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, 2008
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, non-
accelerated filer, or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act.
Large accelerated filed [ ] Accelerated filer [ ] Non-accelerated filer [x] Smaller reporting company [ ]
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, 2008) was $50,531,972.
Number of shares of common stock of the Registrant outstanding as of March 27, 2009, was 9,854,207.
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, 2008 .............................................
Part III
ii
TABLE OF CONTENTS
Page
PART I ........................................................................................................................................................1
ITEM 1. BUSINESS ..................................................................................................................1
ITEM 1A. RISK FACTORS.......................................................................................................30
ITEM 1B. UNRESOLVED STAFF COMMENTS....................................................................39
PROPERTIES ...........................................................................................................39
ITEM 2.
LEGAL PROCEEDINGS .........................................................................................40
ITEM 3.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .............41
ITEM 4A. EXECUTIVE OFFICERS OF PREFERRED BANK ...............................................41
PART II.....................................................................................................................................................43
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES ............................................................................................................43
ITEM 6. SELECTED FINANCIAL DATA ............................................................................47
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .................................................49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET
RISKS........................................................................................................................77
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..........................77
ITEM 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ...............................................77
ITEM 9A. CONTROLS AND PROCEDURES .........................................................................77
ITEM 9B. OTHER INFORMATION.........................................................................................81
PART III ...................................................................................................................................................82
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................82
ITEM 11. EXECUTIVE COMPENSATION DISCLOSURE...................................................82
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED SHAREHOLDER MATTERS........................82
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE................................................................................82
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ..........................................83
PART IV ...................................................................................................................................................84
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES...................................84
SIGNATURES........................................................................................................................................120
-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. We are a member of the Federal Home Loan Bank of San Francisco (FHLB). At
December 31, 2008, total assets were $1.5 billion, loans and leases were $1.2 billion, deposits were $1.3
billion and shareholders’ equity was $137 million. We had a net loss per share on a diluted basis of $0.51
for the year ended December 31, 2008 as compared to net income of $2.50 per share for the year ended
December 31, 2007.
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. 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 shareholders’ 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
Conduct and Board Committee Charters upon request by phone or in writing at the above phone number or
address, attention: Edward J. Czajka, Executive Vice President and Chief Financial Officer.
1
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
The Bank conducts banking business from our main office in downtown Los Angeles, California
and 12 full-service branch banking offices in Los Angeles, Orange and San Bernardino 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
in the three counties served by Preferred Bank which represented 41% of all Chinese-Americans in
California.
2
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, 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 businesses and 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 Current Focus
Our national economy and California in particular are in the midst of an unprecedented recession
the likes of which have not been experience in many decades. Management’s primary focus during 2008
was on credit quality, capital management and liquidity management. This document will discuss our 2008
results but a large part of this document will discuss the many challenges facing the Bank during 2009 and
beyond.
Operating Strategies
•
Improve asset quality as we shift our lending focus from production to portfolio management
and close monitoring.
• Maintain strong capital ratios as needed to weather the current economic crisis through
possible reduced cash dividends and downsizing of the balance sheet.
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, 2008, we
had a total of $220.6 million in purchased loans and $18.8 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. Due to the extremely difficult economic environment during 2008, the
3
Bank did not originate many new loans as management was more focused on managing existing loan
relationships, specifically, troubled borrowers.
We originate our loans from our twelve 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, 2008, 80% of our loans carried interest rates that adjust with changes in the
Prime Rate, 11% carried interest rates tied to LIBOR or other indices and 4% carried a fixed and other rate.
Approximately 45% of our loan portfolio has an interest rate floor.
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, 2008
(Dollars in thousands)
$ 592,697
237
$ 2,501
56.42%
1.49x
6.11%
$ 290,803
63
$ 4,616
60.56%
1.28x
6.44%
$ 273,890
518
$ 529
4.86%
$ 73,205
202
$ 362
3.83%
(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 original value.
(2) Average debt coverage ratio, or DCR, is calculated based upon the net operating income of the property divided
by the debt service.
4
We had 199 loans with outstanding principal balances between $1 million to $5 million, 47 loans
with outstanding balances between $5 million and $10 million, and 22 loans over $10 million as of
December 31, 2008.
Real Estate Mini-Perm Loans
Real estate mini-perm loans secured by retail, industrial, office and residential multi-family
properties have been the fastest growing segment of our loan portfolio and comprise 32% of our loan
portfolio as of December 31, 2008. We seek diversification through maintaining a broad base of borrowers
and monitoring our exposure to various property types.
The following table sets forth the breakdown of our real estate mini-perm portfolio by property
type:
Property Type
Commercial/Office
Retail
Industrial
Residential 1-4
Apartment 4+
Land/Special purpose
Total
At December 31, 2008
Amount
(Dollars in thousands)
77,924
82,663
55,424
66,968
110,922
198,796
592,697
$
$
Percentage of Loans in
Each Category in Total
Loan Portfolio
6.33%
6.71
4.50
5.44
9.01
16.15
48.14%
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, 2008
(In thousands)
$360,481
$42,965
$40,182
$53,724
$62,895
$32,451
$592,697
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
5
and cash flow of the borrower or guarantor(s). This completed credit memorandum is then submitted to an
officer or committee having the appropriate authority for approval. For further information on our different
levels of authority, see “—Loan Authorizations” below.
Once a loan is approved by the appropriate authority level, loan documents are drawn by our note
department, which also funds the loan when approval conditions are met. On larger, relatively complex
transactions, loan documents are prepared or reviewed by outside legal counsel.
Underwriting Standards: Our principal underwriting standards for real estate mini-perm loans are
as follows:
• Maximum LTV of 65%-70%, 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 any 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 or at lower cash flow 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 have traditionally been an active construction lender with construction loans comprising
23.6% of the total loan portfolio as of December 31, 2008. Previously, construction loans have comprised
well over 30% of the total loan portfolio but given the stress on this part of the portfolio, Management is
actively working to reduce our exposure to this type of loan. Our 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, 2008
Amount
(Dollars in thousands)
Percentage of Loans in
Each Category in Total
Loan Portfolio
$
23,589
27,117
14,729
149,535
41,538
32,142
2,153
290,803
$
1.92%
2.20
1.20
12.15
3.37
2.61
0.17
23.62%
6
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 65%-70% LTV discussed above under “—Real Estate Mini-Perm Loans—
Underwriting Standards,” we generally require a maximum 65% LTV for construction loans.
Monitoring: The monitoring of construction loans is accomplished under the supervision of our
Chief Credit Officer. We engage third-party inspectors to report on the percentage of project completion as
well as to evaluate whether the project is proceeding at an acceptable pace. The third-party inspector also
recommends whether we should approve or disapprove disbursement request amounts. The third-party
inspector produces monthly reports on each project that contain the evaluation and recommendation for
each project. The Chief Credit Officer reviews each report and makes a final determination regarding the
disbursement requests. All approved disbursements are funded by our 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, 2008, we
had $273.9 million of commercial loans outstanding, which represented 22.2% 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).
7
• 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.
Trade Finance Credits
Our trade finance portfolio totaled $73.2 million, or approximately 6% of our total loan portfolio
as of December 31, 2008. 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
8
credit to accommodate the issuance of letters of credit early in the season and to carry accounts receivable
after shipping.
Monitoring: We monitor trade finance credits by reviewing monthly borrowing base certificates
of accounts receivable and inventory for both availability and turnover trends and tracking loan covenants
on a quarterly basis. To supplement our review of borrowing bases, we utilize the services of third party
accounts receivable and inventory auditors for certain credits. Finally, it is accepted trade finance practice
to fund the payment of letters of credit on a “tenor” basis. That means that an advance under the trade
finance line has a maturity (commonly 90 days). This serves as a self-monitoring mechanism because a
matured and unpaid advance is a possible indicator of poor accounts receivable and/or inventory turnover.
Loan Concentrations
Financial instruments that potentially subject the Bank to concentrations of credit risk consist
primarily of loans and investments. These concentrations may be impacted by changes in economics,
industry or political factors. The Bank monitors its exposure to these financial instruments and obtains
collateral as appropriate to mitigate such risk.
As of December 31, 2008 and 2007, the concentration of loans secured by real estate in our total
loan portfolio was approximately 72%. Over the course of 2008, the local and national economy has seen a
substantial deterioration that has been led by residential real estate. California has been particularly hard hit
among a few other states. This has put a substantial amount of pressure on the value of our residential
construction and residential-use land loans. As such, we have seen a significant increase in non-performing
loans in these two sectors. This increase in non-performing loans has led to substantial loan losses and
significant increase in the provision for loan losses over the course of 2008 and we expect this trend to
continue well into 2009. Management is actively seeking to decrease our concentrations of residential
construction loans and residential-use land loans through foreclosure, payoffs and note sales.
Our construction and commercial 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, 2008
Amount
(Dollars in Thousands)
$
$
101,513
109,780
70,153
258,041
143,064
200,949
883,500
Percentage of Loans
in Each Category in
Total Loan Portfolio
8.24%
8.92
5.70
20.96
11.62
16.32
71.76%
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.
9
Collateral Type
Occupied 1-4
Unimproved land
Land development
Improved properties
Commercial construction
1-4 SFR construction
LTV
Maximum
90%
65%
75%
85%
80%
85%
Our underwriting practice, however, is to lend at lower LTV’s. At December 31, 2008, the
weighted average LTV of our construction and commercial real estate portfolio based on LTVs at the time
of origination was 58%.
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.
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, 2008, 5.1% 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, 2008 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, 2008
Maturity
Rate Structure for
Loans Maturing
Over One Year
One Year
or Less
$ 360,481
271,161
175,662
69,007
3
589
876,903
$
One
through
Five Years
$ 199,766
19,642
87,462
3,900
45
—
$ 310,815
Over Five
Years
Total
Fixed
Rate
Floating
Rate
(In thousands)
$
32,450
—
10,766
298
—
—
$ 43,514
$
592,697
290,803
273,890
73,205
48
589
$ 1,231,232
$
$
39,114
6,999
179
—
15
—
46,307
$
$
193,102
12,643
98,049
4,198
30
—
308,022
Real estate mini-perm
Real estate-construction
Commercial
Trade finance
Consumer
Other
Total
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. 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
10
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
Real estate-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 $41.6 million for real estate secured loans and $24.9 million for
unsecured loans at December 31, 2008. 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
11
before our Chief Credit Officer will release loan documentation for execution. Our Chief Credit Officer
and his staff work entirely independent of loan production and have full responsibility for all loan
disbursements.
Loan Grading and Loan Review
We seek to quantify the risk in our lending portfolio by maintaining a loan grading system
consisting of eight different categories (Grades 1-8). The grading system is used to determine, in part, the
provision for loan losses. The first four grades in the system are considered satisfactory. The other four
grades range from a “special mention” category to a “loss” category. These four grades are further
discussed below under the section subtitled “classified assets.”
The originating loan officer initially assigns a grade to each credit as part of the loan approval
process. Such grade may be changed as a loan application moves through the approval process.
Prior to funding, all new loans of $1.0 million or over are reviewed by our Chief Credit Officer
who may assign a different grade to the credit. The grade on each individual loan is reviewed at least
annually by the loan officer responsible for monitoring the credit. The Board of Directors reviews monthly
the aggregate amount of all loans graded as special mention, substandard or doubtful, and each individual
loan that has a grade within such range. Additionally, changes in the grade for a loan may occur through
any of the following means:
• monthly reviews by the Chief Credit Officer of a sample of loans approved under individual
loan authority;
•
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
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
12
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
•
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, 14% 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.
From time to time, we also access the deposit broker market for deposits to meet short-term
liquidity requirements. At December 31, 2008, we held $236.8 million of deposits obtained in this manner.
In addition, we also are a member of the Certificate of Deposit Account Registry Service, or “CDARS”.
Our membership allows us to share our deposits that exceed FDIC insurance limits with other financial
institutions and other financial institutions share their deposits with us in a reciprocal deposit-sharing
transaction that allows our customers to receive full FDIC insurance coverage on their large deposit
balances. This arrangement has been deemed to be considered a brokered deposit by regulators and thus
must be reported as such even though the deposits represent customer relationships. As of December 31,
2008 we had $94.3 million in CDARS deposits.
There were no significant rate differences between the rates on these deposits as compared to our
internally generated Jumbo CDs.
13
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.
On October 3, 2008, the FDIC temporarily raised the basic limit on federal deposit insurance
coverage from $100,000 to $250,000 per depositor through December 31, 2009 under the Emergency
Economic Stabilization Act of 2008.
Additionally, the Bank has elected to participate in the FDIC’s Temporary Liquidity Guarantee
Program (TLGP) program where the FDIC provides unlimited deposit insurance through December 31,
2009, for certain transaction accounts at FDIC-insured participating institutions.
Other Borrowings: We also borrow from the FHLB pursuant to an existing commitment based on
the value of the collateral pledged (both loans and securities) in our portfolio. We had $58 million in
outstanding FHLB advances with a weighted average interest rate of 4.04% and a remaining maturity
greater than one year at December 31, 2008. We currently have $118.6 million in additional available
borrowing capacity at the FHLB. In addition, we have pledged $59.9 million securities at the Federal
Reserve Bank Discount Window and may borrow against that as well.
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.
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
14
(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, 2008 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 shareholders’ 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, 2008 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, 2008, we had 268 loans
in excess of $1.0 million, totaling $1.1 billion. These loans comprise approximately 26% 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, 2008, excluding government deposits, brokered deposits and deposits as direct
collateral for loans, we had 43 depositors with deposits in excess of $3.0 million that totaled $249 million
or 19.8% 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
limits, and a wider variety of products and services. Additionally, we compete with Chinese-American and
mainstream community banks for both deposits and loans.
15
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 shareholders. 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.
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
16
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, 2008 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 located primarily
in infill locations.
(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
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.
17
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.
Recent Economic Developments
Negative developments beginning in the latter half of 2007 in the sub-prime mortgage market and the
securitization markets for such loans and other factors have resulted in uncertainty in the financial markets
in general and a related general economic downturn, which continued through 2008 and are anticipated to
continue at least well through 2009. Dramatic declines in the housing market, with decreasing home prices
and increasing delinquencies and foreclosures, have negatively impacted the credit performance of
mortgage and residential construction loans and resulted in significant write-downs of assets by many
financial institutions. In addition, the values of real estate collateral supporting many commercial as well as
residential loans have declined and may continue to decline. General downward economic trends, reduced
availability of commercial credit and increasing unemployment have negatively impacted the credit
performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the
stability of the financial markets and the economy have resulted in decreased lending by financial
institutions to their customers and to each other. This market turmoil and tightening of credit has led to
increased commercial and consumer delinquencies, lack of customer confidence, increased market
volatility and widespread reduction in general business activity. Competition among depository institutions
for deposits has increased significantly. Bank stock prices have been negatively affected as has the ability
of banks to raise capital or borrow in the debt markets compared to recent years. The bank regulatory
agencies have been very aggressive in responding to concerns and trends identified in examinations, and
this has resulted in the increased issuance of enforcement orders and other supervisory actions requiring
action to address credit quality, liquidity and risk management and capital adequacy, as well as other safety
and soundness concerns.
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
18
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%.
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, 2008, 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, 2008 are as follows:
Leverage Ratio
Preferred Bank ................................................................................................. 9.76%
Minimum requirement for “Well-Capitalized” institution ............................... 5.00%
Minimum regulatory requirement .................................................................... 4.00%
Tier 1 Risk-Based Capital Ratio
Preferred Bank ................................................................................................. 10.39%
19
Minimum requirement for “Well-Capitalized” institution ............................... 6.00%
Minimum regulatory requirement .................................................................... 4.00%
20
Total Risk-Based Capital Ratio
Preferred Bank ................................................................................................ 11.65%
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 $28 million at December
31, 2008. 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.
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 good 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.
21
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. Pursuant to the Emergency Economic
Stabilization Act of 2008 (“EESA”), the maximum deposit insurance amount has been increased from
$100,000 to $250,000 through December 31, 2009. 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. Pursuant to the Federal Deposit Insurance Reform Act of 2005, the FDIC is authorized
to set the reserve ratio for the DIF annually at between 1.15% and 1.50% of estimated insured deposits.
The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. In an
effort to restore capitalization levels and to ensure the DIF will adequately cover projected losses from
future bank failures, the FDIC, in October 2008, proposed a rule to alter the way in which it differentiates
for risk in the risk-based assessment system and to revise deposit insurance assessment rates, including
base assessment rates. First quarter 2009 assessment rates were increased to between 12 and 50 cents for
every $100 of domestic deposits, with most banks paying between 12 and 14 cents.
On February 27, 2009, the FDIC approved an interim rule to institute a one-time special
assessment of 20 cents per $100 in domestic deposits to restore the DIF reserves depleted by recent bank
failures. The interim rule additionally reserves the right of the FDIC to charge an additional up-to-10 basis
point special premium at a later point if the DIF reserves continue to fall. The FDIC also approved an
increase in regular premium rates for the second quarter of 2009. For most banks, this will be between 12
to 16 basis points per $100 in domestic deposits. Premiums for the rest of 2009 have not yet been set.
Additionally, by participating in the TLGP, banks temporarily become subject to "systemic risk
special assessments" of 10 basis points for transaction account balances in excess of $250,000 assessments
up to 100 basis points of the amount of TLGP debt issued. Further, all FDIC-insured institutions are
required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing
Corporation ("FICO"), an agency of the Federal government established to recapitalize the predecessor to
the DIF. The FICO assessment rates, which are determined quarterly, averaged 0.0112% of insured
deposits in fiscal 2008. These assessments will continue until the FICO bonds mature in 2017.
The FDIC may terminate a depository institution's deposit insurance upon a finding that the
institution's financial condition is unsafe or unsound or that the institution has engaged in unsafe or
unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank's depositors. The
termination of deposit insurance for a bank would also result in the revocation of the bank's charter by the
DFI.
Federal Home Loan Bank System
We are a member of the Federal Home Loan Bank of San Francisco, or FHLB. Among other
benefits, each of the 12 Federal Home Loan Banks, 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 restricted capital stock and maintain a certain amount
of cash reserves in the FHLB.
At December 31, 2008, the Bank was in compliance with the FHLB’s stock ownership and cash
reserve requirements. As of December 31, 2008 and 2007, our investment in FHLB capital stock totaled
$4,996,000 and $4,700,000, respectively.
Each FHLB is required to provide funds to the Affordable Housing Program and the Resolution
Funding Corporation. Due to this requirement and recent market developments, the FHLB could reduce the
22
amount of dividends paid to the Bank and could also raise interest rates on future advances to the Bank. If
dividends were reduced or interest rates on future advances were increased, the Bank's net interest margin
would also be impacted.
