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, 2009
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
Common Stock, No Par Value
Name of each exchange on
which registered
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
(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 whether the registrant has submitted electronically and posted on its corporate Web
site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes [ ] 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 “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filed [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [x]
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, 2009) was $32,690,545.
Number of shares of common stock of the Registrant outstanding as of April 12, 2010, was 16,012,126.
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, 2009 .....................................
Part III
ii
TABLE OF CONTENTS
Page
PART I ........................................................................................................................................................ 2
ITEM 1. BUSINESS ........................................................................................................................................... 2
ITEM 1A. RISK FACTORS ............................................................................................................................... 34
ITEM 1B. UNRESOLVED STAFF COMMENTS ........................................................................................ 43
ITEM 2.
PROPERTIES .................................................................................................................................... 44
LEGAL PROCEEDINGS ................................................................................................................ 45
ITEM 3.
ITEM 4. RESERVED ....................................................................................................................................... 45
PART II..................................................................................................................................................... 46
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES ..................................................................................................................................... 46
ITEM 6. SELECTED FINANCIAL DATA ......................................................................................................
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .................................................................... 52
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISKS .............. 84
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .......................................... 84
ITEM 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE .................................................................. 84
ITEM 9A. CONTROLS AND PROCEDURES ............................................................................................... 84
ITEM 9B. OTHER INFORMATION ............................................................................................................... 86
PART III ................................................................................................................................................... 87
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ................. 87
ITEM 11. EXECUTIVE COMPENSATION ................................................................................................. 87
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED SHAREHOLDER MATTERS ........................................ 87
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
DIRECTOR INDEPENDENCE ..................................................................................................... 87
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ............................................................ 88
PART IV ................................................................................................................................................... 89
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES .............................................................. 89
SIGNATURES ........................................................................................................................................ 134
-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.
Examples of forward-looking statements include but are not limited to: (i) projections of revenues,
expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital
structure and other financial items; (ii) statements of plans, objectives and expectations of the Bank or its
management or Board of Directors, including those relating to regulatory actions, business plans, products
or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying
such statements. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “continue,”
“remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking
statements but are not the exclusive means of identifying such statements. 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 1A. RISK FACTORS - Risk Factors That May Affect Future Results.”
We undertake no obligation to update these forward-looking statements to reflect events or circumstances
that occur after the date on which such statements were made, except as required by law.
ITEM 1. BUSINESS
References in this Annual Report on Form 10-K to “we,” “us,” or “our,” and the “Bank” mean
Preferred Bank and its wholly-owned subsidiary, PB Investment and Consulting, Inc.
General
We are one of the larger 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. 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, 2009, our total
assets were $1.3 billion, loans and leases were $1.0 billion, deposits were $1.1 billion and shareholders’
equity was $85.4 million. We had a net loss per share on a diluted basis of $6.30 for the year ended
December 31, 2009 as compared to net loss of $0.51 per share for the year ended December 31, 2008. The
loss in 2009 was due to a provision for loan loss of $71.3 million as well as a valuation allowance recorded
on our deferred tax asset of $27.1 million. As a result of the loss incurred in 2009 and pursuant to the
regulatory requirements discussed below, we intend to seek to raise capital in an effort to increase our
capital ratios. In addition we have worked successfully and continue to work diligently to reduce our levels
of non-performing assets which contributed significantly to our losses in 2008 and 2009.
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 are generally focused on businesses as opposed
to retail customers and have a small number of customer relationships for whom we provide a high level of
service and personal attention. 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.
2
During the third quarter of 2007, we established a subsidiary, PB Investment and Consulting, Inc.,
to operate a Representative Office for us in Taipei, Taiwan. This office’s primary function is to coordinate
banking services to our customers in Taiwan.
On March 16, 2010, our Board of Directors consented to the issuance of a Consent Order (the
“Order”) from the Federal Deposit Insurance Corporation (the “FDIC”) and the California Department of
Financial Institutions (the “DFI”). Pursuant to the Order, issued on March 22, 2010, we must, among other
things, increase our capital and maintain certain regulatory capital ratios prior to specified dates. We will
attempt to raise capital to satisfy the requirements of the Order. Our ability to raise additional capital will
depend on conditions in the capital markets, which are outside our control. Accordingly, we cannot be
certain of our ability to raise additional capital on terms acceptable to us. This fact, among others, raises
substantial doubt about the Bank’s ability to continue as a going concern. See “REGULATION AND
SUPERVISION – Recent Regulatory Developments – Consent Order” and “– Going Concern.”
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.
Our Traditional Banking Business
We have historically provided 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 have traditionally provided
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. We do not typically provide
single-family residential mortgages.
• 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.
3
• 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 operational traditional internet banking system with bill pay services for these
customers.
Our Current Focus
As a result of the recession nationally and in California, beginning in 2008, we significantly
curtailed making new loans and establishing new business relationships. Since that time, our primary focus
has been management of our existing loan portfolio, capital management and liquidity management. We
have adopted the following operating strategies as part of our current focus:
• Managing our existing loan portfolio as we shift our focus from the origination of new loans
to portfolio management, close monitoring of our existing loan portfolio and problem asset
resolution..
• Maintaining strong capital ratios as we strive to meet the requirements of the Order by
reducing losses, downsizing our balance sheet and raising additional capital.
• Maintaining strong liquidity ratios as we operate under the regulatory restrictions of the Order
that restrict our ability to access brokered certificates of deposit (“CD’s”).
Our Market
The Bank has traditionally conducted operations from our main office in downtown Los Angeles,
California and 12 full-service branch banking offices in Los Angeles, Orange and San Bernardino
Counties. As part of the Bank’s focus on operating efficiency, in February 2010, the Bank combined its
Chino Hills and Santa Monica branches into its Diamond Bar and Century City branches, respectively, and
as a result, the Bank currently operates 10 branch offices. 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 2005, there were over 450,000 Chinese-Americans living
in the three counties in which the Bank has branches, which represented 41% of all Chinese-Americans in
California.
We believe that continuing consolidation of banks generally in Southern California, and among
the banks serving the Chinese-American market in particular, has created an underserved market of small
and mid-sized businesses, real estate developers, investors and high net worth depositors that we can
continue to attract as customers.
4
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 Lending Activities
Our current loan portfolio is comprised of the following four categories of loans:
• Real estate mini-perm loans;
• Real estate construction loans;
• Commercial loans; and
• Trade finance.
In addition to these loan types, we have historically made a small amount of consumer loans
principally as an accommodation to our business customers. We have also utilized our relationships within
the banking industry to purchase and sell participations in loans that meet our underwriting criteria. As of
December 31, 2009, we had a total of $158.6 million in purchased participation loans and $16.7 million in
loans that we sold. 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, the Bank ceased originating
new loans as management was more focused on managing existing loan relationships, specifically,
delinquent and non-performing loans.
We have historically originated our loans from our banking offices in Los Angeles, Orange, and
San Bernardino counties. For mini-perm and construction loans, we have relied 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 have sought referrals from existing banking clients as well as
referrals from professionals, such as certified public accountants, attorneys and business managers.
At December 31, 2009, 81% of our loans carried interest rates that adjust with changes in the
Prime Rate, 10% carried interest rates tied to LIBOR or other indices and 6% carried a fixed rate or were
tied to CD rates. Approximately 71% of our loan portfolio has an interest rate floor.
The following table sets forth information regarding our four major loan categories:
5
Real Estate Mini Perm
Portfolio size
Number of loans
Average loan size
Average LTV(1)
Average DCR(2)
Weighted average rate
Average years since origination
Real Estate Construction
Portfolio size
Number of loans
Average loan size
Average LTV(1)
Weighted average rate
Average years since origination
Commercial Loans
Portfolio size
Number of loans
Average loan size
Weighted average rate
Average years since origination
Trade Finance
Portfolio size
Number of loans
Average loan size
Weighted average rate
Average years since origination
At December 31, 2009
(Dollars in thousands)
$ 565,273
244
$ 2,317
58.37%
1.49x
5.70%
2.9 years
$ 202,187
38
$ 5,321
65.07%
6.07%
2.1 years
$ 227,421
420
$ 541
5.20%
3 years
$ 47,998
115
$ 417
5.51%
4 years
(1) Average loan-to-value at origination, 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 at origination, or DCR, is calculated based upon the net operating income of the
property divided by the debt service.
We had 175 loans with outstanding principal balances between $1 million to $5 million, 43 loans
with outstanding principal balances between $5 million and $10 million, and 15 loans with outstanding
principal balances over $10 million as of December 31, 2009.
Real Estate Mini-Perm Loans
Real estate mini-perm loans are secured by retail, industrial, office and residential multi-family
properties and comprise 54% of our loan portfolio as of December 31, 2009. We seek diversification in our
loan portfolio by maintaining a broad base of borrowers and monitoring our exposure to various property
types as well as geographic concentrations. Total real estate mini-perm loans were $565.3 million at
December 31, 2009 as compared to $592.7 million as of December 31, 2008. With the exception of the
land component of the mini-perm portfolio, this portion of our loan portfolio has performed well. Net
charge-offs of mini-perm loans (excluding land) accounted for only 18.3% of our net loan charge-offs in
6
2009. Conversely, the land component of the mini-perm portfolio has accounted for 25.9% of our net
charge-offs in 2009. We have worked to reduce the balance of land loans in our portfolio due to the high
loss rates experienced in this sector of the portfolio during 2009.
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, 2009
Amount
(Dollars in thousands)
84,092
113,435
61,785
57,280
107,626
74,633
66,422
565,273
$
$
Percentage of Loans in
Each Category in Total
Loan Portfolio
8.06%
10.87
5.92
5.49
10.32
7.15
6.37
54.18%
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, 2009
(In thousands)
$281,991
$54,450
$81,259
$58,706
$57,913
$30,953
$565,273
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 are selected by the Chief
Credit Officer or Credit Administration.
All appraisals for loans over $1.2 million are reviewed by an additional outside appraiser.
Appraisals for loans under that amount are reviewed by internal staff. A credit memorandum is then
prepared by summarizing all third party reports and preparing an analysis of the adequacy of primary and
secondary repayment sources; namely the property DCR and LTV as well as the outside financial strength
and cash flow of the borrower or guarantor(s). This completed credit memorandum is then submitted to an
officer or committee having the appropriate authority for approval. For further information on our different
levels of authority, see “—Loan Authorizations” below.
Once a loan is approved by the appropriate authority level, loan documents are drawn by our note
department, which also funds the loan when approval conditions are met. On larger, relatively complex
transactions, loan documents are prepared or reviewed by outside legal counsel.
Underwriting Standards: Our principal underwriting standards for real estate mini-perm loans are
as follows:
7
• 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, for 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. In addition, to the
extent any of our mini-perm loans become delinquent 90 days or more or become classified loans, we order
new appraisals every six months.
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
Until we began reducing the origination of construction loans in the first quarter of 2008, we were
an active construction lender with construction loans comprising well over 30% of our total loan portfolio
as of September 30, 2007. Given the losses experienced in this portion of the portfolio, management
worked to reduce total construction loans and as a result construction loans comprised only 19.4% of the
total loan portfolio as of December 31, 2009. Construction loans comprised 43.2% of our net loan charge-
offs during 2009 Management is actively working further to reduce our exposure to construction loans. We
had 63 construction loans totaling $290.8 million as of December 31, 2008 which has been reduced to 34
construction loans totaling to $202.2 million as of December 31, 2009. Because of our decision to curtail
construction lending in early 2008 there was only $53.2 million of undisbursed construction funds
remaining in this portfolio as of December 31, 2009. This would indicate that in aggregate, the
construction projects supporting these loans are 79.2% complete. 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, 2009
Amount
(Dollars in thousands)
$
$
3,448
14,013
7,088
105,843
38,062
33,733
—
202,187
Percentage of Loans in
Each Category in Total
Loan Portfolio
0.33%
1.34
0.68
10.15
3.65
3.23
—
19.38%
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
8
Origination,” but with one 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 a matter of practice, the
Bank generally requires a deposit relationship with commercial borrowers. As of December 31, 2009, we
had $227.0 million of commercial loans outstanding, which represented 21.8% of the overall loan
portfolio. This loan category has traditionally experienced lower loss rates, particularly when compared to
the loss rates on construction loans. During 2009, commercial loans comprised 6.8% of the Bank’s net
loan charge-offs. Currently, the Bank is seeking to slowly grow this line of business primarily because of
the additional deposit relationships as well as the diversity that this portfolio brings to our overall loan
portfolio. Lines of credit typically have a 12 month commitment and are secured by the borrower’s assets.
In cases of larger commitments, an updated certificate from the borrower may be required to determine
eligibility at the time of any given advance. Term loans seldom exceed 60 months, but in no case exceed
the depreciable life of the tangible asset being financed.
Trade Finance Credits: Our trade finance portfolio totaled $48.4 million, or approximately 5% of
our total loan portfolio as of December 31, 2009. Of this amount, virtually all loans were made to U.S.
based importers who are also our current borrowers or depositors. Trade finance loans are essentially
commercial loans but are typically made to importers. This portfolio has, similar to commercial loans,
performed relatively well. During 2009, trade finance loans comprised 5.9% of the Bank’s net loan charge-
offs. 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, certified public
accountants 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.
9
We offer the following services to exporters:
• Export letters of credit;
• Export finance;
• Documentary collections;
• Bills purchase program; and
•
International wire transfers.
Loan Origination: A commercial loan begins with a loan officer obtaining preliminary financial
information from the borrower and guarantors and summarizing the loan request in a deal sheet. The deal
sheet is then reviewed by senior management and/or those who have the loan authority to approve the
credit. Following preliminary approval, the loan officer undertakes a formal underwriting analysis,
including third party credit reports and asset verifications. From this information and analysis, a credit
memorandum is prepared and submitted to an officer or committee having the appropriate approval
authority for review. After approval, the note department prepares loan documentation reflecting the
conditions of approval and funds the loan when those conditions are met.
Underwriting Standards: Our underwriting standards for commercial loans are designed to
identify, measure, and quantify the risk inherent in these types of credits. Our underwriting process and
standards help us identify the primary and secondary repayment sources. The following are our major
underwriting guidelines:
• Cash flow is our primary underwriting criteria. We require a minimum 1.5:1 DCR for our
commercial loans. We also review trends in the borrower’s sales levels, gross profit and
expenses.
• We evaluate the borrower’s financial statements to determine whether a given borrower’s
balance sheet provides for appropriate levels of equity and working capital.
• Since most of our borrowers are closely held companies, we require the principals to guarantee
the company debt. Our underwriting process, therefore, includes an evaluation of the
guarantor’s net worth, income and credit history. Where circumstances warrant, we may
require guarantees be secured by collateral (generally with real estate).
• Where there is a reliance on the accounts receivable and inventory of a company, we evaluate
their condition, which may include third party onsite audits.
Monitoring: For those borrowers whose credit availability is tied to a formula based on advances
as a percentage of accounts receivable and inventory (typically ranging from 40%-80% and from 0%-50%,
respectively), we review monthly borrowing base certificates for both availability and turnover trends.
Periodically, we also conduct third party onsite audits, the frequency of which is dependent on the
individual borrower. On a quarterly basis, we monitor the financial performance of a borrower by
analyzing the borrower’s financial statements for compliance with financial covenants.
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. The Order requires that the Bank develop a plan to reduce
10
its concentrations of risk in commercial real estate with a specific emphasis on construction and land loans.
As such, the Bank has been and continues to work on reducing total construction and land loans.
As of December 31, 2009 and 2008, the percentage of loans secured by real estate in our total loan
portfolio was approximately 74% and 72%, respectively. Over the course of 2008 and 2009, the local and
national economy has experienced 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 2009 and we expect this trend to continue in 2010 but on a significantly diminished scale.
Management is continuing to decrease our concentrations of residential construction loans and residential-
use land loans through payoffs, foreclosure 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, 2009
Amount
(Dollars in Thousands)
$
$
87,540
127,448
68,872
201,185
141,359
74,633
66.422
767,459
Percentage of Loans
in Each Category in
Total Loan Portfolio
8.39%
12.21
6.60
19.29
13.55
7.15
6.37
73.56%
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 with loan-to-value ratios that are this high.
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%
At December 31, 2009, the weighted average LTV of our construction and commercial real estate
portfolio based on LTVs at the time of origination was 61%.
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.
11
Our construction and commercial real estate loans by geographic concentration are as follows.
(Dollars in thousands)
Mini-Perm Residential
Mini-Perm Commercial
Construction Residential
Construction Commercial
Total Real Estate Loans
Inland
Empire
$ 2,945
60,471
7,999
1,701
$ 73,116
So. CA
Other
CA
Out of
Area
Total
$ 3,146 $ 606
$ 86,963
49,008
49,035
313,100
4,318
10,009
121,577
43,215
5,815
7,551
$ 564,855 $ 69,741 $ 59,747
$ 93,659
471,614
143,905
58,282
$ 767,459
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, 2009, 7.8% of our real estate portfolio was secured by real
estate located outside of California. At December 31, 2009, the top 20 borrowing relationships of the Bank
totaled $390.3 million in loans outstanding and comprised 30.1% of the total loan portfolio.
Purchased Loan Participations
As of December 31, 2009, the Bank had $157.1 million in loans outstanding that were purchased
from other financial institutions representing 16.5% of the loan portfolio. These loans include commercial
real estate, construction and commercial loans. Loan participations comprised 44.2% of the Bank’s loan
charge-offs in 2009. The higher loss rate is primarily due to the fact that we are unable to control
monitoring of the loan projects and loans for loss prevention as we do not have the primary relationship
with the borrowers. Although these loans are underwritten using the same standards as loans that the Bank
originates directly, it is the intangible factors mentioned above that lead to higher loss rates. In light of the
performance of this part of the portfolio, the Bank has ceased purchasing loan participations and does not
anticipate purchasing loan participations in the future.
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 74% of
our loan portfolio at December 31, 2009 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, 2009, we had 233 loans
in excess of $1.0 million, totaling $919.3 million. These loans comprise approximately 28% of our loan
portfolio based on number of loans and 88% based on total loans outstanding balance. Excluding credit
card and consumer overdraft lines, our average loan size is $1.3 million.
Loan Maturities
In addition to measuring and monitoring concentrations in our loan portfolio, we also monitor the
maturities and interest rate structure of our loan portfolio. The following table shows the amounts of loans
and leases outstanding as of December 31, 2009 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.
12
At December 31, 2009
Maturity
Rate Structure for
Loans Maturing
Over One Year
One Year
or Less
$ 281,991
165,146
136,712
47,998
—
302
632,149
$
One
through
Five Years
$ 252,329
37,040
88,843
—
119
—
$ 378,331
Over Five
Years
Total
Fixed
Rate
Floating
Rate
(In thousands)
$
30,953
—
1,866
—
—
—
$ 32,819
$
565,273
202,186
227,421
47,998
119
302
$ 1,043,299
$
$
49,981
—
133
—
107
—
50,221
$
$
233,301
37,040
90,576
—
12
—
360,929
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, 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. Demand or other loans having no stated maturity and no
stated schedule of repayments are reported as due in one year or less. The table also presents, for loans and
leases with maturities over one year, an analysis with respect to fixed interest rate loans and leases and
floating interest rate loans and leases.
At December 31, 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
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
As a result of the deterioration of the credit portfolio during the last two years, the loan policy has
been modified to reflect changes in the authorizations and approvals required to originate various loan
types.
•
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
13
Chief Executive Officer and the Chief Credit Officer have combined approval authority up to
$5.0 million.
• Board of Directors Loan Committee. Our Board of Directors loan committee consists of four
members of the Board of Directors and our Chief Executive Officer. It has approval authority
up to our legal lending limit, which was approximately $39.2 million for real estate secured
loans and $23.5 million for unsecured loans at December 31, 2009. The Board of Directors
loan committee also reviews all loan commitments granted in excess of $1.0 million on a
quarterly basis for the preceding quarter.
All individual loan authorities are granted by the loan committee of our Board of Directors and
are based on the individual’s demonstrated credit judgment and lending experience.
If a credit falls outside of the guidelines set forth in our lending policies, the loan is not approved
until it is reviewed by a higher level of credit approval authority. Credit approval authority has three levels,
as listed above from lowest to highest level. Policy exceptions for cash flow, waiver of guarantee,
excessive LTV or bad credit require approval of the President or Chief Credit Officer regardless of size.
We believe that the current authority levels provide satisfactory management and a reasonable
percentage of secondary review. Any conditions placed on loans in the approval process must be satisfied
before our Chief Credit Officer will release loan documentation for execution. Our Chief Credit Officer
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
allowance 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.
14
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 Order requires us to reduce our assets that were classified as ‘substandard’ as of September
30, 2009 to not more than 100% of Tier 1 capital and ALLL by September 17, 2010, which is 180 days
from the effective date of the Order, and down to 50% of Tier 1 capital and ALLL by December 17, 2010,
which is 270 days from the effective date of the Order.
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.
Total deposits were $1.2 billion as of December 31, 2009, of which 17.6% were demand deposits,
14.1% were in savings and interest-bearing checking, 28.3% were in CD’s > $100k and 40% were in other
CD’s. 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 and
consistent with the requirements of the Order
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 excluding CDs greater than $100,000, which are
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 evidence of this is the fact that our average jumbo CD customer has been a customer of the
Bank for over six years. Further, 8% of these Jumbo CDs are pledged as collateral for loans from us to the
depositor or the depositor’s affiliated business or family member. We monitor interest rates offered by our
competitors and pay a rate we believe is competitive with the range of rates offered by such competitors.
As of January 31, 2010, the Bank is subject to Part 337.6 of the FDIC Rules and Regulations which
stipulates that a Bank that is not considered to be ‘well-capitalized’ may not pay a rate of interest of any
deposits that exceed 75 basis points over the national average. We monitor these national averages on a
weekly basis and adjust our offering rates accordingly to maintain compliance with this FDIC rules and
regulations.
Traditionally, the Bank would also access the brokered deposit market for deposits to meet short-
term liquidity requirements. In addition, we also are a member of the Certificate of Deposit Account
15
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. During the fourth quarter of 2009, due to the fact that the Bank is no longer considered to be
well-capitalized, the Bank is no longer allowed to access the brokered deposit market which also includes
the CDARS reciprocal deposits. As such, the Bank will not renew any of these brokered deposits and will
let all of them mature during the course of 2010 and 2011. In addition, pursuant to the Order, the Bank
must submit to the FDIC and DFI a written plan for eliminating its reliance on brokered deposits.
Accordingly, management has worked to create and execute a contingency funding plan to ensure that the
Bank has sufficient liquidity to meet these brokered deposit maturities and to also have additional
contingent cash on hand. Although traditionally brokered deposits have not been a significant source of
funding for the Bank, the Bank did begin to rely more on brokered deposits to augment its funding sources
during the credit crisis of late 2008. At that time, the cost of brokered deposits was significantly lower than
traditional retail deposits and thus represented an opportunity to reduce the Bank’s cost of funds. In order
to be able to meet the cash requirements of the maturities of the brokered deposits, management has
worked to increase cash on hand, which as of December 31, 2009 was $68 million but has grown to $222.0
million and represented 131% of total brokered deposits and CDARS balances as of March 31, 2010.
Based on scheduled loan maturities and required repayments, management anticipates a substantial pay
down in the loan portfolio during 2010 which will result in additional cash on the balance sheet. In
addition, management is also looking to sell certain of its investment securities which cannot be pledged as
collateral at the FHLB for future borrowings. Finally, the Bank is also able to raise deposits from time to
time from other financial institutions to augment its cash position. Management is confident that these
efforts will result in maintaining sufficient cash to be able to pay out maturing brokered deposits and
CDARS deposits and also maintain a substantial level of contingent liquidity.
