate of the value of the property at the
time the appraisal is made.
(2) Average debt coverage ratio, or DCR, is calculated based upon the net operating income of the property divided by the debt service.
We had 137 loans with outstanding principal balances between $1 million to $5 million, 25 loans between
$5 million and $10 million, and 11 loans over $10 million as of December 31, 2005.
Real Estate Mini-Perm Loans
Real estate mini-perm loans secured by retail, office and residential properties have been the fastest
growing segment of our loan portfolio and comprise 48% of our loan portfolio as of December 31, 2005. We
believe the primary reason for this growth is strong demand for commercial and residential real estate in Southern
California. We also have focused our marketing efforts on this loan type, especially since we believe competitive
sources of such financing have reduced their participation for this type of loan due to the declining rate
environment. We seek diversification through maintaining a broad base of borrowers and monitoring our exposure
to various property types.
The following table sets forth the breakdown of our real estate mini-perm portfolio by property type:
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Prope rty Type
Commercial/Office
Industrial
Retail
Apartment 4+
Residential 1-4
Other
Total
At De ce mbe r 31, 2005
Pe rce ntage of Loans
in Each C ate gory in
Total Loan Portfolio
Amount
(Do lla rs in tho us a nds )
75,530
51,623
99,304
43,206
34,003
68,585
372,251
9.79 %
6.69
12.88
5.60
4.41
8.90
48.27 %
$
$
The following table sets forth the maturity of our real estate mini-perm loan portfolio:
At De ce mbe r 31, 2005
Le ss than
More than
1-Ye ar
2-Ye ars
3-Ye ars
4-Ye ars
5-Ye ars
5-Ye ars
(In thousands)
Total
O utstandi ng
Bal ance
$99,866
$53,087
$29,662
$37,999
$75,186
$76,451
$372,251
Loan Origination. The loan origination process for mini-perm loans begins by a loan officer collecting
preliminary property information and financial data from a prospective borrower. After a preliminary deal sheet is
prepared and approved by management, the loan officer collects the necessary third party reports such as appraisals,
credit reports, environmental assessments and preliminary title reports as well as detailed financial information. We
utilize third party appraisers from an appraiser list approved by our Board of Directors’ loan committee. From that
list, appraisers for loans under $1.2 million are selected by the individual loan officer, appraisers for loans between
$1.2 million and $3.0 million are selected by the loan officer with the concurrence of the Chief Credit Officer and
appraisers for loans over $3.0 million are selected by the Chief Credit Officer.
All appraisals for loans over $1 million are reviewed by an additional outside appraiser. Appraisals for
loans under that amount are reviewed by internal staff. A credit memorandum is then prepared by summarizing all
third party reports and preparing an analysis of the adequacy of primary and secondary repayment sources; namely
the property DCR and LTV as well as the outside financial strength and cash flow of the borrower or guarantor(s).
This completed credit memorandum is then submitted to an officer or committee having the appropriate authority
for approval. For further information on our different levels of authority, see “—Loan Authorizations” below.
Once a loan is approved by the appropriate authority level, loan documents are drawn by our note
department, which also funds the loan when approval conditions are met. On larger, relatively complex transactions,
loan documents are prepared or reviewed by outside legal counsel.
Underwriting Standards. Our principal underwriting standards for real estate mini-perm loans are as
follows:
• Maximum LTV of 80%-85%, depending on the property type. However, our practice is to lend at
more conservative levels.
• Minimum DCR of 1.2-1.25, depending on the property type.
• Requirements of personal guarantees from the principals of closely-held entity.
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Monitoring. We monitor our mini-perm portfolio in different ways. First, on loans over $2 million, we
conduct site inspections and gather rent rolls and operating statements on the subject properties at least annually.
Using this information, we evaluate a given property’s ability to service present payment requirements, and we
perform “stress testing” to evaluate the property’s ability to service debt at higher debt levels. Second, on an annual
basis, we request updated financial information from our borrowers and/or guarantors to monitor their financial
capacity.
The vast majority of our mini-perm loans carry a five year maturity. However, it has been our practice to
renew these loans for additional five-year periods based on a satisfactory payment record and an updated
underwriting profile.
Real Estate Construction
We are an active construction lender with construction loans comprising 22% of the total loan portfolio as
of December 31, 2005. Construction loans are typically short-term loans of up to 18 months for the purpose of
funding the costs of constructing a building. Outstanding construction loans by property type are summarized as
follows:
Property Type
Office
Retail
Industrial
For sale attached residential
For sale detached residential
Apartment
Special purpose
Total
At December 31, 2005
Amount
Pe rce ntage of Loans
in Each C ate gory in
Total Loan Portfolio
(Dollars in thousands)
$
1,664
15,271
13,860
60,889
42,802
16,498
20,662
171,646
$
0.22 %
1.98
1.80
7.90
5.55
2.14
2.67
22.26 %
Loan Origination. The origination process for construction loans is identical to our real estate mini-perm
origination process described above under “—Real Estate Mini-Perm Loans—Loan Origination,” but with an
additional step. We generally require a third party review of the developer’s proposed building costs.
Underwriting Standards. Our underwriting standards for construction loans are identical to those described
above under “—Real Estate Mini-Perm Loans—Underwriting Standards.” For the for-sale-housing projects,
however, the DCR requirement is not applicable. In addition, we require that the construction loan applicant has
proven experience in the type of project we are considering. Finally, notwithstanding the maximum 80%-85% LTV
discussed above under “—Real Estate Mini-Perm Loans—Underwriting Standards,” we generally require a
maximum 80% LTV for construction loans.
Monitoring. The monitoring of construction loans is accomplished under the supervision of our Chief
Credit Officer. We engage third-party inspectors to report on the percentage of project completion as well as to
evaluate whether the project is proceeding at an acceptable pace. The third-party inspector also recommends
whether we should approve or disapprove disbursement request amounts. The third-party inspector produces
monthly reports on each project that contain the evaluation and recommendation for each project. The Chief Credit
Officer reviews each report and makes a final determination regarding the disbursement requests. All approved
disbursements are funded by the note department.
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Commercial Loans
We offer a variety of commercial loan products including lines of credit for working capital, term loans for
capital expenditures and commercial and stand-by letters of credit. As of December 31, 2005, we had $149.4
million of commercial loans outstanding, which represented 19% of our overall loan portfolio. Lines of credit
typically have a 12 month commitment and are secured by the borrower’s assets. In cases of larger commitments, an
updated certificate from the borrower may be required to determine eligibility at the time of any given advance.
Term loans seldom exceed 60 months, but in no case exceed the depreciable life of the tangible asset being
financed.
Loan Origination. A commercial loan begins with a loan officer obtaining preliminary financial
information from the borrower and guarantors and summarizing the loan request in a deal sheet. The deal sheet is
then reviewed by senior management and/or those who have the loan authority to approve the credit. Following
preliminary approval, the loan officer undertakes a formal underwriting analysis, including third party credit reports
and asset verifications. From this information and analysis, a credit memorandum is prepared and submitted to an
officer or committee having the appropriate approval authority for review. After approval, the note department
prepares loan documentation reflecting the conditions of approval and funds the loan when those conditions are met.
Underwriting Standards. Our underwriting standards for commercial loans are designed to identify,
measure and quantify the risk inherent in these types of credits. Our underwriting process and standards help us
identify the primary and secondary repayment sources. The following are our major underwriting guidelines:
• Cash flow is our primary underwriting criteria. We require a minimum 1.5:1 DCR for our commercial
loans. We also review trends in the borrower’s sales levels, gross profit and expenses.
• We evaluate the borrower’s financial statements to determine whether a given borrower’s balance
sheet provides for appropriate levels of equity and working capital.
• Since most of our borrowers are closely held companies, we require the principals to guarantee the
company debt. Our underwriting process, therefore, includes an evaluation of the guarantor’s net
worth, income and credit history. Where circumstances warrant, we usually require guarantees be
secured by collateral (generally with real estate).
• Where there is a reliance on the accounts receivable and inventory of a company, we evaluate their
condition, which may include third party onsite audits.
Monitoring. For those borrowers whose credit availability is tied to a formula based on advances as a
percentage of accounts receivable and inventory (typically 80% and 25%, respectively), we review monthly
borrowing base certificates for both availability and turnover trends. Periodically, we also conduct third party onsite
audits, the frequency of which is dependent on the individual borrower. On a quarterly basis, we monitor the
financial performance of a borrower by analyzing the borrower’s financial statements for compliance with financial
covenants.
Trade Finance Credits
Our trade finance portfolio totaled $76.7 million, or approximately 10% of our total loan portfolio as of
December 31, 2005. Of this amount, virtually all loans were made to U.S. based importers who are also our current
borrowers or depositors. We also provide standby letters of credit and foreign exchange services to our clients. Our
new trade finance credit relationships result from contacts and relationships with existing clients, CPAs and trade
facilitators such as customs brokers. In many cases, the ability to generate new trade finance business is also a result
of cultivated social contacts and extended family.
We offer the following services to importers:
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• Commercial letters of credit;
•
Import lines of credit;
• Documentary collections;
•
International wire transfers; and
• Acceptances / trust receipt financing.
We offer the following services to exporters:
• Export letters of credit;
• Export finance;
• Documentary collections;
• Bills purchase program; and
•
International wire transfers.
Loan Origination. Our trade finance origination process is equivalent to our commercial loan process.
Since we lend only to U.S. based companies, our due diligence process is equivalent to that of our commercial loan
process with an emphasis on evaluating and verifying the assets of the borrowers and principals.
Underwriting Standards. Trade finance underwriting standards are based on our commercial loan
standards. Typically, these loans are secured by receivables and inventories with advance rates similar to that of
commercial loans. In many cases, we also require real estate or cash as partial collateral to further enhance our
collateral position. However, in underwriting these credits, we also analyze the borrower’s working capital
requirements with a greater focus on the trade cycle and seasonality of the inventory being imported. Often an
importer needs to order product months in advance, which requires us to structure the credit to accommodate the
issuance of letters of credit early in the season and to carry accounts receivable after shipping.
Monitoring. We monitor trade finance credits by reviewing monthly borrowing base certificates of
accounts receivable and inventory for both availability and turnover trends and tracking loan covenants on a
quarterly basis. To supplement our review of borrowing bases, we utilize the services of third party accounts
receivable and inventory auditors for certain credits. Finally, it is accepted trade finance practice to fund the
payment of letters of credit on a “tenor” basis. That means that an advance under the trade finance line has a
maturity (commonly 90 days). This serves as a self-monitoring mechanism because a matured and unpaid advance
is a possible indicator of poor accounts receivable and/or inventory turnover.
Loan Concentrations
As of December 31, 2005 and December 31, 2004, we had a concentration of loans secured by real estate.
At those dates, real estate-related loans comprised 71% and 76%, respectively, of total loans. A substantial decline
in the performance of the economy in general, or a decline in real estate values in the bank’s primary market areas,
in particular, could have an adverse impact on collectibility, increase the level of real estate-related non-performing
loans or have other adverse effects which alone or in the aggregate could have a material adverse effect on our
business, financial condition, results of operations and cash flows.
Our real estate loans by type of collateral are as follows:
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Property Type
Office
Retail(1)
Industrial
1-4 family
Multi-family
Land/Special
Total
At December 31, 2005
Amount
Pe rce ntage of Loans
in Each C ate gory in
Total Loan Portfolio
(Dollars in thousands)
77,194
114,575
65,483
137,694
59,704
89,247
543,897
10.01 %
14.86
8.49
17.86
7.74
11.57
70.53 %
$
$
Includes shopping centers, strip malls or stand-alone properties which house retailers.
(1)
(2) Examples, other than land, include hospitality and self-storage.
To manage the risks inherent in this concentration in our loan portfolio, we have adopted a number of
policies and procedures. For example, we have adopted regulatory loan-to-value standards that must be met at the
time of origination, which are summarized below:
C ollate ral Type
Occupied 1-4
Unimproved land
Land development
Improved properties
Construction
Commercial construction
1-4 SFR construction
LTV
Maximum
90%
65%
75%
85%
80-85%
80%
85%
Our underwriting practice, however, is to lend at lower LTV’s. At December 31, 2005, the weighted
average LTV of our real estate portfolio based on LTVs at the time of origination was 58.63%.
Our practice is to require DCR’s on commercial real estate loans of 1.2 to 1.25x, depending on the property
type. We also underwrite our commercial real estate loans using a rate that is 1-2% greater than the proposed
interest rate on the loan.
In addition, we have established certain concentration limits for our real estate lending activities by
property type. Our other real estate loan limitations include out of area (California) lending at no more than 15% of
our portfolio. At December 31, 2005, 1.4% of our real estate portfolio was secured by real estate located outside of
California.
Loan Maturities
In addition to measuring and monitoring concentrations in our loan portfolio, we also monitor the
maturities and interest rate structure of our portfolio. The following table shows the amounts of loans and leases
outstanding as of December 31, 2005 which, based on remaining scheduled repayments of principal, were due in
one year or less, more than one year through five years, and more than five years. The table also presents, for loans
and leases with maturities over one year, an analysis with respect to fixed interest rate loans and leases and floating
interest rate loans and leases.
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At December 31, 2005
Maturity
Rate Structure for
Loans Maturing
ove r O ne Ye ar
O ne Ye ar
or Le ss
O ne
through
Five Ye ars
O ve r Five
Ye ars
Total
Fixe d
Rate
Floating
Rate
(In thousands)
Real estate mini-perm
Real estate construction
Commercial
Trade finance
Consumer
Leases receivable and other
Total
$ 99,866
125,397
112,878
76,238
29
465
$ 414,873
$ 195,934
46,249
34,482
462
92
532
$ 277,751
$ 76,451
—
2,068
—
—
—
$ 78,519
$ 372,251
171,646
149,428
76,700
121
997
$ 771,143
$ 13,563
—
208
—
—
532
$ 14,303
$ 258,822
46,249
36,342
462
92
—
$ 341,967
The following table shows the amounts of loans and leases outstanding as of December 31, 2004, which,
based on remaining scheduled repayments of principal, were due in one year or less, more than one year through
five years, and more than five years. Demand or other loans having no stated maturity and no stated schedule of
repayments are reported as due in one year or less. The table also presents, for loans and leases with maturities over
one year, an analysis with respect to fixed interest rate loans and leases and floating interest rate loans and leases.
At December 31, 2004
Maturity
O ne
Rate Structure for
Loans Maturing
ove r O ne Ye ar
O ne Ye ar
through
O ve r Five
or Le ss
Five Ye ars
Ye ars
Total
Fixe d
Rate
Floating
Rate
(In thousands)
Real estate mini-perm
Real estate construction
Commercial
Trade finance
Consumer
Leases receivable and other
Total
$ 65,565
77,362
68,152
42,929
2
462
$ 254,472
$ 213,485
34,640
30,011
3,022
63
713
$ 281,935
$ 79,170
—
384
—
—
—
$ 79,554
$ 358,227
112,002
98,541
45,951
65
1,175
$ 615,961
$ 13,844
—
117
—
—
713
$ 14,674
$ 278,811
34,640
30,279
3,022
63
—
$ 346,815
As reflected in this data, the maturity of our portfolio is divided generally between loans maturing within
one year or less and loans maturing between one and five years. Most of our shorter maturity loans are commercial,
construction and trade finance loans. Most of the loans that have maturities between one and five years are real
estate-mini perm loans. Regardless of maturity, most of our loans have interest rates that adjust with changes in the
Prime Rate.
Loan Authorizations
•
Individual Authorities. Individual loan officers have approval authority up to $750,000 for loans
secured by first trust deeds or cash and up to $500,000 for unsecured transactions. The Chief
Executive Officer and the Chief Credit Officer have combined approval authority up to $7.0 million
for secured loans and up to $5.0 million for unsecured loans.
• Management Loan Committee. The Management Loan Committee consists of the Chief Executive
Officer, the Chief Credit Officer and senior commercial and real estate lending officers. It has
approval authority up to $16.7 million for secured loans and up to $10.0 million for unsecured loans.
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• Board of Directors Loan Committee. Our Board of Directors loan committee consists of three
members of the board of directors. It has approval authority up to our legal lending limit, which was
approximately $33.5 million for secured loans and $20.1 million for unsecured loans at December 31,
2005. The Board of Directors loan committee also reviews all loan commitments granted in excess of
$1 million on a quarterly basis for the preceding quarter.
All loan individual authorities are granted by the loan committee of our board of directors and are based on
the individual’s demonstrated credit judgment and lending experience.
If a credit falls outside of the guidelines set forth in our lending policies, the loan is not approved until it is
reviewed by a higher level of credit approval authority. Credit approval authority has three levels, as listed above
from lowest to highest level. Policy exceptions for cash flow, waiver of guarantee, excessive LTV or bad credit
require approval of the President or Chief Credit Officer regardless of size.
We believe that the current authority levels provide satisfactory management and a reasonable percentage
of secondary review. Any conditions placed on loans in the approval process must be satisfied before our Chief
Credit Officer will release loan documentation for execution. Our Chief Credit Officer and his staff work entirely
independent of loan production and have full responsibility for all loan disbursements.
Loan Grading and Loan Review
We seek to quantify the risk in our lending portfolio by maintaining a loan grading system consisting of
eight different categories (Grades 1-8). The grading system is used to determine, in part, the provision for loan
losses. The first four grades in the system are considered satisfactory. The other four grades range from a “special
mention” category to a “loss” category. These four grades are further discussed below under the section subtitled
“classified assets.”
The originating loan officer initially assigns a grade to each credit as part of the loan approval process.
Such grade may be changed as a loan application moves through the approval process.
Prior to funding, all new loans of $1.0 million or over are reviewed by our Chief Credit Officer who may
assign a different grade to the credit. The grade on each individual loan is reviewed at least annually by the loan
officer responsible for monitoring the credit. The board of directors reviews monthly the aggregate amount of all
loans graded as special mention, substandard or doubtful, and each individual loan that has a grade within such
range. Additionally, changes in the grade for a loan may occur through any of the following means:
• monthly reviews by the Chief Credit Officer of a sample of loans approved under individual loan
authority;
•
annual reviews conducted by an outside loan reviewer of certain categories of loans determined by the
Board of Directors’ audit committee. In 2004 and 2005, the outside loan reviewer reviewed all loans to
insiders in excess of $400,000, watch list credits in excess of $400,000 and a sample of larger loans in
our loan portfolio;
•
bank regulatory examinations; and
• monthly action plans submitted to the Chief Credit Officer by the responsible lending officers for each
credit graded 5-8.
Loan Delinquencies. When a borrower fails to make a committed payment, we attempt to cure the
deficiency by contacting the borrower to seek payment. Habitual delinquencies and loans delinquent 30 days or
more are reviewed for possible changes in grading.
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Classified Assets. Federal regulations require that each insured bank classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, examiners have authority to identify problem
assets, and, if appropriate, classify them. We use grades 5-8 of our loan grading system to identify potential problem
assets. There were $5.5 million, $4.5 million and $3.9 million in classified loans at December 31, 2005, December
31, 2004 and December 31, 2003, respectively.
The following describes grades 5-8 of our loan grading system:
•
•
Special Mention—Grade 5. Generally these are assets that display negative trends or other causes for
concern. This grade is regarded as a transition category. We will either upgrade the credit if
meaningful progress is evident within six months, or downgrade the credit to a more severe grade as
appropriate.
Substandard—Grade 6. These are assets that in management’s judgment have potential weaknesses
that may result in deterioration of the repayment prospects and, therefore, deserve the attention of
management. Usually, these assets are long-term problems that are likely to remain and require
management action plans. These loans exhibit an increasing reliance on collateral for repayment.
• Doubtful—Grade 7. These assets are inadequately protected by the current worth and paying capacity
of the borrower or of the collateral pledged, if any. Although loss may not be imminent, if the
weaknesses are not corrected, there is a good possibility that we will sustain some loss.
• Loss—Grade 8. Assets classified as “loss” are considered uncollectible and of such little value in the
near term that their continuance as active assets is not warranted. This does not mean they have no
recovery or salvage value.
Deposit Products and Other Sources of Funds
Our primary sources of funds for use in our lending and investment activities consist of:
•
deposits and related services;
• maturities and principal and interest payments on loans and securities; and
•
other borrowings.
We closely monitor rates and terms of competing sources of funds and utilize those sources we believe to
be the most cost effective, consistent with our asset and liability management policies.
Deposits and Related Services. We have historically relied primarily upon, and expect to continue to rely
primarily upon, deposits to satisfy our needs for sources of funds. An important balance sheet component impacting
our net interest margin is the composition and cost of our deposit base. We can improve our net interest margin to
the extent that growth in deposits can be focused in the less volatile and somewhat more traditional core deposits, or
total deposits less CDs greater than $100,000, commonly referred to as Jumbo CDs.
We provide a wide array of deposit products. We offer regular checking, savings, NOW and money market
deposit accounts; fixed-rate, fixed maturity retail certificates of deposit ranging in terms from 14 days to five years;
and individual retirement accounts and non-retail certificates of deposit consisting of Jumbo CDs. We attempt to
price our deposit products in order to promote deposit growth and satisfy our liquidity requirements. We provide
courier service to pick up non-cash deposits, and for those customers that use large amounts of cash, we arrange for
armored car and vault service.
We provide a high level of personal service to our high net worth individual customers who have
significant funds available to invest. We believe our Jumbo CDs are a stable source of funding because they are
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based primarily on service and personal relationships with senior bank officers rather than interest rate. Further, 3%
of these Jumbo CDs are pledged as collateral for loans from us to the depositor or the depositor’s affiliated business
or family member. We monitor interest rates offered by our competitors and pay a rate we believe is competitive
with the range of rates offered by such competitors.
We also receive a significant amount of our deposits from governmental agencies. At December 31, 2005,
we had $69.0 million in government agency deposits, or 7% of our total deposits at that date. Generally, a condition
to holding some of these deposits is that we must pledge qualifying government securities in the amount of 110% of
the deposit we hold. At December 31, 2005, we had $97.5 million of government securities pledged for the benefit
of our government agency deposits.
From time to time, we also access the deposit broker market for deposits to meet short-term liquidity
requirements. At December 31, 2005, we held $13.0 million of deposits obtained in this manner. There were no
significant rate differences between the rates on these deposits as compared to our internally generated Jumbo CDs.
We intend to focus our efforts on attracting deposits from our business lending relationships in order to
reduce our cost of funds and improve our net interest margin. Also, we believe that we have the ability to attract
sufficient additional funding by re-pricing the yields on our CDs in order to meet loan demands during times that
growth rates in core deposits differ from loan growth rates.
In addition to the marketing methods listed above, we seek to attract new clients and deposits by:
•
•
expanding long-term business customer relationships, including referrals from our customers, and
building deposit relationships through our branch relationship officers.
Other Borrowings. We may occasionally use our federal funds lines of credit to support liquidity needs
created by seasonal deposit flows, to temporarily satisfy funding needs from increased loan demand and for other
short-term purposes. We have two federal funds lines with other financial institutions pursuant to which we can
borrow up to $50.0 million on an unsecured basis. These lines may be terminated by the respective lending
institutions at any time. At December 31, 2005, we had $1.5 million outstanding under these federal funds lines.
We also borrow from the Federal Home Loan Bank, or FHLB, pursuant to an existing commitment based
on the value of the collateral pledged (either loans or securities). We had $20 million in outstanding FHLB
advances with a weighted average interest rate of 3.71% and remaining maturities greater than one year at
December 31, 2005.
Our Investment Activities
Our investment strategy is designed to be complementary to and interactive with our other strategies (i.e.,
cash position; borrowed funds; quality, maturity, stability and earnings of loans; nature and stability of deposits;
capital and tax planning). The target percentage for our investment portfolio is between 10% to 40% of total assets.
Our general objectives with respect to our investment portfolio are to:
•
•
•
•
achieve an acceptable asset/liability mix;
provide a suitable balance of quality and diversification to our assets;
provide liquidity necessary to meet cyclical and long-term changes in the mix of assets and liabilities;
provide a stable flow of dependable earnings;
• maintain collateral for pledging requirements;
-14-
• manage and mitigate interest rate risk;
•
•
comply with regulatory and accounting standards; and
provide funds for local community needs.
Investment securities consist primarily of U.S. agency issues, investment grade corporate notes, municipal
bonds and mortgage-backed securities. In addition, for bank liquidity purposes, we use (1) overnight federal funds,
which are temporary overnight sales of excess funds to correspondent banks and (2) interest-bearing deposits at
other financial institutions, which consist of certificates of deposit spread over many financial institutions to take
advantage of 100% FDIC insured coverage.
All of our investment securities are classified as “available-for-sale” pursuant to SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities. Available for sale securities are reported at fair
value, with unrealized gains and losses excluded from earnings and instead reported as a separate component of
stockholders’ equity. Held to maturity securities would be securities that we have both the intent and the ability to
hold to maturity. These securities would be carried at cost adjusted for amortization of premium and accretion of
discount.
Our securities portfolio is managed in accordance with guidelines set by our investment policy. Specific
day-to-day transactions affecting the securities portfolio are managed by our Chief Financial Officer. In accordance
with our written investment policy, all executions also require the prior written approval of the President. These
securities activities are reviewed periodically, as needed, by our investment committee and are reported to our board
of directors.
Our investment policy addresses strategies, types and levels of allowable investments and is reviewed and
approved annually by our board of directors. It also limits the amount we can invest in various types of securities,
places limits on average life and duration of securities, and limits the securities dealers with whom we can conduct
business.
Our Concentrations / Customers
Except as described below, no individual or single group of related accounts is considered material in
relation to our assets or deposits or in relation to our overall business. Approximately 77% of our loan portfolio at
December 31, 2005 consisted of real estate-secured loans, including commercial loans secured by real estate,
construction loans and real estate mini-perm loans. Moreover, our business activities are focused in Southern
California. Consequently, our business is dependent on the trends of this regional economy, and in particular, the
commercial real estate markets. At December 31, 2005, we had 173 loans in excess of $1 million, totaling
$585.5 million. These loans comprise approximately 20% of our loan portfolio by number of loans and 76% by total
loans outstanding. Excluding credit card and consumer overdraft lines, our average loan size is $870,822.
At December 31, 2005, excluding government deposits, brokered deposits and deposits as direct collateral
for loans, we had 21 depositors with deposits in excess of $3.0 million totaled $118.7 million or 12.2% of our total
deposits. In addition to these depositors, 95 depositors held a total of $123 million or 12.6% of our total deposits.
Our Competition
The banking and financial services business in Southern California is highly competitive. Within the
Chinese-American market, where we have a particular focus, competition is also intense. This increasingly
competitive environment is a result primarily of growth in community banks, changes in regulation, changes in
technology and product delivery systems, and the accelerating pace of consolidation among financial services
providers. We compete for loans, deposits and customers with other commercial banks, savings and loan
associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies,
money market funds, credit unions and other nonbank financial service providers. Many of these competitors are
-15-
much larger in total assets and capitalization, have greater access to capital markets and offer a broader range of
financial services than we can offer.
