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, 2007
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
33539
(State or other jurisdiction of
incorporation or organization)
(FDIC Certificate Number)
601 S. Figueroa Street, 29th 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. [ ]
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 [x] Non-accelerated filer [ ]
Indicate 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, 2007) was $318,802,000.
Number of shares of common stock of the Registrant outstanding as of March 13, 2008, was 9,776,007.
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, 2007 .............................................
Part III
ii
TABLE OF CONTENTS
Page
ITEM 2.
ITEM 3.
ITEM 4.
PART I ........................................................................................................................................................1
ITEM 1. BUSINESS ..................................................................................................................1
ITEM 1A. RISK FACTORS…………………………………………………………………. 29
ITEM 1B. UNRESOLVED STAFF COMMENTS…………………………………………. 38
PROPERTIES ...........................................................................................................38
LEGAL PROCEEDINGS .........................................................................................39
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .............39
PART II.....................................................................................................................................................40
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES ............................................................................................................40
ITEM 6. SELECTED FINANCIAL DATA ............................................................................44
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .................................................46
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET
RISKS........................................................................................................................70
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..........................71
ITEM 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ...............................................71
ITEM 9A. CONTROLS AND PROCEDURES .........................................................................71
ITEM 9B. OTHER INFORMATION.........................................................................................74
PART III ...................................................................................................................................................75
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................75
ITEM 11. EXECUTIVE COMPENSATION DISCLOSURE...................................................75
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS........................75
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE................................................................................76
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ..........................................76
PART IV ...................................................................................................................................................77
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES...................................77
SIGNATURES........................................................................................................................................110
-i-
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 as a California state-chartered bank in Los
Angeles, California with initial capital of $20 million. Our deposits are insured by the Federal Deposit
Insurance Corporation. At December 31, 2007, total assets were $1.5 billion, loans and leases were $1.2
billion, deposits were $1.3 billion and shareholders’ equity was $153 million. Net income per share on a
diluted basis was $2.50 for the year ended December 31, 2007 as compared to $2.21 per share for the year
ended December 31, 2006.
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, 2007, approximately 54% of our non-governmental
deposits and 20% 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.
During the third quarter of 2007, Preferred Bank established a new subsidiary, PB Investment and
Consulting, Inc. The purpose of this subsidiary is to operate a Representative Office for Preferred Bank in
Taipei, Taiwan. This office’s primary function is to coordinate banking services to customers of Preferred
Bank in Taiwan. The new subsidiary has been funded with $30,000 in initial capital.
Our main office is located at 601 S. Figueroa Street, 29th 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 Charters can also be
accessed on our website. We will provide, at no cost, a copy of our Code of Personal and Business
1
Conduct and Board Committee Charters upon request by phone or in writing at the above phone number or
address, attention: Edward J. Czajka, 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 do not typically provide single-
family residential mortgages. We provide construction loans and mini-permanent (“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 other professionals. 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.
• We provide a fully operating traditional internet banking system with bill pay services for
these customers.
Our Market
From our main office in downtown Los Angeles, California and 11 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.
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 2000, there were over 450,000 Chinese-Americans living
2
in the three counties served by Preferred Bank which represented 41% of all Chinese-Americans in
California.
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 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;
an experienced, multi-lingual management team and staff who have an understanding of
Asian markets and cultures who we believe can provide sophisticated credit solutions faster,
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
smaller 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
• Expand our franchise by establishing new branches in Southern California. We may open
additional branches by the end of 2008.
• 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 and main stream 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.
• Access capital markets as needed and enhance our equity-based compensation programs
through the increased liquidity provided by being a public company.
3
•
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:
•
•
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; and
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.
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 loans that meet our underwriting criteria. As of December 31, 2007, we
had a total of $260.7 million in purchased loans and $25.4 million in loans that we sold. The purchased
loans were accounted for in accordance with the Accounting Standards Executive Committee (AcSEC)
Statement of Position (SOP) 03-3. 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 internal business development efforts. 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, 2007, 84% of our loans carried interest rates that adjust with changes in the
Prime Rate, 14% carried interest rates tied to LIBOR or other indices and 2% carried a fixed rate.
Approximately 37% of our loan portfolio has an interest rate floor.
4
The following table sets forth information regarding our four major loan categories:
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)
Average DCR(2)
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
At December 31, 2007
(Dollars in thousands)
$ 518,304
207
$ 2,504
54.28%
1.54x
8.06%
$ 366,706
103
$ 3,560
59.46%
1.26x
8.27%
$ 255,912
498
$ 514
7.46%
$ 91,565
186
$ 492
7.33%
(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 207 loans with outstanding principal balances between $1 million to $5 million, 47 loans
with outstanding balances between $5 million and $10 million, and 21 loans over $10 million as of
December 31, 2007.
Real Estate Mini-Perm Loans
Real estate mini-perm loans secured by retail, office and residential multi-family properties have
been the fastest growing segment of our loan portfolio and comprise 42% of our loan portfolio as of
December 31, 2007. We believe the primary reason for this growth is strong demand for commercial and
residential multi-family real estate in Southern California. We seek diversification through maintaining a
broad base of borrowers and monitoring our exposure to various property types.
5
The following table sets forth the breakdown of our real estate mini-perm portfolio by property
type:
Property Type
Commercial/Office
Industrial
Retail
Apartment 4+
Residential 1-4
Land/Special purpose
Total
At December 31, 2007
Amount
(Dollars in thousands)
64,450
76,968
61,512
68,493
56,635
190,246
518,304
$
$
Percentage of Loans in
Each Category in Total
Loan Portfolio
5.23%
6.24
4.99
5.55
4.59
15.43
42.03%
The following table sets forth the maturity of our real estate mini-perm loan portfolio:
1-Year
2-Years
Less than
3-Years
4-Years
5-Years
5-Years
Balance
More Than
Total Outstanding
At December 31, 2007
(In thousands)
$268,018
$83,377
$40,001
$31,974
$53,866
$41,068
$518,304
Loan Origination. The loan origination process for mini-perm loans begins with 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 $1.2 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:
6
• Maximum LTV of 70%-75%, 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 the closely-held entity.
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 29.7% of the total loan
portfolio as of December 31, 2007. 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
Commercial/Office
Retail
Industrial
For sale attached residential
For sale detached residential
Apartment
Land/Special purpose
Total
At December 31, 2007
Amount
(Dollars in thousands)
$
$
41,245
24,409
8,533
162,110
46,686
72,141
11,582
366,706
Percentage of Loans in
Each Category in Total
Loan Portfolio
3.34%
1.98
0.69
13.15
3.79
5.85
0.94
29.74%
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 have proven experience in the type of project we are considering. Finally,
notwithstanding the maximum 70%-75% LTV discussed above under “—Real Estate Mini-Perm Loans—
Underwriting Standards,” we generally require a maximum 70% LTV for construction loans.
7
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 centralized note department.
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, 2007, we
had $255.9 million of commercial loans outstanding, which represented 20.8% of the 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 may
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 ranging from 40%-80% and from 0%-50%,
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.
8
Trade Finance Credits
Our trade finance portfolio totaled $91.6 million, or approximately 7% of our total loan portfolio
as of December 31, 2007. 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:
• 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.
9
Loan Concentrations
As of December 31, 2007 and 2006, the concentration of loans secured by real estate in our total
loan portfolio was approximately 72% and 71%, respectively. 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 collectability, 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:
Property Type
Commercial/Office
Retail(1)
Industrial
1-4 family
Multi-family
Land/Special purpose(2)
Total
At December 31, 2007
Amount
(Dollars in Thousands)
$
$
105,695
85,921
85,501
265,431
140,634
201,828
885,010
Percentage of Loans
in Each Category in
Total Loan Portfolio
8.57%
6.97
6.93
21.53
11.40
16.37
71.77%
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. Below is a list of the maximum loan-to-values used that must be met at
loan origination, however, in practice, we rarely originate loans at loan-to-value ratios that are this high.
Collateral Type
Occupied 1-4
Unimproved land
Land development
Improved properties
Construction
Commercial construction
1-4 SFR construction
LTV
Maximum
90%
65%
75%
85%
70-75%
80%
85%
Our underwriting practice, however, is to lend at lower LTV’s. At December 31, 2007, the
weighted average LTV of our real estate portfolio based on LTVs at the time of origination was 57.1%.
Our practice is to require DCR’s on commercial real estate loans of 1.2x 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.
10
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, 2007, 5.7% 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, 2007 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.
At December 31, 2007
Maturity
Rate Structure for
Loans Maturing
Over One Year
One Year
or Less
$ 268,018
162,379
316,037
67,361
—
One
through
Five Years
$ 209,218
82,228
50,669
23,858
44
Over Five
Years
Total
Fixed
Rate
Floating
Rate
(In thousands)
$
41,068
11,305
—
346
—
$
518,304
255,912
366,706
91,565
44
$
23,696
198
—
—
—
$
226,590
93,335
50,669
24,204
44
452
$ 814,247
116
$ 366,133
—
$ 52,719
568
$ 1,233,099
116
24,010
$
—
394,842
$
Real estate mini-perm
Commercial
Construction
Trade finance
Consumer
Leases receivable and
other
Total
The following table shows the amounts of loans and leases outstanding as of December 31, 2006,
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.
11
At December 31, 2006
Maturity
Rate Structure for
Loans Maturing
Over One Year
One Year
or Less
$ 166,075
118,321
182,927
72,083
45
One
through
Five Years
$ 209,805
79,429
88,094
13,984
—
Over Five
Years
Total
Fixed
Rate
Floating
Rate
(In thousands)
$
62,400
3,635
—
—
—
$ 438,280
201,385
271,021
86,067
45
$
17,528
343
2,904
—
—
$
254,677
82,721
85,190
13,984
—
185
$ 539,636
334
$ 391,646
—
66,035
519
$ 997,317
$
334
21,109
$
—
436,572
$
Real estate mini-perm
Commercial
Construction
Trade finance
Consumer
Leases receivable and
other
Total
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 $1.5 million 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 $20.0 million for secured loans and up to $12.0
million for unsecured loans.
• 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 $42.3 million for real estate secured loans and $25.4 million for
unsecured loans at December 31, 2007. The Board of Directors loan committee also reviews
all loan commitments granted in excess of $1.0 million on a quarterly basis for the preceding
quarter.
All individual loan 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
12
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 2006 and 2007, 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.
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.
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
13
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 based primarily on service and personal relationships with senior Bank officers rather than interest
rate. Further, 8% 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, 2007, we had $130.2 million in government agency deposits, or 10.4% of our total deposits. 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, 2007, we had $152.4 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, 2007, we held $70.5 million of deposits obtained in this manner.
14
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. As of December 31, 2007, we have three federal funds lines with other
financial institutions pursuant to which we can borrow up to $100 million on an unsecured basis and an
unsecured line of credit with the Federal Home Loan Bank of San Francisco or FHLBSF in the amount of
$24 million. At December 31, 2007, our secured borrowing line with the FHLBSF was $161 million. The
unsecured federal funds lines may be terminated by the respective lending institutions at any time. At
December 31, 2007, we had $36 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 $75 million in
outstanding FHLB advances with a weighted average interest rate of 4.25% and a remaining maturity
greater than one year at December 31, 2007.
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% and 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;
• manage and mitigate interest rate risk;
•
•
comply with regulatory and accounting standards; and
provide funds for local community needs.
15
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.
As of December 31, 2007 the company classified all of its investment securities 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 CEO and 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 72% of
our loan portfolio at December 31, 2007 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, 2007, we had 275 loans
in excess of $1.0 million, totaling $1.1 billion. These loans comprise approximately 27% of our loan
portfolio based on number of loans and 89% based on total loans outstanding balance. Excluding credit
card and consumer overdraft lines, our average loan size is $1.2 million.
At December 31, 2007, excluding government deposits, brokered deposits and deposits as direct
collateral for loans, we had 24 depositors with deposits in excess of $3.0 million that totaled $128 million
or 13.1% of our total deposits.
Our Competition
The banking and financial services business in Southern California is highly competitive. This
increasingly competitive environment faced by banks is a result primarily of changes in laws and
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 services
providers. Many of these competitors are much larger in total assets and capitalization, have greater access
to capital markets, including foreign ownership and/or 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
16
limits, and a wider variety of products and services. Additionally, we compete with Chinese-American and
mainstream 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, ATMs, and remote deposit capture.
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
The Bank is extensively regulated under both federal and state laws. Regulation and supervision
by the federal and state banking agencies is intended primarily for the protection of depositors and the
Deposit Insurance Fund (“DIF”) administered by the Federal Deposit Insurance Corporation (“FDIC”), and
not for the benefit of stockholders. Set forth below is a summary description of key laws and regulations
which relate to the Bank’s operations. These descriptions are qualified in their entirety by reference to the
applicable laws and regulations.
As a California state-chartered bank which is not a member of the Federal Reserve System, we are
subject to supervision, periodic examination and regulation by the California Commissioner of Financial
Institutions and the Department of Financial Institutions (“DFI”), as the Bank’s state regulator, and by the
FDIC as the Bank’s primary federal regulator. 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 are generally intended to protect depositors and are not intended for the
protection of shareholders. If, as a result of an examination, either the DFI or the FDIC should determine
that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or
other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or
has violated any law or regulation, various remedies are available to the DFI and the FDIC. These
remedies include the power to require affirmative action to correct any conditions resulting from any
violation or practice; enter into informal nonpublic or formal public memoranda of understanding or
written agreements with the Bank to take corrective action; issue an administrative cease and desist order
that can be judicially enforced; direct an increase in capital; enjoin unsafe or unsound practices; restrict the
Bank’s growth; assess civil monetary penalties; and remove officers and directors. Ultimately the FDIC
could terminate the Bank’s FDIC insurance and the DFI could revoke the Bank’s charter or take possession
and close and liquidate the Bank.
17
The Bank’s profitability, like most financial institutions, is primarily 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. In general, the difference between the interest
rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest
rates received by the Bank on our interest-earning assets, such as loans extended to customers and
securities held in our investment portfolio, will comprise the major portion of the Bank’s earnings. These
rates are highly sensitive to many factors that are beyond the control of the Bank, such as inflation,
recession and unemployment, and the impact which future changes in domestic and foreign economic
conditions might have on the Bank cannot be predicted.
The Bank’s business is also influenced by 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 (with objectives such as curbing inflation and combating recession) through 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 target federal funds and
discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas
influence the growth of bank loans, investments and deposits and also affect interest earned on interest-
earning assets and paid on interest-bearing liabilities. The nature and impact of any future changes in
monetary and fiscal policies on the Bank cannot be predicted.
Changes such as the following in federal or state banking laws or the regulations, policies or
guidance of the federal or state banking agencies could have an adverse cost or competitive impact on the
Bank’s operations:
(i) In December 2006, the federal banking agencies issued final guidance to reinforce sound risk
management practices for bank holding companies and banks in commercial real estate (CRE)
loans which establishes CRE concentration thresholds as criteria for examiners to identify CRE
concentration that may warrant further analysis. The implementation of these guidelines could
result in increased reserves and capital costs for banks with “CRE concentration.” Management
believes that the Bank’s CRE portfolio as of December 31, 2007 does not have the risks
associated with high CRE concentration due to mitigating factors, including moderate loan-to-
value ratios, adequate debt coverage ratios and a wide variety of property types.
(ii) In September 2006 the federal banking agencies issued final guidance and, subsequently, in
March 2007 proposed additional guidance on alternative or “nontraditional” residential mortgage
products that allow borrowers to defer repayment of principal and sometimes interest, including
“interest-only” mortgage loans, and “payment option” adjustable rate mortgages (“ARMs”) where
a borrower has flexible payment options, including payments that have the potential for negative
amortization, and ARMs with low initial payments based on a fixed introductory or “teaser” rate
that adjusts after a short initial period. While acknowledging that innovations in mortgage
lending can benefit some consumers, the guidance states that management should (1) assess a
borrower’s ability to repay the loan, including any principal balances added through negative
amortization, at the fully indexed rate that would apply after the introductory period; (2) recognize
that certain nontraditional mortgages are untested in a stressed environment and warrant strong
risk management standards as well as appropriate capital and loan loss reserves; and (3) ensure
that borrowers have sufficient information to clearly understand loan terms and associated risks
prior to making a product or payment choice. The Bank does not presently offer any mortgage
products which are the subject of the banking agencies’ present or proposed guidance.
(iii) Pursuant to the Financial Services Regulatory Relief Act of 2006, the SEC and the Federal
Reserve have released, as Regulation R, joint proposed rules expected to be finalized by midyear
to implement exceptions provided for in the Gramm-Leach-Bliley Act (“GLBA”) for bank
securities activities which banks may conduct without registering with the SEC as securities
brokers or moving such activities to a broker-dealer affiliate. The proposed Regulation R “push
out” rules exceptions would allow a bank, subject to certain conditions, to continue to conduct
18
securities transactions for customers as part of the Bank’s trust and fiduciary, custodial and
deposit “sweep” functions, and to refer customers to a securities broker-dealer pursuant to a
networking arrangement with the broker-dealer. The Bank does not presently engage in any
securities activities.
Because California law permits commercial banks chartered by the state to engage in any activity
permissible for national banks, the Bank may form subsidiaries to engage in the many so-called “closely
related to banking” or “nonbanking” activities commonly conducted by national banks in operating
subsidiaries, and, further, may conduct certain “financial” activities in a subsidiary to the same extent as
may a national bank. Generally, a financial subsidiary is permitted to engage in activities that are
“financial in nature” or incidental thereto, even though they are not permissible for the national bank to
conduct directly within the bank. The definition of “financial in nature” includes, among other items,
underwriting, dealing in or making a market in securities, including, for example, distributing shares of
mutual funds. A financial subsidiary may not, however, under present law, engage as principal in
underwriting insurance (other than credit life insurance), issue annuities or engage in real estate brokerage
or development or in merchant banking activities. In order to form a financial subsidiary, the Bank must
be “well-capitalized,” “well-managed” and in satisfactory compliance with the Community Reinvestment
Act (“CRA”). Further, the Bank must exclude from its assets and capital all equity investments, including
retained earnings, in a financial subsidiary, and the assets of a financial subsidiary may not be consolidated
with the Bank’s assets. The Bank would also be subject to the same risk management and affiliate
transaction rules that apply to national banks with financial subsidiaries.
The Bank is also subject to the requirements and restrictions of various consumer laws,
regulations and the Community Reinvestment Act, or CRA.
Capital Standards
The federal banking agencies have adopted risk-based minimum capital guidelines for banks
which are intended to provide a measure of capital 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 recorded as off-balance sheet items.
The risk-based capital ratio is determined by classifying assets and certain off-balance sheet
financial instruments into weighted categories, with higher levels of capital being required for those
categories perceived as representing greater risk. Under the capital guidelines, a banking organization’s
total capital is divided into tiers. “Tier I capital” consists of (1) common equity, (2) qualifying
noncumulative perpetual preferred stock, (3) a limited amount of qualifying cumulative perpetual preferred
stock and (4) minority interests in the equity accounts of consolidated subsidiaries (including trust-
preferred securities), less goodwill and certain other intangible assets. Qualifying Tier I capital may
consist of trust-preferred securities, subject to certain criteria and quantitative limits for inclusion of
restricted core capital elements in Tier I capital. “Tier II capital” consists of hybrid capital instruments,
perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, preferred
stock and trust-preferred securities that do not qualify as Tier I capital, a limited amount of the allowance
for loan and lease losses and a limited amount of unrealized holding gains on equity securities. “Tier III
capital” consists of qualifying unsecured subordinated debt. The sum of Tier II and Tier III capital may
not exceed the amount of Tier I capital.