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 under the Securities Exchange Act of 1934 (“Exchange Act”)
as adopted by the FDIC. As such, among other requirements, 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 and facilitate communications with 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
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;
23
•
•
•
•
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 reserves, which earned interest at 0.25%
as of December 31, 2008, at specified levels against their transaction accounts (primarily checking, NOW
“negotiable order of withdrawal” and Super NOW checking accounts) and non-personal time deposits. As
of December 31, 2008 and 2007, we were in compliance with these requirements as established by the
Federal Reserve Bank to maintain reserve balances of $579,000 and $1,305,000, respectively.
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
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, 2008, the
Bank’s largest single lending relationship had a combined outstanding balance of $31.3 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);
24
•
•
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.
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.
25
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.
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
26
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
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.
27
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.
The EESA increased Federal Deposit Insurance Corporation (“FDIC”) deposit insurance on most
accounts from $100,000 to $250,000. This increase is in place until the end of 2009 with no increase in
deposit insurance premiums paid by the banking industry. In addition, the FDIC has implemented two
temporary liquidity programs to (i) provide deposit insurance for the full amount of most non-interest
bearing transaction accounts (the “Transaction Account Guarantee”) through the end of 2009 and
(ii) guarantee certain unsecured senior debt of financial institutions and their holding companies through
June 2012 under a temporary liquidity guarantee program (the “Debt Guarantee Program” and together the
“TLGP”). The Bank has elected to participate in both the Debt Guarantee Program and the Temporary
Liquidity Guarantee Program (“TLGP”). The FDIC charges “systemic risk special assessments” to
depository institutions that participate in the TLGP. The FDIC has recently proposed that Congress give
the FDIC expanded authority to charge fees to those holding companies which benefit directly and
indirectly from the FDIC guarantees.
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.
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.
28
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.
Employees
As of December 31, 2008, the Bank had a total of 142 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.
29
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.
Difficult economic and market conditions have adversely affected our industry
Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies
and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and
resulted in significant write-downs of assets by many financial institutions. General downward economic
trends, reduced availability of commercial credit and increasing unemployment have negatively impacted
the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns
over the stability of the financial markets and the economy have resulted in decreased lending by financial
institutions to their customers and to each other. This market turmoil and tightening of credit has led to
increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility
and widespread reduction in general business activity. Financial institutions have experienced decreased
access to deposits and borrowings. The resulting economic pressure on consumers and businesses and the
lack of confidence in the financial markets may adversely affect our business, financial condition, results of
operations and stock price. We do not expect that the difficult conditions in the financial markets are likely
to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects
of these difficult market conditions on us and others in the financial institutions industry. In particular, we
may face the following risks in connection with these events:
• We potentially face increased regulation of our industry. Compliance with such regulation may
increase our costs and limit our ability to pursue business opportunities. Proposals have been
discussed that call for a complete overhaul of the current regulatory framework applicable to
commercial banks. We cannot assess the impact of any such changes on our business at this time.
• The process we use to estimate losses inherent in our credit exposure requires difficult, subjective
and complex judgments, including forecasts of economic conditions and how these economic
conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty
concerning economic conditions may adversely affect the accuracy of our estimates which may, in
turn, impact the reliability of the process.
30
• We may be required to pay significantly higher FDIC premiums because market developments have
significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured
deposits. As previously discussed, the FDIC is increasing assessments on FDIC-insured institutions
and may impose a one-time assessment of 10-20 basis points on all deposits on June 30, 2009.
• Our banking operations are concentrated primarily in California. Adverse economic conditions in
this region in particular could further impair borrowers’ ability to service their loans, decrease the
level and duration of deposits by customers, and further erode the value of loan collateral. These
conditions include the effects of the current general decline in real estate sales and prices in many
markets across the United States, the current economic recession, and higher rates of
unemployment. These conditions could increase the amount of our non-performing assets and have
an adverse effect on our efforts to collect our non-performing loans or otherwise liquidate our non-
performing assets (including other real estate owned) on terms favorable to us, if at all, and could
also cause a decline in demand for our products and services, or a lack of growth or a decrease in
deposits, any of which may cause us to incur losses, adversely affect our capital, and hurt our
business.
A continued deterioration 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, 2008, 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.
If current levels of market disruption and volatility continue or worsen, there can be no assurance
that we will not experience an adverse effect, which may be material, on our ability to access capital and
on our business, financial condition and results of operations
Recent legislative and regulatory initiatives to address difficult market and economic conditions may
not stabilize the U.S. banking system. On Oct. 3, 2008, President Bush signed into law the Emergency
Economic Stabilization Act of 2008 (the “EESA”) and, on February 17, 2009, President Obama signed into
law the American Recovery and Reinvestment Act (the “ARRA”) in response to the current crisis in the
financial sector. The U.S. Treasury and banking regulators are implementing a number of programs under
this legislation to address capital and liquidity issues in the banking system. There can be no assurance,
however, as to the actual impact that the EESA and the ARRA will have on the financial markets,
including the extreme levels of volatility and limited credit availability currently being experienced. The
failure of these legislations to help stabilize the financial markets and a continuation or worsening of
current financial market conditions could have a material adverse effect on our business, financial
condition, results of operations, access to credit, or the value of our securities.
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 and are anticipated to continue at least well
31
through 2009. 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
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.
32
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
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 further 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. Although the Bank has significantly curtailed its lending activities and substantially
33
tightened its underwriting standards, if our more underwriting criteria in effect when loans were granted
proves to be ineffective, we may incur additional 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. Although a substantial amount of loan losses have been incurred in 2008, the underwriting and
credit monitoring policies and procedures that we have adopted to address this risk may not prevent
additional losses that could have a material adverse effect on our business, financial condition, results of
operations and cash flows. Additional 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 continued
economic downturn in the State of California, a further 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
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 further realized, our net income could be
adversely affected.
At December 31, 2008, our construction loans were $290.8 million, or 24% of our total loans and
leases held, and the average loan size of our construction loans was $4.6 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. Construction lending has
been a significant source of the loan losses incurred in 2008 and this may continue into 2009 due to
declining real estate values and lack of available financing to sell finished residential properties.
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
34
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 further losses in our loan portfolio.
Adverse economic conditions in Asia could impact our business adversely.
We believe that our Chinese-American 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 continue to 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, 2008, approximately $73.2 million, or 6%, 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
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, 2008, we held $464.1 million of Jumbo CDs, representing
37% 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
35
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 but not in the immediate future. In the long term, in addition to seeking deposit and loan
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 as they become available. 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:
• maintain effective 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.
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.
36
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.
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 2007-2008, multiple rate decreases 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
37
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.
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.
The price of our common stock may be volatile or may decline.
The trading price of our common stock has fluctuated and may in the future fluctuate widely as a
result of a number of factors, many of which are outside our control. In addition, the stock market is
subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of
many companies. These broad market fluctuations could adversely affect the market price of our common
stock. Among the factors that could affect our stock price are:
•
•
•
•
•
actual or anticipated quarterly fluctuations in our operating results and financial condition;
changes in revenue or earnings estimates or publication of research reports and
recommendations by financial analysts;
failure to meet analysts’ revenue or earnings estimates;
speculation in the press or investment community;
strategic actions by us or our competitors, such as acquisitions or restructurings;
38
•
•
•
•
•
•
actions by institutional shareholders;
fluctuations in the stock price and operating results of our competitors;
general market conditions and, in particular, developments related to market conditions for
the financial services industry;
proposed or adopted regulatory changes or developments;
anticipated or pending investigations, proceedings or litigation that involve or affect us; or
domestic and international economic factors unrelated to our performance.
The stock market and, in particular, the market for financial institution stocks, has experienced
significant volatility. As a result, the market price of our common stock has been and in the future may be
volatile. In addition, the trading volume in our common stock may fluctuate more than usual and cause
significant price variations to occur. The trading price of the shares of our common stock and the value of
our other securities will depend on many factors, which may change from time to time, including, without
limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity
or equity related securities, and other factors identified above in “Forward-Looking Statements”. Current
levels of market volatility are unprecedented. The capital and credit markets have been experiencing
volatility and disruption for more than a year. In recent months, the volatility and disruption have reached
unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and
credit availability for certain issuers without regard to those issuers’ underlying financial strength.
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 (see exhibit 10.12). We
moved to the new location in February 2008. This lease now expires in August of 2020.
On July 2, 2008, the Bank received approval from the Federal Deposit Insurance Corporation
(FDIC) to establish a branch office in Anaheim, California. On July 3, 2008 the Bank signed a lease to
establish this branch office to be located at 1055 North Tustin Avenue (see exhibit 10.13). The branch is
opened in December 2008. On July 18, 2008, the Bank received approval from the Federal Deposit
Insurance Corporation (FDIC) to establish a branch office in Pico Rivera, California. On July 25, 2008 the
Bank signed a lease to establish this branch office to be located at 7004 Rosemead Boulevard (see exhibit
10.14). The branch opened in December 2008.
On October 31, 2008 we closed down the operations of our full service branch located in
Valencia, California at 24501 Town Center Drive. This branch office was deemed by management to be
unprofitable based on small levels of deposits and loans serviced by this office. All accounts of this office
were transferred to our closest branch which is located in Century City, California. The lease on this
facility expires on October 31, 2009. We are actively seeking a tenant to sublease this space from us.
39
At December 31, 2008, we maintained twelve full-service branch offices in Alhambra, Arcadia
Century City, City of Industry, Diamond Bar, Pico Rivera, Santa Monica, Torrance, Anaheim, Irvine, and
Chino, California all of which we lease, except the Irvine branch which we own. We believe that no single
lease is material to our operations. Leases for branch offices are generally 3 to 12 years in length and
generally provide renewal terms of 3 to 5 additional years.
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 $1,700,000 for the year ended December 31, 2008 and $1,397,000 for
December 31, 2007.
The Bank accounts for its leases under the provision of SFAS No. 13, Accounting for leases.
Certain leases have scheduled rent increases, and certain leases include an initial period of free or reduced
rent as an inducement to enter into the lease agreement (“rent holiday”). The Bank recognizes rent expense
for rent increases and rent holiday on a straight line basis over the terms of the underlying lease without
regard to when rent payments are made.
The following table provides certain information with respect to our leased branch locations.
Location
Address
Los Angeles County
Alhambra
Arcadia
Century City
City of Industry
Diamond Bar
Los Angeles (Head Office & branch)
Pico Rivera
Santa Monica
Torrance
Valencia (Vacant).................................. 24501 Town Center Drive, Suite 103
325 E. Valley Blvd.
1469 S. Baldwin Avenue
1801 Century Park East, Suite 100
17515-A Colima Road
1373 S. Diamond Bar Blvd.
601 S. Figueroa Street, 29th Floor
7004 Rosemead Blvd.
524 Wilshire Blvd.
3501 Sepulveda Blvd., Suite 107
Orange County
Anaheim
Irvine (Purchased Branch Premises)
1055 N. Tustin Avenue
890 Roosevelt Avenue
Current
Lease
Term
Expiration
Date
Square
Footage
Total
Deposits at
December 31,
2008
(in thousands)
03/31/09
04/30/09
06/30/11
03/14/15
11/30/09
08/31/20
02/10/19
08/31/12
06/30/16
11/30/11
7/15/18
N/A
6,000
2,600
4,416
5,610
3,440
22,627
2,850
1,355
4,800
2,926
2,750
4,960
$184,428
75,755
46,146
94,234
60,790
535,216
3,519
37,565
132,943
—
3,342
57,793
San Bernardino County
Chino
ITEM 3. LEGAL PROCEEDINGS
3926 Grand Avenue, #E
10/14/10
2,973
32,455
From time to time we are a party to claims and legal proceedings arising in the ordinary course of
business. We accrue for any probable loss contingencies that are estimable and disclose any possible losses
in accordance with SFAS No. 5, "Accounting for Contingencies." 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.
40
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, 2008.
ITEM 4A. EXECUTIVE OFFICERS OF THE BANK
The following table sets forth our executive officers, their positions and their ages. Each officer is
appointed by, and serves at the pleasure of the Board of Directors.
Name
Age (1)
Position with Bank
Li Yu ........................
[68]
Chairman of the Board, President and Chief Executive Officer
Robert Kosof............
[65]
Executive Vice President and Chief Credit Officer
Edward J. Czajka .....
[44]
Executive Vice President and Chief Financial Officer
Nick Pi………..........
[48]
Executive Vice President and Group Manager
(1) As of March 13, 2009.
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.
Robert Kosof has been Executive Vice President and Chief Credit Officer since 2008. Before
joining Preferred Bank he was Executive Vice President and Chief Credit Officer of RP Realty Partners
Entrepreneurial Fund from 2006 to 2008. Prior to that, he was Senior Vice President and Chief Lending
Officer for Bank Leumi USA from 1987 to 2006. His responsibilities included credit approval and credit
quality for the California branches of the Bank. From 1985 to 1987 he was Executive Vice President and
Director for Olympic National Bank. From 1974 to 1985 he was Senior Vice President and head of Loan
Administration which included Loan Adjustments for Imperial Bank.
Edward J. Czajka has been Senior Vice President and Chief Financial Officer since 2006 and
was promoted to Executive Vice President in 2008. 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
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.
41
42
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
SHAREHOLDER 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 $5.50 on March 27, 2009 and there were 9,854,207 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:
2007
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
2008
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
High
Low
$44.84
$41.61
$43.44
$41.00
$26.00
$17.20
$12.25
$11.49
$36.09
$36.04
$35.05
$24.51
$16.15
$ 5.10
$ 3.70
$ 5.03
Cash
Dividends
Declared
$0.17
$0.17
$0.17
$0.17
$0.17
$0.10
$0.10
$0.10
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 27, 2009, 9,854,207 shares of the Bank’s common stock were held by 125
shareholders of record.
Dividends
On January 28, 2009 we declared a cash dividend in the amount of $0.08 per share. The cash
dividend was paid on February 26, 2009 to shareholders’ of record at the close of business on February 12,
2009.
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
43
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, 2008, we could have paid $28 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.
Issuer’s Purchases of Equity Securities.
44
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 and the first quarter of 2008:
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
February 13, 2008
February 14, 2008
February 19, 2008
February 27, 2008
February 28, 2008
March 3, 2008
March 4, 2008
March 10, 2008
March 11, 2008
March 13, 2008
Total
Total Cost
$ 171,820
527,175
258,971
540,760
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
694,680
379,736
437,254
215,054
254,564
103,923
88,550
45,706
400,000
1,985,000
142,932
696,000
207,993
$ 19,115,443
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
10,300
12,358
5,000
4,600
2,367
20,000
100,000
8,300
40,000
12,500
715,425
45
Securities Authorized for Issuance Under Equity Compensation Plans.
The following table provides information as of December 31, 2008 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)
1,393,200
—
1,393,200
Weighted average
exercise price of
outstanding
options
(b)
$23.63
—
Number of securities
available for future
issuance under equity
compensation plans
excluding securities
reflected in column (a)
(c)
638,450
—
638,450
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 shareholder 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 Performance
Preferred Bank
NASDAQ Composite
NASDAQ Bank
SNL Bank and Thrift
400
350
300
250
200
150
100
50
0
e
u
l
a
V
x
e
d
n
I
02/14/05
12/31/05
12/31/06
12/31/07
12/31/08
46
Index
Preferred Bank
NASDAQ Composite
NASDAQ Bank Index
SNL Bank and Thrift Index
Period Ending
02/14/05
100.00
100.00
100.00
100.00
12/31/05
204.71
105.88
99.09
102.84
12/31/06
280.61
115.9604.28
109.99
120.17
12/31/07
185.81
127.34
85.72
91.64
12/31/08
44.77
75.71
65.21
52.70
ITEM 6. SELECTED FINANCIAL DATA
The following table shows our selected historical financial data for the periods indicated. You
should read our selected historical financial data, together with the notes thereto, in conjunction with the
more detailed information in our consolidated financial statements and related notes and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this
Form 10-K
Our financial condition data as of December 31, 2008 and 2007 and our statement of income data
for the years ended December 31, 2008, 2007 and 2006 have been derived from our audited historical
financial statements included elsewhere in this Form 10-K.
Our financial condition data as of December 31, 2006, 2005 and 2004 and our statement of
income data for the year ended December 31, 2005 and 2004 have been derived from our audited historical
financial statements that are not included in this Form 10-K.
Financial Condition Data:
Total assets
Total deposits
Investments securities available-for-
sale, at fair value sale
Loans and leases, gross
Cash and cash equivalents
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
(Loss) income before provision for
income taxes
Provision for income taxes
Net (loss) income
2008
2007
2006
2005
2004
At or for the Year Ended December 31,
(Dollars in thousand, except per share data)
$ 1,483,231
1,257,323
$ 1,542,610
1,253,110
$ 1,348,841
1,161,344
$ 1,136,720
975,467
$ 907,270
801,535
104,406
1,231,232
69,586
35,127
137,491
245,268
1,233,099
22,803
8,444
152,952
$ 85,959
34,634
51,325
30,560
$ 112,607
44,199
68,408
4,900
20,765
4,941
35,594
63,508
3,090
21,461
(9,888)
(4,876)
$ (5,012)
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
47
.
2008
At or for the Year Ended December 31,
2006
2005
2007
2004
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)
$ (0.51)
$ (0.51)
$ 14.09
9,755,207
$ 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
9,790,858
10,330,232
10,194,515
9,782,645
8,227,597
9,810,391
10,580,949
10,556,282
10,195,958
8,713,851
$ 1,506,228
1,444,340
149,635
$ 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
(0.33)%
1.88%
1.98%
1.67%
1.33%
(3.35)
9.27
3.62
63.26
16.94
9.92
5.06
30.02
17.38
10.82
5.18
32.35
15.26
10.90
4.54
36.69
15.51
8.47
3.94
43.34
5.42%
1.69%
0.11%
—%
0.06%
6.87
1.90
0.08
—
0.95
to total loans and leases
2.19
1.21
1.03
1.16
1.09
Allowance for loans and lease losses
to non-performing loans
Net charge-offs (recoveries) to
average loans and leases
40.33
71.27
913.93
—
1,758.64
1.52
0.02
0.08
(0.02)
0.18
(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.
48
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, 2008 and 2007, and
the results of operations for the years ended December 31, 2008, 2007 and 2006. 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 in 2006 and 2007; however, as a
result of the rapid slowdown in the real estate market, deteriorating economic conditions, and volatile
interest rate movements, the Bank incurred a net operating loss in 2008 due to significant credit quality
issues as well as losses on its investment portfolio. More specifically:
• Our net interest margin decreased primarily because of rapid and significant decreases in
interest rates during 2008 as our balance sheet is asset-sensitive.