We also compete with three publicly listed Chinese-American banks, and subsidiary banks and branches of
foreign banks, from countries such as Taiwan and China, many of which have greater lending limits, and a wider
variety of products and services. We also compete with smaller Chinese-American community banks for both
deposits and loans.
Competition for deposit and loan products remains strong from both banking and non-banking firms and
this competition directly affects the rates of those products and the terms on which they are offered to consumers.
Technological innovation continues to contribute to greater competition in domestic and international
financial services markets. Many customers now expect a choice of several delivery systems and channels,
including telephone, mail, internet and ATMs.
Mergers between financial institutions have placed additional pressure on banks to consolidate their
operations, reduce expenses and increase revenues to remain competitive. In addition, competition has intensified
due to federal and state interstate banking laws, which permit banking organizations to expand geographically with
fewer restrictions than in the past. These laws allow banks to merge with other banks across state lines, thereby
enabling banks to establish or expand banking operations in our market. The competitive environment is also
significantly impacted by federal and state legislation that make it easier for non-bank financial institutions to
compete with us.
REGULATION AND SUPERVISION
The following discussion of statutes and regulations affecting banks is only a summary and does not
purport to be complete. This discussion is qualified in its entirety by reference to such statutes and regulations. No
assurance can be given that such statutes or regulations will not change in the future.
General
As a California state-chartered bank whose accounts are insured by the FDIC up to a maximum of
$100,000 per depositor, we are subject to regulation, supervision and regular examination by the California
Commissioner and the FDIC. In addition, while we are not a member of the Federal Reserve System, we are subject
to certain regulations of the Federal Reserve Board, or the FRB. The regulations of these agencies govern most
aspects of our business, including the making of periodic reports by us, and our activities relating to dividends,
investments, loans, borrowings, capital requirements, certain check-clearing activities, branching, mergers and
acquisitions, reserves against deposits and numerous other areas. Supervision, legal action and examination of us by
the FDIC is generally intended to protect depositors and is not intended for the protection of shareholders.
Our earnings and growth are largely dependent on our ability to maintain a favorable differential or
“spread” between the yield on our interest-earning assets and the rate paid on our deposits and other interest-bearing
liabilities. As a result, our performance is influenced by general economic conditions, both domestic and foreign,
the monetary and fiscal policies of the federal government, and the policies of the regulatory agencies, particularly
the FRB. The FRB implements national monetary policies (such as seeking to curb inflation and combat recession)
by its open-market operations in United States government securities, by adjusting the required level of reserves for
financial institutions subject to its reserve requirements and by varying the discount rate applicable to borrowings
by banks which are members of the Federal Reserve System. The actions of the FRB in these areas influence the
growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits.
The nature and impact of any future changes in monetary policies cannot be predicted.
The bank is also subject to the requirements and restrictions of various consumer laws, regulations and the
Community Reinvestment Act, or CRA.
-16-
Capital Standards
The FDIC has risk-based capital adequacy guidelines intended to provide a measure of capital adequacy
that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on
the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are reported
as off-balance-sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts
of off-balance-sheet items are multiplied by one of several risk adjustment percentages, which range from 0.0% for
assets with low credit risk, such as certain U.S. government securities, to 100.0% for assets with relatively higher
credit risk, such as business loans.
A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total
risk-adjusted assets and off-balance-sheet items. The regulators measure risk-adjusted assets and off-balance-sheet
items against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier
1 capital. Tier 1 capital consists of common stock, retained earnings, noncumulative perpetual preferred stock and
minority interests in certain subsidiaries. Tier 2 capital may consist of a limited amount of the allowance for loan
and lease losses and certain other instruments with some characteristics of equity. The inclusion of elements of Tier
2 capital is subject to certain other requirements and limitations of the federal banking agencies. Since December
31, 1992, the FDIC has required a minimum ratio of qualifying total capital to risk-adjusted assets and off-balance-
sheet items of 8.0%, and a minimum ratio of Tier 1 capital to risk-adjusted assets and off-balance-sheet items of
4.0%. In addition, to be considered “well capitalized,” an institution must maintain a minimum ratio of qualifying
total capital to risk-adjusted assets and off-balance-sheet items of 10%, and a minimum ratio of Tier 1 capital to
risk-adjusted assets and off-balance-sheet items of 6.0%.
In addition to the risk-based guidelines, the FDIC requires banking organizations to maintain a minimum
amount of Tier 1 capital to average total assets, referred to as the leverage ratio. For a banking organization rated in
the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio is
3.0%. It is improbable, however, that an institution with a 3.0% leverage ratio would receive the highest rating by
the regulators since a strong capital position is a significant part of the regulators’ ratings. For all banking
organizations not rated in the highest category, the minimum leverage ratio is at least 100 to 200 basis points above
the 3.0% minimum. Thus, the effective minimum leverage ratio, for all practical purposes, is at least 4.0% or 5.0%.
In addition, to be considered “well capitalized,” an institution must maintain a minimum leverage ratio of 5.0%. In
addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the FDIC
has the discretion to set individual minimum capital requirements for specific institutions at rates significantly above
the minimum guidelines and ratios.
A bank that does not achieve and maintain the required capital levels may be issued a capital directive by
the FDIC to ensure the maintenance of required capital levels. As discussed above, we are required to maintain
certain levels of capital. The regulatory capital guidelines as well as our actual capitalization as of December 31,
2005 is as follows:
Leverage Ratio
Preferred Bank ................................................................................................ 11.63%
5.00%
Minimum requirement for “Well-Capitalized institution................................
4.00%
Minimum regulatory requirement ...................................................................
Tier 1 Risk-Based Capital Ratio
Preferred Bank ................................................................................................ 12.59%
6.00%
Minimum requirement for “Well-Capitalized institution................................
4.00%
Minimum regulatory requirement ...................................................................
Total Risk-Based Capital Ratio
Preferred Bank ................................................................................................ 13.51%
Minimum requirement for “Well-Capitalized institution................................ 10.00%
8.00%
Minimum regulatory requirement ...................................................................
-17-
Prompt Corrective Action
Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve
the problems of insured depository institutions, including those institutions that fall below one or more prescribed
minimum capital ratios described above. An institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized or undercapitalized may be treated as though it were in the next lower capital
category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower
capital category, an insured depository institution is subject to more restrictions.
In addition to measures taken under the prompt corrective action provisions, commercial banking
organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound
practices in conducting their businesses or for violations of any law, rule or regulation or any condition imposed in
writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of
a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of
insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance
of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and
prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or
restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was
not granted.
Premiums for Deposit Insurance
Through the Bank Insurance Fund, or BIF, the FDIC insures our customer deposits up to prescribed limits
for each depositor. The amount of FDIC assessments paid by each BIF member institution is based on its relative
risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based
on the institution’s capitalization risk category and supervisory subgroup category. An institution’s capitalization
risk category is based on the FDIC’s determination of whether the institution is well capitalized, adequately
capitalized or less than adequately capitalized. An institution’s supervisory subgroup category is based on the
FDIC’s assessment of the financial condition of the institution and the probability that FDIC intervention or other
corrective action will be required.
FDIC-insured depository institutions pay an assessment rate equal to the rate assessed on deposits insured
by the Savings Association Insurance Fund.
The assessment rate currently ranges from zero to 34 cents per $100 of domestic deposits. The FDIC may
increase or decrease the assessment rate schedule on a semi-annual basis. Due to continued growth in deposits and
some recent bank failures, the BIF is nearing its minimum ratio of 1.25% of insured deposits as mandated by law. If
the ratio drops below 1.25%, it is likely the FDIC will be required to assess premiums on all banks. Any increase in
assessments or the assessment rate could have a material adverse effect on our business, financial condition, results
of operations or cash flows, depending on the amount of the increase. Furthermore, the FDIC is authorized to raise
insurance premiums under certain circumstances.
The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the
FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or
unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the
institution’s regulatory agency. The termination of our deposit insurance would have a material adverse effect on
our business, financial condition, results of operations or cash flows.
All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment
of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the
Federal Housing Finance Board. The bonds, commonly referred to as FICO bonds, were issued to capitalize the
Federal Savings and Loan Insurance Corporation. The FDIC established the FICO assessment rates effective for the
fourth quarter of 2005 at approximately 1.34 cents for each $100 of assessable deposits. The FICO assessments are
-18-
adjusted quarterly to reflect changes in the assessment bases of the FDIC’s insurance funds and do not vary
depending on a depository institution’s capitalization or supervisory evaluations.
The enactment in February, 2006, of the Federal Deposit Insurance Reform Act of 2006, or the “FDIRA”,
provides, among other things, for the merger of the BIF and the SAIF into the Deposit Insurance Fund; future
inflation adjustment increases in the standard maximum deposit insurance amount of $100,000; the increase of
retirement account coverage to $250,000; changes in the formula and factors to be considered by the FDIC in
calculating the FDIC reserve ratio, assessments and dividends, and a one-time aggregate assessment credit for
depository institutions in existence on December 31, 1996 (or their successors) which paid assessments to
recapitalize the insurance funds after the banking crises of the late 1980s and early 1990s. The FDIC is to issue
regulations implementing the provisions of FDIRA. At that time it is uncertain what effect FDIRA and the
forthcoming regulations will have on the Bank.
Federal Home Loan Bank System
We are a member of the Federal Home Loan Bank of San Francisco, or FHLB-SF. Among other benefits,
each Federal Home Loan Bank, or FHLB, serves as a reserve or central bank for its members within its assigned
region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each
FHLB makes available loans or advances to its members in compliance with the policies and procedures established
by the board of directors of the individual FHLB. As an FHLB member, we are required to own capital stock in an
FHLB in an amount equal to the greater of:
•
1% of its aggregate outstanding principal amount of its residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each calendar year; or
•
5% of its FHLB advances or borrowings.
A new capital plan of the FHLB-SF was approved by the Federal Housing Finance Board and was
implemented on April 1, 2004. The new capital plan incorporates a single class of stock with a par value of $100 per
share, and may be issued, exchanged, redeemed and repurchased only at par value. Each member is required to own
stock in an amount equal to the greater of:
•
a membership stock requirement with an initial cap of $25 million (100% of “membership asset value”
as defined); or
•
an activity based stock requirement (based on percentage of outstanding advances).
The new capital stock is redeemable on five years’ written notice, subject to certain conditions.
Federal Reserve System
The FRB requires all depository institutions to maintain noninterest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW checking accounts) and non-personal
time deposits. At December 31, 2005, we were in compliance with these requirements.
Impact of Monetary Policies
Our earnings and growth are subject to the influence of domestic and foreign economic conditions,
including inflation, recession and unemployment. Our earnings are affected not only by general economic
conditions but also by the monetary and fiscal policies of the United States and federal agencies, particularly the
FRB. The FRB can and does implement national monetary policy, such as seeking to curb inflation and combat
recession, by its open market operations in United States government securities and by its control of the discount
rates applicable to borrowings by banks from the FRB. The actions of the FRB in these areas influence the growth
of bank loans and leases, investments and deposits and affect the interest rates charged on loans and leases and paid
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on deposits. The FRB’s policies have had a significant effect on the operating results of commercial banks and are
expected to continue to do so in the future. The nature and timing of any future changes in monetary policies are not
predictable.
Extensions of Credit to Insiders and Transactions with Affiliates
The Federal Reserve Act and FRB Regulation O, which is applicable to us, place limitations and conditions
on loans or extensions of credit to:
•
•
•
a bank’s executive officers, directors and principal shareholders (i.e., in most cases, those persons who
own, control or have power to vote more than 10% of any class of voting securities);
any company controlled by any such executive officer, director or shareholder; or
any political or campaign committee controlled by such executive officer, director or principal
shareholder.
Loans and leases extended to any of the above persons must comply with loan-to-one-borrower limits,
require prior full board approval when aggregate extensions of credit to the person exceed specified amounts, must
be made on substantially the same terms (including interest rates and collateral) as, and follow credit-underwriting
procedures that are not less stringent than, those prevailing at the time for comparable transactions with non-
insiders, and must not involve more than the normal risk of repayment or present other unfavorable features. In
addition, Regulation O provides that the aggregate limit on extensions of credit to all insiders of a bank as a group
cannot exceed the bank’s unimpaired capital and unimpaired surplus. Regulation O also prohibits a bank from
paying an overdraft on an account of an executive officer or director, except pursuant to a written pre-authorized
interest-bearing extension of credit plan that specifies a method of repayment or a written pre-authorized transfer of
funds from another account of the officer or director at the bank.
Consumer Protection Laws and Regulations
Our regulatory agencies are focusing greater attention on compliance with consumer protection laws and
their implementing regulations. Examination and enforcement have become more intense in nature, and insured
institutions have been advised to monitor carefully compliance with such laws and regulations. We are subject to
many federal consumer protection statutes and regulations, some of which are discussed below.
The Community Redevelopment Act (CRA) is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the
federal regulatory agencies, in examining insured depository institutions, to assess a bank’s record of helping meet
the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with safe
and sound banking practices. The CRA further requires the agencies to take a financial institution’s record of
meeting its community credit needs into account when evaluating applications for, among other things, domestic
branches, mergers or acquisitions, or holding company formations. The agencies use the CRA assessment factors in
order to provide a rating to the financial institution. The ratings range from a high of “outstanding” to a low of
“substantial noncompliance.” In its last examination for CRA compliance, as of November 15, 2005, we were rated
“Satisfactory.”
The Equal Credit Opportunity Act, or ECOA, generally prohibits discrimination in any credit transaction,
whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status,
age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of
any rights under the Consumer Credit Protection Act.
The Truth in Lending Act, or TILA, is designed to ensure that credit terms are disclosed in a meaningful
way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all
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creditors must use the same credit terminology to express rates and payments, including the annual percentage rate,
the finance charge, the amount financed, the total of payments and the payment schedule, among other things.
The Fair Housing Act, or FH Act, regulates many practices, including making it unlawful for any lender to
discriminate in its housing-related lending activities against any person because of race, color, religion, national
origin, sex, handicap or familial status. A number of lending practices have been found by the courts to be, or may
be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself.
The Home Mortgage Disclosure Act, or HMDA, grew out of public concern over credit shortages in
certain urban neighborhoods and provides public information that will help show whether financial institutions are
serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also
includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower
characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination
statutes.
Finally, the Real Estate Settlement Procedures Act, or RESPA, requires lenders to provide borrowers with
disclosures regarding the nature and cost of real estate settlements. Also, RESPA prohibits certain abusive practices,
such as kickbacks, and places limitations on the amount of escrow accounts. Penalties under the above laws may
include fines, reimbursements and other penalties. Due to heightened regulatory concern related to compliance with
the CRA, TILA, FH Act, ECOA, HMDA and RESPA generally, we may incur additional compliance costs or be
required to expend additional funds for investments in our local community.
Recent and Proposed Legislation
Our operations are subject to extensive regulation by federal, state and local governmental authorities and
are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part
or all of their respective operations. Because our business is highly regulated, the laws, rules and regulations
applicable to us are subject to regular modification and change.
From time to time, legislation is enacted which has the effect of increasing the cost of doing business,
limiting or expanding permissible activities or affecting the competitive balance between banks and other financial
institutions. Proposals to change the laws and regulations governing the operations and taxation of banks and other
financial institutions are frequently made in Congress, in the California legislature and before various bank
regulatory agencies.
Sarbanes-Oxley Act
On July 30, 2002, the President signed into law SOX, implementing legislative reforms intended to address
corporate and accounting fraud. In general, SOX applies to publicly reporting companies, that is, companies
(including banks) that have a class of securities registered under Section 12 of the Exchange Act. Upon
commencement of the offering, we will become subject to the provisions of SOX, as well as the rules and
regulations adopted by the SEC to implement SOX. In addition to the establishment of a new accounting oversight
board which will enforce auditing, quality control and independence standards and will be funded by fees from all
publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms.
To maintain auditor independence, any non-audit services being provided to an audit client will require pre-
approval by our audit committee members. In addition, the audit partners must be rotated.
SOX also requires chief executive officers and chief financial officers, or their equivalent, to certify to the
accuracy of periodic reports filed, subject to civil and criminal penalties if they knowingly or willfully violate this
certification requirement. In addition, under SOX and implementing regulations of the SEC, legal counsel is
required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company
to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report
such evidence to the audit committee or other similar committee of the board of directors or the board itself.
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Longer prison terms and increased penalties will also be applied to corporate executives who violate
federal securities laws, the period during which certain types of suits can be brought against a company or its
officers has been extended and bonuses issued to top executives prior to restatement of a company’s financial
statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are
also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are
restricted. The Act accelerates the time frame specified for disclosures by public companies. Directors and executive
officers must also provide information for most changes in ownership in a company’s securities within two business
days of the change.
SOX also prohibits any officer or director of a company or any other person acting under their direction
from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of our financial statements for the purpose of rendering the financial statements
materially misleading. SOX and implementing regulations of the SEC require inclusion of an internal control report
and assessment by management in the annual report to shareholders. In addition, SOX requires that each financial
report required to be prepared in accordance with (or reconciled to) accounting principles generally accepted in the
United States of America and filed with the SEC reflect all material correcting adjustments that are identified by the
independent auditors in accordance with accounting principles generally accepted in the United States of America
and the rules and regulations of the SEC.
Following the effective date of our registration statement under the Exchange Act, as directed by Section
302(a) of SOX, our chief executive officer and chief financial officer each will be required to provide certification
relating to the contents of our annual and quarterly reports and our disclosure controls and procedures and our
internal control over financial reporting.
USA PATRIOT Act
In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting
and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of
2001, referred to as the USA PATRIOT Act. Under the USA PATRIOT Act, financial institutions are subject to
prohibitions regarding specified financial transactions and account relationships as well as enhanced due diligence
and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For
example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to
take reasonable steps:
• To conduct enhanced scrutiny of account relationships to guard against money laundering and report
any suspicious transaction;
• To ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited
into, each account as needed to guard against money laundering and report any suspicious
transactions;
• To ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the
owners of the foreign bank, and the nature and extent of the ownership interest of each such owner;
and
• To ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if
so, the identity of those foreign banks and related due diligence information.
Under the USA PATRIOT Act, financial institutions were given 180 days from enactment to establish anti-
money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:
• The development of internal policies, procedures, and controls;
• The designation of a compliance officer;
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• An ongoing employee training program; and
• An independent audit function to test the programs.
On February 17, 2004, our board of directors adopted comprehensive policies and procedures to address
the requirements of the USA PATRIOT Act.
Financial Services Modernization Legislation
On November 12, 1999 the Gramm-Leach-Bliley Act of 1999, also known as the Financial Services
Modernization Act, was signed into law. The Financial Services Modernization Act is intended to modernize the
banking industry by removing barriers to affiliation among banks, insurance companies, the securities industry and
other financial service providers. It provides financial organizations with the flexibility of structuring such
affiliations through a holding company structure or through a financial subsidiary of a bank, subject to certain
limitations. The Financial Services Modernization Act establishes a new type of bank holding company known as a
financial holding company that may engage in an expanded list of activities that are financial in nature, which
include securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking.
The Financial Services Modernization Act also sets forth a system of functional regulation that makes the
FRB the “umbrella supervisor” for holding companies, while providing for the supervision of the holding
company’s subsidiaries by other federal and state agencies. A bank holding company may not become a financial
holding company if any of its subsidiary financial institutions are not well-capitalized or well-managed. Further,
each bank subsidiary of the holding company must have received at least a satisfactory CRA rating. The Financial
Services Modernization Act also expands the types of financial activities a national bank may conduct through a
financial subsidiary, addresses state regulation of insurance, provides privacy protection for nonpublic customer
information of financial institutions, modernizes the FHLB system and makes miscellaneous regulatory
improvements. The FRB and the Secretary of the Treasury must coordinate their supervision regarding approval of
new financial activities to be conducted through a financial holding company or through a financial subsidiary of a
bank. While the provisions of the Financial Services Modernization Act regarding activities that may be conducted
through a financial subsidiary directly apply only to national banks, those provisions indirectly apply to state-
chartered banks.
In addition, we are subject to other provisions of the Financial Services Modernization Act, including those
relating to CRA, privacy and safe-guarding confidential customer information, regardless of whether we elect to
establish a holding company and become a financial holding company or to conduct activities through a financial
subsidiary.
We do not believe that the Financial Services Modernization Act will have a material adverse effect on our
operations in the near term. However, to the extent that it permits banks, securities firms and insurance companies to
affiliate, the financial services industry will continue to experience further consolidation. The Financial Services
Modernization Act is intended to grant to community banks certain powers as a matter of right that larger
institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the
amount of competition that we face from larger institutions and other types of companies offering financial
products, many of which may have substantially more financial resources than us.
Safety and Soundness Standards
The Federal Deposit Insurance Corporation Improvement Act, or FDICIA, imposes certain specific
restrictions on transactions and requires federal banking regulators to adopt overall safety and soundness standards
for depository institutions related to internal control, loan underwriting and documentation and asset growth.
Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the
use of brokered deposits, limits the aggregate extensions of credit by a depository institution to an executive officer,
director, principal shareholder or related interest and reduces deposit insurance coverage for deposits offered by
undercapitalized institutions for deposits by certain employee benefits accounts. The federal banking agencies may
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require an institution to submit to an acceptable compliance plan as well as have the flexibility to pursue other more
appropriate or effective courses of action given the specific circumstances and severity of an institution’s
noncompliance with one or more standards.
California Financial Information Privacy Act
The California Financial Information Privacy Act, or CFIPA, which was enacted in August 2003, imposes
stricter limits on the use of consumers’ nonpublic personal information by financial institutions beyond those
imposed by the Financial Services Modernization Legislation. CFIPA applies to any financial institution doing
business in California, but only with respect to the individual consumers of the institution that reside in California.
Under CFIPA, and subject to certain specified exceptions, a financial institution must now obtain a
consumer’s written consent before disclosing the consumer’s nonpublic personal information to any nonaffiliated
third party. Before releasing a consumer’s nonpublic personal information to an affiliate, the financial institution
must give the consumer the opportunity to direct that his or her information not be disclosed. This “opt-out”
requirement also applies to information a financial institution discloses in connection with (1) certain joint
marketing agreements with other financial institutions and (2) agreements with “affinity partners” in whose name
the financial institution issues credit cards or other financial products. A financial institution that meets certain
conditions may, however, share nonpublic personal information with its wholly owned financial institution
subsidiaries or sister companies engaged in the same line of business.
CFIPA provides a statutory form of “opt-out” notice that a financial institution may use to offer consumers
the opportunity to communicate their privacy preferences. A financial institution may satisfy CFIPA’s notice
requirements by sending out this form annually. Alternatively, a financial institution may use its own form, subject
to specific requirements and limitations.
Since these provisions are more restrictive than the privacy provisions of the Financial Services
Modernization Act, CFIPA would require us to adopt new policies, procedures and disclosure documentation. The
cost of complying with this legislation is not predictable at this time.
Fair and Accurate Transactions Act
In December 2003, the U.S. Congress adopted, and the President signed, the Fair and Accurate
Transactions Act, referred to as the FACT Act. One of the provisions of the FACT Act provides that, when the
implementing regulations have been issued and become effective, the FACT Act will preempt elements of the
California Financial Information Privacy Act. The FACT Act requires the FRB and the Federal Trade Commission
to issue final regulations within nine months of the effectiveness of the FACT Act, and that those regulations must
become effective within six months of issuance. The provisions of the regulations that will implement the FACT
Act, and the timing of their effect on us, cannot be determined at this time.
Other
Various other legislation, including proposals to overhaul the bank regulatory system and to limit the
investments that a depository institution may make with insured funds, is introduced into Congress or the California
Legislature from time to time. We cannot determine the ultimate effect that any potential legislation, if enacted, or
regulations promulgated thereunder, would have upon our business, financial condition, results of operations or
cash flows.
Employees
As of December 31, 2005, the Bank had a total of 120 full-time employees and 5 part-time employees.
None of the employees are represented by a union or collective bargaining group. The management of the Bank
believes that their employee relations are satisfactory.
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Available Information
The Company also maintains an internet website at www.preferredbank.com. The Company makes its
website content available for information purposes only. It should not be relied upon for investment purposes.
We are subject to the reporting and other requirements of the Securities Exchange Act of 1934, as
amended. In accordance with Sections 12, 13 and 14 of the Exchange Act and as a bank that is not a member of the
Federal Reserve System, we file certain reports, proxy materials, information statements and other information with
the FDIC, copies of which can be inspected and copied at the public reference facilities maintained by the FDIC, at
the Public Reference Section, Room F-6043, 550 17th Street, N.W., Washington, DC 20429. Requests for copies
may be made by telephone at (202) 898-8913 or by fax at (202) 898-3909. [Form 3, 4 and 5 filed electronically with
FDIC, at the FDIC’s website at http://www.fdic.gov.]
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Risk Factors That May Affect Future Results
In addition to other information contained in this report, the following discusses certain factors which may
affect our financial results and operations and should be considered in evaluating us:
Changes in economic conditions, and in particular a prolonged economic slowdown in the State of
California, could hurt our business materially.
Our business is directly affected by factors such as economic, political and market conditions, broad trends
in industry and finance, legislative and regulatory changes, changes in governmental monetary and fiscal policies
and inflation, all of which are beyond our control. We are particularly susceptible to conditions and changes
affecting the State of California and Southern California in view of the concentration of our operations and the
collateral securing our loan portfolio in Southern California. In 2003, the negative effects of weak national and
international economic recoveries, the threat of terrorism and the uncertainty associated with the impact of the war
in Iraq on California’s economy were exacerbated by the state’s budget crisis and the recent hike in energy prices,
the recall of its governor and wildfires in Southern California. Deterioration in economic conditions, in California
and Southern California in particular, could result in the following consequences, any of which could have a
material adverse effect on our business, financial condition, results of operations and cash flows:
•
•
•
•
•
problem assets and foreclosures may increase;
loan delinquencies may increase;
demand for loans and our other products and services may decline;
deposits may decrease or become more expensive; and
collateral for loans made by us, especially real estate, may decline in value, in turn reducing
customers’ borrowing power or capacity to repay, and reducing the value of assets and collateral
associated with our existing loans.
In addition, because we make loans to small to medium-sized businesses, many of our customers may be
particularly susceptible to economic slowdowns or recessions and may be unable to make scheduled principal or
interest payments during these periods.
Most of our loans are secured by real estate, and a downturn in the California real estate market
could have a material adverse effect on our business, financial condition, results of operations and cash flows.