At December 31, 2009, excluding government deposits, brokered deposits and deposits as direct
collateral for loans, we had 32 depositors with deposits in excess of $3.0 million that totaled $179 million
or 15.4% of our total deposits.
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 advertising our CD rates on national internet rate
marketing web sites.
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. On May 13, 2009, legislation was signed that extended this
temporary increase through December 31, 2013.
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. Effective October 1, 2009
the unlimited deposit insurance part of TLGP was extended until June 30, 2010.
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 $23 million in
outstanding FHLB advances with a weighted average interest rate of 4.20% and a remaining maturity of
16
less than one year at December 31, 2009. We currently have $65.5 million in additional available
borrowing capacity at the FHLB. In addition, we have pledged $53.8 million securities at the Federal
Reserve Bank Discount Window and may borrow against that as well. On February 11, 2009, we issued
$26.0 million of unsecured senior debt in a pooled private placement transaction which carries the 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.
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.
The total fair value and historical cost of investment securities amounted to $114.5 million and
$121.6 million as of December 31, 2009, respectively. Investment securities consist primarily of
investment grade corporate notes, municipal bonds, collateralized mortgage obligations, collateralized debt
obligations and U.S agency mortgage-backed securities and the fair value of these securities at December
31, 2009 were $24.7 million, $44.2 million, $18.1 million, $2.2 million and $25.2 million, respectively. In
addition, for bank liquidity purposes, we use overnight federal funds, which are temporary overnight sales
of excess funds to correspondent banks.
As of December 31, 2009 the Bank classified all of its investment securities as “available-for-
sale” pursuant to Investments – Debt and Equity Securities Topic of FASB ASC. 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.
17
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 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 two 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.
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 physical branch offices, 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.
18
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
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 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:
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
19
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 economic developments over the last two years in the sub-prime mortgage market and the
securitization markets for such loans and other factors resulted in uncertainty in the financial markets in
general and a related general economic downturn, which continued through 2009. Although this economic
downturn has abated somewhat during the latter half of 2009, it is anticipated that national economic
weakness will continue in 2010. 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 significantly higher levels of 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. Although residential real estate values
have stabilized recently, it is widely expected that commercial real estate values will continue to decline.
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 banks 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
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
20
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, 2009, the Bank’s capital
ratios met the minimum percentage requirements to be considered adequately capitalized under Prompt
Corrective Actions guidelines of the FDIC’s rules and regulations. As noted on page 23 of this document,
the Bank, under its Order, is required to maintain capital ratios in excess of those ratios considered to be
‘well-capitalized’.
The current risk-based capital guidelines which apply to the Company and the Bank are based
upon the 1988 capital accord of the International Basel Committee on Banking Supervision, a committee of
central banks and bank supervisors and regulators from the major industrialized countries that develops
broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they
apply. A new international accord, referred to as Basel II, became mandatory for large or “core”
international banks outside the U.S. in 2009 (total assets of $250 billion or more or consolidated foreign
exposures of $10 billion or more) and emphasizes internal assessment of credit, market and operational
risk, as well as supervisory assessment and market discipline in determining minimum capital
requirements. It is optional for other banks. The Basel Committee is currently reconsidering regulatory-
capital standards, supervisory and risk-management requirements and additional disclosures to further
strengthen the Basel II framework in response to recent worldwide economic developments. It is expected
the Basel Committee may reinstitute a minimum leverage ratio requirement. The U.S. banking agencies
have indicated separately that they will retain the minimum leverage requirement for all U.S. banks. It also
is possible that a new tangible common equity ratio standard will be added. 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 stipulated in the Order, the
Bank must maintain regulatory capital ratios higher than the ratios required under Prompt Corrective
Action guidelines. See “REGULATION AND SUPERVISION – Recent Regulatory Developments -
Consent Order.” The regulatory capital guidelines as well as our actual capitalization as of December 31,
2009 are as follows:
Leverage Ratio
Preferred Bank ................................................................................................. 6.16%
5.00%
Minimum requirement for “Well-Capitalized” institution ...............................
4.00%
Minimum regulatory requirement ....................................................................
Tier 1 Risk-Based Capital Ratio
Preferred Bank ................................................................................................. 7.24%
6.00%
Minimum requirement for “Well-Capitalized” institution ...............................
4.00%
Minimum regulatory requirement ....................................................................
Total Risk-Based Capital Ratio
Preferred Bank ................................................................................................
Minimum requirement for “Well-Capitalized” institution ..............................
Minimum regulatory requirement ...................................................................
8.52%
10.00%
8.00%
21
For further information regarding the capital ratios of the Bank see the discussion under Note 11 –
“Restrictions on Cash Dividends, Regulatory Capital Requirements” in the notes to the consolidated
financial statements.
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 $0 at December 31, 2009.
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. Further, pursuant to the Order, we are currently prohibited from paying cash dividends or any
other payments to our shareholders without the prior written consent of the FDIC and the DFI.
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.
Recent Regulatory Developments
Consent Order
On March 16, 2010, the members of the Board of Directors of the Bank consented to the issuance
of the Order from the FDIC and the DFI. The following discussion summarizes the provisions of the Order
issued on March 22, 2010:
(i) the Bank must have and maintain qualified management and notify the FDIC and the
DFI in writing when it proposes to make any changes in its Board of Directors or senior executive
officers at least 30 days prior to the date any change is to become effective;
(ii) within 120 days of the Order, the Bank must obtain an independent study of the
management and personnel structure of the Bank to determine whether the Bank’s leadership
structure is appropriate;
(iii) the Board must increase its participation in the affairs of the Bank, assuming full
responsibility for the approval of sound policies and objectives and for the supervision of all of
the Bank’s activities;
(iv) within 60 days of the Order, the Bank must develop and adopt a plan to meet and
maintain the capital requirements contained in the Order and the FDIC’s Statement of Policy on
Risk-Based Capital. The minimum capital ratios and the dates by which such capital ratios must
be obtained are set forth in the table below:
22
Ratio
Tier 1 Leverage Ratio
Tangible Common Equity Ratio
Total Risk-Based Capital Ratio
Preferred Bank
at 12/31/09
6.2%
6.5%
8.5%
Requirement as of
7/15/10
8.5%
8.5%
10.0%
Requirement as of
9/15/10
10.0%
10.0%
12.0%
(v) if all or part of the increase in capital required by the Order is accomplished by the
sale of new securities, the Board of Directors must adopt and implement a plan for such sale; any
offering materials must include an accurate description of the financial condition of the Bank and
the circumstances giving rise to the offering; and the plan for the offering and any materials must
be submitted to the FDIC for review and non-objection and to the DFI for any permits or
approvals;
(vi) the Bank must not pay cash dividends or make any other payments to its
shareholders without prior written consent of the FDIC and the DFI;
(vii) within 270 days of the Order, the Bank must reduce the assets classified as
“Substandard” as of September 30, 2009, to not more than 50% of the Bank’s Tier 1 capital and
ALLL;
(viii) within 60 days of the Order, the Bank must develop or revise, adopt and implement
a written plan for systematically reducing the amount of loans or other extensions of credit
advanced, directly or indirectly, to or for the benefit of, any borrowers in the “commercial real
estate” concentration, with particular emphasis on those borrowers in the construction and land
development area;
(ix) within 60 days of the Order, the Bank must develop or revise, adopt and implement a
written liquidity and funds management policy that adequately addresses liquidity needs and
appropriately reduces its reliance on non-core funding sources;
(x) within 30 days of the Order, the Bank must develop or revise, adopt, and implement a
written plan addressing retention of profits, reducing overhead expenses, and setting forth a
comprehensive budget covering the calendar year ending December 31, 2010, and thereafter, at
least 30 days prior to the commencement of each subsequent calendar year, the Board of Directors
must develop, adopt, and implement a plan and comprehensive budget covering the subsequent
calendar year.
To address the items contained in the Order, management is currently undertaking the
following actions:
• We have engaged an investment banker in order to raise a sufficient amount of new
capital to satisfy the requirements of the Order. Based on discussions with numerous
potential investors, management is confident that this capital-raising effort will be
successful and will close during the second quarter of 2010;
• We have made substantial progress in reducing assets classified as substandard as of
September 30, 2009 levels in order to comply with item (vii) above;
• We have created a written plan addressing the retention of profits and have a Board-
approved budget for 2010 and
• We are currently working to develop written Plans to: reduce construction and land
loan concentrations and revise our liquidity and funds management policies.
Going Concern
23
As previously mentioned, we are required by federal regulatory authorities to maintain adequate
levels of capital to support our operations. As part of the recently issued Order, the Bank is also required to
increase its capital and maintain certain regulatory capital ratios prior to certain dates specified in the Order
We have also committed to the FDIC and the DFI to adopt a consolidated capital plan to augment
and maintain a sufficient capital position. Our existing capital resources may not satisfy our capital
requirements for the foreseeable future and may not be sufficient to offset any problem assets. Further,
should our asset quality erode and require significant additional provision for credit losses, resulting in net
operating losses at the Bank, our capital levels will decline. We will attempt to raise capital to satisfy the
terms of the Order. Our ability to raise additional capital will depend on conditions in the capital markets
at that time, which are outside our control, and on our financial performance. Accordingly, we cannot be
certain of our ability to raise additional capital on terms acceptable to us. This uncertainty about our ability
to raise additional capital and comply with the terms of the Order raises substantial doubt about our ability
to continue as a going concern.
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. In May 2009, legislation was
signed that extended this temporary increase to $250,000 per depositor through December 31, 2013. 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. Subsequently, the
FDIC issued a final rule that altered the way the FDIC calculates federal deposit insurance assessment rates
beginning in the second quarter of 2009 and thereafter. Under the rule, the FDIC first establishes an
institution’s initial base assessment rate. This initial base assessment rate ranges, depending on the risk
category of the institution, from 12 to 45 basis points. The Federal Deposit Insurance Corporation would
then adjust the initial base assessment (higher or lower) to obtain the total base assessment rate. The
adjustments to the initial base assessment rate are based upon an institution’s levels of unsecured debt,
secured liabilities, and brokered deposits. The total base assessment rate ranges from 7 to 77.5 basis points
of the institution’s deposits. The FDIC also adopted a 3 cent increase in assessment rates on January 1,
2011.
In addition to the regular quarterly assessments, 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 reserved 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. On May 22, 2009, the FDIC amended the interim rule and imposed a final special
assessment of 5 cents per $100 of each depository institution assets reduced by the amount of its Tier 1
capital, as of June 30, 2009, which was collected on September 30, 2009. In lieu of further special
assessments, on November 12, 2009 the FDIC approved a final rule requiring each insured institution to
prepay on December 30, 2009 the estimated amount of quarterly assessment for the fourth quarter of 2009
and all of 2010, 2011 and 2012. The rule includes a process for exemption from the prepayment for which
the Bank qualified. No prepayment was made in December 2009.
24
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 through
December 31, 2009. Subsequent to December 31, 2009, such assessments range from 15 basis to 25 basis
points depending on the institutions risk category. 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 0.0106% of insured deposits in fiscal
2009. 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.
As of December 31, 2009, the Bank had $23 million in outstanding FHLB advances and available
additional borrowing capacity of $64.3 million. At December 31, 2009, the Bank was in compliance with
the FHLB’s stock ownership and cash reserve requirements. As of December 31, 2009 and 2008, our
investment in FHLB capital stock totaled $4,996,000, 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
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, we
established a subsidiary, PB Investment and Consulting, Inc. to operate a Representative Office for us in
Taipei, Taiwan. This office’s primary function is to coordinate banking services and facilitate
25
communications with customers of Preferred Bank in Taiwan. 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.
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.
26
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.
USA PATRIOT Act
The USA PATRIOT Act of 2001 and its implementing regulations significantly expanded the
anti-money laundering and financial transparency laws. Under the USA PATRIOT Act, financial
institutions are required to establish and maintain anti-money laundering programs which include:
•
•
•
•
•
the establishment of a customer identification program;
the development of internal policies, procedures, and controls;
the designation of a compliance officer;
an ongoing employee training program; and
an independent audit function to test the programs.
The Bank has adopted comprehensive policies and procedures to address the requirements of the
USA PATRIOT Act. Material deficiencies in anti-money laundering compliance can result in public
enforcement actions by the banking agencies, including the imposition of civil money penalties and
supervisory restrictions on growth and expansion. Such enforcement actions could also have serious
reputation consequences for the Bank.
Federal Reserve System
The FRB requires all depository institutions to maintain reserves, which earned interest at 0.25%
as of December 31, 2009, 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, 2009 and 2008, we were in compliance with these requirements as established by the
Federal Reserve Bank to maintain reserve balances of $989,000 and $579,000, 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.
27
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, 2009, the
Bank’s largest single lending relationship had a combined outstanding balance of $24.7 million, secured
predominantly by commercial real estate properties in the Bank’s lending area, and which is performing in
accordance with their terms of the Bank’s loans.
Extensions of Credit to Insiders and Transactions with Affiliates
The Bank is subject to Federal Reserve Regulation O and companion California banking law
limitations and conditions on loans or extensions of credit to:
•
•
•
the Bank’s executive officers, directors and principal shareholders (i.e., in most cases, those
persons who own, control or have power to vote more than 10% of any class of voting
securities);
any company controlled by any such executive officer, director or shareholder; or
any political or campaign committee controlled by such executive officer, director or principal
shareholder.
Loans and leases extended to any of the above persons must comply with loan-to-one-borrower
limits, require prior full board approval when aggregate extensions of credit to the person exceed specified
amounts, must be made on substantially the same terms (including interest rates and collateral) as, and
follow credit-underwriting procedures that are not less stringent than those prevailing at the time for
comparable transactions with non-insiders, and must not involve more than the normal risk of repayment or
present other unfavorable features. In addition, Regulation O provides that the aggregate limit on
extensions of credit to all insiders of a bank as a group cannot exceed the bank’s unimpaired capital and
unimpaired surplus. Regulation O also prohibits a bank from paying an overdraft on an account of an
executive officer or director, except pursuant to a written pre-authorized interest-bearing extension of
credit plan that specifies a method of repayment or a written pre-authorized transfer of funds from another
account of the officer or director at the bank. California has laws and the DFI has regulations which adopt
and also apply Regulation O to the Bank.
The Bank also is subject to certain restrictions imposed by Federal Reserve Act Sections 23A and
23B and Federal Reserve Regulation W on any extensions of credit to, or the issuance of a guarantee or
letter of credit on behalf of, any affiliates, the purchase of, or investments in, stock or other securities
thereof, the taking of such securities as collateral for loans, and the purchase of assets of any affiliates.
Such restrictions prevent any affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts. Further, such secured loans and investments to or in any
affiliate are limited, individually, to 10.0% of the Bank’s capital and surplus (as defined by federal
regulations), and such secured loans and investments are limited, in the aggregate, to 20.0% of the Bank’s
capital and surplus. A financial subsidiary is considered an affiliate subject to these restrictions whereas
other nonbanking subsidiaries are not considered affiliates. Additional restrictions on transactions with
affiliates may be imposed on the Bank under the FDI Act prompt corrective action provisions and the
supervisory authority of the federal and state banking agencies.
28
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.
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
29
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
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.
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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.
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 Obama Administration published a comprehensive regulatory reform plan that is intended to
modernize and protect the integrity of the United States financial system. The reform plan proposes, among
other matters, the creation of a new federal agency, the Consumer Financial Protection Agency, that would
be dedicated to protecting consumers in the financial products and services market. The creation of this
agency could result in new regulatory requirements and raise the cost of regulatory compliance. In
addition, legislation stemming from the reform plan could require changes in regulatory capital
requirements, and compensation practices. If implemented, the foregoing regulatory reforms may have a
material impact on our operations.
The EESA increased Federal Deposit Insurance Corporation (“FDIC”) deposit insurance on most
accounts from $100,000 to $250,000. This increase was to be in place until the end of 2009 with no
increase in deposit insurance premiums paid by the banking industry. During 2009, legislation extended
the temporary increase until December 31, 2013. In addition, the FDIC had 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 Debt Guarantee Program issue end date and the guarantee expiration
date were both extended, to October 31, 2009 and December 31, 2012, respectively. Participating holding
companies that have not issued FDIC-guaranteed debt prior to April 1, 2009 must apply to remain in the
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Debt Guarantee Program. Participating institutions will be subject to surcharges for debt issued after that
date. Effective October 1, 2009, the Transaction Account Guarantee program was extended until June 30,
2010, with an increased assessment after December 31, 2009. The FDIC charges “systemic risk special
assessments” to depository institutions that participate in the TLGP.
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.
Employees
As of December 31, 2009, the Bank had a total of 126 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.
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 ........................
[69]
Chairman of the Board, President and Chief Executive Officer
Edward J. Czajka .....
[45]
Executive Vice President and Chief Financial Officer
Lucilio Couto ...........
[41]
Executive Vice President and Acting Chief Credit Officer
Robert Kosof ............
[66]
Nick Pi………..........
[49]
(1) As April 14, 2010.
Executive Vice President and Head of Commercial and Industrial Loans and
Regional Branch Manager
Executive Vice President and Group Manager
Li Yu has been our President and Chief Executive Officer since 1993. From December 1991 to
the present, he has served as Chairman of our Board of Directors. From 1987 to 1991, he was involved in
several privately held companies of which he was the owner. From 1982 to 1987, he served as Chairman of
the Board of California Pacific National Bank, which became a part of Bank of America. Mr. Yu received
a Masters of Business Administration, or MBA, from the University of California, Los Angeles. He was
also the past President of the National Association of Chinese American Bankers, and is currently a
member of the Board of Visitors of UCLA’s Anderson Graduate School of Management.
Edward J. Czajka has been Senior Vice President and Chief Financial Officer since 2006 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. Prior to this,
Mr. Czajka was Executive Vice President and Chief Financial Officer of North Valley Bancorp, a publicly-
32
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.
Lucilio Couto was recently appointed on February 22, 2010 as Executive Vice President and
Acting Chief Credit Officer pending regulatory Notice of Non disapproval; prior to that, he served as
Senior Vice President and Special Assistant to the Chairman of the Board and he has been with Preferred
Bank since July 2009. Before joining Preferred Bank he served in senior management positions at two
other Southern California financial institutions including Vineyard Bank, NA. Mr. Couto served as the
Chief Risk Officer of Vineyard Bank from July 2007 to April 2009 and Executive Vice President and
Chief Credit Officer from September 2008 to April 2009. Prior to joining Vineyard Bank, Mr. Couto spent
16 years working for the FDIC in a variety of positions, including most recently Senior Risk Management
Examiner. He has expertise in risk management, regulatory compliance, credit analysis and financial
statement analysis. Mr. Couto received a Bachelor’s degree of finance from California State University,
San Bernardino in 1991and graduated from the University of Wisconsin’s Graduate School of Banking in
2004.
Robert Kosof was recently appointed on February 22, 2010 as Executive Vice President and
Head of Commercial and Industrial Loans and Regional Branch Manager; prior to that, he served as
Executive Vice President and Chief Credit Officer and he has been with Preferred Bank 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.
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.
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 (the “Exchange Act”). 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. Forms 3, 4 and 5 are filed electronically with FDIC, at the FDIC’s
website at http://www.fdic.gov.
33
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 us. Events or
circumstances arising from one or more of these risks could adversely 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.
We are operating pursuant to the terms of the Order and uncertainty over our ability to comply
with such terms raises substantial doubt about our ability to continue as a going concern.
We are operating pursuant to a Consent Order issued on March 22, 2010 by the FDIC and DFI
(the “Order”), under which, among other things, requires us to increase and maintain our leverage, tangible
common equity, and total risk-based capital ratios to at least 8.5%, 8.5%, and 10%, respectively, by July
20, 2010 and 10%, 10%, and 12%, respectively, by September 17, 2010. See “REGULATION AND
SUPERVISION – Recent Regulatory Developments – Consent Order” and “—Going Concern.” Failure to
increase our capital ratios or further declines in our capital ratios exposes us to additional restrictions and
regulatory actions, including potential regulatory take-over. This uncertainty as to our ability to meet
existing or future regulatory requirements raises substantial doubt about our ability to continue as a going
concern. If we cannot continue as a going concern, our shareholders will lose some or all of their
investment.
In addition, our independent registered accounting firm in their audit report for fiscal year 2009
has expressed substantial doubt about our ability to continue as a going concern. Our audited financial
statements were prepared under the assumption that we will continue our operations on a going concern
basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of
business. Our financial statements do not include any adjustments that might be necessary if we are unable
to continue as a going concern.
Further, our customers, employees, vendors, and others with whom we do business may react
negatively to the substantial doubt about our ability to continue as a going concern. This negative reaction
may lead to heightened concerns regarding our financial condition that could result in a significant loss in
deposits and customer relationships, key employees, vendor relationships and our ability to do business
with institutions upon which we rely.
Our operations may require us to raise additional capital in the future, but that capital may not
be available or may not be on terms acceptable to us when it is needed.
We are required by federal and state banking regulatory authorities to maintain adequate levels of
capital to support our operations. As part of the Order, we are also required to maintain certain regulatory
capital ratios prior to certain dates specified in the Order. The minimum capital ratios and the dates by
which such capital ratios must be obtained are set forth in the table below:
Ratio
Tier 1 Leverage Ratio
Tangible Common Equity Ratio
Total Risk-Based Capital Ratio
Preferred Bank
at 12/31/09
6.2%
6.5%
8.5%
Requirement as of
7/15/10
8.5%
8.5%
10.0%
Requirement as of
9/15/10
10.0%
10.0%
12.0%
We have also committed to the FDIC and the DFI to adopt a consolidated capital plan to augment
and maintain a sufficient capital position. Our existing capital resources may not satisfy our capital
requirements for the foreseeable future and may not be sufficient to offset any problem assets. Further,
should our asset quality erode and require significant additional provisions for credit losses, resulting in
34
additional net operating losses, our capital levels will decline and we will need to raise capital to satisfy our
agreements under the Order.
Our ability to raise additional capital will depend on conditions in the capital markets at that time,
which are outside our control, and on our financial performance. Accordingly, we cannot be certain of our
ability to raise additional capital on terms acceptable to us. Inability to raise additional capital when
needed, raises substantial doubt about our ability to continue as a going concern.
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.
Although a substantial amount of loan losses have been incurred in 2008 and 2009, the underwriting and
credit monitoring policies and procedures that we have adopted to address this risk may not prevent
additional losses that could have an 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.
For the year ended December 31, 2009, we recorded a provision for loan and lease losses and net loan
charge-offs of $71.3 million and $55.4 million, respectively, compared to $30.6 million and $18.5 million
for the year ended December 31, 2008.
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 future losses may exceed current estimates. While we believe that our allowance
for loan and lease losses is adequate to cover current losses, we cannot ensure 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, 2009, our construction loans were $202.2 million, or 19.4% of our total loans
and leases held, and the average loan size of our construction loans was $5.4 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
35
been a significant source of our loan losses incurred in 2008 and 2009 and this may continue, albeit at a
lower level into 2010.
Difficult economic and market conditions have adversely affected our industry and us
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 significantly higher 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.
• The classification of our criticized loans as special mention, substandard, doubtful and loss and the
related provision for loan losses, and the estimated losses inherent in our loan portfolio, could be
increased by our primary regulators in connection with an examination of our loan portfolio, which
could subject us to restrictions on our operations and require us to increase our capital.
• 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 has increased assessments on FDIC-insured
institutions and may impose further increases.
• Our banking operations are concentrated primarily in California. Continued 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. This 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, 2009, approximately
36
74% 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.
As a result of these financial and economic crises, we have experienced substantial increases in
nonperforming loans. Total nonperforming loans increased to $145.3 million at December 31, 2009 from
$66.8 million at December 31, 2008 and $20.9 million at December 31, 2007, representing 13.9%, 5.42%
and 1.69% of total loans owned at December 31, 2009, December 31, 2008 and December 31, 2007,
respectively. Total nonperforming assets increased to $204.5 million at December 31, 2009 from $101.9
million at December 31, 2008 and $29.3 million at December 31, 2007, representing 15.7%, 6.87% and
1.90% of total assets at December 31, 2009, December 31, 2008 and December 31, 2007, respectively.
