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, 2012
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. [x]
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 [x] Non-accelerated filer [ ] Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [ ] No [x]
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant,
computed by reference to the price at which the common equity was last sold as of the last business day of the
Registrant’s most recently completed second fiscal quarter (June 30, 2012) was $176,802,994.
Number of shares of common stock of the Registrant outstanding as of March 12, 2013, was 13,241,700.
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, 2012 .............................................
Part III
ii
TABLE OF CONTENTS
Page
PART I ........................................................................................................................................................ 2
BUSINESS ............................................................................................................................................. 3
ITEM 1.
ITEM 1A. RISK FACTORS .................................................................................................................................. 32
ITEM 1B. UNRESOLVED STAFF COMMENTS ................................................................................................ 42
PROPERTIES ...................................................................................................................................... 42
ITEM 2.
LEGAL PROCEEDINGS .................................................................................................................... 43
ITEM 3.
ITEM 4. MINE SAFETY DISCLOSURES ........................................................................................................ 43
PART II .................................................................................................................................................... 43
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.............................................. 43
SELECTED FINANCIAL DATA ....................................................................................................... 48
ITEM 6.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ............................................................................................................. 50
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK ............................... 77
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ..................................................... 77
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ..................................................................................................... 77
ITEM 9A. CONTROLS AND PROCEDURES ..................................................................................................... 77
ITEM 9B. OTHER INFORMATION…………………………………………………………………………… 82
PART III ................................................................................................................................................... 81
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ............................... 81
ITEM 11. EXECUTIVE COMPENSATION ......................................................................................................... 81
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED SHAREHOLDER MATTERS ................................................................................ 81
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE ............................................................................................................................... 81
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES ........................................................................ 82
PART IV ................................................................................................................................................... 83
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES ........................................................................ 83
SIGNATURES........................................................................................................................................ 131
-i-
Forward-Looking Statements
PART I
Certain matters discussed in this report may constitute forward-looking statements within the
meaning of Section 27A of 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 we operate and
projections of future performance. Such statements can generally be identified by the use of forward-
looking language, such as “is expected to,” “will likely result,” “anticipated,” “estimate,” “forecast,”
“intends to,” or may include other similar words, phrases, or future or conditional verbs such as “believes,”
“plans,” “continue,” “remain,” “may,” “will,” “would,” “should,” “could,” “can,” or similar language. Our
actual results, performance, or achievements may differ significantly from the results, performance, or
achievements expected or implied in such forward-looking statements. When considering these statements,
the reader should consider that they are subject to certain risks and uncertainties, as well as any cautionary
statements made within the report, and should also note that these statements are made as of the date of the
report and based only on information known to us at that time.
Factors causing risk and uncertainty, which could cause future results to be materially different
from forward-looking statements contained in this report as well as from historical performance, include
but are not limited to:
Regulatory decisions regarding the bank, and impact of future regulatory and governmental
agency decisions including Basel III capital standards
Adequacy of allowance for loan and lease loss estimates in comparison to actual future losses
Further realization of risk inherent in our existing construction loans
The impact of the amount of the Bank’s non-performing loans, particularly in the Bank’s existing
residential construction and residential-use sectors, by comparison with pre-recession levels
Necessity of additional capital in the future, and possible unavailability of that capital on
acceptable terms
Difficult economic and market conditions which may continue to adversely affect the Bank and
our industry
Possible loss of members of senior management or other key employees upon which the Bank
heavily relies
Natural disasters or recurring energy shortages
Variations in interest rates which may negatively affect the Bank’s financial performance
Strong competition from other financial service entities
Possibility that the Bank’s underwriting practices may prove not to be effective
Possibility that appraised property values may not hold at a level greater than the amount of the
debt they secure
Adverse economic conditions in Asia which could impact the Bank’s business adversely
Impact of the European debt crisis and the economic impact of Federal budgetary policies
Failure to attract deposits, inhibiting growth
Interruption or break in the communication, information, operating, and financial control systems
upon which the Bank relies
Potential changes in the U.S. government’s monetary policies
Environmental liability with respect to properties to which the Bank takes title
2
Negative publicity
Possible security breaches in our online banking services
These factors are further described in this Annual Report on Form 10-K within Item 1A. We do
not undertake, and we specifically disclaim any obligation to update any forward looking statements to
reflect the occurrence of events or circumstances after the date of such statements 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 (“FDIC”). We are a
member of the Federal Home Loan Bank of San Francisco (“FHLB”). At December 31, 2012, our total
assets were $1.6 billion, loans were $1.1 billion, deposits were $1.4 billion and shareholders’ equity grew
to $187.8 million. We had net earnings per share on a diluted basis of $1.78 for the year ended
December 31, 2012 as compared to net earnings of $0.93 per share for the year ended December 31, 2011.
The earnings variance from 2011 to 2012 was aided by the $25.7 million reversal of the Bank’s valuation
allowance on its deferred tax asset, compared to a $4.5 million partial reversal of deferred tax asset
valuation allowance in 2011. Net interest income before provision for credit losses increased from $53.8
million for the year ended December 31, 2011 to $61.5 million for the year ended December 31, 2012. We
recorded a provision for credit losses of $19.8 million in 2012, which was $14.1 million greater than the
provision of $5.7 million recorded in 2011, which offsets a portion of the increases in income for the year.
We continue to work diligently to reduce our levels of non-performing and adversely classified assets
which contributed significantly to our full year losses in 2010, 2009 and 2008. Evidence of the reduction of
non-performing assets can be seen in the Bank’s operating performance in 2012 and 2011. As non-
performing assets have declined, the Bank has returned to profitability.
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 into 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.
We derive our income primarily from interest received on our loan and investment securities
portfolio, 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 mostly within Southern California, to fund
our loan and investment activities.
3
We conduct operations from our main office in downtown Los Angeles, California and ten full-
service branch banking offices in Los Angeles, Orange, and San Francisco Counties (San Francisco as of
February 2013). We market our services and conduct our business primarily in Los Angeles, Orange,
Ventura, Riverside, San Bernardino and San Francisco Counties. Additionally, the Bank opened a new
branch in San Francisco, California, in February of 2013, and we are looking to further expand our services
into Northern California in the following months.
As a result of the rapid slowdown in the real estate market and deteriorating economic conditions,
the Bank incurred net operating losses in 2009 and in 2010 due to significant credit quality issues.
Although the Bank was profitable in 2011 and 2012, if general economic conditions and the real estate
market experience a decline, the Bank could suffer future losses. 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. Although management remains committed to improving credit quality in the loan portfolio,
management has also been focused on growing the Bank’s loans and deposits in light of the improvement
in the economy and the credit quality of the Bank’s loan portfolio over the past two years.
As a result of improvements in various components of our business, including the level of non-
performing assets, which were confirmed in a regulatory examination during 2012, the Consent Order
(which was entered into on March 22, 2010) was terminated and the Bank entered into a Memorandum of
Understanding (“MOU”) with both the FDIC and the California Department of Financial Institutions
(“DFI”) on May 25, 2012. Among other things, the MOU requires the Bank to maintain a Tier 1 leverage
ratio of 10% and requires the Bank to continue to reduce its adversely classified assets. As of December 31,
2012, the Tier 1 Leverage Ratio of the Bank was 11.96%, exceeding the 10% level required by the MOU
and the Bank’s classified assets to total capital ratio was within the requirement of the MOU. The Board of
Directors and management remain committed to meeting those and the other requirements of the MOU.
See “REGULATION AND SUPERVISION”
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 tab, 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 FDIC:
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 with or furnished to the FDIC pursuant to Section 13(a)
or 15(d) of the Securities Exchange Act of 1934,
Our Form 4 statements of holdings of our directors and executive officers.
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
4
construction loans and mini-permanent (“mini-perm”) loans for residential, commercial,
industrial and other income producing properties, although construction lending is no longer a
focus for new business. A portion of our real estate loans are to borrowers who are also
international trade finance customers. We do not typically market single-family residential
mortgages but provide them as an accommodation to our business customers.
Middle Market Business—consisting of manufacturing, service and distribution companies
with annual sales of approximately $5 million to $100 million and with borrowing
requirements of up to approximately $12 million. We offer a range of lending products to
customers in this market, including working capital loans, equipment financing and
commercial real estate loans. In 2011, we increased our focus on generation of working capital
and equipment financing loans. Additionally, we provide a full range of deposit products and
related services including safe deposit boxes, account reconciliation, courier service and cash
management services.
International Trade Finance—consisting of importers and exporters based in the U.S.
requiring both borrowing and operational products. We offer a full range of products to
international trade finance customers, including commercial and standby letters of credit,
acceptance financing, documentary collections, foreign draft collections, international wires
and foreign exchange.
Private Banking—consisting of wealthy individuals residing in the Pacific Rim area with
residences, real estate investments or businesses in Southern California. We offer all of our
banking products and services to this segment through our multi-lingual team of professionals
knowledgeable in the business environment and financial affairs of Pacific Rim countries. We
believe our language capabilities provide us with a competitive advantage.
Professionals—consisting generally of physicians, accountants, attorneys, business managers
and other professionals. We provide specialized personal banking services to customers in this
segment including courier service, several types of specialized deposit accounts and personal
and business loans as well as lines of credit.
We provide a fully operational traditional Internet banking system with bill pay services for these
customers.
Our Current Focus
As a result of the recession which began in 2009, we significantly curtailed making new loans as
we shifted our loan officers’ focus from production to portfolio management. Since that time, our primary
focus has been management of our existing loan portfolio, capital management and liquidity management,
especially in 2009, 2010 and 2011. In light of the significant progress made in 2011 and 2012 towards
implementation of these goals, we have refocused our efforts towards new business development and
profitable growth, and have adopted the following operating strategies:
Continue to reduce adversely classified and non-performing assets, through the continued
successful strategy of loan workouts and sales as well as sales of OREO;
Maintaining strong capital ratios, continuing to maintain capital at levels required by the
MOU.
Develop new, profitable banking relationships, by hiring new business development officers
who are developing new customer relationships.
5
Our Market
We conduct operations from our main office in downtown Los Angeles, California and 10 full-
size branch banking offices in Los Angeles and Orange Counties as of December 31, 2012. We market our
services and conduct our business primarily in Los Angeles, Orange, Ventura, Riverside and San
Bernardino counties. In February 2013, we opened a branch in San Francisco and will be working to further
expand into the Northern California market throughout 2013.
We believe that Chinese-Americans continue to be the largest Asian ethnic group in Los Angeles
County. According to the U.S. Census 2010, between 2000 and 2010, the Chinese-American population in
the United States grew by approximately 38%, with 37% of all Chinese-Americans living in California.
There were about 523,000 Chinese-Americans living in the five Southern California counties in which the
Bank conducts businesses in 2010. In San Francisco County, there were approximately 172,000 Chinese
Americans which represented 21% of the population of San Francisco County.
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-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 number of residential real estate
and 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, 2012, we had a total of $85.1 million in purchased participation
loans and $16.9 million in loans that we sold. We manage our loan portfolio to provide for an adequate
return, but also to provide for diversification of risk. Due to the recessionary environment through 2009 and
2010, we pared back originating new loans as management was more focused on managing existing loan
relationships, specifically, delinquent and non-performing loans. Although we significantly pared back
lending in those years, lending activities did not stop and beginning in 2011 we began an earnest effort to
build back the Bank’s customer base. This culminated in small loan growth in 2011 and more robust
growth in 2012.
We have historically originated our loans from our banking offices in Los Angeles and Orange
counties. For mini-perm and construction loans, we have relied on referrals from existing clients who are
6
real estate investors, owner/operators, 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 consultants.
At December 31, 2012, 79% of our loans carried interest rates that adjust with changes in the
Prime Rate, 8% carried interest rates tied to LIBOR or other indices and 13% carried a fixed rate or were
tied to CD rates. Approximately 76% of our loan portfolio has an interest rate floor.
The following table sets forth information regarding our four major loan portfolios:
Real Estate Mini Perm(3)
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, 2012
(Dollars in thousands)
$ 684,797
293
$ 2,337
61.79%
1.56x
5.31%
2.6 years
$ 74,410
15
$ 4,961
59.52%
5.75%
3.1 years
$ 324,753
474
$ 685
5.03%
2.3 years
$ 47,412
161
$ 294
4.65%
4.6 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.
(3) Real estate mini perm includes loans held for sale of $12,150.
7
We had 192 loans with outstanding principal balances between $1 million to $5 million, 49 loans
with outstanding principal balances between $5 million and $10 million, and 12 loans with outstanding
principal balances over $10 million as of December 31, 2012.
Real Estate Mini-Perm Loans
Real estate mini-perm loans are secured by retail, industrial, office, residential and residential
multi-family properties and comprise 61% of our loan portfolio as of December 31, 2012. 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 and industry concentrations. Total real estate mini-perm
loans were $684.8 million at December 31, 2012 as compared to $575.2 million as of December 31, 2011.
Net charge-offs of mini-perm loans accounted for 45.4% of our net loan charge-offs in 2012 compared to
57.3% in 2011. Excluding the land component of the portfolio, mini-perm net charge offs have accounted
for 15.7% of our net charge-offs in 2012 compared to 47.4% in 2011. We have worked to reduce the
balance of land loans in our portfolio which totaled $34.3 million and $39.2 million at December 31, 2012
and 2011, respectively, which accounted for 29.7% and 9.9% of our net charge-offs in 2012 and 2011,
respectively.
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, 2012
Amount
(Dollars in thousands)
$ 101,113
162,983
61,325
33,961
118,427
34,308
172,680
$ 684,797
Percentage of Loans in
Each Category in Total
Loan Portfolio
8.93%
14.40
5.42
3.00
10.46
3.03
15.26
60.50%
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, 2012
(In thousands)
$127,706
$63,628
$84,721
$100,899
$191,888
$115,955
$684,797
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.
8
All appraisals for loans over $250,000 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(s) or guarantor(s). This completed credit memorandum is then submitted to an officer
or committee having the appropriate authority for approval. For further information on our different levels
of authority, see “—Loan Authorizations” below.
Once a loan is approved by the appropriate authority level, loan documents are drawn by our note
department, which also funds the loan when approval conditions are met. On larger, relatively complex
transactions, loan documents are prepared or reviewed by outside legal counsel.
Underwriting Standards: Our principal underwriting standards for real estate mini-perm loans are
as follows:
Maximum LTV of 50%-85%, depending on the property type. However, our practice is to lend
at a maximum LTV of 65%.
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 $1.5
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 adversely 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 6.6% of the
total loan portfolio as of December 31, 2012 and comprised 8.0% of the portfolio as of December 31, 2011
including one construction loan held for sale at that date. Construction loans comprised 8.9% of our net
loan charge-offs during 2012. We had 16 construction loans totaling $75.9 million as of December 31,
2011, and 15 construction loans totaling $74.4 million as of December 31, 2012. 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:
9
Property Type
Commercial / Office
Retail
Industrial
For sale attached residential
For sale detached residential
Apartment 4+
Land / Special Purpose
Total
At December 31, 2012
Amount
(Dollars in thousands)
$ —
795
10,355
15,964
20,383
26,913
—
$ 74,410
Percentage of Loans in
Each Category in Total
Loan Portfolio
0.00%
0.07
0.92
1.41
1.80
2.38
0.00
6.58%
Loan Origination: The origination process for construction loans is similar to our real estate mini-
perm origination process described above under “—Real Estate Mini-Perm Loans—Loan 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 under consideration. Finally,
notwithstanding the maximum 75%-80% LTV discussed above under “—Real Estate Mini-Perm Loans—
Underwriting Standards,” we generally require a maximum 70% LTV for construction loans at origination.
Monitoring: The monitoring of construction loans is accomplished under the supervision of our
Chief Credit Officer and the credit administration department. 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 as compared to the original construction schedule. The third-party inspector also
recommends whether we should approve or disapprove disbursement request amounts based on their site
inspection and their review of the project budget. The third-party inspector produces a narrative report for
each disbursement that contains evaluation and recommendation for each project. The CCO or credit
administration 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 typically requires a deposit relationship with commercial borrowers. As of December 31, 2012, we
had $324.8 million of commercial loans outstanding, which represented 28.7% of the overall loan portfolio,
compared to $252.2 million outstanding as of December 31, 2011. This loan category has traditionally
experienced lower loss rates, particularly when compared to the loss rates on construction and land loans.
Currently, the Bank is working to grow this line of business primarily because of the additional deposit
relationships as well as the risk diversity that this portfolio brings to our overall loan portfolio which is
typically more concentrated in real estate-related loans. Lines of credit typically have a 12 month
commitment and are secured by the borrower’s assets. In cases of larger commitments, an updated
borrowing base 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.
10
Trade Finance Credits: Our trade finance portfolio totaled $47.4 million, or 4.2% of our total
loan portfolio as of December 31, 2012, compared to $49.8 million as of December 31, 2011. 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 or
exporters. This portfolio has, similar to commercial loans, performed relatively well. During 2012, trade
finance loans had overall net charge-offs of $0.2 million and comprised 86 basis points of the Bank’s 2012
net 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.
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 or trade finance 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 and trade finance 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 and trade finance loans. We also review trends in the borrower’s sales levels, gross
profit and expenses.
11
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 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.