A downturn in the California real estate market could hurt our business because most of our loans are
secured by real estate located in California. As of December 31, 2005, approximately 71% of our loan portfolio
consisted of loans collateralized by various types of California real estate. Real estate values and real estate markets
are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates
and the availability of loans to potential purchasers, changes in tax laws and other laws, regulations and policies and
acts of nature. In addition, real estate values in California could be affected by, among other things, earthquakes and
national disasters particular to the state. If real estate prices decline, the value of real estate collateral securing our
loans will be reduced. As a result, we may experience greater charge-offs and, similarly, our ability to recover on
defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more
likely to suffer losses on defaulted loans.
We rely heavily on our senior management team and other employees, the loss of whom could
significantly harm our business.
Our success depends heavily on the abilities and continued service of our executive officers, especially Li
Yu, our founder, Chairman, President and Chief Executive Officer, and Walter Duchanin, our Executive Vice
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President. These two individuals, who have worked together since our founding, are integral to implementing our
business plan. We currently do not have employment agreements or non-competition agreements with Messrs. Yu
or Duchanin. If we lose the services of any of our executive officers, especially Mr. Yu or Mr. Duchanin, our
business, financial condition, results of operations and cash flows may be adversely affected. Furthermore,
attracting suitable replacements may be difficult and may require significant management time and resources.
We also rely to a significant degree on the abilities and continued service of our private banking, loan
origination, underwriting, administrative, marketing and technical personnel. Competition for qualified employees
in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and
experience in, the California community banking industry. The process of recruiting personnel with the combination
of skills and attributes required to carry out our strategies is often lengthy. If we fail to attract and retain the
necessary deposit generation, loan origination, underwriting, administrative, marketing and technical personnel, our
business, financial condition, results of operations and cash flows may be materially adversely affected.
A natural disaster or recurring energy shortage, especially in California, could harm our business.
Historically, Southern California has been vulnerable to natural disasters. Therefore, we are susceptible to
the risks of natural disasters, such as earthquakes, wildfires, floods and mudslides. Natural disasters could harm our
operations directly through interference with communications, as well as through the destruction of facilities and
our operational, financial and management information systems. Uninsured or underinsured disasters may reduce a
borrower’s ability to repay mortgage loans. Disasters may also reduce the value of the real estate securing our loans,
impairing our ability to recover on defaulted loans. Southern California has also experienced energy shortages
which, if they recur, could impair the value of the real estate in those areas affected. The occurrence of natural
disasters or energy shortages in Southern California could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
Our business is subject to interest rate risk and variations in interest rates may negatively affect our
financial performance.
Market interest rates are affected by many factors that are beyond our control and are hard to predict,
including inflation, recession, performance of the stock markets, a rise in unemployment, tightening money supply,
exchange rates, monetary and other policies of various governmental and regulatory agencies, domestic and
international disorder and instability in domestic and foreign financial markets.
Changes in the interest rate environment may reduce our profits. Changes in interest rates will influence
not only the interest we receive on our loans and investment securities and the amount of interest we pay on
deposits, it will also affect our ability to originate loans and obtain deposits and our costs in doing so.
We expect that we will continue to realize a substantial portion of our income from the differential or
“spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on
deposits, borrowings and other interest-bearing liabilities. Because interest rates are based on the maturity, repricing
and other characteristics of an instrument, conditions that trigger changes in interest rates do not produce equivalent
changes in interest income earned on our interest-earning assets and interest expense paid on our interest-bearing
liabilities. Accordingly, fluctuations in interest rates could adversely affect our interest rate spread and, in turn, our
profitability.
In addition, an increase in the general level of interest rates may adversely affect the ability of some
borrowers to pay the interest on and principal of their obligations, which could reduce our cash flows and harm our
asset quality.
We face strong competition from financial services companies and other companies that offer
banking services, and our failure to compete effectively with these companies could have a material adverse
effect on our business, financial condition, results of operations and cash flows.
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We conduct our operations primarily in California. Increased competition within California may result in
reduced loan originations and deposits. Ultimately, we may not be able to compete successfully against current and
future competitors. Many competitors offer the types of loans and banking services that we offer. These competitors
include national banks, regional banks and other community banks. We also face competition from many other
types of financial institutions, including finance companies, brokerage firms, insurance companies, mortgage banks
and other financial intermediaries. In particular, our competitors include financial institutions whose greater
resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and
mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with
larger capitalization and financial intermediaries not subject to bank regulatory restrictions may have larger lending
limits which would allow them to serve the credit needs of larger customers. These institutions, particularly to the
extent they are more diversified than we are, may be able to offer the same loan products and services we offer at
more competitive rates and prices.
We also compete with three publicly listed Chinese-American banks, and subsidiary banks and branches of
foreign banks, many of which have greater lending limits, and a wider variety of products and services than us. We
also compete with smaller Chinese community banks for both deposits and loans.
We also face competition from out-of-state financial intermediaries that have opened loan production
offices or that solicit deposits in our market areas. If we are unable to attract and retain banking customers, we may
be unable to continue our loan growth and level of deposits, and our business, financial condition, results of
operations and cash flows may be materially adversely affected.
If our underwriting practices are not effective, we may suffer losses in our loan portfolio and our
results of operations may be harmed.
We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices.
Depending on the type of loan, these practices include analysis of a borrower’s prior credit history, financial
statements, tax returns and cash flow projections, valuation of collateral based on reports of independent appraisers
and verification of liquid assets. Although we believe that our underwriting criteria are appropriate for the types of
loans we make, we cannot assure you that they will be effective in mitigating all risks. If our underwriting criteria
prove to be ineffective, we may incur losses in our loan portfolio, and these losses may exceed the amounts set aside
as reserves in our allowance for loan losses.
If our allowance for loan and lease losses is inadequate to cover actual losses, our financial results
would be harmed.
A significant source of risk arises from the possibility that losses could be sustained because borrowers,
guarantors and related parties may fail to perform in accordance with the terms of their loans and leases. The
underwriting and credit monitoring policies and procedures that we have adopted to address this risk may not
prevent unexpected losses that could have a material adverse effect on our business, financial condition, results of
operations and cash flows. Unexpected losses may arise for a wide variety of reasons, many of which are beyond
our ability to predict, influence or control. Some of these reasons could include a prolonged economic downturn in
the State of California, a decline in the California real estate market, changes in the interest rate environment,
adverse economic conditions in Asia and natural disasters.
Like all financial institutions, we maintain an allowance for loan and lease losses to provide for loan and
lease defaults and non-performance. Our allowance for loan and lease losses may not be adequate to cover actual
loan and lease losses, and future provisions for loan and lease losses could materially and adversely affect our
business, financial condition, results of operations and cash flows. Our allowance for loan and lease losses reflects
our best estimate of the losses inherent in the existing loan and lease portfolio at the relevant balance sheet date and
is based on management’s evaluation of the collectibility of the loan and lease portfolio, which evaluation is based
on historical loss experience and other significant factors. The determination of an appropriate level of loan and
lease loss allowance is an inherently difficult process and is based on numerous assumptions. The amount of future
losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that
may be beyond our control and these losses may exceed current estimates. While we believe that our allowance for
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loan and lease losses is adequate to cover current losses, we cannot assure you that we will not increase the
allowance for loan and lease losses further or that regulators will not require us to increase our allowance. Either of
these occurrences could materially adversely affect our business, financial condition and results of operations would
not affect cash flow directly.
If the risks inherent in construction lending are realized, our net income could be adversely affected.
At December 31, 2005, our construction loans were $171.6 million, or 22% of our total loans and leases
held, and the average loan size of our construction loans was $2.0 million. The risks inherent in construction
lending include the possibility that contractors may fail to complete, or fail to complete on a timely basis,
construction of the relevant properties; substantial cost overruns in excess of original estimates and financing;
market deterioration during construction; and a lack of permanent take-out financing. Loans secured by these
properties also involve additional risk because the properties have no operating histories. In these loans, funds are
advanced upon the security of the project under construction, which is of uncertain value prior to completion of
construction, and the estimated operating cash flow to be generated by the completed project. The borrowers’ ability
to repay their obligations to us and the value of our security interest in the collateral will be materially adversely
affected if the projects do not generate sufficient cash flow by being either sold or leased.
If the appraised value of our real property collateral is greater than the proceeds we realize from a
sale or foreclosure of the property, we may suffer a loss on our investment.
In considering whether to make a loan on or secured by real property, we require an appraisal. However,
an appraisal is only an estimate of the value of the property at the time the appraisal is made. If the appraisal does
not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an
amount equal to the indebtedness secured by the property and we may suffer a loss on our investment.
Adverse economic conditions in Asia could impact our business adversely.
We estimate that at December 31, 2005, approximately 60% of our non-governmental deposits and 25% of
our loans were with customers from the Chinese-American market. We believe these customers maintain significant
ties to many Asian countries and, therefore, could be affected by economic and other conditions in those countries.
We cannot predict the behavior of the Asian economies. U.S. economic policies, the economic policies of countries
in Asia, domestic unrest and/or military tensions, crises in leadership succession, currency devaluations, cases of
Severe Acute Respiratory Syndrome, or SARS, and an unfavorable global economic condition may among other
things adversely impact the Asian economies. We generally do not loan to customers or take collateral located
outside of Southern California. However, if Asian economic conditions should deteriorate, we could experience an
outflow of deposits by our Chinese-American customers. In addition, adverse economic conditions could prevent or
delay these customers from meeting their obligations to us. This may adversely impact the recoverability of
investments with or loans made to these customers. Adverse economic conditions may also negatively impact asset
values and the profitability and liquidity of companies operating in Asia, which will also impact the Bank’s
liquidity.
At December 31, 2005, approximately $76.7 million, or 10%, of our loan portfolio consisted of loans made
to finance international trade activities. Changes in monetary policy, including changes in interest rates,
governmental regulation of international trade activities, currency valuation, price competition, competition from
other financial institutions and general economic and political conditions could negatively impact the amount of
goods imported to and exported from the United States, the ability of borrowers to repay loans made by us, and the
number and extent of importers’ and exporters’ need for our trade finance activities. It is possible that if the U.S.
dollar continues to weaken against other foreign currencies, as it has during 2004, the cost of imported goods will
increase, which could have an adverse impact on some of our customers who import goods for resale in the United
States. Such factors could have a material adverse effect on our business, financial condition, results of operations
and cash flows.
If we cannot attract deposits, our growth may be inhibited.
-29-
We plan to increase significantly the level of our assets, including our loan portfolio. Our ability to
increase our assets depends in large part on our ability to attract additional deposits at competitive rates. We intend
to seek additional deposits by continuing to establish and strengthening our personal relationships with our
customers and by offering deposit products that are competitive with those offered by other financial institutions in
our markets. We cannot assure you that these efforts will be successful. Our inability to attract additional deposits at
competitive rates could have a material adverse effect on our business, financial condition, results of operations and
cash flows.
We rely primarily on large certificates of deposits to fund our operations, and the potential volatility
of such deposits and the unavailability of any such funds in the future could adversely impact our growth
strategy and prospects.
We primarily rely on deposits, in particular certificates of deposit of $100,000 or more, or Jumbo CDs, to
fund our operations. At December 31, 2005, we held $472.9 million of Jumbo CDs, representing 48% of total
deposits. These deposits are considered volatile and could be subject to withdrawal. Withdrawal of a material
amount of such deposits would adversely impact our liquidity, profitability, business, financial condition, results of
operations and cash flows.
Our inability to raise additional capital when needed or on favorable terms could inhibit our growth
and could harm our operations.
To the extent that our deposits and total assets continue to grow, we may need to increase our capital in
order to maintain our compliance with regulatory capital requirements. We may also need additional capital to fund
growth in our loan portfolio or in the event we are unable to attract sufficient deposits in order to fund our growth.
We cannot predict the timing and amount of our future capital requirements. If our capital needs exceed our
earnings, we may seek funding through the capital markets; however, we may not be able to obtain capital when we
need to or when it would be advantageous for us to do so. Failure to raise capital when needed could limit or
eliminate our ability to grow, or in extreme instances, materially adversely affect our operations. Moreover, even if
capital is available, it may be upon terms that are not favorable to existing common shareholders and could dilute
their interest.
Our inability to manage our growth could harm our business.
We anticipate that our asset size and deposit base will continue to grow over time, perhaps significantly.
To manage the expected growth of our operations and personnel, we will be required to, among other things:
•
improve existing and implement new transaction processing, operational and financial systems,
procedures and controls;
• maintain effective underwriting guidelines; and
•
expand our employee base and train and manage this growing employee base.
If we are unable to manage growth effectively, our business, financial condition, results of operations
and cash flows could be materially adversely affected.
We rely on communications, information, operating and financial control systems technology from third-
party service providers, and we may suffer an interruption in or break of those systems that may result in lost
business and we may not be able to obtain substitute providers on terms that are as favorable if our relationships
with our existing service providers are interrupted.
We rely heavily on third-party service providers for much of our communications, information, operating
and financial control systems technology, including customer relationship management, general ledger, deposit,
servicing and loan origination systems. Any failure or interruption or breach in security of these systems could
-30-
result in failures or interruptions in our customer relationship management, general ledger, deposit, servicing and/or
loan origination systems. We cannot assure you that such failures or interruptions will not occur or, if they do occur,
that they will be adequately addressed by us or the third parties on which we rely. The occurrence of any failures or
interruptions could have a material adverse effect on our business, financial condition, results of operations and cash
flows. If any of our third-party service providers experience financial, operational or technological difficulties, or if
there is any other disruption in our relationships with them, we may be required to locate alternative sources of such
services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services
with similar functionality as found in our existing systems without the need to expend substantial resources, if at all.
Any of these circumstances could have a material adverse effect on our business, financial condition, results of
operations and cash flows.
The U.S. government’s monetary policies or changes in those policies could have a major effect on
our operating results, and we cannot predict what those policies will be or any changes in such policies or the
effect of such policies on us.
Our earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the
U.S. government and its agencies. The monetary policies of the Federal Reserve Bank, or the FRB, have had, and
will continue to have, an important effect on the operating results of commercial banks and other financial
institutions through its power to implement national monetary policy in order, among other things, to curb inflation
or combat a recession.
The monetary policies of the FRB, effected principally through open market operations and regulation of
the discount rate and reserve requirements, have had major effects upon the levels of bank loans, investments and
deposits. For example, in 2001, several drops in the discount rate by the Federal Open Market Committee placed
tremendous pressure on the profitability of all financial institutions because of the resulting contraction of net
interest margins. It is not possible to predict the nature or effect of future changes in monetary and fiscal policies.
We are subject to extensive government regulation, and these regulations may hamper our ability to
increase assets and earnings and could result in a decrease in the value of your shares.
Our operations are subject to extensive regulation by federal, state and local governmental authorities and
are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part
or all of our operations. Because our business is highly regulated, the laws, rules and regulations applicable to us are
subject to regular modification and change, which may have the effect of increasing or decreasing the cost of doing
business, modifying permissible activities or enhancing the competitive position of other financial institutions.
These laws are primarily intended for the protection of consumers, depositors and the deposit insurance funds and
not for the protection of shareholders of bank holding companies or banks. There are currently proposed various
laws, rules and regulations that, if adopted, would impact our operations. We cannot assure you that these proposed
laws, rules and regulations or any other laws, rules or regulations will not be adopted in the future, which could
make compliance much more difficult or expensive, restrict our ability to originate, further limit or restrict the
amount of commissions, interest or other charges earned on loans originated by us or otherwise adversely affect our
business, financial condition, results of operations or cash flows.
We are exposed to risk of environmental liability with respect to properties to which we take title.
In the course of our business, we may foreclose on and take title to properties securing our loans. If
hazardous substances were discovered on any of the properties, we may be held liable to governmental entities or to
third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in
connection with environmental contamination or may be required to investigate or clean up hazardous or toxic
substances or chemical releases at a property. Many environmental laws can impose liability regardless of whether
we knew of or were responsible for the contamination. In addition, if we arrange for the disposal of hazardous or
toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from
the site, even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial
expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our
ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent
-31-
interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental
liability.
The threat of terrorism has depressed the economy generally and could worsen, particularly if there
are further terrorist events.
The terrorist attacks and international conflicts of recent years have resulted in continued uncertainty
regarding the economic outlook of the United States. The possibility of further terrorist attacks, as well as continued
terrorist threats, may prolong the depth and length of this economic uncertainty. Future terrorist acts and responses
to such activities could adversely affect us in a number of ways, including an increase in delinquencies,
bankruptcies or defaults that could result in a higher level of non-performing assets, net charge-offs and provision
for loan losses.
Executive Officers of the Bank
The following table sets forth our executive officers, their positions and their ages. Each officer is
appointed by our Board of Directors and serves at their pleasure.
Name
Age (1)
Position with Bank
Li Yu ........................
[65]
Chairman of the Board, President and Chief Executive Officer
Walt Duchanin .........
[52]
Executive Vice President and Chief Credit Officer
Chris Chan................
[44]
Senior Vice President and Chief Financial Officer
________________
(1) As of March 29, 2006
Li Yu has been our President and Chief Executive Officer since 1993. From December 1991 to the present,
he has served as Chairman of our Board of Directors. From 1987 to 1991, he was involved in several privately held
companies of which he was the owner. From 1982 to 1987, he served as Chairman of the Board of California
Pacific National Bank, which became a part of Bank of America. Mr. Yu received a Masters of Business
Administration, or MBA, from the University of California, Los Angeles. He was also the past President of the
National Association of Chinese American Bankers, and is currently a member of the Board of Visitors of UCLA’s
Anderson Graduate School of Management.
Chris Chan has been our Senior Vice President and Chief Financial Officer since 1997. From 1996 until
1997, he was the Senior Vice President and Chief Financial Officer of First Professional Bank, and from 1989 until
1996, he was Vice President/Finance of First Public Savings Bank. Mr. Chan received a MBA from Pepperdine
University and a Bachelors of Science degree in finance from the University of Southern California, or USC. Mr.
Chan who joined Preferred Bank in 1997, has resigned from the Company but will remain until the end of March.
He indicated that his decision to leave was based on personal considerations and to pursue other interests.
Walter Duchanin has been our Executive Vice President and Chief Credit Officer since 1995 and our
Senior Vice President and Senior Loan Officer from 1992 to 1995. From 1988 to 1992, he was the Senior Vice
President and Credit Administrator of Simi Valley Bank, and from 1983 to 1988, he was Group Vice President of
Marathon National Bank. Mr. Duchanin’s banking experience also includes American International Bank and Bank
of America. Mr. Duchanin received a Bachelors of Science degree in finance from USC.
-32-
ITEM 2. PROPERTIES
Our corporate headquarters are located at 601 S. Figueroa Street, 20th Floor, Los Angeles, California
90017. The lease for this floor extends until August 31, 2008, with one option for us to extend the term of the lease
for five years. We paid $313,000 in lease expenses for 2004 related to this lease.
At December 31, 2005, we maintained ten full-service branch offices in Alhambra, Century City, City of
Industry, Torrance, Arcadia, Irvine, Diamond Bar, Valencia, Santa Monica and Chino, California all of which we
lease. We believe that no single lease is material to our operations.
We believe that our present facilities are adequate for our current needs, and that alternative or additional
space, if necessary, will be available at market terms to facilitate, among other things, our growth in branches and/or
loan production offices. For the year ended December 31, 2005, we paid $1,235,000 in lease payments. For the year
ended December 31, 2004, we paid $1,036,000 in lease payments.
We believe that our existing facilities are adequate for our present purposes. We believe that, if necessary,
we could secure alternative facilities on similar terms without adversely affecting our operations.
The following table provides certain information with respect to our leased branch locations.
Location
Los Angeles County
Address
Current
Lease Term
Expiration
Date
Square
Footage
Total Deposits
at
December 31,
2005
(In thousands)
Alhambra ........................................... 325 E. Valley Blvd.
Arcadia............................................... 1469 S. Baldwin Avenue
Century City....................................... 1801 Century Park East, Suite 100
City of Industry .................................. 17515-A Colima Road
Diamond Bar ..................................... 1373 S. Diamond Bar Blvd.
Los Angeles (Head Office &
601 S. Figueroa Street, 20th Floor
branch)........................................................
Santa Monica ..................................... 524 Wilshire Blvd.
Torrance ............................................. 3501 Sepulveda Blvd., Suite 107
Valencia ............................................. 24501 Town Center Drive, Suite 103
03/31/09
04/30/09
06/30/11
03/14/15
11/30/09
08/31/08
8/31/12
10/31/06
10/31/11
6,000
2,600
4,416
5,610
3,440
1,568
1,355
4,800
2,926
$169,378
71,034
53,353
96,297
63,125
287,015
12,891
161,301
5,914
Orange County
Irvine.................................................. 2301 Dupont Drive, Suite 150
05/31/09
3,584
46,028
San Bernardino County
Chino.................................................. 3926 Grand Avenue, #E
10/14/10
2,973
9,130
ITEM 3. LEGAL PROCEEDINGS
From time to time we are a party to claims and legal proceedings arising in the ordinary course of business.
There are no pending legal proceedings or, to the best of our knowledge, threatened legal proceedings, to which we
are a party which may have a material adverse effect upon our financial condition, results of operations and business
prospects.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There was no submission of matters to a vote of security holders during the fourth quarter of the year
ended December 31, 2005.
-34-
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Market Information
Our Common Stock commenced trading on the Nasdaq National Market on February 15, 2005 under the
symbol “PFBC.” Prior to being listed on the Nasdaq National Market, our common stock was listed for trading on
the OTC Bulletin Board under the symbol “PFBL.” While listed for trading on the OTC Bulletin Board, there was
limited trading at widely varying prices and on a number of days, there were no trades at all in our common stock.
The initial public offering price of our common stock on February 14, 2005 was $38.00 per share. Our
common stock closed at $49.95 on March 29, 2006 and 6,706,304 outstanding shares of our common stock.
The following table sets forth the high and low sales prices for our common stock for the periods indicated
as reported by the OTC Bulletin Board, as well as the number of shares sold in each period:
2003
First Quarter ...............
Second Quarter ...........
Third Quarter..............
Fourth Quarter ............
2004
First Quarter ...............
Second Quarter ...........
Third Quarter..............
Fourth Quarter ............
2005
$
$
$
$
High
17.00
17.00
18.00
N/A
22.00
N/A
N/A
N/A
$
$
$
$
Low
14.75
17.00
18.00
N/A
17.80
N/A
N/A
N/A
Number of
Shares
Sold
1,100
6,800
1,000
0
22,400
0
0
0
First Quarter ( 1/1 – 2/14) $
22.00
First Quarter (2/15 – 3/31) $ 45.00
$ 42.08
Second Quarter ...........
$ 43.00
Third Quarter..............
$ 45.99
Fourth Quarter ............
$ 22.00
38.00
$
37.00
$
39.16
$
39.25
$
900
2,943,000
1,360,300
756,900
1,203,500
The foregoing reflects information available to us and does not necessarily include all trades in our
common stock during the periods indicated.
Dividends
The following table sets forth during the periods indicated the dividends declared per share of our common
stock.
-35-
Calendar Year Ended December 31,
2005..........................................................
2004..........................................................
2003..........................................................
2002..........................................................
2001..........................................................
2000..........................................................
1999..........................................................
1998..........................................................
1997..........................................................
Dividends Declared
Per Share
$0.64
$0.60
$0.24
$0.38
$0.38
$0.30
$0.30
$0.25
$0.25
On February 24, 2006, we paid a dividend of $0.20 per share to shareholders of record on February 10,
2006.
We began paying dividends on a quarterly basis in the first quarter of 2006, subject to regulatory, capital
and contractual constraints. Any determination to pay dividends in the future will, however, be at the discretion of
our board of directors and will depend upon our earnings, financial condition, results of operations, capital
requirements, available investment opportunities, regulatory restrictions, contractual restrictions and other factors
that our board of directors may deem relevant. Accordingly, there can be no assurance that any stock or cash
dividends will be declared in the future, and if any are declared, what amount they will be.
Because we are a California state-chartered bank, our ability to pay dividends or make distributions to
shareholders is subject to restrictions set forth in the California Financial Code. California Financial Code Section
642 restricts the amount available for cash dividends by state-chartered banks to the lesser of: (1) retained earnings;
or (2) the bank’s net income for its last three fiscal years (less any distributions to shareholders made during such
period).
However, Section 643 of the California Financial Code provides that notwithstanding the provisions of
Section 642, a state-chartered bank may, with the prior approval of the California Commissioner, make a
distribution to its shareholders in an amount not exceeding the greater of:
•
•
•
retained earnings;
net income for a bank’s last preceding fiscal year; or
net income of the bank for its current fiscal year.
If the California Commissioner finds that the shareholders’ equity of the Bank is not adequate or that the
payment of a dividend would be unsafe or unsound for the Bank, the California Commissioner may order the Bank
not to pay a dividend to the Bank’s shareholders.
As of December 31, 2005, we could have paid $28.3 million in dividends without the approval of the
California Commissioner.
In addition, under California law, the California Commissioner has the authority to prohibit a bank from
engaging in business practices which the California Commissioner considers to be unsafe or injurious to its business
or financial condition. It is possible, depending on our financial condition and other factors, that the California
Commissioner could assert that the payment of dividends or other payments to our shareholders might under some
circumstances be unsafe or injurious to our business or financial condition and prohibit such payment.
The FDIC also has the authority to prohibit a bank from engaging in business practices which the FDIC
considers to be unsafe or unsound. It is possible, depending upon our financial condition and other factors, that the
-36-
FDIC could assert that the payment of dividends or other payments might under some circumstances be such an
unsafe or unsound practice and prohibit such payment.
ITEM 6. SELECTED FINANCIAL DATA
The following table shows our selected historical financial data for the periods indicated. You should read
our selected historical financial data, together with the notes thereto, in conjunction with the more detailed
information in our financial statements and related notes and “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” included elsewhere in this Form 10-K
Our financial condition data as of December 31, 2005 and 2004 and our statement of income data for the
years ended December 31, 2005, 2004 and 2003 have been derived from our audited historical financial statements
included elsewhere in this Form 10-K.
The statement of income data for the years ended December 31, 2002 and 2001 and the financial condition
data as of December 31, 2002 and 2001 have been derived from our audited financial statements that are not
included in this Form 10-K.