• The provision for credit losses in 2008 increased substantially from 2007 reflecting the
uncertain economic conditions, especially in the real estate market.
• The Bank recorded significant charges on its investment portfolio due to other than
temporary impairment (“OTTI”).
• The level of non-performing loans increased significantly during 2008 to a level much
higher than in prior periods.
• Our loan-to-deposit ratio ended at maximum levels in 2008, reflecting difficulty in
growing deposits at the same level as loans.
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. In
addition, if the corporate bond market does not improve in liquidity and values from 2008 levels or
worsens from 2008 levels, we could experience additional OTTI charges on our investment portfolio.
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, approximately
half 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, 2008 the Bank recorded a net loss of $5.0 million as compared
to a net income of $26.5 million for December 31, 2007. The decrease in net earnings during 2008 is
primarily due to increases in credit loss provision, write-downs on investment securities and a decrease in
our net interest income as a result of significant decreases in interest rate during 2008. See —“Results of
Operations”.
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% increase from 2006. The increase 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.
49
Recent Developments
There have been significant disruptions in the U.S. and international financial system during the
period covered by this report. As a result, available credit has been reduced or ceased to exist. The
availability of credit, confidence in the entire financial sector, and the financial markets have been
adversely affected. The U.S. Government, the governments of other countries, and multinational
institutions have provided vast amounts of liquidity and capital for the banking system.
In response to the financial crises affecting the overall banking system and financial markets in the
United States, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was
enacted to provide up to $700 billion to the United States Department of Treasury (“U.S. Treasury”) to
purchase mortgages, mortgage backed securities and certain other financial instruments from financial
institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
On October 14, 2008, under the authority of EESA, the U.S. Treasury announced the Troubled Asset
Relief Program (“TARP”) Capital Purchase Program. Under this program, the U.S. Treasury would
purchase up to $250 billion of senior preferred shares from qualified U.S. financial institutions.
On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment
Act (the “ARRA”) in response to the current crisis in the financial sector. The U.S. Treasury and banking
regulators are implementing a number of programs under this legislation to address capital and liquidity
issues in the banking system.
Federal and state governments could pass additional legislation responsive to current credit
conditions. As an example, we could experience higher credit losses because of federal or state legislation
or regulatory action that reduces the principal amount or interest rate under existing loan contracts. Also,
we could experience higher credit losses because of federal or state legislation or regulatory action that
limits the Bank’s ability to foreclose on property or other collateral or makes foreclosure less economically
feasible.
The Federal Deposit Insurance Corporation (“FDIC”) insures deposits at FDIC insured financial
institutions up to certain limits. The FDIC charges insured financial institutions premiums to maintain the
Deposit Insurance Fund. Current economic conditions have increased expectations for bank failures, in
which case the FDIC would take control of failed banks and ensure payment of deposits up to insured
limits using the resources of the Deposit Insurance Fund. In such case, the FDIC may increase premium
assessments to maintain adequate funding of the Deposit Insurance Fund, including requiring riskier
institutions to pay a larger share of the premiums. An increase in premium assessments would increase the
Bank’s expenses. The EESA included a provision for a temporary increase in the amount of deposits
insured by FDIC to $250,000 until December 2009. On October 14, 2008, the FDIC announced a new
program — the Temporary Liquidity Guarantee Program — that provides unlimited deposit insurance
coverage on funds in non-interest bearing transaction deposit accounts and NOW accounts with rates not in
excess of 0.5% not otherwise covered by the existing temporary deposit insurance limit of $250,000. All
eligible institutions will be covered under the program for the first 30 days without incurring any costs.
After the initial period, participating institutions will be assessed an annualized 10 basis point surcharge on
the additional insured deposits. The Bank has chosen to participate in the Temporary Liquidity Guarantee
Program. The behavior of depositors in regard to the level of FDIC insurance could cause the Bank’s
existing customers to reduce the amount of deposits held at the Bank, and or could cause new customers to
open deposit accounts at the Bank. The level and composition of the Bank’s deposit portfolio directly
impacts the Bank’s funding cost and net interest margin. As a result of these measures, it is likely that the
premiums the Bank pays for FDIC insurance will increase, which would adversely affect net income. The
impact of such measures cannot be assessed at this time.
The actions described above, together with additional actions announced by the U.S. Treasury and
other regulatory agencies, continue to develop. It is not clear at this time what impact, EESA, TARP, other
liquidity and funding initiatives of the U.S. Treasury and of other bank regulatory agencies that have been
previously announced, and any additional programs that may be initiated in the future, will have on the
financial markets and the financial services industry. The extreme levels of volatility and limited credit
50
availability currently being experienced could continue to effect the U.S. banking industry and the broader
U.S. and global economies, which will have an affect on all financial institutions, including the Bank.
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 credit 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. On a non-recurring basis, the Bank measures the
fair value of impaired collateral dependent loans based on fair value of the collateral value which is derived
from appraisals that take into consideration prices in observable transactions involving similar assets in
similar locations in accordance with SFAS No. 114, Accounting for Impairments by a Creditor.
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, nonaccrual
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.
The allowance adequacy analysis requires a significant amount of judgment and subjectivity by
management especially in regards to the qualitative portion of the analysis. We cannot provide you with
any assurance that further economic difficulties or other circumstances which would adversely affect our
borrowers and their ability to repay outstanding loans and leases will not occur. These difficulties or other
circumstances could result in increased losses in our loan and lease portfolio, which could result in actual
losses that exceed reserves previously established.
Investment Securities
The classification and accounting for investment securities are discussed in detail in Note 1 of the
Consolidated Financial Statements presented elsewhere herein. Under SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities, investment securities must be classified as held-to-
maturity, available-for-sale, or trading. The appropriate classification is based partially on our ability to
hold the securities to maturity and largely on management’s intentions with respect to either holding or
selling the securities. The classification of investment securities is significant since it directly impacts the
51
accounting for unrealized gains and losses on securities. Unrealized gains and losses on trading securities
flow directly through earnings during the periods in which they arise, whereas unrealized gains and losses
on available-for-sale securities are recorded as a separate component of shareholders’ equity (accumulated
other comprehensive income or loss) and do not affect earnings until realized. The fair values of our
investment securities are generally determined by an independent pricing service and are considered to be
level 2 or 3 categories as defined by SFAS No. 157. Management reviews the fair value of investment
securities on a monthly basis for reasonableness. On a quarterly basis, management thoroughly assesses the
fair values of impaired investment securities by looking at other data regarding the fair values such as:
recent trading levels of the same or similarly rated securities, reviewing assumptions used in discounted
cash flow analyses for reasonableness and other information such as general market conditions.
We are obligated to assess, at each reporting date, whether there is an "other-than-temporary"
impairment to our investment securities. Such impairment must be recognized in current earnings rather
than in other comprehensive income. The determination of other-than-temporary impairment is a subjective
process, requiring the use of judgments and assumptions. We examine all individual securities that are in
an unrealized loss position at each reporting date for other-than-temporary impairment. Specific
investment-related factors we examine to assess impairment include the nature of the investment, severity
and duration of the loss, the probability that we will be unable to collect all amounts due, an analysis of the
issuers of the securities and whether 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 evaluate whether the
creditworthiness of the issuer calls the realization of contractual cash flows into question.
As required under Emerging Issues Task Force ("EITF") 99-20, Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interest in Securitizes Financial Assets, and EITF 99-
20-1, Amendments to the Impairment Guidance of EITF Issue No. 99- 20, the Bank considers all available
information relevant to the collectability of the pooled trust preferred securities, including information
about past events, current conditions, and reasonable and supportable forecasts, when developing the
estimate of future cash flows and making its other-than-temporary impairment assessment for our portfolio
of pooled trust preferred securities. The Bank considers factors such as remaining payment terms of the
security, prepayment speeds, the financial condition of the underlying issuers and expected defaults.
We re-examine the financial resources, intent and the overall ability of the Bank to hold the
securities until their fair values recover. Management does not believe that there are any investment
securities, other than those identified in the current and previous periods, which are deemed to be "other-
than-temporarily" impaired as of December 31, 2008. Investment securities are discussed in more detail in
Note 2 to the Company's consolidated financial statements presented elsewhere in this report.
52
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 shareholder 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 shareholder 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 to 10,274,632 at December 31, 2006.
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,
2007
2006
2008
(Dollars in thousands, except per share data)
Net (loss) income
Net (loss) income per share, basic(1)
Net (loss) income per share, diluted(1)
Return on average assets
Return on average shareholders’ equity
$ (5,012)
$ (0.51)
$ (0.51)
(0.33)%
(3.35)%
$ 26,467
$ 2.56
$ 2.50
1.88%
16.94%
$ 23,351
$ 2.29
$ 2.21
1.98%
17.38%
(1) Adjusted to reflect 3-for-2 stock split effected in the form of dividend, distributed on February 20, 2007.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Statement of Operations 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
(Loss) income before income taxes
Income tax (benefit) expenses
Net (loss) income
Net (loss) income per share, basic(1)
Net (loss) income per share, diluted(1)
53
Year Ended December 31,
2008
2007
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 85,959
34,634
51,325
30,560
20,765
4,941
35,594
(9,888)
(4,876)
$ (5,012)
$ 112,607
44,199
68,408
4,900
63,508
3,090
21,461
45,137
18,670
$ 26,467
$ (0.51)
$ (0.51)
$ 2.56
$ 2.50
$ (26,648)
(9,565)
(17,083)
25,660
(42,743)
1,851
14,133
(55,025)
(23,546)
$ (31,479)
$ (3.07)
$ (3.01)
(1) Adjusted to reflect 3-for-2 stock split effected in the form of dividend distributed on February 20, 2007
Net income decreased $31.5 million, or $3.01 per diluted share, for the year-ended December 31,
2008, from $26.5 million, or $2.50 per diluted share, for the year ended December 31, 2007. Our return on
average assets was (0.33)% and return on average shareholders’ equity was (3.35)% for the year ended
December 31, 2008, compared to 1.88% and 16.94%, respectively, for the year ended December 31, 2007.
Net income declined in 2008 from 2007, principally as a result of a decrease in net interest income
by $17.1 million, a $25.7 million increase in the provision for credit losses and an increase in the
impairment on available for sale securities by $11.8 million, partially offset by a decrease in the provision
for income taxes by $23.5 million.
The $17.1 million, or 25%, decrease in net interest income was due primarily to the lower interest
rate environment as well as an increase in nonaccrual loans in 2008. Our overall cost of funds in 2008
decreased by 134 basis points to 3.06%, compared to 4.40% for 2007 while yields on earning assets
decreased 228 basis points to 6.02% from 8.31%. The combined impact of a declining interest rate
environment in 2008 and increased competition in the deposit market were the primary drivers of our
decreased cost of funds during 2008.
As of December 31, 2008, 80% of our loan portfolio was tied to the Prime Rate, which has the
potential to re-price daily, and 11% was tied to the London Interbank Offer Rate, or LIBOR, or other
indices, which re-price periodically. Approximately 45% 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 2% of our loan portfolio had
interest rate ceilings at various rates limiting the amount of interest rate increases that can be passed on to
the borrower. Our weighted average maturity of certificates of deposit at December 31, 2008 was 4.4
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 2008.
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.
54
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 $9.6 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 $9.6 million, or 16%, 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 12
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 38 basis points to 8.31% 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.
Net Interest Income and Net Interest Margin
Year ended December 31, 2008 compared to 2007
Net interest income before the provision for credit losses for the year ended December 31, 2008
decreased $17.1 million, or 25%, to $51.3 million from $68.4 million for the year ended December 31,
2007. This decrease was due to a decrease in interest income of $26.6 million, partially offset by a decrease
in interest expense of $9.6 million. Total interest expense decreased primarily as a result of decreases in
interest rates on time certificates of deposit maturing and being replaced at current lower prevailing rates.
The $26.6 million decrease in total interest income was due to both a decrease in interest rates on loans and
an increase in the total amount of loans that went into nonaccrual status during 2008.
The average yield on our interest-earning assets decreased to 6.02% in the year ended December
31, 2008 from 8.31% in the year ended December 31, 2007. The decrease was mainly due to lower rates
earned on loans and investment securities and an increase in loans on nonaccrual status.
The cost of average interest-bearing liabilities decreased to 3.06% in the year ended December 31,
2008 from 4.40% in the year ended December 31, 2007. The decrease was primarily driven by generally
lower rates paid on deposits during 2008 over 2007 which is a result of lower market rates.
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 $22.3 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
55
rates. The $22.3 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 8.31% 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.
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. Nonaccrual loans are included in
the calculation of average loans and leases while non-accrued interest thereon is excluded from the
computation of yields earned.
Year Ended December 31, 2008
Year Ended December 31, 2007
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, 2006
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:
$1,220,348 $ 75,120
11,458
209,714
96
9,073
—
5,204
—
253
6.16%
5.46%
1.06%
—
4.86%
$1,103,248
210,635
43,278
$ 98,817
11,818
2,268
8.96%
5.61%
5.24%
$ 867,672
179,533
89,322
$ 77,186
8,793
4,377
399
4,280
22
214
5.51%
5.00%
2,401
3,590
108
189
$1,444,339
$ 86,927
6.02%
$1,361,840
$113,139
8.31%
$1,142,528
$ 90,653
8.90%
4.90%
4.90%
4.50%
5.26%
7.93%
Cash and due from banks
Other assets
Total assets
22,200
39,699
$1,506,238
22,943
20,524
$1,405,307
24,228
13,993
$1,180,749
(Table continues in the next page)
56
Year Ended December 31, 2008
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
Average
Balance
Interest
Income or
Expense
Average
Yield or
Cost
(Dollars in thousands)
LIABILITIES AND
SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits
Interest-bearing demand
Money market
Savings
Time certificates of deposit
Total interest-bearing deposits
Short-term borrowings
33,650
109,383
73,042
823,249
1,039,324
$ 265
1,099
1,433
28,396
31,193
19,547
533
Long-term debt (FHLB)
72,691
2,908
Total interest-bearing liabilities
1,131,562
34,634
Noninterest-bearing liabilities:
Demand deposits
Other liabilities
Total liabilities
Shareholders’ equity
Total liabilities and
shareholders’ equity
Net interest income
Net interest spread
Net interest margin
205,764
19,267
1,356,593
149,635
$1,506,238
0.79%
1.01%
1.96%
3.45%
3.00%
2.73%
4.00%
3.06%
$ 31,489
99,551
91,717
739,696
962,453
$ 458
2,210
3,494
36,263
42,425
1.45%
2.22%
3.81%
4.90%
4.41%
$ 26,353 $ 316
106,962 2,140
67,317 2,427
597,504 25,675
798,136 30,558
1.20%
2.00%
3.61%
4.30%
3.83%
6,249
295
4.72%
1,071 58
5.42%
35,608
1,479
4.15%
21,233 808
3.81%
1,004,310
44,199
4.40%
820,440 31,424
3.83%
220,050
24,732
1,249,092
156,215
$1,405,307
207,685
18,237
1,046,362
$ 134,387
$1,180,749
$ 52,294
2.96%
3.62%
$ 68,940
3.91%
5.06%
$ 59,229
4.10%
5.18%
(1)Yields on securities have been adjusted to a tax-equivalent basis. The average balance of investment securities for
2006 represents the carrying value.
(2)Includes average nonaccrual loans and leases.
(3)Net loan and lease fees of $250,000, $2.2 million and $4.5 million for the year ended December 31, 2008, 2007 and
2006, respectively, are included in the yield computations.
(4)Includes Federal Home Loan Bank stock.
While our interest income decreased, primarily due to the lower interest rate environment as wells
as an increase in nonaccrual loans in 2008, decreases in interest expense on our deposits reflecting
decreases on rates primarily on our time certificates of deposit, caused our net interest margin to decrease
from 5.06% in 2007 to 3.62% in 2008. 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.
57
2008 vs. 2007
2007 vs. 2006
Net Change
Rate
Volume
Net Change
Rate
Volume
Year Ended December 31,
(In thousands)
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 (FHLB)
Total interest expense
Net interest income
$ (23,698)
(359)
(2,172)
$ (33,354) $ 9,656
(84)
(275)
(1,081)
(1,091)
$ 21,631
3,025
(2,109)
$ 213
1,340
286
$ 21,418
1,685
(2,395)
(22)
39
(26,212)
(11)
(6)
(34,737)
(11)
45
8,525
(86)
25
22,486
20
(1)
1,858
(106)
26
20,628
(194)
(1,111)
(2,061)
(223)
(1,311)
(1,452)
29
200
(609)
142
70
1,108
74
225
190
68
(155)
918
(7,867)
239
1,428
(9,566)
$ (16,646)
5,864
(13,731)
407
(168)
1,485
(57)
7,376
(16,942)
$ (17,795) $ 1,149
10,547
237
671
12,775
$ 9,711
3,934
(8)
80
4,495
$ (2,637)
6,613
245
591
8,280
$ 12,348
(1) Amounts have been adjusted to a tax-equivalent basis.
As reflected above, although average total loans increased, rates on those loans were substantially
lower due to market rates and were lower due to a significant increase in loans on nonaccrual status. The
lower asset yields were only partially offset by lower rates paid on deposits due to overall lower market
rates and the asset sensitivity of the balance sheet.
Provision for Credit Losses
In anticipation of credit risk inherent in our lending business and the recent ongoing financial
crisis, we set aside allowances through charges to earnings. Such charges were not made only for our
outstanding loan portfolio, but also for off-balance sheet items, such as commitments to extend credits or
letters of credit. The charges made for our outstanding loan portfolio were credited to allowance for loan
losses, whereas charges for off-balance sheet items were credited to the reserve for off-balance sheet items,
which is presented as a component of other liabilities.
The provision for credit losses for 2008 increased $25.7 million to $30.6 million from $4.9
million for 2007. The bank’s net loans and lease charge-offs increased $18.3 million to $18.5 million
during 2008 from $240,000 in 2007. The increase in the provision for credit losses during 2008 is due to a
higher level of classified loans and nonperforming loans at December 31, 2008 and is the result of the
application of management’s established allowance for loan and lease loss adequacy calculation. Classified
assets increased from $27.8 million as of December 31, 2007 to $117.6 million as of December 31, 2008
and nonperforming loans increased from $7.9 million as of December 31, 2007 to $66.8 million as of
December 31, 2008. This decrease in credit quality was primarily centered in two types of loans;
residential construction and residential land. As of December 31, 2008 these two loan types comprised
64% of nonperforming loans. Throughout 2008, management has worked to decrease the balances of these
two loan types. The ratio of allowance for loan losses to total loans increased from 1.21% of total loans at
December 31, 2007 to 2.19% at December 31, 2008. Management believes that through the application of
the methodology’s quantitative and qualitative components, that the provision and overall level of reserve
is adequate for losses estimated to be inherent in the portfolio as of December 31, 2008.