The risk-based capital guidelines require a minimum ratio of qualifying total capital to risk-
adjusted assets of 8.0%, and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4.0%. In addition
to the risk-based guidelines, the federal bank regulatory agencies require banking organizations to maintain
a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking
organization rated well capitalized, in the highest of the five categories used by regulators to rate banking
organizations, the minimum leverage ratio of Tier I capital to total assets must be 3.0%.
19
An institution’s risk-based capital, leverage capital and tangible capital ratios together determine
the institution’s capital classification. An institution is treated as well capitalized if its total capital to risk-
weighted assets ratio is 10.00% or more; its core capital to risk-weighted assets ratio is 6.00% or more; and
its core capital to adjusted total assets ratio is 5.00% or more. At December 31, 2007, the Bank’s capital
ratios exceed these minimum percentage requirements to be considered well capitalized.
The current risk-based capital guidelines are based upon the 1988 capital accord of the
International Basel Committee on Banking Supervision. A new international accord, referred to as
Basel II, which emphasizes internal assessment of credit, market and operational risk, supervisory
assessment and market discipline in determining minimum capital requirements, currently becomes
mandatory for large international banks outside the U.S. in 2008. In October 2006, the U.S. federal
banking agencies issued a notice of proposed rulemaking for comment to implement Basel II for U.S.
banks with certain differences from the international Basel II framework and which would not be fully in
effect for U.S. banks until 2012. Further, the U.S. banking agencies propose to retain the minimum
leverage requirement and prompt corrective action regulatory standards. In December 2006 the federal
banking agencies issued another notice of proposed rulemaking for comment, referred to as Basel IA that
proposed alternative capital requirements for smaller U.S. banks which may be negatively impacted
competitively by certain provisions of Basel II. Additional guidance issued in February 2007 stated the
agencies’ expectation that to determine the extent to which banks should hold capital in excess of
regulatory minimum levels, examiners would examine the combined implications of a bank’s compliance
with qualification requirements for regulatory risk-based capital standards, the quality and results of the
bank’s internal capital adequacy assessment process, and the examiners’ assessment of the bank’s risk
profile and capital position. At this time the impact that proposed changes in capital requirements may
have on the cost and availability of different types of credit and the potential compliance cost to the Bank
of implementing the requirements of the final rulemaking which is applicable to the Bank are uncertain.
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, 2007 are as follows:
Leverage Ratio
Preferred Bank ................................................................................................. 10.31%
Minimum requirement for “Well-Capitalized” institution ............................... 5.00%
Minimum regulatory requirement .................................................................... 4.00%
Tier 1 Risk-Based Capital Ratio
Preferred Bank ................................................................................................. 10.54%
Minimum requirement for “Well-Capitalized” institution ............................... 6.00%
Minimum regulatory requirement .................................................................... 4.00%
Total Risk-Based Capital Ratio
Preferred Bank ................................................................................................ 11.57%
10.00%
Minimum requirement for “Well-Capitalized” institution ..............................
8.00%
Minimum regulatory requirement ...................................................................
Dividends and Other Transfers of Funds
The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends.
Under such restrictions, the amount available for payment of dividends totaled $50 million at December
31, 2007. In addition, the banking agencies have the authority to prohibit the Bank from paying dividends,
depending upon the Bank’s financial condition, if such payment would be deemed to constitute an unsafe
or unsound practice.
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Prompt Corrective Action
The FDIC also possesses broad powers under the Federal Deposit Insurance Act (the “FDI Act”)
to take “prompt corrective action” and other supervisory action to resolve the problems of insured
depository institutions that fall within any undercapitalized category. 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, the federal banking agencies have adopted non-capital safety and soundness standards
to assist examiners in identifying and addressing potential safety and soundness concerns before capital
becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal
controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting,
(iv) asset quality and growth, (v) earnings, (vi) risk management, and (vii) compensation and benefits.
Subprime Lending Guidelines
As a result of a number of federally insured financial institutions extending their lending risk
selection standards to attract lower credit quality borrowers due to their loans having higher interest rates
and fees, the federal banking regulatory agencies have jointly issued interagency guidance on subprime
lending, including guidance issued in September 2006 and March 2007 on nontraditional residential
mortgage products. Subprime lending involves extending credit to individuals with less than perfect credit
histories. The guidelines consider subprime lending a high-risk activity that is unsafe and unsound if the
risks associated with subprime lending are not properly controlled. The federal banking agencies expect
regulatory capital one and one-half to three times higher than that typically set aside for prime assets for
institutions that:
•
•
have subprime assets equal to 25% or higher of Tier 1 capital, or
have subprime portfolios experiencing rapid growth or adverse performance trends, are
administered by inexperienced management, or have inadequate or weak controls.
The Bank presently does not engage in subprime lending.
Premiums for Deposit Insurance
Through the DIF, the FDIC insures our customer deposits up to prescribed limits for each
depositor. The amount of FDIC assessments paid by each DIF member institution is based on its relative
risk of default as measured by regulatory capital ratios and other supervisory factors. The assessment rate
currently ranges from zero to 27 cents per $100 of domestic deposits. The FDIC may increase or decrease
the assessment rate schedule on a semi-annual basis. The Federal Deposit Insurance Reform Act of 2006,
or FDIRA, provides, among other things, for 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 issued final regulations, effective January 1, 2007, implementing the provisions of
FDIRA. The Bank expects to receive a one-time assessment credit that is expected to exceed any increase
in assessments by the FDIC in 2007.
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,
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were issued to capitalize the Federal Savings and Loan Insurance Corporation. The FDIC established the
FICO assessment rates effective for the fourth quarter of fiscal 2006 at approximately 1.24 cents for each
$100 of assessable deposits. The FICO assessments are 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.
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. The 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 a certain amount of capital stock in the FHLB.
At December 31, 2007, the Bank was in compliance with the FHLB’s stock ownership
requirement and our investment in FHLB capital stock totaled $4,700,000.
Interstate Banking and Branching
Subject to certain size limitations under the Riegle-Neal Interstate Banking Act, banks have the
ability to acquire or merge with banks in other states; and, subject to certain state restrictions, banks may
also acquire or establish new branches outside their home state. Interstate branches are subject to certain
laws of the states in which they are located. The Bank presently has not engaged in any interstate banking
activity.
Securities Registration
The Bank’s securities are registered with the FDIC under the Exchange Act as adopted by the
FDIC. As such, the Bank is subject to the information, proxy solicitation, insider trading, corporate
governance and other requirements and restrictions of the Exchange Act.
Foreign Operations
The Bank has a representative office in Taipei, Taiwan. During the third quarter of 2007, the Bank
established a new subsidiary, PB Investment and Consulting, Inc. The purpose of this subsidiary is to
operate a Representative Office for Preferred Bank in Taipei, Taiwan. This office’s primary function is to
coordinate banking services to customers of Preferred Bank in Taiwan. The new subsidiary has been
funded with $30,000 in initial capital. Our Taipei office operates under the supervision of Taiwan Banking
Authorities.
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 addresses accounting oversight and corporate governance
matters and, among other things:
•
•
•
•
required executive certification of financial presentations;
increased requirements for board audit committees and their members;
enhanced disclosure of controls and procedures and internal control over financial reporting;
enhanced controls on, and reporting of, insider trading; and
22
•
increased penalties for financial crimes and forfeiture of executive bonuses in certain
circumstances.
This legislation and its implementing regulations resulted in increased costs of compliance,
including certain outside professional costs. To date, these costs have not had a material impact on the
Bank.
USA PATRIOT Act
The USA PATRIOT Act of 2001 and its implementing regulations significantly expanded the
anti-money laundering and financial transparency laws. Under the USA PATRIOT Act, financial
institutions are required to establish and maintain anti-money laundering programs which include:
•
•
•
•
•
the establishment of a customer identification program;
the development of internal policies, procedures, and controls;
the designation of a compliance officer;
an ongoing employee training program; and
an independent audit function to test the programs.
The Bank has adopted comprehensive policies and procedures to address the requirements of the
USA PATRIOT Act. Material deficiencies in anti-money laundering compliance can result in public
enforcement actions by the banking agencies, including the imposition of civil money penalties and
supervisory restrictions on growth and expansion. Such enforcement actions could also have serious
reputation consequences for the Bank.
Federal Reserve System
The FRB requires all depository institutions to maintain noninterest-bearing reserves at specified
levels against their transaction accounts (primarily checking, NOW “negotiable order of withdrawal” and
Super NOW checking accounts) and non-personal time deposits. At December 31, 2007, 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 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.
Loans-to-One Borrower Limitations
With certain limited exceptions, the maximum amount of obligations, secured or unsecured, that
any borrower (including certain related entities) may owe to a California state bank at any one time may
not exceed 25% of the sum of the shareholders’ equity, allowance for loan losses, capital notes and
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debentures of the bank. Unsecured obligations may not exceed 15% of the sum of the shareholders’
equity, allowance for loan losses, capital notes and debentures of the bank. The Bank has established
internal loan limits which are lower than the legal lending limits for a California bank. At December 31,
2007, the Bank’s largest single lending relationship had a combined outstanding balance of $34.1 million,
secured predominantly by commercial real estate properties in the Bank’s lending area, and which is
performing in accordance with their terms of the Bank’s loans.
Extensions of Credit to Insiders and Transactions with Affiliates
The Bank is subject to Federal Reserve Regulation O and companion California banking law
limitations and conditions on loans or extensions of credit to:
•
•
•
the 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. California has laws and the DFI has regulations which adopt
and also apply Regulation O to the Bank.
The Bank also is subject to certain restrictions imposed by Federal Reserve Act Sections 23A and
23B and Federal Reserve Regulation W on any extensions of credit to, or the issuance of a guarantee or
letter of credit on behalf of, any affiliates, the purchase of, or investments in, stock or other securities
thereof, the taking of such securities as collateral for loans, and the purchase of assets of any affiliates.
Such restrictions prevent any affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts. Further, such secured loans and investments to or in any
affiliate are limited, individually, to 10.0% of the Bank’s capital and surplus (as defined by federal
regulations), and such secured loans and investments are limited, in the aggregate, to 20.0% of the Bank’s
capital and surplus. A financial subsidiary is considered an affiliate subject to these restrictions whereas
other nonbanking subsidiaries are not considered affiliates. Additional restrictions on transactions with
affiliates may be imposed on the Bank under the FDI Act prompt corrective action provisions and the
supervisory authority of the federal and state banking agencies.
Consumer Protection Laws and Regulations
Examination and enforcement by the state and federal banking agencies for non-compliance with
consumer protection laws and their implementing regulations have become more intense. We are subject to
many consumer statutes and regulations, some of which are discussed below. The Bank is also subject to
federal and state laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising
and unfair competition.
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The Home Ownership and Equity Protection Act of 1994, or HOEPA, requires extra disclosures
and consumer protections to borrowers for certain lending practices. The term “predatory lending,” much
like the terms “safety and soundness” and “unfair and deceptive practices,” is far-reaching and covers a
potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive
definition. Typically, however, predatory lending involves at least one, and perhaps all three, of the
following elements:
• making unaffordable loans based on the assets of the borrower rather than on the borrower’s
ability to repay an obligation (“asset-based lending”);
•
•
inducing a borrower to refinance a loan repeatedly in order to charge high points and fees
each time the loan is refinanced (“loan flipping”); and/or
engaging in fraud or deception to conceal the true nature of the loan obligation from an
unsuspecting or unsophisticated borrower.
Regulations and banking agency guidelines aimed at curbing predatory lending significantly
widen the pool of high-cost home-secured loans covered by HOEPA. In addition, the regulations bar
certain refinances within a year with another loan subject to HOEPA by the same lender or loan servicer.
Lenders also will be presumed to have violated the law—which says loans should not be made to people
unable to repay them—unless they document that the borrower has the ability to repay. Lenders that
violate the rules face cancellation of loans and penalties equal to the finance charges paid. The Bank does
not expect these rules and potential state action in this area to have a material impact on our financial
condition or results of operations.
Privacy policies are required by federal banking regulations which limit the ability of banks and
other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties.
Pursuant to those rules, financial institutions must provide:
•
•
•
initial notices to customers about their privacy policies, describing the conditions under which
they may disclose nonpublic personal information to nonaffiliated third parties and affiliates;
annual notices of their privacy policies to current customers; and
a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.
These privacy protections affect how consumer information is transmitted through diversified
financial companies and conveyed to outside vendors. In addition, state laws may impose more restrictive
limitations on the ability of financial institutions to disclose such information. California has adopted such
a privacy law that, among other things, generally provides that customers must “opt in” before information
may be disclosed to certain nonaffiliated third parties.
The Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act, or
the FACT Act, requires financial firms to help deter identity theft, including developing appropriate fraud
response programs, and gives consumers more control of their credit data. It also reauthorizes a federal
ban on state laws that interfere with corporate credit granting and marketing practices. In connection with
the FACT Act, the federal financial institution regulatory agencies proposed rules that would prohibit an
institution from using certain information about a consumer it received from an affiliate to make a
solicitation to the consumer, unless the consumer has been notified and given a chance to opt out of such
solicitations. A consumer’s election to opt out would be applicable for at least five years. The agencies
have also proposed guidelines required by the FACT Act for financial institutions and creditors which
require financial institutions to identify patterns, practices and specific forms of activity, known as “Red
Flags,” that indicate the possible existence of identity theft and require financial institutions to establish
reasonable policies and procedures for implementing these guidelines.
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The Check Clearing for the 21st Century Act, or Check 21, facilitates check truncation and
electronic check exchange by authorizing a new negotiable instrument called a “substitute check,” which is
the legal equivalent of an original check. Check 21 does not require banks to create substitute checks or
accept checks electronically; however, it does require banks to accept a legally equivalent substitute check
in place of an original. In addition to its issuance of regulations governing substitute checks, the Federal
Reserve has issued final rules governing the treatment of remotely created checks (sometimes referred to as
“demand drafts”) and electronic check conversion transactions (involving checks that are converted to
electronic transactions by merchants and other payees).
The Community Reinvestment Act, or 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.”
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 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. The Federal Reserve amended regulations issued under
HMDA to require the reporting of certain pricing data with respect to higher priced mortgage loans for
review by the federal banking agencies from a fair lending perspective. We do not expect the HMDA data
reported by the Bank to raise material issues regarding its compliance with the fair lending laws.
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.
Finally, the National Flood Insurance Act, or NFIA, requires homes in flood-prone areas with
mortgages from a federally regulated lender to have flood insurance. Hurricane Katrina focused awareness
on this requirement. Lenders are required to provide notice to borrowers of special flood hazard areas and
26
require such coverage before making, increasing, extending or renewing such loans. Financial institutions
which demonstrate a pattern and practice of lax compliance are subject to the issuance of cease and desist
orders and the imposition of per loan civil money penalties, up to a maximum fine which currently is
$125,000. Fine payments are remitted to the Federal Emergency Management Agency for deposit into the
National Flood Mitigation Fund.
Due to heightened regulatory concern related to compliance with HOEPA, privacy laws and
regulations, FACT, Check 21, CRA, TILA, FH Act, ECOA, HMDA, RESPA and NFIA generally, we may
incur additional compliance costs or be required to expend additional funds for CRA investments.
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, federal and state legislation is enacted which may have the effect of materially
increasing the cost of doing business, limiting or expanding permissible activities, or affecting the
competitive balance between banks and other financial service providers. 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. The Bank
cannot predict whether or when potential legislation will be enacted, and if enacted the effect that it, or any
implementing regulations, would have on our financial condition or results of operations. In addition, the
outcome of any investigations initiated by state or federal authorities or litigation may result in necessary
changes in our operations, additional regulation and increased compliance costs.
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 institution’s,
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.
27
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 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.
28
Employees
As of December 31, 2007, the Bank had a total of 137 full-time equivalent 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.
Available Information
The Bank also maintains an internet website at www.preferredbank.com. The Bank 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.]
ITEM 1A. RISK FACTORS
Risk Factors That May Affect Future Results
In addition to the other information on the risks we face and our management of risk contained in
this annual report or in our other filings, the following are significant risks which may affect our business,
financial condition, operations and prospects and the value and price of our common stock could decline.
The risks identified below are not intended to be a comprehensive list of all risks we face and additional
risks that we may currently view as not material may also impair our business operations and results.
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 changes in economic, political and market
conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government
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.
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;
low cost or noninterest-bearing deposits may decrease; and
29
•
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, 2007, approximately 72% of the book
value of our loan portfolio consisted of loans collateralized by various types of 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, particularly in California, the value of real estate collateral securing our loans could
be significantly 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. If there is a significant decline in real
estate values, especially in California, the collateral for our loans will provide less security.
Recent Developments related to the subprime mortgage market and the capital markets and the
response of Congress and bank regulators to such developments could adversely affect banks in the future.
Negative developments in the latter half of 2007 in the subprime mortgage market and the
securitization markets for such loans have contributed to uncertainty in the financial markets generally and
the expectation of a general economic downturn in 2008. Performance of consumer loans and residential
mortgage loan portfolios are reported to have deteriorated at many institutions. The values of real estate
collateral supporting many residential mortgages and commercial loans have declined and may continue.
Stock prices of financial companies, including banks and bank holding companies, have decreased
substantially, which could negatively affect the ability of banks and bank holding companies to raise
capital or borrow in the debt markets compared to recent years. There is a potential for new federal or state
laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory
agencies are expected to be very aggressive in responding to concerns and trends identified in
examinations, including the expected issuance of many formal enforcement orders.
We rely heavily on our senior management team and other key employees, the loss of whom
could materially and adversely affect 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. Mr. Yu, who founded the
company, is integral to implementing our business plan. We currently do not have an employment
agreement or non-competition agreement with Mr. Yu. Accordingly, members of our senior management
team are not contractually prohibited from leaving or joining one of our competitors. If we lose the services
of any of our executive officers, especially Mr. Yu, 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 and personnel in the banking industry is intense and there are a limited number of
30
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 qualified management personnel and the necessary
deposit generation, loan origination, underwriting, administrative, finance, 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. Rising interest rates, generally, are associated with a lower volume of loan originations, while
lower interest rates are usually associated with higher loan originations.
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, re-pricing 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. In rising interest rate environments, loan repayment rates may decline and in
falling interest rate environments, loan repayment rates may increase
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.
We conduct our operations primarily in California. The banking and financial services businesses
in California are highly competitive and increased competition within California may result in reduced loan
originations and deposits. Ultimately, we may not be able to compete successfully against current and
31
future competitors. Many competitors offer the types of loans and banking services that we offer in our
service areas. These competitors include national banks, regional banks and other community banks. We
also face competition from many other types of financial institutions, including saving and loan
associations, finance companies, brokerage firms, insurance companies, credit union, 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. Areas of competition include
interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of
products and services provided, including new technology-driven products and services. Competitive
conditions may intensify as continued merger activity in the financial services industry produces larger,
better-capitalized and more geographically diverse companies. 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 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 we could sustain losses 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 collectability 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
32
these losses may exceed current estimates. While we believe that our allowance for 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, 2007, our construction loans were $366.7 million, or 29.7% of our total loans
and leases held, and the average loan size of our construction loans was $3.6 million. The risks inherent in
construction lending include, among other things, 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 in our loan portfolio.