Declines in real estate prices and the volume of sales, especially in certain parts of California,
along with the reduced availability of certain types of credit, have resulted in increases in delinquencies
and losses in our portfolio of construction loans. Further declines in real estates prices with the continued
economic recession in our markets and continued high or increased unemployment levels could cause
additional losses which could continue to adversely affect our earnings and financial condition.
We and KPMG, our independent registered public accounting firm, have identified a material
weakness in our internal control over financial reporting.
Management and KPMG, our independent registered public accountants, have identified a
material weakness in our internal control over financial reporting related to the allowance for loan losses.
The identified deficiency that was considered a material weakness related to management’s policies and
procedures for the monitoring and timely evaluation of and revision to management’s approach for
assessing credit risk inherent in the Bank’s loan portfolios to reflect changes in the economic environment.
While we are taking steps to address the identified material weakness and prevent additional
material weaknesses from occurring, there is no guarantee that these steps will be sufficient to remediate
the identified material weakness or prevent additional material weaknesses from occurring. If we fail to
remediate the material weakness, or if additional material weaknesses are discovered in the future, we may
fail to meet our future reporting obligations and our financial statements may contain material
misstatements. Any such failure could also adversely affect the results of the periodic management
evaluations and annual auditor attestation reports regarding the effectiveness of our internal control over
financial reporting.
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
37
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.
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 nor our other executives.. 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.
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
38
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
tightened its underwriting standards, if our more conservative 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 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.
39
In considering whether to make a loan on or secured by real property, we require an appraisal on
such property. However, an appraisal is only an estimate of the value of the property at the time the
appraisal is made. If the appraisal does not reflect the amount that may be obtained upon any sale or
foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the
property and we may suffer 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, 2009, approximately $48.2 million, or 4.6%, 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.
Although we are not planning to grow the balance sheet in the immediate future, 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. Due to the fact that the Bank was deemed not to be well capitalized in the
fourth quarter of 2009, we were restricted from accessing the brokered deposit market, which also includes
the CDARS reciprocal deposits. As such, the Bank will not renew any of these brokered deposits and will
let all of them mature during the course of 2010 and 2011. In addition, pursuant to the Order, the Bank
must submit to the FDIC and the DFI a written plan for eliminating its reliance on brokered deposits.
Accordingly, management has worked to create and execute a contingency funding plan to ensure that the
Bank has sufficient liquidity to meet these brokered deposit maturities and to also have additional
contingent cash on hand. 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. Our average jumbo deposit customer has been a customer of the Bank for
over six years. At December 31, 2009, we held $328.6 million of Jumbo CDs, representing 28% of total
deposits. These deposits are considered by the banking industry to be volatile and could be subject to
40
withdrawal. Withdrawal of a material amount of such deposits would adversely impact our liquidity,
profitability, business, financial condition, results of operations and cash flows.
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.
In addition to the Order, governmental regulation and regulatory actions against us may
further impair our operations or restrict our growth and could result in a decrease in the value of your
shares.
In addition to the requirements of the Order, we are subject to significant governmental
supervision and regulation. 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,
41
rules and regulations or any other laws, rules or regulations will not be adopted in the future, which could
make compliance much more difficult or expensive, restrict our ability to originate loans, further limit or
restrict the amount of commissions, interest or other charges earned on loans originated by us or otherwise
adversely affect our business, financial condition, results of operations or cash flows.
We are exposed to risk of environmental liability with respect to properties to which we take
title.
In the course of our business, we may foreclose on and take title to properties securing our loans.
If hazardous substances were discovered on any of the properties, we may be held liable to governmental
entities or to third parties for property damage, personal injury, investigation and clean-up costs incurred
by these parties in connection with environmental contamination or may be required to investigate or clean
up hazardous or toxic substances or chemical releases at a property. Many environmental laws can impose
liability regardless of whether we knew of or were responsible for the contamination. In addition, if we
arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of
cleaning up and removing those substances from the site, even if we neither own nor operate the disposal
site. Environmental laws may require us to incur substantial expenses and may materially limit use of
properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of
a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement
policies with respect to existing laws may increase our exposure to environmental liability.
Negative publicity could damage our reputation.
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.
Pursuant to the Order, we are prohibited from paying cash dividends or any other payments to
our shareholders.
Under the terms of the Order, we are prohibited from paying cash dividends or any other
payments to our shareholders without the prior written consent of the FDIC and the DFI. We do not know
when the Bank will receive regulatory approval to pay dividends to our shareholders. These restrictions
could have a negative effect on the value of our common stock.
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:
42
•
•
•
•
•
•
•
•
•
•
•
•
failure to comply with the terms of the Order;
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;
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 still historically high. The capital and credit markets have been experiencing
volatility and disruption for more than a year. 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.
Your share ownership may be diluted by the issuance of additional shares of our common stock
in the future.
Your share ownership may be diluted by the issuance of additional shares of our common stock in
the future. Our amended and restated articles of incorporation do not provide for preemptive rights to the
holders of our common stock. Any authorized but unissued shares are available for issuance by our Board
of Directors. As a result, if we issue additional shares of common stock to raise additional capital or for
other corporate purposes, you may be unable to maintain your pro rata ownership in the Bank.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
43
ITEM 2. PROPERTIES
Our headquarters and main branch office are located at 601 S. Figueroa Street, Los Angeles,
California, 90017. This lease expires in August of 2020.
At December 31, 2009, 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. In February 2010, we
consolidated our Chino and Diamond Bar branches and our Santa Monica and Century City branches.
Since such consolidation, we maintain ten full-service branches. 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 $1,829,000 for the year ended December 31, 2009 and $1,700,000 for
December 31, 2008.
The Bank accounts for its leases under the provision of ASC 840, 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 owned and 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)
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
24501 Town Center Drive, Suite 103
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,
2009
(in thousands)
05/31/19
02/01/14
06/30/11
03/14/15
11/30/16
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
$125,029
83,167
42,242
88,873
67,432
477,340
11,679
33,275
121,994
—
17,601
65,370
San Bernardino County
Chino
3926 Grand Avenue, #E
10/14/10
2,973
26,410
44
ITEM 3. LEGAL PROCEEDINGS
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 ASC 450, "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.
ITEM 4. RESERVED
45
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 $1.54 on April 12 2010 and there were 16,012,126 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:
2008
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
2009
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
High
Low
$26.00
$17.20
$12.25
$11.49
$6.80
$5.92
$3.91
$3.44
$16.15
$ 5.10
$ 3.70
$ 5.03
$ 4.85
$ 3.76
$ 2.70
$ 1.25
Cash
Dividends
Declared
$0.17
$0.10
$0.10
$0.10
$0.08
*
*
*
*On April 16, 2009, the Bank’s Board of Directors elected to indefinitely suspend the Bank’s cash
dividend in order to preserve the Bank’s capital.
Holders
As of April 12, 2010, 16,012,126 shares of the Bank’s common stock were held by 154
shareholders of record.
Dividends
On April 16, 2009, the Bank’s Board of Directors elected to indefinitely suspend the Bank’s cash
dividend in order to preserve the Bank’s capital. Further, under the terms of the Order, we are prohibited
from paying cash dividends or any other payments to our shareholders without the prior written consent of
the FDIC and the DFI.
46
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 near future will, however, be
at the discretion of the FDIC and the DFI and will depend upon our satisfaction of the requirements under
the Order, which in turn will depend upon our earnings, financial condition, results of operations, capital
requirements, available investment opportunities, regulatory restrictions, contractual restrictions and other
factors that our board of directors may deem relevant. Accordingly, there can be no assurance that any
stock or cash dividends will be declared in the future, and if any are declared, what amount they will be.
Because we are a California state-chartered bank, our ability to pay dividends or make
distributions to shareholders are 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.
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.
Recent Sales of Unregistered Securities
On July 24, 2009, the Bank commenced a rights offering and concurrent public offering of up to
$10 million of the Bank’s common stock, no par value, to its existing shareholders. Each right entitled the
holder to purchase its pro rata allocation of shares of the Bank’s common stock at the subscription price of
$2.88 per share. The Bank could, in its sole discretion, increase the number of shares offered by up to an
additional 10% of the offering amount. The rights offering was over-subscribed and the Bank received
approval from the California Department of Financial Institutions to issue additional shares.
On September 9, 2009, the Bank completed its rights offering and concurrent public offering. The
Bank issued 5,912,919 shares of its common stock, no par value in exchange for approximately $17.0
million. The Bank conducted this rights offering and concurrent public offering to raise equity capital to
enhance its capital position.
47
Shares of the Bank's common stock are exempt from registration with the Securities and Exchange
Commission under Section 3(a)(2) of the Securities Act of 1933, as amended, and were issued pursuant to
a stock permit issued by the California Department of Financial Institutions. The Bank’s shares are listed
and freely tradable on the NASDAQ Global Select Market under the symbol "PFBC."
Issuer’s Purchases of Equity Securities.
No repurchases of the Bank’s common stock were made by or on behalf of the Bank in
2009.
Securities Authorized for Issuance Under Equity Compensation Plans.
The following table provides information as of December 31, 2009 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)
1,428,200
—
1,428,200
Weighted average
exercise price of
outstanding
options
(b)
$22.51
—
Number of securities
available for future
issuance under equity
compensation plans
excluding securities
reflected in column (a)
(c)
498,350
—
498,350
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.
48
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
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
12/31/09
Index
Preferred Bank
NASDAQ Composite
NASDAQ Bank
SNL Bank and Thrift
02/14/05
100.00
100.00
100.00
100.00
12/31/05
204.71
105.88
99.09
102.84
Period Ending
12/31/06
280.61
115.96
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
12/31/09
13.60
108.94
53.14
51.99
49
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, 2009 and 2008 and our statement of operations
data for the years ended December 31, 2009, 2008 and 2007 have been derived from our audited historical
financial statements included elsewhere in this Form 10-K.
Our financial condition data as of December 31, 2007, 2006 and 2005 and our statement of
operations data for the year ended December 31, 2006 and 2005 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 Operations Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest (loss) income after
provision for loan and lease losses
Noninterest income
Noninterest expense
(Loss) income before provision for
income taxes
(Benefit) provision for income taxes
Net (loss) income
2009
2008
2007
2006
2005
At or for the Year Ended December 31,
(Dollars in thousand, except per share data)
$ 1,306,781
1,160,412
$ 1,483,231
1,257,323
$ 1,542,610
1,253,110
$ 1,348,841
1,161,344
$ 1,136,720
975,467
114,464
1,043,299
68,071
59,190
85,374
104,406
1,231,232
69,586
35,127
137,491
245,268
1,233,099
22,803
8,444
152,952
198,689
997,317
26,878
—
145,932
162,935
771,143
25,123
—
123,846
$ 58,876
22,812
36,064
$ 85,959
34,634
51,325
$ 112,607
44,199
68,408
$ 90,262
31,424
58,838
$ 60,082
16,062
44,020
71,250
30,560
4,900
1,960
2,110
(35,186)
6,476
51,953
(80,663)
(8,128)
(72,535)
20,765
4,941
35,594
(9,888)
(4,876)
$ (5,012)
63,508
3,090
21,461
45,137
18,670
$ 26,467
56,878
3,028
20,017
39,889
16,538
$ 23,351
41,910
3,868
17,571
28,207
11,382
$ 16,825
50
.
2009
At or for the Year Ended December 31,
2007
2006
2008
2005
Share Data:
Net (loss)income per share, basic(2) (10)
Net (loss) 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
to total loans and leases
Allowance for loans and lease losses
to non-performing loans
Net charge-offs (recoveries) to
average loans and leases
(Dollars in thousands, except per share data)
$ (6.30)
$ (0.51)
$ 2.56
$ 2.29
$ 1.72
$ (6.30)
$ 5.41
15,767,126
$ (0.51)
$ 14.09
9,755,207
$ 2.50
$ 15.37
9,953,532
$ 2.21
$ 14.20
10,274,706
$ 1.65
$ 12.34
10,037,856
11,518,145
9,790,858
10,330,232
10,194,515
9,782,645
11,518,145
9,810,391
10,580,949
10,556,282
10,195,958
$ 1,440,279
1,357,385
129,959
$ 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
(5.04)%
(0.33)%
1.88%
1.98%
1.67%
(55.81)
6.53
2.72
(122.13)
(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
13.92%
5.42%
1.69%
0.11%
—%
15.65
6.87
1.90
0.08
—
4.10
2.19
1.21
1.03
1.16
29.47
40.33
71.27
913.93
—
4.76
1.52
0.02
0.08
(0.02)
(1) These amounts include all property held by us as a result of foreclosure.
(2) Net income per share, basic is computed by dividing net income adjusted by presumed dividend payments and earnings on
unvested restricted stock by the weighted average number of common shares outstanding. Losses are not allocated to
participating securities. Unvested shares of restricted stock are excluded from basic shares outstanding. Net income per share,
diluted 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 loss or earnings of the Bank.
(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
(5)
throughout this annual report have been rounded to the closest whole number, tenth or hundredth as the case may be.
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.
51
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, 2009 and 2008, and
the results of operations for the years ended December 31, 2009, 2008 and 2007. 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 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 net operating losses in 2008 due to significant credit quality issues as well
as losses on its investment portfolio. These losses continued in 2009. More specifically:
• Our net interest margin decreased primarily due to lower rates earned on loans and a
significant increase in loans on nonaccrual status.
• The provision for credit losses in 2009 increased substantially from prior periods
reflecting the rapid increase in classified and nonperforming loans due to the
unprecedented economic conditions, especially in the real estate market.
• The Bank recorded significant expenses in connection with the decline in value and the
disposition of other real estate owned.
• The level of non-performing loans increased significantly during 2009 to a level much
higher than in prior periods.
If general economic conditions and the real estate market do not show signs of sustained recovery,
these trends could continue. Our national economy and California in particular are in the midst of a
recovery from an unprecedented recession that has its roots in real estate values. As a result, Management’s
primary focus during 2010 will remain on credit quality, capital preservation and liquidity management.
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, 2009 the Bank recorded a net loss of $72.5 million as compared
to a net loss of $5.0 million for December 31, 2008. The increase in net loss during 2009 is primarily due
to increases in credit loss provision, a valuation allowance recorded on the Bank’s deferred tax asset,
increased expenses associated with OREO including valuation allowance and a decrease in our net interest
income as a result lower overall loans outstanding and a significant increase in non-accrual loans in 2009.
See —“Results of Operations”.
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 rates during 2008.
52
Regulatory Matters
On March 16, 2010, the members of the Board of Directors of the Bank consented to the issuance
of a Consent Order (the “Order”) from the FDIC and the DFI. The Order was signed on March 22, 2010
and among other things, the Order requires that the Bank must have and maintain qualified management
and notify the FDIC and the DFI in writing when it proposes to make any changes in its Board of Directors
or senior executive officers at least 30 days prior to the date any change is to become effective, requires
that the Bank must develop and adopt a plan to meet and maintain the capital requirements contained in the
Order and the FDIC’s Statement of Policy on Risk-Based Capital. The minimum capital ratios and the
dates by which such capital ratios must be obtained are set forth in the table below:
Ratio
Tier 1 Leverage Ratio
Tangible Common Equity Ratio
Total Risk-Based Capital Ratio
Preferred Bank
at 12/31/09
6.2%
6.5%
8.5%
Requirement as of
7/15/10
8.5%
8.5%
10.0%
Requirement as of
9/15/10
10.0%
10.0%
12.0%
The Order also prohibits the Bank from paying cash dividends or making any other payments to
its shareholders without prior written consent of the FDIC and the DFI, requires that the Bank reduce
classified assets to not more than 50% of the Bank’s Tier 1 capital and ALLL within 270 days of the Order,
requires that the Bank reduce concentrations of construction and land loans, requires that the Bank adopt
an enhanced written liquidity management policy and adopt a written plan which addresses profit retention.
The Bank is required by this Order to submit quarterly progress reports detailing actions taken to comply
with this order.
The Board of Directors and management are committed to addressing and resolving the matters
raised in the Order on a timely basis and actions have already been undertaken to comply with each
requirement.
On February 9, 2010, the Bank was notified by the FDIC that the FDIC had determined that the
Bank was ‘adequately capitalized’ as of December 31, 2009 based on the capital ratios contained in the
Bank’s Call Report as of December 31, 2009 which was filed on January 28, 2010. An amended Call
Report is expected to be filed and the Bank still expects to be adequately capitalized.
The Bank utilizes a variety of funding sources in conducting its operations, including the use of
“brokered deposits” as defined by banking regulators. Such brokered deposits totaled $189.6 million at
December 31, 2009. During the fourth quarter of 2009, due to the fact that the Bank is no longer
considered to be well-capitalized, the Bank is no longer allowed to access the brokered deposit market
which also includes the CDARS reciprocal deposits. As such, the Bank will not renew any of these
brokered deposits and will let all of them mature during the course of 2010 and 2011. In addition, pursuant
to the Order, the Bank must submit to the FDIC and the DFI a written plan for eliminating its reliance on
brokered deposits. Accordingly, we have worked and planned diligently to ensure that the Bank has
sufficient liquidity to meet these brokered deposit maturities and to also have additional contingent cash on
hand. We have worked to increase cash on hand which as of December 31, 2009 was $68 million. Based
on scheduled loan maturities and required repayments, management anticipates a substantial pay down in
the loan portfolio during 2010 which will result in additional cash on the balance sheet. In addition,
management is also looking to sell certain of its investment securities which cannot be pledged as collateral
at the FHLB for future borrowings. Finally, the Bank is also able to raise deposits from time to time from
other financial institutions to augment its cash position. Management is confident that these efforts will
result in maintaining sufficient cash to be able to pay out maturing brokered deposits and CDARS deposits
and also maintain a substantial level of contingent liquidity
53
Recent Developments
There have been significant disruptions in the U.S. and international financial system during the
period covered by this report. The financial services industry continues to suffer high volatility and adverse
financial conditions. Regionally high unemployment, slumping residential real estate values, decreased
liquidity in capital and credit markets, and a general lack of confidence in the financial service sector of the
economy as a result of recent bank failures present challenges. 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 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. Legislation was
passed that included a provision for a temporary increase in the amount of deposits insured by FDIC to
$250,000 until December 2013. 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. 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, premiums the Bank pays for FDIC insurance have increased and
may continued to 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
54
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 increased levels of volatility and limited credit
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 effect 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 Receivables Topic of FASB ASC covering loan impairments.
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 Investments – Debt and Equity
Securities Topic of FASB ASC, 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
55
maturity and largely on management’s intentions with respect to either holding or selling the securities.
The classification of investment securities is significant since it directly impacts the accounting for
unrealized gains and losses on securities. Unrealized gains and losses on trading securities flow directly
through earnings during the 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 Fair Value Measurements and Disclosures Topic of FASB ASC. 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. For debt securities, we assess whether (a) we have the intent to
sell the security and (b) it is more likely than not that we will be required to sell the security prior to its
anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of
the investment. Previously, this assessment required us to assert we had both the intent and the ability to
hold a security for a period of time sufficient to allow for an anticipated recovery in fair value to avoid
recognizing an other-than-temporary impairment. In instances when a determination is made that an other-
than-temporary impairment exists but we do not intend to sell the debt security and it is not more likely
than not that we will be required to sell the debt security prior to its anticipated recovery, the newly
adopted FASB guidance covering recognition and presentation of other-than-temporary impairments,
changes the presentation and amount of the other-than-temporary impairment recognized in the income
statement. The other-than-temporary impairment is separated into (a) the amount of the total other-than-
temporary impairment related to a decrease in cash flows expected to be collected from the debt security
(the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors.
The amount of the total other-than-temporary impairment related to the credit loss is recognized in
earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized
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.
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, 2009. Investment securities are discussed in more detail in
Note 2 to the Bank’s consolidated financial statements presented elsewhere in this report.
56
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. Income taxes are
discussed in more detail in “Notes to Consolidated Financial Statements, Note 1 — Summary of Significant
Accounting Policies” and “Note 6 — Income Taxes”
Stock Split Effected in the form of a Stock Dividend
On January 25, 2007 the 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 Global Select Market 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:
2009
Year Ended December 31,
2008
2007
(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
$ (72,535)
$ (6.30)
$ (6.30)
(5.04)%
(55.81)%
$ (5,012)
$ (0.51)
$ (0.51)
(0.33)%
(3.35)%
$ 26,467
$ 2.56
$ 2.50
1.88%
16.94%
(1) Adjusted to reflect 3-for-2 stock split effected in the form of dividend, distributed on February 20, 2007.
57
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Statement of Operations Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest (loss) income after provision for loan and lease losses
Noninterest income
Noninterest expense
Loss before income taxes
Income tax benefit
Net loss
Net loss per share, basic
Net loss per share, diluted
Year Ended December 31,
2009
2008
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 58,876
22,812
36,064
71,250
(35,186)
6,476
51,953
(80,663)
(8,128)
$ (72,535)
$ 85,959
34,634
51,325
30,560
20,765
4,941
35,594
(9,888)
(4,876)
$ (5,012)
$ (6.30)
$ (6.30)
$ (0.51)
$ (0.51)
$ (27,083)
(11,822)
(15,261)
40,690
(55,951)
1,535
16,359
(70,775)
(3,252)
$ (67,523)
$ (5.79)
$ (5.79)
The Bank’s net loss increased to $72.5 million, or $6.30 per diluted share, for the year-ended
December 31, 2009, from a net loss of $5.0 million, or $0.51 per diluted share, for the year ended
December 31, 2008. Our return on average assets was (5.04)% and return on average shareholders’ equity
was (55.81)% for the year ended December 31, 2009, compared to (0.33)% and (3.35)%, respectively, for
the year ended December 31, 2008.
Net loss increased from 2008 to 2009, principally as a result of a decrease in net interest income
of $15.3 million, a $40.7 million increase in the provision for credit losses and an increase in OREO
expenses of $20.0 million, partially offset by a increase in the benefit for income taxes by $3.3 million as
the Bank recorded a valuation on its deferred tax asset in 2009 of $27.1 million. Without the valuation
allowance on the deferred tax asset, the benefit for income taxes would have been $35.1 million.
The $15.3 million, or 29.7%, decrease in net interest income was due primarily to the lower loan
totals as well as a significant increase in nonaccrual loans in 2009. Our overall cost of funds in 2009
decreased by 98 basis points to 2.08%, compared to 3.06% for 2008 while yields on earning assets
decreased 162 basis points to 4.40% from 6.02%. The impact of a declining interest rate environment in
2009 was the primary driver of our decreased cost of funds during 2009.
As of December 31, 2009, 81% of our loan portfolio was tied to the Prime Rate, which has the
potential to re-price daily, and 10% was tied to the London Interbank Offer Rate, or LIBOR, or other
indices, which re-price periodically. Approximately 71% 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, 2009 was 7.6
months.
58
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)
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.
The Bank’s net loss for 2008 was $5.0 million or $0.51 per diluted share compared to net income
of $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.
59
Net Interest Income and Net Interest Margin
Year ended December 31, 2009 compared to 2008
Net interest income before the provision for credit losses for the year ended December 31, 2009
decreased $15.2 million, or 29.7%, to $36.1 million from $51.3 million for the year ended December 31,
2008. This decrease was due to a decrease in interest income of $27.1 million, partially offset by a decrease
in interest expense of $11.8 million. Total decrease in net interest income is primarily due to the lower loan
totals as well as a significant increase in nonaccrual loans in 2009.