At or for the Year Ended December 31,
2005
2004
2003
2002
2001
(Dollars in thousands, e xce pt pe r share data)
Financial Condition Data:
Total assets
Total deposits
Investments securities available-for sale,
$
1,136,720
975,467
162,935
$
907,270
801,535
164,635
$
761,825
662,812
155,869
$
706,052
614,868
97,961
$
658,273
576,325
114,237
at fair value sale
Loans and leases
Cash and due from banks
Other real estate owned (1)
Shareholders’ equity
Statement of Income Data:
Interest income
Interest expense
771,143
25,123
-
123,846
615,961
35,212
8,258
76,808
504,053
22,960
8,258
67,736
448,512
24,351
8,188
59,918
374,160
17,568
795
57,122
$
60,082
16,062
$
38,643
7,447
$
34,376
8,696
$
33,902
10,718
$
40,032
19,184
Net interest income
Provision for loan and lease losses
44,020
2,110
31,196
1,550
25,680
2,100
23,184
10,146
20,848
900
Net interest income after provision for loan
and lease losses
Noninterest income
Noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
41,910
3,868
17,571
28,207
11,382
16,825
$
29,646
4,199
15,339
18,506
7,354
11,152
$
23,580
4,923
13,774
14,729
5,696
9,033
$
13,038
4,514
10,261
7,291
2,888
4,403
$
19,948
5,664
12,379
13,233
5,205
8,028
$
-37-
2005
At or for the Year Ended December 31,
2003
2004
2002
2001
Share Data:
Net income per share, basic(2)
Net income per share, diluted(2)
Book value per share(3)
Shares outstanding at period end
Weighted average number of shares
outstanding, basic(2)
Weighted average number of shares
outstanding, diluted(2)
Selected Other Balance Sheet Data(4):
(Dollars in n thousands, exce pt per share data)
$
$
$
2.58
2.48
18.51
6,691,904
$
2.02
$
1.92
13.83
$
5,554,182
$
1.66
$
1.58
12.42
$
5,454,982
$
0.82
$
0.77
11.06
$
5,415,282
$
1.52
$
1.43
10.66
$
5,358,782
6,521,763
5,518,398
5,440,319
5,398,114
5,272,605
6,797,305
5,809,234
5,715,542
5,724,186
5,622,402
Average assets
Average earning assets
Average shareholders’ equity
$
1,006,222
969,019
110,250
$
840,265
791,227
71,896
$
752,097
707,588
63,704
$
679,185
636,053
60,285
$
623,549
588,162
54,436
Selected Financial Ratios(4):
Return on average assets
Return on average shareholders'
equity(3)
Shareholders’ equity to assets(5)
Net interest margin(6)
Efficiency ratio(7)
Selected Asset Quality Ratios:
Non-performing loans to total loans
and leases(8)
Non-performing assets to total
assets(9)
Allowance for loan and lease losses
to total loans and leases
Allowance for loan and lease losses
to non-performing loans
Net charge-offs (recoveries) to average
loans and leases
1.67 %
15.26
1.33 %
15.51
1.20 %
14.18
0.65 %
7.30
1.29 %
14.75
10.90
4.54
36.69
8.47
3.94
43.34
8.89
3.63
45.01
8.49
3.65
37.05
8.68
3.54
46.69
0.00 %
0.06 %
0.20 %
1.43 %
1.61 %
0.00
1.16
0.95
1.09
1.22
1.22
2.05
2.06
0.00
1,758.64
616.80
144.23
(0.02)
0.18
1.11
1.38
1.04
1.31
81.32
0.11
n.m. Not meaningful.
(1) These amounts include all property held by us as a result of foreclosure.
(2) Net income per share, basic is based on the weighted average shares of common stock outstanding during the period. Net income per share,
diluted is based on the weighted average shares of common stock plus common stock equivalents determined using the treasury stock
method.
(3) Book value per share represents our shareholders’ equity divided by the number of shares of common stock issued and outstanding at the
end of the period indicated (exclusive of shares exercisable under our stock option plans).
(4) Average balances used in this chart and throughout this offering circular are based on daily averages. Percentages as used throughout this
offering circular have been rounded to the closest whole number, tenth or hundredth as the case may be.
(5) For a discussion of the components of the capital ratios, see “Management’s Discussion and Analysis of Financial Condition and Results of
Operations—Capital Resources.”
(6) Net interest margin is net interest income expressed as a percentage of average total interest-earning assets.
(7) The efficiency ratio is the ratio of noninterest expense divided by the sum of net interest income before the provision for loan and lease
losses plus noninterest income.
(8) Non-performing loans consist of loans on nonaccrual and loans past due 90 days or more and restructured debt.
(9) Non-performing assets consist of non-performing loans, restructured debt and other real estate owned. Since 2002, we have had two
significant non-performing assets consisting of a leveraged lease to United Airlines which has now been charged off and a single office
building property located in San Francisco. For more details, see subheadings “Overview,” “Results of Operations—The UAL Leveraged
Lease” and “Financial Condition—Non-Performing Assets” under “Management’s Discussion and Analysis of Financial Condition and
Results of Operations.”
-38-
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion provides information about the results of operations, financial condition,
liquidity, and capital resources of Preferred Bank (the “Bank”). This information is intended to facilitate the
understanding and assessment of significant changes and trends related to our financial condition and the results of
our operations. This discussion and analysis should be read in conjunction with the Bank’s consolidated financial
statements and the accompanying notes presented elsewhere herein.
Overview
We are a California chartered, full-service commercial bank focused on the Chinese-American market. We
conduct our banking business from our headquarters in Los Angeles, and through our ten full-service branch
banking offices located in Alhambra, Century City, City of Industry, Torrance, Arcadia, Irvine, Diamond Bar,
Valencia, Santa Monica and Chino, California.
We derive our income primarily from interest received on our loan and investment securities portfolios,
and fee income we receive in connection with servicing our loan and deposit customers. Our major operating
expenses are the interest we pay on deposits and borrowings, and the salaries and related benefits we pay our
management and staff. We rely primarily on locally-generated deposits, most of which we receive from the
Chinese-American market within Southern California, to fund our loan and investment activities.
On February 17, 2005, we completed initial public offering (“IPO”) of 2,438,000 shares of our common
stock at $38.00 per share in a firm commitment underwritten offering. The number of shares sold included 318,000
shares sold pursuant to the underwriters’ exercise of their over-allotment option. Of the 2,438,000 shares sold,
Preferred Bank sold 985,622 shares and 1,452,378 shares were sold by certain selling shareholders. The net
proceeds to us from our IPO of common stock were approximately $35 million (before expenses).
One of our strategic goals is to focus on improving profitability while achieving reasonable but controlled
asset growth. To attain this goal, we plan to continue to expand our branch network in Southern California. In
December 2002, we established a branch office in Diamond Bar and in January 2004, we opened our Valencia
Branch. To further expand our franchise, we opened our Santa Monica and Chino Branches in April and December
2005, respectively
For the three-year period ended December 31, 2005, our net interest income grew by 89.87%. However,
our net income grew by 282.13% during this period. The primary reason for the significant rate of growth in our
net income as compared to our net interest income is attributed to the additional provisions in the amount of $8.6
million in 2002 and $700,000 in 2003 to our allowance for loan and lease losses due to an investment in a aircraft
leveraged lease with United Airlines, or the UAL Leveraged Lease. The investment in the UAL Leveraged Lease
was originally made in November 1997. During 2002, United Airlines declared bankruptcy which resulted in the
aforementioned provisions to the allowance for loan and lease losses. Also contributing to the strong growth in our
net interest income, which impacts our net income, is the increase in our loan portfolio balances and the Bank’s
asset sensitive balance sheet in the rising interest rate environment in the current year. See “—Results of
Operations—The UAL Leveraged Lease” for additional information on the UAL Leveraged Lease. As a result of
this significant provision, our net income was adversely affected. In addition to the additional provision to our
allowance for loan and lease losses, in reaction to the uncertainty caused by the UAL Leveraged Lease we
restrained the rate of growth of our loan originations, and increased our federal funds sold and investment in short-
term, but lower-yielding investment securities during 2002 and the early half of 2003. We charged off $1.0 million,
$1.2 million and $1.0 million for the quarters ended September 30, 2003, December 31, 2003 and June 30, 2004,
respectively. We have no further exposure to the UAL Leveraged Lease, and we currently have no exposure to any
other leveraged lease.
In connection with the complete charge-off of the remaining balance of the UAL Leveraged Lease, and in
part in response to changes in interest rates, we changed the mix of our assets by accelerating the growth of our loan
-39-
originations, especially commercial real estate loans, reducing the amount of federal funds sold and investing in
higher-yielding investment securities. Our net income grew at the rate of 50.9% for the year ended December 31,
2005 as compared to the year ended December 31, 2004. We expect to continue to shift our asset mix in this manner
for the foreseeable future subject to changes in market conditions and other factors described in this offering
circular.
We acquired 60 Federal by foreclosure on September 27, 2002. It consisted of a five story, 88,156 square
foot adapted warehouse and office building located in the “South of Market” area of San Francisco. The annual
operating income of approximately $496,000 was included as noninterest income during the year 2004.
Critical Accounting Policies
Our accounting policies are integral to understanding the financial results reported. Our most complex
accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments
and contingencies. We have established detailed policies and control procedures that are intended to ensure
valuation methods are well controlled and consistently applied from period to period. In addition, these policies and
procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The
following is a brief description of our current accounting policies involving significant management valuation
judgments.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses, or ALLL, represents our best estimate of losses inherent in the
existing loan and lease portfolio. The allowance for loan and lease losses is increased by the provision for loan and
lease losses charged to expense and reduced by loans and leases charged off, net of recoveries.
We evaluate our allowance for loan and lease losses quarterly. We believe that the allowance for loan and
lease losses is a “critical accounting estimate” because it is based upon management’s assessment of various factors
affecting the collectibility of the loans and leases, including current economic conditions, past credit experience,
delinquency status, the value of the underlying collateral, if any, and a continuing review of the portfolio of loans
and leases.
Like all financial institutions, we maintain an ALLL based on a number of quantitative and qualitative
factors. The amount of the allowance is based on management’s evaluation of the collectibility of the loan and lease
portfolio and that evaluation is based on historical loss experience and other significant factors. These other
significant factors include the level and trends in delinquent, non-accrual and adversely classified loans and leases,
trends in volume and terms of loans and leases, levels and trends in credit concentrations, effects of changes in
underwriting standards, policies, procedures and practices, national and local economic trends and conditions,
changes in capabilities and experience of lending management and staff and other external factors including
industry conditions, competition and regulatory requirements.
We cannot provide you with any assurance that further economic difficulties or other circumstances which
would adversely affect our borrowers and their ability to repay outstanding loans and leases will not occur. These
difficulties or other circumstances could result in increased losses in our loan and lease portfolio, which could result
in actual losses that exceed reserves previously established.
Investment Securities
The classification and accounting for investment securities are discussed in detail in Note 1 of the
consolidated financial statements presented elsewhere herein. Under SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities, investment securities generally must be classified as held-to-maturity,
available-for-sale, or trading. The appropriate classification is based partially on our ability to hold the securities to
maturity and largely on management's intentions with respect to either holding or selling the securities. The
classification of investment securities is significant since it directly impacts the accounting for unrealized gains and
losses on securities. Unrealized gains and losses on trading securities flow directly through earnings during the
-40-
periods in which they arise, whereas for available-for-sale securities, they are recorded as a separate component of
stockholders' equity (accumulated other comprehensive income or loss) and do not affect earnings until realized.
The fair values of our investment securities are generally determined by reference to quoted market prices and
reliable independent sources.
We are obligated to assess, at each reporting date, whether there is an “other-than-temporary” impairment
to our investment securities. Such impairment must be recognized in current earnings rather than in other
comprehensive income. We examine all individual securities that are in an unrealized loss position at each reporting
date for other-than-temporary impairment. Specific investment level factors we examine to assess impairment
include the severity and duration of the loss, an analysis of the issuers of the securities and if there has been any
cause for default on the securities and any change in the rating of the securities by the various rating agencies.
Additionally, we reexamine the financial resources and overall ability the Company has and the intent management
has to hold the securities until their fair values recover.
In November 2005, the FASB issued Staff Position (“FSP”) Nos. FAS 115-1 and 124-1 to address the
determination as to when an investment is considered impaired, whether that impairment is other than temporary
and the measurement of an impaired loss. This FSP nullified certain requirements of Emerging Issues Task Force
03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1),
and references existing guidance on other than temporary impairment. Furthermore, this FSP creates a three step
process in determining when an investment is considered impaired, whether that impairment is other than
temporary, and the measurement of an impairment loss. The FSP is effective for reporting periods beginning after
December 15, 2005. It is not anticipated that adoption will have a material impact on our financial condition or
results of operations.
Results of Operations
The following tables summarize key financial results for the periods indicated:
Net income
Net income per share, basic
Net income per share, diluted
Return on average assets
Return on average shareholders’ equity
Year Ended December 31,
2 0 0 5
2 0 0 4
2 0 0 3
( D o lla rs in t h o u s a n d s , e xc e p t p e r s h a re d a t a )
$
16,825
$
11,152
$
9,033
$
2.58
$
2.02
$
1.66
$
2.48
$
1.92
$
1.58
1.67 %
15.26 %
1.33 %
15.51 %
1.20 %
14.18 %
-41-
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Statement of Income Data:
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
Net interest income after provision for loan and lease losses
Noninterest income
Noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
Net income per share, basic
Net income per share, diluted
Year Ended December 31,
2 0 0 5
2 0 0 4
In c re a s e
( D e c re a s e )
( D o lla rs in t h o u s a n d s , e xc e p t p e r s h a re d a t a )
$
60,082
16,062
$
38,643
7,447
$
21,439
8,615
44,020
2,110
41,910
3,868
17,571
28,207
11,382
31,196
1,550
29,646
4,199
15,339
18,506
7,354
12,824
560
12,264
(331)
2,232
9,701
4,028
$
16,825
$
11,152
$
5,673
$
2.58
$
2.02
$
0.56
$
2.48
$
1.92
$
0.56
Net income increased 50.9% to $16.8 million, or $2.48 per diluted share, for the year ended December 31,
2005, from $11.2 million, or $1.92 per diluted share, for the year ended December 31, 2004. Our return on average
assets was 1.67% and return on average shareholders’ equity was 15.26% for the year ended December 31, 2005,
compared to 1.33% and 15.51%, respectively, for the year ended December 31, 2004.
Net income improved significantly in 2005 from 2004, principally as a result of an increase in net interest
income of $12.8 million, partially offset by an increase in noninterest expense of $2.2 million and increase in
provision for income taxes of $4.0 million.
The $12.8 million, or 41.1%, increase in net interest income primarily resulted from increased loan volume,
in particular commercial real estate loans, and a 15 basis point improvement in net interest margin. Our overall cost
of funds in 2005 increased by 106 basis points to 2.31%, compared to 1.25% for 2004. The combined impact of an
increasing interest rate environment and increased competition in the deposit market were the primary drivers of our
increased cost of funds during 2005.
As of December 31, 2005, 89% of our loan portfolio was tied to the Prime Rate, which reprices daily, and
9% was tied to the London Interbank Offer Rate, or LIBOR, or other indices, which reprice periodically.
Approximately 36% of our loan portfolio had a floor interest rate at various levels, which can provide us with
protection in a falling interest rate environment should the Prime Rate decline to a level below the floor interest rate.
Approximately 2% of our loan portfolio had interest rate ceilings at various rates limiting the amount of interest rate
increases that can be passed on to the borrower. Our weighted average maturity of certificates of deposit at
December 31, 2005 was 4 months. As a result, our interest-bearing liabilities generally reprice much slower than our
loan portfolio and our net income should be positively impacted by a rising interest rate environment.
Net Interest Income and Net Interest Margin
Our net interest income before the provision for loan and lease losses for the year ended December 31,
2005 increased $12.8 million, or 41.1%, as compared to the year ended December 31, 2004. This increase was due
to an increase in interest income of $21.4 million, and offset by an increase in interest expense of $8.6 million. Total
interest expense increased primarily as a result of increases in interest rates with time certificates of deposit
maturing and being replaced at current prevailing rates. The $21.4 million increase in total interest income was due
-42-
to both increase interest rates and the volume of loans. Rising short-term interest rates also contributed to the
increase in total interest income.
The average yield on our interest-earning assets increased significantly to 6.20% in year ended December
31, 2005 from 4.88% in the year ended December 31, 2004. The increase was mainly due to the rising interest rate
environment with lower rate loans maturing and being replaced by loans at higher prevailing rates, as well as
investment securities maturing or being called and reinvested at higher prevailing rates.
The cost of average interest-bearing liabilities increased to 2.31% for the year ended December 31, 2005
from 1.25% for the year ended December 31, 2004. The increase was primarily driven by rising interest rates with
lower cost time deposits maturing and being replaced at higher prevailing rates. The increase in the ratio of time
certificates of deposit to average interest-bearing deposits from 70.88% to 72.57%, and the increase in the cost of
FHLB long-term borrowings all contributed to the increase in the cost of average interest-bearing liabilities.
Our interest income, interest expense, net interest income, and net interest margin are influenced by the
distribution of our assets and liabilities and the income earned and costs incurred on such assets and liabilities. The
following table presents, for the periods indicated, the information regarding the distribution of average assets,
liabilities and shareholders’ equity, as well as the net interest income from average interest-earning assets and the
resulting yields expressed in percentages. Non-accrual loans are included in the calculation of average loans and
leases while non-accrued interest thereon is excluded from the computation of yields earned.
-43-
ASSETS:
Interest-earning assets:
Loans and leases(1)(2)(3)
Investments securities(1)
Federal funds sold and securities
purchased under resale agreements
Interest-bearing deposits with other banks
Certificate of deposits with other banks
Other earning assets (4)
Total interest-earning assets
Noninterest earning assets:
Cash and due from banks
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’
EQUITY
Interest-bearing liabilities:
Deposits:
Interest-bearing demand
Money market
Savings
Time certificates of deposit
Total interest-bearing deposits
Short-term borrowings
Long-term debt
Total interest-bearing liabilities
Non-interest-bearing liabilities:
Demand deposits
Other liabilities
Total liabilities
Year Ended December 31, 2005
Year Ended December 31, 2004
Year Ended December 31, 2003
Average
Balance
Interest
Income or
Expense
Average
Yield or
Cost
Average
Balance
Interest
Income or
Expense
Average
Yield or
Cost
Average
Balance
Interest
Income or
Expense
Average
Yield or
Cost
(D o lla rs in tho us a nds )
$
692,320
166,991
101,754
$
50,443
6,123
3,264
7.29 %
3.67
3.21
$
541,402
159,229
81,948
$
32,046
5,272
1,105
5.92 %
3.31
1.35
$
466,793
124,964
109,839
$
28,301
4,656
1,273
4,716
3,238
969,019
144
108
60,082
3.05
3.34
6.20
6,390
2,258
791,227
133
85
38,643
2.08
3.76
4.88
4,622
1,370
707,588
88
58
34,376
23,873
13,330
1,006,222
$
29,590
19,448
840,265
$
26,756
17,753
752,097
$
6.06 %
3.73
1.16
1.90
4.23
4.86
0.18
0.54
0.39
1.93
1.54
2.70
2.87
1.59
149
1,304
511
13,610
15,574
11
477
16,062
0.56
1.07
1.33
2.76
2.29
3.64
3.26
2.31
26,757
121,444
38,346
493,510
680,057
302
14,636
694,995
184,102
16,875
895,972
26,064
118,039
24,311
409,894
578,308
41
17,582
595,931
157,688
14,750
768,369
71,896
840,265
82
735
76
6,196
7,089
1
357
7,447
0.31
0.62
0.31
1.51
1.23
2.44
2.03
1.25
44
506
85
7,452
8,087
1
608
8,696
23,853
93,067
22,008
386,948
525,876
37
21,219
547,132
126,361
14,900
688,393
63,704
752,097
Shareholders’ equity
Total liabilities and shareholders’ equity
110,250
1,006,222
Net interest income
Net interest spread
Net interest margin
44,020
31,196
25,680
3.89
4.54 %
3.63
3.94 %
3.27
3.63 %
(1) Yields on loans and leases and securities have not been adjusted to a tax-equivalent basis because the impact is not material.
(2)
Includes average non-accrual loans and leases of $463,000 and $3.7 million for the year ended December 31, 2004 and 2003, respectively,
primarily reflecting the balance of the UAL Leveraged Lease.
(3) Net loan and lease fees of $3.1 million, $1.5 million and $1.2 million for the year ended December 31, 2005, 2004 and 2003, respectively,
are included in the yield computations.
Includes Federal Home Loan Bank stock.
(4)
-44-
As a result of the combination of: (1) interest income increased, primarily due to increase loan volume and
rising interest rates and (2) interest expense increased in response to the increasing interest rate environment , our
net interest margin increased to 4.54% in 2005 from 3.94% in 2004.
In addition to the distribution, yields and costs of our assets and liabilities, our net income is also affected
by changes in the volume of and rates on our assets and liabilities. The following table shows the change in interest
income and interest expense and the amount of change attributable to variances in volume, rates and the
combination of volume and rates based on the relative changes of volume and rates.
Year Ended December 31,
2005 vs. 2004
2004 vs. 2003
Net Change
Rate
Volume
Mix
Net Change
Rate
Volume
Mix
(In tho us ands )
$
18,397
851
2,159
$
8,336
585
1,837
$
10,061
266
322
0
$
0
0
$
3,747
616
(168)
$
(685)
(561)
188
$
4,442
1,179
(356)
$
(10)
(2)
0
11
23
52
(11)
(41)
34
21,441
10,799
10,642
67
569
435
7,414
10
120
8,615
65
547
370
5,943
1
188
7,113
2
22
65
1,471
9
(68)
1,502
$
12,826
$
3,686
$
9,140
0
0
0
0
0
0
0
0
0
0
0
45
27
9
(7)
36
34
0
0
4,267
(1,056)
5,335
(12)
38
229
(9)
(1,256)
0
(251)
(1,249)
34
81
(17)
(1,682)
0
(158)
(1,742)
4
149
8
423
0
(93)
491
0
(1)
0
3
0
0
2
$
5,516
$
686
$
4,844
$
(14)
Interest income:
Loans and leases
Investment securities
Federal funds sold and securities purchased
under resale agreements
Interest-bearing deposits with other banks
Other earning assets
Total interest income
Interest expense:
Interest-bearing demand
Money market
Savings
Time certificates of deposit
Short-term borrowings
Long-term debt
Total interest expense
Net interest income
As reflected above, due to our decision to increase our loan originations and to change the mix of our
investment portfolio by increasing the amount of higher yielding investment securities, most of the increase in our
net interest income during 2005 was attributable to a combination of increases in the volume of our interest earning
assets and increases in the cost of time certificates of deposit.
Provision for Loan and Lease Losses
The provision for loan and lease losses in each period is a charge against earnings in that period. The
provision is that amount required to maintain the allowance for loan and lease losses at a level that, in
management’s judgment, is adequate to absorb loan and lease losses inherent in the loan and lease portfolio.
The provision for loan and lease losses for 2005 was $2.1 million as compared to $1.6 million for 2004. In
2005, we experienced minimum net loan and lease recoveries of $105,000 as compared to net loan and lease
-45-
charge-offs of $1.0 million for 2004. The increase in our provision during 2005 represents the estimate of losses
inherent in the existing loan and lease portfolio that increased considerably from 2004.
The UAL Leveraged Lease
In November 1997, we purchased for $6.6 million a leveraged aircraft lease, with United Airlines as lessee,
subject to non-recourse debt outstanding at the time of $17.8 million. During 2002, United Airlines declared
bankruptcy. Despite various restructuring proposals made during the subsequent 18 months, the subject aircraft was
ultimately acquired by the non-recourse lender for the fair market value of the aircraft, an amount below the $15.0
million remaining loan balance, resulting in our investment being eliminated. As a result of these events, in 2002 we
made a $8.6 million provision to our allowance for loan and lease losses, and charged-off $3.1 million of this
investment. In 2003, we made an additional provision of $700,000 and charged-off $5.2 million. During 2004, we
charged-off the remaining $1.0 million on this leveraged lease and made no additional provision. Our entire
investment in the UAL Leveraged Lease has been charged-off as of May 31, 2004.
The following table summarizes the UAL Leveraged Lease, and the provision for losses, the specific
allowances and the charge-offs pertaining to the lease losses for the periods indicated:
(In thousands)
Total Lease Balance...................................................................
Provision in 2002.......................................................................
Charged-off in 2002 ..................................................................
Lease Balance at December 31, 2002
Provision in 2003.......................................................................
Charged-off in 2003 ..................................................................
Lease Balance at December 31, 2003 ...................................
Charged-off in May 2004 ..........................................................
UAL
Leveraged
Lease
Specific
Allowances
$
9,316 (1)
$
—
(3,084)
6,232
(5,232)
1,000
(1,000)
8,616
(3,084)
5,53
700
(5,232)
1,000
(1,000)
Lease Balance at December 31, 2004 ...................................
$
—
$
—
(1) The $9.3 million balance as of December 31, 2002 reflects the original lease investment of $6.4 million plus recognized lease income from
1997 to 2002 of $2.9 million.
Noninterest Income
We earn noninterest income primarily through fees related to:
•
•
•
services provided to deposit customers;
services provided in connection with trade finance; and
services provided to current and potential loan customers as well as loan pre-payment penalties.
In addition, we earn rental income from other real estate owned, such as 60 Federal, and income from
increases in the surrender value of bank owned life insurance policies, or BOLI.
-46-
The following table presents, for the periods indicated, the major categories of noninterest income:
Service charges and fees on deposit accounts
Trade finance income
Increase in cash surrender value of life insurance
Net other real estate owned income
Gain on sale of investment securities, net
Other income
Total noninterest income
Ye ar Ende d
De ce mbe r 31,
2005
2004
2003
(In tho us a nds )
$
2,297
707
312
195
-
357
$
2,393
729
316
526
35
200
$
2,419
677
347
227
1,111
142
$
3,868
$
4,199
$
4,923
Total noninterest income decreased by $331,000 or 7.9%, to $3.9 million during 2005 from $4.2 million
during 2004. The decline in noninterest income was attributed to a decrease in operating income from the other real
estate owned (OREO) property sold in the first quarter of 2005 and decrease in deposit fee income due to an
increase in the Bank’s earnings allowance which customers’ earning on their deposit increase while bank’s service
charges and fees on deposit accounts decreased with rising interest rate environment.
Our results can be influenced by the unpredictable nature of gains and losses in connection with the sale of
investment securities and other real estate owned. We do not engage in active securities trading; however, from time
to time we sell securities in our portfolio to realize gains or reduce losses, and to rebalance our portfolio. It is likely
we will continue this practice in the future. From time to time, we acquire real estate in connection with non-
performing loan transactions, and sell such real estate to recoup a portion of the principal amount of the defaulted
loans. These sales can result in gains or losses from time to time that are not expected to occur in predictable
patterns during future periods.
Service charges on deposit accounts increased primarily due to increase in non-sufficient funds charges and
account analysis fees associated with demand deposit activities.
Noninterest Expense
Noninterest expense is the cost, other than interest expense and the provision for loan and lease losses,
associated with providing banking and financial services to customers and conducting our business.