As of December 31, 2012 and 2011, the percentage of loans secured by real estate in our total loan
portfolio was approximately 67% and 68%, respectively. Since the recession of 2008-2009 we continue to
experience a higher number of non-performing loans in these two sectors by comparison with pre-recession
levels although non-performing loans have consistently trended down over the past two years. This
heightened number of non-performing loans led to substantial loan losses and a significant increase in the
provision for loan losses beginning in 2009 and continuing through 2012, albeit at lower levels. Due to the
severe recession of 2008-2009, management is keenly aware of credit concentrations and managing such
concentrations remains a top priority.
12
Our combined construction and mini-perm real estate loans by type of collateral including loans
held for sale are as follows:
Property Type
Commercial/Office
Retail(1) (2)
Industrial
Residential 1-4
Apartment 4+
Land(3)
Special purpose(4)
Total
At December 31, 2012
Amount
(Dollars in thousands)
$ 101,113
163,778
71,680
70,308
145,340
34,308
172,680
$ 759,207
Percentage of Loans in
Each Category in Total
Loan Portfolio
8.93%
14.47
6.34
6.21
12.84
3.03
15.26
67.08%
Includes shopping centers, strip malls or stand-alone properties which house retailers.
Includes of loans held for sale of $5,000.
Includes of loans held for sale of $7,150.
(1)
(2)
(3)
(4) Examples, other than land, include hospitality and self-storage.
To manage the risks inherent in concentrations 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
85%
50%
60%
80%
75%
80%
At December 31, 2012, the weighted average LTV of our construction and commercial real estate
portfolio based on LTVs at the time of origination was 66%. 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.
13
Our construction and mini-perm real estate loans including loans held for sale by geographic
concentration are as follows.
(Dollars in thousands)
Inland
Empire
So. CA
Other CA(1)
Out of
State(2)
Total
Mini-Perm Residential
Mini-Perm Commercial
Construction Residential
Construction Commercial
Total Real Estate Loans
$ 1,216
41,457
5,543
—
$ 48,216
$ 49,485
467,162
23,617
27,708
$ 6,187 $ 2,633
39,023
—
10,356
$ 567,972 $ 91,007 $ 52,012
77,634
7,186
—
$ 59,521
625,276
36,346
38,064
$ 759,207
1) Includes mini-perm commercial loans held for sale of $5,000.
2) Includes mini-perm commercial loans held for sale of $7,150.
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 10% of our portfolio. At December 31, 2012, 4.6% of our real estate portfolio was secured by real
estate located outside of California. At December 31, 2012, the top 20 borrowing relationships of the Bank
totaled $403.1 million in loans outstanding and comprised 36% of the total loan portfolio.
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 67% of our loan
portfolio at December 31, 2012 consisted of real estate secured 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 real estate markets. At December 31, 2012, we had 253 loans in excess of
$1.0 million, totaling $968.5 million. These loans comprise approximately 24.1% of our loan portfolio
based on number of loans and 85.6% based on the total outstanding balance. Excluding credit card and
consumer overdraft lines, our average loan size is $1.2 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
outstanding as of December 31, 2012 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 with maturities over one year, an analysis with respect to fixed interest rate loans and
floating interest rate loans.
14
At December 31, 2012
Maturity
Rate Structure for
Loans Maturing
Over One Year
One Year or
Less
One through
Five Years
Over Five
Years
Total
Fixed
Rate
Floating
Rate
Real estate mini-perm* $ 127,706
Real estate-
construction
Commercial
Trade finance
Consumer
Other
50,645
182,393
40,201
99
232
$
441,136
$ 115,955
$
684,797
$ 78,118
$ 478,973
(In thousands)
23,765
117,086
7,211
—
—
—
25,274
—
—
—
74,410
324,753
47,412
99
232
—
22,740
—
—
—
23,765
119,620
7,211
—
—
Total
$ 401,276
$
589,198
$ 141,229
$ 1,131,703
$ 100,858
$ 629,569
*Includes loans held for sale of $12,150.
The following table shows the amounts of loans outstanding as of December 31, 2011, 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 with
maturities over one year, an analysis with respect to fixed interest rate loans and floating interest rate loans.
At December 31, 2011
Maturity
Rate Structure for
Loans Maturing
Over One Year
Real estate mini-perm
Real estate-
construction*
Commercial
Trade finance
Consumer
Other
One Year or
Less
One through
Five Years
Over Five
Years
Total
Fixed
Rate
Floating
Rate
$ 166,683
$
327,732
$ 80,757
$
575,172
$ 75,763
$ 332,726
(In thousands)
54,761
142,982
41,992
232
370
21,177
100,644
7,758
4
—
—
8,535
—
—
—
75,938
252,161
49,750
236
370
—
6,574
—
—
—
21,177
102,605
7,758
4
—
Total
$ 407,020
$
457,315
$ 89,292
$ 953,627
$ 82,337 $ 464,270
*Includes loans held for sale of $3,996.
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.
15
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 $1,000,000 for unsecured transactions. The
Chief Executive Officer, Chief Operating Officer and the Chief Credit Officer have combined
approval authority up to $9.0 million for loans secured by first deeds of trust and up to $7.5
million for unsecured transactions. Loans in excess of these two limits are submitted to our
Board of Directors Loan Committee for approval.
Board of Directors Loan Committee. Our Board of Directors loan committee consists of five
members of the Board of Directors and our Chief Executive Officer. It has approval authority
up to our legal lending limit, which was approximately $50.3 million for real estate secured
loans and $30.2 million for unsecured loans at December 31, 2012. The Bank has established
internal loan limits which are significantly lower than these legal lending limits. 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 poor 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 acceptable risk; whereas the
fifth grade is a short term transition grade. Loans in this category are subjected to enhanced analysis and
either demonstrate their acceptableness and are returned to an acceptable grade or are moved to a
“substandard” category should the loan’s underlying credit elements so dictate. The other three grades
range from a “substandard” category to a “loss” category. These three 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 the Credit Administration
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 (grade 5), substandard (6) or doubtful
(7), 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 Credit Administration 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.
16
Loan Delinquencies: When a borrower fails to make a committed payment, we attempt to cure the
deficiency by contacting the borrower to seek payment. Habitual delinquencies and loans delinquent 30
days or more are reviewed for possible changes in grading.
Classified Assets: Federal regulations require that each insured bank classify its assets on a regular
basis. In addition, in connection with examinations of insured institutions, examiners have authority to
identify problem assets, and, if appropriate, classify them. We use grades 6-8 of our loan grading system to
identify potential problem assets.
Purchased Loan Participations
As of December 31, 2012, the Bank had $85.1 million in loans outstanding that were purchased
from other financial institutions representing 7.6% of the loan portfolio. This is down from pre-recession
levels when the Bank had $260.7 million or 21.1% of the loan portfolio in participations purchased as of
December 31, 2007. These loans include commercial real estate, construction and commercial loans. Loan
participations comprised 26.7% of the Bank’s loan net charge-offs in 2012. The higher loss rate is primarily
due to the fact that we are unable to control monitoring of the borrower and the loan projects 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 factors mentioned
above that management believes lead to higher loss rates. In light of the performance of this part of the
portfolio, the Bank has significantly curtailed purchasing new loan participations.
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 $1.4 billion as of December 31, 2012, of which 32.9% were demand deposits,
25.6% were in savings and interest-bearing checking, 34.1% were in CD’s greater than $100,000 and 7.4%
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.
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, negotiable order
of withdrawal (NOW) and money market deposit accounts; fixed-rate, fixed maturity retail certificates of
deposit ranging in terms from 14 days to two 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 remote deposit capture service
or 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 the
17
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, 7% 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.
Historically, the Bank has accessed 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 Registry
Service, or “CDARS”. Our membership ordinarily 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. However, under the terms of the MOU, the Bank currently may
not accept brokered deposits through CDARS. As a result, the Bank’s CDARS deposit balance has
decreased to zero. Brokered deposits (including CDARS reciprocal deposits) were zero as of December 31,
2012 whereas total brokered deposits were $4.7 million as of December 31, 2011.
The Bank has a robust Contingency Funding Plan which is designed to identify potential liquidity
events, specifies monitoring requirements and also indicates steps to be taken in order to raise liquidity
levels to ensure that the Bank has sufficient liquidity. Due to the high levels of cash on hand and
marketable securities as well as ongoing monitoring and forecasting efforts, management is confident that
the Bank has sufficient liquidity to meet all of its obligations.
At December 31, 2012, excluding government deposits, brokered deposits and deposits as direct
collateral for loans, we had 57 depositors with deposits in excess of $3.0 million that totaled $444.8
million, or 32.8% 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, improve our net interest margin and enhance the franchise value of the
Bank
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 December 31, 2012, the FDIC’s Transaction Account Guarantee (“TAG”) program ended.
TAG was originally created in response to the financial crisis in 2008 and the program was renewed as part
of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The program provided for
unlimited FDIC insurance on all noninterest-bearing transaction accounts with the goal of creating stability
and confidence in the financial system in a time of great stress. With the termination of this program at
December 31, 2012, demand deposit accounts are now insured for up to $250,000. It is not expected that
the termination of this program will have a material impact on the Bank.
Other Borrowings: In the past we have also borrowed 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 no outstanding FHLB advances at December 31, 2012. We currently have $124.7 million in available
borrowing capacity at the FHLB. In addition, we have pledged $78.2 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 carried the FDIC
guarantee under its Temporary Liquidity Guarantee Program. The issuance had a 3-year maturity and a
fixed interest rate of 2.74% paid semiannually, and matured in February 2012. Under the Temporary
Liquidity Guarantee Program, the FDIC will provide a 100% guarantee of certain unsecured senior debt of
eligible FDIC-insured institutions. As of December 31, 2012, the Bank has no senior debt.
18
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; and
Provide funds for local community needs.
The total fair value and historical cost of investment securities (including both securities held-to-
maturity and securities available-for-sale) amounted to $211.7 million and $208.3 million as of December
31, 2012, respectively. Investment securities consist primarily of investment grade corporate notes,
municipal bonds, collateralized mortgage obligations, U.S. government agency securities, and U.S agency
mortgage-backed securities. 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, 2012 the Bank had one investment security as “held-to-maturity” and
classified the rest 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 are securities that we have both the intent and the ability to
hold to maturity. These securities are 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 Asset/Liability and Funds Management Policy. These securities activities
are reviewed monthly by our investment committee and are reported to our Board of Directors.
Our investment policy addresses strategies, types and levels of allowable investments and is
reviewed and approved annually (or more often, as required) 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
19
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 customers.
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, remote deposit capture
and mobile banking.
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 administered by the FDIC, and not for the benefit of shareholders.
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 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 filing 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. The Bank is subject to significant
regulation and restrictions by federal and state laws and regulatory agency. 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 (i) require affirmative action to
correct any conditions resulting from any violation or practice; (ii) direct an increase in capital and the
maintenance of higher specific minimum capital ratios, which may preclude the Bank from being deemed
well capitalized and restrict its ability to accept certain brokered deposits; (iii) restrict the Bank’s growth
geographically, by products and services, or by mergers and acquisitions, including bidding in FDIC
receiverships for failed banks; (vi) enter into informal nonpublic or formal public memoranda of
understanding or written agreements with the Bank to take corrective action; (v) issue an administrative
cease and desist order that can be judicially enforced; (vi) enjoin unsafe or unsound practices; (vii) assess
20
civil monetary penalties; and (viii) require prior approval of senior executive officers and director changes
or 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 of 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 Board of Governors of the Federal
Reserve System (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.
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 to the same extent as may a national bank, and, further, may conduct certain “financial”
activities in a subsidiary as authorized by the Gramm-Leach-Bliley Act of 1999. 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 a 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 Bank’s obligations under Community Reinvestment Act (“CRA”) to help meet the credit needs of
their communities including low-and moderate-income neighborhoods. Further, the Bank would be
required to exclude from its assets and capital all equity investments, including retained earnings, in a
financial subsidiary, and the assets of a financial subsidiary may not be consolidated with the Bank’s assets.
The Bank would also be subject to the same risk management and affiliate transaction rules that apply to
national banks with financial subsidiaries. The Bank presently has no financial subsidiaries.
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. We
cannot predict whether or when potential legislation or new regulations will be enacted, and if enacted, the
effect that new legislation or any implemented regulations and supervisory policies would have on our
financial condition and results of operations. Such developments may further alter the structure, regulation,
and competitive relationship among financial institutions, and may subject us to increased regulation,
disclosure, and reporting requirements. Moreover, the bank regulatory agencies continue to be aggressive
in responding to concerns and trends identified in examinations, and this has resulted in the increased
issuance of enforcement actions to financial institutions requiring action to address credit quality, capital
adequacy, liquidity and risk management, as well as other safety and soundness concerns. In addition, the
outcome of any investigations initiated by federal or state authorities or the outcome of litigation may result
in additional regulation, necessary changes in our operations and increased compliance costs.
21
Economic, Legislative and Regulatory Developments
From approximately December 2007 through June 2009, the U.S. economy was in recession.
Business activity across a wide range of industries and regions in the United States was greatly reduced.
Although economic conditions have improved, certain sectors, such as real estate, remain weak and
unemployment remains high. Local governments and many businesses are still experiencing difficulty due
to reduced consumer spending and continued liquidity challenges in the credit markets by comparison with
pre-recession levels. In response to the factors that triggered the recession, legislative and regulatory
initiatives were, and are expected to continue to be, introduced and implemented, which substantially
intensify the regulation of the financial services industry.
The Dodd-Frank Act
The events of the past several years have led to numerous new laws and regulatory pronouncements in the
United States and internationally for financial institutions. The Dodd-Frank Wall Street Reform and
Consumer Protection Act ("Dodd-Frank Act"), enacted in 2010, is one of the most far reaching legislative
actions affecting the financial services industry in decades and significantly restructures the financial
regulatory regime in the United States.
The Dodd-Frank Act broadly affects the financial services industry by creating new resolution authorities,
requiring ongoing stress testing of capital, mandating higher capital and liquidity requirements, increasing
regulation of executive and incentive-based compensation and requiring numerous other provisions aimed
at strengthening the sound operation of the financial services sector depending, in part, on the size of the
financial institution. Among other things, the Dodd-Frank Act provides for:
capital standards applicable to bank holding companies may be no less stringent than those applied
to insured depository institutions;
annual stress tests and early remediation or so-called living wills are required for larger banks with
more than $50 billion assets as well risk committees of its board of directors that include a risk
expert and such requirements may have the effect of establishing new best practices standards for
smaller banks;
trust preferred securities must generally be deducted from Tier 1 capital over a three-year phase-in
period ending in 2016, although depository institution holding companies with assets of less than
$15 billion as of year-end 2009 are grandfathered with respect to such securities for purposes of
calculating regulatory capital;
the assessment base for federal deposit insurance was changed to consolidated assets less tangible
capital instead of the amount of insured deposits, which generally increased the insurance fees of
larger banks, but had relatively less impact on smaller banks;
repeal of the federal prohibition on the payment of interest on demand deposits, including business
checking accounts, and made permanent the $250,000 limit for federal deposit insurance;
the establishment of the Consumer Finance Protection Bureau (the "CFPB") with responsibility for
promulgating regulations designed to protect consumers' financial interests and prohibit unfair,
deceptive and abusive acts and practices by financial institutions, and with authority to directly
examine those financial institutions with $10 billion or more in assets for compliance with the
regulations promulgated by the CFPB;
limits, or places significant burdens and compliance and other costs, on activities traditionally
conducted by banking organizations, such as originating and securitizing mortgage loans and other
financial assets, arranging and participating in swap and derivative transactions, proprietary
trading and investing in private equity and other funds; and
22
the establishment of new compensation restrictions and standards regarding the time, manner and
form of compensation given to key executives and other personnel receiving incentive
compensation, including documentation and governance, proxy access by stockholders, deferral
and claw-back requirements.
As required by the Dodd-Frank Act, federal regulators have published for comment proposed regulations to
(i) increase capital requirements on banks and bank holding companies, and (ii) implement the so-called
"Volcker Rule" of the Dodd-Frank Act, which would significantly restrict certain activities by covered
bank holding companies, including restrictions on proprietary trading and private equity investing. Final
rules are expected in 2013.
Many of the regulations to implement the Dodd-Frank Act have not yet been published for comment or
adopted in final form and/or will take effect over several years, making it difficult to anticipate the overall
financial impact on the Bank, our customers or the financial industry more generally. Individually and
collectively, these proposed regulations resulting from the Dodd-Frank Act may materially and adversely
affect the Bank's business, financial condition, and results of operations. Provisions in the legislation that
require revisions to the capital requirements of the Bank could require the Bank to seek additional sources
of capital in the future.
Federal Banking Agencies Compensation Guidelines
Guidelines adopted by the federal banking agencies pursuant to the Federal Deposit Insurance Act
(“FDI Act”) prohibit excessive compensation as an unsafe and unsound practice and describe compensation
as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an
executive officer, employee, director or principal shareholder. In June 2010, the federal bank regulatory
agencies jointly issued additional comprehensive guidance on incentive compensation policies (the
“Incentive Compensation Guidance”) intended to ensure that the incentive compensation policies of
banking organizations do not undermine the safety and soundness of such organizations by encouraging
excessive risk-taking. The Incentive Compensation Guidance, which covers all employees that have the
ability to materially affect the risk profile of an organization, either individually or as part of a group, is
based upon the key principles that a banking organization’s incentive compensation arrangements should
(i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively
identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii)
be supported by strong corporate governance, including active and effective oversight by the organization’s
Board of Directors. Any deficiencies in compensation practices that are identified may be incorporated into
the organization’s supervisory ratings, which can affect its ability to make acquisitions or perform other
actions. The Incentive Compensation Guidance provides that enforcement actions may be taken against a
banking organization if its incentive compensation arrangements or related risk-management controls or
governance processes pose a risk to the organization’s safety and soundness and the organization is not
taking prompt and effective measures to correct the deficiencies.