The average yield on our interest-earning assets decreased to 4.40% in the year ended December
31, 2009 from 6.02% in the year ended December 31, 2008. The decrease was mainly due to lower rates
earned on loans and an increase in loans on nonaccrual status.
The cost of average interest-bearing liabilities decreased to 2.08% in the year ended December 31,
2009 from 3.06% in the year ended December 31, 2008. The decrease was primarily driven by generally
lower rates paid on deposits during 2009 over 2008 which is a result of lower market rates.
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.
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.
60
Year Ended December 31, 2009
Year Ended December 31, 2008
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, 2007
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:
$1,162,221 $ 53,055
6,520
102,378
37
14,983
4.56%
6.37%
0.25%
$1,220,348 $ 75,120
11,458
209,714
96
9,073
6.16%
5.46%
1.06%
$1,103,248
210,635
43,278
$ 98,817
11,818
2,268
—
77,803
—
176
—
0.23%
—
5,204
—
253
—
4.86%
399
4,280
22
214
$1,357,385
$ 59,788
4.40%
$1,444,339
$ 86,927
6.02%
$1,361,840
$113,139
8.96%
5.61%
5.24%
5.51%
5.00%
8.31%
Cash and due from banks
Other assets
Total assets
10,571
72,323
$1,440,279
22,200
39,699
$1,506,238
22,943
20,524
$1,405,307
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
$ 30,395
89,740
58,433
843,108
1,021,676
1
Long-term debt (FHLB and Senior)
72,761
$ 223
619
687
18,602
20,131
—
2,681
Total interest-bearing liabilities
1,094,438
22,812
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
201,998
13,884
1,310,320
129,959
$1,440, 279
0.73%
0.69%
1.18%
2.21%
1.97%
0.50%
3.69%
2.08%
$ 33,650
109,383
73,042
823,249
1,039,324
$ 265
1,099
1,433
28,396
31,193
0.79%
1.01%
1.96%
3.45%
3.00%
$ 31,489 $ 458
99,551 2,210
91,717 3,494
739,696 36,263
962,453 42,425
1.45%
2.22%
3.81%
4.90%
4.41%
19,547
533
2.73%
6,249 295
4.72%
72,691
2,908
4.00%
35,608 1,479
4.15%
1,131,562
34,634
3.06%
1,004,310 44,199
4.40%
205,764
19,267
1,356,593
149,635
$1,506,238
220,050
24,732
1,249,092
156,215
$1,405,307
$ 36,976
$ 52,294
$ 68,940
2.32%
2.72%
2.96%
3.62%
3.91%
5.06%
(1)Yields on securities have been adjusted to a tax-equivalent basis.
(2)Includes average nonaccrual loans and leases.
(3)Net loan and lease fees income (expense) of ($1.1) million, $250,000 and $2.2 million for the year ended December
31, 2009, 2008 and 2007, respectively, are included in the yield computations.
(4)Includes Federal Home Loan Bank stock.
While our interest income decreased, primarily due to the lower loan totals as wells as a
significant increase in nonaccrual loans in 2009, decreases in interest expense on our deposits reflecting
lowering of interest paid on all types of deposits, caused our net interest margin to decrease from 3.62% in
2008 to 2.72% in 2009. 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.
61
Year Ended December 31,
2009 vs. 2008
Net Change
Rate
Volume
Net Change
2008 vs. 2007
Rate
Volume
(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
Total interest expense
Net interest income
$ (22,065)
(4,938)
(60)
$ (18,631) $ (3,434)
(6,597)
1,659
40
(100)
$ (23,698)
(359)
(2,172)
$ (33,354)
(275)
(1,091)
$ 9,656
(84)
(1,081)
—
(76)
(27,139)
—
(456)
(17,528)
—
380
(9,611)
(22)
39
(26,212)
(11)
(6)
(34,737)
(11)
45
8,525
(42)
(481)
(745)
(17)
(306)
(497)
(25)
(175)
(248)
(194)
(1,111)
(2,061)
(223)
(1,311)
(1,452)
29
200
(609)
(9,795)
(533)
(226)
(11,822)
$ (15,317)
98
(9,893)
(293)
(240)
3
(229)
(640)
(11,182)
$ (6,346) $ (8,971)
(7,867)
239
1,428
(9,566)
$ (16,646)
(13,731)
(168)
(57)
(16,942)
$ (17,795)
5,864
407
1,485
7,376
$ 1,149
(1) Amounts have been adjusted to a tax-equivalent basis.
As reflected above, average total loans decreased and rates on loans 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 response to the credit risk inherent in our lending business and the recent ongoing financial
crisis, we set aside allowances for loan losses 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 2009 increased $40.7 million to $71.3 million from $30.6
million for 2008. The bank’s net loans and lease charge-offs increased to $55.4 million during 2009 from
$18.5 million in 2008. The increase in the provision for credit losses during 2009 is due to a higher level of
classified loans and nonperforming loans at December 31, 2009 and is the result of the application of
management’s established allowance for loan and lease loss adequacy calculation. In addition to this, the
Bank made refinements in the assumptions for calculating its adequacy of allowance for loan losses as
prescribed under Contingencies Topic of FASB ASC. In calculating the need for allowance levels based
on historical losses, the Bank shortened its historical loss measurement period from seven years to three
years starting in third quarter of 2009. Also, the Bank has increased qualitative factors such as the mix of
the loan portfolio, local and national economic conditions as well as the overall level of classified and non-
performing loans in determining the overall allowance. Nonperforming loans increased from $66.8 million
as of December 31, 2008 to $145.3 million as of December 31, 2009. This decrease in credit quality was
primarily centered in two types of loans; residential construction and residential land. As of December 31,
2009 these two loan types comprised 60% of nonperforming loans. Throughout 2009, management has
worked to decrease the balances of these two loan types. The ratio of allowance for loan losses to total
62
loans increased from 2.19% of total loans at December 31, 2008 to 4.10% at December 31, 2009.
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, 2009.
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 $27.6 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. 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.
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
sale of investment securities
The following table presents, for the periods indicated, the major categories of noninterest
income:
Service charges and fees on deposit accounts
Trade finance income
Increase in cash surrender value of life insurance
Net gain (loss) on sale of investment securities
Other income
Total noninterest income
Year Ended December 31,
2008
2009
2007
$ 2,189
384
318
3,142
443
$ 6,476
(In thousands)
$ 1,764
652
362
(11)
2,174
$ 4,941
$ 1,696
752
343
—
299
$ 3,090
Total noninterest income increased by $1.6 million or 31%, to $6.5 million during 2009 from $4.9
million during 2008. The increase in noninterest income was due mainly to the gain on sale of investment
securities of $3.1 million which was partially offset by life insurance proceeds of $1.6 million recorded in
connection with a former Bank executive during 2008.
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 Bank executive.
63
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.
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 services
Office supplies and equipment expense
Total other-than-temporary impairment losses
Portion of loss recognized in other comprehensive income
Loss on sale of OREO and related expense
Other expense
Total noninterest expense
Year Ended December 31,
2008
2007
2008
$ 7,629
3,416
201
4,063
1,246
4,774
(1,319)
23,071
8,872
$ 51,953
(In thousands)
$ 8,557
2,822
424
3,023
1,269
12,371
—
3,016
4,112
$ 35,594
$ 11,868
2,395
409
2,719
955
621
—
205
2,289
$ 21,461
Total noninterest expense increased $16.4 million, or 46.0% to $52.0 million during 2009 from
$35.6 million during 2008. Salaries and benefits decreased $0.9 million due primarily to staff reductions
and decrease in bonus expense which is based on overall profitability. We had 126 and 142 full-time
equivalent employees at December 31, 2009 and 2008, respectively. Net occupancy expense increased by
$594,000 from $2.8 million in 2008 to $3.4 million in 2009 mainly due to two new branches opened in the
fourth quarter of 2008 located in Anaheim and Pico Rivera, California. Professional fees increased by $1.1
million to $4.1 million during 2009 from $3.0 million in 2008 due primarily to an increase in legal costs
associated with non-performing loans and OREO as well as higher audit fees. Net other-than-temporary
impairment (“OTTI”) credit-related charges totaled $3.5 million compared to $12.4 million during 2008.
OREO related expenses totaled $23.1 million in 2009, increasing $20.1 million from $3.0 million in 2008.
OREO expense in 2009 consistent of $15.0 million in OREO valuation charges, loss on sale of OREO of
$4.1 million and other OREO related charges of $4.0 million. Other expenses were $8.9 million in 2009, an
increase of $4.8 million over $4.1 million in 2008 due mainly to increases in loan collection related
expenses and higher FDIC insurance premiums.
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 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
64
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.
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.
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. Based upon management’s analysis of the realization of the Bank’s deferred tax assets
at December 31, 2009, management determined that the realization of the deferred tax asset was not more
likely than not and therefore the Bank recorded a valuation allowance on the deferred tax asset of $27.1
million as a charge to income tax expense. To the extent future earnings are recognized, the realization of
the deferred tax asset will be recorded as a credit to income tax expense. In the meantime until such time as
the valuation allowance is reversed, the Bank will not record an income tax provision or benefit on the
statement of operations. .
Net of the valuation allowance recorded on the deferred tax asset, we recorded an income tax
benefit of $8.1 million for 2009 and $4.9 million for 2008, and the provision for income taxes of $18.7
million for 2007. Our effective tax rates were (10.1)%, (49.3)% and 41.4% for 2009, 2008 and 2007,
respectively, as compared to the statutory tax rate of 42.05%.
The difference from the statutory rate for 2009, 2008 and 2007 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 ASC 718.
Financial Condition
For the period between December 31, 2009 and December 31, 2008, our assets, loans and deposits
declined at the rate of 11.9%, 15.3% and 7.7%, respectively. Our total assets at December 31, 2009 were
$1.31 billion compared to $1.48 billion at December 31, 2008. Our earning assets at December 31, 2009
totaled $1.23 billion compared to $1.39 billion at December 31, 2008. Total deposits at December 31, 2009
and December 31, 2008 were $1.16 billion and $1.26 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.
65
2009
2008
2007
2006
2005
Year Ended December 31,
Loans and leases:
Real estate—Single family & Multi-
family
Real estate—Land for Housing
Real estate— Land for Income properties
Real estate— Commercial
Real estate— For Sale Housing
Construction
Real estate— Other Construction
Total real estate loans
Commercial & Industrial
Trade Finance & Others
Total gross loans and leases
Less: allowance for loan and lease losses
Deferred loan and lease fees, net
$ 164,906
36,379
38,254
325,734
$ 177,890
74,816
52,232
287,759
143,905
58,282
767,460
227,421
48,418
1,043,299
(42,810)
585
191,073
99,730
883,500
273,890
73,205
1,231,232
(26,935)
(167)
(In thousands)
$ 125,128
98,203
50,916
255,639
208,796
146,328
885,010
255,912
91,565
1,233,099
(14,896)
(682)
$ 77,062
79,748
25,135
266,990
189,975
70,391
709,301
201,385
86,067
997,317
(10,236)
(1,759)
$ 77,209
37,198
7,015
266,864
103,691
51,920
543,897
149,428
76,700
771,143
(8,939)
(1,537)
Total net loans and leases
$ 1,001,074
$ 1,204,130
$1,217,521
$ 985,322
$ 760,667
Total gross loans and leases at December 31, 2009 were $1.04 billion, down from the $1.23
billion as of December 31, 2008. Real estate mini-perm loans which are real estate loans collateralized by
various types of commercial and residential real estate, were down from $592.7 million as of December 31,
2008 to $565.3 million at December 31, 2009. Real estate construction loans which are loans made to
borrowers and developers for the purpose of constructing residential or commercial properties, decreased
$88.6 million from December 31, 2008. Commercial & industrial and trade finance loans which are
primarily working capital revolving and term loans for business operations decreased $71.7 million from
December 31, 2008 to December 31, 2009. These decreases in loan volumes are the result in a reduction in
the demand for credit as well as a decision to emphasize the management and supervision of the Bank’s
loan portfolio as opposed to growth in the loan portfolio. We anticipate that this trend will continue
through at least the middle of 2010.
Our real estate mini-perm loan portfolio declined in 2009 by $27.2 million or 4.6% to $565.3
million from $592.7 million at December 31, 2009. The decline was due to repayment of existing mini-
perm loans during 2009. As of December 31, 2009, land loans totaled $74.6 million compared to $127.3
million as of December 31, 2008. Residential-use land, which has experienced the most value
deterioration, comprises $36.4 million of total loans as of December 31, 2009 compared to $74.8 million in
residential-use land loans as of December 31, 2008, a decrease of 51.3%. 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 2010.
For the four years prior to 2009, the growth trend for our real estate mini-perm loan portfolio has
been as follows: during the year 2008 it grew by $74.4 million, or 14%, to $592.7 million from $518.3
million at December 31, 2007; 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.
66
The following table provides information about our real estate mini-perm portfolio by property
type:
At December 31, 2009
At December 31, 2008
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)
$
$
84,092
113,435
61,785
57,280
107,626
141,055
565,273
8.06%
10.87
5.92
5.49
10.32
13.53
54.19%
Percentage of
Loans in Each
Category in Total
Loan Portfolio
Amount
(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%
During 2009 real estate construction loans declined by $88.6 million or 31% to $202.2 million at
December 31, 2009 from $290.8 million at December 31, 2008; and declined in 2008 by $75.9 million or
21% 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. Real estate construction-residential has been one 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 2010.
Commercial loans outstanding at December 31, 2009 decreased by $46.5 million, or 17.0%, to
$227.4 million from $273.9 million at December 31, 2008; and 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 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. Total
commercial loan commitments (including undisbursed amounts) at December 31, 2009 decreased $86.4
million or 20.9% to $327.4 from $414.3 million at December 31, 2008 while the rate of credit utilization
increased to 69.6% as of December 31, 2009 from 66.1% at December 31, 2008. We believe that this
increase in utilization is primarily incidental and secondarily due to the increased need for funding by our
business customers. Subject to market conditions and interest rates, we may expand our commercial loans
in the future through enhanced marketing efforts and expansion of our branch network.
Trade finance loans decreased $25.2 million or 34.4% during 2009 to $48.0 million from $73.2
million at December 31, 2008, and 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. The decrease is due to the Bank’s pullback in this type of lending since the economic
recession began.
Leases receivable and other loans decreased during 2009 by $217,000 or 34% to $420,000 at
December 31, 2009 from $637,000 at December 31, 2008; and 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.
67
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.
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
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
______________________________
2009
$ 137,301
7,571
387
145,259
59,190
$ 204,449
Year Ended December 31,
2007
2008
2006
(Dollars in thousands)
$ 66,588
—
197
66,785
35,127
$ 101,912
$ 20,900
—
—
20,900
8,444
$ 29,344
$ 1,120
—
—
1,120
—
$ 1,120
$
$
2005
—
—
—
—
—
—
13.92%
15.65
5.42%
6.87%
1.69%
1.90%
0.11%
0.08%
0.00%
0.00%
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 $6,170,000, $4,953,000 and $546,000, for
2009, 2008, and 2007, respectively. When an asset is placed on non-accrual status, previously accrued but
unpaid interest is reversed against current income. Subsequent collections of cash are applied as principal
reductions when received, except when the ultimate collectability of principal is probable, in which case
interest payments are credited to income.
The following table depicts the Bank’s past due loans by type:
Loan Type
30-89 Days
90 + Days & Still
Accruing
Non-accrual
#
$
#
$
#
$
Commercial & Industrial
Real Estate-Mini-Perm
Construction-Residential
Construction-Commercial
Land-residential
Land-commercial
Total as of December 31, 2009
Total as of December 31, 2008
1
3
—
1
—
—
5
13
($ in thousands)
$
$
359 —
2
4,272
— —
8,759 —
— —
— —
$
$
13,390
51,445 —
2
$
$
—
7,571
—
—
—
—
7,571
—
5
9
9
2
4
4
33
20
$
$
$
1,568
28,826
61,790
5,138
25,252
14,727
137,301
66,588
As of December 31, 2009, we had 19 OREO properties for $59.2 million as compared five OREO
properties for $35.1 million as of December 31, 2008. During 2009, the Bank sold 14 OREO properties at
68
a net loss of $4.1 million. The following table summarizes the Bank’s OREO, which is included in non-
performing assets of $209.6million:
Loan Type
OREO
#
$
Commercial & Industrial
Real Estate-Mini-Perm
Construction-Residential
Construction-Commercial
Land-residential
Land-commercial
Total as of December 31, 2009
Total as of December 31, 2008
($ in thousands)
—
$
2
1
1
12
3
19
5
—
21,958
933
1,611
27,005
7,683
59,190
35,127
$
$
Management anticipates that the balances of the Bank’s OREO will remain at these historically
elevated levels in future quarters as the Bank eventually takes title to more non-performing loans through
the foreclosure process and then seeks to dispose of such properties. The Bank has placed a particular
emphasis on the effort of disposing of OREO properties as soon as is practicable.
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.
Impaired Loans and Leases
Impaired loans and leases are commercial & industrial, trade finance, 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. 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 $106.1million, $117.6 million and $27.6 of impaired loans or leases at December 31,
2009, 2008, and 2007, respectively. The total allowance for loan and lease losses related to these loans and
leases were $10.6 million, $16.0 million and $3.7 million at December 31, 2009, 2008 and 2007,
respectively. Interest income recognized on such loans and leases during 2009, 2008 and 2007 was $4.2
million, $4.3 million and $1.9 million, respectively. The average recorded investment on impaired loans
and leases during 2009, 2008 and 2007 was $103.1 million, $94.2 million and $17.1 million, respectively.
69
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 loan and lease 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’ and
‘substandard’ that are not already included in impaired loan analysis; (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 or is charged off.
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 and real estate construction. Real estate is
further segmented by individual product type–office, industrial, retail, multi family, SFR, land residential,
special purpose and land commercial. Real estate construction is further segmented by office, industrial,
retail, multifamily and SFR. 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
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.
70
The table below summarizes loans and leases, average loans and leases, non-performing loans and
leases and changes in the allowance for loan and lease losses arising from loan and lease losses and
additions to the allowance from provisions charged to operating expense:
Allowance for Loan and Lease Loss History
Allowance for loan losses:
Balance at beginning of period
Actual charge-offs:
Commercial
Trade finance
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
2009
2008
Year Ended December 31,
2007
(Dollars in thousands)
2006
2005
$ 26,935
$ 14,896
$ 10,236
$ 8,939
$ 6,724
7,716
3,246
24,293
24,456
—
—
59,711
3,924
—
397
15
—
—
4,336
55,375
71,250
$ 42,810
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
Total gross loans and leases at end of period
Average total loans and leases
Non-performing loans and leases
1,043,299
1,162,221
145,259
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
—
Selected ratios:
Net charge-offs (recoveries) to average
loans and leases
Provision for loan losses to average
loans and leases
Allowance for loan losses to loans and
leases at end of period
Allowance for loan losses to non-
performing loans and leases
4.76%
6.13%
4.10%
1.52%
2.50%
2.19%
0.02%
0.44%
1.21%
0.23%
1.03%
0.08%
(0.02)%
29.47%
40.33%
71.27%
913.93%
0.30%
1.16%
n.m.
The allowance for loan and lease losses of $42.8 million at December 31, 2009, represented
4.10% of total loans and leases and 29.47% of non-performing loans and leases. 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. The decline in the coverage ratio for the allowance for loan
and lease losses to non-performing loans and leases from 40.33% at December 31, 2008 to 29.47% at
December 31, 2009 was primarily a result of greater charge-offs taken on non-performing loans in 2009.
Net charge-offs (recoveries) to average loans and leases were 4.76% for the year-ended December 31,
2009 compared to 1.52% for the year-ended December 31, 2008. See “Critical Accounting Policies,” and
Note 3 of the “Notes to Consolidated Financial Statements.”
71
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:
Allocatio
n of the
Allowanc
e
2009
2008
Allocatio
n of the
Allowanc
e
Percent
of Loans
in Each
Category
in Total
Loans
Percent of
Loans in
Each
Category in
Total
Loans
At December 31,
2007
Allocation
of the
Allowance
Percent of
Loans in
Each
Category in
Total Loans
(Dollars in thousands)
2006
2005
Allocation
of the
Allowance
Percent of
Loans in
Each
Category
in Total
Loans
Allocation
of the
Allowance
$ 8,314
1,411
21.8%
4.6
$ 3,018
2,317
22.2%
5.9
$ 3,095
803
20.8%
5.4
$ 2,262
897
20.2%
8.6
$ 2,312
1,231
Percent of
Loans in Each
Category in
Total Loans
19.4%
9.9
14,885
19.4
11,108
23.6
6,213
41.7
3,169
27.2
1,837
22.3
17,376
—
7
817
$ 42,810
54.2
0.0
0.0
0.0
100.0%
9,484
—
1,004
4
$ 26,935
48.1
0.0
0.1
0.1
100.0%
4,779
1
5
—
$ 14,896
32.1
0.0
0.0
0.0
100.0%
3,822
3
4
79
$ 10,236
43.9
0.0
0.1
0.0
100.0%
3,513
5
6
35
$ 8,939
48.2
0.1
0.1
0.0
100.0%
Commercial
Trade finance
Real estate
Real estate-
construction
Real estate
-mini-perm
Lease
Other
Unallocated
Total
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 and $60,000 at December 31,
2009 and 2008, 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
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, 2009 and 2008, there were no
securities classified in the held-to-maturity portfolio.
The Bank performs regular impairment analysis on its investment securities portfolio. On January
1, 2009, the Bank adopted new FASB standards which provide further guidance on; identifying whether a
market for an asset or liability is distressed or inactive, determining whether an entity has the intent and
72
ability to hold a security to its anticipated recovery and whether an investment is other-than-temporarily-
impaired. If it is determined that the impairment is other than temporary for equity securities, the
impairment loss is recognized in earnings equal to the difference between the investment’s cost and its fair
value. If it is determined that the impairment is other-than-temporary for debt securities, the Bank will
recognize the credit component of an other-than-temporary impairment in earnings and the non-credit
component in other comprehensive income when the Bank does not intend to sell the security and it is
more likely than not that the Bank will not be required to sell the security prior to 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 investment grade corporate notes, U.S
Agency mortgage-backed securities, municipal bonds, collateralized mortgage obligations and
collateralized debt obligations. 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, 2009, investment securities classified as
available-for-sale with a carrying value of $90.1 million were pledged to secure public deposits.
The carrying value of our investment securities at December 31, 2009 totaled $114.5 million
compared to $104.4 million at December 31, 2008. During 2009, our investment securities portfolio
increased which was due to investment of excess cash. The carrying value of our portfolio of investment
securities at December 31, 2009, 2008 and 2007 was as follows:
2007
131,032
30,191
25,899
—
46,553
6,684
4,909
245,268
$
$
Estimated Fair Value
At December 31,
2008
2009
(In thousands)
23,115
22,722
13,601
—
42,778
2,075
115
104,406
$
$
U.S. Government agencies
Corporate notes
Mortgage-backed securities
Collateralized mortgage obligations
Municipal securities
Collateralized debt obligations
Freddie Mac preferred stock
$
—
24,741
25,228
18,116
44,178
2,201
—
Total securities available-for-sale
$
114,464
73
The following table shows the maturities of investment securities at December 31, 2009, and the
weighted average yields of such securities:
At December 31, 2009
Within One
Year
After One Year
but within
Five Years
After Five Years
but within
Ten Years
After Ten
Years
Total
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
(Dollars in thousands)
Corporate notes
Mortgage-backed
securities
Collateralized mortgage
obligations
Municipal securities
Collateralized debt
obligations
Total securities
Available-for-sale
$ —
—
—
—
—
—%
—
—
—
—
$ —
—%
$ 5,615
—
—
844
—
—
—
—
—
—
—
1,658
—
5.52
%
4.39
—
6.68
—
$ 19,126
4.98 %
$24,741
24,384
3.82
25,228
18,116
42,520
7.16
6.88
18,116
44,178
2,201
5.73
2,201
5.10%
3.84
7.16
6.88
5.73
$ —
—%
$ —
—%
$ 8,117
5.64
%
$ 106,347
5.86
%
$114,464
5.85%
The Bank owns four collateralized debt obligations (“CDO’s”) which consist of pools of bank
trust preferred securities. As of December 31, 2009, the amortized cost of all four CDO’s exceeded the fair
value. The fair value was determined based on future expected cash flows which were estimated using a
discount rate that is an interest rate that represents a market equivalent rate on a similarly-rated corporate
security with a similar maturity date that trades in an active market. Added to that rate was an illiquidity
premium of 400 basis points which determined the actual discount rate. Management then estimated the
expected future defaults within the underlying pool of issuers which was based on taking the current
deferrals/defaults in the pools and then determining which banks were likely to default in the future. This
future expectation of defaults was based on the individual banks’ tier 1 leverage capital (compared to
regulatory requirements), tangible common equity (“TCE”) ratios and levels of non-performing assets
compared to total assets. Based on this information, Management would then make an assertion as to
whether each bank issuer was likely to defer interest payments or default altogether. In addition to those
specific defaults, Management estimated additional default rates, with higher default rates applied over the
next few years and then decreasing over the remaining term of the securities.