The following table presents, for the periods indicated, the major categories of noninterest expense:
Ye ar Ende d
De ce mbe r 31,
2005
2004
2003
(In tho us a nds )
$
10,252
2,163
444
1,534
867
2,311
$
9,741
1,826
250
855
754
1,913
$
8,733
1,745
270
799
721
1,506
$
17,571
$
15,339
$
13,774
Salaries and employee benefits
Net occupancy expense
Business development and promotion expense
Professional fees
Office supplies and equipment expense
Other expense
Total noninterest expense
-47-
Total noninterest expense increased $2.2 million, or 14.6%, to $17.5 million during 2005 from
$15.3 million during 2004. Salaries and employee benefits increased $1.0 million, or 5.2%, as a result of an increase
in the number of employees and employee benefits. We had 122 and 113 full-time equivalent employees at
December, 2005 and 2004, respectively. We also opened two new branch offices in 2005 which resulted in an
increase of the occupancy expense. Our professional expenses included the audit fees also increased significantly in
connection with additional reporting and compliance requirements as a public company.
Provision for Income Taxes
We recorded a tax provision of $11.4 million for 2005 and $7.4 million for 2004. Our effective tax rates
were 40.4% and 39.7% for 2005 and 2004, respectively, as compared to the expected effective tax rate of 42.1%.
The difference from the expected rates in both periods is due to the nontaxable nature of income from municipal
securities and BOLI.
Financial Condition
For the period between December 31, 2004 and December 31, 2005, our assets, loans and deposits grew at
the rate of 25.3%, 25.2% and 21.7%, respectively. Our total assets at December 31, 2005 were $1.1 billion
compared to $907.3 million at December 31, 2004. Our earning assets at December 31, 2005 totaled $1.1 billion
compared to $847.1 million at December 31, 2004. Total deposits at December 31, 2005 and December 31, 2004
were $975.5 million and $801.5 million, respectively.
Loans and Leases
The largest component of our assets and source of interest income is our loan portfolio. The following table
sets forth the amount of our loans and leases outstanding at the end of each of the periods indicated. We had no
foreign loans or energy-related loans as of the dates indicated.
Loans and leases:
Real estate—mini-perm
Real estate—construction
Commercial
Trade finance
Consumer
Leases receivable and other
Total gross loans and leases
Less: allowance for loan and lease losses
Deferred loan and lease fees, net
Total net loans and leases
Ye a r Ende d De c e mbe r 3 1,
2 0 0 5
2 0 0 4
2 0 0 3
2 0 0 2
2 0 0 1
$
372,251
$
358,220
$
250,993
$
214,661
$
138,829
171,646
149,428
76,700
121
997
112,002
98,547
45,951
222
1,018
94,816
117,607
37,829
348
2,460
85,584
108,767
31,439
446
7,615
78,031
122,808
31,687
409
2,396
771,143
615,960
504,053
448,512
374,160
(8,939)
(1,537)
(6,724)
(2,383)
(6,168)
(1,395)
(9,257)
(1,212)
(4,906)
(865)
$
760,667
$
606,853
$
496,490
$
438,043
$
368,389
Our total loans and leases increased by $155.2 million, or 25.2% between December 31, 2005 and
December 31, 2004. This follows increases of $111.9 million, or 22.2% between December 31, 2004 and 2003,
$55.5 million, or 12.4% between December 31, 2003 and 2002, and $74.4 million, or 19.9% between December
2002 and 2001. Most of this loan growth has been in real estate construction loans and commerical loans. This
growth reflects the strong real estate economy in the Southern California market during this period.
Our real estate mini-perm loan portfolio grew during 2005 by $14.0 million, or 3.9%, to $372.3 million at
December 31, 2005 from $358.2 million at December 31, 2004, and grew in 2004 by $107.2 million, or 42.7%,
-48-
from $251.0 million at December 31, 2003. This follows a $36.3 million, or 16.9% increase at December 31, 2003
compared to December 31, 2002. We believe this growth reflects a combination of our marketing efforts as well as
a reduction of competition for permanent financing for smaller retail and office properties from other sources, such
as insurance companies, during portions of this period. We are unable to predict whether these other sources will
provide permanent financing on these properties at higher levels. If they or other sources offer permanent financing
on these properties, we may not be able to continue to grow our portfolio at rates experienced in 2004 and 2005.
The following table provides information about our real estate mini-perm portfolio by property type:
Prope rty Type
Commercial/Office
Industrial
Retail
Apartment 4+
Residential 1-4
Other
Total
At De ce mbe r 31, 2005
Pe rce ntage of Loans
in Each C ate gory in
Total Loan Portfolio
Amount
(Do lla rs in tho us a nds )
75,530
51,623
99,304
43,206
34,003
68,585
372,251
9.79 %
6.69
12.88
5.60
4.41
8.90
48.27 %
$
$
Real estate construction loans grew significantly during 2005 by $59.6 million or 53% to $171.6 million at
December 31, 2005 from $112.0 million at December 31, 2004, and grew in 2004 by $17.2 million or 18.1%, from
December 31, 2003, and grew in 2003 by $9.2 million, or 10.8%, from $85.6 million at December 31, 2002. This
follows a modest increase of $7.55 million, or 9.68%, at December 31, 2002 compared to December 31, 2001. We
expect the construction portfolio will continue to grow subject to market conditions and interest rates.
Commercial loans outstanding at December 31, 2005 increased significantly by $50.9 million, or 51.6%, to
$149.4 million at December 31, 2005 from $98.5 million at December 31, 2004, and decreased modestly in 2004 by
$19.1 million, or 16.2%, from $117.6 million at December 31, 2003. Total commercial loan commitments
(including undisbursed amounts) at December 31, 2005 increased $45.7 million or 22.4% to $249.4 million
compared to $203.7 million at December 31, 2004. During this period, the rate of credit utilization increased from
48.4% at December 31, 2004 to 59.9% at December 31, 2005 causing the higher balance of outstanding commercial
loans. We believe increased utilization of commercial loan is due to increased working capital requirements of some
of our larger distribution customers. Subject to market conditions and interest rates, we intend to expand our
commercial loans in the future through enhanced marketing efforts and expansion of our branch network.
Trade finance loans grew significantly during 2005 by $30.7 million, or 66.9%, to $76.7 million at
December 31, 2005, and grew in 2004 by $8.1 million, or 21.5%, from $37.8 million at December 31, 2003. We
believe this increase is due to higher utilization of existing credit lines as well as the addition of new customers.
comparable to that of our commercial loan customers as well as continued caution by us in the application of our
underwriting standards. It is possible that if the U.S. dollar continues to weaken against other foreign currencies, as
it has during 2004, the cost of imported goods will increase, which could have an adverse impact on some of our
customers who import goods for resale in the United States.
Leases receivable and other loans declined during 2005 by $21,000, or 2.1%, to $1.0 million at December
31, 2005 slightly from December 31, 2004, and declined by $1.4 million, or 58.6%, from $2.5 million at December
31, 2003. In 2004, the decline was principally due to the $1.0 million charge-offs with respect to the UAL
Leveraged Lease.
-49-
Non-Performing Assets
Generally, loans and leases are placed on non-accrual status when they become 90 days or more past due
or at such earlier time as management determines timely recognition of interest to be in doubt. Accrual of interest is
discontinued on a loan or lease when management believes, after considering economic and business conditions and
collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful.
We had no OREO property as of December 31, 2005. We sold an OREO property at 60 Federal on March
15, 2005. For the year ended December 31, 2005, our OREO income was $195,000 compared to $526,000 for the
period ended December 31, 2004.
We record OREO properties at the lower of the carrying value of the loan or fair market value of the
property based on current appraisals, less estimated selling costs.
The following table summarizes the loans and leases for which the accrual of interest has been
discontinued and loans and leases more than 90 days past due and still accruing interest, including those loans and
leases that have been restructured, and OREO:
Non-accrual loans and leases, not restructured
Accruing loans and leases past due 90 days or more
Restructured loans and leases
T otal non-performing loans (NPLs)
OREO
Year Ended December 31,
2005
2004
2003
2002
2001
$ —
$
382
$
1,000
$
6,235
$
2,077
(Dollars in thousands)
—
—
—
—
—
—
—
—
—
—
382
8,258
(2)
1,000
8,258
(1)
(2)
6,235(1)
8,188
(1)
(2)
3,956
—
6,033
795
T otal non-performing assets (NPAs)
$ —
$
8,641
$
9,258
$
14,423
$
6,828
Selected ratios:
NPLs to total loans and leases held for investment
NPAs to total assets
______________________________
(1) Represents the UAL Leveraged Lease.
(2) Represents 60 Federal.
0.00%
0.00%
0.06%
0.95%
0.20%
1.22%
1.39%
2.04%
1.61%
1.04%
The amount of interest income that we would have recorded on non-accrual and impaired loans and leases
had the loans and leases been current totaled $41,000, $15,000, $132,000, $26,000 and $633,000 for 2005, 2004,
2003, 2002 and 2001 respectively. All payments received on loans classified as non-accrual are applied first to
principal.
Impaired Loans and Leases
Impaired loans and leases are commercial, commercial real-estate, other real-estate related and individually
significant mortgage and consumer loans and leases for which it is probable that we will not be able to collect all
amounts due according to the contractual terms of the loan or lease agreement. The category of impaired loans and
leases is not comparable with the category of non-accrual loans and leases, although the two categories overlap.
Non-accrual loans and leases include impaired loans and leases that are not reviewed on an individual basis for
impairment. Management may choose to place a loan or lease on non-accrual status due to payment delinquency or
uncertain collectibility, while not classifying the loan or lease as impaired if it is probable that we will collect all
amounts due in accordance with the original contractual terms of the loan or lease or the loan or lease is not a
commercial, commercial real estate, other real estate related or an individually significant mortgage or consumer
loan or lease.
-50-
In determining whether or not a loan or lease is impaired, we apply our normal loan and lease review
procedures on a case-by-case basis taking into consideration the circumstances surrounding the loan or lease and
borrower, including the collateral value, the reasons for the delay, the borrower’s prior payment record, the amount
of the shortfall in relation to the principal and interest owed and the length of the delay. We measure impairment on
a loan-by-loan basis using either the present value of expected future cash flows discounted at the loan’s or lease’s
effective interest rate or at the fair value of the collateral if the loan or lease is collateral dependent, less estimated
selling costs. Loans or leases for which an insignificant shortfall in amount of payments is anticipated, but where we
expect to collect all amounts due, are not considered impaired.
We had $800,000, $382,000 and $1 million of impaired loans or leases at December 31, 2005, 2004, and
2003 respectively. The total allowance for loan and lease losses related to these loans and leases was $300,000,
$57,000 and $850,000 at December 31, 2005, 2004 and 2003, respectively.
At December 31, 2005, we had no loans not disclosed above as non-accrual loans, as to which management
has serious doubts as to the ability of the borrower to comply with the present loan repayment terms.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is maintained at a level which, in management’s judgment, is
adequate to absorb loan and lease losses inherent in the loan and lease portfolio. The amount of the allowance is
based on management’s evaluation of the collectibility of the loan and lease portfolio and that evaluation is based on
historical loss experience and other significant factors. These other significant factors include the level and trends in
delinquent, non-accrual and adversely classified loans and leases, trends in volume and terms of loans and leases,
levels and trends in credit concentrations, effects of changes in underwriting standards, policies, procedures and
practices, national and local economic trends and conditions, changes in capabilities and experience of lending
management and staff and other external factors including industry conditions, competition and regulatory
requirements.
We must maintain an adequate allowance for loan and lease losses, or ALLL, based on a comprehensive
methodology that assesses the probable losses inherent in the loan portfolio. The appropriateness of both the
methodology and the adequacy of the ALLL are the responsibility of the Chief Credit Officer under the supervision
of our board of directors. Each quarter end, our Chief Credit Officer must assess the methodology and adequacy of
the ALLL, representing that they comply with applicable banking regulations and generally accepted accounting
principles.
Like all financial institutions, we maintain an ALLL based on a number of quantitative and qualitative
factors, including those discussed above. Provisions for loan and lease losses are provided on both a specific and
general basis. Specific allowances are provided for specific credits for which the expected/anticipated loss is
measurable. General valuation allowances are based on the historical loss experience in those categories covering
the most recent eight quarters, as well as factors noted above.
The table below summarizes loans and leases, average loans and leases, non-performing loans and leases
and changes in the allowance for loan and lease losses arising from loan and lease losses and additions to the
allowance from provisions charged to operating expense:
-51-
Allowance For Loan Losses & Loss Histories
Year Ended December 31,
2005
2004
2003
2002
2001
(Do llars in tho us a nds )
$
6,724
$
6,168
$
9,257
$
4,906
$
4,391
5
0
0
0
0
0
5
103
0
0
0
1,000
0
1,103
39
74
0
0
5,232
0
5,345
1,947
653
0
549
3,084
1
6,234
222
8
0
0
219
0
449
110
0
0
0
0
0
110
(105)
2,110
8,939
$
106
0
0
0
0
3
109
994
1,550
6,724
$
45
111
0
0
0
0
156
5,189
2,100
6,168
$
16
60
0
363
0
0
439
5,795
10,146
9,257
$
64
0
0
0
0
0
64
385
900
4,906
$
771,143
692,320
0
615,961
541,402
382
504,063
466,793
1,000
448,512
418,845
6,418
374,160
338,097
6,033
Allowance for loan losses:
Balance at beginning of period
Actual charge-offs:
Commercial
Trade finance
Construction
Real estate (mini-perm)
Leveraged lease
Other (credit card)
Total charge-offs
Less recoveries:
Commercial
Trade finance
Construction
Real estate (mini-perm)
Leveraged leases
Other
Total recoveries
Net loans charged-off (recovered)
Provision for loan losses
Balance at end of period
Total loans at end of period
Average total loans and leases
Non-performing loans and leases
Selected ratios:
Net charge-offs (recoveries) to average loans and
Provision for allowance for loan and lease losses
(0.02) %
0.18 %
1.11 %
1.38 %
0.11 %
to average loans and leases
0.30 %
0.29 %
0.45 %
2.42 %
0.27 %
Allowance for loan and lease losses to loans and
leases at end of period
Allowance for loan and lease losses to
non-performing loans and leases
1.16 %
1.09 %
1.22 %
2.06 %
1.31 %
n.m.
1758.64 %
616.8 %
144.23 %
81.32 %
The allowance for loan and lease losses of $8.9 million at December 31, 2005, represented 1.16% of total
loans and leases, net of deferred fees and costs. At December 31, 2004, the allowance for loan and lease losses
totaled $6.7 million, or 1.09% of total loans and leases, net of deferred fees and costs, and 1758.6% of non-
performing loans and leases as of that date. At December 31, 2003, the allowance for loan and lease losses totaled
$6.2 million, or 1.22% of total loans and leases, net of deferred fees and costs, and 616.8% of non-performing loans
and leases. Net charge-offs (recoveries) to average loans and leases were (0.02)% for 2005 compared to 0.18% for
the year ended December 31, 2004. See “—Critical Accounting Policies,” and Note 5 of the “Notes to Financial
Statements.” Of the total net loan and lease charge-offs during 2004 and for each of 2003 and 2002, charge-offs of
the UAL Leveraged Lease represented 100.60%, 100.83%, and 53.22%.
-52-
In allocating our allowance for loan and lease losses, management has considered the credit risk in the
various loan and lease categories in our portfolio. As such, the allocations of the allowance for loan and lease losses
are based upon average historical net loan and lease loss experience and the other factors discussed above. While
every effort has been made to allocate the allowance to specific categories of loans, management believes that any
allocation of the allowance for loan and lease losses into loan categories lends an appearance of precision that does
not exist.
The following table indicates management’s allocation of the allowance and the percent of loans in each
category to total loans and leases as of each of the following dates:
At December 31,
2005
2004
2003
2002
2001
Percent
of Loans
in Each
Percent
of Loans
in Each
Percent
of Loans
in Each
Percent
of Loans
in Each
Percent
of Loans
in Each
Allocation
Category
Allocation Category
Allocation Category
Allocation Category
Allocation Category
of the
Allowance
in Total
Loans
of the
Allowance
in Total
Loans
of the
Allowance
in Total
Loans
of the
Allowance
in Total
Loans
of the
Allowance
in Total
Loans
(Do llars in tho us ands )
Commercial*
$
2,312
19.4 %
$
1,511
16.0 %
$
1,390
23.3 %
$
1,392
24.2 %
$
1,487
31.8 %
Trade finance*
Real estate construction*
Real estate (mini-perm)*
Lease
Other
Unallocated
1,231
1,837
3,513
5
6
35
9.9
22.3
48.2
0.1
0.1
0.0
645
1,064
3,456
7
4
37
7.5
18.2
58.1
0.1
0.1
0.0
438
508
2,132
861
12
827
7.5
18.8
49.8
0.4
0.2
0.0
556
623
1,662
4,380
12
632
7.0
19.1
47.9
1.6
0.2
0.0
481
408
1,024
433
5
1,068
8.3
20.9
36.4
2.4
0.2
0.0
Total
$
8,939
100.0 %
$
6,724
100.0 %
$
6,168
100.0 %
$
9,257
100.0 %
$
4,906
100.0 %
*These categories include watch list credits.
As noted above, we reserved for the UAL Leveraged Lease in 2002 and wrote the remaining balance off in
2003 and 2004. Since this was the only asset of its type, we have not established a “lease portfolio” category for
lease loss analysis nor allocation within the overall ALLL. After 2000, we revised our methodology to allocate the
allowance more specifically among the various portfolios utilizing qualitative factors including concentrations and
trends within the portfolio.
Allowance for Losses Related to Undisbursed Loan and Lease Commitments
We maintain a reserve for undisbursed loan and lease commitments. Management estimates the amount of
probable losses by applying the loss factors used in our allowance for loan and lease loss methodology to our
estimate of the expected usage of undisbursed commitments for each loan and lease type. The allowance for
undisbursed loan and lease commitments totaled $110,000, $200 and $102,000 at December 31, 2005, 2004 and
2003, respectively. Because the amount were insignificant, we included them in the allowance for loan and lease
losses.
-53-
Investment Securities Available for Sale
Our portfolio of investment securities consists primarily of U.S. Treasury securities, government agencies,
investment grade corporate notes, mortgage-backed securities, municipal bonds and FHLMC preferred stock, which
is included in other securities. We carry our entire securities portfolio as available-for-sale securities. We invest in
securities to generate interest income and to maintain a liquid source of funding for our lending and other
operations, including withdrawals of deposits. While we do not engage in active trading in our investment securities
portfolio, we have realized and intend to realize gains from sales of selected securities primarily in response to
changes in interest rates. At December 31, 2005, investment securities available-for-sale with a carrying value of
$80 million was pledged to secure public deposits.
The carrying value of our investment securities at December 31, 2005 totaled $162.9 million compared to
$164.6 million at December 31, 2004. During 2005, we maintained our investment securities portfolio which
reflects continuing growth in our deposits and a strategic decision to maintain liquidity. The carrying value of our
portfolio of investment securities at December 31, 2005, 2004 and 2003 was as follows:
Es tima te d Ma rke t Va lue
At De c e mbe r 3 1,
2 0 0 5
2 0 0 4
2 0 0 3
U.S. Treasury securities
U.S. Government agencies
Corporate notes
Mortgage-backed securities
Municipal securities
Other securities
Total securities available-for-sale
$ —
85,238
36,463
16,003
19,387
5,844
162,935
$
(In tho us a nds )
$ —
71,027
53,913
12,713
19,111
7,871
164,635
$
$
1,016
36,321
72,217
17,579
26,127
2,609
155,869
$
The following table shows the maturities of investment securities at December 31, 2005, and the weighted
average yields of such securities (municipal securities are not on a tax-equivalent basis):
Within O ne Year
Amount
Yield
After O ne Year
but within
Five Years
Amount
Yield
After Five Years
but within
Ten Years
Amount
After Ten Years
Total
Yield
Amount
Yield
Amount
Yield
At December 31, 2005
(Do llars in tho us ands )
U.S. Treasury Securities
U.S. Government Agencies
Corporate notes
Mortgage-backed securities
Municipal securities
Other securities
Total securities available-
for-sale
61,724
17,831
$ — — % $ — — % $ — — % $ — — % $ —
85,238
36,463
16,003
19,387
5,844
18,219
3.64
1,034
6.12
3.39
202
— —
— —
4.17
6.64
— —
— —
— —
— —
6.32
3.91
5.58
5.00
3.24
4.39
— —
— —
4.13
13,784
15,801
19,387
2,397
5,295
3,814
3,447
$
83,002
3.35 %
$
19,455
3.77 %
$
9,109
5.20 %
$
51,369
5.24 %
$
162,935
— %
3.38
5.40
3.90
5.58
4.49
4.10 %
The following table shows the maturities of investment securities at December 31, 2004, and the weighted
average yields of such securities (municipal securities are not on a tax-equivalent basis):
-54-
After O ne Year
After Five Years
After Ten Years
Total
At December 31, 2004
Within O ne Year
Amount
Yield
but within
Five Years
Amount
Yield
but within
Ten Years
Amount
Yield
Amount
Yield
Amount
Yield
(Do llars in tho us ands )
23,972
27,269
3,946
$ — — % $ — — % $ — — % $ — — % $ —
71,027
53,913
12,713
19,111
7,871
— —
8.22
4.21
4.07
2.38
— —
6.69
3.29
3.79
— —
2.89
5.59
3.23
3.65
— —
2.23
2.52
2.59
— —
2.49
47,056
19,794
6,616
1,936
1,502
765
11,669
2,519
5,347
1,386
5,506
5,352
$
60,539
2.40 %
$
75,402
3.62 %
$
12,239
4.95 %
$
16,455
4.17 %
$
164,635
— %
2.66
4.18
3.10
3.94
2.45
3.33 %
U.S. Treasury Securities
U.S. Government Agencies
Corporate notes
Mortgage-backed securities
Municipal securities
Other securities
Total securities available-
for-sale
Additional information concerning investment securities is provided in Note 4 of the “Notes to Financial
Statements” contained elsewhere in this offering circular.
Deposits
Total deposits were $975.5 million at December 31, 2005 compared to $801.5 million at December 31,
2004. Noninterest-bearing demand deposits increased to $211.9 million at December 31, 2005 compared to $180.8
million at December 31, 2004. The ratio of noninterest-bearing deposits to total deposits was 21.7% at December
31, 2005 and 22.6% at December 31, 2004. Interest-bearing deposits are comprised of money market accounts,
regular savings accounts, time deposits of under $100,000 and time deposits of $100,000 or more.
The following table shows the average amount and average rate paid on the categories of deposits for each
of the periods indicated:
2005
Year Ended December 31,
2004
2003
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Noninterest-bearing deposits
Interest-bearing demand deposits
Money market
Savings
Time certificates of deposit
Total
$
184,102
26,757
121,444
38,346
493,510
864,159
$
0.00 %
0.56
1.07
1.33
2.76
2.29 %
157,688
26,064
118,039
24,311
409,894
735,996
$
0.00 %
0.31
0.62
0.31
1.51
0.96 %
126,361
23,853
93,067
22,008
386,948
652,237
$
0.00 %
0.18
0.54
0.39
1.93
1.23 %
(Do llars in tho us ands )
$
$
Average total deposits increased steadily through 2005. The increase in average total deposits for 2005 was
primarily driven by increases of $83.6 million in time certificates of deposit and $26.4 million in noninterest bearing
demand deposits. Additional information concerning deposits is provided in Note 7 of the “Notes to Financial
Statements” contained elsewhere in the offering circular.
The largest component of our deposits has been, and in the near term is likely to be, time certificates of
deposit of $100,000 or more. We market and receive time certificates of deposit from our existing and new high net
worth customers, especially from the Chinese communities within our branch network. While we do not attempt to
be a market leader in offered interest rates, we attempt to offer competitive rates on these time certificates of deposit
within a range offered by other banks with which we compete.
-55-
The following table shows the maturities of time certificates of deposit and other time deposits of $100,000
or more at December 31, 2005:
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
Capital Resources
At De ce mbe r 31,
2005
(In tho us a nds )
299,799
$
99,870
155,648
5,222
560,539
$
Current risk-based regulatory capital standards generally require banks to maintain a ratio of “core” or
“Tier 1” capital (consisting principally of common equity) to risk-weighted assets of at least 4%, a ratio of Tier 1
capital to adjusted total assets (leverage ratio) of at least 4% and a ratio of total capital (which includes Tier 1
capital plus certain forms of subordinated debt, a portion of the allowance for loan and lease losses and preferred
stock) to risk-weighted assets of at least 8%. Risk-weighted assets are calculated by multiplying the balance in each
category of assets by a risk factor, which ranges from zero for cash assets and certain government obligations to
100% for some types of loans, and adding the products together.
Our goal is to exceed the minimum regulatory capital requirements for well-capitalized institutions. At
December 31, 2005, our capital ratios were above the minimum requirements for well-capitalized institutions. In the
future, we intend to make minor adjustments and increase our investment securities portfolio, such as reducing our
investments in corporate notes, which are 100% risk weighted assets, and increasing our investments in mortgage-
backed securities or U.S. agency notes, which are generally 20% risk weighted assets. In addition, in the future, we
intend to originate credit lines when possible for 365 days or less, which are 0% risk weighted assets, instead of 366
days or more, which are 50% risk weighted assets. We believe that our existing capital will be sufficient for the
foreseeable future to satisfy minimum regulatory capital requirements, including as those increase due to our
presently anticipated growth in our loan portfolio.
At December 31, 2005
At December 31, 2004
Leverage Ratio
Preferred Bank................................................................................
Minimum requirement for “Well-Capitalized” institution .............
Minimum regulatory requirement...................................................
Tier 1 Risk-Based Capital Ratio
Preferred Bank................................................................................
Minimum requirement for “Well-Capitalized” institution .............
Minimum regulatory requirement...................................................
Total Risk-Based Capital Ratio
Preferred Bank................................................................................
Minimum requirement for “Well-Capitalized” institution .............
Minimum regulatory requirement...................................................
11.63%
5.00%
4.00%
12.59%
6.00%
4.00%
13.51%
10.00%
8.00%
9.30%
5.00%
4.00%
9.33%
6.00%
4.00%
10.15%
10.00%
8.00%
-56-
Contractual Obligations and Off-Balance Sheet Arrangements
The following table presents our contractual cash obligations, excluding deposits, as of December 31,
2005:
Contractual Obligations
(1)
FHLB Advances
Operating Lease Obligations
Total
Amount of Commitment Expiring Per Period
Total
Amounts
Committed
$
$
20,000
6,194
26,194
Less Than
1 Year
$ —
1,328
1,328
$
1-3 Years
(In thousands)
3-5 Years After 5 Years
$
$
12,000
2,443
14,443
$
$
8,000
1,343
9,343
$ —
1,080
1,080
$
(1) Contractual obligations do not include interest.