In considering whether to make a loan on or secured by real property, we require an appraisal on
such property. 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 in our loan portfolio.
Adverse economic conditions in Asia could impact our business adversely.
We estimate that at December 31, 2007, approximately 54% of our non-governmental deposits
and 20% 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, 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, 2007, approximately $91.6 million, or 7.4%, 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 weakens against other foreign currencies,
the cost of imported goods will increase, which could have an adverse impact on some of our customers
33
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.
We plan to increase significantly the level of our assets, including our loan portfolio. Our ability
to increase our asset base depends in large part on our ability to attract additional deposits at attractive
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, 2007, we held $639.5 million of Jumbo CDs, representing
51% of total deposits. These deposits are considered by the banking industry to be 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.
Our financial performance and profitability depend on our ability to execute our corporate growth
strategy. We anticipate that our asset size and deposit base will continue to grow over time, perhaps
significantly. In addition to seeking deposit and loan and lease growth in our existing markets, we intend to
pursue expansion opportunities through strategically placed new branches, or by acquiring branch locations
that we find attractive. Continued growth, however, may present operating and other integration problems.
Our growth plans may place a strain on our administrative, operational, staffing and financial resources and
increase demands on our systems and controls. 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.
34
The following risks, associated with our growth, internally or by acquisition, could have a material
adverse effect on our business, financial condition, results of operations and cash flows:
•
•
•
•
•
•
•
the potential disruption of our ongoing business
our inability to continue to upgrade or maintain effective operating and financial control
systems
our inability to recruit and hire necessary personnel or to successfully integrate new personnel
into our operations
our inability to successfully integrate the operations of an acquired business or to manage our
growth effectively
the inability of our management to maximize our financial and strategic position after
acquisitions by successful implementation of uniform product offerings and the incorporation
of uniform technology into our produce offerings, services and control systems
the inability to maintain uniform standards, controls, procedures and policies and the
impairment of relationships with employees and customers as a result of changes in
management
our inability to respond promptly or adequately to the emergence of unexpected expansion
difficulties
We cannot assure you that we will be successful in overcoming these risks or any other problems
encountered in connection with implementing our internal growth strategies. If we are unable to manage
our 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.
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, interruption or breach in security of these systems could 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.
35
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, affected 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 2004-2006, seventeen increases in the Fed Funds rate by
the Federal Open Market Committee placed tremendous pressure on the profitability of many 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 which may hamper our ability to increase our
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 and supervisory guidance and policies 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. Perennially, various laws, rules and
regulations are proposed which, if adopted, could impact our operations by making compliance much more
difficult or expensive, restricting our ability to originate or sell loans or further restricting the amount of
interest or other charges or fees earned on loans or other products. 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
loans, 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 interpretations or enforcement
policies with respect to existing laws may increase our exposure to environmental liability.
Negative publicity could damage our reputation.
36
Reputation risk, or the risk to our earnings and capital from negative publicity or public opinion,
is inherent in our business. Negative publicity or public opinion could adversely affect our ability to keep
and attract customers and expose us to adverse legal and regulatory consequences. Negative public
opinion could result from our actual or perceived conduct in any number of activities, including lending
practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing
or inadequate protection of customer information, and from actions taken by government regulators and
community organizations in response to that conduct.
Terrorist attacks may have depressed the economy in the past and if there are additional terrorist
events especially in our market, the economy could be adversely affected.
The possibility of further terrorist attacks, as well as continued terrorist threats, may create and
perpetuate 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 ........................
[67]
Chairman of the Board, President and Chief Executive Officer
Edward J. Czajka .....
[43]
Senior Vice President and Chief Financial Officer
Nick Pi………..........
[47]
Executive Vice President and Group Manager
(1) As of March 13, 2008.
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.
Edward J. Czajka has been Senior Vice president and Chief Financial Officer since 2006. Before
joining Preferred Bank, Mr. Czajka was Chief Financial Officer of Presidio Bank, a San Francisco-based
bank that was then in organization. In this capacity, he was responsible for overall operations
implementation and all back office functions including information technology, human resources,
accounting and branch operations. Prior to this, Mr. Czajka was Executive Vice President and Chief
Financial Officer of North Valley Bancorp, a publicly-traded multi-bank holding company located in
Redding, California. From 1994 through 2000, Mr. Czajka held the position of Vice President, Corporate
Controller for Pacific Capital Bancorp in Santa Barbara, California.
Nick Pi has been our Executive Vice President and Group Manager since 2006 and our Senior
Vice President and Corporate Banking Officer from 2003 to 2006. Before joining Preferred Bank, Mr. Pi
was the Senior Vice President and Commercial Real Estate Lending Team Leader of Chinatrust Bank
(U.S.A.) from 2000 to 2003. Prior to this, he held various corporate titles from Assistant Vice President to
Senior Vice President at Chinatrust bank (U.S.A.), mainly in the branch operation and lending fields from
1995 to 2000. His lending and credit experience also includes Grand Pacific Financing Corporation from
37
1989 to 1995, an affiliate of China Trust Group. Mr. Pi received a BA degree in Business School from
National Taiwan University, Taiwan and a MBA degree from Emporia State University.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
On October 10, 2007 we purchased a branch office in Irvine at 890 Roosevelt Avenue for
$2,282,000 to move our branch office from our leased premises to this new location. We moved to the new
branch in February 2008. As a result of this purchase we entered into a modification of our lease agreement
at our Irvine leased premises that calls for the termination of that lease being moved up to February 29,
2008. We lease all of our other branch facilities. On March 9, 2007 we entered into a fifth amendment to
our lease on our corporate headquarters suite that calls for us to move the headquarters and main branch
office from the 20th floor at 601 S. Figueroa Street, Los Angeles, California to the 29th floor in the same
building, increasing our space from 15,648 square feet to 22,627 square feet. We moved to the new
location in February 2008. This lease now expires in August of 2020. The total lease expense for this
office for 2007 was $359,000.
At December 31, 2007, 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 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. Total lease expense was $1,397,000 for the year ended December 31, 2007 and $1,308,000 for
December 31, 2006.
The following table provides certain information with respect to our leased branch locations.
L
ocation
A
ddress
38
Current
Lease
Term
Expiration
Square
Footage
Total
Deposits at
December 31,
2007
Los Angeles County
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 & branch).... 601 S. Figueroa Street, 29th Floor
Santa Monica......................................... 524 Wilshire Blvd.
Torrance ................................................ 3501 Sepulveda Blvd., Suite 107
Valencia................................................. 24501 Town Center Drive, Suite 103
Orange County
Date
03/31/09
02/28/08
06/30/11
03/14/15
11/30/09
08/31/20
08/31/12
06/30/16
11/30/11
Irvine ..................................................... 2301 Dupont Drive, Suite 150
02/29/08
Irvine (Purchased Branch Premises) ..... 890 Roosevelt Ave.
N/A
San Bernardino County
(in thousands)
$192,341
83,430
63,623
120,974
86,431
364,663
46,619
192,647
1,542
61,872
—
6,000
2,600
4,416
5,610
3,440
22,627
1,355
4,800
2,926
3,584
4,960
Chino ..................................................... 3926 Grand Avenue, #E
10/14/10
2,973
37,866
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.
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, 2007.
39
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Market Information
Our Common Stock commenced trading on the Nasdaq Global 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 $25.33 per share.
Our common stock closed at $16.90 on March 13, 2008 and there were 9,776,007 outstanding shares of
our common stock. The number of shares and per share data has been adjusted to reflect our February 20,
2007 three-for-two stock split effected in the form of a dividend.
The following table sets forth the high and low sales prices for our common stock for the periods
indicated as reported by the NASDAQ, as well as the cash dividends declared per share during the last two
years:
2006
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
2007
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
High
Low
$34.00
$36.11
$41.53
$40.70
$44.84
$41.61
$43.44
$41.00
$29.42
$32.91
$35.28
$35.29
$36.09
$36.04
$35.05
$24.51
Cash
Dividends
Declared
$0.13
$0.13
$0.13
$0.14
$0.17
$0.17
$0.17
$0.17
The above sales prices and cash dividends declared per share amounts have been retroactively
adjusted to reflect our February 2007 three-for-two stock split.
Holders
As of March 13, 2008, 9,776,007 shares of the Bank’s common stock were held by 114
shareholders of record.
Dividends
On January 22, 2008 we declared a cash dividend in the amount of $0.17 per share. The cash
dividend was paid on February 19, 2008 to stockholders’ of record at the close of business on February 5,
2008.
40
We began paying dividends on a quarterly basis in the first quarter of 2005, 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, 2007, we could have paid $50 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 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.
41
Issuer’s Purchases of Equity Securities.
As part of the stock repurchase plan announced in June 2007, the Bank repurchased the
following shares during the third and fourth quarters of 2007:
Date
July 30, 2007
July 31, 2007
August 1, 2007
August 3, 2007
August 7, 2007
August 8, 2007
August 9, 2007
August 10, 2007
August 13, 2007
August 15, 2007
October 26, 2007
October 29, 2007
October 30, 2007
October 31, 2007
November 1, 2007
November 2, 2007
November 5, 2007
November 6, 2007
November 8, 2007
November 9, 2007
November 13, 2007
November 14, 2007
November 15, 2007
November 16, 2007
November 19, 2007
November 20, 2007
November 21, 2007
November 23, 2007
November 29, 2007
November 30, 2007
December 4, 2007
December 5, 2007
December 6, 2007
December 7, 2007
Total
Number of Shares
4,400
13,500
6,600
13,900
4,200
13,900
15,000
8,000
15,000
5,500
14,900
14,900
6,260
7,700
19,200
15,900
5,700
19,200
25,100
16,800
22,500
5,100
14,300
5,500
7,800
31,100
21,500
19,600
22,700
21,600
26,100
26,100
14,200
16,240
500,000
Total Cost
$ 171,820
527,175
258,971
540,204
164,682
536,041
571,397
307,520
557,170
206,889
474,714
464,300
194,368
239,778
593,576
477,289
169,000
544,049
673,154
441,948
582,950
134,461
397,214
156,260
219,348
873,179
593,280
537,951
592,892
569,221
692,694
691,680
379,736
437,254
$ 14,972,165
42
Securities Authorized for Issuance Under Equity Compensation Plans.
The following table provides information as of December 31, 2007 regarding equity compensation
plans under which equity securities of the Bank were authorized for issuance.
Plan Category
Equity incentive plans approved by security holders
Equity incentive plans not approved by security holders
Number of
securities to be
issued upon
exercise of
outstanding
options
(a)
1,107,900
—
1,107,900
Weighted average
exercise price of
outstanding
options
(b)
$26.69
—
Number of securities
available for future
issuance under equity
compensation plans
excluding securities
reflected in column (a)
(c)
883,250
—
883,250
The shares data reflected above has been adjusted to reflect our February 20, 2007 three-for-two
stock split effected in the form of a dividend.
Stock Performance Graph
The following graph shows a comparison of stockholder return on the Bank’s common stock
based on the market price of the common stock assuming the reinvestment of dividends, for the period
beginning February 15, 2005 assuming an investment of $100 in each as of February 15, 2005. The Bank
is not included in either of these indices. Total shareholder return for the Bank, as well as for the indices, is
based on the cumulative amount of dividends for a given period (assuming dividend reinvestment) and the
difference between the share price at the beginning and at the end of the period. This graph is historical
only and may not be indicative of possible future performance of the common stock.
Preferred Bank
Total Return Perf
ormance
Preferred Bank
NASDAQ Composite
NASDAQ Bank Index
SNL Bank and Th
rift
Index
350
300
250
200
150
100
l
e
u
a
V
x
e
d
n
I
50
02/14/05
12/31/05
06/30/06
12/31/06
06/30/07
12/
31/07
43
Index
Preferred Bank
NASDAQ Composite
NASD
AQ Bank Index
SNL Ba
nk and Thrift Index
02/14/05
100.00
100.00
100.0
0
100.0
0
12/31/05
204.71
105.88
99.09
102.84
Period Ending
06/30/06
248.61
104.2804.28
2.83
10
0
108.2
12/31/06
280.61
115.9
6
109. 9
9
120.17
06/
30/07
282.59
124.98
101.41
5.12
11
12/31/07
185.81
127.34
85.72
91.64
ITEM 6. SELECTE
D FINANCIAL
DATA
The following
should read our select
m
ore detailed inform
Discussion and Analysis of
Form 10-K
table shows our selected
ed historical financial d
ation in our consolidated fi
histori
ata, togeth
nanc
Financial ondition and
cal financi
with
er
ial statem
Resul
al data
d cated.
the notes th
n ion wi
ents and related notes and “Managem
ts of Operat n included elsewhere in this
ods in i
in conju ct
for the peri
ereto,
You
th the
ent’s
io s”
C
Our finan
for the years ended
financial statements included els
cial condition data s o
Dece
a
ewh e i
er n this Form 10-K.
f December 3 ,
1 20
07 and 200 an our stateme t o ncome data
6 d
mber 31, 2007, 2006 and 2005 have been derived from
our audit d
torical
n
f i
e his
Our financial con
income data for the
financial statements that ar
dition data s of Dec
a
m
d
year ended Dece ber 31, 2004 and 00
K.
1 2005,
ember 3 ,
2
this Form 10-
e not inclu ed in
2004 an 2
3 have been e
d 003 an
d riv
d our st te
a ment o
ed from our u ted historica
a di
f
l
At or f
or
th Year Ended D em r 31,
be
ec
e
2007
2006
2005
(Dollar n
s i
th us
o and, except per a
sh re d
2004
ata)
2003
Financial Condition Data:
Total assets
Total deposits
Investments securities available-for-
sale, at fair value sale
Loans and leases, gross
Cash and due from banks
Other real estate owned(1)
Shareholders’ equity
Statement of Income Data:
Interest income
Interest expense
Net interest income
Provision for credit 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
$ 1,542,610
1,253,110
$ 1,348,841
1,161,344
$ 1,136,720
975,467
$ 907,270
801,535
$ 761,825
662,812
245,268
1,233,099
22,803
8,444
152,952
$ 112,607
44,199
68,408
4,900
63,508
3,090
21,461
45,137
18,670
$ 26,467
198,689
997,317
26,878
—
145,932
$ 90,262
31,424
58,838
1,960
56,878
3,028
20,017
39,889
16,538
$ 23,351
162,935
771,143
25,123
—
123,846
$ 60,082
16,062
44,020
2,110
41,910
3,868
17,571
28,207
11,382
$ 16,825
164,635
615,961
35,212
8,258
76,808
$ 38,643
7,447
31,196
1,550
29,646
4,199
15,339
18,506
7,354
$ 11,152
155,869
504,053
22,960
8,258
67,736
$ 34,376
8,696
25,680
2,100
23,580
4,923
13,774
14,729
5,696
$ 9,033
44
2007
At or for the Year Ended December 31,
2005
2004
2006
2003
Share Data:
Net income per share, basic(2) (10)
Net income per share, diluted(2) (10)
Book value per share(3) (10)
Shares outstanding at period end(10)
Weighted average number of shares
outstanding, basic(2) (10)
Weighted average number of shares
outstanding, diluted(2) (10)
Selected Other Balance Sheet Data(4):
Average assets
Average earning assets
Average shareholders’ equity
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 loans and lease losses
(Dollars in thousands, except per share data)
$ 2.56
$ 2.50
$ 15.37
9,953,532
$ 2.29
$ 2.21
$ 14.20
10,274,706
$ 1.72
$ 1.65
$ 12.34
10,037,856
$ 1.35
$ 1.28
$ 9.22
8,331,273
$ 1.11
$ 1.05
$ 8.28
8,182,473
10,330,232
10,194,515
9,782,645
8,227,597
8,160,479
10,580,949
10,556,282
10,195,958
8,713,851
8,573,313
$ 1,405,311
1,362,433
156,217
$ 1,180,749
1,142,126
134,384
$ 1,006,222
969,019
110,250
$ 840,265
791,227
71,896
$ 752,097
707,588
63,704
1.88%
1.98%
1.67%
1.33%
1.20%
16.94
9.92
5.02
30.02
17.38
10.82
5.15
32.35
15.26
10.90
4.54
36.69
15.51
8.47
3.94
43.34
14.18
8.89
3.63
45.01
1.69%
0.11%
—%
0.06%
0.20%
1.90
0.08
—
0.95
1.22
to total loans and leases
1.21
1.03
1.16
1.09
1.22
Allowance for loans and lease losses
to non-performing loans
Net charge-offs (recoveries) to
average loans and leases
71.27
913.93
—
1,758.64
616.80
0.02
0.08
(0.02)
0.18
1.11
(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 annual report are based on daily averages. Percentages as
used throughout this annual report 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 credit 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.
(10) Adjusted to reflect 3-for-2 stock split effected in the form of a dividend, distributed on February 20, 2007.
45
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Our discussion and analysis of earnings and related financial data are presented herein to assist
investors in understanding the financial condition of our Company at December 31, 2007 and 2006, and
the results of operations for the years ended December 31, 2007, 2006 and 2005. This discussion should be
read in conjunction with the consolidated financial statements and related footnotes of our Company
presented elsewhere herein. Historical share and per share data has been adjusted to reflect our February
2007 three-for-two stock split.
Overview
We experienced growth in assets, loans, deposits and net income, and improvements in our
efficiency ratio, however, as a result of the rapid slowdown in the real estate market, deteriorating
economic conditions, and volatile interest rate movements, we identified some negative trends in certain of
our performance metrics. For example:
• Our net interest margin decreased primarily because of rapid and significant decreases in
interest rate during the last quarter of 2007
• The provision to our allowance for loan losses was increased from 2006 reflecting the
uncertain economic conditions, especially in the real estate market
• As a result of these factors our return on average assets, and return on average
shareholders’ equity declined in 2007 compared to 2006
• The level of non-performing loans increased significantly during 2007 to a level much
higher than in prior periods
• A significant portion of our loan growth in 2007 was attributed to growth in our real
estate loan portfolio. If negative developments in the real estate market that started in the
last quarter of 2007 continue in 2008, continued loan growth from this sector may not be
repeated at the same level, if at all.
• Our loan-to-deposit ratio ended at maximum levels in 2007, reflecting an emphasis on
low-cost deposit generation and alternative sources of funds to support continued growth
in our loan portfolio, which can be adversely affected by trends in interest rates.
If general economic conditions and the real estate market continue to deteriorate, these trends
could continue and intensify and we could experience other negative effects in our performance.
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.
For the year-ended December 31, 2007 the Bank recorded net earnings of $26.5 million as
compared to $23.4 million for December 31, 2006 representing a 13.3% increase from 2006. The increase
46
in net earnings during 2007 is primarily due to an increase in our net interest income as a result of growth
in our loan and deposit portfolio. See —“Results of Operation”.
For the year-ended December 31, 2006 the Bank recorded net earnings of $23.4 million as
compared to $16.8 million for December 31, 2005 representing a 39% increase from 2005.The increase in
net earnings during 2006 is primarily due to an increase in our net interest income as a result of growth in
our loan and deposit portfolio and the Bank’s asset sensitive balance sheet in the rising interest rate
environment.
In response to changes in interest rates, we changed the mix of our assets by accelerating the
growth of our loan originations, especially commercial real estate loans, reducing the amount of federal
funds sold and investing in higher-yielding investment securities. We expect to try to increase deposits and
other funding sources to fund additional loan growth which we expect will slow during 2008.