Management then proceeded to determine credit-related OTTI based on guidance of Investments –
Debt and Equity Securities Topic of FASB ASC. In this analysis, Management ran expected cash flows on
all four securities using a discount rate that was equal to the accretable yield on all four securities and using
the same default assumptions as described above. The result of this analysis indicated that these securities
had credit-related other-than-temporary impairments totaling $3.2 million which was recognized in income
during 2009. The non-credit amount at December 31, 2009 was $1.3 million and is reflected in
accumulated other comprehensive loss.
As of December 31, 2009, the Bank owned nine corporate securities where the amortized cost
exceeded fair value. The total amortized cost of these securities was $21.9 million and their fair value was
$20.1 million. Management performed an analysis on all of the issuers of these securities which focused on
the recent financial results of the companies, capital ratios and long-term prospects of the issuer and
deemed the all nine corporate securities to be temporarily impaired. The Bank had recorded a credit-related
OTTI charges of $220,000 on corporate securities during 2009.
As of December 31, 2009, the Bank owned two collateralized mortgage obligations (“CMO’s)
where the amortized cost exceeded fair value. The total amortized cost of these securities was $20.1 million
and their fair value was $18.1 million. Management determined that none of the CMO securities was
other-than-temporarily impaired as of December 31, 2009. This determination was made based on several
factors such as debt rating of these securities, amount of credit protection, the Bank’s intent and ability to
74
hold the securities until a recovery in value and the determination that it is not more likely than not that the
Bank will be required to sell the securities prior to recovery of amortized cost basis.
The Bank owns 60 municipal investment securities. All but three carry an investment-grade rating.
As of December 31, 2009, 28 of these issues with a total amortized cost of $30.5 million were in an
unrealized loss position. The unrealized loss on these 28 securities was $2.3 million. Management
determined that none of the municipal securities was other-than-temporarily impaired as of December 31,
2009. This determination was made based on several factors such as the Bank’s intent and ability to hold
the securities until a recovery in value and the determination that it is not more likely than not that the Bank
will be required to sell the securities prior to recovery of amortized cost basis. In addition, management
reviews all of the ratings on the municipal investment securities, recent ratings changes, as well as the
length of time that the security has been impaired to determine whether the security is other than temporary
impaired.
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 $1.16 billion at December 31, 2009 compared to $1.26 billion at December
31, 2008. Noninterest-bearing demand deposits increased $8.1 million or 4.14%. The ratio of noninterest-
bearing deposits to total deposits was 18% at December 31, 2009 and 16% at December 31, 2008. 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. Interest-bearing
demand and savings deposits decreased by $25.9 million or 13.71%, and time deposits decreased $79.1
million or 9.08%.
The following table shows the average amount and average rate paid on the categories of deposits
for each of the periods indicated:
2009
2008
Year Ended December 31,
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
2007
Average Rate
(Dollars in thousands)
$ 201,972
0.00%
$ 205,764
0.00%
$ 220,050
0.00%
30,395
89,740
58,433
843,108
0.73
0.69
1.18
2.21
33,650
109,383
73,042
823,249
0.79
1.01
1.96
3.45
31,489
99,551
91,717
739,696
1.45
2.22
3.81
4.90
Noninterest-bearing
deposits
Interest-bearing demand
Money market
Savings
Time certificates of
deposit
Total
$ 1,223,648
1.97%
$ 1,245,088
3.00%
$ 1,182,503
4.41%
Average total deposits decreased in 2009. The decrease in average total deposits for 2009 was
primarily driven by a decrease of $19.6 million in money market accounts and a decrease $14.6 million in
savings accounts. 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.
75
The following table shows the maturities of time certificates of deposit and other time deposits of
$100,000 or more at December 31, 2009 and 2008:
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
At December 31,
2009
2008
(In thousands)
$ 290,738
140,336
206,690
154,902
$ 792,666
$ 454,178
226,651
184,131
6,821
$ 871,781
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 as well as maintain tier 1 leverage and tangible common equity above 10% as required by the
Order. At December 31, 2009, our capital ratios were above the minimum requirements for adequately
capitalized institutions. In the future, the Bank will likely seek to raise additional capital in order to
strengthen its capital ratios and to maintain compliance with the provisions of the Order. In addition, we
intend to make adjustments to our balance sheet which will 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 less than one year, which have a zero percent
conversion factor, instead of 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.
At December 31,
2009
At December 31,
2008
Leverage Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
6.16%
5.00%
4.00%
Tier 1 Risk-Based Capital Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
7.24%
6.00%
4.00%
Total Risk-Based Capital Ratio
Preferred Bank ...........................................................................
Minimum requirement for “Well-Capitalized” institution .........
Minimum regulatory requirement ..............................................
8.52%
10.00%
8.00%
9.76%
5.00%
4.00%
10.39%
6.00%
4.00%
11.65%
10.00%
8.00%
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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, 2009:
Amount of Commitment Expiring per Period
Contractual Obligations (1)
FHLB Advances
Senior Debt
Operating Lease Obligations
Total
Total
Amounts
Committed
$ 23,000
25,996
18,933
$ 67,929
Less Than
1 year
$ 23,000
—
2,565
$ 25,565
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$ —
25,996
4,289
$ 30,285
$ —
—
3,843
3,843
$
$ —
—
8,236
8,236
$
(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, 2009:
Amount of off-balance sheet Expiring per Period
Total
Amounts
Committed
$ 199,430
1,009
7,639
$ 208,078
Less Than
1 year
$ 160,782
1,009
5,824
$ 167,615
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$ 14,781
—
1,815
$ 16,596
$ 22,133
—
—
$ 22,133
$ 1,734
—
—
$ 1,734
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%. Our loan-to-deposit ratio was 89.9% at December 31,
2009 compared to 97.9% at December 31, 2008.
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, 2009, we could borrow up to an
additional $65.5 million on top of the $23 million already outstanding with collateral of specifically
identified loans and securities. In addition, we have pledged securities with a market value of $53.8 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, 2009, the
77
Bank was required to purchase the greater of $3,503,000 of FHLB stock based on the volume of
“membership assets” as defined by the FHLB or $1,081,000 in FHLB stock based on 4.7% of outstanding
borrowings with the FHLB. At December 31, 2009, the Bank held $4,996,000 in FHLB stock.
The Bank has taken additional steps to both preserve and enhance its future liquidity needs:
On February 11, 2009, the Bank issued $26.0 million of unsecured senior debt in a pooled private
placement transaction which carries the FDIC’s 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.
On April 16, 2009, the Bank’s Board of Directors elected to indefinitely suspend the Bank’s cash
dividend in order to preserve the Bank’s capital.
On July 24, 2009, the Bank commenced a rights offering and concurrent public offering at the
subscription price of $2.88 per share. On September 9, 2009, the Bank completed its rights offering and
concurrent public offering. The Bank issued 5,912,919 shares of its common stock, no par value in
exchange for approximately $17.0 million. The Bank conducted this rights offering and concurrent public
offering to raise equity capital to enhance its capital position.
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 18% at December 31, 2009 and 27% at
December 31, 2008. 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.
78
Our exposure to interest rate risk is monitored continuously by senior management and is
reviewed by the ALCO at least eight times a year, and at least quarterly by our board of directors. Interest
rate risk exposure is measured using interest rate sensitivity analysis to determine our change in net
portfolio value and net interest income in the event of hypothetical changes in interest rates. If potential
changes to net portfolio value and net interest income resulting from our analysis of hypothetical interest
rate changes are not within board-approved limits, the board may direct management to adjust the asset and
liability mix to bring interest rate risk within board-approved limits. This analysis of hypothetical interest
rate changes is performed on a monthly basis by a third party vendor utilizing detailed data that we provide
to them.
Market Value of Portfolio Equity
We measure the impact of market interest rate changes on the net present value of estimated cash
flows from our assets and liabilities defined as market value of portfolio equity, using a simulation model.
This simulation model assesses the changes in the market value of interest rate sensitive financial
instruments that would occur in response to an instantaneous and sustained increase or decrease in market
interest rates.
The following table presents forecasted changes in net portfolio value using a base market rate
and the estimated change to the base scenario given an immediate and sustained upward and downward
movement in interest rates of 100 and 200 basis points at December 31, 2009.
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)
$ 120,385
$ 120,239
$ 121,072
$ 122,992
$ 122,855
Percentage
Change
from Base
Percentage
of Total
Assets
Percentage of
Portfolio Equity
Book Value
(0.57)%
(0.69)
—
1.59
1.47
9.02%
9.01
9.07
9.21
9.20
141.01%
140.84
141.81
144.06
143.90
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, 2009, 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.
79
This analysis indicates the impact of changes in net interest income for the given set of rate changes and
assumptions. It assumes no growth in the balance sheet and that its structure will remain similar to the
structure at year end. It does not account for all factors that impact this analysis, including changes by
management to mitigate the impact of interest rate changes or secondary impacts such as changes to our
credit risk profile as interest rates change. Furthermore, loan prepayment rate estimates and spread
relationships change regularly. Interest rate changes create changes in actual loan prepayment rates that
will differ from the market estimates incorporated in this analysis. Changes that vary significantly from the
assumptions may have significant effects on our net interest income.
For the rising and falling interest rate scenarios, the base market interest rate forecast was
increased or decreased on an instantaneous and sustained basis.
Sensitivity of Net Interest Income December 31, 2009
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)
46,632
46,159
47,209
48,441
48,312
$
$
$
$
$
Percentage
Change
from Base
Net Interest
Margin
Percent
Net Interest
Margin Change
(in basis points)
(1.22)%
(2.22)
—
2.61
2.34
3.80%
3.76
3.85
3.95
3.94
(0.05)
(0.09)
—
0.10
0.09
At December 31, 2009, we had $1,079.3 million in assets and $654.5 million in liabilities re-
pricing within one year. This indicates that approximately $424.8 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, 2009 is 164.9%. 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 Standards
In December 2007, the FASB issued guidance now codified as Accounting Standards Codification
(“ASC”) Topic 805, “Business Combinations”. This standard replaces previous guidance and applies to
all transactions and other events in which one entity obtains control over one or more other businesses.
This guidance 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 previous guidance
whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed
based on their estimated fair value. This standard 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 previous guidance. Under this standard, the requirements of ASC Topic 420, “Exit or
Disposal Cost Obligations,” 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 ASC Topic 450, “Contingencies.” This statement is effective for business combinations for
80
which the acquisition date is on after the beginning of the first annual reporting period beginning on or
after December 15, 2008. The Bank adopted this standard on January 1, 2009 and the adoption did not
have a significant impact on the Bank’s consolidated financial statements.
In December 2007, the FASB issued guidance now codified as ASC Topic 810-10-65-1,
“Consolidations”. This standard amends previous guidance on accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard 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, it 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. The Bank adopted
this standard on January 1, 2009 and the adoption did not have a significant impact on the Bank’s
consolidated financial statements.
In March 2008, the FASB issued guidance now codified as ASC Section 815-10-50, “Derivatives
and Hedging”. This guidance changes disclosure requirements for derivative instruments and hedging
activities. The standard requires enhanced disclosures about (a) how and why derivative instruments are
used, (b) how derivative and related hedged items are accounted for under ASC 815 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 has
no derivative instruments designated as hedges. The Bank adopted this standard on January 1, 2009 and the
adoption did not have a significant impact on the Bank’s consolidated financial statements.
In June 2008, the FASB issued guidance now codified as ASC Section 260-10-45, Earnings Per
Share. This guidance 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 standard is effective for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is
prohibited. The Bank adopted this standard on January 1, 2009 and the adoption did not have a significant
impact on the Bank’s consolidated financial statements.
In December 2008, the FASB issued guidance now codified as ASC Section 860-10-50,
Transfers and Servicing. This disclosure-only standard 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 standard 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
standard 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 in the first quarter of 2009 did not have a significant impact on the Bank’s
consolidated financial statements.
In April 2009, the FASB issued guidance now codified as ASC Topic 820-10-65-4, Fair Value
Measurements and Disclosures. This standard provides guidance on how to determine fair value when the
volume and level of activity for the asset or liability have significantly decreased when compared with
normal market activity for the asset or liability. This standard provides additional authoritative guidance in
determining whether a market is active or inactive, and whether a transaction is distressed. This guidance
is applicable to all assets and liabilities (i.e. financial and nonfinancial) and requires enhanced disclosures.
This standard is effective for interim periods ending after June 15, 2009, but early adoption is permitted for
interim periods ending after March 15, 2009. The Bank early adopted the provisions of this standard
during the first quarter of 2009. The Bank’s adoption of this guidance in the first quarter of 2009 did not
have a material effect on the Bank’s consolidated financial statements.
81
In April 2009, the FASB issued guidance now codified as ASC Topic 320-10-65-1, Investments
— Debt and Equity Securities. This guidance clarifies the interaction of the factors that should be
considered when determining whether a debt security is other-than-temporarily impaired. For debt
securities, management must assess whether (a) it has the intent to sell the security and (b) it is more likely
than not that it will be required to sell the security prior to its anticipated recovery. These steps are done
before assessing whether the entity will recover the cost basis of the investment. Previously, this
assessment required management to assert it has both the intent and the ability to hold a security for a
period of time sufficient to allow for an anticipated recovery in fair value to avoid recognizing an other-
than-temporary impairment. In instances when a determination is made that an other-than-temporary
impairment exists but the investor does not intend to sell the debt security and it is not more likely than not
that it will be required to sell the debt security prior to its anticipated recovery, this guidance changes the
presentation and amount of the other-than-temporary impairment recognized in the income statement. The
other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary
impairment related to a decrease in cash flows expected to be collected from the debt security (the credit
loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The
amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings.
The amount of the total other-than-temporary impairment related to all other factors is recognized in other
comprehensive income. This standard is effective for interim periods ending after June 15, 2009, but early
adoption is permitted for interim periods ending after March 15, 2009. The Bank early adopted the
provisions of this standard during the first quarter of 2009 and as a result of the adoption recorded a
cumulative effect after-tax adjustment of $1.6 million increase to the opening balance of retained earnings
and accumulated other comprehensive income.
In April 2009, the FASB issued guidance now codified as ASC Section 825-10-50, Financial
Instruments. This standard requires disclosures about fair value of financial instruments for interim
reporting periods of publicly traded companies as well as in annual financial statements. This standard also
amends ASC Topic 270, Interim Reporting, to require those disclosures in summarized financial
information at interim reporting periods. This standard is effective for interim periods ending after June
15, 2009, but early adoption is permitted for interim periods ending after March 15, 2009. The Bank early
adopted the provisions of this disclosure only ASC during the first quarter of 2009.
In May 2009, the FASB issued guidance now codified as ASC 855, Subsequent Events. This
guidance establishes general standards for accounting for and disclosure of events that occur after the
balance sheet date but before financial statements are available to be issued (“subsequent events”). More
specifically, this standard sets forth the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for potential recognition in the
financial statements, identifies the circumstances under which an entity should recognize events or
transactions occurring after the balance sheet date in its financial statements and the disclosures that should
be made about events or transactions that occur after the balance sheet date. This standard provides largely
the same guidance on subsequent events which previously existed only in auditing literature. This standard
is effective for interim periods ending after June 15, 2009. In connection with preparation of the
consolidated financial statements, the Bank evaluated subsequent events through the date of the issuance of
this report. The adoption of this standard did not have a material effect on the Bank’s consolidated
financial statements
In June 2009, the FASB issued guidance now codified as ASC 860, Transfers and Servicing. This
guidance removes the concept of a qualifying special-purpose entity (QSPE) from ASC 860, Transfers and
Servicing and removes the exception from applying variable interest accounting to variable interest entities
that are QSPE’s. This statement also clarifies the requirements for isolation and limitations on portions of
financial assets that are eligible for sale accounting. This statement is effective for fiscal years beginning
after November 15, 2009. Accordingly, the Bank will adopt this guidance on January 1, 2010. The Bank is
currently evaluating the impact of adopting this standard on the consolidated financial statements.
In June 2009, the FASB issued guidance now codified as ASC 810, Consolidation. This guidance
amends ASC 810, Consolidation to require an analysis to determine whether a variable interest gives
a company a controlling financial interest in a variable interest entity (VIE). This statement requires an
ongoing reassessment of and eliminates the quantitative approach previously required for determining
82
whether a company is the primary beneficiary. This statement is effective for fiscal years beginning after
November 15, 2009. Accordingly, the Bank will adopt this guidance on January 1, 2010. The Bank is
currently evaluating the effect the adoption of this guidance will have on its consolidated financial
statements.
In June 2009, the FASB issued ASC Update No. 2009-01, “Topic-105-Generally Accepted
Accounting Principles, amendments based on Statement of financial Accounting Standards No. 168-The
FASB Accounting Standards Codification and hierarchy of Generally Accepted Accounting Principles”.
This update establishes the FASB Accounting Standards Codification as the source of authoritative
accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation
of financial statements in conformity with GAAP. The update is effective for financial statements issued
for interim and annual periods ending after September 15, 2009. The Bank adopted the FASB Accounting
Standards Codification for the quarter ending September 30, 2009. FASB Accounting Standards
Codification does not change GAAP and did not have a material effect on the Bank’s consolidated
financial statements. All accounting references have been updated, and therefore SFAS references have
been replaced with ASC references.
In August 2009, the FASB issued ASC Update No. 2009-05, “Fair Value Measurements and
Disclosures (Topic 820)-Measuring Liabilities at Fair Value”. This update provides amendments to FASB
ASC 820, “Fair Value Measurements and Disclosures”, for the fair value measurement of liabilities. This
update also provides clarification that in circumstances in which a quoted price in an active market for the
identical liability is not available, a reporting entity is required to measure fair value using one or more of
the following techniques: 1) A valuation technique that uses: a) the quoted price of the identical liability
when traded as an asset, b) quoted prices for similar liabilities or similar liabilities when trades as assets,
and 2) another valuation technique that is consistent with the principles of Topic 820. Two examples
would be an income approach, such as a present value technique, or a market approach, such as a technique
that is based on the amount at the measurement date that the reporting entity would pay to transfer the
identical liability or would receive to enter into the identical liability. This update is effective for the first
interim and annual periods beginning after August 28, 2009. The Bank’s adoption of this guidance in the
fourth quarter of 2009 did not have a material effect on the Bank’s consolidated financial statements.
In January 2010, the FASB issued ASC Update No. 2010-01, “Equity (Topic 505), Accounting
for Distributions to Shareholders with Components of Stock and Cash a consensus of the FASB Emerging
Issues Task Force”. This update clarifies that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total amount of cash that all
shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS
prospectively and is not a stock dividend for purposes of applying Topic 505 (Equity) and Topic 260
(Earnings Per Share). The update is effective for annual and interim periods ending after December 15,
2009. The adoption of this update, during the fourth quarter of 2009, did not have a material impact on the
Bank’s financial statements.
In January 2010, the FASB issued ASC Update No. 2010-06, "Fair Value Measurements and
Disclosures (Topic 820)-Improving Disclosures about Fair Value Measurements". This update provides
amendments to Subtopic 820-10 and requires the following new disclosures: 1) Transfers in and out of
Levels 1 and 2, and 2) Activity in Level 3 fair value measurements that discloses separately information
about Level 3 purchases, sales, issuances, and settlements. Additionally, this update clarifies existing
disclosures of the level of disaggregation, and disclosures about inputs and valuation techniques. The new
disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and
settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are
effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal
years. The Bank is currently evaluating the effect the adoption of this update will have on its consolidated
financial statements.
83
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, 2009, we carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and procedures and internal controls
over financial reporting pursuant to Securities and Exchange Commission (“SEC”) rules. Based upon that
evaluation, and the identification of the material weakness in our internal control over financial reporting
as described below under “Management’s Report on Internal Control over Financial Reporting”, the Chief
Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were
not effective as of December 31, 2009. Nevertheless, based on a number of factors, including the
performance of additional procedures by management designed to ensure the reliability of our financial
reporting, we believe that the financial statements in this Annual Report on Form 10-K fairly present, in all
material respects, our financial position, results of operations and cash flows for the periods presented in
conformity with GAAP.
Management’s Report on Internal Control over Financial Reporting
The Management of the Bank is responsible for establishing and maintaining adequate internal
control over financial reporting pursuant to the rules and regulations of the SEC. The Bank’s internal
control over financial reporting is a process designed to provide reasonable assurance regarding the
84
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, 2009. 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.
A material weakness is a control deficiency, or combination of control deficiencies, in internal
control over financial reporting such that there is a reasonable possibility that a material misstatement of
the Bank’s annual or interim financial statements will not be prevented or detected on a timely basis. The
Bank believes that a material weakness in internal controls over financial reporting exists related to the
monitoring and control activities necessary to respond to potential risks identified in the Bank’s loan
portfolio and real estate owned. Specifically, management’s monitoring and control activities did not
appropriately revise internal controls to address the risks identified through the Bank’s risk assessment
process. The risk assessment process noted that 2009 market conditions related to the Bank’s loan
portfolio and real estate owned were deteriorating at a significantly greater rate than noted in prior years.
As a result, when the accounting department was informed of this fact, internal controls should have been
revised to require more frequent updates of (a) appraisals or other value indicators, which are significant
inputs in determining the fair value of impaired loan collateral and owned real estate and, (b) qualitative
loss factors, which are significant inputs in determining the loan and lease loss allowance. However,
personnel responsible for estimating the allowance for loan losses and real estate owned did not make such
revisions. In addition, management’s review process did not detect that such controls were not
appropriately revised.
Based on management’s assessment and the criteria discussed above, we have concluded that, as
of December 31, 2009, internal control over financial reporting was not effective as a result of the
aforementioned material weakness.
KPMG LLP, the independent registered public accounting firm that audited the Bank’s financial
statements included in this Annual Report on Form 10-K, has issued an attestation report on the
effectiveness of the Bank’s internal control over financial reporting as of December 31, 2009. This report
85
which expresses an adverse opinion on the effectiveness of the Bank’s internal control over financial
reporting as of December 31, 2009, was filed with the FDIC and is included in Exhibit 99.1.
Remediation of Material Weakness
As part of the execution of the remediation plans to address the material weaknesses, we:
•
•
•
•
engaged an outside firm, during the fourth quarter of 2009, to conduct loan review,
assess and validate the appropriateness of loan grades, and assess the allowance for loan
and lease losses to strengthen our internal loan review function.
implemented a tracking system to identify due dates for obtaining updated valuations on
classified loans and OREO assets in order to ensure that updated valuations are obtained
in a timely manner.
revised our allowance for loan and lease loss policy.
revised our policy and procedures for OREO.