On February 7, 2011, the Board of Directors of the FDIC approved a joint proposed rulemaking to
implement Section 956 of Dodd-Frank for banks with $1 billion or more in assets. Section 956 prohibits
incentive-based compensation arrangements that encourage inappropriate risk taking by covered financial
institutions and are deemed to be excessive, or that may lead to material losses. The proposed rule would
move the United States closer to aspects of international compensation standards by (i) requiring deferral of
a substantial portion of incentive compensation for executive officers of particularly large institutions; (ii)
prohibiting incentive-based compensation arrangements for covered persons that would encourage
inappropriate risks by providing excessive compensation; (iii) prohibiting incentive-based compensation
arrangements for covered persons that would expose the institution to inappropriate risks by providing
compensation that could lead to a material financial loss; (iv) requiring policies and procedures for
incentive-based compensation arrangements that are commensurate with the size and complexity of the
institution; and (v) requiring annual reports on incentive compensation structures to the institution's
appropriate Federal regulatory agency. Final rules are still pending.
23
The scope, content and application of the U.S. banking regulators’ policies on incentive
compensation may continue to evolve. It cannot be determined at this time whether compliance with such
policies will adversely affect our ability to hire, retain and motivate key employees.
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 adequacy guidelines, a banking
organization’s total capital is divided into tiers. “Tier I capital” currently includes common equity and trust
preferred securities, subject to certain criteria and quantitative limits. Under Dodd-Frank depository
institution holding companies, such as the Company, with more than $15 billion in total consolidated assets
as of December 31, 2009, will no longer be able to include trust preferred securities as Tier I regulatory
capital as of the end of a three-year phase-out period in 2016, and may be obligated to replace any
outstanding trust preferred securities issued prior to May 19, 2010, with qualifying Tier I regulatory capital
during the phase-out period. “Tier II capital” includes hybrid capital instruments, other qualifying debt
instruments, a limited amount of the allowance for loan and lease losses, and a limited amount of
unrealized holding gains on equity securities. Following the phase-out period under Dodd-Frank, trust
preferred securities will be treated as Tier II capital. “Tier III capital” consists of qualifying unsecured
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-
weighted assets of 8% and a minimum ratio of Tier I capital to risk-weighted assets of 4%. An institution is
defined 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 average assets ratio is 5.00%
or more.
24
The regulatory capital guidelines as well as Preferred Bank’s actual capitalization as of December
31, 2012 are as follows:
Leverage Ratio
Preferred Bank .................................................................................................
Minimum requirement for “Well-Capitalized” institution ...............................
Minimum regulatory requirement ....................................................................
Tier 1 Risk-Based Capital Ratio
Preferred Bank .................................................................................................
Minimum requirement for “Well-Capitalized” institution ...............................
Minimum regulatory requirement ....................................................................
11.96%
5.00%
4.00%
13.73%
6.00%
4.00%
Total Risk-Based Capital Ratio
Preferred Bank ................................................................................................
Minimum requirement for “Well-Capitalized” institution ..............................
Minimum regulatory requirement ...................................................................
14.98%
10.00%
8.00%
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.
Memorandum of Understanding
As a result of improvements in components of the Bank’s operations, including a reduction in the
level of its non-performing loans, which were confirmed in a regulatory examination during 2012, the
Consent Order was terminated and the Bank entered into a Memorandum of Understanding (MOU) with
both the FDIC and the California Department of Financial Institutions (“DFI”) on May 25, 2012. Among
other things, the MOU requires the Bank to maintain a Tier 1 leverage ratio of 10% and requires the Bank
to continue to reduce its adversely classified assets. As December 31, 2012, the Tier 1 Leverage Ratio of
the Bank was 11.96%, exceeding the 10% level required by the MOU and the Bank’s classified asset levels
were lower than required by the MOU. The MOU 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. The
Board of Directors and management remain committed to maintaining the Tier 1 Leverage Ratio
requirement and meeting the other requirements of the MOU.
Prompt Corrective Action Regulations
The FDI Act provides a framework for regulation of depository institutions and their affiliates,
including parent holding companies, by their federal banking regulators. Among other things, it requires the
relevant federal banking regulator to take “prompt corrective action” with respect to a depository institution
if that institution does not meet certain capital adequacy standards, including requiring the prompt
submission of an acceptable capital restoration plan. Supervisory actions by the appropriate federal banking
regulator under the prompt corrective action rules generally depend upon an institution’s classification
within five capital categories as defined in the regulations. The relevant capital measures are the capital
ratio, the Tier 1 capital ratio, and the leverage ratio. However, the federal banking agencies have also
adopted non-capital safety and soundness standards to assist examiners in identifying and addressing
potential safety and soundness concerns before capital becomes impaired. These include 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.
A depository institution’s capital tier under the prompt corrective action regulations will depend
upon how its capital levels compare with various relevant capital measures and the other factors established
25
by the regulations. A bank will be: (i) “well capitalized” if the institution has a total risk-based capital ratio
of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or
greater and is not subject to any order or written directive by any such regulatory authority to meet and
maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a
total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a
leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has
a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a
leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based
capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less
than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than
2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a
capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or
unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters.
The FDI Act generally prohibits a depository institution from making any capital distributions
(including payment of a dividend) or paying any management fee to its parent holding company if the
depository institution would thereafter be “undercapitalized.” “Undercapitalized” institutions are subject to
growth limitations and are required to submit a capital restoration plan. The regulatory agencies may not
accept such a plan without determining, among other things, that the plan is based on realistic assumptions
and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to
submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly
undercapitalized” depository institutions may be subject to a number of requirements and restrictions,
including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce
total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized”
institutions are subject to the appointment of a receiver or conservator.
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. The appropriate federal banking
agency may, under certain circumstances, reclassify a well-capitalized insured depository institution as
adequately capitalized. The FDI Act provides that an institution may be reclassified if the appropriate
federal banking agency determines (after notice and opportunity for a hearing) that the institution is in an
unsafe or unsound condition or deems the institution to be engaging in an unsafe or unsound practice. The
appropriate agency is also permitted to require an adequately capitalized or undercapitalized institution to
comply with the supervisory provisions as if the institution were in the next lower category (but not treat a
significantly undercapitalized institution as critically undercapitalized) based on supervisory information
other than the capital levels of the institution.
Basel Accords
The regulatory agencies’ risk-based capital guidelines are based upon the 1988 capital accord
(“Basel I”) of the internal Basel Committee on Bank Supervision (“Basel Committee”), a committee of
central banks and bank supervisors/regulators from the major industrialized countries that develops broad
policy guidelines, which each country’s supervisors can use to determine the supervisory policies they
apply to their home jurisdiction. In 2004 the Basel Committee proposed a new capital accord (“Basel II”)
to replace Basel I that provided approaches for setting capital standards for credit risk and capital
requirements for operational risk and refining the existing capital requirements for market risk exposures.
U.S. banking regulators published a final rule for Basel II implementation requiring banks with over $250
billion in consolidated total assets or on-balance sheet foreign exposure of $10 billion (“core banks”) to
adopt the advanced approaches of Basel II while allowing other banks to elect to “opt in.” The regulatory
agencies later issued a proposed rule for larger banks that would give banking organizations that do not use
the advanced approaches the option to implement a new risk-based capital framework that would adopt the
standardized approach of Basel II for credit risk, the basic indicator approach of Basel II for operational
risk and related disclosure requirements. A definitive rule was not issued.
In December 2010, the Basel Committee released its final framework for strengthening
international capital and liquidity regulation, now officially identified as “Basel III.” If and when
26
implemented by the U.S. banking agencies and fully phased-in, it would require bank holding companies
and their bank subsidiaries to maintain substantially more capital than currently required, with a greater
emphasis on common equity. The Basel III capital framework, among other things:
introduces as a new capital measure, Common Equity Tier 1 (“CET1”), more commonly known in
the United States as “Tier 1 Common,” and defines CET1 narrowly by requiring that most
adjustments to regulatory capital measures be made to CET1 and not to the other components of
capital, and expands the scope of the adjustments as compared to existing regulations;
if fully phased in as currently proposed, requires covered banks to maintain: (i) a newly adopted
international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a
2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased
in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%); (ii) an
additional “SIFI buffer” for those large institutions deemed to be systemically important, ranging
from 1.0% to 2.5%, and up to 3.5% under certain conditions; (iii) a minimum ratio of Tier 1
capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is
added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a
minimum Tier 1 capital ratio of 8.5% upon full implementation); (iv) a minimum ratio of Total
(that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital
conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in,
effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and (v)
as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio
of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (as the
average for each quarter of the month-end ratios for the quarter); and
an additional “countercyclical capital buffer,” generally to be imposed when national regulators
determine that excess aggregate credit growth becomes associated with a buildup of systemic risk,
that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when
fully implemented.
The federal bank regulatory agencies issued joint proposed rules in June 2012 that would revise
the risk-based capital requirement and the method for calculating risk-weighted assets to make them
consistent with Basel III and provisions of the Dodd-Frank Act. The proposed rules would apply to all
depository institutions and top-tier bank holding companies with assets of $500 million or more. Among
other things, the proposed rules establish a new minimum common equity Tier 1 ratio (4.5% of risk-
weighted assets) and a higher minimum Tier 1 risk-based capital requirement (6.0% of risk-weighted
assets) and assigns higher risk weighting to exposures that are more than 90 days past due or are on
nonaccrual status and certain commercial real estate facilities that finance the acquisition, development or
construction of real property. The proposed rules also require unrealized gains and losses on certain
securities holdings to be included in calculating capital ratios; limit capital distributions and certain
discretionary bonus payments by financial institutions defined as systemically important, though not so
deemed by the Basel Committee, unless an additional capital conservation buffer of 0% to 1.0% of risk-
weighted assets is maintained. The proposed rules, including alternative requirements for smaller
community financial institutions like the Company, would, when finalized, be phased in through 2019. The
implementation of the Basel III framework was to commence January 1, 2013. However, due to the
number of comment letters received by the federal banking agencies in response to the notice of proposed
rulemaking, the initial implementation has been postponed indefinitely.
Dividends and Other Transfers of Funds
The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends
including the prohibitions contained in the MOU. Under such restrictions, there was no amount available
for payment of dividends at December 31, 2012. 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 MOU, we are
27
currently prohibited from paying cash dividends or any other payments to our shareholders without the
prior written consent of the FDIC and the DFI.
Deposit Insurance
The FDIC insures our customer deposits through the Deposit Insurance Fund of the FDIC up to
prescribed limits for each depositor. 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 Deposit Insurance Fund or that may prejudice
the interest of the bank’s depositors. The termination of deposit insurance for the Bank would also result in
the revocation of the Bank’s charter by the DFI.
FDIC insurance expense totaled $2.3 million for 2012. FDIC insurance expense includes deposit
insurance assessments and Financing Corporation (“FICO”) assessments related to outstanding FICO bonds
to fund interest payments on bonds to recapitalize the predecessor to the Deposit Insurance Fund. These
assessments will continue until the FICO bonds mature in 2017. The FICO assessment rates, which are
determined quarterly, ranged from 0.00160% to 0.00165% during 2012. The total FICO assessments we
paid in 2012 was $78,000.
We are generally unable to control the amount of premiums that we are required to pay for FDIC
insurance. If there are additional bank or financial institution failures or if the FDIC otherwise determines,
we may be required to pay even higher FDIC premiums than the recently increased levels. These
announced increases and any future increases in FDIC insurance premiums may have a material and
adverse effect on our earnings and could have a material adverse effect on the value of, or market for, our
common stock.
Federal Home Loan Bank System
We are a member of the 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,
2012, the Bank had no outstanding FHLB advances and borrowing capacity of $124.7 million. At
December 31, 2012, the Bank was in compliance with the FHLB’s stock ownership and cash reserve
requirements. As of December 31, 2012 and 2011, our investment in FHLB capital stock totaled
$4,282,000 and $4,164,000, respectively. Due to 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 be negatively impacted.
Securities Registration
The Bank’s common stock is publicly held and listed on the NASDAQ Global Select Market
(“NASDAQ”), and the Bank is subject to the periodic reporting information, proxy solicitation, insider
trading, corporate governance and other requirements and restrictions of the Securities Exchange Act of
1934 as adopted by the FDIC and the regulations of the Securities and Exchange Commission (the “SEC”)
promulgated thereunder as well as listing requirements of NASDAQ. Dodd-Frank includes the following
provisions that affect corporate governance and executive compensation, which are or, in the future, may
be applicable to the Bank: (1) shareholder advisory votes on executive compensation, (2) executive
compensation “clawback” requirements for companies listed on national securities exchanges in the event
of materially inaccurate statements of earnings, revenues, gains or other (3) enhanced independence
requirements for compensation committee members, and (4) SEC authority to adopt proxy access rules
which would permit shareholders of publicly traded companies to nominate candidates for election as
director and have those nominees included in a company’s proxy statement.
28
The Sarbanes-Oxley Act
The Bank is subject to the accounting oversight and corporate governance requirements of the
Sarbanes-Oxley Act of 2002, including among other things, required executive certification of financial
presentations, requirements for board audit committees and their members, and disclosure of controls and
procedures and internal control over financial reporting.
Federal Reserve System
The FRB requires all depository institutions to maintain reserves, which earned interest at an
annual rate of 0.25% as of December 31, 2012 at specified levels against their transaction accounts
(primarily checking, NOW and Super NOW checking accounts) and non-personal time deposits. As of
December 31, 2012 and 2011, we were in compliance with these requirements as established by the Federal
Reserve Bank to maintain reserve balances of $3.1 million and $1.0 million, respectively.
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 state chartered bank. At December 31,
2012, the Bank’s largest single lending relationship had a combined outstanding balance of $47.6 million,
secured predominantly by commercial real estate properties in the Bank’s lending area, and which is
performing in accordance with the 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 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
29
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.
Operations and Consumer Compliance
The Bank must comply with numerous federal anti-money laundering and consumer privacy and
protection statutes and implementing regulations, including the Consumer Financial Protection Act of
2010, which constitutes part of the Dodd-Frank Act and establishes the CFPB, as described above, the USA
PATRIOT Act of 2001, the Bank Secrecy Act, the Foreign Account Tax Compliance Act, effective in
2013, the CRA, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions
Act, the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Fair
Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National
Flood Insurance Act, the Americans with Disabilities Act and various federal and state privacy protection
laws.
The CFPB is an independent entity within the Federal Reserve. It has broad rulemaking,
supervisory and enforcement authority over consumer financial products and services, including deposit
products, residential mortgages, home-equity loans and credit cards, and contains provisions on mortgage-
related matters such as steering incentives, determinations as to a borrower’s ability to repay and
prepayment penalties. The CFPB’s functions include investigating consumer complaints, conducting
market research, rulemaking, supervising and examining banks consumer transactions, and enforcing rules
related to consumer financial products and services.
These laws and regulations mandate certain disclosure and other requirements and regulate the
manner in which financial institutions must deal with customers when taking deposits, making loans,
collecting loans, and providing other services. Failure to comply with these laws and regulations can
subject the Bank to various penalties, including but not limited to enforcement actions, injunctions, fines or
criminal penalties, punitive damages to consumers, and the loss of certain contractual rights. The Bank is
also subject to federal and state laws prohibiting unfair or fraudulent business practices, untrue or
misleading advertising and unfair competition.
Employees
As of December 31, 2012, the Bank had a total of 133 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.
30
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 ........................
[72]
Chairman of the Board and Chief Executive Officer
Wellington Chen ......
[53]
President and Chief Operating Officer
Edward J. Czajka ......
[48]
Executive Vice President and Chief Financial Officer
Lucilio Couto ...........
[44]
Executive Vice President and Chief Credit Officer
Robert Kosof ............
[69]
Executive Vice President and Head of Commercial and Industrial Loans and
Regional Branch Manager
(1) As of March 1, 2013.
Li Yu has been our 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.
Wellington Chen has been the Bank’s Senior Executive Vice President since June 22, 2011 and
was promoted to President on August 21, 2012, and has been the Bank’s Chief Operating Officer since
August 9, 2011. Prior to joining Preferred Bank, Mr. Chen was Executive Vice President and Director of
Corporate Banking for East-West Bank in Pasadena, California where he oversaw a significant portion of
the loan and deposit production activities. Prior to that, he was Senior Executive Vice President and a
Director of Far East National Bank in Los Angeles.
Edward J. Czajka has been Senior Vice President and Chief Financial Officer since 2006 and
was promoted to Executive Vice President since 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,
(Nasdaq: NOVB) a publicly-traded multi-bank holding company located in Redding, California. From
1994 through 2000, Mr. Czajka held the position of Vice President, Corporate Controller for Pacific Capital
Bancorp in Santa Barbara, California. Mr. Czajka graduated summa cum laude from Capella University
with a BS in Business Administration and is a graduate of the Bank Administration Institute Graduate
School of Banking at Vanderbilt University.