In the normal course of business, we enter into off-balance sheet arrangements consisting of commitments
to fund commercial letters of credit and standby letters of credit. The following table presents these off-balance
sheet arrangements at December 31, 2005:
Amount of Commitment Expiring Per Period
Other Commitments
Commercial letters of credit
Standby letter of credit
Total
Liquidity
Total
Amounts
Committed
Less Than
1 Year
$
$
11,023
8,363
19,386
$
$
11,023
6,963
17,986
1-3 Years
3-5 Years After 5 Years
(In thousands)
$ —
1,400
1,400
$
$ —
$
-
— —
$ —
$
-
Based on our existing business plan, we believe that our level of liquid assets is sufficient to meet our
current and presently anticipated funding needs. During the balance of 2004, and for the near term, we intend to
continue the reduction of our lower yielding liquid assets, such as federal funds sold, and increasing our loan
portfolio and higher yielding investment securities.
We rely on deposits as the principal source of funds and, therefore, must be in a position to service
depositors’ needs as they arise. We attempt to maintain a loan-to-deposit ratio below approximately 90%. Our loan-
to-deposit ratio was 78.0% at December 31, 2005 and 75.7% at December 31, 2004.
Borrowings from the Federal Home Loan Bank of San Francisco, or FHLBSF, is another source of funding
for our loan and investment activities. We may lend up to 90% of our borrowings from the FHLBSF that are
securitized by certain loans. At December 31, 2005, we could borrow up to $22.2 million with collateral of
specifically identified loans and securities. We intend to explore the feasibility of utilizing the FHLBSF as a source
of funding to a greater extent than we have in the past. At December 31, 2005, our borrowing line with the FHLBSF
was $42.2 million We also attempt to maintain a liquidity ratio (liquid assets, including cash and due from banks,
federal funds sold and investment securities not pledged as collateral expressed as a percentage of total deposits)
above approximately 18%. Our liquidity ratio was 30.0% at December 31, 2005 and 28.6% at December 31, 2004.
Subject to prevailing market and other conditions, we will seek to reduce our liquidity ratio, which had increased
during 2003, in response to the UAL Leveraged Lease and growth of our deposits, by increasing our loan portfolio
consistent with our underwriting standards, and possibly funding a greater portion of our loans and certain
investment securities with borrowings from the FHLBSF.
-57-
We believe that if the level of liquid assets (our primary liquidity) does not meet our liquidity needs, other
available sources of liquid assets (our secondary liquidity), including the purchase of federal funds, sales of
securities under agreements to repurchase, sales of loans, discount window borrowings from the Federal Reserve
Bank (where we maintain a borrowing line of $9.5 million) and the FHLBSF, could be employed to meet those
current and presently anticipated funding needs.
In assessing our liquidity, we also take into account commitments to extend credit. The following table sets
forth our other significant commitments at December 31, 2005:
Other Commitments
Commitments to extend credit
Standby letter of credit
Total
Amount of Commitment Expiring Per Period
Total
Amounts
Committed
Less Than
1 Year
1-3 Years
3-5 Years After 5 Years
$
$
356,570
8,363
364,933
$
$
233,745
6,963
240,708
$
(In thousands)
120,827
1,400
122,227
$
812
$
$
1,186
— —
1,186
$
$
812
Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and
rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk arises primarily from
interest rate risk inherent in our lending and deposit taking activities. To that end, management actively monitors
and manages our interest rate risk exposure. We do not have any market risk sensitive instruments entered into for
trading purposes. We manage our interest rate sensitivity by matching the re-pricing opportunities on our earning
assets to those on our funding liabilities. Management uses various asset/liability strategies to manage the re-pricing
characteristics of our assets and liabilities designed to ensure that exposure to interest rate fluctuations is limited and
within our guidelines of acceptable levels of risk-taking. Hedging strategies, including the terms and pricing of
loans and deposits and managing the deployment of our securities, are used to reduce mismatches in interest rate re-
pricing opportunities of portfolio assets and their funding sources.
Interest rate risk is addressed by our Asset Liability Management Committee, or the ALCO, which is
comprised of the Chief Executive Officer, Chief Financial Officer and members of the board of directors. The
ALCO monitors interest rate risk by analyzing the potential impact on the net portfolio of equity value and net
interest income from potential changes in interest rates, and considers the impact of alternative strategies or changes
in balance sheet structure. The ALCO manages our balance sheet in part to maintain the potential impact on net
portfolio value and net interest income within acceptable ranges despite rate changes in interest rates.
Our exposure to interest rate risk is monitored continuously by senior management and is reviewed by the
ALCO at least eight times a year, and at least quarterly by our board of directors. Interest rate risk exposure is
measured using interest rate sensitivity analysis to determine our change in net portfolio value and net interest
income in the event of hypothetical changes in interest rates. If potential changes to net portfolio value and net
interest income resulting from our analysis of hypothetical interest rate changes are not within board-approved
limits, the board may direct management to adjust the asset and liability mix to bring interest rate risk within board-
approved limits. This analysis of hypothetical interest rate changes is performed on a monthly basis by a third party
vender utilizing detailed data that we provide to them.
Market Value of Portfolio Equity
We measure the impact of market interest rate changes on the net present value of estimated cash flows
from our assets, liabilities and off-balance sheet items, defined as market value of portfolio equity, using a
simulation model. This simulation model assesses the changes in the market value of interest rate sensitive financial
instruments that would occur in response to an instantaneous and sustained increase or decrease in market interest
rates.
-58-
The following table presents forecasted changes in net portfolio value using a base market rate and the
estimated change to the base scenario given an immediate and sustained upward and downward movement in
interest rates of 100 and 200 basis points at December 31, 2005.
Market Value of Portfolio Equity
Interest Rate S cenario
Up 200 basis points
Up 100 basis points
BASE
Down 100 basis points
Down 200 basis points
Percentage
Change
from Base
Percentage
of Total
Assets
Percentage of
Portfolio Equity
Book Value
Market Value
(Do lla rs in
tho us ands )
$
114,242
117,858
(6.50) %
(3.54)
122,184
—
123,427
123,093
1.02
0.74
10.05 %
92.25 %
10.37
10.75
10.86
10.83
95.16
98.66
99.66
99.39
The computation of prospective effects of hypothetical interest rate changes are based on numerous
assumptions, including relative levels of market interest rates, asset prepayments and deposit decay, and should not
be relied upon as indicative of actual results. Further, the computations do not contemplate any actions we may
undertake in response to changes in interest rates. Actual amounts may differ from the projections set forth above
should market conditions vary from the underlying assumptions.
Net Interest Income
In order to measure interest rate risk at December 31, 2005, we used a simulation model to project changes
in net interest income that result from forecasted changes in interest rates. This analysis calculates the difference
between net interest income forecasted using a rising and a falling interest rate scenario and a net interest income
forecast using a base market interest rate derived from the current treasury yield curve. The income simulation
model includes various assumptions regarding the re-pricing relationships for each of our products. Many of our
assets are floating rate loans, which are assumed to re-price immediately, and to the same extent as the change in
market rates according to their contracted index. Some loans and investment vehicles include the opportunity of
prepayment (embedded options), and accordingly the simulation model uses national indexes to estimate these
prepayments and reinvest their proceeds at current yields. Our non-term deposit products re-price more slowly,
usually changing less than the change in market rates and at our discretion.
This analysis indicates the impact of changes in net interest income for the given set of rate changes and
assumptions. It assumes no growth in the balance sheet and that its structure will remain similar to the structure at
year end. It does not account for all factors that impact this analysis, including changes by management to mitigate
the impact of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates
change. Furthermore, loan prepayment rate estimates and spread relationships change regularly. Interest rate
changes create changes in actual loan prepayment rates that will differ from the market estimates incorporated in
this analysis. Changes that vary significantly from the assumptions may have significant effects on our net interest
income.
For the rising and falling interest rate scenarios, the base market interest rate forecast was increased or
decreased on an instantaneous and sustained basis.
-59-
Sensitivity of Net Interest Income
December 31, 2005
Adjusted Net
Interest Income
(Do llars in
tho us ands )
$
60,526
56,376
Percentage
Change
from Base
Net Interest
Margin Percent
Net Interest Margin
Change (in basis
points)
15.85 %
7.91
52,243
—
51,486
50,621
(1.45)
(3.10)
5.55 %
5.16
4.79
4.72
4.64
76
37
—
(7)
(15)
Interest Rate S cenario
Up 200 basis points
Up 100 basis points
BASE
Down 100 basis points
Down 200 basis points
At December 31, 2005, we had $984.2 million in assets and $759.8 million in liabilities re-pricing within
one year. This means that $224.4 million more of our interest rate sensitive assets than our interest rate sensitive
liabilities will change to the then current rate (changes occur due to the instruments being at a variable rate or
because the maturity of the instrument requires its replacement at the then current rate). The ratio of interest-earning
assets to interest-bearing liabilities maturing or re-pricing within one year at December 31, 2005 is 129.5%. In
theory, this analysis indicates that at December 31, 2005, if interest rates were to increase, the gap would tend to
result in a higher net interest margin. However, changes in the mix of earning assets or supporting liabilities can
either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest
rate spread between an asset and its supporting liability can vary significantly while the timing of re-pricing of both
the asset and its supporting liability can remain the same, thus impacting net interest income. This characteristic is
referred to as basis risk, and generally relates to the re-pricing characteristics of short-term funding sources such as
certificates of deposit.
Gap Analysis
Another way to measure the impact that future changes in interest rates will have on net interest income is
through a cumulative gap measure. The gap represents the net position of assets and liabilities subject to re-pricing
in specified time periods.
The following table sets forth the distribution of re-pricing opportunities of our interest-earning assets and
interest-bearing liabilities, the interest rate sensitivity gap (that is, interest rate sensitive assets less interest rate
sensitive liabilities), cumulative interest-earning assets and interest-bearing liabilities, the cumulative interest rate
sensitivity gap, the ratio of cumulative interest-earning assets to cumulative interest-bearing liabilities and the
cumulative gap as a percentage of total assets and total interest-earning assets as of December 31, 2005. The table
also sets forth the time periods during which interest-earning assets and interest-bearing liabilities will mature or
may re-price in accordance with their contractual terms. The interest rate relationships between the re-priceable
assets and re-priceable liabilities are not necessarily constant and may be affected by many factors, including the
behavior of customers in response to changes in interest rates. This table should, therefore, be used only as a guide
as to the possible effect of changes in interest rates might have on our net interest margins.
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At December 31, 2005
Amounts Maturing or Re-pricing in
3 Months
or Less
3 to
12 Months
1 to
5 Years
More than
5 Years
Noninterest
Sensitive(1)
Total
(Dollars in thousands)
$ —
$ —
$ —
$ —
25,123
25,123
158,300
25,192
745,523
144
195
—
$
929,354
—
50,925
—
698
3,252
—
$
54,875
—
24,040
—
14,302
—
—
$
38,342
— —
—
—
—
55,388
—
—
158,300
155,545
745,523
15,144
—
—
$
55,388
3,943
29,695
58,761
$
7,390
29,695
1,136,720
$
$ —
$ —
$ —
$ —
211,942
211,942
202,986
299,599
1,500
—
—
$
504,085
$
425,269
929,354
504,085
425,269
—
255,718
—
—
—
$
255,718
$
(200,843)
984,229
759,803
224,426
—
5,222
20,000
—
—
$
25,222
$
13,120
1,022,571
785,025
237,546
—
—
—
—
—
$ —
$
55,388
1,077,959
785,025
292,934
202,986
560,539
21,500
15,907
123,846
1,136,720
$
—
—
—
15,907
123,846
351,695
$
$
(292,934)
ASSETS
Cash and due from banks
Federal funds sold and securities
purchased under resale agreements
Investment securities available-for-sale
Loans and leases—floating rate
Loans and leases—fixed rate
Certificates of deposit with other financial
institutions and other earning assets
Other assets(2)
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Noninterest-bearing demand deposits
Interest-bearing demand deposits, money
market and savings
Time certificates of deposit
Long-term debt
Other liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
GAP
Cumulative interest-earning assets
Cumulative interest-bearing liabilities
Cumulative GAP
Cumulative interest-earning assets to
cumulative interest-bearing liabilities
184.36%
129.54%
130.26%
137.32%
Cumulative GAP as % of:
Total assets
Interest-earning assets
37.41 %
39.31 %
19.74%
20.74%
20.90%
21.96%
25.77%
27.08%
(1) Assets or liabilities and equity which are not interest rate-sensitive.
(2) Allowance for loan and lease losses of $8.9 million as of December 31, 2005 is included in other assets.
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At December 31, 2004
Amounts Maturing or Re-pricing in
3 Months
or Less
3 to
12 Months
1 to
5 Years
More than
5 Years
Noninterest
Sensitive(1)
Total
(Dollars in thousands)
$ —
$ —
$ —
$ —
35,212
35,212
73,000
11,181
557,270
1,812
—
—
$
643,263
—
42,579
32,291
807
4,402
—
$
80,079
—
62,142
—
831
950
—
$
63,923
— —
—
—
—
43,381
—
13,844
73,000
159,283
589,561
17,294
—
—
$
57,225
2,609
24,959
62,780
$
7,961
24,959
907,270
$
$ —
$ —
$ —
$ —
180,849
180,849
171,974
279,662
5,000
—
—
$
456,636
$
186,627
643,263
456,636
186,627
—
168,463
5,000
—
—
$
173,463
$
(93,384)
723,342
630,099
93,243
—
587
5,000
—
—
$
5,587
$
58,336
787,265
635,686
151,579
—
—
—
—
—
$ —
$
57,225
844,490
635,686
208,804
171,974
448,712
15,000
13,927
76,808
907,270
$
—
—
—
13,927
76,808
271,584
$
$
(208,804)
AS SETS
Cash and due from banks
Federal funds sold and securities
purchased under resale agreements
Investment securities available-for-sale
Loans and leases—floating rate
Loans and leases—fixed rate
Certificates of deposit with other financial
institutions and other earning assets
Other assets(2)
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Noninterest-bearing demand deposits
Interest-bearing demand deposits, money
market and savings
Time certificates of deposit
Long-term debt
Other liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
GAP
Cumulative interest-earning assets
Cumulative interest-bearing liabilities
Cumulative GAP
Cumulative interest-earning assets to
cumulative interest-bearing liabilities
140.87%
114.80%
123.84%
132.85 %
Cumulative GAP as % of:
Total assets
Interest-earning assets
20.57%
22.03%
10.28%
11.01%
16.71%
17.89%
23.01 %
24.65 %
(1) Assets or liabilities and equity which are not interest-rate sensitive.
(2) Allowance for loan and lease losses of $6.2 million as of December 31, 2004 is included as a reduction of other assets.
Gap analysis has certain limitations. Measuring the volume of re-pricing or maturing assets and liabilities
does not always measure the full impact on the portfolio value of equity or net interest income. Gap analysis does
not account for rate caps on products, dynamic changes such as increasing prepayment speeds as interest rates
decrease, basis risk, embedded options or the benefit of no-rate funding sources. The relation between product rate
re-pricing and market rate changes (basis risk) is not the same for all products. The majority of interest-earning
assets generally re-price along with a movement in market rates, while non-term deposit rates in general move more
slowly and usually incorporate only a fraction of the change in market rates. Products categorized as non-rate
sensitive, such as our noninterest-bearing demand deposits, in the gap analysis behave like long term fixed rate
funding sources. These factors tend to make our actual behavior more asset sensitive than is indicated in the gap
analysis. We have experienced higher net interest income when rates rise, and lower net interest income when rates
-62-
fall. Therefore, we use income simulation, net interest income rate shocks and market value of portfolio equity as
our primary interest rate risk management tools.
The market value of portfolio equity and net interest income analyses under various interest rate shock
scenarios described above indicate that we were asset sensitive at September 30, 2004. As a result, we believe that
our balance sheet should generally be positively impacted by a rising interest rate environment.
Recent Accounting Pronouncements
In December 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of
Position No. 03-3 (“SOP 03-3”), Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-
3 addresses the accounting for differences between contractual cash flows and the cash flows expected to be
collected from purchased loans or debt securities if those differences are attributable, in part, to credit quality. SOP
03-3 requires purchased loans and debt securities to be recorded initially at fair value based on the present value of
the cash flows expected to be collected with no carryover of any valuation allowance previously recognized by the
seller. Interest income should be recognized based on the effective yield from the cash flows expected to be
collected. To the extent that the purchased loans or debt securities experience subsequent deterioration in credit
quality, a valuation allowance would be established for any additional cash flows that are not expected to be
received. However, if more cash flows subsequently are expected to be received than originally estimated, the
effective yield would be adjusted on a prospective basis. SOP 03-3 is effective for loans and debt securities acquired
by the Company after December 15, 2004. The adoption of this Statement on January 1, 2005 did not have a
material impact on the Company's financial position, results of operations, or cash flows.
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This Statement supersedes
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and its related
implementation guidance and is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. This
Statement establishes standards for the accounting for transactions in which an entity exchanges its equity
instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for
goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the
issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions.
This Statement requires a public entity to measure the cost of employee services received in exchange for
award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the
period during which an employee is required to provide service in exchange for the award - the requisite service
period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees
do not render the requisite service. The grant-date fair value of employee share options and similar instruments will
be estimated using option-pricing models adjusted for unique characteristics of those instruments (unless observable
market prices for the same or similar instruments are available). If an equity award is modified after the grant date,
incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified
award over the fair value of the original award immediately before the modification.
The revised accounting for stock-based compensation requirements must be adopted by the Company on
January 1, 2006. SFAS No. 123R allows for two alternative transition methods. The Company intends to follow the
modified prospective method, which requires application of the new statement to new awards and to awards
modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion
of awards for which the requisite service has not been rendered that are outstanding as of the required effective date
shall be recognized as the requisite services are rendered on or after the effective date. The compensation cost of
that portion of awards shall be based on the grant-date fair value of those awards as calculated for pro-forma
disclosures under the original SFAS No. 123. Had the Company adopted SFAS No. 123R in prior periods, the
impact on net income and earnings per share would have been approximately similar to the pro forma net income
and earnings per share as disclosed in Note 1 of our consolidated financial statements presented elsewhere herein.
Stock option expense for fiscal 2006 is estimated to be $1.0 million, net of tax, which may change as a result of
future stock option grants, forfeitures and/or other items.
-63-
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which
addresses accounting for changes in accounting principle, changes in accounting estimates, changes required by an
accounting pronouncement in the instance that the pronouncement does not include specific transition provisions
and error correction. SFAS No. 154 requires retrospective application to prior periods' financial statements of
changes in accounting principle and error correction unless impracticable to do so. SFAS No. 154 states an
exception to retrospective application when a change in accounting principle, or the method of applying it, may be
inseparable from the effect of a change in accounting estimate. When a change in principle is inseparable from a
change in estimate, such as depreciation, amortization or depletion, the change to the financial statements is to be
presented in a prospective manner. SFAS No. 154 and the required disclosures are effective for accounting changes
and error corrections in fiscal years beginning after December 15, 2005.
In November 2005, the FASB issued Staff Position (“FSP”) Nos. FAS 115-1 and 124-1 to address the
determination as to when an investment is considered impaired, whether that impairment is other than temporary
and the measurement of an impaired loss. This FSP nullified certain requirements of Emerging Issues Task Force
03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1),
and references existing guidance on other than temporary impairment. Furthermore, this FSP creates a three step
process in determining when an investment is considered impaired, whether that impairment is other than
temporary, and the measurement of an impairment loss. The FSP is effective for reporting periods beginning after
December 15, 2005. It is not anticipated that adoption will have a material impact on our financial condition or
results of operations.
During December 2005, the FASB issued FSP Statement of Position (“SOP”) 94-6-1, Terms of Loan
Products That May Give Rise to a Concentration of Credit Risk, which addresses the circumstances under which the
terms of loan products give rise to such risk and the disclosures or other accounting considerations that apply for
entities that originate, hold, guarantee, service, or invest in loan products with terms that may give rise to a
concentration of credit risk. The guidance under this FSP is effective for interim and annual periods ending after
December 19, 2005 and for loan products that are determined to represent a concentration of credit risk, disclosure
requirements of SFAS No. 107, Disclosures about Fair Value of Financial Instruments, should be provided for all
periods presented. The adoption of this FSP did not have a significant impact on the Company's consolidated
financial statements.
Inflation
The majority of our assets and liabilities are monetary items held by us, the dollar value of which is not
affected by inflation. Only a small portion of total assets is in premises and equipment. The lower inflation rate of
recent years has not had the positive impact on us that was felt in many other industries. Our small fixed asset
investment minimizes any material effect of asset values and depreciation expenses that may result from fluctuating
market values due to inflation. Higher inflation rates may increase operating expenses or have other adverse effects
on borrowers of the banks, making collection on extensions of credit more difficult for us. Rates of interest paid or
charged generally rise if the marketplace believes inflation rates will increase.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISKS
For quantitative and qualitative disclosures regarding market risks in our portfolio, see, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Quantitative and Qualitative Disclosure
About Market Risk.”
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Bank, including the “Report of Independent Registered Public Accounting
Firm,” are included in this report immediately following Part IV.
-64-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and
with the participation of our management, including our Chief Executive Officer along with our Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and our Chief Financial
Officer concluded that our disclosure controls and procedures are effective. There have been no significant changes
in our internal controls during the period covered by this report that has materially affected or is reasonably likely to
materially affect our internal controls over financial reporting.
Our disclosure controls and procedures are designed to ensure that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the
reports that we file under the Exchange Act is accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
ITEM 9B. OTHER INFORMATION
None.
-65-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors and executive officers of the Bank, to the extent not included under
“Item 1 under the heading “Executive Officers of the Bank” appearing at the end of Part I of this report, will appear
in the Bank’s definitive proxy statement for the 2005 Annual Meeting of Shareholders (the “2005 Proxy
Statement”), and such information either shall be (i) deemed to be incorporated herein by reference from the section
entitled “ELECTION OF DIRECTORS,” if filed with the Federal Deposit Insurance Corporation pursuant to
Regulation 14A not later than 120 days after the end of the Bank’s most recently completed fiscal year or (ii)
included in an amendment to this report filed with the Federal Deposit Insurance Corporation on Form 10-K/A not
later than the end of such 120 day period.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation will appear in the 2005 Proxy Statement, and such
information either shall be (i) deemed to be incorporated herein by reference from the sections entitled
“COMPENSATION OF DIRECTORS” and “COMPENSATION OF EXECUTIVE OFFICERS,” if filed with the
Federal Deposit Insurance Corporation pursuant to Regulation 14A not later than 120 days after the end of the
Bank’s most recently completed fiscal year or (ii) included in an amendment to this report filed with the Federal
Deposit Insurance Corporation on Form 10-K/A not later than the end of such 120 day period.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain beneficial owners and management and information
related to the Bank’s equity compensation plans will appear in the 2005 Proxy Statement, and such information
either shall be (i) deemed to be incorporated herein by reference from the sections entitled “BENEFICIAL STOCK
OWNERSHIP OF PRINCIPAL SHAREHOLDERS AND MANAGEMENT” and “SECURITIES AUTHORIZED
FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS,” if filed with the Federal Deposit Insurance
Corporation pursuant to Regulation 14A not later than 120 days after the end of the Bank’s most recently completed
fiscal year or (ii) included in an amendment to this report filed with the Federal Deposit Insurance Corporation on
Form 10-K/A not later than the end of such 120 day period.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions will appear in the 2005 Proxy
Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the section
entitled “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,” if filed with the Federal Deposit
Insurance Corporation pursuant to Regulation 14A not later than 120 days after the end of the Bank’s most recently
completed fiscal year, or (ii) included in an amendment to this report filed with the Federal Deposit Insurance
Corporation on Form 10-K/A not later than the end of such 120 day period.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services will appear in the 2005 Proxy Statement,
and such information either shall be (i) deemed to be incorporated herein by reference from the section entitled
“INDEPENDENT PUBLIC ACCOUNTANTS,” if filed with the Federal Deposit Insurance Corporation pursuant to
Regulation 14A not later than 120 days after the end of the Bank’s most recently completed fiscal year or (ii)
included in an amendment to this report filed with the Federal Deposit Insurance Corporation on Form 10-K/A not
later than the end of such 120 day period.
-66-
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
Preferred Bank:
Report of Independent Registered Public Accounting Firm.....................................................................................
Statements of Financial Condition at December 31, 2005 and 2004........................................................................
Statements of Income and Comprehensive Income for the Years Ended December 31, 2005,
2004 and 2003 ...................................................................................................................................................
Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2005, 2004 and
2003...................................................................................................................................................................
Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003 .............................................
Notes to Financial Statements for the Years Ended December 31, 2005, 2004 and 2003 .......................................
Page
68
69
70
71
72
73
(a)(2) Financial statement schedules
Schedules have been omitted because they are not applicable, not material or because the information is
included in the consolidated financial statements or the notes thereto.
(a)(3) Exhibits
Exhibit No.
3.1
3.2
4.1
10.1
10.2
10.3
10.4
10.5*
10.6*
10.7*
10.8*
10.9*
10.10*
21.1
24.1
31.1
31.2
32.1
32.2
Exhibit Description
Amended and Restated Articles of Incorporation(1)
Amended and Restated Bylaws(1)
Common Stock Certificate(2)
Lease relating to the Bank’s principal executive office at 601 S. Figueroa Street, 20th Floor, Los Angeles,
California with Mitsui Fudoson (U.S.A.), Inc.(1)
Agreement for Item-Processing Services with Fiserv Solutions, Inc., dated as of July 31, 2002(1)
Agreement for Data-Processing with Fiserv Solutions, Inc., dated as of May 1, 2003(1)
Maintenance and Service Agreement, dated August 1, 2003 with Exilcom, Inc. d/b/a Northstar Technologies(1)
1992 Stock Option Plan(1)
Management Incentive Bonus Plan(1)
Deferred Compensation Plan(1)
Stock Option Gain Deferred Compensation Plan(1)
2004 Equity Incentive Plan(1)
Form of Indemnification Agreement for directors and executive officers(1)
Subsidiaries of the Registrant
Power of Attorney
Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section
906 of the Sarbanes-Oxley Act of 2002
Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section
906 of the Sarbanes-Oxley Act of 2002
__________________________
(1)
(2)
*
Incorporated by reference from Registrant’s Registration Statement on Form 10 filed with the Federal
Deposit Insurance Corporation on January 18, 2005.
Incorporated by reference from Registrant’s Registration Statement on Form 10 Amendment No. 1 filed
with the Federal Deposit Insurance Corporation on February 2, 2005.
Denotes management contract or compensatory plan or arrangement.
-67-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Preferred Bank:
We have audited the accompanying statements of financial condition of Preferred Bank (the Bank) as of
December 31, 2005 and 2004 and the related statements of income and comprehensive income, changes in
shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. These
financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on
these financial 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 assurance
about whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of Preferred Bank as of December 31, 2005 and 2004 and the results of its operations and its cash
flows for each of the years in the three-year period ended December 31, 2005 in conformity with U.S. generally
accepted accounting principles.