By implementing the above actions, we believe that our financial reporting will be significantly
improved. However, there can be no assurances that our efforts will be successful or that additional efforts
will not be necessary to remediate this material weakness.
ITEM 9B. OTHER INFORMATION
None
86
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors and executive officers of the Bank, to the extent not included
under “Item 1 under the heading “Executive Officers of the Bank”, will appear in the Bank’s definitive
proxy statement for the 2010 Annual Meeting of Shareholders (the “2010 Proxy Statement”), and such
information either shall be (i) deemed to be incorporated herein by reference from the section entitled
“ELECTION OF DIRECTORS” AND “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE” and “THE COMMITTEES OF THE BOARD,” 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
Information concerning executive compensation will appear in the 2010 Proxy Statement, and
such information either shall be (i) deemed to be incorporated herein by reference from the sections
entitled “COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION,”
“COMPENSATION COMMITTEE’S REPORT,” “COMPENSATION DISCUSSION AND
ANALYSIS,” “SUMMARY COMPENSATION TABLE,” “OUTSTANDING EQUITY AWARDS, ”
“NON-QUALIFIED DEFERRED COMPENSATION,” “CHANGE OF CONTROL AGREEMENTS, ”
and “COMPENSATION 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 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 2010 Proxy Statement, and
such information either shall be (i) deemed to be incorporated herein by reference from the sections
entitled “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT”
and “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 2010
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
“BOARD 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.
87
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services will appear in the 2010 Proxy
Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the
section entitled “INDEPENDENT AUDITOR FEES,” and “AUDIT COMMITTEE PRE-APPROVAL
POLICY” 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.
88
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
Report of Independent Registered Public Accounting Firm ..................................................................................... 89
Consolidated Statements of Financial Condition at December 31, 2009 and 2008 .................................................. 90
Consolidated Statements of Operations and Comprehensive(Loss) Income for the Years Ended December 31,
2009, 2008 and 2007 .......................................................................................................................................... 91
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2009, 2008
and 2007 ............................................................................................................................................................. 92
Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2008 and 2007 ........................ 93
Notes to Consolidated Financial Statements ............................................................................................................. 94
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
31.1
31.2
32.1
32.2
99.1
99.2
(1)
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. (3)
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(4)
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(4)
Subsidiaries of the Registrant
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
Report of Independent Registered Public Accounting Firm
Management’s Report on Internal Control over Financial Reporting
Incorporated by reference from Registrant’s Registration Statement on Form 10 filed with the Federal
89
(2)
(3)
(4)
*
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.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on May 9, 2007.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on November 7, 2008.
Denotes management contract or compensatory plan or arrangement.
90
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
subsidiary as of December 31, 2009 and 2008, 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, 2009. 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 consolidated 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, 2009 and 2008, and
the results of their operations and their cash flows for each of the years in the three year period ended
December 31, 2009, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Bank will
continue as a going concern. As further described in note 1 to the consolidated financial statements, at
December 31, 2009, the Bank is currently operating under a consent order with the Federal Deposit
Insurance Corporation and the California Department of Financial Institutions. The consent order restricts
certain operations and requires the Bank to, among other things, achieve specified regulatory capital ratios
by July 15, 2010 and September 15, 2010. Failure to achieve all of the order’s requirements may lead to
additional regulatory actions including placing the Bank into receivership or conservatorship. These
matters raise substantial doubt about the Bank’s ability to continue as a going concern. Management’s
plans in regard to these matters also are described in note 1 to the consolidated financial statements. The
2009 consolidated financial statements do not include any adjustments that might result from the outcome
of this uncertainty.
We also have audited in accordance with attestation standards of the Public Company Accounting
Oversight Board (United States), the Bank’s internal control over financial reporting as of December 31,
2009 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 April 14, 2010,
expressed an adverse opinion on the effectiveness of the Bank’s internal control over financial reporting.
/s/ KPMG LLP
Los Angeles, California
April 14, 2010
91
PREFERRED BANK
Consolidated Statements of Financial Condition
December 31, 2009 and 2008
(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
2009
2008
$
14,071
54,000
68,071
114,464
1,043,299
(42,810)
585
1,001,074
59,190
—
6,325
7,304
5,582
4,996
3,604
36,171
$
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
Total assets
$
1,306,781
$
1,483,231
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
Senior debt
Accrued interest payable
Other liabilities
Total liabilities
Commitments and contingencies
Shareholders’ equity:
Preferred stock. Authorized 5,000,000 shares; no shares issued and
outstanding at December 31, 2009 and 2008.
Common stock, no par value. Authorized 100,000,000 shares; issued and
outstanding 15,767,126 and 9,755,207 shares at December 31, 2009
and 2008, respectively.
Treasury stock, at cost (715,425 shares at December 31, 2009 and 2008)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss:
Non-credit portion of other-than-temporary impairment on securities
available-for-sale, net of tax of $555 at December 31, 2009
Unrealized loss on securities available-for-sale, net of tax of $2,426 and
$3,614 at December 31, 2009 and December 31, 2008, respectively.
Total shareholders’ equity
$
204,545
119,168
44,033
328,597
464,069
1,160,412
—
23,000
25,996
2,949
9,050
1,221,407
$
196,408
126,251
62,883
464,085
407,696
1,257,323
786
58,000
—
5,446
24,185
1,345,740
—
—
89,038
(19,115)
6,291
13,267
(764)
(3,343)
85,374
72,009
(19,115)
4,582
86,582
—
(6,567)
137,491
Total liabilities and shareholders’ equity
$
1,306,781
$
1,483,231
See accompanying notes to the consolidated financial statements.
92
PREFERRED BANK
Consolidated Statements of Operations and Comprehensive (Loss) Income
Years Ended December 31, 2009, 2008 and 2007
(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
Senior debt
Total interest expense
Net interest income before provision for credit losses
Provision for credit losses
Net interest (loss) income after provision for credit losses
Noninterest income:
Fees and service charges on deposit accounts
Trade finance income
BOLI income
Net gain (loss) on sale of investment securities
Other income
Total noninterest income
Noninterest expense:
Salaries and employee benefits
Net occupancy expense
Business development and promotion expense
Professional services
Office supplies and equipment expense
Total other-than-temporary impairment losses
Portion of loss reclassified in other comprehensive income
Net of other-than-temporary impairment losses
Loss on sale of OREO and related expense
Other
Total noninterest expense
(Loss) income before income taxes
Income tax (benefit) expense
Net (loss) income
Other comprehensive income (loss):
2009
2008
2007
$ 53,055
5,784
37
58,876
$ 75,120
10,743
96
85,959
$ 98,817
11,522
2,268
112,607
842
687
10,521
8,080
—
2,014
668
22,812
36,064
71,250
(35,186)
2,189
384
318
3,142
443
6,476
7,629
3,416
201
4,063
1,246
1,645
1,810
3,455
23,071
8,872
51,953
(80,663)
(8,128)
$ (72,535)
1,364
1,433
20,047
8,349
533
2,908
—
34,634
51,325
30,560
20,765
1,764
652
362
(11)
2,174
4,941
8,557
2,822
424
3,023
1,269
12,371
—
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
1,696
752
343
—
299
3,090
11,868
2,395
409
2,719
955
621
—
621
205
2,289
21,461
45,137
18,670
$ 26,467
Unrealized net gain (loss) 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 income (loss) , net of tax
Comprehensive (loss) income
6,541
(1,905)
4,636
(2,177)
2,459
$ (70,076)
(18,116)
12,071
(6,045)
2,542
(3,503)
$ (8,515)
(1,778)
—
(1,778)
747
(1,031)
$ 25,436
Net (loss) income per share
Basic
Diluted
Weighted-average common shares outstanding
Basic
Diluted
Dividends per share
$ (6.30)
$ (6.30)
$ (0.51)
$ (0.51)
$ 2.56
$ 2.50
15,668,126
15,668,126
9,790,858
9,810,391
10,330,232
10,580,949
$ 0.08
$ 0.47
$ 0.68
See accompanying notes to the consolidated financial statements.
93
PREFERRED BANK
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2009, 2008 and 2007
(In thousands, except share and dividends declared per share data)
Common Stock
Shares
Amount
Treasury
Stock
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Total
Shareholders’
Equity
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
—
—
—
—
—
—
—
(7,091)
261
2,210
(14,976)
1,185
(5)
26,467
—
(1,031)
(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
Balance as of December 31, 2008
Cumulative effect adjustment for
reclassification of the previously
recognized non-credit related
impairment write-downs, net of
taxes
Balance as of December 31, 2008, as
revised
Issuance of Stock
Stock issuance costs
Cash dividends paid ($0.08 per share)
Restricted stock award grant
Share-based compensation expense
Net loss
Noncredit related impairment loss on
investment securities recorded in the
current year, net of taxes
Change in unrealized loss on securities
17,100
146
(215,425)
—
—
—
—
—
—
—
—
—
—
(4,139)
—
—
—
—
11
—
—
1,623
—
—
(4,587)
—
—
—
—
(5,012)
—
—
—
—
—
—
(4,587)
11
146
(4,139)
1,623
(5,012)
—
(3,503)
(3,503)
9,755,207
$ 72,009
$(19,115)
$ 4,582
$ 84,996
$
(4,981)
$ 137,491
—
—
—
—
1,586
(1,586)
—
9,755,207
5,912,919
$ 72,009 $ (19,115) $
17,029
—
—
—
99,000
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
4,582 $ 86,582 $
—
(104)
—
—
1,813
—
—
—
(780)
—
—
(72,535)
(6,567)
—
$ 137,491
17,029
—
—
—
—
—
(104)
(780)
—
1,813
(72,535)
—
—
822
822
available-for-sale, net of taxes
Balance as of December 31, 2009
—
15,767,126
—
$ 89,038
—
—
$ (19,115) $ 6,291
—
$ 13,267
$
1,638
(4,107)
$
1,638
85,374
See accompanying notes to consolidated financial statements.
94
PREFERRED BANK
Consolidated Statements of Cash Flows
Years Ended December 31, 2009, 2008 and 2007
(In thousands)
Cash flows from operating activities:
Net (loss) income
Adjustments to reconcile net income to net cash provided by operating
2009
2008
2007
$
(72,535)
$
(5,012)
$
26,467
activities:
Provision for credit losses
Amortization of net deferred loan fees
Net loss on sale of other real estate owned
(Gain) 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 from share-based payment arrangement
Deferred tax expense (benefits)
Increase in BOLI, accrued interest receivable and other assets
(Decrease) 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
Proceeds from sale of loans
Net decrease (increase) in loans
Purchase of bank premises and equipment
Net cash provided by (used in) investing activities
Cash flows from financing activities:
(Decrease) increase in deposits
Proceeds from FHLB borrowings
Decrease in other borrowings
Proceeds from senior debt borrowings, net of issuance cost
Excess tax benefit from share-based payment arrangement
Net proceeds of stock options exercised
Net proceeds from stock issuance
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:
71,250
(751)
4,078
(3,142)
15,015
3,455
—
626
1,113
1,813
—
20,170
(17,966)
(17,631)
5,495
21,432
48,262
(76,056)
34,336
8,812
46,255
(281)
82,760
(96,911)
—
(35,000)
25,996
—
—
16,925
—
(780)
(89,770)
(1,515)
69,586
68,071
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
$
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
(107,775)
130,578
22,803
$
$
$
$
25,309
975
$
$
34,681
4,475
$
$
43,978
21,300
Real estate acquired in settlement of loans
Loans to facilitate the sale of other real estate owned
Transfer of loan receivable to loans held for sale
58,694
$
$
34,941
$ 11,510
28,439
$
$
5,010
$ —
$ —
$ —
$ —
See accompanying notes to consolidated financial statements.
95
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(1) REGULATORY MATTERS AND GOING CONCERN CONSIDERATION
Consent Order
On March 16, 2010, the members of the Board of Directors of the Bank consented to the
issuance of a Consent Order (the “Order”) from the FDIC and the DFI. The following discussion
summarizes the provisions of the Order issued on March 22, 2010:
(i) the Bank must have and maintain qualified management and notify the FDIC and the DFI
in writing when it proposes to make any changes in its Board of Directors or senior executive
officers at least 30 days prior to the date any change is to become effective;
(ii) within 120 days of the Order, the Bank must obtain an independent study of the
management and personnel structure of the Bank to determine whether the Bank’s leadership
structure is appropriate;
(iii) the Board must increase its participation in the affairs of the Bank, assuming full
responsibility for the approval of sound policies and objectives and for the supervision of all of the
Bank’s activities;
(iv) within 60 days of the Order, the Bank must develop and adopt a plan to meet and
maintain the capital requirements contained in the Order and the FDIC’s Statement of Policy on
Risk-Based Capital. The minimum capital ratios and the dates by which such capital ratios must be
obtained are set forth in the table below:
Deadline
July 15, 2010
July 15, 2010
July 15, 2010
September 15, 2010
September 15, 2010
September 15, 2010
Ratio
Minimum Required Ratio
Tier 1 Leverage Ratio
Tangible Common Equity Ratio
Total Risk-Based Capital Ratio
Tier 1 Leverage Ratio
Tangible Common Equity Ratio
Total Risk-Based Capital Ratio
8.5%
8.5%
10.0%
10.0%
10.0%
12.0%
(v) if all or part of the increase in capital required by the Order is accomplished by the sale of
new securities, the Board of Directors must adopt and implement a plan for such sale; any offering
materials must include an accurate description of the financial condition of the Bank and the
circumstances giving rise to the offering; and the plan for the offering and any materials must be
submitted to the FDIC for review and non-objection and to the DFI for any permits or approvals;
(vi) the Bank must not pay cash dividends or make any other payments to its shareholders
without prior written consent of the FDIC and the DFI;
(vii) within 270 days of the Order, the Bank must reduce the assets classified as
“Substandard” as of September 30, 2009, to not more than 50% of the Bank’s Tier 1 capital and
ALLL;
(viii) within 60 days of the Order, the Bank must develop or revise, adopt and implement a
written plan for systematically reducing the amount of loans or other extensions of credit advanced,
96
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
directly or indirectly, to or for the benefit of, any borrowers in the “commercial real estate”
concentration, with particular emphasis on those borrowers in the construction and land
development area;
(ix) within 60 days of the Order, the Bank must develop or revise, adopt and implement a
written liquidity and funds management policy that adequately addresses liquidity needs and
appropriately reduces its reliance on non-core funding sources;
(x) within 30 days of the Order, the Bank must develop or revise, adopt, and implement a
written plan addressing retention of profits, reducing overhead expenses, and setting forth a
comprehensive budget covering the calendar year ending December 31, 2010, and thereafter, at
least 30 days prior to the commencement of each subsequent calendar year, the Board of Directors
must develop, adopt, and implement a plan and comprehensive budget covering the subsequent
calendar year.
Going Concern
During 2008 and 2009, the Bank experienced significant increases in non-performing assets
and potential problem loans, particularly related to residential construction and land development.
This resulted in a significant increase in credit costs experienced by the Bank. The increase in non-
accrual loans has also resulted in margin compression as a result of accrued interest reversals and
the lack of on-going interest recognition. Non-accrual loans increased from $66.6 million at
December 31, 2008 to $137.3 million at December 31, 2009. This credit deterioration has resulted
in significant net losses. Given the current economic conditions, the Bank may continue to
experience asset quality weakness and high levels of non-performing assets which could result in
future negative earnings and financial condition pressures.
As previously mentioned, we are required by federal regulatory authorities to maintain
adequate levels of capital to support our operations. As part of the recently issued Consent Order,
the Bank is also required to increase its capital and maintain certain regulatory capital ratios prior to
certain dates specified in the Order
We have also committed to the FDIC and the DFI to adopt a consolidated capital plan to
augment and maintain a sufficient capital position. Our existing capital resources may not satisfy
our capital requirements for the foreseeable future and may not be sufficient to offset any problem
assets. Further, should our asset quality erode and require significant additional provision for credit
losses, resulting in net operating losses at the Bank, our capital levels will decline. Consistent with
the Order, we will attempt to raise capital to satisfy our agreements with the FDIC and the DFI.
Our ability to raise additional capital will depend on conditions in the capital markets at that time,
which are outside our control, and on our financial performance. Accordingly, we cannot be certain
of our ability to raise additional capital on terms acceptable to us.
Depending on the ability of the Bank to return to profitability, the level of capital raised and
satisfaction of other aspects of the Order, the FDIC and DFI can institute other corrective measures
and have broad enforcement powers to impose additional restrictions on operations. The conditions
and events discussed above raise substantial doubt as to the Bank’s ability to continue as a going
concern.
97
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The accompanying consolidated financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the discharge of liabilities in the normal
course of business for the foreseeable future, and do not include any adjustments to reflect the
possible future effects on the recoverability or classification of assets, and the amounts or
classification of liabilities that may result from the outcome of any regulatory action including
being placed into receivership or conservatorship.
To address the items contained in the Order, management is currently undertaking the
following actions:
• We have engaged an investment banker in order to raise sufficient amounts of new
capital to satisfy the requirements of the Order.
• We have developed a plan to reduce assets classified as substandard as of September
30, 2009 levels in order to comply with the Order.
• We have created a written plan addressing the retention of profits and have a Board-
approved budget for 2010.
• We are currently working to develop written plans to reduce construction and land
loan concentrations and to revise our liquidity and funds management policies.
• We have developed a written liquidity and funds management policy.
• We intend to retain a third party to assess the Bank’s leadership structure.
• We are developing a plan to address other items in the Order.
However, there can be no assurance that the Bank will be able to comply fully with the
provisions of the Order, or that efforts to comply with the Order will not have adverse effects on the
Company’s ability to continue as a going concern.
(2) 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.
98
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Material estimates that are particularly susceptible to significant changes in the near-
term relate to the determination of the allowance for loan losses. In connection with the
determination of the allowance for loan losses, management obtains independent appraisals
for significant properties, evaluates overall loan portfolio characteristics and delinquencies
and monitors economic conditions.
The consolidated financial statements reflect management’s evaluation of subsequent
events through the date of issuance of this Annual Report on Form 10-K.
(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 $989,000 and $579,000 as
of December 31, 2009 and 2008, 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
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, 2009 and 2008, there
were no securities classified in the held-to-maturity portfolio.
The Bank performs regular impairment analysis on its investment securities portfolio
January 1, 2009, the Bank adopted new FASB standards which provide further guidance on;
identifying whether a market for an asset or liability is distressed or inactive, determining
whether an entity has the intent and ability to hold a security to its anticipated recovery and
whether an investment is other-than-temporarily-impaired. If it is determined that the
impairment is other than temporary for equity securities, the impairment loss is recognized in
earnings equal to the difference between the investment’s cost and its fair value. If it is
determined that the impairment is other-than-temporary for debt securities, the Bank will
recognize the credit component of an other-than-temporary impairment in earnings and the
non-credit component in other comprehensive income when the Bank does not intend to sell
the security and it is more likely than not that the Bank will not be required to sell the
security prior to recovery. The new cost basis is not changed for subsequent recoveries in
fair value. The adoption of the provisions of these standards resulted in a cumulative effect
99
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
after-tax adjustment of $1.6 million to the opening balance of retained earnings and
accumulated other comprehensive income.
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. 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.
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. Interest received on nonaccrual loans is
subsequently recognized as interest income or applied against the principal balance of the
loan. 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
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.
A loan is restructured when the Bank determines that a borrower’s financial condition
has deteriorated but, still has the ability to repay the loan. A loan is considered restructured
100
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
when for economic or legal reasons related to a borrower’s financial difficulties, the Bank
grants a concession to the borrower that it would not otherwise consider.
(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 loan and lease
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’ and ‘substandard’ that are not already included in impaired loan analysis;
(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 -
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
101
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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 costs. 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. Buildings are
amortized on the straight-line method over 30 years.
(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 operations and
comprehensive (loss) 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.
(k) Earnings per Share
Earnings per share (EPS) are computed on a basic and diluted basis. Basic EPS is
computed by dividing net income adjusted by presumed dividend payments and earnings on
unvested restricted stock by the weighted average number of common shares outstanding.
Losses are not allocated to participating securities. Unvested shares of restricted stock are
excluded from basic shares outstanding. 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.
102
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(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 ASC 718. 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 12 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, 2009 then additional losses could
be realized in 2010. 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.
(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
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, 2009, approximately 94% 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
103
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
collateral values and an increase in delinquencies and defaults. A decline in collateral values
such as that experienced in housing prices in 2008 and 2009 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.
(r) Recently Issued Accounting Standards
In June 2008, the FASB issued guidance now codified as ASC Section 260-10-45,
Earnings Per Share. This guidance 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. The Bank adopted this standard on January 1, 2009 and the adoption did not have
a significant impact on the Bank’s consolidated financial statements.
In June 2009, the FASB issued guidance now codified as ASC 860, Transfers and
Servicing. This guidance removes the concept of a qualifying special-purpose entity
(QSPE) from ASC 860, Transfers and Servicing and removes the exception from applying
variable interest accounting to variable interest entities that are QSPE’s. This statement also
clarifies the requirements for isolation and limitations on portions of financial assets that are
eligible for sale accounting. This statement is effective for fiscal years beginning after
November 15, 2009. Accordingly, the Bank will adopt this guidance on January 1, 2010. The
Bank is currently evaluating the impact of adopting this standard on the consolidated
financial statements.
In June 2009, the FASB issued guidance now codified as ASC 810, Consolidation. This
guidance amends ASC 810, Consolidation to require an analysis to determine whether a
variable interest gives a company a controlling financial interest in a variable interest entity
(VIE). This statement requires an ongoing reassessment of and eliminates the quantitative
approach previously required for determining whether a company is the primary
beneficiary. This statement is effective for fiscal years beginning after November 15, 2009.
Accordingly, the Bank will adopt this guidance on January 1, 2010. The Bank is currently
evaluating the effect the adoption of this guidance will have on its consolidated financial
statements.
104
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
In January 2010, the FASB issued ASC Update No. 2010-06, Fair Value Measurements
and Disclosures (Topic 820)-Improving Disclosures about Fair Value Measurements". This
update provides amendments to Subtopic 820-10 and requires the following new disclosures:
1) Transfers in and out of Levels 1 and 2, and 2) Activity in Level 3 fair value measurements
that discloses separately information about Level 3 purchases, sales, issuances, and
settlements. Additionally, this update clarifies existing disclosures of the level of
disaggregation, and disclosures about inputs and valuation techniques. The new disclosures
and clarifications of existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases, sales,
issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements. Those disclosures are effective for fiscal years beginning after December 15,
2010, and for interim periods within those fiscal years. The Bank is currently evaluating the
effect the adoption of this update will have on its consolidated financial statements.
(3) 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 and Freddie Mac), 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, the total other-than-temporary impairment
recognized in accumulated other comprehensive income, gross unrealized gains and losses,
estimated fair value of securities available for sale as of December 31, 2009 and 2008.
2009
Corporate notes
Mortgage-backed securities
Collateralized mortgage
obligations
Municipal securities
Collateralized debt obligations(1)
Total securities available-for-sale
Amortized
cost
Gross
unrealized
gains
$ 26,564
25,002
$
54
229
Gross
unrealized
losses
(In thousands)
$ (1,877)
(3)
Non-credit
other-than-
temporary
impairment
Estimated
fair value
$
—
—
$ 24,741
25,228
20,118
46,348
3,520
$ 121,552
—
122
—
405
$
(2,002)
(2,292)
—
$ (6,174)
—
—
(1,319)
$ (1,319)
18,116
44,178
2,201
$114,464
105
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(1) As of December 31, 2008, the Company recorded an OTTI charge of $4.3 million for CDO securities. Upon adoption of
new FASB OTTI impairment guidance, the Company reclassified the noncredit portion of previously recognized OTTI
CDO totaling $3.1 million, on a pre-tax basis, from the opening balance of retained earnings to other comprehensive
income as of March 31, 2009.