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 collectability 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 collectability
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.
47
Investment Securities
We assess, at each reporting date, whether there is an “other-than-temporary” impairment to our
investment securities. Such impairment is 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 issuer 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 Bank 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 recognition of impairment loss equal to
the difference between the investment’s cost and it’s fair value. The FSP is effective for reporting periods
beginning after December 15, 2005. The adoption of this FSP did not have a material impact on the
Company’s financial condition or results of operations.
Stock Split Effected in the form of a Stock Dividend
On January 25, 2007 Preferred Bank announced that its Board of Directors had approved a 3-
for-2 stock split to be effected in the form of a stock dividend. Each stockholder of record at the close
of business on February 5, 2007 received one additional share of common stock for every two shares of
common stock that they owned as of such date. The additional shares were distributed on February 20,
2007. A stockholder who would otherwise be entitled to receive a fractional share of common stock
received in lieu thereof, cash in a proportional amount based on the closing price of the common stock on
the Nasdaq Stock Exchange on the record date. After giving effect to the stock split, we have
retroactively adjusted the number of common shares outstanding at December 31, 2006 and 2005 to
10,274,632 and 10,037,782, respectively. Accordingly, all references in the accompanying statement of
financial condition, results of operations and statement of changes in shareholders’ equity to the number
of common stock shares and earnings per share amounts have been retroactively adjusted for all period
presented. As a result of the stock split, and in accordance with the 1992 Equity Incentive Stock Option
Plan, the Interim Plan, and the 2004 Equity Incentive Plan, all outstanding stock options and exercise
prices were adjusted based on the same 3-for-2 formula.
Results of Operations
The following tables summarize key financial results for the periods indicated:
Year Ended December 31,
2006
2005
2007
(Dollars in thousands, except per share data)
Net income
Net income per share, basic(1)
Net income per share, diluted(1)
Return on average assets
Return on average shareholders’ equity
$ 26,467
$ 2.56
$ 2.50
1.88%
16.94%
$ 23,351
$ 2.29
$ 2.21
$ 16,825
$ 1.72
$ 1.65
1.98%
17.38%
1.67%
15.26%
(1) Adjusted to reflect 3-for-2 stock split effected in the form of dividend, distributed on February 20, 2007.
48
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Statement of Income Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest income after provision for loan and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Income taxes
Net income
Net income per share, basic(1)
Net income per share, diluted(1)
Year Ended December 31,
2007
2006
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 112,607
44,199
68,408
4,900
63,508
3,090
21,461
45,137
18,670
$ 26,467
$ 2.56
$ 2.50
$ 90,262
31,424
58,838
1,960
56,878
3,028
20,017
39,889
16,538
$ 23,351
$ 2.29
$ 2.21
$ 22,345
12,775
9,570
2,940
6,630
62
1,444
5,248
2,132
$ 3,116
$ 0.27
$ 0.29
(1) Adjusted to reflect 3-for-2 stock split effected in the form of dividend distributed on February 20, 2007
Net income increased 13.3% to $26.5 million, or $2.50 per diluted share, for the year-ended
December 31, 2007, from $23.4 million, or $2.21 per diluted share, for the year ended December 31, 2006.
Our return on average assets was 1.88% and return on average shareholders’ equity was 16.94% for the
year ended December 31, 2007, compared to 1.98% and 17.38%, respectively, for the year ended
December 31, 2006.
Net income improved in 2007 from 2006, principally as a result of an increase in net interest
income by $6.6 million, partially offset by a $2.9 million increase in the provision of credit losses, an
increase in noninterest expense by $1.4 million and an increase in the provision for income taxes by $2.1
million.
The $6.6 million, or 12%, increase in net interest income was primarily as a result of the growth in
the loan portfolio across all loan products partially offset by a decrease in the net interest margin of 16
basis points. Our overall cost of funds in 2007 increased by 57 basis points to 4.40%, compared to 3.83%
for 2006 while yields on earning assets increased 34 basis points to 8.27% from 7.93%. The combined
impact of a rising interest rate environment in late 2006 and increased competition in the deposit market
were the primary drivers of our increased cost of funds during 2007.
As of December 31, 2007, 84% of our loan portfolio was tied to the Prime Rate, which has the
potential to re-price daily, and 14% was tied to the London Interbank Offer Rate, or LIBOR, or other
indices, which re-price periodically. Approximately 37% of our loan portfolio had a floor interest rate at
various levels, which would provide us with some protection in a falling interest rate environment should
the Prime Rate decline to a level below the floor interest rate. Approximately 1% 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, 2007 was 3.7
months. As a result, our interest-bearing liabilities generally re-price slower than our loan portfolio and our
net income has been negatively impacted by the declining rate environment during 2007.
49
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Statement of Income Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest income after provision for loan and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Income taxes
Net income
Net income per share, basic(1)
Net income per share, diluted(1)
Year Ended December 31,
2006
2005
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 90,262
31,424
58,838
1,960
56,878
3,028
20,017
39,889
16,538
$ 23,351
$ 2.29
$ 2.21
$ 60,082
16,062
44,020
2,110
41,910
3,868
17,571
28,207
11,382
$ 16,825
$ 1.72
$ 1.65
$ 30,180
15,362
14,818
(150)
14,968
(840)
2,446
11,682
5,156
$ 6,526
$ 0.57
$ 0.56
(1) Adjusted to reflect 3-for-2 stock split effected in the form of dividend distributed on February 20, 2007.
Net income increased 39.3% to $23.4 million, or $2.21 per diluted share, for the year ended
December 31, 2006, from $16.8 million, or $1.65 per diluted share, for the year ended December 31, 2005.
Our return on average assets was 1.98% and return on average shareholders’ equity was 17.38% for the
year ended December 31, 2006, compared to 1.67% and 15.26%, respectively, for the year ended
December 31, 2005.
Net income improved significantly in 2006 from 2005, principally as a result of an increase in net
interest income of $14.8 million, partially offset by an increase in noninterest expense of $2.4 million and
an increase in the provision for income taxes of $5.2 million.
The $14.8 million, or 34%, increase in net interest income was primarily as a result of the growth
in the loan portfolio across all loan products coupled with a 61 basis point improvement in our net interest
margin. Our overall cost of funds in 2006 increased by 152 basis points to 3.83%, compared to 2.31% for
2005. The combined impact of a rising interest rate environment and increased competition in the deposit
market were the primary drivers of our increased cost of funds during 2006.
As of December 31, 2006, 85% of our loan portfolio was tied to the Prime Rate, which re-prices
daily, and 13% was tied to the London Interbank Offer Rate, or LIBOR, or other indices, which re-price
periodically. Approximately 37% 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 1% 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, 2006 was 4 months. As a result, our interest-
bearing liabilities generally re-price much slower than our loan portfolio and our net income should be
positively impacted by a rising interest rate environment.
50
Net Interest Income and Net Interest Margin
Year ended December 31, 2007 compared to 2006
Net interest income before the provision for credit losses for the year ended December 31, 2007
increased $9.6 million, or 16.3%, to $68.4 million from $58.8 million for the year ended December 31,
2006. This increase was due to an increase in interest income of $22.5 million, partially offset by an
increase in interest expense of $12.8 million. Total interest expense increased primarily as a result of
increases in interest rates on time certificates of deposit maturing and being replaced at current prevailing
rates. The $22.5 million increase in total interest income was due to both an increase in interest rates on
loans and a shift in asset mix from overnight investments such as fed funds to loans.
The average yield on our interest-earning assets increased to 8.27% in the year ended December
31, 2007 from 7.93% in the year ended December 31, 2006. The increase was mainly due to slightly higher
rates earned on the investment portfolio as well as a shift in earning assets away from fed funds and into
loans.
The cost of average interest-bearing liabilities increased to 4.40% in the year ended December 31,
2007 from 3.83% in the year ended December 31, 2006. The increase was primarily driven by generally
higher rates paid on deposits during 2007 over 2006 which is partially a result of higher market rates and
increased competition for deposit dollars from banks and thrifts.
Year ended December 31, 2006 compared to 2005
Our net interest income before the provision for loan and lease losses for the year ended
December 31, 2006 increased $14.8 million, or 34%, as compared to the year ended December 31, 2005.
This increase was due to an increase in interest income of $30.2 million, partially offset by an increase in
interest expense of $15.4 million. Total interest expense increased primarily as a result of increases in
interest rates on time certificates of deposit maturing and being replaced at current prevailing rates. The
$30.2 million increase in total interest income was due to both an increase in interest rates and an increase
in 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 7.93% in the year ended
December 31, 2006 from 6.23% in the year ended December 31, 2005. 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 3.83% for the year ended December
31, 2006 from 2.31% for the year ended December 31, 2005. The increase was primarily driven by rising
interest rates with lower cost time deposits maturing and being replaced at higher prevailing rates.
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.
51
Year Ended December 31, 2007
Year Ended December 31, 2006
Average
Balance
Interest Income
or Expense
Average
Yield or
Cost
Average
Balance
Interest
Income or
Expense
Average
Yield or
Cost
(Dollars in thousands)
Year Ended December 31, 2005
Interest
Income or
Expense
Average
Yield or
Cost
Average
Balance
ASSETS
Interest-earning assets:
Loans and leases (2) (3)
Investment securities (1)
Federal funds sold
Certificates of deposits with
other banks
Other earning assets (4)
Total interest-earning assets
Noninterest-earning assets:
$1,103,248
211,228
43,278
$ 98,817
11,818
2,268
8.96%
5.59%
5.24%
$ 867,672
179,533
89,322
$ 77,186
8,793
4,377
8.90%
4.90%
4.90%
$ 692,320
166,991
101,754
$ 50,443
6,445
3,264
399
4,280
22
214
5.51%
5.00%
2,401
3,590
108
189
4,716
4.50%
5.26% 3,238
144
108
$1,362,433
$113,139
8.30%
$1,142,528
$ 90,653
7.93%
$ 969,019
$ 60,404
Cash and due from banks
Other assets
Total assets
22,943
19,931
$1,405,307
24,228
13,993
$1,180,749
23,873
13,330
$1,006,222
LIABILITIES AND
SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits:
$ 31,489
Interest-bearing demand
99,551
Money market
91,717
Savings
Time certificates of deposit
739,696
Total interest-bearing deposits 962,453
$ 458
2,210
3,494
36,263
42,425
$ 26,353
1.45%
106,962
2.22%
3.81%
67,317
4.90% 597,504
798,136
4.41%
$ 316
2,140
2,427
25,675
30,558
$ 26,757
121,444
38,346
$ 149
1.20%
1,304
2.00%
3.61%
511
4.30% 493,510 13,610
15,574
3.83%
680,057
Short-term borrowings
6,249
295
4.72%
1,071
58
5.42%
302
11
Long-term debt
35,608
1,479
4.15% 21,233
808
3.81% 14,636 477
Total interest-bearing liabilities
1,004,310
44,199
4.40%
820,440
31,424
3.83%
694,995
16,062
Noninterest-bearing liabilities:
Demand deposits
Other liabilities
Total liabilities
Shareholders’ equity
Total liabilities and
220,050
24,732
1,249,092
156,215
shareholders’ equity
$1,405,307
207,685
18,237
1,046,362
$ 134,387
$1,180,749
184,102
16,875
895,972
$ 110,250
$1,006,222
7.29%
3.86%
3.21%
3.05%
3.34%
6.23%
0.56%
1.07%
1.33%
2.76%
2.29%
3.64%
3.26%
2.31%
Net interest income
Net interest spread
Net interest margin
$ 68,940
$ 59,229
$ 44,342
3.90%
5.06%
4.10%
5.18%
3.92%
4.58%
(1) Yields on securities have been adjusted to a tax-equivalent basis.
(2)
(3) Net loan and lease fees of $2.2 million, $4.5 million and $3.1 million for the year ended December 31, 2007, 2006
Includes average non-accrual loans and leases.
and 2005, respectively, are included in the yield computations.
Includes Federal Home Loan Bank stock.
(4)
While our interest income increased, primarily due to increased loan volume and rising interest
rates, increases in interest expense on our deposits reflecting increases on rates primarily on our time
certificates of deposit, caused our net interest margin to decrease from 5.18% in 2006 to 5.02% in 2007.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.
52
Year Ended December 31,
2007 vs. 2006
Net Change
Rate
Volume
Net Change
2006 vs. 2005
Rate
Volume
(In thousands)
$ 21,631
3,025
(2,109)
$ 213
1,340
286
$ 21,418
1,685
(2,395)
$ 26,743
2,269
1,113
$ 13,967
1,785
1,511
$ 12,776
484
(398)
(86)
25
22,486
20
(1)
1,858
(106)
26
20,628
(36)
81
30,170
35
69
17,367
(71)
12
12,803
Interest income:
Loans and leases
Investment securities(1)
Federal funds sold
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
142
70
1,108
10,547
237
671
12,775
$ 9,711
74
225
190
68
(155)
918
3,934
(8)
80
4,495
$ (2,637)
6,613
245
591
8,280
$ 12,348
167
836
1,916
12,065
47
331
15,362
$ 14,808
169
991
1,530
(2)
(155)
386
9,197
19
116
12,023
$ 5,344
2,868
28
215
3,339
$ 9,464
(1) Amounts have been adjusted to a tax-equivalent basis.
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 the net interest income during 2007 was attributable to the increases in the rate on interest-
earning assets which offset the increases in the cost of time certificates of deposit and savings.
Provision for Credit 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 credit losses for 2007 increased $2.9 million to $4.9 million from $1.96 million
for 2006. The bank’s net loans and lease charge-offs decreased $423,000 to $240,000 during 2007 from
$663,000 in 2006. The increase in the provision for credit losses during 2007 is due to a higher level of
classified assets identified during 2007 and is the result of the application of management’s established
allowance for loan and lease loss methodology. Although net loan and lease charge-offs decreased for the
same period, the application of the methodology’s quantitative and qualitative components resulted in
management’s judgment that the provision and overall level of reserve is adequate for losses estimated to
be inherent in the portfolio as of December 31, 2007.
The provision for credit losses for 2006 decreased slightly by $150,000 to $1.96 million from
$2.11 million for 2005. The bank’s net loans and lease charge-offs increased $768,000 to $663,000 during
2006 from a $105,000 recovery in 2005. The decrease in the provision for credit losses during 2006 is the
result of the application of management’s established allowance for loan and lease methodology. Although
net loan and lease charge-offs increased for the same period, the application of the methodology’s
quantitative and qualitative components resulted in management’s judgment that the provision and overall
level of reserve was adequate for losses inherent in the portfolio as of December 31, 2006.
53
Noninterest Income
We earn noninterest income primarily through fees related to:
•
•
•
•
services provided to deposit customers
services provided in connection with trade finance
services provided to current loan customers
increases in the cash surrender value of bank owned life insurance policies
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
Other income
Total noninterest income
Year Ended December 31,
2006
2007
2005
$ 1,696
752
343
—
299
$ 3,090
(In thousands)
$ 1,660
777
326
—
265
$ 3,028
$ 2,297
707
312
195
356
$ 3,868
Total noninterest income increased by $62,000 or 2%, to $3.1 million during 2007 from $3.0
million during 2006. The increase in noninterest income was due to a slight increase in service charge
income of $36,000, an increase in earnings on life insurance of $17,000, an increase in other income of
$34,000 offset by a decrease in trade finance income of $25,000.
Total noninterest income decreased by $840,000 or 28%, to $3.0 million during 2006 from $3.9
million during 2005. The decrease in noninterest income was primarily attributed to a decrease in deposit
service fee income as a result of an increase in the Bank’s earning allowance which customers earn on their
deposits due to the rising interest rate environment. In addition, in 2005 the Bank realized $195,000 in
operating rental income from other real estate owned (OREO) property sold in the first quarter of 2005.
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 change the duration of the portfolio or to
re-position the portfolio for various reasons. It is likely we may 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.
54
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:
Salaries and employee benefits
Net occupancy expense
Business development and promotion expense
Professional fees
Office supplies and equipment expense
Other expense
Total noninterest expense
Year Ended December 31,
2006
2005
2007
$ 11,868
2,395
409
2,719
955
3,115
$ 21,461
(In thousands)
$ 12,216
2,303
451
1,948
943
2,156
$ 20,017
$ 10,252
2,163
444
1,534
867
2,312
$ 17,571
Total noninterest expense increased $1.4 million, or 7% to $21.5 million during 2007 from
$20.0 million during 2006. Professional fees increased by $771,000 to $2.7 million during 2007 from $1.9
million in 2006 mainly due to increased audit fees and the cost of compliance with Section 404 of the
Sarbanes-Oxley Act. In addition, we began to outsource our internal audit function during 2007 the cost of
which was also included in professional fees. Other expense increased by $959,000 to $3.1 million during
2007 from $2.2 million in 2006 primarily due to a $289,000 charge and a $332,000 charge representing the
write-down to fair value of two investment securities which management had deemed to be other than
temporarily impaired. Salaries and benefits decreased $348,000 due primarily to a decrease in bonus
expense in accordance with the Bank’s incentive bonus plan. We had 137 and 132 full-time equivalent
employees at December 31, 2007 and 2006, respectively.
Total noninterest expense increased $2.4 million, or 14%, to $20.0 million during 2006 from
$17.5 million during 2005. Salaries and employee benefits increased $2.0 million, or 19%, primarily as a
result of an increase in the number of employees and employee benefits. We had 132 and 122 full-time
equivalent employees at December 31, 2006 and 2005, respectively. Also part of the increase in salary and
employee benefits is due to stock options expense recorded in 2006 in the amount of $752,000 as a result
of adoption of SFAS No. 123(R) in 2006. Professional fees increased by approximately $400,000 to $1.9
million during 2006 from $1.5 million in 2005 mainly due to the cost of preparation to implement section
404 of the Sarbanes-Oxley Act as well as complying with the provisions of the Federal Deposit Insurance
Corporation Improvement or FDICIA and audit fees also increased significantly in connection with
additional reporting and compliance requirements as a public company.
Provision for Income Taxes
We recorded an income tax provision of $18.7 million for 2007, $16.5 million for 2006 and $11.4
million for 2005. Our effective tax rates were 41.4%, 41.5% and 40.4% for 2007, 2006 and 2005,
respectively, as compared to the statutory tax rate of 42.05%. The difference from the statutory rate for
55
2006 and 2005 is due to the nontaxable nature of income from municipal securities and earnings on cash
surrender value of Bank-Owned Life Insurance. The effective tax rates for 2007 and 2006 were further
impacted by stock option expense associated with the adoption of SFAS No. 123(R).
Financial Condition
For the period between December 31, 2007 and December 31, 2006, our assets, loans and deposits
grew at the rate of 14.4%, 23.6% and 7.9%, respectively. Our total assets at December 31, 2007 were
$1.54 billion compared to $1.35 billion at December 31, 2006. Our earning assets at December 31, 2007
totaled $1.48 billion compared to $1.30 billion at December 31, 2006. Total deposits at December 31, 2007
and December 31, 2006 were $1.25 billion and $1.16 billion, 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.