58
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.
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
Other income
Total noninterest income
Year Ended December 31,
2007
2008
2006
$ 1,764
652
362
2,163
$ 4,941
(In thousands)
$ 1,696
752
343
299
$ 3,090
$ 1,660
777
326
265
$ 3,028
Total noninterest income increased by $1.9 million or 60%, to $4.9 million during 2008 from $3.1
million during 2007. The increase in noninterest income was due mainly to life insurance proceeds of $1.6
million recorded in connection with a former Preferred Bank executive.
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.
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.
Noninterest Expense
Noninterest expense is the cost, other than interest expense and the provision for credit losses,
associated with providing banking and financial services to customers and conducting our business.
59
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
Impairment on available for sale securities
OREO related expense
Other expense
Total noninterest expense
Year Ended December 31,
2007
2006
2008
$ 8,557
2,822
424
3,023
1,269
12,371
3,016
4,112
$ 35,594
(In thousands)
$ 11,868
2,395
409
2,719
955
621
205
2,289
$ 21,461
$ 12,216
2,303
451
1,948
943
—
17
2,139
$ 20,017
Total noninterest expense increased $14.1 million, or 66% to $35.6 million during 2008 from
$21.5 million during 2007. Net occupancy expense increased by $427,000 from $2.4 million in 2007 to
$2.8 million in 2008 mainly due to normal lease expense increases as well as to the two new branches
opened in the fourth quarter of 2008 located in Anaheim and Pico Rivera. Professional fees increased by
$304,000 to $3.0 million during 2008 from $2.7 million in 2007 due primarily to an increase in legal costs
associated with non-performing loans. Impairment on available for sale securities increased by $11.8
million to $12.4 million during 2008 from $621,000 in 2007 primarily due to other than temporary
impairment (“OTTI”) charges representing the write-down to fair value of investment securities which
management had deemed to be other than temporarily impaired. Office supplies and equipment expense
increased $314,000 from $1.0 million in 2007 to $1.3 million in 2008. OREO related expenses totaled
$3.0 million in 2008, increasing $2.8 million from $205,000 in 2007 due primarily to an increase in OREO
valuation allowance. Other expenses were $4.1 million in 2008, an increase of $1.8 million over $2.3
million in 2007 due mainly to increases in loan collection related expenses and FDIC insurance
assessments. Salaries and benefits decreased $3.3 million due primarily to a decrease in bonus expense
which is based on overall profitability. We had 142 and 137 full-time equivalent employees at December
31, 2008 and 2007, respectively.
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 $150,000 to $2.3 million during
2007 from $2.1 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.
Provision for Income Taxes
We accounted for income taxes under the asset and liability method, which requires the
recognition of deferred tax assets and liabilities for the expected future tax consequences of events that
have been included in the financial statements. Under this method, deferred tax assets and liabilities are
determined based on the differences between the financial statements and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of
a change in tax rates on deferred tax rates on deferred tax assets and liabilities is recognized in income in
the period that includes the enacted date.
60
We record net tax assets to the extent it believes these assets will more likely than not be realized. In
making such determination, we consider all available positive and negative evidence, including scheduled
reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent
financial operations. In the event we determine that it would be able to realize its deferred income tax
assets in the future in excess of their net recorded amount, we would make an adjustment to reduce the
current period provision for income taxes
We recorded an income tax benefit of $4.9 million for 2008, and the provision for income taxes of
$18.7 million for 2007 and $16.5 million for 2006. Our effective tax rates were (49.3)%, 41.4% and
41.5% for 2008, 2007 and 2006, respectively, as compared to the statutory tax rate of 42.05%.
The difference from the statutory rate for 2008, 2007 and 2006 is mainly due to the tax
preferential tax treatment of life insurance proceed received, the earnings on cash surrender value of Bank-
Owned Life Insurance, the interest income from municipal securities and stock option expense associated
with the adoption of SFAS No. 123(R).
Financial Condition
For the period between December 31, 2008 and December 31, 2007, our assets, declined at the
rate of 3.9%, while our loans and deposits were essentially flat. Our total assets at December 31, 2008 were
$1.48 billion compared to $1.54 billion at December 31, 2007. Our earning assets at December 31, 2008
totaled $1.39 billion compared to $1.48 billion at December 31, 2007. Total deposits at December 31, 2008
and December 31, 2007 were $1.26 billion and $1.25 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.
2008
2007
2006
2005
2004
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
$ 592,697
290,803
273,890
73,205
48
589
1,231,232
(26,935)
(167)
$ 1,204,130
$ 518,304
366,706
255,912
91,565
44
568
1,233,099
(14,896)
(682)
$ 1,217,521
(In thousands)
$ 438,280
271,021
201,385
86,067
45
519
997,317
(10,236)
(1,759)
$ 985,322
$ 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
Total gross loans and leases at December 31, 2008 were $1.23 billion, flat from the $1.23 billion
as of December 31, 2007. Real estate mini-perm loans which are real estate loans collateralized by various
types of commercial and residential real estate, were up from $518.3 million as of December 31, 2007 to
$592.7 million at December 31, 2008. Real estate construction loans which are loans made to borrowers
and developers for the purpose of constructing residential or commercial properties, decreased $75.9
million from December 31, 2007. Commercial & industrial and international loans which are primarily
working capital revolving and term loans for business operations were essentially flat at $347 million at
December 31, 2007 and 2008.
61
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 of 2007 slowed down to 3.8%.
Our real estate mini-perm loan portfolio grew during 2008 by $74.4 million or 14% to $592.7
million from $518.3 million at December 31, 2007. A portion of this growth in 2008 was due to the
conversion of construction loans whereby the construction of the property was completed and the loan was
then renewed and converted to a mini-perm loan. This can be seen below as real estate mini-perm loans on
apartments went from $68.5 million at December 31, 2007 to $110.9 million at December 31, 2008. As of
December 31, 2008, land loans totaled $127.3 million compared to $150.8 million as of December 31,
2007. Residential-use land, which has experienced the most value deterioration, comprises $74.8 million of
the total land loans as of December 31, 2008 compared to $91.8 million in residential-use land loans as of
December 31, 2007. Although we have not seen any systemic weakness in most of our mini-perm
portfolio, we do believe that if this weak economic environment continues, we will see an increase in
nonperforming loans in our mini-perm portfolio which could lead to additional loan losses in 2009.
For the four years prior to 2008, the growth trend for our real estate mini-perm has been as
follows: during the year 2007 it grew by $80.0 million, or 18.3%, to $518.3 million from $438.3 million at
December 31, 2006; during 2006 it grew by $66.0 million, or 17.7%, from $372.3 million at December 31,
2005; during 2005 it grew by $14.0 million, or 3.9% from $358.2 at December 31, 2004.
The following table provides information about our real estate mini-perm portfolio by property
type:
At December 31, 2008
At December 31, 2007
Property Type
Amount
Percentage of
Loans in Each
Category in Total
Loan Portfolio
Commercial/Office
Retail
Industrial
Residential 1-4
Apartment 4+
Land/Special purpose
Total
(Dollars in thousands)
$
$
77,924
82,663
55,424
66,968
110,922
198,796
592,697
6.33%
6.71
4.50
5.44
9.01
16.15
48.14%
Percentage of
Loans in Each
Category in Total
Loan Portfolio
Amount
(Dollars in thousands)
$
$
64,450
61,512
76,968
56,635
68,493
190,246
518,304
5.23%
4.99
6.24
4.59
5.55
15.43
42.03%
During 2008 real estate construction loans declined by $75.9 million or 21% to $290.8 million at
December 31, 2008 from $366.7 million at December 31, 2007; and grew in 2007 by $95.7 million or
35.3%, 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. Real estate construction-residential has been the hardest hit of our loan segments
due to the combination of deterioration in residential real estate values and lack of available financing. We
expect the construction portfolio will continue to decrease in total balances and will decrease as percentage
of the total loan portfolio as Management works to reduce our exposure to this type of real estate loan due
to the weakness in the real estate market. If we are not successful in reducing our exposure in the segment
and real estate values continue to decrease, we may experience additional loan losses in this segment of the
portfolio in 2009.
Commercial loans outstanding at December 31, 2008 increased by $18.0 million, or 7%, to $273.9
million from $255.9 million at December 31, 2007; and increased by $54.5 million, or 27%, to $255.9
62
million at December 31, 2007 from $201.4 million at December 31, 2006; and increased by $51.9 million,
or 35%, to $201.4 million at December 31, 2006 from $149.4 million at December 31, 2005; and increased
by $50.9 million, or 52%, to $149.4 million at December 31, 2005 from $98.5 million at December 31,
2004. Total commercial loan commitments (including undisbursed amounts) at December 31, 2008
decreased $1.6 million or 0.4% to $370.0 from $371.6 million at December 31, 2007 while the rate of
credit utilization decreased to 74.0% as of December 31, 2008 from 68.9% at December 31, 2007. We
believe that this decrease 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 decreased $18.4 million or 20% during 2008 to $73.2 million from $91.6
million at December 31, 2007, and grew in 2007 by $5.5 million, or 6.4%, from $86.1 million at December
31, 2006. We believe this increase is due to the economic recession and to the realized decline in import
and export activity. With economic recovery not expected to occur in 2009, trade finance activity likewise,
will not see any rebound in 2009.
Leases receivable and other loans increased during 2008 by $21,000, or 4%, to $589,000 at
December 31, 2008 from $568,000 at December 31, 2007; and increased during 2007 by $49,000, or 9.4%,
to $519,000 from December 31, 2006.
Non-Performing Assets
Generally, loans and leases are placed on nonaccrual status when they become 90 days or more
past due or at such earlier time as management determines timely recognition of interest to be in doubt.
Accrual of interest is discontinued on a loan or lease when management believes, after considering
economic conditions, business conditions and collection efforts, that the borrower’s financial condition is
such that collection of interest is not likely.
As of December 31, 2008 we had five other real estate owned (“OREO”) properties for $35.1
million as compared to one OREO property for $8.4 million as of December 31, 2007. We had no OREO
properties as of December 31, 2006. For the years-ended December 31, 2008, 2007 and 2006, we had no
OREO income. The foreclosed properties include:
- A construction project in Oakland, California for which the Bank is attempting to rezone
part of the project to higher density in an effort to enhance the property value. The carrying
amount of $7.9 million is based upon the appraised "as-is" value as of September 2008.
- A $12.2 million partially completed condo/apartment project in the Westside of Los
Angeles. The amount represents the value of an accepted letter of interest from a potential
buyer. We are currently negotiating a sales agreement and there are three additional offers
that we have received for approximately the same amount. The last appraisal was concluded
on October 23, 2008 for a value of $15.47 million.
- A $1.8 million residential tract land property in Carson City, Nevada which represents a
23.08% ownership interest in this property. The Bank was a participant in the loan.
- A $5.7 million freeway adjacent commercial zoned land in Beaumont, California which
represents a 50% ownership interest in this property. Carrying cost is 64% of appraisal
value based on an appraisal completed on December 30, 2008. The Bank was a participant
in the loan.
- A $7.5 million freeway adjacent residential land in Beaumont, California which represents a
50% ownership interest in this property. Carrying cost is 54% of appraisal value based on an
appraisal completed on December 31, 2008. The Bank was a participant in the loan.
63
OREO 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.
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:
Nonaccrual 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)
Selected ratios:
NPLs to total gross loans and leases held for investment
NPAs to total assets
______________________________
2008
$ 66,588
—
197
66,785
35,127
$ 101,912
Year Ended December 31,
2006
2007
2005
(Dollars in thousands)
$ 20,900
—
—
20,900
8,444
$ 29,344
$ 1,120
—
—
1,120
—
$ 1,120
$ —
—
—
—
—
$ —
2004
$
382
—
—
382
8,258
$ 8,641
5.42%
6.87%
1.69%
1.90%
0.11%
0.08%
0.00%
0.00%
0.06%
0.95%
The amount of interest income that we would have been recorded on the nonaccrual and impaired
loans and leases had the loans and leases been current totaled $4,953,000, $546,000, and $41,000 for 2008,
2007, and 2006, respectively. All payments received on loans classified as nonaccrual are applied first to
principal.
Impaired Loans and Leases
Impaired loans and leases are commercial & industrial, real estate mini-perm and real estate
construction loans 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 nonaccrual loans and leases, although the two categories overlap.
Nonaccrual 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 nonaccrual 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.
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 $117.6 million, $27.6 million and $5.4 million of impaired loans or leases at December
31, 2008, 2007, and 2006, respectively. The total allowance for loan and lease losses related to these loans
64
and leases were $12.9 million, $3.7 million and $357,000 at December 31, 2008, 2007 and 2006,
respectively. Interest income recognized on such loans and leases during 2008, 2007 and 2006 was $4.3
million, $1.9 million and $395,000, respectively. The average recorded investment on impaired loans and
leases during 2008, 2007 and 2006 was $94.2 million, $17.1 million and $4.1 million, respectively
At December 31, 2008, we had $66.6 million of outstanding loans disclosed above as nonaccrual
loans for which management questions the ability of the borrower to comply with the present loan
repayment terms. These consisted of nineteen loans totaling $60.3 million that are secured by real estate
and five commercial loans totaling $6.3 million.
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.
The methodology we use to estimate the amount of our allowance for credit losses is based on
both objective and subjective criteria. While some criteria are formula driven, other criteria are subjective
inputs included to capture environmental and general economic risk elements which may trigger losses in
the loan portfolio, and to account for the varying levels of credit quality in the loan portfolios of the entities
we have acquired that have not yet been captured in our objective loss factors.
Specifically, our allowance methodology contains four elements: (a) amounts based on specific
evaluations of impaired loans; (b) amounts of estimated losses on loans classified as ‘special mention’;
(c) amounts of estimated losses on loans not adversely classified which we refer to as ‘pass’ based on
historical loss rates by loan type; and (d) amounts for estimated losses on loans rated as pass based on
economic and other factors that indicate probable losses were incurred but were not captured through the
other elements of our allowance process.
Impaired loans are identified at each reporting date based on certain criteria and individually
reviewed for impairment. A loan is considered impaired when it is probable that a creditor will be unable to
collect all amounts due according to the original contractual terms of the loan agreement. We measure
impairment of a loan based upon the fair value of the loan's collateral if the loan is collateral dependent or
the present value of cash flows, discounted at the loan's effective interest rate, if the loan is not
collateralized. The impairment amount on a collateralized loan and a noncollateralized loan is set up as a
specific reserve.
Our loan portfolio, excluding impaired loans which are evaluated individually, is categorized into
several pools for purposes of determining allowance amounts by loan pool. The loan pools we currently
evaluate are: commercial & industrial, international, real estate - residential land, real estate construction -
residential, real estate construction-commercial and real estate – other. Within these loan pools, we then
evaluate loans rated as pass credits, separately from adversely classified loans. The allowance amounts for
pass rated loans, which are not reviewed individually, are determined using historical loss rates developed
through migration analyses. The adversely classified loans are further grouped into three credit risk rating
categories: special mention, substandard and doubtful.
Finally, in order to ensure our allowance methodology is incorporating recent trends and
economic conditions, we apply environmental and general economic factors to our allowance methodology
including: credit concentrations; delinquency trends; economic and business conditions;; the quality of
lending management and staff; lending policies and procedures; loss and recovery trends; nature and
volume of the portfolio; nonaccrual and problem loan trends; and other adjustments for items not covered
by other factors.
Although we believe our process for determining our allowance adequacy to be adequate and
believe that we have considered all risks within the loan portfolio, there can be no assurance that our
65
allowance will be adequate to absorb future losses. Factors such as a prolonged and deepened recession,
higher unemployment rates than we have already anticipated, continued deterioration of California real
estate values as well as natural disasters, civil unrest and terrorism can have a significantly negative impact
on the performance of our loan portfolio and the occurrence of any single one of these factors may lead to
additional future losses which can negatively impact our earnings, capital and liquidity.
The table below summarizes loans and leases, average loans and leases, non-performing loans and
leases and changes in the allowance for credit 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
Real estate-construction
Real estate -mini-perm
Leveraged lease
Other (credit card)
Total charge-offs
Less recoveries:
Commercial
Trade finance
Real estate-construction
Real estate -mini-perm
Leveraged leases
Other
Total recoveries
Net loans charged-off (recovered)
Provision for credit losses
Balance at end of period
2008
2007
Year Ended December 31,
2006
(Dollars in thousands)
2005
2004
$ 14,896
$ 10,236
$ 8,939
$ 6,724
$ 6,168
4,686
—
8,636
5,206
—
—
18,528
—
—
—
7
—
—
7
18,521
30.560
$ 26,935
240
—
—
—
—
—
240
—
—
—
—
—
—
—
240
4,900
$ 14,896
273
390
—
—
—
—
663
—
—
—
—
—
—
—
663
1,960
$ 10,236
5
—
—
—
—
—
5
110
—
—
—
—
—
110
(105)
2,110
$ 8,939
103
—
—
—
1,000
—
1,103
106
—
—
—
—
3
109
994
1,550
$ 6,724
Total gross loans and leases at end of period
Average total loans and leases
Non-performing loans and leases
1,231,232
1,220,348
66,785
1,233,099
1,103,248
20,900
997,317
867,674
1,120
771,143
692,320
—
615,961
541,402
382
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
1.52%
2.50%
2.19%
0.02%
0.44%
1.21%
0.08%
(0.02)%
0.23%
1.03%
0.30%
1.16%
0.18%
0.29%
1.09%
40.33%
71.27%
913.93%
n.m.
1,758.64%
The allowance for loan and lease losses of $26.9 million at December 31, 2008, represented
2.19% of total loans and leases and 40.33% of non-performing loans and leases. At December 31, 2007,
the allowance for loan and lease losses totaled $14.9 million, or 1.21% of total loans and leases, net of
deferred fees and costs, and 71.27% of non-performing loans and leases. At December 31, 2006 the
66
Commercial*
Trade
finance*
Real estate
Real estate-
constructio
n*
Real estate
-mini-
perm*
Lease
Other
Unallocated
Total
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. Net charge-offs
(recoveries) to average loans and leases were 1.52% for the year-ended December 31, 2008 compared to
0.02% for the year-ended December 31, 2007. See “Critical Accounting Policies,” and Note 3 of the
“Notes to Consolidated Financial Statements.”