Lucilio Couto was appointed Executive Vice President on February 2, 2010 and on August 9,
2011 was appointed Chief Credit Officer. Prior to that, he was Senior Vice President and Special Assistant
to the Chairman. 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 as Senior Risk Management
Examiner. He has expertise in risk management, regulatory compliance, credit analysis and financial
statement analysis. Mr. Couto received his Bachelor’s degree of finance from California State University
San Bernardino in 1991 and graduated from the University of Wisconsin’s Graduate School of Banking in
2004.
31
Robert Kosof was 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.
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 and as adopted by the FDIC (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 Accounting and
Securities Disclosure Section, Division of Supervision and Consumer Protection, 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.
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 subject to certain requirements and prohibitions under the MOU and we cannot assure
you whether or when the MOU will be terminated.
The Bank has been subject to the MOU since May 2012, which required us to maintain a higher
tier 1 leverage capital ratio than statutorily required and to improve asset quality among other items. The
MOU 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.
As of the date of this filing, we are in compliance with all the requirements of the MOU. We will
continue to work to maintain compliance with all provisions of the MOU. Although we are in compliance
with the provisions of the MOU, we cannot assure that we will maintain full compliance with the
requirements in the MOU and whether or when the MOU will be terminated. Although the requirements
and restrictions of the MOU are not judicially enforceable, the Bank is committed to comply with all
provisions of the MOU and to maintain good relations with our regulators.
If our allowance for loan and lease losses is inadequate to cover actual losses, our financial
results would be harmed.
32
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 were incurred between 2008 and 2012, 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 reversal of the recent gains made 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, 2012, we recorded a provision for loan and lease losses and net loan charge-
offs of $19.8 million and $22.9 million, respectively, compared to $5.7 million and $14.9 million for the
year ended December 31, 2011.
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 but 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, 2012, our construction loans were $74.4 million, or 6.6% of our total loans held,
and the average loan size of our construction loans was $5.0 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 was a significant source of our
loan losses incurred in 2009 and 2010.
The impact of the new Basel III capital standards will likely impose enhanced capital adequacy
standards on us.
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the
Basel Committee, announced agreement on the calibration and phase-in arrangements for a strengthened
set of capital requirements, known as Basel III, which were approved in November 2010 by the G20
leadership. Basel III increases the minimum Tier 1 common equity ratio to 4.5%, net of regulatory
deductions, and introduces a capital conservation buffer of an additional 2.5% of common equity to risk-
weighted assets, raising the target minimum common equity ratio to 7%. Basel III increases the minimum
Tier 1 capital ratio to 8.5% inclusive of the capital conservation buffer, increases the minimum total capital
33
ratio to 10.5% inclusive of the capital buffer and introduces a countercyclical capital buffer of up to 2.5%
of common equity or other fully loss absorbing capital for periods of excess credit growth. Basel III also
introduces a non-risk adjusted Tier 1 leverage ratio of 3%, based on a measure of total exposure rather than
total assets, and new liquidity standards. The Basel III capital and liquidity standards will be phased in over
a multi-year period. Although the liquidity requirements will not, in their present form, apply to us, the
Federal Reserve will likely implement changes to the capital adequacy standards applicable to us which
will increase our capital requirements and compliance costs.
Additional requirements imposed by the Dodd-Frank Act could adversely affect us.
Recent government efforts to strengthen the U.S. financial system have resulted in the imposition of
additional regulatory requirements, including expansive financial services regulatory reform legislation.
Dodd-Frank sets out sweeping regulatory changes. Changes imposed by Dodd-Frank include, among
others: (i) new requirements on banking, derivative and investment activities, including modified capital
requirements, the repeal of the prohibition on the payment of interest on business demand accounts, and
debit card interchange fee requirements; (ii) corporate governance and executive compensation
requirements; (iii) enhanced financial institution safety and soundness regulations, including increases in
assessment fees and deposit insurance coverage; and (iv) the establishment of new regulatory bodies, such
as the Bureau of Consumer Financial Protection. Certain provisions are effective immediately; however,
much of the Financial Reform Act is subject to further rulemaking and/or studies. As such, while we are
subject to the legislation, we cannot fully assess the impact of Dodd-Frank until final rules are
implemented.
Current and future legal and regulatory requirements, restrictions and regulations, including those
imposed under Dodd-Frank, may adversely impact our profitability and may have a material and adverse
effect on our business, financial condition, and results of operations, may require us to invest significant
management attention and resources to evaluate and make any changes required by the legislation and
accompanying rules and may make it more difficult for us to attract and retain qualified executive officers
and employees.
Difficult economic and market conditions have adversely affected our industry and us.
During 2008-2010, dramatic declines in the housing market, with decreasing home prices and
increasing delinquencies and foreclosures, 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 economy have resulted in decreased lending by
financial institutions to their customers and to each other. This 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 2011 and 2012 saw national and local
economic conditions improve, a weak housing market and elevated unemployment levels continue to be a
drag on the economy. 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.
34
• The classification of our criticized loans as 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 Southern California. Adverse economic
conditions in this region in particular could impair borrowers’ ability to service their loans, decrease
the level and duration of deposits by customers, and 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.
As of December 31, 2012, approximately 67% 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
non-performing loans in recent years. However, total non-performing loans decreased to $26.1 million at
December 31, 2012 from $47.5 million at December 31, 2011 and $101.9 million at December 31, 2010,
representing 1.7%, 5.0% and 11.1% of total loans owned at December 31, 2012, December 31, 2011 and
December 31, 2010, respectively. Total non-performing assets decreased to $47.3 million at December 31,
2012 from $85.5 million at December 31, 2011 and $155.5 million at December 31, 2010, representing
3.0%, 6.5% and 12.4% of total assets at December 31, 2012, December 31, 2011 and December 31, 2010,
respectively.
Declines in 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 estate 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 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 and Chief Executive Officer. Mr. Yu, who founded the Bank, 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.
35
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
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. Although management measures the impact of changing
interest rates on the Bank’s net interest income and believes that current interest rate risk is low,
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.
36
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 unions, 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, verification of liquid assets and any other information deemed relevant.
Although we believe that our underwriting criteria are appropriate for the types of loans we make, we
cannot assure you that they will be effective in mitigating all risks. If our 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.
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
37
an unfavorable global economic condition may among other things adversely impact the Asian economies.
We generally do not loan to customers or take collateral located outside of Southern California. However,
if Asian economic conditions should deteriorate, we could experience an outflow of deposits by our
Chinese-American customers. In addition, adverse economic conditions could prevent or delay these
customers from meeting their obligations to us. This may adversely impact the recoverability of
investments with or loans made to these customers. Adverse economic conditions may also negatively
impact asset values and the profitability and liquidity of companies operating in Asia, which will also
impact the Bank’s liquidity.
At December 31, 2012, approximately $47.4 million, or 4.2%, 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 products and services. 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 planning to continue to grow the balance sheet, we intend to seek additional
deposits by continuing to establish and strengthen our personal relationships with our customers and by
offering deposit products that are competitive with those offered by other financial institutions in our
markets. Although we are confident that our liquidity is sufficient, we cannot assure you that our liquidity
management 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 to a certain degree on large certificates of deposits (over $250,000) 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.
Our average jumbo deposit customer has been a customer of the Bank for over six years which
indicates that these are long-term customers who consistently renew their CDs with the Bank. At December
31, 2012, we held $208.0 million of Jumbo CDs, representing 15.3% of total deposits. These deposits are
considered by the banking industry to be volatile and could be subject to withdrawal. Withdrawal of a
material amount of such deposits would adversely impact our liquidity, profitability, business, financial
condition, results of operations and cash flows.
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,
38
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, implemented 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 2008-2009, 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 due to high levels of adjustable rate
loans. It is not possible to predict the nature or effect of future changes in monetary and fiscal policies.
In addition to the MOU, 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 MOU, 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 not for the protection of shareholders of bank holding
companies or banks. Perennially, various laws, rules and regulations are proposed which, if adopted, could
impact our operations by making compliance much more difficult or expensive, restricting our ability to
originate or sell loans or further restricting the amount of interest or other charges or fees earned on loans
or other products. We cannot assure you that these proposed laws, rules and regulations or any other laws,
rules or regulations will not be adopted in the future, which could make compliance much more difficult or
expensive, restrict our ability to originate loans, further limit or restrict the amount of commissions, interest
or other charges earned on loans originated by us or otherwise adversely affect our business, financial
condition, results of operations or cash flows.
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.
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
39
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 MOU, we are prohibited from paying cash dividends or any other payments to
our shareholders.
Under the terms of the MOU, 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.
40
The price of our common stock may be volatile or may decline.
The trading price of our common stock has fluctuated and may in the future fluctuate widely as a
result of a number of factors, many of which are outside our control. In addition, the stock market is subject
to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many
companies. These broad market fluctuations could adversely affect the market price of our common stock.
Among the factors that could affect our stock price are:
Actual or anticipated quarterly fluctuations in our operating results and financial condition;
Changes in revenue or earnings estimates or publication of research reports and
recommendations by financial analysts;
Failure to meet analysts’ revenue or earnings estimates;
Speculation in the press or investment community;
Strategic actions by us or our competitors, such as acquisitions or restructurings;
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 two years. 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.
41
We could be liable for breaches of security in our online banking services. Fear of security
breaches could limit the growth of our online services.
We offer various Internet-based services to our clients, including online banking services. The
secure transmission of confidential information over the Internet is essential to maintain our clients’
confidence in our online services. Advances in computer capabilities, new discoveries or other
developments could result in a compromise or breach of the technology we use to protect client transaction
data. In addition, individuals may seek to intentionally disrupt our online banking services or compromise
the confidentiality of customer information with criminal intent. Although we have developed systems and
processes that are designed to prevent security breaches and periodically test our security, failure to
mitigate breaches of security could adversely affect our ability to offer and grow our online services, result
in costly litigation and loss of customer relationships and could have an adverse effect on our business.
Our controls and procedures could fail or be circumvented.
Management regularly reviews and updates our internal controls, disclosure controls and
procedures and corporate governance policies and procedures. Any system of controls, however well
designed and operated, is based in part on certain assumptions and can provide only reasonable, but not
absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these
controls have been met. Any failure or circumvention of our controls and procedures, and any failure to
comply with regulations related to controls and procedures could adversely affect our business, results of
operations and financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
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, 2012, we maintained ten full-service branch offices in Alhambra, Arcadia,
Century City, City of Industry, Diamond Bar, Los Angeles, Pico Rivera, Torrance, Anaheim, and Irvine,
California all of which we lease, except the Irvine branch which we own. On November 26, 2012 we
announced that we had received regulatory approval to open a new branch office in San Francisco,
California. This branch subsequently opened on February 6, 2013. 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 $1.6 million for the year ended December 31, 2012 and $1.7 million for December
31, 2011.
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, and includes the San Francisco branch opened on February 6, 2013.
42
Location
Address
Current
Lease Term
Expiration
Date
Square
Footage
Total Deposits
at
December 31,
2012
(in thousands)
Los Angeles County
Alhambra
Arcadia
Century City
City of Industry
Diamond Bar
Los Angeles (Head Office & branch)
Pico Rivera
Torrance
Orange County
Anaheim
Irvine (Owned Branch Premises)
Northern California
San Francisco
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.
21615 Hawthorne Boulevard, Suite 100
05/31/19
02/01/14
06/30/16
03/14/15
11/30/16
08/31/20
02/10/19
06/30/16
6,000
2,600
4,416
5,610
3,440
22,627
2,850
4,800
$214,611
94,173
98,801
134,717
91,536
477,160
20,602
142,581
1055 N. Tustin Avenue
890 Roosevelt Avenue
7/15/18
N/A
2,750
4,960
23,684
59,662
600 California Street, Suite 550
12/19/17
3,679
—
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. MINE SAFETY DISCLOUSRES
Not applicable
(cid:1)(cid:3)(cid:4)(cid:5)(cid:6)(cid:7)(cid:7)
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is listed on the NASDAQ Global Select Market under the symbol “PFBC.” Our
common stock closed at $16.43 on March 12, 2013 and there were 13,241,700 outstanding shares of our
common stock on that date. The number of shares and per share data has been adjusted to reflect our June
17, 2011 one-for-five reverse stock split.
43
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:
2011
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
2012
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
High
$10.50
$9.00
$9.50
$8.29
$12.49
$13.36
$14.50
$14.57
Low
$ 7.10
$ 7.10
$ 7.00
$ 7.20
$ 7.40
$ 11.16
$ 10.52
$ 12.95
Cash
Dividends
Declared
*
*
*
*
*
*
*
*
*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 March 12, 2013, 13,241,700 shares of the Bank’s common stock were held by 117
shareholders of record.
Reverse Stock Split
At the May 24, 2011 Annual Meeting of Shareholders, the shareholders of the Bank approved the
proposal to authorize the Board of Directors in its discretion, without further authorization of the Bank’s
shareholders, to amend the Bank’s Articles of Incorporation to effect a reverse split of the Bank’s common
stock by a ratio of one for five (“Reverse Stock Split”). Pursuant to Section 697 of the California Financial
Code, the approval of the Reverse Stock Split was also subject to receipt of an Order of Exemption from
the California Department of Financial Institutions, which the Bank received on June 17, 2011. Upon
receipt of the Order of Exemption, the Bank’s Board of Directors amended the Bank’s Articles of
Incorporation to reflect the effect of the Reverse Stock Split of the Bank’s common stock effective with
respect to the shareholders of record at the close of business on June 17, 2011 (the “Effective Time”). At
the Effective Time every five shares of Preferred Bank’s pre-split common shares automatically were
converted into one post-split share. The Reverse Stock Split affected all holders of common stock
uniformly and did not affect any shareholder’s percentage ownership interest in the Bank, except record
holders of common stock otherwise entitled to a fractional share as a result of the Reverse Stock Split
received a cash payment in lieu of such fractional share in a proportional amount based on the closing price
of the common stock on the NASDAQ Stock Exchange at the Effective Time. Under the terms of the
Bank’s equity incentive plans, at the Effective Time, the number of shares reserved for issuance under the
plans was proportionately decreased in accordance with the exchange ratio. Under the terms of the options
granted under the plans, at the Effective Time, the number of shares covered by each option decreased and
the conversion or exercise price per share increased in accordance with the exchange ratio. After giving
effect to the Reverse Stock Split, we have retroactively adjusted the number of common shares outstanding
at December 31, 2010 and 2009 to 13,188,305 and 3,153,425, respectively. Accordingly, all references in
the accompanying consolidated statements of financial condition, statements of operations and statements
of changes in shareholders’ equity to the number of common stock shares and earnings per share amounts
have been retroactively adjusted for all periods presented. The number of authorized common shares
remains at 20,000,000 subsequent to the Reverse Stock Split.
44
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 MOU, 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 began paying dividends on a quarterly basis in the
first quarter of 2005, subject to regulatory, capital and contractual constraints. Our ability to pay dividends
going forward will be partially determined by the FDIC and DFI as it relates to the MOU. With the
eventual termination of the MOU, dividend payments 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 1132 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 1133 of the California Financial Code provides that notwithstanding the
provisions of Section 1132, 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
There were no sales of unregistered securities in 2012.
Issuer’s Purchases of Equity Securities.
No repurchases of the Bank’s common stock were made by or on behalf of the Bank in 2012.
45
Securities Authorized for Issuance Under Equity Compensation Plans.
The following table provides information as of December 31, 2012, 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)
505,239
—
505,239
Weighted average
exercise price of
outstanding
options
(b)
$23.25
—
Number of securities
available for future
issuance under equity
compensation plans
excluding securities
reflected in column (a)
(c)
731,676
—
731,676
The shares data reflected above has been adjusted to reflect our June 2011 one-for-five stock split;
and shares under the 2004 Equity Plan available as a result of the Bank’s tender offer and repurchase of
certain options on October 29, 2010.
46
Stock Perf
formance Gra
aph
The followi
on the market
ning December
included in eit
on the cumula
ence between t
and may not be
ing graph show
price of the co
r 31, 2007 assu
ther of these in
ative amount of
the share price
indicative of p
ws a compariso
ommon stock a
uming an inves
dices. Total sh
f dividends for
at the beginnin
possible future
on of sharehold
assuming the re
stment of $100
hareholder retur
a given period
ng and at the en
performance o
der return on th
einvestment of
in each as of D
rn for the Bank
d (assuming div
nd of the perio
of the common
he Bank’s comm
f dividends, for
December 31, 2
k, as well as fo
vidend reinves
od. This graph i
n stock.
based
beginn
is not
based
differe
only a
mon stock
r the period
nk
2007. The Ban
or the indices, i
is
e
stment) and the
is historical
Total Re
eturn Perfo
ormance
Preferred B
Bank
NASDAQ C
Composite
NASDAQ B
Bank
SNL Bank a
and Thrift
15
50
12
25
10
00
75
7
50
5
25
2
e
u
l
a
V
x
e
d
n
I
0
12/31/07
1
12/31/08
12/31/0
09
12/
/31/10
12/31/11
2
12/31/12
Index
Preferred
NASDAQ
NASDAQ
SNL Ban
d Bank
Q Composite
Q Bank
nk and Thrift
12/3
1/07
12/3
31/08
12
2/31/09
12/31/10
1
12/31/11
12/31/12
10
10
10
10
0.00
0.00
0.00
0.00
24.09
60.02
78.46
57.51
7.32
87.24
65.67
56.74
7.15
103.08
74.97
63.34
6.06
102.26
67.10
49.25
11.54
120.42
79.64
66.14
Period Ending
P
47
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, 2012 and 2011 and our statement of operations
data for the years ended December 31, 2012, 2011 and 2010 have been derived from our audited historical
financial statements included elsewhere in this Form 10-K.