2007
2006
2005
2004
2003
Year Ended December 31,
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
$ 518,304
366,706
255,912
91,565
44
568
1,233,099
(14,896)
(682)
$ 1,217,521
$ 438,280
271,021
201,385
86,067
45
519
997,317
(10,236)
(1,759)
$ 985,322
(In thousands)
$ 372,251
171,646
149,428
76,700
121
997
771,143
(8,939)
(1,537)
$ 760,667
$ 358,220
112,002
98,547
45,951
222
1,018
615,960
(6,724)
(2,383)
$ 606,853
$ 250,993
94,816
117,607
37,829
348
2,460
505,053
(6,168)
(1,395)
$ 496,490
Total gross loans and leases increased by $235.8 million, or 23.6% during 2007 from the prior
year. This growth is due to what was primarily a strong real estate market through most of 2007. In the
latter part of 2007 the residential real estate market weakened considerably and loan growth during the
fourth quarter slowed down to 3.8%. We had an increase of $226.2 million, or 29.3% between December
31, 2006 and 2005 which was due to a concerted marketing effort as well as a very strong real estate
market.
Our real estate mini-perm loan portfolio grew significantly during 2007 by $80 million or 18.3%
to $518.3 million from $438.3 million at December 31, 2006. For the prior four years between 2006 and
2003 the growth trend for our real estate mini-perm has been as follows: during the year 2006 it grew by
$66.0 million, or 17.7%, to 438.3 million from $372.3 million at December 31, 2005, during 2005 it grew
by $14.0 million, or 3.9%, from $358.2 million at December 31, 2004, during 2004 it grew by $107.2
million, or 42.7% from $251.0 at December 31, 2003. We believe this growth reflects a combination of
our marketing efforts as well as a previously strong real estate market.
56
The following table provides information about our real estate mini-perm portfolio by property
type:
Property Type
Commercial/Office
Industrial
Retail
Apartment 4+
Residential 1-4
Land/Special purpose
Total
At December 31, 2007
Amount
(Dollars in thousands)
64,450
76,968
61,512
68,493
56,635
190,246
518,304
$
$
Percentage of Loans in
Each Category in Total
Loan Portfolio
5.23%
6.24
4.99
5.55
4.59
15.43
42.03%
During 2007 real estate construction loans grew by $95.7 million or 35.3% to $366.7 million at
December 31, 2007 from $271.0 million at December 31, 2006, and grew in 2006 by $99.4 million or
57.9%, from $171.6 million at December 31, 2005, and grew in 2005 by $59.6 million, or 53.2%, from
$112.0 million at December 31, 2004. We expect the construction portfolio will slowly decrease in total
balances and will decrease as percentage of the total loan portfolio as construction transactions have
slowed down considerably amid the current uncertain real estate market.
Commercial loans outstanding at December 31, 2007 increased significantly by $54.5 million, or
27.1%, to $255.9 million at December 31, 2007 from $201.4 million at December 31, 2006, and increased
by $51.9 million, or 34.8%, to $201.4 million at December 31, 2006 from $149.4 million at December 31,
2005. Total commercial loan commitments (including undisbursed amounts) at December 31, 2007
increased $31.4 million or 9.2% to $371.6 from $340.2 million at December 31, 2006 while the rate of
credit utilization increased to 68.9% as of December 31, 2007 from 59.2% at December 31, 2006. We
believe that this increase in utilization is a result of an increase in the number of commercial customers and
is consistent with the rest of the market. 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 increased $5.5 million or 6.4% during 2007 to $91.6 million from $86.1
million at December 31, 2006, and grew in 2006 by $9.4 million, or 12.2%, from $76.7 million at
December 31, 2005. 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 our
continued caution 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 did during 2007, 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 increased during 2007 by $48,000, or 8.5%, to $612,000 at
December 31, 2007 and declined during 2006 by $554,000, or 49.6%, to $564,000 from December 31,
2005.
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
57
economic conditions, business conditions and collection efforts, that the borrower’s financial condition is
such that collection of interest is doubtful.
As of December 31, 2007 we had one OREO property for $8.4 million as compared to none as of
December 31, 2006. In 2005 we sold an OREO property that had been generating income for the bank.
For the years-ended December 31, 2007 and December 31, 2006, we had no OREO income as compared to
$195,000 of OREO income realized for the year-ended December 31, 2005. The OREO property owned as
of December 31, 2007 consists of approximately 15 acres of property in the Oakland Hills area in the East
Bay of California. There is one completed luxury single family residence and 7 lots totaling 3.5 acres and a
parcel of 11.6 acres currently zoned for 38 property sites. Our goal is to obtain a zoning change on the 11.6
acres to multi-family townhomes or condos and then obtain the entitlements on the entire property and then
dispose of the property. On an as-is basis, the property appraised at $9.3 million as of August 13, 2007.
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:
2007
Year Ended December 31,
2005
2006
2004
2003
Non-accrual loans and leases, not restructured
Accruing loans and leases past due 90 days or more
Restructured loans and leases
Total non-performing loans (NPLs)
OREO
Total non-performing assets (NPAs)
$ 20,900
—
—
20,900
8,444
$ 29,344
$ 1,120
—
—
1,120
—
$ 1,120
$ —
—
—
—
—
$ —
$
382
—
—
382
8,258(2)
$ 8,641
$ 1,000
—
—
1,000(1)
8,258(2)
$ 9,258
(Dollars in thousands)
Selected ratios:
NPLs to total gross loans and leases held for investment
NPAs to total assets
______________________________
(1) Represents the UAL Leveraged Lease.
(2) Represents 60 Federal.
1.69%
1.90%
0.11%
0.08%
0.00%
0.00%
0.06%
0.95%
0.20%
1.22%
The amount of interest income that we would have recorded on the non-accrual and impaired
loans and leases had the loans and leases been current totaled $546,000, $41,000, $0, $15,000 and
$132,000 for 2007, 2006, 2005, 2004 and 2003 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 collectability, 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.
58
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 $20.9 million, $1.1 million and $800,000 of impaired loans or leases at December 31,
2007, 2006, and 2005 respectively. The total allowance for loan and lease losses related to these loans and
leases were $3,233,000, $11,000 and $300,000 at December 31, 2007, 2006 and 2005, respectively.
At December 31, 2007, we had $20.9 million of outstanding loans disclosed above as non-accrual
loans which management questions the ability of the borrower to comply with the present loan repayment
terms. These consisted of three commercial loans totaling $6.5 million and two loans totaling $14.4
million that are secured by real estate.
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 collectability 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.
59
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:
Allowance for Loan and Lease Loss History
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 credit losses
Balance at end of period
2007
2006
Year Ended December 31,
2005
(Dollars in thousands)
2004
2003
$ 10,236
$ 8,939
$ 6,724
$ 6,168
$ 9,257
240
—
—
—
—
—
240
—
—
—
—
—
—
—
240
4,900
273
390
—
—
—
—
663
—
—
—
—
—
—
—
663
1,960
$ 14,896
$ 10,236
5
—
—
—
—
—
5
110
—
—
—
—
—
110
(105)
2,110
$ 8,939
103
—
—
—
1,000
—
1,103
106
—
—
—
—
3
109
994
1,550
$ 6,724
39
74
—
—
5,232
—
5,345
45
111
—
—
—
—
156
5,189
2,100
$ 6,168
Total gross loans and leases at end of period
Average total loans and leases
Non-performing loans and leases
1,233,099
1,103,248
20,900
997,317
867,674
1,120
771,143
692,320
—
615,961
541,402
382
504,053
466,793
1,000
Selected ratios:
Net charge-offs (recoveries) to average
loans and leases
Provision for allowance for credit losses
to average loans and leases
Allowances for credit losses to loans
and leases at end of period
Allowance for credit losses to non-
performing loans and leases
0.02%
0.44%
1.21%
0.08%
(0.02)%
0.18%
1.11%
0.23%
1.03%
0.30%
1.16%
0.29%
1.09%
0.45%
1.22%
71.27%
913.93%
n.m.
1758.64%
616.80%
The allowance for loan and lease losses of $14.9 million at December 31, 2007, represented
1.21% of total loans and leases and 71.27% of non-performing loans and leases. At December 31, 2006
the allowance for loan and lease losses totaled $10.2 million or 1.03% of total loans and leases, net of
deferred fees and costs, and 913.93% of non-performing loans and leases as of that date. At December 31,
2005, the allowance for loan and lease losses totaled $8.9 million, or 1.16% of total loans and leases, net of
deferred fees and costs. Net charge-offs (recoveries) to average loans and leases were 0.02% for the year-
ended December 31, 2007 compared to 0.08% for the year-ended December 31, 2006. See “Critical
Accounting Policies,” and Note 3 of the “Notes to Consolidated Financial Statements.”
60
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 reflects 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:
2007
2006
Allocation
of the
Allowance
Allocation
of the
Allowance
Percent of
Loans in
Each
Category
in Total
Loans
Percent of
Loans in
Each
Category
in Total
Loans
$ 3,095
803
20.8%
5.4
$ 2,262
897
20.2%
8.6
At December 31,
2005
2004
2003
Allocation
of the
Allowance
Percent of
Loans in
Each
Category
in Total
Loans
(Dollars in thousands)
$ 2,312
1,231
19.4%
9.9
Allocation
of the
Allowance
Percent of
Loans in
Each
Category
in Total
Loans
Allocation
of the
Allowance
$ 1,511
645
16.0%
7.5
$ 1,390
438
6,213
41.7
3,169
27.2
1,837
1,064
18.2
508
4,779
1
5
—
$ 14,896
32.1
0.0
0.0
0.0
100.0%
3,822
3
4
79
$ 10,236
43.9
0.0
0.1
0.0
100.0%
3,513
5
6
35
$ 8,939
22.3
48.2
0.1
0.1
0.0
100.0%
3,456
7
4
37
$ 6,724
58.1
0.1
0.1
0.0
100.0%
2,132
861
12
827
$ 6,168
Percent of
Loans in
Each
Category
in Total
Loans
23.3%
7.5
18.8
49.8
0.4
0.2
0.0
100.0%
Commercial*
Trade finance*
Real estate
construction
*
Real estate
(mini-perm)*
Lease
Other
Unallocated
Total
*
These categories include watch list credits.
As noted above, we reserved for the UAL Leveraged Lease in 2002 and 2003 and wrote off the
remaining balance in 2003 and 2004.
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 $100,000, $70,000, $110,000 and
$200 at December 31, 2007, 2006, 2005 and 2004 respectively.
Investment Securities Available for sale
Our portfolio of investment securities consists primarily of U.S. Treasury securities, U.S.
Government agencies securities, 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. We do
not engage in active trading in our investment securities portfolio. While management has the intent and
ability to hold all securities until maturity, we have realized and from time to time may realize gains from
sales of selected securities primarily in response to changes in interest rates. At December 31, 2007,
investment securities classified as available-for-sale with a carrying value of $152.4 million were pledged
to secure public deposits.
61
The carrying value of our investment securities at December 31, 2007 totaled $245.3 million
compared to $198.7 million at December 31, 2006. During 2007, our investment securities portfolio
increased 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, 2007, 2006 and 2005 was as
follows:
U.S. Government agencies
Corporate notes
Mortgage-backed securities
Municipal securities
Other securities
$
Total securities available-for-sale
$
2007
131,032
30,191
32,583
46,553
4,909
245,268
Estimated Market Value
At December 31,
2006
2005
(In thousands)
142,106
16,657
17,200
19,308
3,418
198,689
$
$
$
$
85,238
36,463
16,003
19,387
5,844
162,935
The following table shows the maturities of investment securities at December 31, 2007, and the
weighted average yields of such securities (municipal security yields are on a tax-equivalent basis):
At December 31, 2007
Within One
Year
After One Year
but within
Five Years
After Five Years
but within
Ten Years
After Ten
Years
Total
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
(Dollars in thousands)
U.S. Government
agencies
Corporate notes
Mortgage-backed
securities
Municipal securities
Other securities
Total securities
Available-for-sale
$ 63,336
6,166
4.82%
6.91
$ 65,697 5.33%
6.32
5,858
$ 1,999 5.30%
—
—
$ —
18,167
—%
6.95
$131,032
30,191
1,492
1,937
—
5.61
3.65
—
5,263
2,136
—
5.59
3.50
—
8,102
13,112
—
5.67
4.17
—
17,726
29,368
4,909
6.34
4.33
6.01
32,583
46,553
4,909
$ 72,931
4.99%
$ 78,954 5.37%
$ 23,213 4.79%
$ 70,170
5.63%
$ 245,268
5.08%
6.82
4.61
2.73
6.01
5.28%
The following table shows the maturities of investment securities at December 31, 2006, and the
weighted average yields of such securities (municipal security yields are on a tax-equivalent basis):
62
Within One
Year
After One Year
but within
Five Years
At December 31, 2006
After Five Years
but within
Ten Years
After Ten
Years
Total
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
(Dollars in thousands)
$117,284
—
4.93
%
—
$ 23,470
3,098
5.58
%
6.07
$ 1,352
2,000
3.85
%
7.25
$ — —%
$142,106
11,558
6.67
16,656
129
—
3.35
—
—
—
—
—
—
—
—
—
17,071
19,309
858
5.51
—
—
—
—
2,560
5.89
5.37
6.48
17,200
19,309
3,418
5.03
%
6.63
5.87
5.37
6.24
$ 118,271
4.89
%
$ 26,568
5.64
%
$ 3,352
5.88
%
$ 50,498
5.90
%
$ 198,689
5.26
%
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
Consolidated Financial Statements” in this annual report.
Deposits
Total deposits were $1.25 billion at December 31, 2007 compared to $1.16 billion at December
31, 2006. Noninterest-bearing demand deposits increased to $230.1 million at December 31, 2007
compared to $225.0 million at December 31, 2006. The ratio of noninterest-bearing deposits to total
deposits was 18.4% at December 31, 2007 and 19.4% at December 31, 2006. Interest-bearing deposits are
comprised of interest-bearing demand deposits, 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:
2007
Year Ended December 31,
2006
2005
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
Average
Rate
(Dollars in thousands)
$ 220,050
0.00%
$ 207,685
0.00%
$ 184,102
0.00%
31,489
99,551
91,717
739,696
$ 1,182,503
1.45
2.22
3.81
4.90
4.41%
26,353
106,962
67,317
597,504
$ 1,005,821
1.20
2.00
3.61
4.30
3.83%
26,757
121,444
38,346
493,510
$ 864,159
0.56
1.07
1.33
2.76
2.29%
Noninterest-bearing
deposits
Interest-bearing deposits
Money market
Savings
Time certificates of deposit
Total
Average total deposits increased steadily through 2007. The increase in average total deposits for
2007 was primarily driven by an increase of $144 million in time certificates of deposit, $23 million in
savings and $12 million in noninterest-bearing demand deposits. Additional information concerning
deposits is provided in Note 5 of the “Notes to Consolidated Financial Statements” in the annual report.
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
63
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.
The following table shows the maturities of time certificates of deposit and other time deposits of
$100,000 or more at December 31, 2007 and 2006:
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
Capital Resources
At December 31,
2007
2006
(In thousands)
$ 443,511
221,014
119,263
8,621
$ 792,409
$ 407,432
187,890
107,466
9,469
$ 712,257
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, 2007, 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,
2007
At December 31,
2006
Leverage Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
10.31%
5.00%
4.00%
Tier 1 Risk-Based Capital Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
10.54%
6.00%
4.00%
Total Risk-Based Capital Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
11.57%
10.00%
8.00%
11.50%
5.00%
4.00%
11.52%
6.00%
4.00%
12.33%
10.00%
8.00%
64
Subsequent Events
In accordance with the stock repurchase plan adopted by the Board of Directors in June of 2007,
the Bank repurchased the following shares during the first quarter of 2008:
Date
February 13, 2008
February 14, 2008
February 19, 2008
February 27, 2008
February 28, 2008
March 3, 2008
March 4, 2008
Number of Shares
10,300
12,358
5,000
4,600
2,367
20,000
100,000
Total Cost
$ 215,054
254,564
103,923
88,550
45,706
400,000
1,985,000
Contractual Obligations and Off-Balance Sheet Arrangements
The following table presents our contractual cash obligations, excluding deposits, as of December
31, 2007:
Amount of Commitment Expiring per Period
Contractual Obligations (1)
Total
Amounts
Committed
Less Than
1 year
FHLB Advances
Operating Lease Obligations
Total
$ 75,000
17,147
$ 92,147
$ 27,000
1,976
$ 28,976
(1) Contractual obligations do not include interest.
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$ 48,000
3,764
$ 51,764
$
—
2,787
$ 2,787
$
—
8,620
$ 8,620
65
In the normal course of business, we enter into off-balance sheet arrangements consisting of
commitments to extend credit, to fund commercial letters of credit and standby letters of credit. The
following table presents these off-balance sheet arrangements at December 31, 2007:
Amount of off-balance sheet Expiring per Period
Total
Amounts
Committed
$ 425,737
4,642
12,003
$ 442,382
Less Than
1 year
$ 338,002
4,642
10,033
$ 352,677
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$ 84,445
—
1,970
$ 86,415
$
3,059
—
—
3,059
$
$
231
—
—
231
$
Off-balance sheet arrangements
Commitments to extend credit
Commercial letters of credit
Standby letter of credit
Total
Liquidity
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. 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 95%. Due to higher growth in loans than deposits during 2007,
our loan-to-deposit ratio was 97% at December 31, 2007 compared to 85% at December 31, 2006.
Borrowings from the Federal Home Loan Bank of San Francisco, or FHLBSF, are another source
of funding for our loan and investment activities. At December 31, 2007, we could borrow up to $161
million with collateral of specifically identified loans and securities. In addition, we have $124 million in
uncommitted borrowing lines with four correspondent banks all of which were used at some point in the
fourth quarter of 2007. 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. As an additional condition of borrowing from the FHLBSF, we
are required to purchase FHLB stock. For the year ended December 31, 2007, the Bank was required to
purchase the greater of; $3,512,000 of FHLB stock based on the volume of “membership assets” as defined
by the FHLB or $940,000 in FHLB stock based on 4.7% of outstanding borrowings with the FHLB. At
December 31, 2007, the Bank held $4,700,000 in FHLB stock.
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 ratios were 19% at December 31, 2007 and 19% at
December 31, 2006. We believe that in the event 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 unpledged
investment securities or loans, utilizing the discount window borrowings from the Federal Reserve Bank
(where we maintain $21.8 million in collateralized borrowing capacity) and the FHLBSF, could be
employed to meet those funding needs.
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
66
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 vendor 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 and liabilities 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.
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, 2007.
Interest Rate Scenario
Up 200 basis points
Up 100 basis points
Base
Down 100 basis points
Down 200 basis points
Market Value of Portfolio Equity
Percentage
Change
from Base
Percentage
of Total
Assets
Percentage of
Portfolio Equity
Book Value
0.57%
0.26
—
(0.65)
(6.25)
10.58%
10.55
10.52
10.45
9.86
106.71%
106.38
106.10
105.41
99.47
Market Value
(Dollars in
thousands)
$ 163,212
$ 162,711
$ 162,282
$ 161,233
$ 152,144
67
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, 2007, 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.
Sensitivity of Net Interest Income December 31, 2007
Interest Rate Scenario
Up 200 basis points
Up 100 basis points
Base
Down 100 basis points
Down 200 basis points
Adjusted Net
Interest Income
(Dollars in
thousands)
87,173
80,884
75,433
71,292
67,489
$
$
$
$
$
Percentage
Change
from Base
Net Interest
Margin
Percent
Net Interest
Margin Change
(in basis points)
15.56%
7.23
—
(5.49)
(10.53)
5.92%
5.49
5.12
4.84
4.58
0.80
0.37
—
(0.28)
(0.54)
At December 31, 2007, we had $1.37 billion in assets and $848.3 million in liabilities re-pricing
within one year. This indicates that approximately $520.1 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
68
within one year at December 31, 2007 is 161.3%. In theory, this analysis indicates that at December 31,
2007, 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.