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 our 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:
At December 31,
2006
2005
2004
2008
2007
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
Allocation
of the
Allowance
Percent of
Loans in
Each
Category
in Total
Loans
(Dollars in thousands)
Allocation
of the
Allowance
$ 3,018
2,317
22.2%
5.9
$ 3,095
803
20.8% $ 2,262
897
5.4
20.2%
8.6
$ 2,312
1,231
Percent of
Loans in
Each
Category
in Total
Loans
19.4%
9.9
Allocation
of the
Allowance
Percent of
Loans in
Each
Category
in Total
Loans
$ 1,511
645
16.0%
7.5
11,108
23.6
6,213
41.7
3,169
27.2
1,837
1,064
18.2
22.3
9,484
48.1
4,779
32.1
3,822
43.9
3,513
48.2
3,456
58.1
—
1,004
4
$ 26,935
0.0
0.1
0.1
100.0%
1
5
—
$ 14,896
0.0
0.0
0.0
100.0%
3
4
79
$10,236
0.0
0.1
0.0
100.0%
5
6
35
$ 8,939
0.1
0.1
0.0
100.0%
7
4
37
$ 6,724
0.1
0.1
0.0
100.0%
*
These categories include watch list credits.
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. Provisions for allowance for undisbursed loan and lease commitments are recorded in other expense.
The allowance for undisbursed loan and lease commitments totaled $60,000, $100,000, $70,000, $110,000
and $200 at December 31, 2008, 2007, 2006, 2005 and 2004, respectively.
Investment Securities Available for sale
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 shareholders’ 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
67
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, 2008 and 2007, there were no
securities classified in the held-to-maturity portfolio.
The Bank performs regular impairment analysis on its investment securities portfolio. 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, the long-term financial prospects of the issuer and the Bank’s ability and intent on holding the
securities until recovery. The new cost basis is not changed for subsequent recoveries in fair value.
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.
Our portfolio of investment securities consists primarily of U.S. Government agency securities,
investment grade and non-investment-grade corporate notes, mortgage-backed securities, , municipal
bonds, collateralized debt obligations and FHLMC (“Freddie Mac”) preferred stock, which is included in
other securities. We categorize 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, 2008, investment securities classified as available-
for-sale with a carrying value of $1.2 million were pledged to secure public deposits.
The carrying value of our investment securities at December 31, 2008 totaled $104.4 million
compared to $245.3 million at December 31, 2007. During 2008, our investment securities portfolio
decreased which was due to sales of investment securities and not replacing maturing investment securities
which were no longer required to be pledged to secure public agency deposits. In addition, the Bank
recorded other than temporary impairment charges on certain corporate notes and collateralized debt
obligations of $12.4 million during 2008. The carrying value of our portfolio of investment securities at
December 31, 2008, 2007 and 2006 was as follows:
U.S. Government agencies
Corporate notes
Mortgage-backed securities and
collateralized debt obligations
Municipal securities
Freddie Mac preferred stock
$
Total securities available-for-sale
$
Estimated Market Value
At December 31,
2007
$
(In thousands)
131,032
30,191
32,583
46,553
4,909
245,268
$
$
$
2008
23,115
22,722
15,676
42,778
115
104,406
2006
142,106
16,657
18,057
19,308
2,561
198,689
68
The following table shows the maturities of investment securities at December 31, 2008, and the
weighted average yields of such securities:
At December 31, 2008
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
(Dollars in thousands)
4.98
%
6.07
$16,798
2,884
4.53
%
8.17
$ —
—%
$ 5,303
5.89 %
$23,115
—
—
18,837
6.24
22,722
Yield
4.86%
6.48
U.S. Government agencies
$ 1,014
Corporate notes
Mortgage-backed securities
and collateralized debt
obligations
Municipal securities
Freddie Mac preferred
stock
1,001
—
—
—
Total securities
Available-for-sale
$ 2,015
—
—
—
5.52
%
—
—
—
—
—
—
—
1,047
—
—
6.71
—
15,676
41,731
115
4.88
6.86
—
15,676
42,778
115
4.88
6.86
—
$ 19,682
5.06
%
$ 1,047
6.71
%
$ 81,662
6.34
%
$104,406
6.09%
The following table shows the maturities of investment securities at December 31, 2007, and the
weighted average yields of such securities:
At December 31, 2007
Within One
Year
After One Year
After Five Years
but within
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
$ 63,336
4.82%
6.91
$65,697
5.33
%
5,858 6.32
$1,999
—
5.30
%
—
$ —
—%
$131,032
18,167
6.95
30,191
6,166
Corporate notes
Mortgage-backed securities
and collateralized debt
obligations
Municipal securities
Freddie Mac preferred
stock
Total securities
Available-for-sale
1,492
1,937
—
5.61
3.65
—
5,263 5.59
2,136 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%
$ 78,95
5.37
%
$23,213 4.79
$70,170
%
5.63
%
$245,268
5.28%
5.08
%
6.82
4.61
2.73
6.01
The Bank owns $22.7 million in corporate notes which inherently carry more risk than U.S.
Agency obligations, U.S. Agency mortgage-backed securities or municipal bonds. Two of these notes are
now rated as below investment grade and these are the two corporate notes for which we have previously
recorded OTTI charges. The aggregate carrying amount of these two notes is $1.18 million as of December
31, 2008. If the financial condition does not improve for these two issuers then we may record additional
OTTI charges for these two notes in 2009. The remaining $21.5 million in corporate notes are all either
single-issuer trust preferred securities or subordinated debt of large financial institutions. All of these notes
with the exception of $3.0 million are impaired as of December 31, 2008. If the financial condition of these
issuers deteriorates further, we may be required to record OTTI charges in 2009 on these notes.
The Bank owns four collateralized debt obligations (“CDO’s”) with a carrying value of $3.76
million as of December 31, 2008. These are CDO’s which are collateralized by pools of trust preferred
securities issued primarily by community and regional banks and some insurance companies. With the
decline in the health of many financial institutions, the fair value of these bonds has deteriorated. During
69
2008, we recorded $4.3 million in OTTI charges related to two of these securities. If the financial health of
the underlying banks continues to deteriorate, we may be required to record additional OTTI charges in
2009.
Additional information concerning investment securities is provided in Note 2 of the “Notes to
Consolidated Financial Statements” in this annual report.
Deposits
Total deposits were $1.26 billion at December 31, 2008 compared to $1.25 billion at December
31, 2007. Noninterest-bearing demand deposits decreased to $196.4 million at December 31, 2008
compared to $230.1 million at December 31, 2007. The ratio of noninterest-bearing deposits to total
deposits was 16% at December 31, 2008 and 18% at December 31, 2007. 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:
2008
Year Ended December 31,
2007
2006
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
Average
Rate
(Dollars in thousands)
$ 205,764
0.00%
$ 220,050
0.00%
$ 207,685
0.00%
33,650
109,383
73,042
823,249
$ 1,245,088
0.79
1.01
1.96
3.45
3.00%
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%
Noninterest-bearing
deposits
Interest-bearing demand
Money market
Savings
Time certificates of deposit
Total
Average total deposits increased steadily through 2008. The increase in average total deposits for
2008 was primarily driven by an increase of $83.6 million in time certificates of deposit. 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
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, 2008 and 2007:
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
70
At December 31,
2008
2007
(In thousands)
$ 454,178
226,651
184,131
6,821
$ 871,781
$ 443,511
221,014
119,263
8,621
$ 792,409
Capital Resources
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, 2008, our capital ratios were above the minimum requirements for well-
capitalized institutions. In the future, we intend to make minor adjustments to our balance sheet which may
include reducing the total size of the balance sheet in order to effectively manage our capital ratios. In
addition, in the future, we intend to originate credit lines when possible with an original maturity of one
year or less, which have a zero percent conversion factor, instead of exceeding one year or more, which are
50% risk weighted assets. On a quarterly basis, we perform a stress test on our capital to determine our
level of capital in various economic circumstances looking out twelve months into the future. Although we
believe that our existing capital will be sufficient for the foreseeable future to satisfy minimum regulatory
capital requirements, a continued, deepening recessionary economic environment could possibly the Bank
to be required to raise capital, sell off assets or a combination of both.
At December 31,
2008
At December 31,
2007
Leverage Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
9.76%
5.00%
4.00%
Tier 1 Risk-Based Capital Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
10.39%
6.00%
4.00%
Total Risk-Based Capital Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
11.65%
10.00%
8.00%
10.31%
5.00%
4.00%
10.54%
6.00%
4.00%
11.57%
10.00%
8.00%
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:
Total Cost
215,054
254,564
103,923
88,550
45,706
400,000
1,985,000
142,932
696,000
207,993
215,425 4,139,722
Date
February 13, 2008
February 14, 2008
February 19, 2008
February 27, 2008
February 28, 2008
March 3, 2008
March 4, 2008
March 10, 2008
March 11, 2008
March 13, 2008
Number of Shares
10,300
12,358
5,000
4,600
2,367
20,000
100,000
8,300
40,000
12,500
71
Contractual Obligations and Off-Balance Sheet Arrangements
The following table presents our contractual cash obligations, excluding deposits and
unrecognized tax benefits, as of December 31, 2008:
Amount of Commitment Expiring per Period
Contractual Obligations (1)
FHLB Advances
Fed Funds Purchased
Operating Lease Obligations
Total
Total
Amounts
Committed
$ 58,000
—
17,947
$ 75,947
Less Than
1 year
$ 35,000
—
1,795
$ 36,795
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$ 23,000
—
4,458
$ 27,458
$ —
—
3,159
3,159
$
$ —
—
8,535
8,535
$
(1) Contractual obligations do not include interest.
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.
Commercial letters of credit are originated to facilitate transactions both domestic and foreign while
standby letters of credit are originated to issue payments on behalf of the Bank’s customers when specific
future events occur. Historically, the Bank has rarely issued payment under standby letters of credit, which
the Bank’s customer is obligated to reimburse the Bank. The Bank could also liquidate collateral or offset a
customer’s deposit accounts to satisfy this payment. The following table presents these off-balance sheet
arrangements at December 31, 2008:
Amount of off-balance sheet Expiring per Period
Total
Amounts
Committed
$ 345,653
3,141
21,079
$ 369,873
Less Than
1 year
$ 231,794
3,141
17,394
$ 252,329
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$ 96,854
—
3,685
$ 100,539
$ 3,767
—
—
3,767
$
$ 13,238
—
—
$ 13,238
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 2008,
our loan-to-deposit ratio was 97.9% at December 31, 2008 compared to 98.4% at December 31, 2007.
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, 2008, we could borrow up to an
additional $118.6 million on top of the $58 million already outstanding with collateral of specifically
identified loans and securities. In addition, we have pledged securities with a market value of $65.2 million
at the Federal Reserve Discount Window which we may borrow from on an overnight basis. We have no
uncommitted borrowing lines with other financial institutions. As an additional condition of borrowing
from the FHLBSF, we are required to purchase FHLB stock. For the year ended December 31, 2008, the
72
Bank was required to purchase the greater of $4,179,000 of FHLB stock based on the volume of
“membership assets” as defined by the FHLB or $2,726,000 in FHLB stock based on 4.7% of outstanding
borrowings with the FHLB. At December 31, 2008, the Bank held $4,996,000 in FHLB stock. On
February 11, 2009, the Bank issued $26.0 million of unsecured senior debt in a pooled private placement
transaction which carries the Federal Deposit Insurance Corporation's ("FDIC") guarantee under its
Temporary Liquidity Guarantee Program. The issuance has a 3-year maturity and a fixed interest rate of
2.74% paid semiannually. Under the Temporary Liquidity Guarantee Program, the FDIC will provide a
100% guarantee of certain unsecured senior debt of eligible FDIC-insured institutions.
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 27% at December 31, 2008 and 19% at
December 31, 2007. 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
sales of securities under agreements to repurchase, sales of unpledged investment securities or loans,
utilizing the discount window borrowings from the Federal Reserve Bank as well as borrowing from the
FHLBSF could be employed to meet those funding needs. We have a Contingency Funding Plan Policy
which is reviewed annually by the Board of Directors which sets forth actions to be taken in the event that
our liquidity ratios fall below Board-established guidelines. Although we believe that our funding
resources will be more than adequate to meet our obligations, we cannot be certain of this adequacy if
further economic deterioration or other negative events occur that could impair our ability to meet our
funding obligations.
Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market
prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk
arises primarily from interest rate risk inherent in our lending and deposit taking activities. To that end,
management actively monitors and manages our interest rate risk exposure. We do not have any market
risk sensitive instruments entered into for trading purposes. We manage our interest rate sensitivity by
matching the re-pricing opportunities on our earning assets to those on our funding liabilities. Management
uses various asset/liability strategies to manage the re-pricing characteristics of our assets and liabilities
designed to ensure that exposure to interest rate fluctuations is limited and within our guidelines of
acceptable levels of risk-taking. Hedging strategies, including the terms and pricing of loans and deposits
and managing the deployment of our securities, are used to reduce mismatches in interest rate re-pricing
opportunities of portfolio assets and their funding sources.
Interest rate risk is addressed by our Asset Liability Management Committee, or the ALCO, which
is comprised of the Chief Executive Officer, Chief Financial Officer and members of the board of
directors. The ALCO monitors interest rate risk by analyzing the potential impact on the net portfolio of
equity value and net interest income from potential changes in interest rates, and considers the impact of
alternative strategies or changes in balance sheet structure. The ALCO manages our balance sheet in part to
maintain the potential impact on net portfolio value and net interest income within acceptable ranges
despite rate changes in interest rates.
Our exposure to interest rate risk is monitored continuously by senior management and is
reviewed by the ALCO at least eight times a year, and at least quarterly by our board of directors. Interest
rate risk exposure is measured using interest rate sensitivity analysis to determine our change in net
portfolio value and net interest income in the event of hypothetical changes in interest rates. If potential
changes to net portfolio value and net interest income resulting from our analysis of hypothetical interest
rate changes are not within board-approved limits, the board may direct management to adjust the asset and
liability mix to bring interest rate risk within board-approved limits. This analysis of hypothetical interest
rate changes is performed on a monthly basis by a third party vendor utilizing detailed data that we provide
to them.
73
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, 2008.
Market Value of Portfolio Equity
Interest Rate Scenario
Up 200 basis points
Up 100 basis points
Base
Down 100 basis points
Down 200 basis points
Market Value
(Dollars in
thousands)
$ 145,882
$ 149,264
$ 153,260
$ 159,015
$ 162,497
Percentage
Change
from Base
Percentage
of Total
Assets
Percentage of
Portfolio Equity
Book Value
(4.81)%
(2.61)
—
3.75
6.03
9.84%
10.06
10.33
10.72
10.96
106.10%
108.56
111.47
115.65
118.19
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, 2008, 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.
74
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, 2008
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)
50,391
46,766
43,066
39,488
35,362
$
$
$
$
$
Percentage
Change
from Base
Net Interest
Margin
Percent
Net Interest
Margin Change
(in basis points)
17.01%
8.59
—
(8.31)
(17.89)
3.62%
3.36
3.10
2.84
2.54
0.53
0.27
—
(0.26)
(0.55)
At December 31, 2008, we had $974.2 million in assets and $899.8 million in liabilities re-pricing
within one year. This indicates that approximately $74.4 million more of our interest rate sensitive assets
than our interest rate sensitive liabilities will change to the then current rate (changes occur due to the
instruments being at a variable rate or because the maturity of the instrument requires its replacement at the
then current rate). The ratio of interest-earning assets to interest-bearing liabilities maturing or re-pricing
within one year at December 31, 2008 is 108.3%. In theory, this analysis indicates that at December 31,
2008, 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 December 2007, the FASB issued 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.” This statement is effective for business combinations for which the acquisition date is on
after the beginning of the first annual reporting period beginning on or after December 15, 2008. The
adoption of SFAS 141R is not expected to have a significant impact on the Bank’s consolidated financial
statements.
In December 2007, the FASB issued 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
75
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 a significant impact on the Bank’s
consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and
Hedging Activities-an amendment of FASB Statement No. 133.” SFAS 161 changes disclosure
requirements for derivative instruments and hedging activities. The Statement requires enhanced
disclosures about (a) how and why derivative instruments are used, (b) how derivative and related hedged
items are accounted for under Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect financial position, financial performance, and cash flows. This
Statement is effective for financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early adoption permitted. The Bank had no derivative instruments designated as
hedges as of December 31, 2008, and as such, SFAS 161 is not expected to have an impact on the Bank’s
consolidated financial statements. The Bank will adopt FAS 161 on January 1, 2009.
In June 2008, the FASB issued FSP EITF 03-06-1, Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities. FSP EITF 03-06-1 requires all
outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends to be
considered participating securities and requires entities to apply the two-class method of computing basic
and diluted earnings per share. This FSP is effective for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Early adoption is prohibited. The Bank’s adoption of this
statement is not expected to have a significant impact on the Bank’s consolidated financial statements.
On October 10, 2008, the FASB Staff issued a FASB Staff Position (“FSP”) related to SFAS
No. 157, FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is
not Active. The provisions of FSP 157-3 are effective on issuance. FSP 157-3 clarifies the application of
SFAS No. 157, in a market that is not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that financial asset is not active.
Application issues addressed by the FSP include:
• How management’s internal assumptions should be considered when measuring fair value
when relevant observable data do not exist
• How observable market information in a market that is not active should be considered when
measuring fair value
• How the use of market quotes should be considered when assessing the relevance of
observable and unobservable data available to measure fair value.
The Bank’s adoption of FSP 157-3 did not have a material effect on the Bank’s consolidated
financial statements.
In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, " Disclosures by Public
Entities (Enterprises) About Transfers of Financial Assets and Interests in Variable Interest Entities". This
disclosure-only FSP improves the transparency of transfers of financial assets and an enterprise's
involvement with variable interest entities (VIEs), including qualifying special-purpose entities (QSPEs).
The disclosures required by this FSP are intended to provide greater transparency to financial statement
users about a transferor's continuing involvement with transferred financial assets and an enterprise's
involvement with variable interest entities and qualifying SPEs. This FSP shall be effective for the first
reporting period ending after December 15, 2008, with earlier application encouraged, and shall be applied
for each annual and interim reporting period thereafter. The adoption of this guidance is not expected to
have a significant impact on the Bank’s consolidated financial statements.