/s/ KPMG LLP
Los Angeles, California
March 29 , 2006
-68-
PREFERRED BANK
Statements of Financial Condition
December 31, 2005 and 2004
(In thousands, except for shares)
Assets
Cash and due from banks
Federal funds sold
Cash and cash equivalents
Securities available-for-sale, at fair value
Loans and leases
Less allowance for loan and lease losses
Less unearned income
Net loans and leases
Other real estate owned
Bank premises and equipment, net
Customers’ liability on acceptances
Bank-owned life insurance
Accrued interest receivable
Deferred tax assets and other assets
Total assets
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Demand
Interest-bearing demand
Savings
Time certificates of $100,000 or more
Other time certificates
Total deposits
Acceptances outstanding
Advances from the Federal Home Loan Bank
Federal funds purchased
Accrued interest payable
Other liabilities
Total liabilities
Commitments and contingencies
Stockholders’ equity:
2005
2004
$
25,123
158,300
183,423
$
35,212
73,000
108,212
162,935
771,143
(8,939)
(1,537)
760,667
—
1,835
628
7,637
5,529
14,066
164,635
615,961
(6,724)
(2,382)
606,855
8,258
1,365
2,502
7,388
4,246
3,809
$
1,136,720
$
907,270
$
211,942
154,552
47,685
472,948
88,340
975,467
628
20,000
1,500
3,070
12,209
1,012,874
$
180,849
138,972
33,771
368,661
79,282
801,535
2,502
15,000
—
1,291
10,134
830,462
Preferred stock. Authorized 5,000,000 shares; no share issued and outstanding
at December 31, 2005 and December 31, 2004
—
—
Common stock, no par value. Authorized 100,000,000 shares; issued
and outstanding 6,691,904 and 5,554,182 shares at December 31, 2005
and December 31, 2004, respectively
Retained earnings
Accumulated other comprehensive income (loss):
67,683
57,305
32,138
44,591
Unrealized gain (loss) on securities available-for-sale, net of tax
Total stockholders’ equity
Total liabilities and stockholders’ equity
(1,142)
123,846
1,136,720
$
79
76,808
907,270
$
See accompanying notes to financial statements.
-69-
PREFERRED BANK
Statements of Income and Comprehensive Income
Years ended December 31, 2005, 2004 and 2003
(In thousands, except for shares and net income per share)
Interest income:
Loans and leases, including fees
Investment securities
Federal funds sold and securities purchased under
resale agreements
Total interest income
Interest expense:
Interest-bearing demand
Savings
Time certificates of $100,000 or more
Other time certificates
Federal funds purchased and securities sold under
repurchase agreements
FHLB borrowings
Total interest expense
Net interest income before provision for credit losses
Provision for credit losses
Net interest income after provision for loan losses
Noninterest income:
Fees and service charges on deposit accounts
Trade finance income
BOLI income
Net other real estate owned income
Gain on sale of securities available-for-sale, net
Other income
Total noninterest income
Noninterest expense:
Salary and employee benefits
Net occupancy expense
Business development and promotion expense
Professional services
Office supplies and equipment expense
Other
Total noninterest expense
Income before income taxes
Income taxes
Net income
Other comprehensive income:
Unrealized net gains (losses) on securities available-for-sale
Less reclassification adjustments for gains included in net income
Other comprehensive income (loss), before tax
Income taxes related to items of other comprehensive income
Other comprehensive income (loss), net of tax
Comprehensive income
Net income per share:
Basic
Diluted
Weighted-average common shares outstanding:
Basic
Diluted
Dividends per share
2005
2004
2003
$
50,443
6,375
$
32,048
5,490
$
28,301
4,802
3,264
60,082
1,453
529
11,488
2,104
11
477
16,062
44,020
2,110
41,910
2,297
707
312
195
—
356
3,868
1,105
38,643
817
76
4,985
1,211
1
357
7,447
31,196
1,550
29,646
2,393
729
316
526
35
200
4,199
1,273
34,376
550
85
5,701
1,752
1
607
8,696
25,680
2,100
23,580
2,419
677
347
227
1,111
142
4,923
10,252
2,163
444
1,534
867
2,312
17,571
28,207
11,382
16,825
$
9,741
1,826
250
855
754
1,913
15,339
18,506
7,354
11,152
$
8,733
1,745
270
799
721
1,506
13,774
14,729
5,696
9,033
$
(2,102)
—
(2,102)
881
(1,221)
15,604
$
186
(6)
180
72
108
11,260
$
257
(732)
(475)
200
(275)
8,758
$
$
2.58
2.48
$
2.02
1.92
$
1.66
1.58
6,521,763
6,797,305
0.64
5,518,398
5,809,234
0.60
5,440,319
5,730,379
0.24
See accompanying notes to financial statements.
-70-
PREFERRED BANK
Statements of Changes in Shareholders' Equity
Years ended December 31, 2005, 2004 and 2003
(In thousands, except for shares and dividends declared per share)
C ommon
share s
outstanding
5,415,282
—
—
39,700
—
—
5,454,982
—
—
99,200
—
—
5,554,182
—
—
152,100
985,622
—
C ommon
stock
$
30,646
—
60
303
—
—
31,009
—
206
923
—
—
32,138
—
5
1,510
34,030
—
Accumulated
other
compre hensive
income (loss)
$
246
—
—
—
—
Re taine d
e arnings
$
29,026
(1,303)
—
—
9,033
—
36,756
(3,317)
—
—
11,152
—
44,591
(4,111)
—
—
—
16,825
(275)
(29)
—
—
—
—
108
79
—
—
—
—
—
Total
stockholders’
equity
$
59,918
(1,303)
60
303
9,033
(275)
67,736
(3,317)
206
923
11,152
108
76,808
(4,111)
5
1,510
34,030
16,825
Balance at December 31, 2002
Cash dividends paid $0.24 per share
Tax benefit-exercise of stock options
Stock options exercised
Net income
Change in unrealized gain on securities
available-for-sale, net of taxes
Balance at December 31, 2003
Cash dividends paid $0.60 per share
Tax benefit-exercise of stock options
Stock options exercised
Net income
Change in unrealized gain on securities
available-for-sale, net of taxes
Balance at December 31, 2004
Cash dividends paid $0.64 per share
Tax benefit-exercise of stock options
Stock options exercised
Initial public offering, net of issuance costs
Net income
Change in unrealized gain (loss) on securities
available-for-sale, net of taxes
—
—
—
(1,221)
(1,221)
Balance at December 31, 2005
6,691,904
$
67,683
$
57,305
$
(1,142)
$
123,846
See accompanying notes to financial statements.
-71-
PREFERRED BANK
Statements of Cash Flows
Years ended December 31, 2005, 2004 and 2003
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
2005
2004
2003
$
16,825
$
11,152
$
9,033
Provision for loan and lease losses
Amortization of net deferred loan fees and loan purchase discount
Amortization of investment securities discounts and premiums, net
Gain on sale of securities available-for-sale
Depreciation and amortization
Gain on sale of other real estate owned
Other than temporary impairment write down on investment
Tax Benefit from Exercise of Stock Options
2,110
845
1,366
—
579
—
—
5
1,550
(987)
2,002
(36)
492
—
296
206
Provision for deferred taxes
Decrease (increase) in Bank-Owned Life Insurance, accrued interest receivable
and other assets
Increase in accrued expenses and other liabilities
Net cash provided by operating activities
(1,334)
(6,568)
(7,700)
1,980
14,676
3,718
632
12,457
2,100
(183)
1,397
(1,111)
502
(299)
—
60
(575)
(1,332)
2,977
12,569
Cash flows from investing activities:
Purchase of securities available-for-sale
Proceeds from securities available-for-sale transactions:
Matured and called
Sales
Principal collected and stock dividends
Proceeds from sale of other real estate owned
Net increase in loans
Purchase of bank premises and equipment
Net cash used in investing activities
Cash flows from financing activities:
Net increase in deposits
Proceeds from FHLB borrowings
Repayments of FHLB borrowings
Stock options exercised
Issuance of common stock, net of issuance costs
Cash dividends
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest
Income taxes
Supplemental disclosure of noncash transactions:
(67,405)
(96,189)
(176,808)
60,800
—
4,837
8,258
(156,767)
(1,049)
(151,326)
173,932
16,500
(10,000)
1,510
34,030
(4,111)
211,861
75,211
73,468
5,094
6,779
—
84,606
27,535
5,996
701
(110,928)
(60,836)
(756)
(98)
(122,532)
(118,904)
138,722
5,000
(5,000)
923
—
(3,318)
136,327
26,252
47,944
10,000
(15,000)
303
—
(1,303)
41,944
(64,391)
108,212
183,423
$
81,960
108,212
$
146,351
81,960
$
$
14,769
$
7,011
$
9,297
20,124
6,990
4,832
Loans transferred to other real estate owned through foreclosure
—
—
472
See accompanying notes to financial statements.
-72-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(1) Summary of Significant Accounting Policies
Preferred Bank (the Bank) is a full service commercial bank and is engaged primarily in commercial,
real estate, and international lending to customers with businesses domiciled in the state of California. The
accounting and reporting policies of the Bank are in accordance with accounting principles generally
accepted in the United States of America and conform to general practices in the banking industry. The
following is a summary of the Bank’s significant accounting policies.
(a) Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, and Federal funds sold, all of which have
maturities of less than 90 days.
(b)
Investment Securities
The Bank classifies its debt and equity securities in two categories: held-to-maturity or
available-for-sale. Securities that could be sold in response to changes in interest rates, increased loan
demand, liquidity needs, capital requirements, or other similar factors are classified as securities
available-for-sale. These securities are carried at fair value. Unrealized holding gains or losses, net of
the related tax effect, on available-for-sale securities are excluded from income and are reported as a
separate component of stockholders’ equity as other comprehensive income until realized. Realized
gains and
the sale of available-for-sale securities are determined on a
specific-identification basis. Securities classified as held-to-maturity are those that the Bank has the
positive intent and ability to hold until maturity. These securities are carried at amortized cost, adjusted
for the amortization or accretion of premiums or discounts. At December 31, 2005 and 2004, no
security was held for trading and held-to-maturity purposes.
losses
from
A decline in the fair value of any available-for-sale or held-to-maturity security below cost that is
deemed to be other than temporary results in a reduction in carrying amount to fair value. The
impairment is charged to income and a new cost basis for the security is established.
Premiums and discounts are amortized or accreted over the life of the related held-to-maturity or
available-for-sale security as an adjustment to yield using the effective-interest method. Dividend and
interest income are recognized when earned.
(c) Loans and Credit Fees
Loans are carried at face value, less payments received, the allowance for loan and lease losses, and
deferred loan fees. Loans receivable are stated at the principal amount outstanding. Interest income is
recorded on an accrual basis in accordance with the terms of the loans.
Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. The
accrual of interest on loans is discontinued when principal or interest is past due 90 days or more
unless the loan is both well secured and in the process of collection. When loans are placed on
nonaccrual status, all interest previously accrued, but not collected, is reversed against current period
interest income. Income on nonaccrual loans is subsequently recognized only to the extent that cash is
received and the loan’s principal balance is deemed collectible.
Loan origination fees, offset by certain direct loan origination costs and commitment fees, are deferred
and recognized in income as a yield adjustment using the effective interest yield method over the
contractual life of the loan, which approximates the interest method. If a commitment expires
unexercised, the commitment fee is recognized as income.
-73-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
The Bank considers a loan to be impaired when it is “probable” that it will be unable to collect all
amounts due (i.e., both principal and interest) according to the contractual terms of the loan agreement.
The measurement of impairment may be based on (1) the present value of the expected future cash
flows of the impaired loan discounted at the loan’s original effective interest rate, (2) the observable
market price of the impaired loan, or (3) the fair value of the collateral of a collateral-dependent loan.
The amount by which the recorded investment of the loan exceeds the measure of the impaired loan is
recognized by recording a valuation allowance with a corresponding charge to the provision for loan
losses. The Bank stratifies its loan portfolio by size and treats smaller performing loans with an
outstanding balance less than $750,000 as a homogenous portfolio. For loans in excess of $750,000,
the Bank conducts a periodic review of each loan in order to measure impairment, if any. The Bank
recognizes interest income on impaired loans based on its existing methods of recognizing interest
income on nonaccrual loans.
(d) Allowance for Loan and Lease Losses
Loan and lease losses are charged and recoveries are credited to the allowance account. Additions to
the allowance account are charged to the provision for loan and lease losses. The allowance for loan
and lease losses is maintained at a level considered adequate to provide for losses that can be
reasonably anticipated. The adequacy of the allowance is determined by management based upon a
periodic credit review of the loan and lease portfolio, consideration of historical loss experience,
current economic conditions, changes in the composition of the portfolio, analysis of collateral values,
and other pertinent factors.
Management believes that the allowance for loan and lease losses is adequate. While management uses
available information to recognize losses on loans and leases, future adjustments to the allowance may
be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank’s allowance for loan and lease
losses. Such agencies may require the Bank to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.
(e) Other Real Estate Owned (OREO)
Other real estate owned, consisting of real estate acquired through foreclosure or other proceedings, is
initially stated at fair value of the property based on appraisal, less estimated selling cost. Any cost in
excess of the fair value at the time of acquisition is accounted for as a loan charge-off and deducted
from the allowance for loan and lease losses. A valuation allowance is established for any subsequent
declines in value. Operating expenses of such properties, net of related income, and gains and losses
on their disposition are included in other operating income or expense, as appropriate.
(f) Bank Premises and Equipment
Bank premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation on furniture and equipment is computed on a straight-line method
over the estimated useful lives of the assets, generally three to five years. Leasehold
improvements are capitalized and amortized on the straight-line method over the estimated
useful life of the improvement or the term of lease, whichever is shorter.
(g) Comprehensive Income
Comprehensive income consists of net income and net unrealized gains (losses) on securities
available-for-sale and is presented in the statements of income and comprehensive income.
-74-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(h)
Income Taxes
The Bank accounts for income taxes using the asset and liability method. The objective of the asset
and liability method is to establish deferred tax assets and liabilities for the temporary differences
between the financial reporting basis and the tax basis of the Bank’s assets and liabilities at enacted tax
rates expected to be in effect when such amounts are realized or settled. A valuation allowance is
established for deferred tax assets if based on the weight of available evidence, it is more likely than
not that some portion or all of the deferred tax assets will not be realized. The valuation allowance is
sufficient to reduce the deferred tax assets to the amount that is more likely than not to be realized.
(i) Earnings per Share
Earnings per share (EPS) are computed on a basic and diluted basis. Basic EPS excludes dilution and
is computed by dividing income available to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or converted into common stock
or resulted in the issuance of common stock that then shares in the earnings of the Bank.
(j) Stock Option Plan
The Bank applies the intrinsic-value-based method of accounting prescribed by Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations
including FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB Opinion No. 25, issued in March 2000, to account for its
fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant
only if the current market price of the underlying stock exceeded the exercise price. Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation
(SFAS No. 123) and SFAS No. 148, Accounting for Stock-based Compensation – Transition and
Disclosure, an amendment of FASB Statement No. 123, established accounting and disclosure
requirements using a fair-value-based method of accounting for stock-based employee compensation
plans. As allowed by SFAS No. 123,
the
intrinsic-value-based method of accounting described above and has adopted only the disclosure
requirements of SFAS No. 123, as amended. The following table illustrates the effect on net income if
the fair-value-based method had been applied to all outstanding and unvested awards in each period:
the Bank has elected
to continue
to apply
-75-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
Net income, as reported
Deduct total stock-based employee compensation expense determined
under fair-value-based method for all rewards, net of tax
Pro forma net income
Earnings per share:
Basic—as reported
Basic—pro forma
Diluted—as reported
Diluted—pro forma
Weighted-average common shares
Basic
Diluted
2005
2004
(In thousands)
2003
$
16,825
$
11,152
$
9,033
(426)
16,399
$
(72)
11,080
$
(139)
8,894
$
2005
2004
2003
$
2.58
2.51
2.48
2.41
$
2.02
2.01
1.92
1.91
$
1.66
1.63
1.58
1.55
6,521,763
6,797,305
5,518,398
5,809,234
5,440,319
5,730,379
During 2005, the Bank granted 326,500 options. The per share weighted average fair value of options
granted during 2005 was $9.96 on the date of the grant using the Black-Scholes option-pricing model with
the following assumptions: volatility of 27 %, dividend rate of 2.00%, risk-free interest rate of 4.46%, and
expected life of five years. During 2004, the Bank granted 132,000 options. The per share weighted average
fair value of options granted during 2004 was $2.18 on the date of the grant using the Black-Scholes
option-pricing model with the following assumptions: volatility of 0 %, dividend rate of 2.00%, risk-free
interest rate of 3.80%, and expected life of five years. During 2003, the Bank granted 104,000 options. The
per share weighted average fair value of options granted during 2003 was $1.98 on the date of the grant using
the Black-Scholes option-pricing model with the following assumptions: volatility of 0%, no expected
dividends, risk-free interest rate of 2.65%, and expected life of five years.
(k) Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due
from banks, federal funds sold, and securities purchased under resale agreements.
(l) Bank-Owned Life Insurance (BOLI)
Bank-owned life insurance policies are carried at their cash surrender value less applicable cash
surrender charges. Income from BOLI is recognized when earned.
-76-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(m) Use of Estimates
Management of the Bank has made a number of estimates and assumptions relating to the reporting of
assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial
statements in conformity with accounting principles generally accepted in the United States of
America. Actual results could differ from these estimates. The most significant estimate subject to
change relates to the allowance for loan and lease losses.
(n) Reclassifications
Certain reclassifications have been made to the 2004 and 2003 amounts to conform to the 2005
presentation.
(o) Risk and Uncertainties
The Bank’s operations are located and concentrated primarily in Southern California and are likely to
remain so for the foreseeable future. At December 31, 2005, approximately 97% of the total dollar
amount of the Bank’s loans and commitments was related to collateral or borrowers located within
California. The performance of these loans may be affected by changes in California’s economic and
business conditions. Deterioration in economic conditions could have a material adverse effect on the
quality of the Bank’s loan portfolio and the demand for its products and services. In addition, during
periods of economic slowdown or a recession, the Bank may experience a decline in collateral values
and an increase in delinquencies and defaults. A decline in collateral values and an increase in
delinquencies and defaults increase the possibilities and severity of losses. California real estate is also
subject to certain natural disasters, such as earthquakes, fires, floods and mud slides, as well as civil
unrest, which are typically not covered by the standard hazard insurance policies maintained by the
borrowers. Uninsured disasters may render borrowers unable to repay loans made by the Bank and
lower collateral values. The occurrence of adverse economic conditions or natural disasters in
California could have a material adverse effect on the Bank’s financial condition, results of operations,
and business prospects.
(p) Segment Reporting
Through our branch network, we provide a broad range of financial services to individuals and
companies located primarily in Southern California. There services include demand, time and savings
deposits and real estate, business and consumer lending. While our chief decision makers monitor the
revenue streams of our various products and services, operations are managed and financial
performance in evaluated on a company-wide basis. Accordingly, we consider all of our operations
are aggregated in one reportable operating segment.
(q) Recent Issued Accounting Standards
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This Statement
supersedes Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees, and its related implementation guidance and is a revision of SFAS No. 123, Accounting
for Stock-Based Compensation. This Statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or services that are based on the
fair value of the entity's equity instruments or that may be settled by the issuance of those equity
instruments. This Statement focuses primarily on accounting for transactions in which an entity
obtains employee services in share-based payment transactions.
-77-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
This Statement requires a public entity to measure the cost of employee services received in exchange
for award of equity instruments based on the grant-date fair value of the award. That cost will be
recognized over the period during which an employee is required to provide service in exchange for
the award - the requisite service period (usually the vesting period). No compensation cost is
recognized for equity instruments for which employees do not render the requisite service. The grant-
date fair value of employee share options and similar instruments will be estimated using option-
pricing models adjusted for unique characteristics of those instruments (unless observable market
prices for the same or similar instruments are available). If an equity award is modified after the grant
date, incremental compensation cost will be recognized in an amount equal to the excess of the fair
value of the modified award over the fair value of the original award immediately before the
modification.
The revised accounting for stock-based compensation requirements must be adopted by the Company
on January 1, 2006. SFAS No. 123R allows for two alternative transition methods. The Company
intends to follow the modified prospective method, which requires application of the new statement to
new awards and to awards modified, repurchased, or cancelled after the required effective date.
Additionally, compensation cost for the portion of awards for which the requisite service has not been
rendered that are outstanding as of the required effective date shall be recognized as the requisite
services are rendered on or after the effective date. The compensation cost of that portion of awards
shall be based on the grant-date fair value of those awards as calculated for pro-forma disclosures
under the original SFAS No. 123. Had the Company adopted SFAS No. 123R in prior periods, the
impact on net income and earnings per share would have been approximately similar to the pro forma
net income and earnings per share as disclosed above. Stock option expense for fiscal 2006 is
estimated to be $800,000, net of tax, which may change as a result of future stock option grants,
forfeitures and/or other items.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which
addresses accounting for changes in accounting principle, changes in accounting estimates, changes
required by an accounting pronouncement in the instance that the pronouncement does not include
specific transition provisions and error correction. SFAS No. 154 requires retrospective application to
prior periods' financial statements of changes in accounting principle and error correction unless
impracticable to do so. SFAS No. 154 states an exception to retrospective application when a change
in accounting principle, or the method of applying it, may be inseparable from the effect of a change in
accounting estimate. When a change in principle is inseparable from a change in estimate, such as
depreciation, amortization or depletion, the change to the financial statements is to be presented in a
prospective manner. SFAS No. 154 and the required disclosures are effective for accounting changes
and error corrections in fiscal years beginning after December 15, 2005.
In November 2005, the FASB issued Staff Position (“FSP”) Nos. FAS 115-1 and 124-1 to address the
determination as to when an investment is considered impaired, whether that impairment is other than
temporary and the measurement of an impairment loss. This FSP nullified certain requirements of
Emerging Issues Task Force 03-1 The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments (EITF 03-1), and references existing other than temporary
guidance. Furthermore, this FSP creates a three step process in determining when an investment is
considered impaired, whether that impairment is other than temporary, and the measurement of an
impairment loss. The FSP is effective for reporting periods beginning after December 15, 2005. It is
not anticipated that adoption will have a material impact on our financial condition or results of
operations.
-78-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(2) Cash and Due from Banks
The Bank is required to maintain minimum reserve balances on deposit with the Federal Reserve Bank.
Reserve requirements are based on a percentage of deposit liabilities. The average reserve balances required
were $1,405,000 and $10,827,000 during 2005 and 2004, respectively.
(3) Securities Purchased under Resale Agreements
The Bank enters into purchases of overnight securities under agreements to resell identical securities.
Securities purchased under resale agreements are collateralized by mortgage loans.
The amounts advanced under these agreements represent overnight loans and are reflected as securities
purchased under resale agreements in the statements of financial condition. At December 31, 2005 and 2004,
the Bank has no securities purchased under resale agreements matured both term or within one business day.
(4) Securities Available-for-Sale
The amortized cost and estimated fair value of securities available-for-sale at December 31, 2005 and 2004
are summarized as follows:
Amortized
cost
2005
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
U.S. Agency
Corporate notes
Mortgage-backed securities
Other securities
$
85,913 $
37,209
16,234
25,550
1 $
226
11
51
(675) $
(972)
(243)
(370)
85,239
36,463
16,002
25,231
Total securities available-
$
for-sale
164,906 $
289 $
(2,260) $
162,935
2004
Amortized
cost
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
U.S. Treasury
U.S. Agency
Corporate notes
Other securities
$
71,431 $
52,820
12,771
27,482
24 $
1,154
113
17
(428) $
(61)
(171)
(517)
71,027
53,913
12,713
26,982
Total securities available-
$
for-sale
164,504 $
1,308 $
(1,177) $
164,635
-79-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
Gross unrealized losses on securities available-for-sale and the fair value of the related securities, aggregated
by investment category and length of time that the individual securities have been in a continuous unrealized
loss position, at December 31, 2005 are as follows:
Less than 12 months
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
U.S. Agency
Corporate notes
Mortgage-backed securities
Other securities
$
$
61,725 $
17,831
—
3,447
298 $
212
—
—
23,514 $
18,632
16,002
21,784
377 $
760
243
370
85,239 $
36,463
16,002
25,231
675
972
243
370
83,003 $
510 $
79,932 $
1,750 $
162,935 $
2,260
The Bank’s investment portfolio is primarily comprised of U.S. Agency securities, corporate notes,
mortgage-backed securities, municipalities and Federal Home Loan Mortgage Corporation (FHLMC)
preferred stock which are included in other securities. Approximately $2,400,000 (or less than 2% of the total
investment portfolio) is invested in FHLMC preferred stock at December 31, 2005.
At December 31, 2005, there were 36 and 59 investment securities that were in an unrealized loss position for
less than 12 months and for 12 months or greater, respectively. Temporary impairments related to
U.S. Agency securities, corporate notes, mortgage-backed securities, and municipalities are primarily
attributable to declining market prices caused by interest rate fluctuations. Unrealized losses on the FHLMC
preferred stock are due mainly to lower interest rate environments and market condition and near term
prospects of the issuer,.
Whenever the cost of an investment security exceeds its fair value, management evaluates, among other
factors, general market conditions, the duration and extent to which cost is more than fair value, as well as
specific adverse conditions affecting the business outlook of the issuer. During 2005 and 2004, the Bank’s
FHLMC preferred stock has been in an unrealized loss position. .Although the Bank has the ability and
intent to hold this investment until a market price recovery, management considers this investment is other-
than-temporarily impaired during 2004. Accordingly, the cost basis of the FHLMC preferred stock was
written down by $296,000 to reflect its approximate fair value in 2004. In 2005, the management considered
whether this investment is further other-than-temporarily impaired and believes that unrealized loss position
is temporary in nature and no further other-than-temporarily impairment on this investment as of December
31, 2005..
The amortized cost and estimated fair value of securities at December 31, 2005 and 2004, by contractual
maturity, are shown below. Mortgage-backed securities are classified in accordance with their estimated
average life. The average yield on mortgage-backed securities was 3.99% and 2.89% in 2005 and 2004,
respectively. Expected maturities differ from contractual maturities mainly due to prepayment rates; changes
in prepayment rates will affect a security’s average life.
-80-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total securities available-for-sale
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total securities available-for-sale
2005
Amortized
cost
Estimated
fair value
(In thousands)
83,511 $
19,703
9,405
52,287
83,003
19,455
9,109
51,368
164,906 $
162,935
2004
Amortized
cost
Estimated
fair value
(In thousands)
56,738 $
53,366
6,471
47,929
56,593
53,294
6,665
48,083
164,504 $
164,635
$
$
$
$
Cash proceeds from sales of securities available-for-sale totaled $0, $5,094,000 and $27,535,000 in 2005,
2004, and 2003, respectively. Gross realized gains and losses on sales of securities available-for-sale totaled
$0, and $0, respectively, in 2005, $38,000 and $2,000 respectively, in 2004, $1,111,000 and $0, respectively,
in 2003 based on the specific-identification method. Investment securities having a fair value of
approximately $100,778,000 and $61,426,000 were pledged to secure governmental deposits, treasury tax
and loan deposits, borrowing line from the Federal Reserve Bank, and government deposits as of
December 31, 2005 and 2004, respectively.