U.S. Government agencies
Corporate notes
Mortgage-backed securities
Municipal securities
Collateralized debt obligations
Freddie Mac preferred stock
Total securities available-for-sale
Amortized
cost
$ 22,895
26,071
13,299
46,863
3,757
115
$ 113,000
2008
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
$ 220
16
331
57
—
—
$
—
(3,365)
(29)
(4,142)
(1,682)
—
$
624
$ (9,218)
Estimated
fair value
$ 23,115
22,722
13,601
42,778
2,075
115
$ 104,406
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, 2009 and 2008 are as follows:
Less than 12 months
Estimated
fair value
Unrealized
losses
2009
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
Corporate notes
Mortgage-backed securities
Municipal securities
Collateralized debt obligations
$ 9,411
18,116
11,394
1,262
Total securities available-for-sale
$ 40,183
$ (111)
(2,002)
(204)
(982)
$(3,299)
$ 10,648
388
16,821
939
$ 28,796
$(1,766)
(3)
(2,088)
(337)
$(4,194)
$ 20,059
18,504
28,215
2,201
$ 68,979
$(1,877)
(2,005)
(2,292)
(1,319)
$(7,493)
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)
U.S. Government agencies
Corporate notes
Mortgage-backed securities and
collateralized debt obligations
Municipal securities
Total securities available-for-sale
106
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The Bank’s investment portfolio is primarily comprised of corporate notes, mortgage-
backed securities, collateralized mortgage obligations, municipal securities and collateralized debt
obligations. Other than U.S. government agencies (Fannie Mae and Freddie Mac), 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.
On January 1, 2009, the Bank adopted new FASB standards which provide further guidance on;
identifying whether a market for an asset or liability is distressed or inactive, determining whether
an entity has the intent and ability to hold a security to its anticipated recovery and whether an
investment is other-than-temporarily-impaired (“OTTI”). In accordance with the adoption of these
FASB standards, management has analyzed all investment securities which have an amortized cost
that exceeds fair value as of December 31, 2009.
The Bank owns four collateralized debt obligations (“CDO’s”) which consist of pools of
bank trust preferred securities. As of December 31, 2009, the amortized cost of all four CDO’s
exceeded the fair value. The fair value was determined based on future expected cash flows which
were estimated using a discount rate that is an interest rate that represents a market equivalent rate
on a similarly-rated corporate security with a similar maturity date that trades in an active market.
Added to that rate was an illiquidity premium of 400 basis points which determined the actual
discount rate. Management then estimated the expected future defaults within the underlying pool
of issuers which was based on taking the current deferrals/defaults in the pools and then
determining which banks were likely to default in the future. This future expectation of defaults
was based on the individual banks’ tier 1 leverage capital (compared to regulatory requirements),
tangible common equity (“TCE”) ratios and levels of non-performing assets compared to total
assets. Based on this information, Management would then make an assertion as to whether each
bank issuer was likely to defer interest payments or default altogether. In addition to those specific
defaults, Management estimated additional default rates, with higher default rates applied over the
next few years and then decreasing over the remaining term of the securities.
Management determined credit-related OTTI based on guidance of Investments – Debt and
Equity Securities Topic of FASB ASC. In this analysis, Management calculated expected cash
flows on all four securities using a discount rate that was equal to the accretable yield on all four
securities and using the default assumptions as described above. Total credit-related other-than-
temporary impairments recognized in income relating to these securities were $3.2 million during
2009. The non-credit amount at December 31, 2009 was $1.3 million and is reflected in
accumulated other comprehensive loss. During 2008, the Bank recorded $4.3 million (pre-tax) in
credit and non-credit related impairment losses on two securities. Upon the implementation of new
FASB OTTI guidance on January 1, 2009, the Bank reclassified the combined $3.1 million (pre-
tax) in non-credit-related OTTI impairment losses recognized during 2008 from the opening
balance of retained earnings to other comprehensive income as of March 31, 2009.
As of December 31, 2009, the Bank owned nine corporate securities where the amortized
cost exceeded fair value. The total amortized cost of these securities was $21.9 million and their fair
value was $20.1 million. Management performed an analysis on all of the issuers of these securities
which focused on the recent financial results of the companies, capital ratios and long-term
prospects of the issuer and deemed the all nine corporate securities to be temporarily impaired. The
Bank had previously recorded a credit-related OTTI charges of $220,000 on corporate securities in
the first quarter of 2009. This compares to an OTTI charges relating to corporate securities of $1.7
million in 2008 and $621,000 in 2007.
107
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The Bank had previously owned three issues of FHLMC (“Freddie Mac”) preferred stock.
During the fourth quarter of 2008, the Company recorded an OTTI charge of $6.4 million on its
investment in Freddie Mac. The value of these securities declined significantly after the U.S.
Government placed both companies into conservatorship in September 2008. An additional OTTI
charge of $24,000 was recorded in the first quarter of 2009. All three securities were sold during
fourth quarter of 2009 at a small gain.
As of December 31, 2009, the Bank owned two collateralized mortgage obligations
(“CMO’s) where the amortized cost exceeded fair value. The total amortized cost of these securities
was $20.1 million and their fair value was $18.1 million. Management determined that none of the
CMO securities was other-than-temporarily impaired as of December 31, 2009. This determination
was made based on several factors such as debt rating of these securities, amount of credit
protection, the Bank’s intent and ability to hold the securities until a recovery in value and the
determination that it is not more likely than not that the Bank will be required to sell the securities
prior to recovery of amortized cost basis.
The Bank owns 60 municipal investment securities. All but three carry an investment-grade
rating. The Bank’s strategy with respect to municipal bond investing is to provide liquidity and
federal tax exempt interest income. Typically, the Bank buys general obligation (“GO”) bonds and
seek to minimize its 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. The Bank typically
purchases municipal bonds that have at least an underlying rating of “A” or better. The size of the
average investment security in the municipal portfolio is $772,000. As of December 31, 2009, 28 of
these issues with a total amortized cost of $30.5 million were in an unrealized loss position. The
unrealized loss on these 28 securities was $2.3 million. Management determined that none of the
municipal securities was other-than-temporarily impaired as of December 31, 2009. This
determination was made based on several factors such as the Bank’s intent and ability to hold the
securities until a recovery in value and the determination that it is not more likely than not that the
Bank will be required to sell the securities prior to recovery of amortized cost basis. In addition,
management reviews all of the ratings on the municipal investment securities, recent ratings
changes, as well as the length of time that the security has been impaired to determine whether the
security is other than temporary impaired.
At December 31, 2009, there were 22 and 25 investment securities that were in an unrealized
loss position for less than 12 months and for 12 months or greater, respectively. Temporary
impairments related to 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 2010 on specific investments within these portfolios.
Cash proceeds from sales of securities available-for-sale totaled $48.3 million, $105 million
and $0 in 2009, 2008, and 2007, respectively. Gross realized gains on sales of securities available-
for-sale totaled $3.3 million offset with gross realized losses of $200,000 in 2009. Gross realized
108
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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 $90.1 million and
$68.1 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, 2009
and 2008, respectively.
The amortized cost and estimated fair value of securities at December 31, 2009 and 2008, 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 4.68% and
4.95% in 2009 and 2008, 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
2009
Amortized
cost
Estimated
fair value
(In thousands)
$
—
—
8,103
113,449
$ 121,552
$
—
—
8,117
106,347
$ 114,464
The following table provides a roll-forward of the amounts recognized in earnings for those
debt securities that have been other-than-temporarily impaired because of credit losses which also
have an other-than-temporary impairment due to non-credit factors recorded as a component of
other comprehensive income for twelve months ended December 31, 2009:
Additions for
the amount
related to the
credit loss
for which
OTTI was
not
previously
recognized
Reductions for
securities for
which the
amount
previously
recognized in
OCI was
recognized in
earnings
(in thousands)
Reductions
for
Securities
Sold
Beginning
Balance as of
December 31,
2008
Reductions
for
increases in
cash flows
expected to
be collected
that are
recognized
over the
remaining
life of the
security
Additional
increases to
the amount
related to
credit loss
for which
OTTI loss
was
previously
recognized
Ending
Balance as
of
December
31, 2009
$
1,149
$ 1,616 $ —
$
—
$ 1,815
$ —
$4,580
Amounts related to credit losses
on debt securities for which a
portion of OTTI was recognized
in OCI
109
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(4) Loans and Leases and Allowance for Loan and Lease Losses
The loans and leases portfolio as of December 31, 2009 and 2008 is summarized as follows:
Real estate-mini perm
Real estate-construction
Commercial
Trade finance
Installment/Consumer
Other Loans
Less:
Allowance for loan and lease losses
Deferred loan and fees, net
2009
2008
(In thousands)
$ 565,273
202,187
222,421
47,998
119
301
1,043,299
$ 592,697
290,803
273,890
73,205
48
589
1,231,232
(42,810)
585
$ 1,001,074
(26,935)
(167)
$ 1,204,130
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 $137.3 million of nonaccrual loans and leases at December 31, 2009
compared to $66.6 million at December 31, 2008. These loans and leases had interest due, but not
recognized, of approximately $6.6 million and $5.0 million in 2009 and 2008, respectively. The
Bank had $7.6 million and $0 in loans past due 90 or more days and still accruing interest as of
December 31, 2009 and 2008.
Trouble Debt Restructured (TDR) loans are defined by FASB ASC 310-40, “Troubled Debt
Restructurings by Creditors” and FASB ASC 470-60, “Troubled Debt Restructurings by Debtors”
and evaluated for impairment in accordance with FASB ASC 310-10-35. At December 31, 2009,
loans classified as a TDR totaled $35.3 million, of which $34.9 million was on non-accrual status
and $387,000 was on accrual status. At December 31, 2008, loans classified as a TDR totaled
$198,000 which was on accrual status. As of December 31, 2009 we had $84,000 outstanding
commitments to extend additional funds to one single borrower whose loan was on accrual basis.
As of December 31, 2008, we did not have any outstanding commitments to extend additional
funds to these borrowers.
For the indicated periods, the following table contains financial information on impaired
loans:
Recorded investment with related allowance
Recorded investment with no related allowance
110
As of and for the Year Ended December 31,
2008
2007
2009
(In thousands)
$ 54,206
63,385
$ 24,811
4,221
$ 97,820
8,278
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Allowance on impaired loans
Net recorded investment in impaired loans
Average total recorded investment in impaired loans
(10,600)
$ 95,498
$ 103,145
(16,041)
$ 101,550
$ 94,172
(3,882)
$ 25,210
$ 16,888
Interest income recognized on impaired loans during 2009, 2008 and 2007 was $4.2 million,
$4.3 million and $1.9 million, respectively. At December 31, 2009, the Bank had no commitments
to lend additional funds to debtors whose loans are non-performing.
Changes in the allowance for loan and lease losses are summarized as follows:
Balance at beginning of year
Provision for credit losses
Loans and leases charged off
Recoveries
Balance at end of year
2009
$ 26,935
71,250
(59,711)
4,336
$ 42,810
2008
(In thousands)
$ 14,896
30,560
(18,528)
7
$ 26,935
2007
$ 10,236
4,900
(240)
—
$ 14,896
In the fourth quarter of 2009, the Bank received $7,050,000 from another bank in the full
settlement of a long outstanding lawsuit relating to loan participation between the two banks. After
deducting the remaining carrying value of the loan and related legal expenses, the Bank recorded
approximately $4 million in recovery of loan balances that were previously charged-off.
(5) Bank Furniture and Fixtures
As of December 31, 2009 and 2008, furniture and fixtures consists of the following:
Land and Building
Leasehold improvements
Furniture and fixtures
Less accumulated depreciation and amortization
2009
2008
$ 2,782
6,630
4,428
13,840
(7,515)
$ 6,325
$ 2,782
6,071
4,922
13,775
(6,618)
$ 7,157
Depreciation and amortization expense was $1,113,000, $782,000 and $575,000 for the years
ended December 31, 2009, 2008 and 2007, respectively.
111
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(6) Deposits
Time deposit accounts at December 31, 2009 mature as follows:
Year
2010
2011
2012
Maturities of
time deposits
(In thousands)
637,764
144,997
9,905
792,666
$
$
At December 31, 2009 and 2008, approximately $90,121,000 and $1,216,000, 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 $15,000 and
$591,100 at December 31, 2009 and 2008, respectively.
(7)
Income Taxes
The income taxes expense (benefit) for the years ended December 31, 2009, 2008 and
2007 was as follows:
Current income tax (benefit) expense:
Federal
State
Deferred income tax (benefit) expense:
Federal
State
2009
2008
(In thousands)
2007
$ (27,828)
(470)
(28,298)
$ 4,190
2,016
6,206
$ 15,659
4,997
20,656
19,570
600
20,170
$ (8,128)
(8,189)
(2,893)
(11,082)
$ (4,876)
(1,580)
(406)
(1,986)
$ 18,670
Income tax (benefit) provision
At December 31, 2009 and 2008, other assets include current income taxes receivable of
$30.1 million and $965,000, respectively.
112
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The components of the deferred tax assets and deferred tax liabilities as of December 31,
2009 and 2008 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
ASC 718 non-qualified stock options
OREO reserve
Net operating loss carryforward
Other
Gross deferred tax assets
Deferred tax liabilities:
Discount accretion
FHLB stock
Gross deferred liabilities
Valuation reserve
Net deferred tax assets
2009
2008
(In thousands)
$ 11,761
126
1,574
394
2,980
1,606
1,058
6,024
5,178
1,002
31,703
$ 11,350
614
3,566
453
3,614
5,463
579
737
—
878
27,254
(543)
(426)
(969)
(27,130)
(543)
(426)
(969)
(382)
$ 3,604
$ 25,903
In assessing the realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future taxable income during
the periods in which those temporary differences become deductible. Management considers the
projected future taxable income and tax planning strategies in making this assessment. Based upon
the level of historical taxable income and projections for future taxable income over the periods in
which the deferred tax assets are deductible, management believes that the realization of the
deferred tax asset is not more likely than not and therefore has established a valuation allowance in
the amount of $27.1 million as a charge to income tax expense. The Bank has net operating loss
carryforwards of approximately $73.5 million for California franchise tax purposes. California net
operating loss carry forwards, to the extent not used, will begin to expire in 2029.
It is the policy of management to include any interest or penalties from income tax liabilities
in the provision for income taxes. As of December 31, 2009 and 2008, the total amount of tax
reserve, net of federal tax benefit, was $25,000 and $74,000, respectively, for uncertain tax position
in relation to enterprise zone net interest deductions.
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, 2009, 2008 and 2007 (in thousands):
113
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
2009
Amount
Percentage
Amount
2008
Percentage
Amount
2007
Percentage
Statutory U.S. federal income tax
State taxes, net of federal benefit
Life insurance policies
Valuation allowance
Other
$(28,232)
(6,262)
(87)
27,127
(674)
$ (8,128)
35.0%
7.8
0.1
(33.6)
0.8
10.1%
(In thousands)
$ (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%
The Bank files income tax returns in the U.S. federal jurisdiction and in the State of
California. Under the statute of limitations by the Internal Revenue Service, we are open for audit
for the years ended December 31, 2006 through 2008. Our state income tax returns are open to
audit under the statute of limitations by state tax authority for the years ended December 31, 2005
through 2008. 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. For the tax year 2007, the Bank was assessed for an additional tax liability of $65,000
including interest in March 2010. 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.
(8) Other Real Estate Owned
Total OREO increased to $59.2 million as of December 31, 2009 compared to $35.1 million
as of December 31, 2008. At December 31, 2009, OREO was comprised of 19 properties compared
to 5 properties at December 31, 2008. During 2009, the Bank sold 14 OREO properties at a loss of
$4.1 million. These losses are included in Loss on Sale OREO and Related Expense in the
Consolidated Statements of Operations and Comprehensive (Loss) Income.
An analysis of the activity in the valuation allowance for other real estate losses for the years ended
on December 31, 2009, 2008, and 2007 is as follows:
Balance, beginning of the year
Provision for losses
OREO disposal
Balance, end of the year
2009
$ 1,752
15,015
(2,441)
$ 14,326
2008
(In thousands)
$
—
1,752
—
$ 1,752
2007
$
$
—
—
—
—
The following table depicts Preferred Bank’s OREO properties by type:
114
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Commercial & Industrial
Mini-perm Real Estate
Construction - Commercial
Construction - Residential
Land - Residential
Land - Commercial
Total as of December 31, 2009
Total as of December 31, 2008
#
-
2
1
1
12
3
19
5
$
$ —
21,958,000
1,611,000
933,000
27,005,000
7,683,000
$ 59,190,000
$ 35,127,000
(9) Senior Debt and Other Borrowed Funds
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.
Advances from the Federal Home Loan Bank of San Francisco (FHLBSF) were $23 million
and $58 million at December 31, 2009 and 2008. The average rate on the fixed rate debt was 4.20%
and 4.04% at December 31, 2009 and 2008, respectively. All advances are collateralized by
commercial or residential real estate loans. At December 31, 2009, approximately $88,667,000 of
the Bank’s real estate loans was pledged as collateral. At December 31, 2009, the outstanding
advances mature as follows:
Year
2010
At December 31,
2009
(In thousands)
$23,000
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 $53.8 million.
The Bank had no borrowing outstanding through the discount window outstanding as of December
31, 2009.
(10) 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.
115
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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, 2009 and 2008, the Bank had commitments to fund loans of $208,078,000
and $369,873,000, respectively. Other financial instruments with off-balance-sheet risk at
December 31, 2009 and 2008 are as follows:
Commitments to extend credit
Commercial letters of credit
Standby letters of credit
Total
2009
2008
(In thousands)
$ 199,430
1,009
7,639
$ 345,653
3,141
21,079
$ 208,078
$ 369,873
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, 2009, the future total minimum
lease payments for the Bank’s premises are as follows:
Year
2010
2011
2012
2013
2014
Thereafter
Total lease payment
(In thousands)
2,565
2,236
2,053
1,976
1,870
8,236
18,936
$
$
Rental expense was $1,829,000, $1,700,000 and 1,397,000 for the years ended December 31,
2009, 2008 and 2007, respectively.
(11) 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.
116
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
At December 31, 2009 and 2008, the aggregate loans (including commitments) to related
parties were approximately $14.6 million (of which $5.8 million was outstanding) and $5.2 million
(of which $266,000 was outstanding), respectively. All related party loans were current at
December 31, 2009 and 2008.
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
2009
$
266
5,816
(265)
$ 5,817
2008
(In thousands)
723
$
264
(721)
266
$
2007
$
$
734
—
(11)
723
Deposits: The amount of deposits from related parties was $489,000 and $3,898,000 at
December 31, 2009 and 2008, respectively.
(12) Restrictions on Cash Dividends, Regulatory Capital Requirements
The Bank has authorized 5,000,000 shares of preferred stock. The Board has the authority to
issue the preferred stock in one or more series, and to fix the designations, rights, preferences,
privileges, qualifications, and restrictions, including dividend rights, conversion rights, voting
rights and terms of redemptions, liquidation preferences, and sinking fund terms, any or all of
which may be greater than the rights of the common stock.
Under Section 642 of the California Financial Code, funds available for cash dividend
payments by a bank are restricted to the lesser of: (i) retained earnings or (ii) the bank’s net income
for its last three fiscal years (less any distributions to 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, 2009,
that the Bank meets all capital adequacy requirements to which it is subject.
117
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
As of September 30, 2009, the most recent notification from the FDIC categorized the Bank
as “undercapitalized” under the regulatory framework for prompt corrective action. During the
fourth quarter of 2009, the Bank was profitable and further reduced its asset base. Consequently, as
of December 31, 2009, the Bank believes it meets quantitative thresholds to be classified as
“adequately capitalized”. On February 9, 2010, the Bank was notified by the FDIC that the FDIC
had determined that the Bank was ‘adequately capitalized’ as of December 31, 2009 based on the
capital ratios contained in the Bank’s Call Report as of December 31, 2009 which was filed on
January 28, 2010.
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)
$ 105,268
89,477
89,477
8.52%
7.24%
6.16%
$ 98,896
49,448
49,448
> 8.00%
4.00%
4.00%
$ 123,620
74,172
61,810
> 10.00%
6.00%
5.00%
As of December 31, 2009:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
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%
On April 16, 2009, the Bank agreed to a Memorandum of Understanding (“MOU”) with
Federal Deposit Insurance Corporation (“FDIC”) and California Department of Financial Institutions
(“DFI”). An MOU is an informal regulatory action that is used when circumstances warrant attention
to particular matters of concern, but is less severe than a formal supervisory action, such as a formal
written agreement or cease and desist order. Among the measures provided for in the MOU is that the
Bank maintain a minimum Tier 1 leverage capital ratio and a minimum tangible common equity to
total tangible assets ratio of not less than 8%. As of December 31, 2009, these ratios were 7.24% and
8.52%, respectively. While Tier 1 leverage ratio exceeds the minimum ratio required to be classified
as “well capitalized” under regulatory guidelines, the Tier 1 leverage ratio was not sufficient to meet
the higher level that the Bank agreed to maintain under its agreement with the FDIC and DFI. As a
result, the Bank may be subject to further supervisory action, which could have a material adverse
effect on its results of operations, financial condition and business. Other requirements of the MOU
are for the bank to reduce adversely classified assets, maintain an adequate allowance for loan and
lease losses and to diversify its funding sources. In addition, the Bank also agreed to provide notice
to the FDIC and DFI prior to making any changes to its senior executives or Board of Directors, and
to provide periodic reports on its progress in implementing the measures set forth in the MOU. See
Note1 for a description of the consent order issued March 22, 2010. This order supersedes the MOU.
The Bank utilizes a variety of funding sources in conducting its operations, including the
use of “brokered deposits” as defined by banking regulators. Such brokered deposits totaled $189.6
million at December 31, 2009. During the fourth quarter of 2009, due to the fact that the Bank is no
118
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
longer considered to be well-capitalized, the Bank is no longer allowed to access the brokered
deposit market which also includes the CDARS reciprocal deposits. As such, the Bank will not
renew any of these brokered deposits and will let all of the mature during the course of 2010 and
2011. Accordingly, management has worked and planned diligently to ensure that the Bank has
sufficient liquidity to meet these brokered deposit maturities and to also have additional contingent
cash on hand. Management has worked to increase cash on hand which as December 31, 2009 was
$68 million. Management also is forecasting a substantial pay down in the loan portfolio which will
result in additional cash on the balance sheet. In addition, Management is also looking to sell certain
of its investment securities which cannot be pledged as collateral at the Federal Home Loan Bank for
future borrowings. Finally, the Bank is also able to raise deposits from other financial institutions to
augment its cash position. Management is confident that these efforts will result in a substantial
build-up of cash on the balance sheet with which the brokered CD’s may be paid as they mature.
On February 9, 2010, the Bank was notified by the FDIC that the FDIC had determined
that the Bank was ‘adequately capitalized’ as of December 31, 2009 based on the capital ratios
contained in the Bank’s Call Report as of December 31, 2009 which was filed on January 28, 2010.
An amended Call Report is expected to be filed and the Bank still expects to be adequately
capitalized.
(13) Share-Based Compensation
The Bank remunerates employees and directors through stock option compensation plans; the
1992 Stock Option Plan, Interim Stock Option Plan and the 2004 Equity Incentive Plan which are
discussed below. Effective January 1, 2006, the Bank adopted FASB Accounting Standards
Codification (“ASC”) 718 “Compensation –Stock Compensation” (“ASC 718”). 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 ASC 718. 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, 2009, 2008 and 2007, the
Bank recognized share-based compensation expense of $1.8 million, $1.6 million and $1.2 million,
respectively, resulting in the recognition of $461,000, $443,000 and $192,000 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 2,171,880 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.