Recently Issued Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN 48”). FIN 48 is an interpretation of FAS Statement No. 109, “Accounting for Income
Taxes.” The Interpretation prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be taken in a tax return and
requires additional disclosures. Under the new guidance, recognition is based upon whether or not a
company determines that it is more likely than not that a tax position will be sustained upon examination
based upon the technical merits of the position. In evaluating the more-likely-than-not recognition
threshold, a company should presume the tax position will be subject to examination by a taxing authority
with full knowledge of all relevant information. If the recognition threshold is met, then the tax position is
measured at the largest amount of benefit that is more than 50% likely of being realized upon ultimate
settlement. FIN 48 also provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The Interpretation is effective for fiscal years
beginning after December 15, 2006. Management has not identified any uncertain tax positions. There are
no unrecognized tax benefits that if recognized would affect the effective tax rate. It is the policy of
management to include any interest or penalties from income tax liabilities in the provision for income
taxes. There are no interest and tax penalties recognized in the consolidated financial statements or results
of operations of the Bank.
In addition, in May 2007, the FASB issued FASB Staff Position (“FSP”) FIN 48-1, Definition of
“Settlement” in FASB Interpretation No. 48. This FSP provides guidance on how a company should
determine whether a tax position is effectively settled for the purpose of recognizing previously
unrecognized tax benefits. The FASB clarifies that a tax position could be effectively settled upon
examination by a taxing authority. This guidance should be applied upon the initial adoption of FIN
48. The Bank’s adoption of FIN 48 effective January 1, 2007 was consistent with this FSP.
SFAS No. 141, “Business Combinations (Revised 2007).” SFAS 141R replaces SFAS 141,
“Business Combinations,” and applies to all transactions and other events in which one entity obtains
control over one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining
control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree
at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured
at fair value on the date of acquisition rather than at a later date when the amount of that consideration may
be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process
required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets acquired
and liabilities assumed based on their estimated fair value. SFAS 141R requires acquirers to expense
acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities
assumed, as was previously the case under SFAS 141. Under SFAS 141R, the requirements of SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities,” would have to be met in order to accrue
for a restructuring plan in purchase accounting and, instead, that contingency would be subject to the
probable and estimable recognition criteria of SFAS 5, “Accounting for Contingencies.” The adoption of
SFAS 141R is not expected to have a significant impact on the Bank’s financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair
Value Measurements (“SFAS No. 157”). The Statement provides a revised definition of fair value and
guidance on the methods used to measure fair value. The Statement also expands financial statement
69
disclosure requirements for fair value information. The Statement establishes a fair value hierarchy that
distinguishes between assumptions based on market data from independent sources (“observable inputs”)
and a reporting entity’s internal assumptions based upon the best information available when external
market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in FAS 157
prioritizes inputs within three levels. Quoted prices in active markets have the highest priority (Level 1)
followed by observable inputs other than quoted prices (Level 2) and unobservable inputs having the
lowest priority (Level 3). The Statement is effective for financial statements issued for fiscal years
beginning after November 15, 2007, with earlier application allowed for entities that have not issued
financial statements in the fiscal year of adoption. The Company will adopt SFAS No. 157 effective
January 1, 2008. Adoption of SFAS No. 157 will impact our SFAS No. 107 disclosures regarding the fair
value of financial instruments commencing with our 10-Q report for the first quarter of 2008. The Bank is
currently assessing the impact of SFAS No.157 on its financial condition, results of operations or cash
flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities. This Statement permits companies to choose to measure many financial
instruments and certain other items at fair value. Once a company chooses to report an item at fair value,
changes in fair value would be reported in earnings at each reporting date. This Statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007, with earlier application
allowed for entities that have not issued financial statements in the fiscal year of adoption. We do not plan
to adopt SFAS No. 159. As such, there is no impact on our financial condition, results of operation or cash
flow.
SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements, an amendment of
ARB Statement No. 51.” SFAS 160 amends Accounting Research Bulletin (ARB) No. 51, “Consolidated
Financial Statements,” to establish accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in
a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the
consolidated entity that should be reported as a component of equity in the consolidated financial
statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at
amounts that include the amounts attributable to both the parent and the non-controlling interest. It also
requires disclosure, on the face of the consolidated income statements, of the amounts of consolidated net
income attributable to the parent and to the non-controlling interest. SFAS 160 is effective for the Bank on
January 1, 2009, and is not expected to have significant impact on the Bank’s 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.”
70
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of December 31, 2007, Preferred Bank carried out an evaluation, under the supervision and
with the participation of Preferred Bank management, including Preferred Bank’s Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of Preferred Bank disclosure
controls and procedures and internal controls over financial reporting pursuant to Securities and Exchange
Commission (“SEC”) rules. Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that:
• Preferred Bank disclosure controls and procedures were effective as of the end of the period
covered by this report in timely alerting them to material information relating to Preferred
Bank that is required to be included in Preferred Bank periodic SEC filings.
• Preferred Bank internal controls over financial reporting 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.
• During the quarter ended December 31, 2007 there have been no significant changes in
Preferred Bank internal controls over financial reporting or in other factors that could
significantly affect these controls subsequent to the evaluation date.
• Disclosure controls and procedures are defined in the SEC rules as controls and other
procedures designed to ensure that information required to be disclosed in Exchange Act
reports is recorded, processed, summarized and reported within time periods specified in the
SEC’s rules and forms. Preferred Bank disclosure controls and procedures were designed to
ensure that material information related to Preferred Bank is made known to management,
including the Chief Executive Officer and Chief Financial Officer, in a timely manner.
Management’s Report on Internal Control over Financial Reporting
The Management of Preferred Bank is responsible for establishing and maintaining adequate
internal control over financial reporting pursuant to the rules and regulations of the Securities and
Exchange Commission. The Bank’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal
control over financial reporting includes those written policies and procedures that:
• pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the
transactions and dispositions of the assets of the company;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles;
71
• provide reasonable assurance that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the company’s assets that could have a material effect on the
consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Management under the supervision and with the participation of the Bank’s principal executive
officer and principal financial officer assessed the effectiveness of the Bank’s internal control over
financial reporting as of December 31, 2007. Management based this assessment on criteria for effective
internal control over financial reporting described in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment
included an evaluation of the design of Preferred Bank’s internal control over financial reporting and
testing of the operational effectiveness of its internal control over financial reporting. Management
reviewed the results of its assessment with the Audit Committee of our Board of Directors.
Based on this assessment, management determined that, as of December 31, 2007, Preferred Bank
maintained effective internal control over financial reporting.
KPMG LLP, the independent registered public accounting firm that audited the Bank’s financial
statements included in this Annual Report on Form 10K, has issued an attestation report on the
effectiveness of the Bank’s internal control over financial reporting as of December 31, 2007. This report
which expresses an unqualified opinion on the effectiveness of the Bank’s internal control over financial
reporting as of December 31, 2007 is included in this term under the heading “Report of Independent
Registered Public Accounting Firm.”
72
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Preferred Bank:
We have audited Preferred Bank’s (the Bank) internal control over financial reporting as of December 31,
2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Preferred Bank's management is
responsible for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting, included in the accompanying Management’s
Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the
Bank’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed 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. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Preferred Bank maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission..
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated statements of financial condition of Preferred Bank and subsidiary
as of December 31, 2007 and 2006, and the related consolidated statements of income and comprehensive
income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period
ended December 31, 2007, and our report dated March 13, 2008 expressed an unqualified opinion on those
consolidated financial statements.
KPMG LLP
Los Angeles, California
March 13, 2008
73
ITEM 9B. OTHER INFORMATION
On April 12, 2007 we submitted Form 4 “Statement of Changes in Beneficial Ownership of
Securities” as a late filing for acquisition and disposal of securities with a transaction date of January 31,
2007. The beneficial owner of the subject securities is our Chairman, President and CEO Mr. Li Yu. On
June 19, 2007 we submitted Form 4 “Statement of Changes in Beneficial Ownership of Securities” as a late
filing for disposal of securities with a transaction date of March 23, 2007. The beneficial owner of the
subject securities is Bestwood Trust 1. On November 9, 2007 we submitted Form 4 “Statement of Changes
in Beneficial Ownership of Securities” as a late filing for acquisition of securities with a transaction date of
October 30, 2007. The beneficial owner of the subject securities is our Chairman, President and CEO Mr.
Li Yu.
74
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 2007 Annual Meeting of Shareholders
(the “2007 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.
Code of Ethics
The Bank has adopted a code of ethics that applies to its principal executive officer, principal
financial and accounting officer, controller, and persons performing similar functions. The code of ethics
is posted on our internet website at www.preferredbank.com.
ITEM 11. EXECUTIVE COMPENSATION DISCLOSURE
Information concerning executive compensation will appear in the 2007 Definitive 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 not later than
the end of such 120 day period.
In July 2006, the Securities and Exchange Commission adopted new rules “Executive
Compensation Disclosure” that require companies to report more data on executive and director
compensation, including the total annual compensation of the principal executive and financial officers, the
three other highest paid executive officers, and the Bank ’s directors. The adopted rules, which do not
differ greatly from what had been proposed in January, also revise the guidance on identifying perquisites
and the disclosure requirements for “related person” transactions, officers’ and directors’ equity ownership,
director independence, and the functions of board committees. The requirements affect disclosure in proxy
statements, annual reports, registration statements, and Form 8-K reports. Effective dates vary, beginning
as early as 59 days after the rules are published in the Federal Register. The new rules become effective
November 7, 2006. The Bank has adopted the new rules effective December 31, 2006.
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 2007 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.
75
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE
Information concerning certain relationships and related transactions will appear in the 2007
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 and
“DIRECTOR INDEPENDENCE,” 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 2007 Definitive
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.
76
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
Report of Independent Registered Public Accounting Firm ..................................................................................... 78
Consolidated Statements of Financial Condition at December 31, 2007 and 2006 .................................................. 79
Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2007,
2006 and 2005.................................................................................................................................................... 80
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2007, 2006
and 2005............................................................................................................................................................. 81
Consolidated Statements of Cash Flows for the Years Ended December 31, 2007, 2006 and 2005 ........................ 82
Notes to Consolidated Financial Statements ............................................................................................................. 83
Page
(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*
10.11*
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)
Revised Bonus Plan
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.
77
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Preferred Bank:
We have audited the accompanying consolidated statements of financial condition of Preferred
Bank and its subsidiary (the Bank) as of December 31, 2007 and 2006 and the related consolidated
statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each
of the years in the three-year period ended December 31, 2007. These consolidated financial statements are
the responsibility of the Bank’s management. Our responsibility is to express an opinion on these
consolidated 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 consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Preferred Bank and subsidiary as of December 31, 2007 and
2006, and the results of their operations and their cash flows for each of the years in the three-year period
ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Preferred Bank’s internal control over financial reporting as of December
31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated
March 13, 2008 expressed an unqualified opinion on the effectiveness of the Bank’s internal control over
financial reporting.
KPMG LLP
Los Angeles, California
March 13, 2008
78
PREFERRED BANK
Consolidated Statements of Financial Condition
December 31, 2007 and 2006
(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 unamortized deferred loan fees, net
Net loans and leases
Other real estate owned
Customers’ liability on acceptances
Bank furniture and fixtures, net
Bank-owned life insurance
Accrued interest receivable
Federal Home Loan Bank (“FHLB”) stock
Net deferred tax assets
Other assets
Total assets
Liabilities and Shareholders’ Equity
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
Accrued interest payable
Other liabilities
Total liabilities
Commitments and contingencies
Shareholders’ equity:
2007
2006
$
22,803
$
—
22,803
245,268
1,233,099
(14,896)
(682)
1,217,521
8,444
5,083
4,721
8,168
10,165
4,700
12,278
3,459
26,878
103,700
130,578
198,689
997,317
(10,236)
(1,759)
985,322
—
268
1,711
7,896
8,633
3,682
9,544
2,518
$
1,542,610
$
1,348,841
$
230,083
137,220
93,398
639,455
152,954
1,253,110
5,083
111,000
5,493
14,972
1,389,658
$
224,982
124,094
100,011
619,110
93,147
1,161,344
268
20,000
5,272
16,025
1,202,909
Preferred stock. Authorized 5,000,000 shares; no shares issued and
outstanding at December 31, 2007 and December 31, 2006.
Common stock, no par value. Authorized 100,000,000 shares; issued
and outstanding 9,953,532 and 10,274,632 shares at December 31,
2007 and December 31, 2006, respectively.(1)
Treasury stock, at cost (500,000 shares in 2007)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss:
Unrealized loss on securities available-for-sale, net of tax of $1,072
and $324 at December 31, 2007 and December 31, 2006, respectively.
Total shareholders’ equity
—
—
71,863
(14,976)
2,948
94,595
(1,478)
152,952
69,658
—
1,502
75,219
(447)
145,932
Total liabilities and shareholders’ equity
$
1,542,610
$
1,348,841
(1) Adjusted to reflect February 2007 3-for-2 stock split effected in the form of a dividend.
See accompanying notes to the consolidated financial statements.
79
PREFERRED BANK
Consolidated Statements of Income and Comprehensive Income
Years Ended December 31, 2007, 2006 and 2005
(In thousands, except share and per share data)
Interest income:
Loans and leases
Investment securities, available for sale
Federal funds sold
Total interest income
Interest expense:
Interest-bearing demand
Savings
Time certificates of $100,000 or more
Other time certificates
Federal funds purchased
FHLB borrowings
Total interest expense
Net interest income before provision for credit losses
Provision for credit losses
Net interest income after provision for credit losses
Noninterest income:
Fees and service charges on deposit accounts
Trade finance income
BOLI income
Net other real estate owned income
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:
2007
2006
2005
$ 98,817
11,522
2,268
112,607
$ 77,186
8,699
4,377
90,262
$ 50,443
6,375
3,264
60,082
2,668
3,494
30,879
5,384
295
1,479
44,199
68,408
4,900
63,508
1,696
752
343
—
299
3,090
11,868
2,395
409
2,719
955
3,115
21,461
45,137
18,670
$ 26,467
2,456
2,427
22,006
3,669
58
808
31,424
58,838
1,960
56,878
1,453
529
11,488
2,104
11
477
16,062
44,020
2,110
41,910
1,660
777
326
—
265
3,028
2,297
707
312
195
356
3,868
12,216
2,303
451
1,948
943
2,156
20,017
39,889
16,538
$ 23,351
10,252
2,163
444
1,534
867
2,312
17,571
28,207
11,382
$ 16,825
Unrealized net gains (loss) 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
(1,778)
1,200
(2,102)
—
(1,778)
747
(1,031)
$ 25,436
—
1,200
(505)
695
$ 24,046
—
(2,102)
881
(1,221)
$ 15,604
Net income per share(1):
Basic
Diluted
Weighted-average common shares outstanding(1):
Basic
Diluted
$ 2.56
$ 2.50
$ 2.29
$ 2.21
$ 1.72
$ 1.65
10,330,232
10,580,949
10,194,515
10,556,282
9,782,645
10,195,958
$ 0.43
Dividends per share
(1) Adjusted to reflect February 2007 3-for-2 stock split effected in the form of a dividend.
$ 0.68
$ 0.53
See accompanying notes to the consolidated financial statements.
80
PREFERRED BANK
Consolidated Statements of Changes in Stockholders’ Equity
Years Ended December 31, 2007, 2006 and 2005
(In thousands, except share and dividends declared per share data)
Common Stock
Treasury
Shares
Amount
Stock
Retained
Accumulated
Other
Comprehensive
Total
Stockholders’
Earnings
Income (Loss)
Equity
Additional
Paid-In
Capital
Balance as of December 31, 2004
8,331,199
$ 31,903
$ —
$
235
$ 44,591
$
79
$
76,808
Cash dividends paid ($0.43 per share)
Tax benefit−exercise of stock options
—
—
—
—
Stock options exercised
Initial public offering, net of issuance
228,150
1,510
1,478,433
34,030
costs
Net income
Change in unrealized loss on securities
available-for-sale, net of taxes
—
—
—
—
—
—
—
—
—
—
—
5
—
—
—
—
(4,111)
—
—
—
16,825
—
—
—
—
—
—
(1,221)
(4,111)
5
1,510
34,030
16,825
(1,221)
Balance as of December 31, 2005
10,037,782
$ 67,443
$ —
$
240
$ 57,305
$
(1,142)
$ 123,846
Cash dividends paid ($0.53 per share)
Tax benefit−exercise of share-based
payment
—
—
—
—
Stock options exercised
236,850
2,215
Stock-based payment
Net income
Change in unrealized gain on
securities available-for-sale, net of
taxes
—
—
—
—
—
—
—
—
—
—
—
—
—
510
—
752
—
—
(5,437)
—
—
—
23,351
—
—
—
—
—
—
695
(5,437)
510
2,215
752
23,351
695
Balance as of December 31, 2006
10,274,632
$ 69,658
$ —
$ 1,502
$ 75,219
$
(447)
$ 145,932
Cash dividends paid ($0.68 per share)
Tax benefit−exercise of share-based
—
—
payment
Stock options exercised
Stock buyback
Stock-based payment
3-for-2 stock split, effected February
20, 2007
Net income
Change in unrealized loss on securities
available-for-sale, net of taxes
178,900
(500,000)
—
—
—
—
—
—
2,210
—
—
—
—
(14,976)
—
(5)
—
—
—
—
—
—
—
261
—
—
1,185
—
—
—
(7,091)
—
—
—
—
—
26,467
—
—
—
—
—
—
—
—
(1,031)
(7,091)
261
2,210
(14,976)
1,185
(5)
26,467
(1,031)
Balance as of December 31, 2007
9,953,532
$ 71,863
$(14,976)
$ 2,948
$ 94,595
$
(1,478)
$ 152,952
See accompanying notes to consolidated financial statements.
81
PREFERRED BANK
Consolidated Statements of Cash Flows
Years Ended December 31, 2007, 2006 and 2005
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses
Write-down on investment securities
Amortization of net deferred loan fees
Amortization (accretion) of investment securities discounts
and premiums, net
Depreciation and amortization
Share-based compensation expense
Excess tax benefit from share-based payment arrangement
Deferred tax benefit
Increase in BOLI, accrued interest receivable and other assets
Increase in accrued expenses and other liabilities
2007
2006
2005
$ 26,467
$ 23,351
$ 16,825
4,900
622
1,960
—
2,110
—
(1,077)
(222)
845
(357)
575
1,185
(261)
(1,986)
(17,022)
4,244
(31)
568
752
478
(1,419)
(3,812)
6,168
1,366
579
—
5
(1,334)
(7,700)
1,980
Net cash provided by operating activities
17,290
27,793
14,676
Cash flows from investing activities:
Purchase of securities available-for-sale
Matured and called
Principal collected and stock dividends
Proceeds from sale of other real estate owned
Net increase in loans
Purchase of bank premises and equipment
(312,358)
261,711
2,024
—
(236,022)
(3,585)
(155,034)
116,494
4,017
—
(226,348)
(444)
(67,405)
60,800
4,837
8,258
(156,767)
(1,049)
Net cash used in investing activities
(288,230)
(261,315)
(151,326)
Cash flows from financing activities:
Increase in deposits
Proceeds from FHLB borrowings
Repayments of Federal Funds & FHLB borrowings
Excess tax benefit from share-based payment arrangement
Net proceeds of stock options exercised
Stock buyback
Issuance of common stock, net of issuance costs
Cash payment of 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:
91,766
126,000
(35,000)
261
2,205
(14,976)
—
(7,091)
163,165
(107,775)
130,578
22,803
$
185,877
—
(1,500)
(478)
2,215
—
—
(5,437)
180,677
(52,845)
183,423
$ 130,578
173,932
16,500
(10,000)
—
1,510
—
34,030
(4,111)
211,861
75,211
108,212
183,423
$
Interest
Income taxes
$
$
43,978
21,300
$
$
28,736
18,210
$
$
14,769
20,124
See accompanying notes to consolidated financial statements.