2012
At or for the Year Ended December 31,
2010
2011
2009
2008
Financial Condition Data:
Total assets
Total deposits
Investment securities held-to-maturity
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 income (loss) after
provision for loan and lease losses
Noninterest income
Noninterest expense
Income (loss) before provision for
income taxes
(Benefit) provision for income taxes
Net income (loss)
Accretion of beneficial conversion
feature
Income allocated to participating
securities
Net income (loss) available to
common shareholders
(Dollars in thousands, except per share data)
$ 1,554,856
1,357,527
979
$ 1,309,797
1,117,953
3,021
$ 1,255,866
1,081,265
—
$ 1,306,781
1,160,412
—
$ 1,483,231
1,257,323
—
210,742
1,131,703
151,995
28,280
187,838
166,083
953,627
142,466
37,577
158,048
183,269
915,410
108,233
53,268
141,334
114,464
1,043,299
68,071
59,190
85,374
104,406
1,231,232
69,586
35,127
137,491
$ 61,542
7,783
53,759
19,800
33,959
3,508
34,178
$ 53,790
10,303
43,487
5,700
37,787
2,790
33,392
$ 52,088
14,822
37,266
16,550
20,716
2,807
41,037
$ 58,876
22,812
36,064
71,250
(35,186)
6,476
51,953
3,289
(20,583)
$ 23,872
7,185
(5,049)
$ 12,234
(17,514)
(704)
$ (16,810)
(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)
—
—
(25,600)
—
—
(323)
(195)
—
—
—
$ 23,549
$ 12,039
$ (42,410)
$ (72,535)
$ (5,012)
48
2012
At or for the Year Ended December 31,
2010
2009
2011
2008
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)
$ 1.80
$ 0.93
$ (6.21)
$ (31.49)
$ (0.10)
$ 1.78
$ 14.19
13,234,608
$ 0.93
$ 11.95
13,220,955
$ (6.21)
$ 10.72
13,188,305
$ (31.49)
$ 27.05
3,153,425
$ (2.55)
$ 70.45
1,951,041
13,050,559
12,995,525
6,829,734
2,303,629
1,958,172
13,247,389
12,995,525
6,829,734
2,303,629
1,962,078
$ 1,426,053
1,367,496
178,257
$1,237,034
1,192,942
148,817
$1,343,450
1,276,478
127,289
$ 1,440,279
1,357,385
129,959
$ 1,506,228
1,444,340
149,635
1.67%
0.99%
(1.25)%
(5.04)%
(0.33)%
13.39
12.08
3.96
59.68
8.22
12.07
3.69
72.16
(13.21)
11.25
2.98
102.41
(55.81)
6.53
2.72
122.13
(3.35)
9.27
3.62
63.26
2.31%
4.98%
11.13%
13.89%
5.42%
3.50
6.49
12.30
15.62
6.87
1.84
2.50
3.60
4.10
2.19
78.82
49.98
32.30
29.55
40.33
2.25
1.65
2.71
4.76
1.52
(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.
The net loss available to common shareholders was $6.21 per common share for year ended December 31, 2010, and included
$3.75 loss per share due to the recognition of the intrinsic value of the beneficial conversion feature of the preferred stock.
(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 non-accrual and loans past due 90 days or more and restructured debt.
(9) Non-performing assets consist of non-performing loans and other real estate owned.
(10) Adjusted to reflect 1-for-5 stock split, effective on June 2011.
49
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, 2012 and 2011, and the
results of operations for the years ended December 31, 2012, 2011 and 2010. 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 June 2011
one-for-five stock split, and the conversion of preferred stock to common shares in August 2010.
Overview
We experienced fairly significant growth in assets, loans, deposits and net income in 2012.
Although the national economy is still recovering from the recession, the housing market gained some
strength during 2012 and the monthly job gains have also improved over the course of the year. During
2012, the Bank posted a high level of net income due primarily to the release of the Bank’s valuation
allowance on its deferred tax asset. Pre-tax income was severely hampered by the $14.5 million provision
for loan losses the Bank recorded in the second quarter of 2012 which related to two large credits. Other
noteworthy accomplishments of 2012 include:
Our net interest margin increased due to a number of factors; a decrease in the Bank’s
cost of funds (including demand deposit accounts) from 0.91% in 2011 to 0.62% in 2012,
and an increase in average earning assets from $1.19 billion in 2011 to $1.37 billion in
2012.
The level of non-performing loans decreased significantly from $47.5 million at
December 31, 2011 to $26.1 million at December 31, 2012.
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, 2012, the Bank recorded net income of $23.9 million as
compared to net income of $12.2 million for 2011. Pre-tax income in 2012 was only $3.3 million due
mainly to the $14.5 million provision for loan losses recorded in the second quarter of 2012. However, the
Bank released its valuation allowance on its deferred tax asset in the first quarter which resulted in a tax
benefit for the year of $20.6 million. See —“Results of Operations”.
For the year ended December 31, 2011, the Bank recorded net income of $12.2 million as
compared to a net loss of $16.8 million for December 31, 2010. The return to profitability in 2011 is
primarily due to a significant decrease in the provision for loan losses, and OREO related expenses, a
partial reversal of the valuation allowance on deferred tax asset and an increase in our net interest margin as
a result lower non-accrual loans in 2011. See —“Results of Operations”.
Regulatory Matters
Memorandum of Understanding (MOU)
As a result of a improvements in components of the Bank’s operations, including the level of
adversely classified assets, which were confirmed in a regulatory examination during 2012, the Consent
Order (which was entered into on March 22, 2010) was terminated and the Bank entered into an MOU with
both the FDIC and the California Department of Financial Institutions (“DFI”) on May 25, 2012. Among
50
other things, the MOU requires the Bank to maintain a tier 1 leverage ratio of 10% and requires the Bank to
continue to reduce its adversely classified assets. At December 31, 2012, the Tier 1 Leverage Ratio of the
Bank was 11.96%, exceeding the level required by the MOU and the Bank’s classified asset levels had
been reduced to a level below that required by the MOU. The Board of Directors and management remain
committed to maintaining these requirements and meeting the other requirements of the MOU.
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 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, non-accrual
and adversely classified loans and leases, trends in volume and terms of loans and leases, levels and trends
in credit concentrations, effects of changes in underwriting standards, policies, procedures and practices,
national and local economic trends and conditions, changes in capabilities and experience of lending
management and staff and other external factors including industry conditions, competition and regulatory
requirements.
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.
Other Real Estate Owned (OREO)
Upon acquisition, OREO is stated at the 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. Based on appraisals obtained
every 6-12 months, valuation allowance is established for any subsequent declines in value through a
51
charge to earnings, on an individual basis by property. Operating expenses of such properties, net of related
income, and gains and losses on their disposition are included in noninterest income or expense, as
appropriate.
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
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. The fair values of investment
securities are generally determined by reference to market prices obtained from an independent external
pricing service. In obtaining such valuation information from third parties, we have evaluated the
methodologies used to develop the resulting fair values. The procedures include, but are not limited to,
initial and on-going review of third party pricing methodologies, review of pricing trends, and monitoring
of trading volumes. We ensure whether prices received from independent brokers represent a reasonable
estimate of fair value through the use of external cash flow model developed based on spreads, and when
available, market indices. As a result of this analysis, if we determine there is a more appropriate fair value
based upon the available market data, the price received from the third party maybe adjusted accordingly.
Management reviews the fair value of investment securities on a monthly basis for reasonableness. In
addition, management has a separate fixed income broker/dealer review the fair values received from the
pricing service on a quarterly basis as an additional control over the process of determining fair values. 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 we will recover the cost basis of the
investment. This assessment requires us to assert we have 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
52
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 deferrals, defaults and recoveries.
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, 2012. Investment securities are discussed in more detail in
Note 2 to the Bank’s consolidated financial statements presented elsewhere in this report.
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”
Results of Operations
The following tables summarize key financial results for the periods indicated:
Year Ended December 31,
2011
2010
2012
(Dollars in thousands, except per share data)
Net income (loss)
Net income (loss) per share, basic(1)
Net income (loss) per share, diluted(1)
Return on average assets
Return on average shareholders’ equity
$ 23,872
$ 1.80
$ 1.78
1.67%
13.39%
$ 12,234
$ 0.93
$ 0.93
0.99%
8.22%
$ (16,810)
$ (6.21)
$ (6.21)
(1.25)%
(13.21)%
(1) Adjusted to reflect 1-for-5 reverse stock split effective June, 2011.
53
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Statement of Operations Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest income (loss) after provision for loan and lease
losses
Noninterest income
Noninterest expense
Income (loss) before income taxes
Income tax benefit
Net income (loss)
Income allocated to participating securities
Net income (loss) available to common shareholders
Year Ended December 31,
2012
2011
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 61,542
7,783
53,759
19,800
33,959
3,508
34,178
3,289
(20,583)
$ 23,872
(323)
$ 23,549
$ 53,790
10,303
43,487
5,700
37,787
2,790
33,392
7,185
(5,049)
$ 12,234
(195)
$ 12,039
$ 7,752
(2,520)
10,272
14,100
(3,828)
718
786
(3,896)
(15,534)
$ 11,638
(128)
$ 11,510
Net income (loss) per share, basic
Net income (loss) per share, diluted
$ 1.80
$ 1.78
$ 0.93
$ 0.93
$ 0.87
$ 0.85
The Bank’s net income increased to $23.9 million, or $1.78 per diluted share, for the year ended
December 31, 2012, from a net income of $12.2 million, or $0.93 per diluted share, for the year ended
December 31, 2011. Our return on average assets was 1.67% and return on average shareholders’ equity
was 13.39% for the year ended December 31, 2012, compared to 0.99% and 8.22%, respectively, for the
year ended December 31, 2011.
Net income increased from 2011 to 2012, principally as a result of income tax benefit resulting
from the full reversal of the valuation allowance on the deferred tax asset during 2012. While net interest
income increased by $10.3 million, this was offset by an increase in provision for credit losses during 2012
resulting in a decrease in net income before income taxes of $3.9 million.
The $10.3 million, or 23.6%, increase in net interest income was due primarily to lower rates paid
on deposits and lower levels of non-accrual loans. Our overall cost of funds in 2012 decreased by 32 basis
points to 0.89%, compared to 1.21% for 2011 while average yields on earning assets decreased by 2 basis
points to 4.53% from 4.55%. The impact of the low interest rate environment in 2012 was the primary
driver of our decreased cost of funds during 2012 as higher-rate CD’s continue to mature and renew at
lower rates. Yield on earning assets remained relatively constant, with the slight decrease primarily due to
lower average yields on investments during the year, offset by a higher average interest rate on loans.
As of December 31, 2012, 79% of our loan portfolio was tied to the Prime Rate, which has the
potential to re-price daily, and 8% was tied to the London Interbank Offered Rate, or LIBOR, or other
indices, which re-price periodically. Approximately 76% of our loan portfolio had a floor interest rate at
various levels, which provides us with some protection in the current environment with the Prime Rate at a
level below the floor interest rate. Approximately 3% 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, 2012 was 8.7 months.
54
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
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
Accretion of beneficial conversion feature
Net loss available to common shareholders
Year Ended December 31,
2011
2010
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 53,790
10,303
43,487
5,700
37,787
2,790
33,392
7,185
(5,049)
$ 12,234
—
$ 12,234
$ 52,088
14,822
37,266
16,550
20,716
2,807
41,037
(17,514)
(704)
$ (16,810)
(25,600)
$ (42,410)
$ 1,702
(4,519)
6,221
(10,850)
17,071
(17)
(7,645)
24,699
(4,345)
$ 29,044
25,600
$ 54,644
Net loss per share, basic
Net loss per share, diluted
$ 0.93
$ 0.93
$ (6.21)
$ (6.21)
$ 7.14
$ 7.14
The Bank’s net income increased to $12.2 million, or $0.93 per diluted share, for the year ended
December 31, 2011, from a net loss of $42.4 million, or $6.21 per diluted share, for the year ended
December 31, 2010. Our return on average assets was 0.99% and return on average shareholders’ equity
was 8.22% for the year ended December 31, 2011, compared to (1.25)% and (13.21)%, respectively, for
the year ended December 31, 2010.
Net income increased from 2010 to 2011, principally as a result of an increase in net interest
income, a decrease in the provision for credit losses, a decrease in noninterest expense and a partial reversal
of valuation allowance on deferred tax asset. The decline in non-interest expense was due primarily to
lower credit related noninterest expenses during 2011.
The $6.2 million, or 16.7%, increase in net interest income was due primarily to lower rates paid
on deposits and lower levels of non-accrual loans. Our overall cost of funds in 2011 decreased by 31 basis
points to 1.21%, compared to 1.52% for 2010 while yields on earning assets increased by 41 basis points to
4.55% from 4.14%. The impact of the low interest rate environment in 2011 was the primary driver of our
decreased cost of funds during 2011 as higher-rate CD’s matured and renewed at lower rates.
As of December 31, 2011, 78% of our loan portfolio was tied to the Prime Rate, which has the
potential to re-price daily, and 8% was tied to the London Interbank Offered Rate, or LIBOR, or other
indices, which re-price periodically. Approximately 74% of our loan portfolio had a floor interest rate at
various levels, which provides us with some protection in the current environment with the Prime Rate at a
level below the floor interest rate. Approximately 3% 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, 2011 was 6.2 months.
Net Interest Income and Net Interest Margin
Year ended December 31, 2012 compared to 2011
Net interest income before the provision for credit losses for the year ended December 31, 2012
increased $10.3 million, or 23.6%, to $53.8 million from $43.5 million for the year ended December 31,
55
2011. This increase was due to a decrease in interest expense of $2.5 million and increase in interest
income of $7.8 million. Total increase in interest income is primarily due to the higher average loan
balance of $1.02 billion in 2012, an increase from $902 million average balance in 2011, as well as an
increased average loan interest rate from 5.15% to 5.44% between the periods This increase is partially
offset by decreased investment securities interest income due to lower yields and lower average investment
securities balance during 2012.
The average yield on our interest-earning assets decreased slightly to 4.53% in the year ended
December 31, 2012 from 4.55% in the year ended December 31, 2011. The decrease was mainly due to a
lower yield on investment securities during the year, as well as an increased average balance of other
earning assets, which is primarily cash earning a very low interest rate. These decreases are partially offset
by an increase in average yield on loans, from 5.15% for the year ended December 31, 2011 to 5.44% for
the year ended December 31, 2012.
The cost of average interest-bearing liabilities decreased to 0.89% in the year ended December 31,
2012 from 1.21% in the year ended December 31, 2011. The decrease was primarily driven by generally
lower rates paid on deposits during 2012 versus 2011.
Year ended December 31, 2011 compared to 2010
Net interest income before the provision for credit losses for the year ended December 31, 2011
increased $6.2 million, or 16.7%, to $43.5 million from $37.3 million for the year ended December 31,
2010. This increase was due to a decrease in interest expense of $4.5 million and increase in interest
income of $1.7 million. Total increase in interest income is primarily due to the higher average investment
securities totals of $173.7 million in 2011 versus $125.3 million in 2010 partially offset by a modest
decrease in the average yield of investment securities from 5.05% to 4.37% in 2011.
The average yield on our interest-earning assets increased to 4.55% in the year ended December
31, 2011 from 4.14% in the year ended December 31, 2010. The increase was mainly due to a lower level
of non-accrual loans and leases, partially offset by a slightly decrease in yield on investment securities.
The cost of average interest-bearing liabilities decreased to 1.21% in the year ended December 31,
2011 from 1.52% in the year ended December 31, 2010. The decrease was primarily driven by generally
lower rates paid on deposits during 2011 versus 2010.