119
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Because the 1992 Plan expired in 2003, the Bank did not issue any options under this Plan
during 2009, 2008 and 2007.
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 2009, 2008 and 2007.
The total intrinsic value of share options exercised during the year ended December 31, 2009,
2008 and 2007 was $0, $218,000 and $4,892,000, respectively, from the 1992 Plan and the Interim
Plan. As of December 31, 2009, there was no compensation cost not yet recognized that relates to
options granted under the 1992 Plan and Interim Plans.
The following information under the 1992 Plan and the Interim Plan is presented for the
years ended December 31, 2009, 2008 and 2007:
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
2009
December 31,
2008
(In thousands)
2007
$ —
84
—
—
$ —
97
218
146
$ —
216
4,892
1,607
—
11
257
The following is a summary of the transactions under the 1992 Plan and the Interim Plan for
the years ended December 31, 2009:
1992 Plan and Interim Plan
Number of
Options
440,550
—
(154,850)
(1,500)
284,200
—
(17,100)
—
267,100
—
—
(6,300)
260,800
Weighted
Average Exercise
Price
$ 13.89
—
10.28
12.35
15.87
—
8.57
—
16.32
—
—
8.58
$ 16.51
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
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2009
120
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 $0. As of December 31, 2009, stock options outstanding under
the 1992 Plan and the Interim Plan were as follows:
Options Outstanding
Options Exercisable
Number of
Outstanding
Options
—
75,150
185,650
Weighted
Average
Exercise
Price
$ —
10.69
18.87
Weighted
Average
Remaining
Contractual
Life
—
3.32
4.31
Number of
Outstanding
Options
—
75,150
185,650
Weighted
Average
Exercise
Price
$ —
10.69
18.87
Weighted
Average
Remaining
Contractual
Life
—
3.32
4.31
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, 2009,
2008 and 2007 was $0, $0 and $300,000, respectively. As of December 31, 2009, the total
compensation cost not yet recognized that relates to unvested options granted under the 2004 Plan
was $1,565,000 with a weighted-average recognition period of 1.9 years.
For the years ended December 31, 2009, 2008 and 2007, the estimated weighted-average fair
value per share of options granted under the 2004 Plan were as follows:
2009
$1.40
December 31,
2008
$2.22
2007
$7.83
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,
2009
2008
2007
6.85%
57.76%
3.0 Yrs.
1.50%
5.74%
26.53%
3.34 Yrs.
3.18%
1.87%
23.80%
3.75 Yrs.
4.06%
121
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Historically, expected volatility was determined based on the historical daily volatility of a
set of California peer banks whose shares are publicly available over a period equal to the expected
term of the options granted, as a proxy for the Bank’s historical daily volatility. Currently, the
expected volatility is determined based on the historical daily volatility of the Bank’s stock price
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 and is calculated
based on the “simplified” method. The Bank will continue to use the “simplified” method until it
has enough historical experience to provide a reasonable estimate of expected term. The risk-free
interest rate is based on the U.S. Treasury yield curve at the time of grant for a period equal to the
expected term of the options granted. Dividend yield is computed over the four consecutive
quarters preceding the date of grant.
The following information under the 2004 Plan is presented for the years ended
December 31, 2009, 2008 and 2007:
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
2009
$ 125
1,767
—
—
December 31,
2008
(In thousands)
$ 831
1,627
—
—
2007
$ 2,747
731
300
603
—
—
6
The following is a summary of the transactions under the 2004 Plan for the years ended
December 31, 2009, 2008 and 2007.
2004 Plan
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
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2009
Number of
Options
523,950
350,500
(24,050)
(28,200)
822,200
375,300
—
(71,400)
1,126,100
89,000
—
(47,900)
1,167,200
122
Weighted Average
Exercise Price
26.37
36.46
25.66
34.18
30.55
14.38
—
25.99
25.36
5.17
—
24.57
23.85
$
$
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
As of December 31, 2009, the aggregate intrinsic value of options outstanding under the
2004 Plan was $0. As of December 31, 2009, stock options outstanding under the 2004 Plan were
as follows:
Options Outstanding
Options Exercisable
Weighted
Average
Exercise
Price
$ 4.21
7.77
21.84
26.16
31.92
35.91
43.50
Weighted
Average
Remaining
Contractual
Life
2.51
2.67
3.05
4.34
1.14
1.55
2.14
Number of
Outstanding
Options
9,833
51,266
37,500
461,350
28,350
9,000
75,250
Weighted
Average
Exercise
Price
$ 4.50
9.00
21.84
25.83
31.92
35.91
43.50
Weighted
Average
Remaining
Contractual
Life
2.51
2.41
3.05
4.57
1.14
1.55
2.14
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
Number of
Outstanding
Options
39,500
230,800
150,000
535,300
47,850
15,000
148,750
Restricted Stock Awards
The Bank’s 2004 Plan provides for granting of restricted stock awards (“RSAs”) to key full-
time employees, officers, and the directors of the Bank. The Bank began granting RSA’s in
calendar year 2009. During the year ended December 31, 2009, the Bank granted 99,000 RSAs.
The RSAs granted under the 2004 Plan have a two year vesting period and are to be distributed at
the end of the two year period. The total unrecognized compensation expense for outstanding
RSAs was $298,000 as of December 31, 2009, and will be recognized over 1.14 years.
The following is a summary of the transactions for non-vested RSAs under the 2004 Plan for
the year ended December 31, 2009:
Non-Vested RSAs as of December 31, 2008
Granted
Forfeited or expired
Vested
Non-Vested RSAs outstanding as of December 31, 2009
Number
of Shares
—
Weighted Average
Grant Date
Fair Value
$ —
99,000
—
—
99,000
5.40
$
$ —
$ —
5.40
$
(14) Employee Benefit Plan
Effective January 1, 1994, the Bank began a 401k profit sharing plan for its eligible
employees. Under the plan, the Bank matches 50% of a participant’s contributions up to 6% of
his/her salary subject to federal limitations on maximum contributions. Contributions made by the
Bank for the years ended December 31, 2009, 2008 and 2007 totaled $189,000, $158,000 and
$149,000, respectively.
123
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(15) Bonus Plan
In April 1994, the Management Incentive Bonus Plan was approved. In December 2007 this
Plan was amended and approved by the Board of Directors. 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 $0, $294,000 and $5,112,000 for 2009,
2008 and 2007, respectively. As of December 31, 2009 and 2008, the total bonus accrual included
in the other liabilities amounted to $0 and $992,000, respectively. The amounts accrued are paid
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.
(16) Deferred Compensation Arrangements
In 1996, the Bank implemented deferred compensation arrangements for the Bank’s senior
officers and directors. Pursuant to the Plan, each participant receives benefits for his/her deferred
compensation upon his/her retirement or termination of service with the Bank prior to retirement.
At December 31, 2009 and 2008, liabilities recorded for the deferred compensation plan totaled
approximately $3,742,000 and $8,481,000, respectively.
In order to economically fund its obligation under the deferred compensation arrangements,
the Bank purchased a single-premium life insurance policy under which the executive officers and
directors are the insured, while the Bank is the owner and beneficiary thereof. At December 31,
2009 and 2008, the cash surrender value of the policies totaled $7,304,000 and $8,454,000,
respectively. During 2009, 2008 and 2007, the income on the insurance policies was $318,000,
$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.
(17) Litigation
From time to time, the Bank is a party to claims and legal proceedings arising in the ordinary
course of business. There are no pending legal proceedings or, to the best of management’s
knowledge, threatened legal proceedings, to which the Bank is a party which may have a material
adverse effect upon the Bank’s financial condition, results of operations, or business prospects.
(18) 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
124
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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.
(19) Earnings per Share
The Bank adopted new accounting guidance in 2009 which provides that vested share-based
payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether
paid or unpaid) are participating securities and should be included in the computation of earnings
per share pursuant to the two-class method. For the Bank, participating securities consist of
unvested restricted stock awards. Prior-period earnings per share were not restated as there were no
participating securities outstanding before 2009.
The following table summarizes the basic and diluted earnings(loss) per share calculations
for the periods indicated:
Basic earnings (loss) per share:
Net (loss) income
Less: income and dividends allocated to participating
securities
Net income (loss) allocated to common shareholders-
basic
Basic weighted average common shares outstanding
Basic earnings (loss) per share
Diluted earnings (loss) per share:
Net (loss) income
Less: income and dividends allocated to participating
securities
Net income (loss) allocated to common shareholders-
diluted
Basic weighted average common shares outstanding
Effect of dilutive securities – stock options
Diluted weighted average shares outstanding
Diluted earnings (loss) per share
2009
2007
2008
(In thousands, except per share data)
$
(72,535)
$
(5,012)
$
26,467
(6)
—
—
$
(72,541)
11,518,145
$ (6.30)
(5,012)
$
9,790,858
$ (0.51)
26,467
$
10,330,232
$ 2.56
$
(72,535)
$
(5,012)
$
26,467
(6)
—
—
$
(72,535)
11,518,145
—
11,518,145
$ (6.30)
$
(5,012)
9,790,858
—
9,790,858
$ (0.51)
$
26,467
10,330,232
250,717
10,580,949
$ 2.50
Basic EPS excludes dilution and is computed by dividing net income available to common
stockholders by the weighted average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur if stock options or other contracts to issue
common stock were exercised or converted to common stock that would then share in our earnings,
excluding common shares in treasury.
125
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(20) Quarterly Financial Data (Unaudited)
The following tables summarize the quarterly unaudited financial data for 2009 and 2008:
Quarterly Financial Data (Unaudited)
Year Ended December 31, 2009
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 tax expense (benefit)
Net (loss) income
Earnings(loss) per share
Basic
Diluted
(In thousands, except per share data)
$ 16,926
7,222
9,704
6,550
1,278
6,583
(829)
$ (1,322)
$ 16,423
5,867
10,556
15,450
925
10,304
(7,443)
$ (6,830)
$ 12,111
4,956
7,155
48,250
3,355
24,042
(25,798)
$ (35,984)
$ 13,416
4,767
8,649
1,000
918
11,024
25,942
$ (28,399)
$ ( 0.14)
$ (0.14)
$ (0.69)
$ (0.69)
$ (3.32)
$ (3.32)
$ (1.80)
$ (1.80)
Year Ended December 31, 2008
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 (loss)
Earnings(loss) per share
Basic
Diluted
(In thousands, except per share data)
$ 25,288
10,447
14,841
5,080
782
5,005
2,160
$ 3,378
$ 22,097
8,766
$ 19,885
7,892
13,331
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)
126
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
(21) Fair Value of Financial Instruments
ASC Topic 825, Financial Instruments, 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, Financial Instruments Topic of FASB ASC
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 Financial
Instruments Topic of FASB ASC. 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 an exit price concept as contemplated in ASC Topic 820, Fair Value
Measurements and Disclosures. As a result, the value of the loan portfolio in the event the
loans have to be sold outside the parameters of normal operating activities may differ from
the fair value disclosed. As a result, 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.
Loans measured for impairment based on the fair value of the underlying collateral are
considered recorded at fair value on a non-recurring basis. Impaired loans include all of the
Bank’s non-accrual loans and certain restructured loans, all of which are reviewed
individually for the amount of impairment, if any. 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
127
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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 or if an appraisal value is based on
a discount cash flow rather than a market comparable, such valuation inputs are considered
unobservable and the fair 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)
Loans held for sale
Loans held for sale are required to be measured based on the lower of cost or fair value. If
the fair value of a loan is less than its cost basis, a valuation adjustment is recognized in the
consolidated statement of operations and the loan’s carrying value is adjusted accordingly.
When Bank has loans held for sale, it obtains quotes or bids on all or part of these loans
directly from the purchasing parties.
(e) 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.
(f) 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.
(g) FHLB Borrowings and Senior Debt
The fair value of FHLB borrowings and Senior debt was based on rates currently offered
for borrowings with similar remaining maturities.
(h) 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.
128
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
December 31, 2009
Carrying
amount
Estimated
fair value
December 31, 2008
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
Federal Home Loan Bank stock
$ 68,071
114,464
1,001,074
5,582
4,996
$ 68,071
114,464
1,007,058
5,582
4,996
$ 69,586
104,406
1,204,130
7,807
4,996
$ 69,586
104,406
1,206,554
7,807
4,996
Liabilities:
Demand deposits and
savings:
Noninterest-bearing
Interest-bearing
Time deposits
FHLB borrowings and Senior Debt
Accrued interest payable
$ 204,545
163,201
792,666
48,996
2,949
$ 204,545
163,820
795,967
49,033
2,949
$ 196,408
189,134
871,781
58,000
5,446
$ 196,408
189,134
871,781
66,859
5,446
Off-balance sheet financial instruments
Commitments to extend credit and letters of credit
217
217
281
281
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 ASC Topic 820, Fair Value Measurements and Disclosures, or ASC 820,
on January 1, 2008, and determined the fair values of its financial instruments based on the fair
value hierarchy established in ASC 820. ASC 820 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:
129
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Corporate notes – The Bank measures fair value of corporate notes by using quoted
market prices for similar securities or dealer quotes, a level 2 measurement.
Municipal securities – The Bank measures fair value of state and municipal securities by
using quoted market prices for similar securities or dealer quotes, a level 2 measurement.
Mortgage-backed securities – The Bank measures fair value of mortgage-backed
securities by using quoted market prices for similar securities or dealer quotes, a level 2
measurement.
Collateralized mortgage obligations – The Bank measures fair value of collateralized
mortgage obligations by using quoted market prices for similar securities or dealer
quotes, a level 2 measurement.
Collateralized debt obligations – The Bank uses a discounted cash flow analysis to
determine the fair value of the four collateralized debt obligations which is level 3
measurement. The discount rate is determined by using a market interest rate for a
similarly rated single issuer corporate security using loss rates determined by the
financial health of the underlying issuer banks in each pool.
The following table presents the Bank’s hierarchy for its assets and liabilities measured at fair
value on a recurring basis at December 31, 2009:
(In thousands)
Assets
Fair Value Measurements Using
Quoted Prices in
Active Markets for
Identical Assets
Significant Other
Observable
Inputs
Significant
Unobservable
Inputs
(Level 1)
(Level 2)
(Level 3)
Securities, available-for-sale:
Corporate notes
Mortgage-backed securities
Collateralized mortgage obligations
Municipal securities
Collateralized debt obligations
Total
$ —
—
—
—
—
$ —
$ 24,741
25,228
18,116
44,178
—
$ 112,263
$
$
—
—
—
—
2,201
2,201
At December 31,
2009
$
$
24,741
25,228
18,116
44,178
2,201
114,464
130
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
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:
U.S. Government agencies
Corporate notes
Mortgage-backed securities
Municipal securities
Collateralized debt obligations
Freddie Mac preferred stock
Total
Fair Value Measurements Using
Quoted Prices in
Active Markets for
Identical Assets
Significant Other
Observable
Inputs
Significant
Unobservable
Inputs
(Level 1)
(Level 2)
(Level 3)
$ —
—
—
—
—
—
$ —
$ 23,115
22,722
13,601
42,778
—
115
$ 102,331
$
$
—
—
—
—
2,075
—
2,075
At December 31,
2008
$
$
23,115
22,722
13,601
42,778
2,075
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, 2009:
Fair Value Measurements Using Significant Unobservable Inputs(Level 3)
(Dollars in thousands)
Beginning
Balance as of
December 31,
2008
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,
2009
$
2,075
$
—
$
(3,211)
$
3,337
$
2,201
ASSETS:
Securities, available-for-sale:
Collateral debt obligations
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:
131
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
Fair Value Measurements Using Significant Unobservable Inputs(Level 3)
(Dollars in thousands)
Beginning
Balance as of
December 31,
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
$
6,684
$
916
$
(4,206)
$
(1,319)
$
2,075
ASSETS:
Securities, available-for-sale:
Collateral debt obligations
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 Receivables Topic of FASB ASC covering loan impairments.
Impaired loans held for sale that have a sales contract are considered a level 1 measurement.
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.
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 estimated fair
value on a nonrecurring basis through twelve months ended December 31, 2009, and the total losses
resulting from these fair value adjustments for the twelve months ended December 31, 2009:
(In thousands)
Fair Value Measurements Using
Twelve Months Ended
December 31, 2009
Assets
Impaired loans
Other real estate
d
Total Assets
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
$ —
$ —
$ —
Significant Other
Observable
Inputs
(Level 2)
$ 16,593
$ —
$ 16,593
Significant
Unobservable
Inputs
(Level 3)
$ 34,941
$ 59,190
$ 94,131
At December
31, 2009
$ 51,533
$ 59,190
$ 110,724
Total Losses
$ 23,967
$ 19,093
$ 43,060
132
PREFERRED BANK
Notes to Consolidated Financial Statements─(Continued)
The following table presents the Bank’s hierarchy for its assets measured at estimated fair
value on a nonrecurring basis through twelve months ended December 31, 2008:
(In thousands)
Fair Value Measurements Using
Assets
Impaired loans
Other real estate
d
Total Assets
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
$ —
$ —
$ —
Significant Other
Observable
Inputs
(Level 2)
$ 28,723
$ 9,723
$ 38,446
Significant
Unobservable
Inputs
(Level 3)
6,711
$
$ 25,404
$ 32,115
At December
31, 2008
$ 35,434
$ 35,127
$ 70,561
(22) Subsequent Event
Branch Closures
On February 19, 2010, the Bank closed down the operations of two of its branches located in
Chino, California and Santa Monica, California. All accounts of the Chino office were transferred
to our closest branch which is located in City of Industry, California. All accounts of the Santa
Monica office were transferred to our closest branch which is located in Century City, California.
The Bank expects to record charges of approximately $53,000 in connection with closure of these
two branches in the first quarter of 2010.
We have evaluated events and transactions occurring through the date of filing this report on
Form 10-K. Such evaluation resulted in no adjustments to the accompanying financial statements.
133
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: April 14, 2010
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/ Albert Yu
Albert Yu, Ph.D.
April 14, 2010
April 14, 2010
April 14, 2010
April 14, 2010
April 14, 2010
April 14, 2010
April 14, 2010
April 14, 2010
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
134
INDEX TO FINANCIAL STATEMENTS
Exhibit No.
Exhibit Description
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
31.1
31.2
32.1
32.2
99.1
99.2
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. (3)
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(4)
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(4)
Subsidiaries of the Registrant
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
Report of Independent Registered Public Accounting Firm
Management’s Report on Internal Control over Financial Reporting
(1)
(2)
(3)
(4)
*
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.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on May 9, 2007.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on November 7, 2008.
Denotes management contract or compensatory plan or arrangement.
135
Exhibit 21.1
SUBSIDIARIES OF THE REGISTRANT
Preferred Bank Investment and Consulting, Inc. (PBICI)
136
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: April 14, 2010
/s/ Li Yu
Li Yu
Chairman, President and Chief Executive Officer
137
Exhibit 31.2
CERTIFICATION PURSUANT TO RULE
13a-14(a) AND 15d-14(a),
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Edward J. Czajka, certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Preferred Bank;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s board of directors (or persons performing the equivalent functions):
a)
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: April 14, 2010
/s/ Edward J. Czajka
Edward J. Czajka
Executive Vice President and Chief Financial Officer
- 138 -
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, 2009 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: April 14, 2010
/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.
-95-
Exhibit 32.2
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, 2009 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: April 14, 2010
/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.
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Exhibit 99.1
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Preferred Bank:
We have audited Preferred Bank’s internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The 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.
An entity’s internal control over financial reporting is a process effected by those charged with governance,
management, and other personnel, designed to provide reasonable assurance regarding the preparation of reliable
financial statements in accordance with accounting principles generally accepted in the United States of America.
Because management’s assessment and our audit were conducted to meet the reporting requirements of Section 112
of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), our audit of the Bank’s internal control
over financial reporting included controls over the preparation of financial statements in accordance with
accounting principles generally accepted in the United States of America and with the instructions to the Federal
Financial Institutions Examination Council for Consolidated Reports of Condition and Income. An entity’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 entity;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the United States of America, and that
receipts and expenditures of the entity are being made only in accordance with authorizations of management and
those charged with governance; and (3) provide reasonable assurance regarding prevention, or timely detection and
correction of unauthorized acquisition, use, or disposition of the entity’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.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting,
such that there is a reasonable possibility that a material misstatement of the entity’s annual or interim financial
statements will not be prevented, or detected and corrected on a timely basis. As described in the accompanying
Management’s Report on Internal Control over Financial Reporting, a material weakness was identified.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated statements of financial position of the Bank and subsidiary as of December 31,
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2009 and 2008, 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, 2009. This
material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of
the 2009 consolidated financial statements, and this report does not affect our report dated April 14, 2010, which
expressed an unqualified opinion on those consolidated financial statements.
In our opinion, because of the effect of the aforementioned material weakness on the achievement of the objectives
of the control criteria, the Bank has not maintained effective internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We do not express an opinion or any other form of assurance on management’s statement referring to compliance
with laws and regulations.
/s/ KPMG LLP
Los Angeles, California
April 14, 2010
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Exhibit 99.2
April 14, 2010
Management’s Report on Internal Control over Financial Reporting
Financial Statements
Management of Preferred Bank is responsible for the preparation, integrity and fair presentation of its published
financial statements as of December 31, 2009, and for the year then ended. The consolidated financial statements of
the Preferred Bank have been prepared in accordance with accounting principles generally accepted in the United
States of America and, as such, include some amounts that are based on judgments and estimates of managements.
Internal Control over Financial Reporting
Management is responsible for establishing and maintaining effective internal control over financial reporting
presented in conformity with accounting principles generally accepted in the United States of America and
presented in conformity with such accounting principles and the instructions for the Federal Financial Institutions
Examination Council for Consolidated Reports of Condition and Income. The system contains monitoring
mechanisms and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of any internal control including the possibility of human error
and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only
reasonable effectiveness of internal control may vary over time.
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, 2009. 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.
A material weakness is a control deficiency, or combination of control deficiencies, in internal control over
financial reporting such that there is a reasonable possibility that a material misstatement of the Bank’s annual or
interim financial statements will not be prevented or detected on a timely basis. The Bank believes that a material
weakness in internal controls over financial reporting exists related to the monitoring and control activities
necessary to respond to potential risks identified in the Bank’s loan portfolio and real estate owned. Specifically,
management’s monitoring and control activities did not appropriately revise internal controls to address the risks
identified through the Bank’s risk assessment process. The risk assessment process noted that 2009 market
conditions related to the Bank’s loan portfolio and real estate owned were deteriorating at a significantly greater rate
than noted in prior years. As a result, when the accounting department was informed of this fact, internal controls
should have been revised to require more frequent updates of (a) appraisals or other value indicators, which are
significant inputs in determining the fair value of impaired loan collateral and owned real estate and, (b) qualitative
loss factors, which are significant inputs in determining the loan and lease loss allowance. However, personnel
responsible for estimating the allowance for loan losses and real estate owned did not make such revisions. In
addition, management’s review process did not detect that such controls were not appropriately revised.
Based on management’s assessment and the criteria discussed above, we have concluded that, as of December 31,
2009, internal control over financial reporting was not effective as a result of the aforementioned material weakness.
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Compliance with Laws and Regulations
Management is responsible for compliance with federal and state laws and regulations concerning dividend
restrictions and federal laws and regulations concerning loans to insiders designated by the FDIC as safety and
soundness and regulations.
Management assessed compliance by the Bank with the designated laws and regulations related to safety
and soundness. Based on this assessment, management believes that the Bank complied, in all significant respects,
with the designated laws and regulations related to safety and soundness for the year ended December 31, 2009.
/s/ Li Yu
Li Yu
Chairman, President and Chief Executive Officer
/s/ Edward J. Czajka
Edward J. Czajka
Executive Vice President & Chief Financial Officer
144