82
PREFERRED BANK
Notes to Consolidated Financial Statements-(Continued)
(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)
Principles of Consolidation
The financial statements include the accounts of the Company and its subsidiary, PB
Investment and Consulting, Inc. All intercompany transactions and accounts have been
eliminated in consolidation.
(b) Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, and federal funds sold, all
of which have original or purchased maturities of less than 90 days.
(c)
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 net of applicable taxes until realized. Realized gains and losses
from 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, 2007 and 2006, there
were no securities held for held-to-maturity purposes.
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. Factors considered when determining if a security is temporarily impaired
includes, but is not limited to; length of time of the impairment, severity of the impairment,
near term financial prospects of the issuer, and the Bank’s intent and ability to hold the
security to a recovery in price or maturity. 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.
83
PREFERRED BANK
Notes to Consolidated Financial Statements-(Continued)
(d) Loans and Loan Origination Fees and Costs
Loans are carried at face value, less payments received, the allowance for loan and lease
losses, and net 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 non-
accrual 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 non-accrual status, all interest previously accrued, but not
collected, is reversed against current period interest income. Income on non-accrual loans is
subsequently recognized only to the extent that cash is received and the loan’s principal
balance is deemed collectible. The loan is generally returned to accrual status when the
borrower has brought the past due principal and interest payments current and, in the option
of management, the borrower has demonstrated the ability to make future payments of
principal and interest as scheduled.
Loans are considered for full or partial charge-offs in the event that principal or interest
is over 180 days past due, the loan lacks sufficient collateral and it is not in the process of
collection. We also consider writing off loans in the event of any of the following
circumstances: 1) the impaired loan balances are not covered by the value of the source of
repayment; 2) the loan has been identified for charge-off by regulatory authorities; and 3)any
overdrafts greater than 90 days
84
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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.
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. All
classified loans that are over $2 million are analyzed for impairment. The Bank recognizes
interest income on impaired loans based on its existing methods of recognizing interest
income on nonaccrual loans.
(e) 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 are probable and reasonably estimatable. 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 credit quality and
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.
85
PREFERRED BANK
Notes to Consolidated Financial Statements-(Continued)
(f) 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 through a charge to earnings.
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.
(g) Bank Furniture and Fixtures
Bank furniture and fixtures 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.
(h) 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.
(i)
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.
(j)
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.
86
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(k) Share-Based Compensation
Employees and directors participate in the following stock option compensation plans--
the 1992 Stock Option Plan, Interim Stock Option Plan and the 2004 Equity Incentive Plan
which are discussed in Note 13.
Effective January 1, 2006, the Bank adopted Statement of Financial Accounting
Standards No.123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), using the
modified prospective transition method and therefore has not restated results from prior
periods. Under this transition method, share-based compensation expense for 2006 includes
compensation expense for all share-based compensation awards granted prior to January 1,
2006, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in
accordance with the original provisions of Statement of Financial Accounting Standards
No.123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Share-based
compensation expense for all share-based payment awards granted or modified on or after
January 1, 2006 is based on the grant-date fair value estimated in accordance with the
provisions of SFAS No. 123(R). The Bank recognizes these compensation costs on a straight-
line basis over the requisite services period of the award, which is the option vesting term of
the generally five years, for only those shares expected to vest. The fair value of stock option
awards was estimated using the Black-Scholes option pricing model with the grant-date
assumptions and weighted-average fair value.
Prior to the adoption of SFAS No. 123(R), the Bank accounted for stock compensation
under the intrinsic value method permitted by Accounting Principles Board (“APB”) Opinion
No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”) and related
interpretations. Accordingly, the Bank previously recognized no compensation cost for
employee stock options that were granted with an exercise price equal to the market value of
the underlying common stock on the date of grant.
87
PREFERRED BANK
Notes to Consolidated Financial Statements-(Continued)
For the year ended December 31, 2007, the Bank recognized share-based compensation
expense of $1.2 million resulting in the recognition of $192,000 in related tax benefits. Also,
as a result of adopting SFAS No. 123(R) on January 1, 2006, the Bank’s income before tax
expense and net income for the year ended December 31, 2007 was $1.2 million and
$993,000 respectively lower than if the bank had continued to account for stock-based
compensation under APB 25. Basic and diluted earnings per share for the years ended
December 31, 2007 were $.11 and $.11 lower, respectively, than if the Bank had continued to
account for stock-based compensation under APB 25.
SFAS No. 123(R) requires that cash flows resulting from the realization of tax
deductions in excess of the compensation cost recognized (excess tax benefits) are to be
classified as financing cash flows. Before the adoption of SFAS No. 123(R), the Bank
presented all tax benefits realized from the exercise of stock options as operating cash flows
in the Statements of Cash Flows.
Also SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.
Share-based compensation expense was recorded net of estimated forfeitures for the year
ended December 31, 2007 such that expense was recorded only for those share-based awards
that are expected to vest. Previously under APB 25, to the extent awards were forfeited prior
to vesting, the corresponding previously recognized expense was reversed in the period of
forfeiture.
For the Bank’s stock option plans, compensation cost is based on the fair value of the
underlying stock on the award date and is recognized over the requisite service period of the
award. In 2005 and prior years, the Bank did not recognize compensation costs when
granting stock options in the Bank’s stock option plans. This was due to the exercise price of
option grants being equal to or higher than the quoted market price of the Bank’s common
stock on the grant date as provided under the intrinsic value method of APB 25.
When options are exercised, the Bank’s policy is to issue new shares of stock.
If the compensation cost for the Bank’s stock option plan had been determined with the
fair value at the grant dates for all awards under the Plan consistent with the method of SFAS
No. 123(R), Share Based Payment, prior to January 1, 2006, the Bank’s net income and
earnings per share amounts for the year ended December 31, 2005 would have been reduced
to the pro forma amounts indicated in the table below:
88
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Net income, as reported
Deduct total stock-based employee compensation expense determined
under fair-value-based method for all awards, net of tax
Pro forma net income
Earnings per share(1):
Basic−as reported
Basic−pro forma
Diluted−as reported
Diluted−pro forma
Weighted-average common shares:
Basic
Diluted
2005
(Dollars in thousands)
$
16,825
(426)
16,399
$
2005
$ 1.72
1.68
1.65
1.61
9,782,645
10,195,958
(1) Adjusted to reflect February 2007, 3-for-2 stock split effected in the form of a dividend.
(l)
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand,
amounts due from banks, and federal funds sold.
(m) Bank-Owned Life Insurance (BOLI)
Bank-owned life insurance policies are carried at their cash surrender value. Income
from BOLI is recognized when earned.
(n) 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.
(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, 2007, approximately 95%
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
further negative changes in California’s economic and business conditions and the housing
market of Southern California. Deterioration in economic conditions could have
89
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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 such as that experienced in housing prices in 2007 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. Their 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 is evaluated on a company-wide basis.
Accordingly, we consider all of our operations are aggregated in one reportable operating
segment
(2) Securities Available for Sale
The amortized cost and estimated fair value of securities available-for-sale at December 31,
2007 and 2006 are summarized as follows:
Amortized
cost
2007
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
$ 130,602
30,741
32,718
53,757
$ 247,818
$ 527
195
274
96
$ 1,092
$
(98)
(744)
(46)
(2,754)
$ (3,642)
$131,031
30,192
32,946
51,099
$245,268
U.S. Government agencies
Corporate notes
MBS / Preferred Securities
Other securities
Total securities available-for-sale
U.S. Government agencies
Corporate notes
MBS / Preferred Securities
Other securities
Total securities available-for-sale
Amortized
cost
$ 142,270
16,880
17,376
22,934
$ 199,460
90
2006
Gross
unrealized
gains
Gross
unrealized
losses
Estimated
fair value
$
$
(In thousands)
28
125
8
22
$ 183
$
(192)
(348)
(184)
(230)
(954)
$142,106
16,657
17,200
22,726
$198,689
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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, 2007 and 2006 are as follows:
Less than 12 months
Estimated
fair value
Unrealized
losses
2007
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
U.S. Government agencies
Corporate notes
MBS / Preferred Securities
Other securities
Total
$ 56,683
14,266
2,854
35,870
$ 109,673
$
(98)
(667)
(3)
(2,452)
$(3,220)
$
—
1,075
2,753
8,850
$ 12,678
$ (—)
(77)
(43)
(302)
$ (422)
$ 56,683
15,341
5,607
44,720
$ 122,351
$
(98)
(744)
(46)
(2,754)
$(3,642)
Less than 12 months
Estimated
fair value
Unrealized
losses
2006
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
U.S. Government agencies
Corporate notes
MBS / Preferred Securities
Other securities
Total
$ 96,823
8,311
4,955
9,467
$ 119,556
$
(73)
(26)
(43)
(89)
$ (231)
$ 45,283
8,346
12,245
13,259
$ 79,133
$
(90)
(197)
(134)
(119)
$ (540)
$142,106
16,657
17,200
22,726
$198,689
$ (163)
(223)
(177)
(208)
$ (771)
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.
Preferred Bank performs a regular impairment analysis on the investment securities portfolio.
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. If the Bank
determines that a decline in fair value is other-than-temporary, an impairment write-down is
recognized in current earnings. Other-than-temporary declines in fair value are assessed based on
the duration the security has been in a continuous unrealized loss position, the severity of the
decline in value, the rating of the security and the Bank’s ability and intent on holding the securities
until the fair values recover.
Based on the Bank’s evaluation of the investment securities portfolio during the year ended
December 31, 2007, the bank had determined that two corporate securities were other than
temporarily impaired. Accordingly, the amortized cost of the securities were written down by
$289,000 as of September 30, 2007 and $332,000 as of December 31, 2007, respectively, to reflect
their current market value. As of December 31, 2007 and 2006, the bank owned FHLMC preferred
stock with an amortized cost of $6,564,000 and $2,574,000 and a fair market value of $4,909,000
and $2,561,000, respectively. The fair value of the FHLMC preferred stock was in excess of its
amortized cost through August 31, 2007. The decline in fair value occurred in September of 2007,
the same month that additional FHLMC preferred stock was purchased at substantially higher
91
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
yields. Management performed an impairment analysis as described above and determined, based
on that analysis that this security was temporarily impaired as of December 31, 2007. All issuers of
the Bank’s remaining securities have not, to management’s knowledge, established any cause for
default and the various rating agencies have reaffirmed these securities’ long term investment grade
status at December 31, 2007. The Bank has the ability and intention to hold these securities until
their fair values recover.
At December 31, 2007, there were 57 and 25 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
municipal securities are primarily attributable to declining market prices caused by interest rate
fluctuations. Unrealized losses on the FHLMC preferred stock are due primarily to lower interest
rate environments and near term prospects of the issuer.
The amortized cost and estimated fair value of securities at December 31, 2007 and 2006, 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 5.69% and
5.87% in 2007 and 2006, respectively. Expected maturities differ from contractual maturities
mainly due to prepayment rates; changes in prepayment rates will affect a security’s average life.
Cash proceeds from sales of securities available-for-sale totaled $0, $0 and $0 in 2007, 2006,
and 2005, respectively. Gross realized gains and losses on sales of securities available-for-sale
totaled $0, and $0, respectively, in 2007, $0 and $0 respectively, in 2006, $0 and $0 respectively, in
2005 based on the specific-identification method. Investment securities having a fair value of
approximately $152.4 million and $157.8 million 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, 2007 and 2006, respectively.
92
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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
2007
Amortized
cost
Estimated
fair value
(In thousands)
$ 68,954
72,881
2,000
103,983
$ 247,818
$ 67,230
73,482
1,999
102,557
$ 245,268
2006
Amortized
cost
Estimated
fair value
(In thousands)
$ 118,413
26,499
3,356
51,192
$ 199,460
$ 118,271
26,568
3,353
50,497
$ 198,689
(3) Loans and Leases and Allowance for Loan and Lease Losses
The loans and leases portfolio as of December 31, 2007 and 2006 is summarized as follows:
Real estate
Commercial
Construction
Trade finance
Installment/Consumer
Leases
Other Loans
Less:
Allowance for loan and lease losses
Deferred loan and fees, net
2007
2006
(In thousands)
$ 518,304
255,912
366,706
91,565
44
116
452
1,233,099
$ 438,280
201,385
271,021
86,067
45
185
334
997,317
(14,896)
(682)
$ 1,217,521
(10,236)
(1,759)
$ 985,322
The majority of the Bank’s loans are to customers and businesses in the state of California
and/or secured by properties located primarily 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.
93
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The Bank had $20.9 million of non-accrual loans and leases at December 31, 2007 compared
to $1.1 million at December 31, 2006. These loans and leases had interest due, but not recognized,
of approximately $546,000 and $41,000 in 2007 and 2006, respectively.
The Bank had $20.9 million and $1.1 million of impaired loans and leases as of
December 31, 2007 and 2006, respectively. As of December 31, 2007 and 2006, the amount of
impaired loans and leases for which there is a specific allowance for loan and lease loss was $20.9
million and $1.1 million, respectively, with the amount of the specific allowance for loan and lease
loss of approximately $3,233,000 and $11,000, respectively. The average recorded investment in
impaired loans and leases for 2007 and 2006 was $6.3 million and $1.2 million, respectively.
Interest income recognized on such loans and leases during 2007 and 2006 was $1,235,000 and
$73,000, respectively.
At December 31, 2007, the Bank had no commitments to lend additional funds to debtors
whose loans are non-performing.
Changes in the allowance for loan and lease losses are summarized as follows:
Balance at beginning of year
Provision for credit losses
Loans and leases charged off
Recoveries
Balance at end of year
(4) Bank Furniture and Fixtures
2007
$ 10,236
4,900
(240)
—
$ 14,896
2006
(In thousands)
$ 8,939
1,960
(663)
—
$ 10,236
2005
$ 6,724
2,110
(5)
110
$ 8,939
As of December 31, 2007 and 2006, furniture and fixtures consists of the following:
Leasehold improvements
Furniture and fixtures
Less accumulated depreciation and
amortization
2007
$
786
6,825
7,611
2006
(In thousands)
$ 1,104
3,242
4,346
2005
$ 3,300
3,260
6,560
(2,890)
$ 4,721
(2,635)
$ 1,711
(4,725)
$ 1,835
Depreciation and amortization expense was $575,000, $568,000 and $579,000 for the years
ended December 31, 2007, 2006 and 2005, respectively.
94
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(5) Deposits
Time deposit accounts at December 31, 2007 mature as follows:
Year
2008
2009
2010
Maturities of
time deposits
(In thousands)
783,788
2,519
6,102
792,409
$
$
At December 31, 2007 and 2006, approximately $152,400,000 and $157,806,000,
respectively, of the Bank’s investment securities were pledged as collateral for certain public
deposits. The amount of deposits from related parties was $3,328,000 and $2,630,000 at
December 31, 2007 and 2006, respectively. The aggregate amount of overdrafts that have been
reclassified as loan balances was $89,100 and $24,000 at December 31, 2007 and 2006,
respectively.
(6)
Income Taxes
The income taxes expense (benefit) for the years ended December 31, 2007, 2006 and 2005
was as follows:
Current:
Federal
State
Deferred:
Federal
State
2007
2006
(In thousands)
2005
$ 15,659
4,994
20,653
$ 13,722
4,235
17,957
$ 9,448
3,268
12,716
(1,580)
(403)
(1,983)
$ 18,670
(1,178)
(241)
(1,149)
$ 16,538
(1,055)
(279)
(1,334)
$ 11,382
At December 31, 2007 and 2006, other assets include current income taxes receivable of
$2,624,000 and $1,908,000, respectively. The income tax expense (benefit) for the year ended
December 31, 2006 includes an underpayment penalty in the amount of $115,000 assessed by the
Internal Revenue Service and the State of California Franchise Tax Board during the second quarter
of 2006 for the 2004 tax year.
95
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The components of the deferred tax assets and deferred tax liabilities as of December 31,
2007 and 2006 are as follows:
2007
2006
(In thousands)
Deferred tax assets:
Allowance for loan lease losses
State taxes
Other liabilities, mainly due to accrued bonuses
Deferred compensation
Bank furniture and fixtures, net
Unrealized losses on securities available-for-
sale
Other
Total deferred tax assets
$ 6,305
1,759
143
3,118
466
1,072
259
13,122
$ 4,333
1,443
1,329
2,202
397
324
85
10,113
Deferred tax liabilities:
Discount accretion
FHLB stock
Total deferred liabilities
Net deferred tax assets
(524)
(320)
(844)
(336)
(233)
(569)
$ 12,278
$
9,544
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, 2007, 2006 and 2005 (in thousands):
2007
2006
2005
Amount
Percentage
Amount
Percentage
Amount
Percentage
(In thousands)
Statutory U.S. federal income tax
State taxes, net of federal benefit
Life insurance policies
Other
$ 15,769
3,039
(95)
(43)
$ 18,670
35.0%
6.7
(0.2)
(0.1)
41.4%
$ 13,961
2,597
(91)
71
$ 16,538
35.0%
6.8
(0.2)
(0.1)
41.5%
$ 9,872
1,884
(87)
(287)
$ 11,382
35.0%
6.7
(0.3)
(1.0)
40.4%
96
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(7) Federal Funds Purchased
There were $36 million in federal funds purchased at December 31, 2007 and $0 as of
December 31, 2006 respectively. At December 31, 2007, the Bank had four federal funds
borrowing lines in the amounts of $50,000,000, $30,000,000, $20,000,000 and $24,000,000 at four
separate banks.
U.S. Treasury securities and U.S. Agency securities sold under repurchase agreements are
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,
2007, 2006 and 2005. There were no securities underlying these agreements at December 31, 2007,
2006 and 2005. These overnight agreements averaged $0 for all periods presented. The maximum
amount outstanding at any month-end during 2007, 2006 and 2005 was $0, $0 and $0, respectively.
The average rate for the years ended December 31, 2007, 2006 and 2005 was 0%, 0% and 0%,
respectively.
(8) Other Borrowed Funds
Advances from the Federal Home Loan Bank of San Francisco (FHLBSF) were $75 million
and $20 million at December 31, 2007 and 2006. The average rate on the fixed rate debt was
4.25% and 3.71% at December 31, 2007 and 2006, respectively. All advances are collateralized by
commercial or residential real estate loans. At December 31, 2007, approximately $272,752,000 of
the Bank’s real estate loans was pledged as collateral. At December 31, 2007, the outstanding
advances mature as follows:
Year
2008
2009
2010
2007
(In thousands)
27,000
$
25,000
23,000
75,000
$
The Bank had approved short-term borrowings line available through the discount window at
the Federal Reserve Bank of San Francisco (FRBSF) in the amount of $21.8 million. We had no
borrowing outstanding through the discount window outstanding as of December 31, 2007.