56
Year Ended December 31, 2012
Interest
Income or
Expense
Average
Yield or
Cost
Average
Balance
Year Ended December 31, 2011
Average
Balance
Interest
Income or
Expense
Average
Yield or
Cost
(Dollars in thousands)
Year Ended December 31, 2010
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
Other earning assets
$ 1,018,366
155,199
4,344
189,586
$ 55,400
6,141
26
435
Total interest-earning assets
$ 1,367,495
$ 62,002
Noninterest-earning assets:
Cash and due from banks
Other assets
Total assets
4,556
54,002
$ 1,426,053
5.44%
3.96%
0.60%
0.23%
4.53%
$ 902,346
173,733
—
116,863
5.15%
$ 46,464
7,585
4.37%
— 0.00%
0.22%
257
$ 977,188
125,275
444
173,571
$ 46,130
6,327
1
413
4.72%
5.05%
0.13%
0.24%
$1,192,942
$ 54,306
4.55%
$1,276,478
$ 52,871
4.14%
4,374
39,718
$1,237,034
4,706
62,266
$1,343,450
LIABILITIES AND
SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits
Interest-bearing demand
Money market
Savings
Time certificates of deposit
Total interest-bearing deposits
Short-term borrowings
Long-term debt (FHLB and Senior
debt)
$ 54,534
216,916
21,007
581,265
873,722
$ 290
1,456
75
5,868
7,689
—
—
3,125
94
Total interest-bearing liabilities
876,847
7,783
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
362,118
8,831
1,247,796
178,257
$1,426,053
0.49%
0.80%
0.38%
1.01%
0.88%
0.00%
3.00%
0.89%
$ 42,933
133,056
23,307
625,657
824,953
—
$ 254
1,041
92
8,163
9,550
0.59%
0.78%
0.39%
1.30%
1.16%
— 0.00%
$ 41,153
85,309
40,967
768,607
936,036
16,197
$ 151
504
208
12,532
13,395
677
25,996
753
2.90%
25,996
750
850,949
10,303
1.21%
978,229
14,822
230,088
7,180
1,088,217
148,817
$1,237,034
226,929
11,003
1,216,161
127,289
$1,343,450
$ 54,219
$ 44,003
$ 38,049
3.65%
3.96%
3.34%
3.69%
0.37%
0.59%
0.51%
1.63%
1.43%
4.18%
2.89%
1.52%
2.63%
2.98%
(1)Yields on securities have been adjusted to a tax-equivalent basis.
(2)Includes average non-accrual loans and leases.
(3)Net loan and lease fees income (expense) of $1.1 million, $367,000 and ($974,000) for the year ended December 31, 2012,
2011 and 2010, respectively, are included in the yield computations.
The increase in interest income from loans and decrease in interest expense on time certificate
deposits, as well as reduction of senior debt, partially offset by decreased investment securities interest
income, drove the increase of net interest margin to 3.96% for 2012 compared to 3.69% for 2011. In
addition to the distribution, yields and costs of our assets and liabilities, our net income is also affected by
changes in the volume of and rates on our assets and liabilities. The following table shows the change in
interest income and interest expense and the amount of change attributable to variances in volume, rates
and the combination of volume and rates based on the relative changes of volume and rates.
57
Year Ended December 31,
2012 vs. 2011
Net Change
Rate
Volume
Net Change
2011 vs. 2010
Rate
Volume
(In thousands)
Interest income:
Loans and leases
Investment securities(1)
Federal funds sold
Other earning assets
Total interest income
$ 8,936
(1,444)
26
178
7,696
$ 2,728
(675)
—
12
2,065
$ 6,208
(769)
26
166
5,631
$ 334
1,258
—
(157)
1,435
$ 4,014
(944)
—
(30)
3,040
$ (3,680)
2,202
—
(127)
(1,605)
Interest expense:
Interest-bearing demand
Money market
Savings
Time certificates of
Deposit
Short-term borrowings
36
415
(17)
(28)
(165)
(8)
(2,296)
—
(1,789)
—
64
580
(9)
(507)
—
104
537
(117)
97
197
(40)
7
340
(77)
(4,368)
(678)
(2,301)
(339)
(2,067)
(339)
Long-term debt
Total interest expense
Net interest income
(658)
(2,520)
$ 10,216
27
(1,963)
$ 4,028
(685)
(557)
$ 6,188
3
(4,519)
$ 5,954
3
(2,383)
$ 5,423
—
(2,136)
$ 531
(1) Amounts have been adjusted to a tax-equivalent basis.
Provision for Credit Losses
In response to the credit risk inherent in our lending business and the recent ongoing sluggish
economy, 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 2012 increased $14.1 million to $19.8 million from $5.7 million
for 2011. The Bank’s net loans and lease charge-offs increased to $22.9 million during 2012 from $14.8
million in 2011. The increase in the provision for credit losses during 2012 is due to two significant loan
relationships which were written down in the second quarter of 2012. Since 2009, the Bank has made
significant refinements in the assumptions for calculating its adequacy of allowance for loan losses as
prescribed under Contingencies Topic of FASB ASC as well as prescribed by regulatory guidelines. In
calculating the need for allowance levels based on historical losses, the Bank shortened its historical loss
measurement period from seven years to four years starting in third quarter of 2009 and down to three years
in the first quarter of 2010 and down to two years starting in the second quarter of 2011. Also, the Bank has
augmented the qualitative factors used in calculating allowance levels, such as the mix of the loan portfolio,
concentration levels and trends, local and national economic conditions, changes in capabilities and
experience of lending management and staff and other external factors including industry conditions,
competition and regulatory requirements. Non-performing loans decreased from $47.5 million as of
December 31, 2011 to $26.1 million as of December 31, 2012, as this area continues to be the primary
focus of management. The ratio of allowance for loan losses to total loans decreased from 2.50% of total
loans at December 31, 2011 to 1.84% at December 31, 2012, directionally consistent with non-performing
loan trends over the same period. Management believes that through the application of the allowance
methodology’s quantitative and qualitative components, that the provision and overall level of allowance is
adequate for losses estimated to be inherent in the portfolio as of December 31, 2012.
The provision for credit losses for 2011 decreased $10.9 million to $5.7 million from $16.6
million for 2010. The bank’s net loans and lease charge-offs decreased to $14.8 million during 2011 from
58
$26.5 million in 2010. The decrease in the provision for credit losses during 2011 is due to a lower level of
classified loans and non-performing loans during 2011 and is the result of the application of management’s
established allowance for loan and lease loss adequacy calculation. Non-performing loans decreased from
$101.9 million as of December 31, 2010 to $47.5 million as of December 31, 2011, as this area continues to
be the primary focus of management. The ratio of allowance for loan losses to total loans decreased from
3.6% of total loans at December 31, 2010 to 2.50% at December 31, 2011, directionally consistent with
non-performing loan trends over the same period.
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
Rental income from OREO property
Increases in the cash surrender value of bank owned life insurance policies (“BOLI”)
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,
2011
2010
2012
$ 1,792
309
329
575
503
$ 3,508
(In thousands)
$ 1,742
241
333
81
393
$ 2,790
$ 1,865
382
329
(61)
292
$ 2,807
Total noninterest income increased by $718,000 or 26%, to $3.5 million during 2012 from $2.8
million during 2011. The overall increase in noninterest income was due mainly to an increase in net gain
on sale of investment securities in 2012 and net gain on loan sales of $290,000 compared to 2011.
Total noninterest income decreased by $17,000 or 1%, to $2.8 million during 2011 from $2.8
million during 2010. The overall decrease in noninterest income was due mainly to a decrease in service
charges and fees on deposit accounts of $123,000 and trade finance income of $141,000 partially offset by
an increase in gain on sale of investment securities of $142,000 and other income of $101,000 in 2011.
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 available-for-sale 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 loans, and sell such
real estate to recoup 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.
59
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,
2011
2010
2012
$ 12,523
2,990
294
3,227
1,154
24
—
8,580
5,386
34,178
(In thousands)
$ 11,155
3,060
335
2,267
1,061
32
—
$ 9,591
3,271
246
3,504
1,122
843
(431)
8,303
7,179
$ 33,392
12,481
10,410
$ 41,037
Total noninterest expense increased by $786,000, or 2.4% to $34.2 million during 2012 from
$33.4 million during 2011. Salaries and benefits increased $1.4 million over 2011 levels due to the addition
of business development staff and reinstatement of bonus accruals which had been suspended in 2008.
Professional fees increased by $960,000 to $3.2 million during 2012 from $2.3 million in 2011 due
primarily to an increase in legal costs associated with non-performing loans and OREO as significant
efforts to reduce these balances continued through 2012, as well as an increase in audit fees compared to
2011, resulting from the 2011 utilization of excess audit fee accruals recorded in 2010. Net other-than-
temporary impairment (“OTTI”) credit-related charges were $24,000 in 2012 compared to $32,000 in 2011.
OREO related expenses totaled $8.6 million in 2012, increasing $277,000 from $8.3 million in 2011.
OREO expenses in 2012 consisted of $4.0 million in OREO valuation charges, loss on sale of OREO of
$387,000, and other net OREO related charges of $4.2 million. Other expenses were $5.4 million in 2012, a
decrease of $1.8 million from the $7.2 million in 2011 due mainly to a gain on loan sale of $290,000 for
2012 compared to a loss on loan sale of $656,000 in 2011, and a decrease in FDIC insurance premiums.
Total noninterest expense decreased $7.6 million, or 18.6% to $33.4 million during 2011 from
$41.0 million during 2010. Salaries and benefits increased $1.6 million over 2010 levels due to the addition
of business development staff and a decrease in capitalized loan origination costs. Professional fees
decreased by $1.2 million to $2.3 million during 2011 from $3.5 million in 2010 due primarily to a
decrease in legal costs associated with non-performing loans and OREO as those assets continue to
decrease. Net other-than-temporary impairment (“OTTI”) credit-related charges were $32,000 in 2011
compared to $412,000 in 2010. OREO related expenses totaled $8.3 million in 2011, decreasing $4.2
million from $12.5 million in 2010. OREO expenses in 2011 consisted of $4.9 million in OREO valuation
charges, loss on sale of OREO of $1.1 million and other OREO related charges of $4.5 million. Other
expenses were $7.2 million in 2011, a decrease of $3.2 million from the $10.4 million in 2010 due mainly
to a decrease in losses on loan sales, a decrease in loan collection costs and a decrease in FDIC insurance
premiums.
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
60
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 we believe 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. During 2012, we reversed the valuation allowance of $25.7 million and the
allowance balance is zero as of December 31, 2012. This recognition was the result of an evaluation of our
historical net operating losses and our more recent history of consecutive quarters of profitability. We
assessed the likelihood that our deferred tax asset would be recovered from taxable income and determined
that recovery was more likely than not based upon the totality of the evidence, both positive and negative.
We recorded a net tax benefit of $20.6 million and $5.0 million in December 31, 2012 and 2011,
respectively. The increase in benefit was due to the reversal of the valuation allowance on the deferred tax
asset during 2012. The effective tax rates were (625.9)% and (70.3)% for 2012 and 2011, respectively, as
compared to the statutory tax rate of 42.0%.
Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of net operating loss
and credit carryforwards may be limited in the event a cumulative change in ownership of more than 50
percentage points occurs by one or more five-percent shareholders within a three-year period. We
determined that such an ownership change occurred as of June 21, 2010 as a result of stock issuances. This
ownership change resulted in estimated limitations on the utilization of tax attributes, including net
operating loss carryforwards and tax credits. We estimate that approximately $4.78 million of our
California net operating loss carryforward deferred tax asset was effectively eliminated. Pursuant to Section
382, a portion of the limited net operating loss carryforwards becomes available for use each year. We
estimate that approximately $1.53 million of the restricted net operating loss carryforwards become
available each year.
Financial Condition
For the period between December 31, 2012 and December 31, 2011, our assets, loans and deposits
grew at the rate of 18.8%, 18.6% and 21.4%, respectively. Our total assets at December 31, 2012 were
$1.55 billion compared to $1.31 billion at December 31, 2011. Our earning assets at December 31, 2012
totaled $1.50 billion compared to $1.27 billion at December 31, 2011. Total deposits at December 31, 2012
and December 31, 2011 were $1.36 billion and $1.12 billion, respectively.
Loans and Leases
The largest component of our assets and largest 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, and the percentages of the overall loan pool represented. We had no foreign loans or
energy-related loans as of the dates indicated.
61
2012
2011
Year Ended December 31,
2010
(in thousands)
2009
2008
Loans and leases (by portfolio and class):
Real Estate - Mini-perm:
Real Estate - Residential
$ 177,948
15.7 % $ 143,344
15.0 %
$ 162,000
17.8 %
$ 201,285
19.3 %
$ 252,706
20.6 %
Real Estate - Commercial
494,699
44.8
431,828
45.3
369,640
40.4
363,988
34.9
339,991
27.6
Total Real Estate - Mini-perm
$ 672,647
$ 575,172
$ 531,640
$ 565,273
$ 592,697
Real Estate - Construction:
R/E Construction - Residential
36,347
R/E Construction - Commercial
38,063
3.2
3.4
Total Real Estate - Construction
$ 74,410
39,537
32,405
$ 71,942
4.6
3.4
87,611
33,214
$ 120,825
9.8
3.6
143,905
13.8
191,073
15.5
58,282
5.6
99,730
8.1
$ 202,187
$ 290,803
Commercial & Industrial
324,753
28.7
252,161
26.4
209,520
22.9
227,421
21.8
273,890
22.2
Trade Finance
Other Loans
47,413
330
4.2
0.0
49,750
606
5.2
0.1
50,520
349
5.5
0.0
47,998
420
4.6
0.0
73,205
637
5.9
0.1
$ 1,119,553 100.0 %
$ 949,631
100.0 %
$ 912,854
100.0 %
$ 1,043,299 100.0 %
$ 1,231,232
100.0 %
Total gross loans and leases
Less: allowance for loan and
lease losses
Deferred loan and lease fees, net
Total loan excluding loans held
for sale
Loans held for sale
(20,607)
(2,019)
$ 1,096,927
12,150
Total net loans and leases
$ 1,109,077
(23,718)
(1,037)
$ 924,876
3,996
$ 928,872
(32,898)
58
$ 880,014
2,556
$ 882,570
(42,810)
585
$ 1,001,074
—
$ 1,001,074
(26,935)
(167)
$ 1,204,130
—
$ 1,204,130
Total gross loans at December 31, 2012, net of loans held for sale, were $1.12 billion, up from the
$949.6 million as of December 31, 2011. Real estate mini-perm loans which are real estate loans
collateralized by various types of commercial and residential real estate, were up from $575.2 million as of
December 31, 2011 to $672.6 million at December 31, 2012. Real estate construction loans, which are
loans made to developers for the purpose of constructing residential or commercial properties, increased
slightly by $2.5 million from December 31, 2011. Commercial & industrial loans increased $72.6 million
and trade finance loans which are primarily working capital revolving and term loans for business
operations decreased by $2.3 million from December 31, 2011 to December 31, 2012. Management’s focus
from a lending perspective is on prime-owner-occupied, income-producing commercial real estate and
multi-family real estate as well as commercial & industrial loans as seen in the results of the loan portfolio
changes from December 31, 2011. Management continually evaluates the mix of loan types in the loan
portfolio in order to minimize risk and maximize returns within the portfolio.
There were five loans with a recorded investment of $9.3 million sold during 2012 for a net gain
of $290,000. During 2011, loans with a recorded investment of $42.6 million were sold for a net loss of
$656,000. Two loans with a recorded investment of $12.2 million were transferred to held for sale status in
2012, and zero loans transferred to held for sale status in 2011 remained in the balance as of December 31,
2012.
Our real estate mini-perm loan portfolio increased in 2012 by $109.6 million or 19.1% to $684.8
million from $575.2 million at December 31, 2011. The overall increase was due to management’s focus
from a lending perspective on prime owner-occupied, income-producing commercial real estate as well as
commercial & industrial loans as seen in the results of the loan portfolio changes from December 31, 2011.
Residential real estate loans increased by $34.6 million, or 24.1%, and commercial real estate loans grew
by $75.0 million or 17.3%. Retail-purpose continued to grow during 2012, with an increase of $19.2
million, or 13.3%, land loans decreased $4.9 million, or 12.4%, and special purpose loans increased $22.5
million, or 33.9%. Further detail regarding the real estate mini perm portfolio by property type is provided
in the table below. Following is a summary of the trends in our real estate mini-perm loan portfolio over the
62
prior four years: During 2011, mini-perm loans increased by $43.5 million or 8.2% to $575.2 million from
$531.6 million at December 31, 2010; during 2010, it decreased by $33.6 million, or 5.9%, to $531.6
million from $565.3 million at December 31, 2009; during 2009 it decreased by $27.4 million, or 4.6%, to
$565.3 million from $592.7 million at December 31, 2008.
The following table provides information about our real estate mini-perm portfolio by property
type:
Property Type
Amount
Percentage of Loans in
Each Category in Total
Loan Portfolio
(Dollars in thousands)
Percentage of Loans in
Each Category in Total
Loan Portfolio
Amount
(Dollars in thousands)
At December 31, 2012
At December 31, 2011
Commercial/Office
Retail
Industrial
Residential 1-4
Apartment 4+
Land
Special purpose
Total
$
$
101,113
162,983
61,325
33,961
118,427
34,308
172,680
684,797
8.93%
14.40
5.42
3.00
10.46
3.03
15.26
60.50%
$
$
66,550
143,813
70,332
23,630
96,375
39,169
135,303
575,172
6.98%
15.08
7.38
2.48
10.11
4.11
14.19
60.33%
During 2012, real estate construction loans increased by $2.5 million or 3.5% to $74.4 million at
December 31, 2012 from $71.9 million at December 31, 2011; and declined by $48.9 million or 40.5% to
$71.9 million at December 31, 2010 from $120.8 million at December 31, 2010; and declined in 2010 by
$81.4 million or 40.2%, to $120.8 million from $202.2 million at December 31, 2009; and declined in 2009
by $88.6 million or 30.5%, to $202.2 million from $290.8 million at December 31, 2008. Real estate
construction-residential was one of the hardest hit of our loan segments in the harsh economic climate due
to the combination of deterioration in residential real estate values and lack of available financing.