76
In January 2009, the FASB issued FSP EITF 99-20-1 ("EITF 99-20-1"), Amendments to the
Impairment Guidance of EITF Issue No. 99-20 , which revises the other-than-temporary-impairment
("OTTI") guidance on beneficial interests in securitized financial assets that are within the scope of EITF
Issue 99-20. EITF 99-20-1 amends Issue 99-20 to more closely align its OTTI guidance with paragraph 16
of FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, by
(1) removing the notion of a "market participant" and (2) inserting a "probable" concept related to the
estimation of a beneficial interest's cash flows. EITF 99-20-1 is effective prospectively for interim and
annual periods ending after December 15, 2008. Retrospective application of this FSP is prohibited. The
adoption of this guidance did not have a material effect on the Bank's financial condition, results of
operations, or cash flows.
Inflation
The majority of our assets and liabilities are monetary items held by us, the dollar value of which
is not affected by inflation. Only a small portion of total assets is in premises and equipment. The lower
inflation rate of recent years has not had the positive impact on us that was felt in many other industries.
Our small fixed asset investment minimizes any material effect of asset values and depreciation expenses
that may result from fluctuating market values due to inflation. Higher inflation rates may increase
operating expenses or have other adverse effects on borrowers of the banks, making collection on
extensions of credit more difficult for us. Rates of interest paid or charged generally rise if the marketplace
believes inflation rates will increase.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISKS
For quantitative and qualitative disclosures regarding market risks in our portfolio, see,
“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quantitative
and Qualitative Disclosure About Market Risk.”
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Bank, including the “Report of Independent Registered Public
Accounting Firm,” are included in this report immediately following Part IV.
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, 2008, 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.
77
• 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, 2008 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;
• 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, 2008. 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, 2008, 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
78
effectiveness of the Bank’s internal control over financial reporting as of December 31, 2008. This report
which expresses an unqualified opinion on the effectiveness of the Bank’s internal control over financial
reporting as of December 31, 2008 is included in this term under the heading “Report of Independent
Registered Public Accounting Firm.”
79
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Preferred Bank:
We have audited Preferred Bank’s (the Bank) internal control over financial reporting as of December 31,
2008, 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, 2008, 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, 2008 and 2007, and the related consolidated statements of operations and
comprehensive (loss) income, changes in shareholders’ equity, and cash flows for each of the years in the
three-year period ended December 31, 2008, and our report dated March 30, 2009 expressed an unqualified
opinion on those consolidated financial statements.
/s/ KPMG LLP
Los Angeles, California
March 30, 2009
80
ITEM 9B. OTHER INFORMATION
On April 23, 2008 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 February 8,
2007 and March 7, 2007. The beneficial owner of the subject securities is Bestwood Trust 1. On January
27, 2009, 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 December 17, 2008. The beneficial owner of
the subject securities is Gary Nunnelly.
81
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 4A under the heading “Executive Officers of the Bank”, will appear in the Bank’s definitive
proxy statement for the 2008 Annual Meeting of Shareholders (the “2008 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 2008 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.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED SHAREHOLDER 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 2008 Proxy Statement, and
such information either shall be (i) deemed to be incorporated herein by reference from the sections
entitled “BENEFICIAL STOCK OWNERSHIP OF PRINCIPAL SHAREHOLDERS AND
MANAGEMENT” and “SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY
COMPENSATION PLANS,” if filed with the Federal Deposit Insurance Corporation pursuant to
Regulation 14A not later than 120 days after the end of the Bank’s most recently completed fiscal year or
(ii) included in an amendment to this report filed with the Federal Deposit Insurance Corporation on Form
10-K/A not later than the end of such 120 day period.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE
Information concerning certain relationships and related transactions will appear in the 2008
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.
82
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services will appear in the 2008 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.
83
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
Report of Independent Registered Public Accounting Firm ..................................................................................... 85
Consolidated Statements of Financial Condition at December 31, 2008 and 2007 .................................................. 86
Consolidated Statements of Operations and Comprehensive(Loss) Income for the Years Ended December 31,
2008, 2007 and 2006.......................................................................................................................................... 87
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2008, 2007
and 2006............................................................................................................................................................. 88
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006 ........................ 89
Notes to Consolidated Financial Statements ............................................................................................................. 90
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*
10.12
10.13
10.14
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
Lease relating to the Bank’s principal executive office at 601 S. Figueroa Street, 29th Floor, Los Angeles,
California with 601 Figueroa Co. LLC, dated March 9, 2007.
Lease relating to the Bank’s retail branch office at 1045-1055 North Tustin Avenue, Anaheim, California with
Tustin Retail Center, LLC, dated July 8, 2008
Lease relating to the Bank’s retail branch office at 7004 Rosemead Blvd., Pico Rivera, California with
Thaddeus J. Moriarty, Jr. and Joan F. Moriarty, Trustees of the Moriarty Family Trust, Jacqueline Steward,
Trustee of the Steward Family Trust, dated July 25, 2008
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
84
(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.
85
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Preferred Bank:
We have audited the accompanying consolidated statements of financial condition of Preferred
Bank and its subsidiary (the Bank) as of December 31, 2008 and 2007 and the related consolidated
statements of operations and comprehensive (loss) income, changes in shareholders’ equity, and cash flows
for each of the years in the three-year period ended December 31, 2008. 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, 2008 and
2007, and the results of their operations and their cash flows for each of the years in the three-year period
ended December 31, 2008, 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, 2008, 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 30, 2009 expressed an unqualified opinion on the effectiveness of the Bank’s internal control over
financial reporting.
/s/ KPMG LLP
Los Angeles, California
March 30, 2009
86
PREFERRED BANK
Consolidated Statements of Financial Condition
December 31, 2008 and 2007
(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, at cost
Net deferred tax assets
Other assets
2008
2007
$
19,386
50,200
69,586
104,406
1,231,232
(26,935)
(167)
1,204,130
35,127
786
7,157
8,454
7,807
4,996
25,903
14,879
$
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
Total assets
$
1,483,231
$
1,542,610
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
Fed funds purchased
Accrued interest payable
Other liabilities
Total liabilities
Commitments and contingencies
Shareholders’ equity:
$
196,408
126,251
62,883
464,085
407,696
1,257,323
786
58,000
—
5,446
24,185
1,345,740
$
230,083
137,220
93,398
639,455
152,954
1,253,110
5,083
75,000
36,000
5,493
14,972
1,389,658
Preferred stock. Authorized 5,000,000 shares; no shares issued and
outstanding at December 31, 2008 and 2007.
Common stock, no par value. Authorized 100,000,000 shares; issued
and outstanding 9,755,207 and 9,953,532 shares at December 31,
2008 and 2007, respectively.
Treasury stock, at cost (715,425 and 500,000 shares at December 31,
2008 and December 31, 2007, respectively)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss:
Unrealized loss on securities available-for-sale, net of tax of $3,614 and
$1,031 at December 31, 2008 and December 31, 2007, respectively.
Total shareholders’ equity
—
—
72,009
(19,115)
4,582
84,996
(4,981)
137,491
71,863
(14,976)
2,948
94,595
(1,478)
152,952
Total liabilities and shareholders’ equity
$
1,483,231
$
1,542,610
See accompanying notes to the consolidated financial statements.
87
PREFERRED BANK
Consolidated Statements of Operations and Comprehensive (Loss) Income
Years Ended December 31, 2008, 2007 and 2006
(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
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
Impairment of available for sale securities
OREO related expense
Other
Total noninterest expense
(Loss) income before income taxes
Income tax (benefit) expense
Net (loss) income
Other comprehensive income:
2008
2007
2006
$ 75,120
10,743
96
85,959
$ 98,817
11,522
2,268
112,607
$ 77,186
8,699
4,377
90,262
1,364
1,433
20,047
8,349
533
2,908
34,634
51,325
30,560
20,765
1,764
652
362
2,163
4,941
8,557
2,822
424
3,023
1,269
12,371
3,016
4,112
35,594
(9,888)
(4,876)
$ (5,012)
2,668
3,494
30,879
5,384
295
1,479
44,199
68,408
4,900
63,508
2,456
2,427
22,006
3,669
58
808
31,424
58,838
1,960
56,878
1,696
752
343
299
3,090
1,660
777
326
265
3,028
11,868
2,395
409
2,719
955
621
205
2,289
21,461
45,137
18,670
$ 26,467
12,216
2,303
451
1,948
943
—
17
2,139
20,017
39,889
16,538
$ 23,351
Unrealized net (loss) gain on securities available-for-sale
Less reclassification adjustments included in net (loss) income
Other comprehensive (loss) income, before tax
Income taxes related to items of other comprehensive income
Other comprehensive (loss) income, net of tax
Comprehensive (loss) income
(18,116)
12,071
(6,045)
2,542
(3,503)
$ (8,515)
(1,778)
—
(1,778)
747
(1,031)
$ 25,436
1,200
—
1,200
(505)
695
$ 24,046
Net (loss) income per share
Basic
Diluted
Weighted-average common shares outstanding
Basic
Diluted
Dividends per share
$ (0.51)
$ (0.51)
$ 2.56
$ 2.50
$ 2.29
$ 2.21
9,790,858
9,810,391
10,330,232
10,580,949
10,194,515
10,556,282
$ 0.47
$ 0.68
$ 0.53
See accompanying notes to the consolidated financial statements.
88
PREFERRED BANK
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2008, 2007 and 2006
(In thousands, except share and dividends declared per share data)
Common Stock
Treasury
Shares
Amount
Stock
Retained
Accumulated
Other
Comprehensive
Total
Shareholders’
Earnings
Income (Loss)
Equity
Additional
Paid-In
Capital
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
Share-based compensation expense
Net income
Change in unrealized loss 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
178,900
2,210
—
—
—
Stock buyback
(500,000)
—
(14,976)
Share-based compensation expense
3-for-2 stock split, effected February
20, 2007
Net income
Change in unrealized loss on securities
available-for-sale, net of taxes
—
—
—
—
—
(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
Cash dividends paid ($0.47 per share)
Tax benefit−exercise of share-based
—
—
payment
Stock options exercised
Stock buyback
Share-based compensation expense
Net loss
Change in unrealized loss on securities
available-for-sale, net of taxes
17,100
(215,425)
—
—
—
—
—
146
—
—
—
—
—
—
—
(4,139)
—
—
—
—
11
—
—
1,623
—
—
(4,587)
—
—
—
—
(5,012)
—
—
—
—
—
—
—
(3,503)
(4,587)
11
146
(4,139)
1,623
(5,012)
(3,503)
Balance as of December 31, 2008
9,755,207
$ 72,009
$(19,115)
$ 4,582
$ 84,996
$
(4,981)
$ 137,491
See accompanying notes to consolidated financial statements.
89
PREFERRED BANK
Consolidated Statements of Cash Flows
Years Ended December 31, 2008, 2007 and 2006
(In thousands)
Cash flows from operating activities:
Net (loss) income
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses
Amortization of net deferred loan fees
Loss on sale of other real estate owned
Loss on sale of securities available for sale
Write-down of other real estate owned
Impairment of securities available for sale
Federal Home Loan Bank stock dividends
Amortization (accretion) of investment securities discounts and
premiums, net
Depreciation and amortization
Share-based compensation expense
Excess tax (benefit) expense from share-based payment
arrangement
Deferred tax benefit
Increase in BOLI, accrued interest receivable and other assets
Increase in accrued expenses and other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Proceeds from maturities and redemptions of securities available-
for-sale
Proceeds from sale of securities available-for-sale
Purchase of securities available-for-sale
Proceeds from sale of other real estate owned
Net increase in loans
Purchase of bank premises and equipment
Net cash provided (used) in investing activities
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
Cash payment of dividends
Net cash (used) provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest
Income taxes
Noncash activities:
Real estate acquired in settlement of Loans
Loans to facilitate the sale of other real estate owned
2008
2007
2006
$
(5,012)
$
26,467
$
23,351
30,560
(515)
359
11
1,756
12,371
(296)
(145)
782
1,623
(11)
(11,082)
(9,337)
9,164
30,228
133,162
105,003
(115,585)
848
(46,301)
(3,217)
73,910
4,214
—
(53,000)
11
146
(4,139)
(4,587)
(57,355)
46,783
22,803
69,586
34,681
4,475
28,439
5,010
$
$
$
$
$
4,900
(1,077)
—
—
—
621
(1,018)
(357)
575
1,185
(261)
(1,986)
(16,003)
4,244
17,290
263,735
—
(312,358)
—
(236,022)
(3,585)
(288,230)
91,766
126,000
(35,000)
261
2,205
(14,976)
(7,091)
163,165
1,960
(222)
—
—
—
—
(181)
(31)
568
752
478
(1,419)
(3,631)
6,168
27,793
120,511
—
(155,034)
—
(226,348)
(444)
(261,315)
185,877
—
(1,500)
(478)
2,215
—
(5,437)
180,677
(107,775)
130,578
22,803
(52,845)
183,423
$ 130,578
$
$
$
43,978
21,300
$
$
28,736
18,210
—
—
—
—
See accompanying notes to consolidated financial statements.
90
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) Basis of Presentation
The financial statements include the accounts of Preferred Bank and its subsidiary, PB
Investment and Consulting, Inc. (the “Bank” or the “Company”). The audited consolidated
financial statements of the Company have been prepared in conformity with U.S. generally
accepted accounting principles. Certain reclassifications have been made to the prior year’s
consolidated financial statements to conform to the current year’s presentation.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make estimates
and assumptions. These estimates and assumptions affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods.
Material estimates that are particularly susceptible to significant changes in the near-
term relate to the determination of the allowance for credit losses. In connection with the
determination of the allowance for credit losses, management obtains independent appraisals
for significant properties, evaluates overall loan portfolio characteristics and delinquencies
and monitors economic conditions.
(b) 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.
(c) 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. Included in the Bank’s
cash balances are cash reserves required by FRB in the amounts of $579,000 and $1,305,000
as of December 31, 2008, and 2007, respectively.
(d)
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 shareholders’ equity as
other comprehensive income net of applicable taxes until realized. Realized gains and losses
91
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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, 2008 and 2007, there
were no securities classified in the held-to-maturity portfolio.
The Bank performs regular impairment analysis on its investment securities portfolio.
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, the financial prospects of the
issuer and the Bank’s ability and intent on holding the securities until recovery. The new cost
basis is not changed for subsequent recoveries in fair value.
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.
(e) Loans and Loan Origination Fees and Costs
Loans that the Bank has both the intent and ability to hold for the foreseeable future, or
until maturity, 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.
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.
When a borrower fails to make a committed payment, the Bank attempts to cure the
deficiency by contacting the borrower to seek payment. Habitual delinquencies and loans
delinquent 30 days or more are identified as delinquent.
Loans on which the accrual of interest has been discontinued are designated as
nonaccrual loans. The accrual of interest on loans is discontinued when principal or interest is
past due 90 days or more unless the loan is both well secured and in the process of collection.
When loans are placed on nonaccrual status, all interest previously accrued, but not collected,
is reversed against current period interest income. Income on nonaccrual loans is
subsequently recognized only to the extent that cash is received and the loan’s principal
balance is deemed collectible. 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. The Bank also considers charging off loans in the event of any of the following
circumstances: 1) the impaired loan balances are not covered by the fair value of the
92
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
collateral or discounted cash flow; 2) the loan has been identified for charge-off by
regulatory authorities; and 3) any overdrafts greater than 90 days.
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 $100,000 are analyzed for impairment. The Bank recognizes
interest income on impaired loans based on its existing methods of recognizing interest
income on nonaccrual loans.
(f) Allowance 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 estimable. The adequacy of the
allowance for loan losses 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.
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.
The methodology we use to estimate the amount of our allowance for credit losses is
based on both objective and subjective criteria. While some criteria are formula driven, other
criteria are subjective inputs included to capture environmental and general economic risk
elements which may trigger losses in the loan portfolio.
Specifically, our allowance methodology contains four elements: (a) amounts based on
specific evaluations of impaired loans; (b) amounts of estimated losses on loans classified as
‘special mention’; (c) amounts of estimated losses on loans not adversely classified which we
refer to as ‘pass’ based on historical loss rates by loan type; and (d) amounts for estimated
losses on loans rated as pass based on economic and other factors that indicate probable
losses were incurred but were not captured through the other elements of our allowance
process.
Impaired loans are identified at each reporting date based on certain criteria and
individually reviewed for impairment. A loan is considered impaired when it is probable that
a creditor will be unable to collect all amounts due according to the original contractual terms
of the loan agreement.
Our loan portfolio, excluding impaired loans which are evaluated individually, is
categorized into several pools for purposes of determining allowance amounts by loan pool.
The loan pools we currently evaluate are: commercial & industrial, international, real estate -
93
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
residential land, real estate construction -residential, real estate construction-commercial and
real estate – other. Within these loan pools, we then evaluate loans rated as pass credits,
separately from adversely classified loans. The allowance amounts for pass rated loans which
are not reviewed individually, are determined using historical loss rates developed through
migration analyses. The adversely classified loans are further grouped into three credit risk
rating categories: special mention, substandard and doubtful.
Finally, in order to ensure our allowance methodology is incorporating recent trends and
economic conditions, we apply environmental and general economic factors to our allowance
methodology including: credit concentrations; delinquency trends; economic and business
conditions; the quality of lending management and staff; lending policies and procedures;
loss and recovery trends; nature and volume of the portfolio; nonaccrual and problem loan
trends; and other adjustments for items not covered by other factors. We base our allowance
for loan losses on an estimation of probable losses inherent in our loan portfolio.
(g) 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.
(h) 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.
(i) 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.
(j)
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.
94
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(k) 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 shareholders 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.
(l)
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.
Share-based compensation expense for all share-based payment awards 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
for the entire award of generally three to five years, and options expire between four and ten
years from the date of grant. See Note 13 for further discussion.
(m) 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.
(n) Bank-Owned Life Insurance (BOLI)
Bank-owned life insurance policies are carried at their cash surrender value. Income
from BOLI is recognized when earned.
(o) 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, if the allowance is not adequate as of December 31, 2008 then additional losses could
be realized in 2009. The carrying value of other real estate owned; if real estate values
deteriorate further then the Bank could suffer additional losses on the disposition of its other
real estate owned. If estimates related to future cash flows used to determine fair value of
investment securities is incorrect then the Bank could be subject to further other-than-
temporary impairment charges. Finally, if the Bank does not return to profitability within the
prescribed time frame then we will have to provide a valuation allowance against our
deferred tax assets.
(p) Risk and Uncertainties
Preferred Bank is a commercial bank which takes in deposits from businesses and
individuals and provides loans to real estate developers/owners and individuals. The Bank’s
main source of revenue is interest income from loans and investment securities and its main
expenses are interest expense paid on deposits and borrowings and compensation expenses to
95
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
its employees. The Bank’s operations are located and concentrated primarily in Southern
California and are likely to remain so for the foreseeable future.