(9) Commitments and Contingencies
The Bank is obligated under non-cancellable operating leases for the premises of its head
office and regional offices. As of December 31, 2007, the future total minimum lease payments for
the Bank’s premises are as follows:
97
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Year
2008
2009
2010
2011
2012
Thereafter
Total lease payment
(In thousands)
1,976
1,885
1,879
1,485
1,302
8,620
17,147
$
$
Rental expense was $1,397,000, $1,308,000, and $1,235,000 for the years ended
December 31, 2007, 2006 and 2005, respectively.
(10) 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, instead the natures of these are considered in the
form of executor contracts.
Financial instrument transactions are subject to the Bank’s normal credit standards, financial
controls and risk-limiting, and monitoring procedures. Collateral requirements are determined 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, 2007 and 2006, the Bank had commitments to fund loans of $442,382,000
and $512,376,000, respectively. Other financial instruments with off-balance-sheet risk at
December 31, 2007 and 2006 are as follows:
Commitments to extend credit
Commercial letters of credit
Standby letters of credit
Total
2007
2006
(In thousands)
$ 425,737
4,642
12,003
$ 442,382
$ 496,850
3,860
11,666
$ 512,376
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 credit-worthiness on a 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.
98
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(11) 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, 2007 and 2006, the aggregate loans (including commitments) to related
parties were approximately $5.2 million (of which $723,000 was outstanding) and $12.3 million (of
which $734,000 was outstanding), respectively. All related party loans were current at
December 31, 2007 and 2006.
Changes in the outstanding loans are summarized as follows:
Balance at beginning of year
New loans
Net drawdowns (repayments)
Balance at end of year
2007
$
734
2006
(In thousands)
$ 4,457
—
(11)
723
—
(3,723)
$
734
$
2005
$ 3,060
750
647
$ 4,457
(12) 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.
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
99
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
capital (as defined) to average assets (as defined). Management believes, as of December 31, 2007,
that the Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 2007, 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
For capital adequacy
purposes
To be well capitalized
under prompt corrective
action provision
Amount
Rate
Amount
Rate
Amount
Rate
(In thousands)
As of December 31, 2007:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
$ 167,760
152,764
152,764
11.57%
10.54%
10.31%
$ 115,977
57,989
57,989
> 8.00%
4.00%
4.00%
$ 144,972
86,983
72,486
> 10.00%
6.00%
5.00%
As of December 31, 2006:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
$ 156,656
146,350
146,350
12.33%
11.52%
11.50%
$ 101,634
50,817
50,817
> 8.00%
4.00%
4.00%
$127,042
76,225
63,521
> 10.00%
6.00%
5.00%
(13) Share-Based Compensation
The Bank remunerates employees and directors through stock option compensation plans; the
1992 Stock Option Plan, Interim Stock Option Plan and the 2004 Equity Incentive Plan which are
discussed below. Effective January 1, 2006, the Bank adopted Statement of Financial Accounting
Standards No.123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), using the
modified prospective transition method and therefore has not restated results from prior periods.
Under this transition method share-based compensation expense for 2006 includes compensation
expense for all share-based compensation awards granted prior to January 1, 2006, but not yet
vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the
original provisions of Statement of Financial Accounting Standards No.123, “Accounting for
Stock-Based Compensation.” Share-based compensation expense for all share-based payment
awards granted or modified on or after January 1, 2006 is based on the grant-date fair value
estimated in accordance with the provisions of SFAS No. 123(R). The Bank recognizes these
compensation costs on a straight-line basis over the requisite services period of the award, which is
the option vesting term of generally five years, for only those shares expected to vest. The fair
value of stock option awards was estimated using the Black-Scholes option pricing model with the
grant-date assumptions and weighted-average fair value.
The number of stock options and per stock option data has been adjusted to reflect the Bank’s
February 20, 2007 three-for-two stock split effected in the form of a dividend.
1992 Stock Option Plan and Interim Stock Option Plan
100
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The Bank’s 1992 Stock Option Plan (the “1992 Plan”) provides for granting of non-statutory
stock options and incentive stock options to key full-time employees, officers, and the directors of
the Bank. The number of shares authorized in this plan is 1,447,920 shares. The 1992 Stock Option
Plan expired by its terms in 2003, and no shares are available for future grants. The options vest in
installments of 20% each year and become fully vested after five years. Options under the 1992
Plan expire ten years after the grant date.
Because the 1992 Plan expired in 2003, the Bank did not issue any options under this Plan
during 2007 and 2006.
In May 2003, April 2004 and June 2004, we granted an additional 81,000, 48,000 and
150,000 stock options, respectively to our employees and directors at exercise prices ranging from
$10.69 to $19.04 per share under the Bank’s Interim Stock Option Plan (“Interim Plan”). Even
though the terms of these stock options are consistent with the terms of the stock options granted
under our 1992 Plan, these stock options are outside of the 1992 Plan because they were granted
after the 1992 Plan’s expiration.
The total intrinsic value of share options exercised during the year ended December 31, 2007 and
2006 was $4,892,000 and $5,834,000 respectively from the 1992 Plan and the Interim Plan. As of December
31, 2007, the total compensation cost not yet recognized that relates to unvested options granted under the
1992 Plan and Interim Plan was $77,459 with a weighted-average recognition period of 0.81 years.
For the years ended December 31, 2004, the estimated weighted-average fair value per share of
options granted under the 1992 Plan and the Interim Plan were as follows:
December 31, 2004
$1.47
The estimated weighted-average fair value per share of options granted was estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Weighted Average Assumptions:
Dividend Yield
Expected Volatility
Expected Term
Risk-Free Interest Rate
December 31,
2004
2.00%
0.00%
5.0 Yrs.
3.82%
Expected volatility used in the calculation for 2004 was 0% due to the lack of trading volume in
Preferred Bank stock. The expected term of the options represents the period of time that options granted are
expected to be outstanding based primarily on the historical exercise behavior associated with previous
option grants. The risk-free interest rate is based on the 5 year U.S. Treasury CMT at the time of grant for a
period equal to the expected term of the options granted.
The following information under the 1992 Plan and the Interim Plan is presented for the
years ended December 31, 2007, 2006 and 2005.
December 31,
101
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Grant Date Fair Value of Options Granted
Fair Value of Options Vested
Total Intrinsic Value of Options Exercised
Cash Received from Options Exercised
Actual Tax Benefit Realized from Options
Exercised
2007
2006
(In thousands)
—
216
4,892
1,607
—
162
5,834
1,924
2005
—
106
4,490
1,510
257
506
6
The following is a summary of the transactions under the 1992 Plan and the Interim Plan for
the years ended December 31, 2007:
Options outstanding as of December 31, 2004
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2005
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2006
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2007
1992 Plan and Interim Plan
Number of
Options
903,900
—
(228,150)
(7,350)
668,400
—
(225,450)
(2,400)
440,500
—
(154,850)
(1,500)
284,200
Weighted
Average Exercise
Price
$ 10.75
27.91
6.64
17.57
12.07
—
8.53
12.25
13.89
—
10.28
12.35
$ 15.87
As of December 31, 2007, stock options outstanding under the 1992 Plan and the Interim
Plan were as follows:
Options Outstanding
Options Exercisable
Number of
Outstanding
Options
18,000
80,550
185,650
Weighted
Average
Exercise
Price
$ 7.94
10.69
18.87
Weighted
Average
Remaining
Contractual
Life
0.86
5.33
6.32
Number of
Outstanding
Options
18,000
52,050
109,750
Weighted
Average
Exercise
Price
$ 7.94
10.69
18.77
Weighted
Average
Remaining
Contractual
Life
0.86
5.34
6.22
Exercise Price Range
$5.00 - $9.99
$10.00 - $14.99
$15.00 - $19.99
2004 Equity Incentive Plan
The Bank’s 2004 Equity Incentive Plan (the “2004 Plan”) provides for granting of non-statutory stock
options and incentive stock options to key full-time employees, officers, and the directors of the Bank. Stock
options granted under the Plan have an exercise price equal to the fair market value of the underlying
common stock on the date of grant. Stock options granted under the 2004 Plan generally vest in installments
of 20% each year and become fully vested after five years and expire ten years from the date of grant. Certain
102
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
option and share awards provide for accelerated vesting if there is a change in control (as defined in the
Plan). The number of shares authorized in this plan is 1,800,000 shares.
The total intrinsic value of share options exercised during the year ended December 31, 2007 and
2006 was $300,000 and $124,000, respectively. As of December 31, 2007, the total compensation cost not
yet recognized that relates to unvested options granted under the 2004 Plan was $3,759,173 with a weighted-
average recognition period of 3.2 years.
For the years ended December 31, 2007, 2006 and 2005, the estimated weighted-average fair value
per share of options granted under the 2004 Plan were as follows:
2007
$7.83
December 31,
2006
$7.87
2005
$8.05
The estimated weighted-average fair value per share of options granted was estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Weighted Average Assumptions:
Dividend Yield
Expected Volatility
Expected Term
Risk-Free Interest Rate
December 31,
2007
2006
2005
1.87%
23.80%
3.75 Yrs.
4.06%
1.89%
26.58%
4.25 Yrs.
4.70%
2.00%
27.00%
6.5 Yrs.
4.46%
Expected volatility is determined based on the historical daily volatility of a peer group of similar
banks due to the short period that the bank’s stock has been publicly traded over a period equal to the
expected term of the options granted. The expected term of the options represents the period of time that
options granted are expected to be outstanding based primarily on the historical exercise behavior associated
with previous option grants. The risk-free interest rate is based on the 5 year U.S. Treasury CMT at the time
of grant for a period equal to the expected term of the options granted.
The following information under the 2004 Plan is presented for the years ended December 31, 2007,
2006 and 2005:
Grant Date Fair Value of Options Granted
Fair Value of Options Vested
Total Intrinsic Value of Options Exercised
Cash Received from Options Exercised
Actual Tax Benefit Realized from Options Exercised
2007
2,747
731
300
603
6
December 31,
2006
(In thousands)
561
1,193
124
291
4
2005
3,942
637
—
—
—
103
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The following is a summary of the transactions under the 2004 Plan for the years ended December 31,
2007, 2006 and 2005.
2004 Plan
Options outstanding as of December 31, 2004
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2005
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2006
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2007
Number of
Options
—
489,750
—
(10,500)
479,250
71,250
(11,400)
(15,150)
523,950
350,500
(24,050)
(28,200)
822,200
Weighted Average
$
Exercise Price
—
25.39
—
25.33
25.39
34.44
25.54
27.13
26.37
36.46
25.66
34.18
30.55
$
As of December 31, 2007, stock options outstanding under the 2004 Plan were as follows:
Options Outstanding
Options Exercisable
Number of
Outstanding
Options
579,950
50,250
15,000
177,000
Weighted
Average
Exercise
Price
$ 26.16
31.92
35.91
43.50
Weighted
Average
Remaining
Contractual
Life
7.75
8.15
8.55
9.15
Number of
Outstanding
Options
240,250
10,050
3,000
—
Weighted
Average
Exercise
Price
$ 25.36
31.92
35.91
—
Weighted
Average
Remaining
Contractual
Life
6.89
8.15
8.55
—
Exercise Price Range
$25.00 - $29.99
$30.00 - $34.99
$35.00 - $39.99
$40.00 - $44.99
(14) Employee Benefit Plan
Effective January 1, 1994, the Bank began a 401k 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 subject to federal limitations on maximum contributions. Contributions made by the
Bank for the years ended December 31, 2007, 2006 and 2005 totaled $149,000, $138,000 and
$129,000 respectively.
(15) Bonus Plan
In April 1994, the Management Incentive Bonus Plan was approved. In December 2007 this
Plan was amended and approved by the Board of Directors. This amendment is being filed as
Exhibit 98. 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, the total
amount of bonus payable to our employees each year, the amount of bonus to be carried over and
paid in subsequent years and the allocation of the total amounts among our chairman, officers, and
other employees. All awards are contingent upon the Bank attaining certain financial objectives.
Total expense of the plan recorded by the Bank was approximately $5,112,000, $6,610,000 and
$5,335,000 for 2007, 2006 and 2005, respectively. As of December 31, 2007 and 2006, the total
104
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
bonus accrual included in the other liabilities amounted to $6,339,000 and $9,262,000 respectively.
The amounts accrued are paid out within 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.
(16) 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, 2007 and 2006, liabilities recorded for deferred compensation plan totaled
approximately $7,417,000 and $5,240,000, respectively.
In order to economically 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 insured, while the Bank is the owner and beneficiary thereof. At December 31,
2007 and 2006, the cash surrender value of the policies totaled $8,168,000 and $7,759,000,
respectively. During 2007 and 2006, the income on the insurance policies was $343,000 and
$334,000, respectively.
(17) 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.
(18) Stockholders’ Equity
On January 25, 2007 Preferred Bank announced that its Board of Directors had declared a 3-
for-2 stock split to be paid in the form of a dividend. Each stockholder of record at the close of
business on February 5, 2007 received one additional share of common stock for every two shares
of common stock that they owned as of such date. The additional shares were distributed on
February 20, 2007. A stockholder who would otherwise be entitled to receive a fractional share of
common stock will receive in lieu thereof, cash in a proportional amount based on the closing price
of the common stock on the Nasdaq Stock Exchange on the record date. After giving effect to the
stock split, we have retroactively adjusted the number of common shares outstanding at December
31, 2006 and 2005 to 10,274,632 and 10,037,782, respectively. Accordingly, all references in the
accompanying statements of financial condition, income and comprehensive income, statement of
changes in shareholders’ equity, and footnotes to the number of common shares and earnings per
share amounts have been retroactively adjusted for all periods presented.
(19) Earnings per Share
105
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The following table summarizes the basic and diluted earnings per share calculations for the periods
indicated:
Net Earnings
Weighted Average Basic Shares(1)
Effect of Dilutive Securities:
Dilutive Stock Options
Weighted Average Diluted Shares(1)
Earnings per share(1):
Basic
Diluted
2007
2006
(In thousands, except per share data)
$
16,825
9,782,645
$
10,194,515
23,351
2005
$
26,467
10,330,232
250,717
10,580,949
361,767
10,556,282
413,313
10,195,958
$ 2.56
$ 2.50
$ 2.29
$ 2.21
$ 1.72
$ 1.65
(1) Adjusted to reflect February 2007, 3-for-2 stock split effected in the form of a dividend.
(20) Quarterly Financial Data (Unaudited)
The following tables summarize the quarterly unaudited financial data for 2007 and 2006:
Quarterly Financial Data (Unaudited)
Year Ended December 31, 2007
March 31
June 30
September 30
December 31
Three months ended
Interest income
Interest expense
Interest income before provision for credit losses
Provision for credit losses
Noninterest income
Noninterest expense
Income taxes
Net income
Earnings per share(1)
Basic
Diluted
(In thousands, except per share data)
$ 26,514
10,280
16,234
$ 28,281
10,990
17,291
$ 29,233
11,526
17,707
600
763
650
819
5,376
4,528
$ 6,493
5,483
4,998
$ 6,979
$
750
753
5,519
5,031
7,160
$ 28,579
11,403
17,176
2,900
755
5,083
4,113
5,835
$
$ 0.63
$ 0.61
$ 0.67
$ 0.65
$ 0.69
$ 0.67
$ 0.57
$ 0.57
106
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Quarterly Financial Data (Unaudited)
Year Ended December 31, 2006
March 31
June 30
September 30
December 31
Three months ended
Interest income
Interest expense
Interest income before provision for credit losses
Provision for credit losses
Noninterest income
Noninterest expense
Income taxes
Net income
Earnings per share(1)
Basic
Diluted
(In thousands, except per share data)
$ 19,274
6,037
13,237
$ 21,417
7,152
14,265
$ 23,654
8,432
15,222
560
798
350
809
4,825
3,530
$ 5,119
5,017
4,187
$ 5,520
$
350
724
5,127
4,390
6,078
$ 25,877
9,803
16,074
700
736
5,045
4,431
6,634
$
$ 0.51
$ 0.49
$ 0.54
$ 0.52
$ 0.59
$ 0.57
$ 0.65
$ 0.62
(1) Adjusted to reflect February 2007, 3-for-2 stock split effected in the form of a dividend.
(21) 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 original or purchased 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 market 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.
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.
107
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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 amounts 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
were 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 majority of our commitments to extend credit carry market interest rates if converted
to loans. Because these commitments are generally unassignable by either the borrower or us,
they only have value to the borrower and us. The estimated fair value is not material. 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.
December 31, 2007
Carrying
amount
Estimated
fair value
December 31, 2006
Carrying
amount
Estimated
fair value
(In thousands)
Assets:
Cash and cash equivalents
Securities available-for-sale
Loans, net of allowance and net deferred loan fees
Accrued interest receivable
$ 22,803
245,268
1,217,521
10,165
$ 22,803
245,268
1,217,692
10,165
$ 130,578
198,689
985,322
8,633
$ 130,578
198,689
984,842
8,633
Liabilities:
Demand deposits and
savings:
Noninterest-bearing
Interest-bearing
Time deposits
FHLB borrowings
Commitments to extend credit and letters of credit
Accrued interest payable
$ 230,083
230,618
792,409
111,000
—
5,493
$ 230,083
230,618
802,494
111,068
354
5,493
$ 224,982
224,105
712,257
20,000
—
5,272
$ 224,982
224,105
719,878
20,000
233
5,272
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
108
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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.
109
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 13, 2008
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/ Edward J. Czajka
Edward J. Czajka
/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
Albert Yu, Ph.D.
/s/ Jason C. Yuan
Ambassador Jason C. Yuan
March 13, 2008
March 13, 2008
March 13, 2008
March 13, 2008
March 13, 2008
March 13, 2008
March 13, 2008
March 13, 2008
March 13, 2008
March 13, 2008
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
- 110 -
Exhibit 21.1
SUBSIDIARIES OF THE REGISTRANT
Preferred Bank Investment and Consulting, Inc. (PBICI)
111
Exhibit 24.1
POWER OF ATTORNEY
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, 29th 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 13th day of March, 2008.
/s/ Li Yu
Li Yu
/s/ Edward J. Czajka
Edward J. Czajka
/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
Albert Yu, Ph.D.
/s/ Jason C. Yuan
Ambassador Jason C. Yuan
112
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):
a)
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
b)
Any fraud, whether or not material, that involves management or other employees who have a
113
significant role in the registrant’s internal control over financial reporting.
Date: March 13, 2008
/s/ Li Yu
Li Yu
Chairman, President and Chief Executive Officer
114
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, Edward J. Czajka, 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):
a)
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
b)
Any fraud, whether or not material, that involves management or other employees who have a
115
significant role in the registrant’s internal control over financial reporting.
Date: March 13, 2008
/s/ Edward J. Czajka
Edward J. Czajka
Senior Vice President and
Chief Financial Officer
116
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Preferred Bank (the “Bank”) on Form 10-K for the period ending
December 31, 2007 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 13, 2008
/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.
117
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Preferred Bank (the “Bank”) on Form 10-K for the period ending
December 31, 2007 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 13, 2008
/s/ Edward J. Czajka
Edward J. Czajka
Senior Vice President & 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.
118