Commercial & industrial loans outstanding at December 31, 2012 increased by $72.6 million, or
28.8%, to $324.8 million from $252.2 million as of December 31, 2011; increased by $42.6 million, or
20.4%, to $252.1 million from $209.5 million at December 31, 2010; decreased by $17.9 million, or 7.9%
to $209.5 million from $227.4 million at December 31, 2009; and decreased by $46.5 million, or 17.0%, to
$227.4 million from $273.9 million at December 31, 2008. Total commercial loan commitments (including
undisbursed amounts) at December 31, 2012 increased $100.0 million or 28.4% to $452.4 from $352.4
million at December 31, 2011 while the rate of credit utilization increased to 77.9% as of December 31,
2012 from 71.6% at December 31, 2011. We believe that this increase in utilization is primarily incidental
and secondarily due to the increased need for funding by our business customers.
Trade finance loans decreased slightly in by $2.4 million or 4.8% during 2012, to $49.8 million to
$47.4 million as of December 31, 2012; and decreased by $770,000 during 2011 to $49.8 million from
$50.5 million at December 31, 2010; and grew $2.5 million or 5.3% during 2010 to $50.5 million from
$48.0 million at December 31, 2009, and decreased $25.2 million or 34.4% during 2009 to $48.0 million
from $73.2 million at December 31, 2008.
Other loans, which include installment/consumer debt, leases receivable and other unallocated
loans, are relatively insignificant.
Non-Performing Assets
Non-performing assets are comprised of loans on non-accrual status and OREO, and certain
Troubled Debt Restructurings (“TDRs”). TDRs that are on non-accrual status are included in non-
63
performing assets while TDRs that are performing according to their revised terms are not included in non-
performing asset and evaluated for impairment in accordance with ASC 310-10-35. Generally, loans and
leases are placed on non-accrual status when they become 90 days or more past due or at such earlier time
as management determines timely recognition of interest to be in doubt, unless they are both fully secured
and in process of collection. Accrual of interest is discontinued on a loan or lease when management
believes, after considering economic and business conditions and collection efforts that the borrower’s
financial condition is such that collection of principal and contractually due interest is not likely. OREO
consists of real property acquired through foreclosure or similar means that the Bank intends to offer for
sale.
A TDR is a debt restructuring in which a bank, for economic or legal reasons specifically related
to a borrower’s financial condition, grants a concession to the borrower that it would not otherwise
consider. At December 31, 2012, loans classified as TDRs totaled $7.9 million, of which $7.2 million was
on non-accrual status and $727,000 was performing as agreed. At December 31, 2011, loans classified as
TDRs totaled $27.5 million, of which $11.5 million were on non-accrual status and $16.0 million were on
accrual status.
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 and OREO:
2012
Year Ended December 31,
2010
2011
2009
2008
Non-accrual loans and leases*
Accruing loans and leases past due 90 days or more
Total non-performing loans (NPLs)
OREO
Total non-performing assets (NPAs)
$ 26,145
—
26,145
28,280
$ 54,425
$ 47,453
—
47,453
37,577
$ 85,030
$ 101,860
7
101,867
52,663
$ 154,530
$ 137,301
7,571
144,872
59,190
$ 204,062
$ 66,588
—
66,588
35,127
$ 101,715
(Dollars in thousands)
Selected ratios:
NPLs to total gross loans and leases held for investment
NPAs to total assets
______________________________
2.31%
3.50%
4.98%
6.49%
11.15%
12.30%
13.88%
15.61%
5.40%
6.85%
*Non-accrual Troubled Debt Restructurings (TDRs) that are included in non-accrual loans are as follows: 2012 - $7,150; 2011 -
$11,482; 2010 - $34,681; 2009 - $34,875; 2008 - $0. TDRs that are performing according to their revised terms are not reflected as
non-performing loans (NPLs).
The amount of interest income that we would have been recorded on impaired loans that were
non-accrual loans and leases had the loans and leases been current totaled $1,769,000, $3,369,000, and
$5,570,000, for 2012, 2011, and 2010, 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. See Note 3 of the Consolidated Financial
Statements for further details regarding non-accrual and past due loans by loan class.
As of December 31, 2012, we had 16 OREO properties for $28.3 million as compared 15 OREO
properties for $37.6 million as of December 31, 2011. During 2012, the Bank sold 6 OREO properties, plus
a partial property for which the remainder remains in the OREO balance, at a net loss of $387,000. The
following table summarizes the Bank’s OREO as of the periods presented.
Foreclosed assets (OREO) as of December 31, 2012 and 2011 were as follows:
64
OREO by loan class:
Real Estate-Mini-Perm:
Residential
Commercial
Real Estate-Construction:
Residential
Commercial
Commercial & Industrial
Trade Finance
Other
Total as of December 31
2012
#
$
#
($ in thousands)
2011
$
11
3
1
1
—
—
—
16
$ 15,127
7,829
3,051
2,273
—
—
—
$ 28,280
10 $ 23,565
8,316
3
1
1
—
—
—
15
5,461
235
—
—
—
37,577
$
Management continued to work to reduce OREO balances and has made good progress throughout
2012. As market conditions dictate, the Bank will continue to dispose of these properties with an eye
toward capital preservation. Although management anticipates the disposition of these properties, it is
likely that non-performing real estate loans will be foreclosed upon, thus partially offsetting the OREO
disposition efforts We have placed a particular emphasis on the effort of disposing of OREO properties as
soon as is practicable, but with the intention to minimize losses on sales.
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 considered impaired when it is probable that we will not be able to
collect all amounts due according to the contractual terms of the loan or lease agreement. The category of
impaired loans and leases is not comparable with the category of non-accrual loans and leases.
Management may choose to place a loan or lease on non-accrual status due to payment delinquency or
uncertain collectability, while not classifying the loan or lease as impaired if it is probable that we will
collect all amounts due in accordance with the original contractual terms of the loan or lease or the loan.
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.
TDR loans are defined by ASC 310-40, “Troubled Debt Restructurings by Creditors” and ASC
470-60, “Troubled Debt Restructurings by Debtors,” and evaluated for impairment in accordance with
ASC 310-10-35. The concessions may be granted in various forms, including reduction in the stated
interest rate, reduction in the amount of principal amortization, forgiveness of a portion of a loan balance or
accrued interest, or extension of the maturity date.
65
We had $25.0 million, $73.4 million and $139.0 million of impaired loans or leases at December
31, 2012, 2011, and 2010, respectively. The total allowance for loan and lease losses related to these loans
and leases was $2.3 million, $4.9 million and $14.1 million at December 31, 2012, 2011 and 2010,
respectively. Interest income recognized on such loans and leases during 2012, 2011 and 2010 was
$615,000, $1.2 million and $2.7 million, respectively. The average recorded investment on impaired loans
and leases during 2012, 2011 and 2010 was $36.2 million, $101.6 million and $115.5 million, respectively.
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,.
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 or is not collateral dependent. The impairment amount on a collateralized loan and a non-
collateralized 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 trade finance, real estate and real estate construction.
Real estate is further segmented by individual product type with a general class, residential or commercial.
The commercial class is represented by–office, industrial, retail, special purpose and land commercial
product types. The residential class is represented by multi family, SFR, land residential. Real estate
construction is similarly further segmented by the office, industrial, and retail product types; with
multifamily and SFR product types representing the commercial loan class. 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: substandard, doubtful and loss.
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; non-accrual and problem loan trends; and other adjustments for items not covered by other
factors.
Although we believe that our allowance for loan losses is adequate and believe that we have
considered all risks within the loan portfolio, there can be no assurance that our allowance will be adequate
66
to absorb future losses. Factors such as a prolonged and deepened recession, higher unemployment rates
than we have already anticipated, continued deterioration of California real estate values as well as natural
disasters, civil unrest and terrorism can have a significantly negative impact on the performance of our loan
portfolio and the occurrence of any single one of these factors may lead to additional future losses which
can negatively impact our earnings, capital and liquidity.
The table below summarizes loans and leases, average loans and leases, non-performing loans and
leases and changes in the allowance for 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
Other (credit card)
Total charge-offs
Less recoveries:
Commercial
Trade finance
Real estate-construction
Real estate -mini-perm
Other
Total recoveries
Net loans charged-off
Provision for credit losses
Balance at end of period
2012
2011
Year Ended December 31,
2010
(Dollars in thousands)
2009
2008
$ 23,718
$ 32,898
$ 42,810
$ 26,935
$ 14,896
10,328
197
2,184
10,772
—
23,481
64
—
147
359
—
5,126
—
2,329
8,637
5
16,097
823
117
173
104
—
6,672
—
12,600
7,806
17
27,095
289
—
316
28
—
7,716
3,246
24,293
24,456
—
59,711
3,924
—
397
15
—
4,686
—
8,636
5,206
—
—
—
—
7
—
570
22,911
19,800
$ 20,607
1,217
14,880
5,700
$ 23,718
633
26,462
16,550
$ 32,898
4,336
55,375
71,250
$ 42,810
7
18,521
30,560
$ 26,935
Total gross loans and leases at end of period *
Average total loans and leases **
Non-performing loans and leases
1,131,703
1,018,366
26,145
953,627
902,346
47,453
915,410
977,188
101,867
1,043,299
1,162,221
144,872
1,231,232
1,220,348
66,588
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
2.25%
1.94%
1.84%
1.65%
0.63%
2.50%
2.71%
1.69%
3.60%
4.76%
6.13%
4.10%
1.52%
2.50%
2.19%
78.82%
49.98%
32.29%
29.55%
40.33%
* Includes loans held for sale of $12,150 as of December 31, 2012, $3,996 as of December 31, 2011, $2,556 as of December 31, 2010,
and zero as of December 30, 2009 and 2008.
** Includes average loans held for sale balance of $12,381 for the year ended December 31, 2012, $6,993 for the year ended
December 31, 2011, $8,431 for the year ended December 31, 2010, and zero for the years ended December 31, 2009 and 2008.
The allowance for loan losses of $20.6 million at December 31, 2012, represented 1.84% of total
loans and 78.82% of non-performing loans. The allowance for loan losses of $23.7 million at December
31, 2011, represented 2.50% of total loans and 49.98% of non-performing loans. The increase in the
67
coverage ratio for the allowance for loan losses to non-performing loans from 49.98% at December 31,
2011 to 78.82% at December 31, 2012 was primarily a result of decline in adversely classified and non-
performing loans in 2012. Net charge-offs to average loans were 2.25% for the year ended December 31,
2012 compared to 1.65% for the year ended December 31, 2011. See “Critical Accounting Policies,” and
Note 4 of the “Notes to Consolidated Financial Statements.”
In allocating our allowance for loan and lease losses, management has considered the credit risk in
the various loan and lease categories in our portfolio. As such, the allocations of the allowance for loan and
lease losses are based upon our historical net loan and lease loss experience and the other factors discussed
above. While every effort has been made to allocate the allowance to specific categories of loans,
management believes that any allocation of the allowance for loan and lease losses into loan categories
lends an appearance of precision that does not exist.
The following table reflects management’s allocation of the allowance and the percent of loans in
each portfolio to total loans and leases as of each of the following dates:
2012
2011
Allocation
of the
Allowance
Allocation
of the
Allowance
Percent of
Loans in
Each
Category
in Total
Loans
Real estate-Mini-perm
Real estate-construction
Commercial
Trade finance
Other
Unallocated
Total
$ 10,973
1,655
5,069
427
4
2,479
$ 20,607
60.1%
6.7
29.0
4.2
0.0
0.0
100%
$ 14,831
2,353
3,156
523
7
2,848
$ 23,718
At December 31,
2010
2009
2008
Allocation
of the
Allowance
Allocation
of the
Allowance
Percent
of Loans
in Each
Category
in Total
Loans
Percent
of Loans
in Each
Category
in Total
Loans
Allocation
of the
Allowance
Percent of
Loans in
Each
Category in
Total Loans
(Dollars in thousands)
$ 16,400
6,501
8,215
1,559
5
218
$ 32,898
58.3%
13.2
23.0
5.5
0.0
0.0
100%
$ 17,376
14,885
8,314
1,411
7
817
$42,810
54.2%
19.4
21.8
4.6
0.0
0.0
100%
$ 9,484
11,108
3,018
2,317
1,004
4
$ 26,935
48.1%
23.6
22.2
5.9
0.1
0.1
100%
Percent
of Loans
in Each
Category
in Total
Loans
60.6%
7.6
26.6
5.2
0.0
0.0
100%
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 $100,000 and $150,000 at December
31, 2012 and 2011, respectively.
Investment Securities, Available-for-Sale and Held-to-Maturity
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.
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
68
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.
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 (MBS), municipal bonds, collateralized mortgage obligations (CMO’s)
and U.S. Government agency securities. We have traditionally categorized 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. The Bank purchased a held-to-maturity
security in 2011. At December 31, 2012, investment securities classified as available-for-sale with a
carrying value of $38.9 million were pledged to secure public deposits.
The carrying value of our held-to-maturity investment securities was $979,000 at December 31,
2012 and $3.0 million at December 31, 2011. The carrying value of our available-for-sale investment
securities at December 31, 2012 totaled $210.7 million compared to $166.1 million at December 31, 2011.
The increase was primarily due purchases of securities during the year, in addition to a general rise of the
fair market value of securities owned in all portions of the portfolio. The table below shows the amortized
cost, gross unrealized gains and losses and estimated fair value of securities held-to-maturity as of
December 31, 2012:
Amortized
cost
December 31, 2012
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
Collateralized debt obligations
$ 979
$ 3
$ —
$ 982
69
The carrying value of our portfolio of available-for-sale investment securities at December 31,
2012 and 2011 was as follows:
U.S. Government agency securities
Mutual Fund
Corporate notes
Mortgage-backed securities
Collateralized mortgage obligations
Municipal securities
Principal-only strip securities
Collateralized debt obligations
SBA securities
USDA Security
Estimated Fair Value
At December 31,
2012
2011
(In thousands)
$ —
4,973
50,981
96,924
24,660
25,811
5,846
1,547
—
—
$
5,739
—
38,898
51,734
22,567
21,509
6,923
1,224
10,567
6,922
Total securities available-for-sale
$
210,742
$
166,083
The following table shows the maturities of held-to-maturity and available-for-sale investment
securities at December 31, 2012, and the weighted average yields of such securities. The table does not
consider the impact of prepayments on the maturities:
At December 31, 2012
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
(Dollars in thousands)
Yield
Amount
Yield
Amount
Yield
$ — —%
$ — —%
$ — —%
$ 982
8.13%
$ 982
8.13%
$ —
—%
$ — —%
$ — —%
$ 982
8.13%
$ 982
8.13%
At December 31, 2012
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
(Dollars in thousands)
Yield
Amount
Yield
Amount
Yield
$ —
—%
$ —
—%
$ —
— %
$ 1,548
4.52%
$ 1,548
4.52%
Collateralized Debt
Obligations
Total securities
held-to-maturity
Collateralized debt
obligations
Corporate notes
—
—
5,833
4.90
36,356
4.27
8,791
4.45
50,980
4.37
Principal only strips
Mortgage-backed
securities
Municipal securities
Collateralized mortgage
obligations
—
—
—
—
—
—
—
—
—
—
—
—
5,846
2.20
5,846
2.20
1,228
2.99
13,160
—
—
—
—
—
2,458
82,536
25,811
1.75
7.01
96,924
2.09
25,811
22,202
2.19
24,660
7.01
2.30
Mutual Fund
—
—
—
—
—
4,973
1.76
4,973
1.76
Total securities
available-for-sale
$ —
—%
$ 7,061
4.57
$ 51,974
4.19%
$151,707
2.96%
$210,742
3.32%
70
4.12
—
3.31
—
The Bank owns three collateralized debt obligations (“CDO’s”) in its available-for-sale portfolio
which consist of pools of bank trust preferred securities. As of December 31, 2012, the amortized cost of all
three 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 100 basis points which determined the actual discount rate.
Management then used current deferrals and defaults and 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 at some future date. In addition to those specific defaults,
Management estimated additional default rates as a percentage of the overall pool, with higher default rates
applied in the short-term 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 three securities using a discount rate that was equal to the accretable yield on all three securities and
using all of the same default assumptions as described above. The result of this analysis indicated that all
three securities were temporarily impaired and one of these had a credit-related other-than-temporary
impairment of $24,000 and $32,000 during 2012 and 2011, respectively, which was recognized in income.
The non-credit related impairment for these securities was $317,000 and $847,000 at December 31, 2012
and 2011, respectively, and was reflected in the accumulated other comprehensive loss.
As of December 31, 2012, the Bank owned 6 corporate securities where the amortized cost
exceeded fair value. The total amortized cost of these securities was $19.7 million and their fair value was
$18.2 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 all 6 corporate securities to be temporarily impaired. The Bank had recorded no credit-related
OTTI charges on corporate securities during 2012, and also had zero OTTI charges relating to corporate
securities in 2011 and 2010.
As of December 31, 2012, the Bank owned one collateralized mortgage obligation (“CMO”)
where the amortized cost exceeded fair value. The amortized cost of this security was $3.6 million and the
fair value was $3.5 million. Management determined that the CMO security was not other-than-temporarily
impaired as of December 31, 2012. This determination was made based on several factors such as debt
rating of the security, amount of credit protection, the Bank’s intent and ability to hold the security 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 security prior to recovery of amortized cost basis.