As of December 31, 2008, approximately 95% of the total dollar amount of the Bank’s
loans and commitments was related to collateral or borrowers located within California.
Because the Bank’s loan portfolio is concentrated in commercial and residential real estate,
the performance of these loans may be affected by further negative changes in California’s
economic and business conditions and the real estate market of Southern California.
Deterioration in economic conditions could have a material adverse effect on the quality of
the Bank’s loan portfolio and the demand for its products and services. In addition, during
periods of economic slowdown or a recession, the Bank may experience a decline in
collateral values and an increase in delinquencies and defaults. A decline in collateral values
such as that experienced in housing prices in 2008 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.
(q) Segment Reporting
Through our branch network, the Bank provides 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, the Bank considers all of our operations are aggregated in one reportable
operating segment.
(2) Securities Available for Sale
Financial instruments that potentially subject the Bank to concentrations of credit risk
consist primarily of loans and investments. The Bank monitors its exposure to such risks and
the concentrations may be impacted by changes in economics, industry or political factors.
The Bank aims to maintain a diversified investment portfolio including issuer, sector
and geographic stratification, where applicable, and has established certain exposure limits,
diversification standards and review procedures to mitigate credit risk.
Other than U.S. government agencies; Fannie Mae, Freddie Mac and the Federal Home
Loan Bank, the Bank has no exposure within its investment portfolio to any single issuer
greater that 10% of equity capital.
The table below shows the amortized cost, gross unrealized gains and losses, estimated fair
value of securities available for sale as of December 31, 2008 and 2007.
96
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Amortized
cost
$ 22,895
26,071
17,056
46,863
115
$ 113,000
2008
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
$ 220
16
$
—
(3,365)
$ 23,115
22,722
331
57
—
624
$
(1,711)
(4,142)
—
$ (9,218)
15,676
42,778
115
$ 104,406
2007
Gross
unrealized
gains
Gross
unrealized
losses
Amortized
cost
Estimated
fair value
$ 130,602
30,741
$ 527
195
32,718
47,193
6,564
$ 247,818
274
96
—
$ 1,092
(In thousands)
$
(98)
(744)
(409)
(736)
(1,655)
$ (3,642)
$ 131,032
30,191
32,583
46,553
4,909
$ 245,268
U.S. Government agencies
Corporate notes
Mortgage-backed securities and
collateralized debt obligations
Municipal securities
Freddie Mac preferred stock
Total securities available-for-sale
U.S. Government agencies
Corporate notes
Mortgage-backed securities and
collateralized debt obligations
Municipal securities
Freddie Mac preferred stock
Total securities available-for-sale
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, 2008 and 2007 are as follows:
U.S. Government agencies
Corporate notes
Mortgage-backed securities and
collateralized debt obligations
Municipal securities
Total securities available-for-sale
Less than 12 months
Estimated
fair value
Unrealized
losses
2008
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
$
—
6,120
$ (—)
(800)
$
—
13,581
$ (—)
(2,565)
$
—
19,701
$ (—)
(3,365)
1,035
24,723
$ 31,878
(835)
(2,018)
$(3,653)
1,770
7,792
$ 23,143
(876)
(2,125)
$(5,566)
2,805
32,515
$ 55,021
(1,711)
(4,142)
$(9,218)
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
$ 56,683
$
(98)
$ —
$ (—)
$ 56,683
$
(98)
97
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Corporate notes
Mortgage-backed securities and
collateralized debt obligations
Municipal securities
Freddie Mac preferred stock
Total securities available-for-
sale
14,266
(667)
1,075
(77)
15,341
(744)
7,782
26,033
4,909
(127)
(674)
(1,654)
4,509
7,094
—
(283)
(63)
(—)
12,291
33,127
4,909
(410)
(736)
(1,654)
$ 109,673
$(3,220)
$ 12,678
$ (422)
$ 122,351
$(3,642)
The Bank’s investment portfolio is primarily comprised of U.S. Agency securities, corporate
notes, mortgage-backed securities, municipalities and collateralized debt obligations and Freddie
Mac preferred stock. Other than U.S. government agencies; Fannie Mae, Freddie Mac and the
Federal Home Loan Bank, the Bank has no exposure within its investment portfolio to any single
issuer greater that 10% of equity capital.
Preferred Bank performs a regular impairment analysis on its 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.
In September 2008, the Federal Housing Finance Agency placed Fannie Mae and Freddie
Mac under receivership and suspended indefinitely the payment of future dividends on their issues
of preferred stock. In light of these developments, the Bank recognized an other-than-temporary
impairment loss of $6.4 million in 2008 to write down the value of its Freddie Mac preferred stock
to its fair value as of December 31, 2008. As of December 31, 2008 and 2007, the fair value of the
Freddie Mac preferred stock was $115,000 and $4.9 million, respectively.
The Bank owns four collateralized debt obligations (“CDO’s”) which consist of pools of
bank trust preferred securities. During 2008, the Bank reviewed these securities for impairment
under the provisions of Emerging Issues Task Force (EITF) 99-20 Recognition of Interest Income
and Impairment on Purchased Beneficial Interests That Continue to be Held by a Transferor in
Securitized Financial Assets. During this review, the Bank determined that two of these securities
were other than temporarily impaired and recorded a charge of $4.3 million. The analysis indicated
that these securities would experience a probable future principal default based on the financial
health of the underlying issuer banks. The Bank then projected future cash flows based on expected
future cash flows using a market discount rate to arrive at the fair market value. For the remaining
two collateralized debt obligations, the Bank determined that impairments totaling $1.3 million on
total book value of $2.0 million were temporary as of December 31, 2008, and not due to an
adverse change in the projected cash flows. Although the market value of these securities
represented only 34% of amortized cost, management determined that the deterioration in value was
due to market rates and not due to a probable loss of principal or interest in future cash flows.
Management analyzed the financial health of the underlying issuers and found that risk of principal
loss was not likely. It is possible that the financial health of the underlying issuers could be
adversely affected in the future and that an impairment charge could occur at a future date. The
98
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Bank has the ability and intent to hold these investments until a recovery of fair value, which may
be maturity.
In addition, the Bank has two corporate securities which management deemed to be other-
than-temporarily impaired (“OTTI”) and recorded a charge of $1.7 million during 2008 to reflect
the fair value of these securities. Thus the $4.3 million charge on CDO’s, $1.7 million on corporate
securities and the $6.4 million charge on Freddie Mac securities totals the $12.4 million in OTTI
charges recorded in 2008.
In 2007, the Bank determined that two corporate notes were other than temporarily impaired
and recorded a charge of $621,000. These are the same two corporate securities that the Bank
recorded an OTTI charge in 2008 as well. Management had determined that it was probable that the
Bank would not receive all amounts due under the contractual terms of these securities. These two
corporate securities are currently rated as below investment-grade. On a quarterly basis,
management reviews all corporate notes that are in an unrealized loss position to determine whether
the securities are other-than temporarily impaired. This analysis considers factors such as the
current financial health of the issuer, the long term prospects for the issuer, the rating of the security
and other factors. As of December 31, 2008, based on an analysis of these factors management
determined that no other corporate note, other than those two that were identified, were other-then-
temporarily impaired. If the financial condition of each of the issuers does not improve in 2009, it is
likely the Bank will record additional OTTI charges on these two securities.
The Bank owns 61 municipal investment securities. All but one is investment-grade. The
Bank’s strategy with respect to municipal bond investing is to provide liquidity and federal tax
exempt interest income. Typically, we buy general obligation (“GO”) bonds and seek to minimize
our investments in revenue bonds as GO bonds have multiple sources of revenue with which this
debt can be serviced. The Bank also seeks to purchase municipal bonds that are insured by a major
municipal bond insurer as an enhancement to credit. As of December 31, 2008, the net unrealized
loss on the municipal investment portfolio was $4.1 million on a carrying cost of $46.9 million. The
average investment security in the municipal portfolio is $768,300. The Bank seeks to maintain a
very geographically diverse municipal portfolio to mitigate risk. Management reviews this portfolio
on a quarterly basis for other-than-temporary impairment. Based on management’s assessment of
the issuer, the current investment grade rating and the expectation that all contractual cash flow will
be received, no impairment charges have been recorded on this portfolio. If the economy continues
to worsen and municipalities are negatively affected, then the Bank could record OTTI charges on
the municipal portfolio during 2009.
At December 31, 2008, there were 39 and 21 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 lack of trading
liquidity in these instruments and in the case of corporate notes, resulted from increases in credit
spreads between U.S. Treasuries and corporate bonds subsequent to the date that these securities
were purchased. None of the securities in the Bank’s investment portfolio rely on an insurance wrap
as a credit enhancement. Management believes that it is not probable that the Bank will not receive
all amounts due under the contractual terms of these securities. If economic conditions worsen, or if
the financial condition of specific issuers within these portfolios deteriorates, then the Bank could
record OTTI charges in 2009 on specific investments within these portfolios.
99
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Cash proceeds from sales of securities available-for-sale totaled $105 million, $0 and $0 in
2008, 2007, and 2006, respectively. Gross realized losses on sales of securities available-for-sale
totaled $492,000 offset with gross realized gains of $481,000 in 2008. Investment securities having
a fair value of approximately $68.1 million and $152.4 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, 2008 and 2007, respectively.
The amortized cost and estimated fair value of securities at December 31, 2008 and 2007, 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 4.95% and
5.69% in 2008 and 2007, respectively. Expected maturities differ from contractual maturities
mainly due to prepayment rates; changes in prepayment rates will affect a security’s average life.
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
2008
Amortized
cost
Estimated
fair value
(In thousands)
$
2,000
19,468
1,030
90,502
$ 113,000
$
2,015
19,682
1,047
81,662
$ 104,406
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
100
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(3) Loans and Leases and Allowance for Credit Losses
The loans and leases portfolio as of December 31, 2008 and 2007 is summarized as follows:
Real estate-mini perm
Real estate-construction
Commercial
Trade finance
Installment/Consumer
Leases
Other Loans
Less:
Allowance for loan and lease losses
Deferred loan and fees, net
2008
2007
$ 592,697
290,803
273,890
73,205
48
—
589
1,231,232
$ 518,304
366,706
255,912
91,565
44
116
452
1,233,099
(26,935)
(167)
$ 1,204,130
(14,896)
(682)
$ 1,217,521
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.
The Bank had $66.6 million of nonaccrual loans and leases at December 31, 2008 compared
to $20.9 million at December 31, 2007. These loans and leases had interest due, but not recognized,
of approximately $5.0 million and $280,000 in 2008 and 2007, respectively.
For the indicated periods, the following table contains financial information on impaired
loans:
Recorded investment with related allowance
Recorded investment with no related allowance
Allowance on impaired loans
Net recorded investment in impaired loans
Average total recorded investment in impaired loans
As of and for the Year Ended
December 31,
2008
2007
$ 54,206
63,385
(16,041)
$ 101,550
$ 94,172
$ 24,811
4,221
(3,822)
$ 25,210
$ 16,888
At December 31, 2008, the Bank had no commitments to lend additional funds to debtors
whose loans are non-performing.
101
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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
2008
$ 14,896
30,560
(18,528)
7
$ 26,935
2007
(In thousands)
$ 10,236
4,900
(240)
—
$ 14,896
2006
$ 8,939
1,960
(663)
—
$ 10,236
As of December 31, 2008 and 2007, furniture and fixtures consists of the following:
Land and Building
Leasehold improvements
Furniture and fixtures
Less accumulated depreciation and
amortization
2008
$ 2,782
$ 6,071
4,922
13,775
$
$
2007
—
786
6,825
7,611
(6,618)
$ 7,157
(2,890)
$ 4,721
Depreciation and amortization expense was $782,000, $575,000 and $568,000 for the years
ended December 31, 2008, 2007 and 2006, respectively.
(5) Deposits
Time deposit accounts at December 31, 2008 mature as follows:
Year
2009
2010
2011
Maturities of
time deposits
(In thousands)
864,960
4,976
1,845
871,781
$
$
At December 31, 2008 and 2007, approximately $1,216,000 and $152,400,000, respectively,
of the Bank’s investment securities were pledged as collateral for certain public deposits. The
aggregate amount of overdrafts that have been reclassified as loan balances was $591,000 and
$89,100 at December 31, 2008 and 2007, respectively.
(6)
Income Taxes
The income taxes expense (benefit) for the years ended December 31, 2008, 2007 and 2006
was as follows:
102
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Current income tax expense:
Federal
State
Deferred income tax benefit:
Federal
State
Income tax (benefit) provision
2008
2007
(In thousands)
2006
$ 4,190
2,016
6,206
$ 15,659
4,997
20,656
$ 13,722
4,235
17,957
(8,189)
(2,893)
(11,082)
$ (4,876)
(1,580)
(406)
(1,986)
$ 18,670
(1,178)
(241)
(1,419)
$ 16,538
At December 31, 2008 and 2007, other assets include current income taxes receivable of
$965,000 and $2,624,000, respectively. The income tax provision 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.
The components of the deferred tax assets and deferred tax liabilities as of December 31,
2008 and 2007 are as follows:
Deferred tax assets:
Allowance for loan lease losses
State taxes
Deferred compensation
Bank furniture and fixtures, net
Unrealized losses on securities available-for-sale
Other than temporary impairment on securities
SFAS 123R non-qualified stock options
OREO reserve
Others
Gross deferred tax assets
Deferred tax liabilities:
Discount accretion
FHLB stock
Gross deferred liabilities
Valuation reserve
Net deferred tax assets
2008
2007
(In thousands)
$ 11,350
614
3,566
453
3,614
5,463
579
737
878
27,254
$ 6,305
1,759
3,118
466
1,072
—
202
—
200
13,122
(543)
(426)
(969)
(382)
(524)
(320)
(844)
—
$ 25,903
$ 12,278
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
103
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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 the benefits related to these deductible differences net of the valuation allowance.
A valuation allowance was established in 2008 as it was not currently considered to be more likely
than not the Bank would be able to realize the state benefit for impairment losses treated as capital
losses for state franchise tax filings.
The Bank adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes, on January 1, 2007 and management has determined that there was no effect on
our financial statements as a result of its implementation. It is the policy of management to include
any interest or penalties from income tax liabilities in the provision for income taxes. During 2008,
the Bank accrued $115,000 in additional tax expense related to net interest deductions claimed in
prior years in its California income tax returns.
A reconciliation of the income tax (benefit) provision and the amount computed by applying
the statutory federal income tax rate to (loss) income before income taxes is as follows for the years
ended December 31, 2008, 2007 and 2006 (in thousands):
2008
2007
2006
Amount
Percentage
Amount
Percentage
Amount
Percentage
(In thousands)
Statutory U.S. federal income tax
State taxes, net of federal benefit
Life insurance policies
Other
$ (3,461)
(873)
(674)
132
$ (4,876)
35.0%
8.8
6.8
(1.3)
49.3%
$ 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%
The Bank files income tax returns in the U.S. federal jurisdiction and in the State of
California. With few exceptions, the Bank is no longer subject to U.S. federal or California income
tax examinations by tax authorities for years before 2004. The Bank was under audit by the
California’s Franchise Tax Board for the tax years 2005 and 2006 and was assessed for an
additional tax liability of $45,000 including interest in March 2009. Other than California’s
Franchise Tax Board, the Bank is not currently under examination by any other income or franchise
tax authorities. The Bank does not believe that the conclusion of unresolved matters or claims from
any tax jurisdiction is likely to have a material effect on the Bank’s financial position, results of
operations or cash flows
(7) Federal Funds Purchased
There were $0 million in federal funds purchased at December 31, 2008 and $36 million as
of December 31, 2007, respectively. At December 31, 2008, the Bank had no borrowing lines at
separate financial institutions.
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
104
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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,
2008, 2007 and 2006. There were no securities underlying these agreements at December 31, 2008,
2007 and 2006.
(8) Other Borrowed Funds
Advances from the Federal Home Loan Bank of San Francisco (FHLBSF) were $58 million
and $75 million at December 31, 2008 and 2007. The average rate on the fixed rate debt was 4.04%
and 4.25% at December 31, 2008 and 2007, respectively. All advances are collateralized by
commercial or residential real estate loans. At December 31, 2008, approximately $91,655,000 of
the Bank’s real estate loans was pledged as collateral. At December 31, 2008, the outstanding
advances mature as follows:
Year
2009
2010
2008
(In thousands)
35,000
$
23,000
58,000
$
The Bank had an approved short-term borrowings line available through the discount
window at the Federal Reserve Bank of San Francisco (FRBSF) in the amount of $59.9 million.
The Bank had no borrowing outstanding through the discount window outstanding as of December
31, 2008.
(9) Commitments and Contingencies
Credit Extensions: 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, 2008 and 2007, the Bank had commitments to fund loans of $369,873,000
and $442,382,000, respectively. Other financial instruments with off-balance-sheet risk at
December 31, 2008 and 2007 are as follows:
105
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Commitments to extend credit
Commercial letters of credit
Standby letters of credit
Total
2008
2007
(In thousands)
$ 345,653
3,141
21,079
$ 369,873
$ 425,737
4,642
12,003
$ 442,382
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.
Lease Commitments: The Bank is obligated under non-cancellable operating leases for the
premises of its head office and regional offices. As of December 31, 2008, the future total minimum
lease payments for the Bank’s premises are as follows:
Year
2009
2010
2011
2012
2013
Thereafter
Total lease payment
(In thousands)
1,795
2,461
1,997
1,588
1,571
8,535
17,947
$
$
Rental expense was $1,700,000, 1,397,000 and $1,308,000 for the years ended December 31,
2008, 2007 and 2006, respectively.
(10) Related Party Transactions
Loan and Commitments: The Bank has extended credit to certain directors and officers and
companies in which they have an interest and certain shareholders 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, 2008 and 2007, the aggregate loans (including commitments) to related
parties were approximately $5.2 million (of which $266,000 was outstanding) and $5.2 million (of
which $723,000 was outstanding), respectively. All related party loans were current at
December 31, 2008 and 2007.
106
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Changes in the outstanding loans to related parties are summarized as follows:
Balance at beginning of year
New loans
Net drawdowns (repayments)
Balance at end of year
2008
$
$
723
264
(721)
266
$
2007
(In thousands)
734
—
(11)
723
$
2006
$ 4,457
—
(3,723)
734
$
Deposits: The amount of deposits from related parties was $3,898,000 and $3,328,000 at
December 31, 2008 and 2007, respectively.