-81-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(5) Loans and Leases and Allowance for Loan and Lease Losses
The loan and leases portfolio as of December 31, 2005, 2004 and 2003 is summarized as follows:
Real Estate
Commercial
Construction
Trade Finance
Installment/Consumer
Other Loans
Leases:
Aircraft
Other
Less:
$
2005
2004
(In thousands)
372,251 $
149,428
171,646
76,700
266
320
—
532
358,221
98,547
112,002
45,951
222
305
—
713
771,143
615,961
Allowance for loan and lease losses
Unamortized deferred loan fees, net
(8,939)
(1,537)
(6,724)
(2,382)
$
760,667 $
606,855
The majority of the Bank’s loans are to customers with businesses domiciled in the state of California and/or
secured by properties located in the greater Los Angeles metropolitan area. All loans are made based on the
same credit standards regardless of where the customers and/or collateral properties are located.
The Bank had no nonaccrual loans and leases at December 31, 2005 compared to approximately $382,000 at
December 31, 2004. These loans and leases had interest due, but not recognized, of approximately $0 and
$132,000 in 2005 and 2004, respectively.
The Bank had $800,000 and $382,000 of impaired loans and leases as of December 31, 2005 and 2004,
respectively. As of December 31, 2005 and 2004, the amount of impaired loans and leases for which there is
a specific allowance for loan and lease loss was $800,000 and $382,000, respectively, with the amount of the
specific allowance for loan and lease loss of approximately $300,000 and $57,000, respectively. The average
recorded investment in impaired loans and leases for 2005 and 2004 was $186,000 and $333,000,
respectively. Interest income recognized on such loans and leases during 2005 and 2004 was $41,000 and
$15,000, respectively.
At December 31, 2005, the Bank had no commitments to lend additional funds to debtors whose loans are
nonperforming.
-82-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
Changes in the allowance for loan and lease losses are summarized as follows:
Balance at beginning of year
Provision for loan and lease losses
Loans and leases charged off
Recoveries
Balance at end of year
2005
2004
(In thousands)
6,724 $
2,110
(5)
110
6,168
1,550
(1,103)
109
8,939 $
6,724
$
$
(6) Premises and Equipment
As of December 31, 2005 and 2004, premises and equipment consists of the following:
Leasehold improvements
Furniture, fixtures, and equipment
Less accumulated depreciation and amortization
2005
2004
(In thousands)
3,300 $
3,260
6,560
(4,725)
1,835 $
2,376
3,144
5,520
(4,155)
1,365
$
$
Depreciation and amortization expense was $579,000, $492,000 and $502,000 for the years ended
December 31, 2005, 2004 and 2003, respectively.
(7) Deposits
Time deposit accounts at December 31, 2005 mature as follows:
Year
2006
2007
2008
Maturities of
time deposits
(In thousands)
555,317
257
4,965
560,539
$
$
At December 31, 2005 and 2004, approximately $97,580,000 and $46,051,000, respectively, of the Bank’s
investment securities were pledged as collateral for certain public deposits. The amount of deposits from
related parties was $7,172,000 and $6,207,000 at December 31, 2005 and 2004, respectively. The aggregate
-83-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
amount of overdrafts that have been reclassified as loan balances was $282,000 and $ 249,000 at
December 31, 2005 and 2004, respectively.
(8)
Income Taxes
The provision for income taxes expense (benefit) for the years ended December 31, 2005, 2004 and
2003 was as follows:
Current:
Federal
State
Deferred:
Federal
State
2005
2004
(In thousands)
2003
$
9,448 $
3,268
10,856 $
3,066
12,716
13,922
(1,055)
(279)
(1,334)
(5,426)
(1,142)
(6,568)
4,628
1,643
6,271
(413)
(162)
(575)
$
11,382 $
7,354 $
5,696
At December 31, 2005, other assets include current income taxes receivable of approximately $895,000 and
as of December 31, 2004, other liabilities include current income taxes payable of approximately $6,513,000.
-84-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
The components of the net deferred tax liabilities as of December 31, 2005 and 2004 are as follows:
Deferred tax assets:
Loan losses
State franchise tax
Accrued expenses, mainly due to accrued bonuses
Deferred compensation
Depreciation
Unrealized losses on securities available-for-sale
Other, net
Total deferred tax assets
Deferred tax liabilities:
Discount accretion
Depreciation
FHLB stock dividends
Unrealized gains on securities available-for-sale
Total deferred tax liabilities
Net deferred tax assets
$
2005
2004
(In thousands)
3,805 $
1,108
1,155
1,759
294
829
—
8,950
(118)
—
(157)
—
(275)
2,827
1,051
1,184
1,397
—
—
256
6,715
(77)
(14)
(112)
(52)
(255)
$
8,675 $
6,460
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not
that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers the projected future taxable income and tax planning
strategies in making this assessment. Based upon the level of historical taxable income and projections for
future taxable income over the periods in which the deferred tax assets are deductible, management believes
it is more likely than not the Bank will realize all benefits related to these deductible differences.
A reconciliation of the income tax provision and the amount computed by applying the statutory federal
income tax rate to income before income taxes is as follows for the years ended December 31, 2005, 2004
and 2003 (in thousands):
Statutory U.S. federal
income tax
State taxes, net of
federal benefit
Life insurance policies
Other
2005
2004
2003
Amount
Percentage Amount
Percentage Amount
Percentage
$
9,872
35.0% $
6,477
35.0% $
5,155
35.0%
1,884
(87)
(287)
6.7
(0.3)
(1.0)
1,271
(90)
(304)
6.8
(0.5)
(1.6)
914
(101)
(272)
$ 11,382
40.4% $
7,354
39.7% $
5,696
6.2
(0.7)
(1.8)
38.7%
-85-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(9)
Federal Funds Purchased and Securities Sold under Repurchase Agreements
There were no federal funds purchased at December 31, 2005 and 2004 respectively. At December 31, 2005,
the bank had federal funds borrowing lines of $30,000,000 at Wells Fargo Bank and $20,000,000 at Bank of
America.
U.S. Treasury securities and U.S. Agency securities sold under repurchase agreements were delivered to the
broker-dealers who arranged the transactions. The broker-dealers may have sold, loaned, or otherwise
disposed of such securities to other parties in the normal course of their operation and have agreed to resell to
the Bank identical securities at the maturities of the agreements. There were no outstanding amounts of these
overnight agreements as of December 31, 2005, 2004 and 2003. There were no securities underlying these
agreements at December 31, 2005, 2004 and 2003. These overnight agreements averaged approximately $0, a
$41,000 and $37,000 during 2005, 2004 and 2003, respectively. The maximum amount outstanding at any
month-end during 2005, 2004 and 2003 was $0, $0 and $0, respectively. The average rate for the years ended
December 31, 2005, 2004 and 2003 was 0%, 2.11% and 1.54%, respectively.
(10) Other Borrowed Funds
Advances from the Federal Home Loan Bank of San Francisco (FHLB) were $20 million and $15 million at
December 31, 2005 and 2004, respectively. The average rate on the fixed rate debt were 3.72% and 1.89% at
December 31, 2005 and 2004, respectively. All advances are collateralized by investment securities or
residential real estate loans. At December 31, 2005, approximately $68,946,000 of the Bank’s real estate
loans was pledged as collateral. At December 31, 2005, the outstanding advances mature as follows:
Year
2008
2010
2005
(In thousands)
12,000
8,000
20,000
$
$
The Bank had approved short-term borrowings available through the discount window at the Federal Reserve
Bank of San Francisco (FRBSF). At December 31, 2005, the Bank had $1,500,000 overnight borrowings
from the discount window at FRBSF at the rate of 5.25%. There were no borrowings through the discount
window at FRBSF at December 31, 2004. The available borrowed funds through the discount window at
FRBSF were $15,876,000 and $9,486,000 at December 31, 2005 and 2004, respectively.
-86-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(11) Commitments and Contingencies
The Bank is obligated under certain operating leases for the premises of its head office and regional offices.
As of December 31, 2005, the future total minimum lease payments for the Bank’s premises are as follows:
Year
2006
2007
2008
2009
2010
Thereafter
Total lease
payme nt
(In thousands)
1,328
1,269
1,174
747
596
1,080
6,194
$
$
Rental expense was $1,235,000, $1,036,000, and $976,000 for the years ended December 31, 2005, 2004 and
2003, respectively.
(12) Off-Balance-Sheet Risks
As a financial institution, the Bank enters into a variety of financial transactions with its customers in the
normal course of business. Many of these products do not necessarily entail present or future funded asset or
liability positions but are instead in the nature of executory contracts.
Financial instrument transactions are subject to the Bank’s normal credit standards, financial controls and
risk-limiting, and monitoring procedures. Collateral requirements are made on a case-by-case evaluation of
each customer and product.
The Bank’s exposure to credit risk under commitments to extend credit, standby letters of credit, and
financial guarantees written is limited to the contractual amount of those instruments.
At December 31, 2005 and 2004, the Bank had commitments to fund loans of $364,933,000 and
$286,599,000, respectively. Other financial instruments with off-balance-sheet risk at December 31, 2005
and 2004 are as follows:
Commercial letters of credit
Standby letters of credit
2005
2004
(In thousands)
$
11,023 $
8,363
15,133
5,031
The Bank’s exposure to credit losses in the event of non-performance by the other party to commitments to
extend credit and standby letters 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 creditworthiness on a
-87-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management’s credit evaluation of the counterparty.
(13) Loans to Related Parties
The Bank has extended credit to certain directors and officers and companies in which they have an interest
and certain stockholders which beneficially own more than 5% of the Bank’s capital stock. In management’s
opinion, the loans to these related parties are made on substantially the same terms, including interest rates
and collateral, as those made to nonrelated persons.
At December 31, 2005 and 2004, the aggregate loans (including commitments) to related parties were
approximately $15,713,000 (of which $4,457,000 was outstanding) and $12,858,000 (of which $3,060,000
was outstanding), respectively. All related party loans were current at December 31, 2005 and 2004.
Changes in the outstanding loans are summarized as follows:
Balance at beginning of year
New loans
Net drawdowns (repayments)
Balance at end of year
2005
2004
(In thousands)
2003
$
$
3,060
750
647
4,457
8,502
(5,442)
3,060
3,755
81
4,666
8,502
(14) Restrictions on Cash Dividends, Regulatory Capital Requirements
The Bank has authorized 5,000,000 shares of preferred stock. The Board has the authority to issue the
preferred stock in one or more series, and to fix the designations, rights, preferences, privileges,
qualifications, and restrictions, including dividend rights, conversion rights, voting rights and terms of
redemptions, liquidation preferences, and sinking fund terms, any or all of which may be greater than the
rights of the common stock.
Under Section 642 of the California Financial Code, funds available for cash dividend payments by a bank
are restricted to the lesser of: (i) retained earnings or (ii) the bank’s net income for its last three fiscal years
(less any distributions to stockholders made during such period). Cash dividends may also be paid out of the
greatest of: (i) retained earnings, (ii) net income for a bank’s last preceding fiscal year, or (iii) net income of
the Bank for its current fiscal year upon the prior approval of the Commissioner of Financial Institutions,
State of California, without regard to retained earnings or net income for its prior three fiscal years.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional
discretionary – actions by regulators that, if undertaken, could have a direct effect on the Bank’s financial
statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the
Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities,
and certain off-balance-sheet items, as calculated under regulatory accounting policies. The Bank’s capital
amounts and classification are also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
-88-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
The quantitative measures established by the regulation to ensure capital adequacy require the Bank to
maintain amounts and ratios (set forth in the table below) of total and Tier 1 risk-based capital (as defined in
the regulation) to risk-weighted assets (as defined) and of Tier 1 risk-based capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2005, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2005, the most recent notification from the FDIC categorized the Bank as “well
capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events
since that notification that management believes changed the institution’s category.
The Bank’s actual and required capital amounts and ratios are presented in the following table:
Actual
Amount
Rate
For capital adequacy
purposes
Amount
Rate
(In thousands)
To be well capitalized under
prompt corrective action
provision
Amount
Rate
As of December 31, 2005:
Total risk-based capital
Tier I risk-based capital
Leverage ratio
As of December 31, 2004:
Total risk-based capital
Tier I risk-based capital
Leverage ratio
$
$
133,842
124,793
124,793
13.51% $
12.59%
11.63%
79,282 >
39,641
39,641
8.00% $
4.00
4.00
99,102 >
59,461
49,551
83,398
76,674
76,674
10.15% $
9.33
9.30
65,733 >
32,872
32,978
8.00% $
4.00
4.00
82,166 >
49,308
41,223
10.00%
6.00
5.00
10.00%
6.00
5.00
(15) Stock Option Plans
The 2004 Equity Incentive Plan provides granting of nonqualified stock options, incentive stock options,
stock appreciation rights (SRAs), performance shares, performance units, deferred stock units and restricted
stock to key full-time employees, officers, and the directors of the Bank. The total shares authorized in this
plan are 1,200,000 shares. Options vest 20% each year and become fully vested after five years. Options
expire 10 years after the grant date. In the event of a change in control, all awards granted under the 2004
plan will vest and become exercisable immediately, unless the awards are assumed or substituted by the
successor corporation. As of December 31, 2005, there were 880,500 shares available for future grants.
During 2005, the Bank granted 326,500 options. The per share weighted average fair value of options
granted during 2005 was $9.96 on the date of the grant using the Black-Scholes option-pricing model with
the following assumptions: volatility of 27 %, dividend rate of 2.00%, risk-free interest rate of 4.46%, and
expected life of five years. During 2004, the Bank granted 132,000 options. The per share weighted average
fair value of options granted during 2004 was $2.18 on the date of the grant using the Black-Scholes
option-pricing model with the following assumptions: volatility of 0%, dividend rate of 2.00%, risk-free
interest rate of 3.80%, and expected life of five years. During 2003, the bank granted 104,000 options. The
per share weighted average fair value of options granted during 2003 was $1.98 on the date of the grant using
the Black-Scholes option-pricing model with the following assumptions: volatility of 0%, dividend rate of
2.00%, risk-free interest rate of 2.65%, and expected life of five years.
-89-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
The weighted average exercise price for the outstanding options was $26.45 and $16.12 per share,
respectively, and the weighted average remaining contractual life for the options outstanding was
approximately 6.85 years and 5.42, respectively, at December 31, 2005 and 2004. A summary of option
activity follows:
Outstanding at December 31, 2002
Options granted
Options exercised
Options canceled
Outstanding at December 31, 2003
Options granted
Options exercised
Options canceled
Outstanding at December 31, 2004
Options granted
Options exercised
Options canceled
Number of
options
531,600
104,000
(39,700)
(14,600)
581,300
132,000
(99,200)
(11,500)
602,600
326,500
(152,100)
(11,900)
Weighted
average
option price
$
11.17
16.04
7.62
15.32
12.18
28.51
9.30
17.91
16.12
38.08
9.96
33.20
Outstanding at December 31, 2005
765,100
$
26.45
As of December 31, 2005 and 2004, 336,600 and 375,700 options were exercisable, respectively. The
weighted average exercise prices of exercisable options were $18.83 and $11.46 and December 31, 2005 and
2004, respectively.
(16) Employee Benefit Plan
Effective January 1, 1994, the Bank began a 401(k) profit sharing plan for its eligible employees. Under the
plan, the Bank matches 50% of a participant’s contributions up to 6% of his/her salary. Contributions made
by the Bank for the years ended December 31, 2005, and 2004 totaled $129,000 and $106,000, respectively.
(17) Bonus Plan
In April 1994, the Management Incentive Bonus Plan was approved. The plan is administered by the
Compensation Committee of the board of directors (the Committee). The Committee determines which
employees may participate in the plan. All awards are contingent upon the Bank attaining certain financial
objectives. Total expense of the plan recorded by the Bank was approximately $5,335,000, $4,626,000 and
$3,738,000 for 2005, 2004 and 2003, respectively. As of December 31, 2005, the total bonus accrual
included in the other liabilities amounted to $7,293,000. The amounts accrued are generally paid out over a
three-year period subsequent to the year the bonus was granted. There is no vesting requirement to receive
the bonus; however, employees must be employed with the Bank at the time the bonus is distributed.
-90-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
(18) Deferred Compensation Arrangements
In 1996, the Bank implemented deferred compensation arrangements for the Bank’s senior officers and
directors. Pursuant to the Plan, each participant receives benefits for his/her deferred compensation upon
his/her retirement or termination of service with the Bank prior to retirement. At December 31, 2005 and
2004, liabilities recorded for the estimated present value of deferred compensation totaled approximately
$4,185,000 and $3,324,000, respectively.
In order to fund its obligation under the deferred compensation arrangements, the Bank purchased a
single-premium life insurance policy under which the executive officers and directors are the insureds, while
the Bank is the owner and beneficiary thereof. At December 31, 2005 and 2004, the cash surrender value of
the policy totaled $ 7,637,000 and $7,388,000, respectively. During 2005 and 2004, the income on the
insurance policy was $312,000 and $316,000, respectively.
(19) Litigation
From time to time, the Bank is a party to claims and legal proceedings arising in the ordinary course of
business. There are no pending legal proceedings or, to the best of management’s knowledge, threatened
legal proceedings, to which the Bank is a party which may have a material adverse effect upon the Bank’s
financial condition, results of operations, or business prospects.
(20) Fair Value of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments (SFAS No. 107), requires that an
entity disclose the fair value of all financial instruments, as defined, regardless of whether recognized in the
financial statements of the reporting entity. For purposes of determining fair value, SFAS No. 107 provides
that the fair value of a financial instrument is the amount at which the instrument could be exchanged in a
current transaction between willing parties, other than in a forced or liquidation sale.
The following methods and assumptions were used to estimate the fair value of each class of financial
instruments.
(a) Cash Due from Banks, Federal Funds Sold and Securities Purchased under Resale
Agreements
For cash and short-term instruments whose maturity is less than 90 days, the carrying amount was
assumed to be a reasonable estimate of fair value.
(b) Securities available-for-sale
For securities available-for-sale, fair values were based on quoted market prices obtained from dealer
quotes. If a quoted market price was not available, fair value was estimated using quoted market prices
for similar securities.
(c) Loans
Fair values were estimated for portfolios of loans with similar financial characteristics. Each loan
category was further segmented into fixed and adjustable rate interest terms and by performing and
nonperforming categories.
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PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
The fair value of performing loans was calculated by discounting scheduled cash flows through the
estimated maturity using estimated market discount rates that reflect the credit and interest rate risk
inherent in the loan.
Fair value for nonperforming real estate loans was based on recent external appraisals of the
underlying collateral of the loan. If appraisals were not available, estimated cash flows were
discounted using a rate commensurate with the risk associated with the estimated cash flows.
Assumptions regarding credit risk, cash flows, and discount rates were judgmentally determined using
available market information and specific borrower information.
(d) Accrued Interest Receivable and Accrued Interest Payable
The carrying amount of accrued interest receivable and accrued interest payable approximate its fair
value due to their short-term nature.
(e) Deposits
The fair value of demand deposits, saving accounts, and certain money market deposits was assumed
to be the amount payable on demand at the reporting date. The fair value of fixed maturity certificates
of deposit was estimated using the rates currently offered for deposits with similar remaining
maturities.
(f) FHLB Borrowings
The fair value of FHLB borrowings was based on rates currently offered for borrowings with similar
remaining maturities.
(g) Commitment to Extend Credit and Letters of Credit
The fair value of commitments was estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the present
creditworthiness of the counterparties. The fair value of letters of credit was based on fees currently
charged for similar agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties at the reporting date.
-92-
PREFERRED BANK
Notes to Financial Statements
December 31, 2005, 2004 and 2003
December 31, 2005
December 31, 2004
Carrying
amount
Estimated
fair value
Carrying
amount
Estimated
fair value
(In thousands)
$
$
183,423
162,935
$
183,423
162,935
$
108,212
164,635
$
760,667
5,684
759,554
5,684
606,855
2,481
$
211,942
154,552
560,539
20,000
$
211,942
154,552
561,625
19,417
$
180,849
173,743
447,943
15,000
—
2,584
628
2,584
—
1,292
108,212
164,635
606,582
2,481
180,849
173,743
448,412
14,804
2,206
1,292
Assets:
Cash and cash equivalents
Securities available-for-sale
Loans, net of allowance
and unearned income
Accrued interest receivable
Liabilities:
Demand deposits and
savings:
Non-interest bearing
Interest-bearing
Time deposits
FHLB borrowings
Commitments to extend
credit and letters of credit
Accrued interest payable
The fair value estimates do not reflect any premium or discount that could result from offering the
instruments for sale. Potential taxes and other expenses that would be incurred in an actual sale or
settlement are not reflected in amounts disclosed. The fair value estimates are dependent upon
subjective estimates of market conditions and perceived risks of financial instruments at a point in time
and involve significant uncertainties resulting in variability in estimates with changes in assumptions.
-93-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 29, 2006
PREFERRED BANK
(Registrant)
By /s/ Li Yu
Li Yu
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the registrant in the capacities and on the dates indicated.
/s/ Li Yu
Li Yu
/s/ Chris Chan
Chris Chan
/s/ J. Richard Belliston
J. Richard Belliston
/s/ William C.Y. Cheng
William C.Y. Cheng
/s/ Clark Hsu
Clark Hsu
/s/ Frank T. Lin
Frank T. Lin
/s/ Gary S. Nunnelly
Gary S. Nunnelly
/s/ Chih-Wei Wu
Chih-Wei Wu
/s/ Albert Yu, Ph.D.
Albert Yu, Ph.D.
/s/ Ambassador Jason G. Yuan
Ambassador Jason G. Yuan
Chairman of the Board,
President, Chairman and
Chief Executive Officer
(principal executive officer)
Senior Vice President and
Chief Financial Officer
(principal financial and accounting officer)
Director
Director
Director
Director
Director
Director
Director
Director
-94-
March 29, 2006
March 29, 2006
March 29, 2006
March 29, 2006
March 29, 2006
March 29, 2006
March 29, 2006
March 29, 2006
March 29, 2006
March 29, 2006
SUBSIDIARIES OF THE REGISTRANT
None.
Exhibit 21.1
-95-
POWER OF ATTORNEY
Exhibit 24.1
KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director or an officer, or
both of Preferred Bank, a California state-chartered bank (the “Bank”), does hereby make, constitute and
appoint Li Yu, whose address is in care of the Bank, 601 S. Figueroa Street, 20th Floor, Los Angeles,
California 90017, the true and lawful attorney for the undersigned, with full power of substitution and
revocation to each for the undersigned, and in the name, place and stead of the undersigned, to sign in any
and all capacities and to file or cause to be filed, an annual report on Form 10-K with the Federal Deposit
Insurance Corporation, pursuant to the Securities Exchange Act of 1934, as amended, and any and all
amendments to such Form 10-K, hereby giving to such attorney full power to do everything whatsoever
required or necessary to be accomplished in and about the premises as fully as the undersigned could do if
personally present, hereby ratifying and confirming all that such attorney or substitutes shall lawfully do
or cause to be done by virtue thereof.
IN WITNESS WHEREOF, the undersigned has set his hand this 29th day of March, 2006.
/s/ Li Yu
Li Yu
/s/ Chris Chan
Chris Chan
/s/ J. Richard Belliston
J. Richard Belliston
/s/ William C. Y. Cheng
William C. Y. Cheng
/s/ Clark Hsu
Clark Hsu
/s/ Frank T. Lin
Frank T. Lin
/s/ Gary S. Nunnelly
Gary S. Nunnelly
/s/ Chih-Wei Wu
Chih-Wei Wu
/s/ Albert Yu, Ph.D.
Albert Yu, Ph.D.
/s/ Ambassador Jason G. Yuan
Ambassador Jason G. Yuan
-96-
Exhibit 31.1
CERTIFICATION PURSUANT TO RULE
13a-14(a) AND 15d-14(a),
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Li Yu, certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Preferred Bank;
Based on my knowledge, this report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by
this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))
and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a)
b
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
Designed such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting
principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this report based on such
evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation
of internal control over financial reporting, to the registrant’s auditors and the audit committee of
the registrant’s board of directors (or persons performing the equivalent functions):
-97-
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the
registrant’s ability to record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant’s internal control over financial reporting.
Date: March 29, 2006
/s/ Li Yu
Li Yu
Chairman, President and Chief Executive Officer
-98-
Exhibit 31.2
CERTIFICATION PURSUANT TO RULE
13a-14(a) AND 15d-14(a),
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Chris Chan, certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Preferred Bank;
Based on my knowledge, this report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by
this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))
and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a)
b)
c)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
Designed such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting
principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this report based on such
evaluation; and
-99-
d)
Disclosed in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation
of internal control over financial reporting, to the registrant’s auditors and the audit committee of
the registrant’s board of directors (or persons performing the equivalent functions):
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the
registrant’s ability to record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant’s internal control over financial reporting.
Date: March 29, 2006
/s/ Chris Chan
Chris Chan
Senior Vice President and
Chief Financial Officer
-100-
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.1
In connection with the Annual Report of Preferred Bank (the “Bank”) on Form 10-K for the
period ending December 31, 2005 as filed with the Federal Deposit Insurance Corporation on the date
hereof (the “Report”), I, Li Yu, Chairman, President and Chief Executive Officer of the Bank, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
(2) The information contained in the Report fairly presents, in all material respects, the
financial condition and results of operations of the Bank.
Date: March 29, 2006
/s/ Li Yu
Li Yu
Chairman, President and Chief Executive Officer
A signed original of this written statement required by Section 906, or other document authenticating
acknowledging, or otherwise adopting the signature that appears in typed form within this version of this
written statement required by Section 906, has been provided to the Bank and will be retained by the
Bank and furnished to the Federal Deposit Insurance Corporation or its staff upon request.
-101-
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.2
In connection with the Annual Report of Preferred Bank (the “Bank”) on Form 10-K for the
period ending December 31, 2005 as filed with the Federal Deposit Insurance Corporation on the date
hereof (the “Report”), I, Chris Chan, Senior Vice President and Chief Financial Officer of the Bank,
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
(2) The information contained in the Report fairly presents, in all material respects, the
financial condition and results of operations of the Bank.
Date: March 29, 2006
/s/ Chris Chan
Chris Chan
Senior Vice President and
Chief Financial Officer
A signed original of this written statement required by Section 906, or other document authenticating
acknowledging, or otherwise adopting the signature that appears in typed form within this version of this
written statement required by Section 906, has been provided to the Bank and will be retained by the
Bank and furnished to the Federal Deposit Insurance Corporation or its staff upon request.
-102-