(11) 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 shareholders 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
capital (as defined) to average assets (as defined). Management believes, as of December 31, 2008,
that the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 2008, 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.
107
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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, 2008:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
$ 159,721
142,464
142,464
11.65%
10.39%
9.76%
$ 109,671
54,835
54,835
> 8.00%
4.00%
4.00%
$ 137,088
82,253
68,544
> 10.00%
6.00%
5.00%
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%
(12) 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)”). Share-based
compensation expense for all share-based payment awards 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 for the entire award,
which is the option vesting term of generally three to five years, for only those options 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. When options are
exercised, the Bank’s policy is to issue new shares of stock. For the year ended December 31, 2008,
2007 and 2006, the Bank recognized share-based compensation expense of $1.6 million,
$1.2 million and $752,000, respectively, resulting in the recognition of $443,000, $192,000 and
$33,000 in related tax benefits, respectively.
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
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 2008 and 2007.
108
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
In May 2003, April 2004 and June 2004, the Bank 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”) which
expired in 2004. 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 Bank did not issue any options under the
expired Interim Plan during 2008 and 2007.
The total intrinsic value of share options exercised during the year ended December 31, 2008
and 2007 was $218,000 and $4,892,000, respectively, from the 1992 Plan and the Interim Plan. As
of December 31, 2008, the total compensation cost not yet recognized that relates to unvested
options granted under the 1992 Plan and Interim Plan was $23,000 with a weighted-average
recognition period of 0.46 years.
The following information under the 1992 Plan and the Interim Plan is presented for the
years ended December 31, 2008, 2007 and 2006.
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
2008
December 31,
2007
(In thousands)
$ — $ —
216
4,892
1,607
97
218
146
2006
$ —
162
5,834
1,924
11
257
506
The following is a summary of the transactions under the 1992 Plan and the Interim Plan for
the years ended December 31, 2008:
1992 Plan and Interim Plan
Number of
Options
668,400
—
(225,450)
(2,400)
440,550
—
(154,850)
(1,500)
284,200
—
(17,100)
—
267,100
Weighted
Average Exercise
Price
$ 12.07
—
8.53
12.25
13.89
—
10.28
12.35
15.87
—
8.57
—
$ 16.32
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
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2008
109
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
As of December 31, 2008, the aggregate intrinsic value of options outstanding under the
1992 Plan and the Interim Plan was $2,758,000. As of December 31, 2008, stock options
outstanding under the 1992 Plan and the Interim Plan were as follows:
Options Outstanding
Options Exercisable
Number of
Outstanding
Options
4,500
76,950
185,650
Weighted
Average
Exercise
Price
$ 7.74
10.69
18.87
Weighted
Average
Remaining
Contractual
Life
0.13
4.32
5.31
Number of
Outstanding
Options
4,500
76,950
147,700
Weighted
Average
Exercise
Price
$ 7.74
10.69
18.83
Weighted
Average
Remaining
Contractual
Life
0.13
4.32
5.28
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 between 20-33% each year, become fully vested after three
to five years and expire between four to ten years from the date of grant. Certain 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, 2008
and 2007 was $0 and $300,000, respectively. As of December 31, 2008, the total compensation cost
not yet recognized that relates to unvested options granted under the 2004 Plan was $2,994,000
with a weighted-average recognition period of 2.1 years.
For the years ended December 31, 2008, 2007 and 2006, the estimated weighted-average fair
value per share of options granted under the 2004 Plan were as follows:
2008
$2.22
December 31,
2007
$7.83
2006
$7.87
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:
Expected Dividend Yield
Expected Volatility
Expected Term
Risk-Free Interest Rate
December 31,
2008
2007
2006
5.74%
26.53%
3.34 Yrs.
3.18%
1.87%
23.80%
3.75 Yrs.
4.06%
1.89%
26.58%
4.25 Yrs.
4.70%
110
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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, 2008, 2007 and 2006:
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
2008
December 31,
2007
(In thousands)
$ 831
1,627
—
—
—
$ 2,747
731
300
603
6
2006
$ 561
1,193
124
291
4
The following is a summary of the transactions under the 2004 Plan for the years ended
December 31, 2008, 2007 and 2006.
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
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2008
2004 Plan
Number of
Options
479,250
71,250
(11,400)
(15,150)
523,950
350,500
(24,050)
(28,200)
822,200
375,300
—
(71,400)
1,126,100
Weighted Average
Exercise Price
$ 25.39
34.44
25.54
27.13
26.37
36.46
25.66
34.18
30.55
14.38
—
25.99
25.36
$
111
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
As of December 31, 2008, the aggregate intrinsic value of options outstanding under the
2004 Plan was ($21,799,000). As of December 31, 2008, stock options outstanding under the 2004
Plan were as follows:
Options Outstanding
Options Exercisable
Number of
Outstanding
Options
32,500
162,800
154,000
550,950
47,850
15,000
163,000
Weighted
Average
Exercise
Price
$ 4.50
9.01
21.84
26.18
31.92
35.91
43.50
Weighted
Average
Remaining
Contractual
Life
3.51
3.41
4.05
5.33
7.15
2.55
3.14
Number of
Outstanding
Options
—
—
—
349,275
18,600
6,000
40,750
Weighted
Average
Exercise
Price
$ —
—
—
25.68
31.92
35.91
43.50
Weighted
Average
Remaining
Contractual
Life
—
—
—
5.67
7.15
2.55
3.14
Exercise Price Range
$0.00 - $4.99
$5.00 - $9.99
$20.00 - $24.99
$25.00 - $29.99
$30.00 - $34.99
$35.00 - $39.99
$40.00 - $44.99
(13) 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, 2008, 2007 and 2006 totaled $158,000, 149,000 and
$138,000, respectively.
(14) 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. 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 with the exception of certain bonuses which
may be awarded by the Compensation Committee irrespective of the certain financial targets as part
of new employees first year compensation. This is typically done as an alternative to a signing
bonus. Total expense of the plan recorded by the Bank was approximately $294,000, $5,112,000
and $6,610,000 for 2008, 2007 and 2006, respectively. As of December 31, 2008 and 2007, the
total bonus accrual included in the other liabilities amounted to $992,000 and $6,339,000,
respectively. The amounts accrued are paid out within a three-year period subsequent to the year
the bonus was accrued. The employee must be employed during the year that the bonus was
accrued and must be employed with the Bank at the time the bonus is distributed.
(15) 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, 2008 and 2007, liabilities recorded for the deferred compensation plan totaled
approximately $8,481,000 and $7,417,000, respectively.
112
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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,
2008 and 2007, the cash surrender value of the policies totaled $8,454,000 and $8,168,000,
respectively. During 2008 and 2007, the income on the insurance policies was $362,000 and
$343,000, respectively. The Bank received $1.6 million of life insurance proceeds in connection
with the untimely passing of a former Preferred Bank executive which was recognized in Other
Income for the year ended December 31, 2008.
(16) 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.
(17) Stock dividend
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 shareholder 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 shareholder 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, the Bank retroactively adjusted the number of common shares outstanding at December
31, 2006 to 10,274,632. 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.
(18) Earnings per Share
The following table summarizes the basic and diluted earnings(loss) per share calculations
for the periods indicated:
113
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Net (loss) income
Weighted Average Basic Shares(1)
Effect of Dilutive Securities:
Dilutive Stock Options
Weighted Average Diluted Shares(1)
Earnings(loss) per share(1):
Basic
Diluted
2008
2007
(In thousands, except per share data)
23,351
$
10,194,515
$
10,330,232
26,467
2006
(5,012)
$
9,790,858
19,533
9,810,391
250,717
10,580,949
361,767
10,556,282
$ (0.51)
$ (0.51)
$ 2.56
$ 2.50
$ 2.29
$ 2.21
(1) Adjusted to reflect February 2007, 3-for-2 stock split effected in the form of a dividend.
(19) Quarterly Financial Data (Unaudited)
The following tables summarize the quarterly unaudited financial data for 2008 and 2007:
Quarterly Financial Data (Unaudited)
Year Ended December 31, 2008
March 31
June 30
September 30
December 31
(In thousands, except per share data)
Three months ended
Interest income
Interest expense
$ 25,288
10,447
$ 22,097
8,766
$ 19,885
7,892
Interest income before provision for credit losses
14,841
13,331
5,080
782
5,005
2,160
$ 3,378
7,200
995
6,645
463
18
$
11,993
3,680
762
12,019
457
(3,401)
$
$ 18,689
7,529
11,160
14,600
2,402
11,925
(7,956)
(5,007)
$
$ 0.34
$ 0.34
$ 0.00
$ 0.00
$ (0.35)
$ (0.35)
$ (0.51)
$ (0.51)
Provision for credit losses
Noninterest income
Noninterest expense
Income taxes
Net income (loss)
Earnings(loss) per share
Basic
Diluted
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
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
114
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(20) Fair Value of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments (SFAS No. 107),
requires that an entity disclose the fair value of all financial instruments, as defined, regardless of
whether recognized in the financial statements of the reporting entity. For purposes of determining
fair value, SFAS No. 107 provides that the fair value of a financial instrument is the amount at
which the instrument could be exchanged in a current transaction between willing parties, other
than in a forced or liquidation sale.
The following methods and assumptions were used to estimate the fair value of each class of
financial instruments.
(a) Cash Due from Banks, Federal Funds Sold and Securities Purchased under Resale
Agreements
For cash and short-term instruments whose 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 or if no quotes on similar securities were
available, a discounted cash flow analysis was used based on a market discount rate and
adjusted for pre-payments.
(c) Loans
Loans are not measured at fair value on a recurring basis. Therefore, the following
valuation discussion relates to estimating the fair value disclosures under FAS 107. Fair
values are estimated for portfolios of loans with similar financial characteristics. Loans are
segregated by type and further segmented into fixed and adjustable rate interest terms. The
fair value estimates do not take into consideration the value of the loan portfolio in the event
the loans have to be sold outside the parameters of normal operating activities. The fair value
of performing fixed rate loans is estimated by discounting scheduled cash flows through the
estimated maturity using estimated market prepayment speeds and discount rates that reflect
the market rate of the loans. The fair value of performing adjustable rate loans is estimated by
discounting scheduled cash flows through the next repricing date. As these loans reprice
frequently at market rates and the credit risk is not considered to be greater than normal, the
market value is typically close to the carrying amount of these loans.
Impaired loans are measured and recorded at fair value on a non-recurring basis. Impaired
loans include all of our nonaccrual loans and certain restructured loans, all of which are
reviewed individually for the amount of impairment, if any. Most of our loans are collateral
dependent and, accordingly, we measure impaired loans based on the fair value of such
collateral. The fair value of each loan's collateral is generally based on estimated market
prices from an independently prepared appraisal, which is then adjusted for the cost related to
liquidating such collateral; such valuation inputs result in a nonrecurring fair value
measurement that is categorized as a Level 2 measurement. When adjustments are made to an
appraised value to reflect various factors such as the age of the appraisal or known changes in
the market or the collateral, such valuation inputs are considered unobservable and the fair
115
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
value measurement is categorized as a Level 3 measurement. In addition, unsecured impaired
loans are measured at fair value based generally on unobservable inputs, such as the strength
of a guarantor, discounted cash flow models and management's judgment; the fair value
measurement of these loans is also categorized as a Level 3 measurement. 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.
(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.
116
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
December 31, 2008
Carrying
amount
Estimated
fair value
December 31, 2007
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
$ 69,586
104,406
1,204,130
7,807
$ 69,586
104,406
1,206,554
7,807
$ 22,803
245,268
1,217,521
10,165
$ 22,803
245,268
1,217,692
10,165
Liabilities:
Demand deposits and
savings:
Noninterest-bearing
Interest-bearing
Time deposits
FHLB borrowings
Accrued interest payable
$ 196,408
189,134
871,781
58,000
5,446
$ 196,408
189,134
871,781
66,859
5,446
$ 230,083
230,618
792,409
111,000
5,493
$ 230,083
230,618
792,409
111,068
5,493
Off-balance sheet financial instruments
Commitments to extend credit and letters of credit
369,873
281
442,382
354
The fair value estimates do not reflect any premium or discount that could result from
offering the instruments for sale. Potential taxes and other expenses that would be incurred in
an actual sale or settlement are not reflected in amounts disclosed. The fair value estimates
are dependent upon subjective estimates of market conditions and perceived risks of financial
instruments at a point in time and involve significant uncertainties resulting in variability in
estimates with changes in assumptions.
The Bank adopted SFAS 157 on January 1, 2008, and determined the fair values of our
financial instruments based on the fair value hierarchy established in SFAS 157. SFAS 157 defines
fair value, establishes a three-level fair value hierarchy based on the quality of inputs used to
measure fair value and expands disclosures about fair value measurements. The three-level
categorizations to measure the fair value of assets and liabilities are as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable prices in active markets for similar assets or liabilities; prices for identical or
similar assets or liabilities in markets that are not active; directly observable market
inputs for substantially the full term of the asset and liability; market inputs that are not
directly observable but are derived from or corroborated by observable market data.
Level 3 - Unobservable inputs based on the Bank’s own judgments about the assumptions that a
market participant would use.
The Bank uses the following methodologies to measure the fair value of its financial assets
on a recurring basis:
Securities available-for-sale - For certain actively traded trust preferred securities and
agency preferred stocks, the Bank measures the fair value based on quoted market prices
in active exchange market at the reporting date, a level 1 measurement. The Bank
measures all other securities except collateralized mortgage obligations by using quoted
117
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
market prices for similar securities or dealer quotes, a level 2 measurement. This
category generally includes U.S. Government agency securities, state and municipal
securities, mortgage-backed securities (“MBS”), commercial MBS, asset-backed
securities and corporate bonds. The Bank uses a discounted cash flow analysis to
determine the fair value of the four collateralized mortgage obligations which is level 3
measurement. The discount rate is determined by using a market interest rate for a
similarly rated single issuer trust preferred security using loss rates determined by the
financial health of the underlying issuer banks in each pool.
Equity investments - The Bank measures the fair value of agency preferred equity
investments by using quoted market prices for similar securities or dealer quotes at the
reporting date, a level 2 measurement.
The following table presents the Bank’s hierarchy for its assets and liabilities measured at fair
value on a recurring basis at December 31, 2008:
(In thousands)
Assets
Securities, available-for-sale
Equity Investment
Total Assets
Level 1
$
Fair Value Measurements Using
Level 2
$ 102,216
115
$ 102,331
—
—
—
$
$
$
Level 3
2,075
—
2,075
Total at
Fair Value
$
$
104,291
115
104,406
The following table presents the Bank’s reconciliation and income statement classification of
gains and losses for all assets measured at fair value on a recurring basis using significant
unobservable inputs (Level 3) for year ended December 31, 2008:
Fair Value Measurements Using Significant Unobservable Inputs(Level 3)
(Dollars in thousands)
Beginning
Balance as of
December31,
2007
Purchases,
Issuance and
Settlements
Realized Gains
or Losses in
Earnings
(Expense)
Unrealized
Gains or Losses
in Other
Comprehensive
Income
Ending
Balance as of
December 31,
2008
ASSETS:
Securities, available-for-sale
$
6,684
$
916
$
(4,206)
$
(1,319)
$
2,075
Impaired loans – On a non-recurring basis, the Bank measures the fair value of impaired
collateral dependent loans based on fair value of the collateral value which is derived from
appraisals that take into consideration prices in observable transactions involving similar assets in
similar locations in accordance with SFAS No. 114. Collateral value determined based on recent
independent appraisals are considered a level 2 measurement. Collateral values based on
unobservable inputs that are supported by little or no market data and less current appraisals are
considered a level 3 measurement.
118
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Other real estate owned – Real estate acquired in the settlement of loans is initially recorded
at fair value, less estimated costs to sell. The Bank records other real estate owned at fair value on a
non-recurring basis. However, from time to time, nonrecurring fair value adjustments to other real
estate owned are recorded based on current appraisal value of the property, a Level 2 measurement,
or management’s judgment and estimation based on reported appraisal value, a Level 3
measurement.
The following table presents the Bank’s hierarchy for its assets measured at fair value on a
nonrecurring basis at December 31, 2008:
(In thousands)
Assets
Impaired loans with specific loss
Other real estate owned
Total Assets
Fair Value Measurements Using
Level 3
Level 2
Level 1
$
$
$
— $
— $
— $
28,723 $
9,723 $
38,446 $
6,711
25,404
32,115
Total at
Fair Value
35,434
35,127
70,561
$
$
$
(21) Subsequent Event
On January 28, 2009, the Board of Directors declared a quarterly cash dividend of $0.08 per
common share. The Board of Directors authorized the reduction of the cash dividend to $0.08 per
share for the first quarter of 2009, compared with the $0.10 per share paid in previous quarters. On
February 11, 2009, the Bank issued $26.0 million of unsecured senior debt in a pooled private
placement transaction which carries the Federal Deposit Insurance Corporation's ("FDIC")
guarantee under its Temporary Liquidity Guarantee Program. The issuance has a 3-year maturity
and a fixed interest rate of 2.74% paid semiannually. Under the Temporary Liquidity Guarantee
Program, the FDIC will provide a 100% guarantee of certain unsecured senior debt of eligible
FDIC-insured institutions.
119
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 30, 2009
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.
March 30, 2009
March 30, 2009
March 30, 2009
March 30, 2009
March 30, 2009
March 30, 2009
March 30, 2009
March 30, 2009
March 30, 2009
Chairman of the Board,
President, Chairman and
Chief Executive Officer
(principal executive officer)
Executive Vice President and
Chief Financial Officer
(principal financial and accounting officer)
Director
Director
Director
Director
Director
Director
Director
- 120 -
Exhibit 21.1
SUBSIDIARIES OF THE REGISTRANT
Preferred Bank Investment and Consulting, Inc. (PBICI)
121
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 30th day of March, 2009.
/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/ 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/ Clark Hsu
Clark Hsu
122
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)
b)
All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 30, 2009
Exhibit 31.2
/s/ Li Yu
Li Yu
Chairman, President and Chief Executive Officer
123
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)
b)
All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 30, 2009
Exhibit 32.1
/s/ Edward J. Czajka
Edward J. Czajka
Executive Vice President and Chief Financial Officer
124
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, 2008 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 30, 2009
/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.
125
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, 2008 as filed with the Federal Deposit Insurance Corporation on the date hereof (the “Report”), I,
Edward J. Czajka, Executive Vice President and Chief Financial Officer of the Bank, certify, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
(2)
The information contained in the Report fairly presents, in all material respects, the financial
condition and results of operations of the Bank.
Date: March 30, 2009
/s/ Edward J. Czajka
Edward J. Czajka
Executive 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.
126