The Bank owns 21 municipal investment securities. Each of these securities carries an investment-
grade rating. As of December 31, 2012, zero of these issues were in an unrealized loss position. As such,
management determined that there is no other-than-temporary impairment for municipal investment
securities as of December 31, 2012.
At December 31, 2012, the Bank held one agency-backed principal-only (PO) strip security with a
fair value of $5.8 million and an amortized cost of $5.7 million. The Bank also held one CDO classified as
held-to-maturity with an amortized cost of $979,000 and a fair value of $982,000.
At December 31, 2012, there were 6 and 8 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
71
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 2013 on specific investments within these portfolios.
It is possible that we may recognize OTTI in future periods. We do not intend to sell these
securities until recovery and have determined that it is not more likely than not that we will be required to
sell the securities prior to recovery of their amortized cost basis. Additional information concerning
investment securities is provided in Note 3 of the “Notes to Consolidated Financial Statements” in this
annual report.
Deposits
Total deposits were $1.36 billion at December 31, 2012 compared to $1.12 billion at December
31, 2011. Noninterest-bearing demand deposits increased $206.7 million or 86.2%. The ratio of
noninterest-bearing deposits to total deposits was 32.9% at December 31, 2012 and 21.5% at December 31,
2011. Interest-bearing deposits are comprised of interest-bearing demand deposits, money market accounts,
regular savings accounts, time deposits of under $250,000 and time deposits of $250,000 or more. Interest-
bearing demand and savings deposits increased by $91.1 million or 35.6%, and time deposits decreased
$58.3 million or 9.4%. The increase in demand and interest-bearing demand deposits is a direct result of
management’s desire to grow this segment of the deposit base as these deposits are typically related to
long-term customer relationships and also carry the lowest interest costs.
The following table shows the average amount and average rate paid on the categories of deposits
for each of the periods indicated:
2012
Average
Balance
Average
Rate
Year Ended December 31,
2011
Average
Average
Balance
Rate
(Dollars in thousands)
2010
Average
Balance
Average
Rate
$ 362,118
0.00%
$ 230,088
0.00%
$ 226,929
0.00%
54,534
216,916
21,007
581,265
0.53
0.67
0.36
1.01
42,933
133,056
23,307
625,657
0.59
0.78
0.39
1.30
41,153
85,309
40,967
768,607
0.37
0.59
0.51
1.63
Noninterest-bearing
deposits
Interest-bearing demand
Money market
Savings
Time certificates of
deposit
Total
$ 1,235,840
0.62%
$ 1,055,041
0.91%
$ 1,162,965
1.15%
Average total deposits increased in 2012. The increase in average total deposits for 2012 was
primarily driven by an increase of $132.0 million in average noninterest-bearing deposits, and an increase
of $83.9 million in average money market accounts. The net average deposit increase is partially offset by a
$44.4 million decrease in average time certificates of deposit. The increase in demand and interest demand
deposits is a direct result of management’s desire to grow this segment of the deposit base as these deposits
are typically related to long-term customer relationships and also carry the lowest interest costs. The
decrease in time deposits is due primarily to the maturity and non-renewal of CD accounts obtained
through rate listing services.
The largest single 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 competing banks.
72
The following table shows the maturities of time certificates of deposit at December 31, 2012 and
2011:
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
Capital Resources
At December 31,
2012
2011
(In thousands)
$ 172,477
114,245
191,142
80,956
$ 558,820
$ 257,212
105,881
187,764
71,375
$ 622,232
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 a tier 1 leverage ratio above 10% as required by the MOU. At December 31, 2012 and
2011, our capital ratios were above the minimum requirements for well capitalized institutions. On a
quarterly basis, we perform a stress test on our capital to determine our level of capital in various economic
circumstances looking out twenty-four months into the future.
Leverage Ratio
Preferred Bank .........................................................................
Minimum requirement for “Well-Capitalized” institution .......
Minimum regulatory requirement ............................................
Tier 1 Risk-Based Capital Ratio
Preferred Bank .........................................................................
Minimum requirement for “Well-Capitalized” institution .......
Minimum regulatory requirement ............................................
Total Risk-Based Capital Ratio
Preferred Bank .........................................................................
Minimum requirement for “Well-Capitalized” institution .......
Minimum regulatory requirement ............................................
At December 31,
2012
At December 31,
2011
11.96%
5.00%
4.00%
13.73%
6.00%
4.00%
14.98%
10.00%
8.00%
12.51%
5.00%
4.00%
14.51%
6.00%
4.00%
15.77%
10.00%
8.00%
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, 2012:
73
Amount of Commitment Expiring per Period
Contractual Obligations (1)
Total
Amounts
Committed
Less Than
1 year
Operating Lease Obligations
Total
$
$
10,874
10,874
$
$
1,882
1,882
(1) Contractual obligations do not include interest.
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$
$
3,592
3,592
$ 3,048
$ 3,048
$ 2,352
$ 2,352
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.
Financial instrument transactions are subject to our normal credit standards, financial controls and
risk-limiting and monitoring procedures. Collateral requirements are based on a case-by-case evaluation of
each customer and product.
The following table presents these off-balance sheet arrangements at December 31, 2012:
Amount of off-balance sheet Expiring per Period
Total
Amounts
Committed
$ 211,118
6,489
6,309
$ 223,916
Less Than
1 year
$ 145,556
6,489
5,509
$ 157,554
1-3 Years
3-5 Years
After 5
Years
(In thousands)
$ 56,844
—
800
$ 57,644
$ 7,964
—
—
$ 7,964
$ 754
—
—
$ 754
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 83.2% at December 31, 2012
compared to 85.3% at December 31, 2011.
Borrowings from the FHLB are another source of funding for our loan and investment activities.
At December 31, 2012, we could borrow up to $124.7 million with collateral of specifically identified loans
and securities. In addition, we have pledged securities with a fair value of $81.3 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 FHLB,
we are required to purchase FHLB stock. For the year ended December 31, 2012, the Bank was required to
maintain the minimum stock requirement of $4,282,000 of FHLB stock based on the volume of
“membership assets” as defined by the FHLB. At December 31, 2012, the Bank held $4,282,000 in FHLB
stock.
We also attempt to maintain a liquidity ratio (liquid assets, including cash and due from banks,
federal funds sold and investment securities not pledged as collateral expressed as a percentage of total
74
deposits) above approximately 18%. Our liquidity ratios were 36% at December 31, 2012 and 33% at
December 31, 2011. 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
FHLB could be employed to meet those funding needs. We have a Contingency Funding Plan 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 Investment Committee which is comprised of the Chief
Executive Officer and members of the Board of Directors. The Investment Committee 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 Investment Committee 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.
Exposure to interest rate risk is monitored continuously by senior management and is reviewed by
the Investment Committee at least quarterly by management and 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 movement in interest
rates of 100, 200, 300 and 400 basis points and an immediate and sustained downward movement in
interest rates of 100 and 300 basis points at December 31, 2012.
75
Interest Rate Scenario
Up 400 basis points
Up 300 basis points
Up 200 basis points
Up 100 basis points
Base
Down 100 basis points
Down 300 basis points
Market Value of Portfolio Equity
Market
Value
Percentage
Change
from Base
Percentage
of Total
Assets
Percentage of
Portfolio Equity
Book Value
(Dollars in thousands)
$ 226,809
$ 211,272
$ 195,407
$ 178,068
$ 163,279
$ 150,856
$ 142,413
38.91%
29.39%
19.68%
9.06%
— %
(7.61%)
(12.78%)
14.59%
13.59%
12.57%
11.45%
10.50%
9.70%
9.16%
120.75%
112.48%
104.03%
94.80%
86.93%
80.31%
75.82%
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, 2012, 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. Non-term deposit products reprice more slowly, usually changing less than the change in market
rates and at management discretion.
This analysis indicates the impact of changes in net interest income for the given set of rate
changes and assumptions. It assumes no growth in the balance sheet and that its structure will remain
similar to the structure at year end. It does not account for all factors that impact this analysis, including
changes by management to mitigate the impact of interest rate changes or secondary impacts such as
changes to our credit risk profile as interest rates change. Furthermore, loan prepayment rate estimates and
spread relationships change regularly. Interest rate changes create changes in actual loan prepayment rates
that will differ from the market estimates incorporated in this analysis. Changes that vary significantly from
the assumptions may have significant effects on our net interest income.
For the rising and falling interest rate scenarios, the base market interest rate forecast was
increased or decreased on an instantaneous and sustained basis.
76
Sensitivity of Net Interest Income December 31, 2012
Adjusted Net
Interest Income
Percentage
Change
from Base
Net Interest
Margin
Percent
Net Interest
Margin Change
$
$
$
$
$
$
$
93,093
82,580
72,132
62,259
55,094
53,827
52,781
(Dollars in thousands)
68.97%
49.89%
30.93%
13.01%
— %
(2.30)%
(4.20)%
6.14%
5.46%
4.78%
4.13%
3.66%
3.59%
3.52%
2.48
1.80
1.12
0.47
—
(0.07)
(0.14)
Interest Rate Scenario
Up 400 basis points
Up 300 basis points
Up 200 basis points
Up 100 basis points
Base
Down 100 basis points
Down 300 basis points
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
Evaluation of Disclosure Controls and Procedures
As of December 31, 2012, 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 SEC rules, as such rules are adopted by the FDIC. 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
77
Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were
effective as of December 31, 2012. 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
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, 2012. Management based this assessment on criteria for effective
internal control over financial reporting described in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included
an evaluation of the design of Preferred Bank’s internal control over financial reporting and testing of the
operational effectiveness of its internal control over financial reporting. Management reviewed the results
of its assessment with the Audit Committee of our Board of Directors. Based on this evaluation,
management determined that the Bank’s system of internal controls over financial reporting was effective
as of December 31, 2012.
78
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Preferred Bank:
We have audited Preferred Bank and subsidiary’s (the Bank) internal control over financial reporting as of
December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, the Bank maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2012, based on criteria established in the Internal Control – Integrated
Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated statements of financial condition of the Bank as of December 31,
2012 and 2011, and the related consolidated statements of operations and comprehensive income (loss),
changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended
December 31, 2012, and our report dated March 15, 2013 expressed an unqualified opinion on those
consolidated financial statements.
/s/ KPMG LLP
Los Angeles, California
March 15, 2013
79
ITEM 9B. OTHER INFORMATION
None
80
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 2013 Annual Meeting of Shareholders (the “2013 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 2013 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 2013 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 2013 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.
81
ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services will appear in the 2013 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.
82
(cid:1)(cid:3)(cid:4)(cid:5)(cid:6)(cid:7)(cid:8)
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
Report of Independent Registered Public Accounting Firm ...................................................................................... 87
Consolidated Statements of Financial Condition at December 31, 2012 and 2011 ................................................... 88
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Years Ended December 31,
2012, 2011 and 2010 .......................................................................................................................................... 89
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2012, 2011
and 2010 ............................................................................................................................................................. 90
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010 ......................... 91
Notes to Consolidated Financial Statements ............................................................................................................. 92
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
3.3
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
10.15*
10.16
12.1
21.1
31.1
31.2
32.1
Exhibit Description
Amended and Restated Articles of Incorporation(1)
Certificate of Determination of the Series A preferred Stock(5)
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, 2008. (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, 2009(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, 2009(4)
Deferred Compensation Plan-Deferred Stock Unit Agreement and Rabbi Trust
Lease relating to the Bank’s retail branch office at 600 California Street, San Francisco, California with
Columbia 600 California Office Properties, LLC, dated October 18, 2012
Computation of Ratio of Earnings to Fixed Charges
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
83
32.2
Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section
906 of the Sarbanes-Oxley Act of 2002
(1)
(2)
(3)
(4)
(5)
*
Incorporated by reference from Registrant’s Registration Statement on Form 10 filed with the Federal
Deposit Insurance Corporation on January 18, 2006.
Incorporated by reference from Registrant’s Registration Statement on Form 10 Amendment No. 1
filed with the Federal Deposit Insurance Corporation on February 2, 2006.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on May 9, 2008.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on November 7, 2009.
Incorporated by reference from Current Report on Form 8-K filed with the Federal Deposit Insurance
Corporation on June 10, 2010.
Denotes management contract or compensatory plan or arrangement.
84
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, 2012 and 2011 and the related consolidated statements of operations and
comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the years in the
three-year period ended December 31, 2012. 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, 2012 and 2011, and
the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the Bank’s internal control over financial reporting as of December 31, 2012, based
on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report dated March 15, 2013 expressed an
unqualified opinion on the effectiveness of the Bank’s internal control over financial reporting.
/s/ KPMG LLP
Los Angeles, California
March 15, 2013
85
PREFERRED BANK
Consolidated Statements of Financial Condition
December 31, 2012 and 2011
(In thousands, except for shares)
Assets
Cash and due from banks
Securities held-to-maturity, at amortized cost
Securities available-for-sale, at fair value
Loans and leases
Less allowance for loan and lease losses
Less unamortized deferred loan costs, net
Net loans and leases
Loans held for sale, at lower of cost or fair value
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
Income tax receivable
Other assets
Total assets
Liabilities and Shareholders’ Equity
Deposits:
Demand
Interest-bearing demand
Savings
Time certificates of $100,000 or more
Other time certificates
Total deposits
Acceptances outstanding
Senior debt
Accrued interest payable
Other liabilities
Total liabilities
Commitments and contingencies
Shareholders’ equity:
2012
2011
$
151,995
979
210,742
1,119,553
(20,607)
(2,019)
1,096,927
12,150
28,280
1,961
4,383
8,049
5,646
4,282
26,975
542
1,943
$
142,466
3,021
166,083
949,631
(23,718)
(1,037)
924,876
3,996
37,577
427
4,789
7,808
4,851
4,164
6,979
—
2,760
$
1,554,856
$
1,309,797
$
446,734
325,018
21,844
463,171
100,760
1,357,527
1,961
—
968
6,562
1,367,018
$
239,987
233,349
22,385
461,665
160,567
1,117,953
427
25,996
1,292
6,081
1,151,749
Preferred stock. Authorized 25,000,000 shares; no shares issued and outstanding
at December 31, 2012 and 2011.
Common stock, no par value. Authorized 20,000,000 shares; issued and
outstanding 13,234,608 and 13,220,955 shares at December 31, 2012 and
2011, respectively.
Treasury stock, at cost 152,985 and 152,835 shares at December 31, 2012 and
2011, respectively)
Additional paid-in capital
Retained earnings (accumulated deficit)
Accumulated other comprehensive loss:
—
—
162,927
162,884
(19,115)
(19,115)
24,544
17,481
23,456
(6,391)
Non-credit portion of other-than-temporary impairment on securities
available-for-sale, net of tax of $133 and $367 at December 31, 2012 and
December 31, 2011, respectively.
Unrealized gain (loss) on securities available-for-sale, net of tax of $1,585 and
($1,554) at December 31, 2012 and December 31, 2011, respectively.
Total shareholders’ equity
Total liabilities and shareholders’ equity
(184)
(481)
2,185
187,838
(2,305)
158,048
$
1,554,856
$
1,309,797
See accompanying notes to the consolidated financial statements.
86
PREFERRED BANK
Consolidated Statements of Operations and Comprehensive Income (Loss)
Years Ended December 31, 2012, 2011 and 2010
(In thousands, except share and per share data)
2012
2011
2010
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
Income (loss) before income taxes
Income tax benefit
Net income (loss)
Income allocated to participating shares
Accretion of beneficial conversion feature
Net income (loss) available to common shareholders
Other comprehensive income (loss):
Unrealized net gain on securities available-for-sale
Less reclassification adjustments included in net (loss) income
Other comprehensive (loss) income, before tax
Income taxes related to items of other comprehensive income
Other comprehensive income (loss) , net of tax
Comprehensive income(loss)
Net (loss) income per share
Basic
Diluted
Weighted-average common shares outstanding
Basic
Diluted
Dividends per share
$ 55,400
6,116
26
61,542
1,746
75
4,667
1,201
—
—
94
7,783
53,759
19,800
33,959
1,792
309
329
575
503
3,508
12,523
2,990
294
3,227
1,154
24
—
24
8,580
5,386
34,178
3,289
(20,583)
$ 23,872
(323)
—
$ 23,549
8,710
551
8,159
(3,372)
4,787
$ 28,659
$ 46,464
7,326
—
53,790
1,295
92
4,956
3,207
—
—
753
10,303
43,487
5,700
37,787
1,742
241
333
81
393
2,790
11,155
3,060
335
2,267
1,061
32
—
32
8,303
7,179
33,392
7,185
(5,049)
$ 12,234
(195)
—
$ 12,039
$ 46,130
5,957
1
52,088
655
208
5,768
6,764
—
677
750
14,822
37,266
16,550
20,716
1,865
382
329
(61)
292
2,807
9,591
3,271
246
3,504
1,122
843
(431)
412
12,481
10,410
41,037
(17,514)
(704)
$ (16,810)
—
(25,600)
$ (42,410)
4,286
(840)
3,446
(25)
3,421
$ 15,655
984
(2,049)
(1,065)
(1,035)
(2,100)
$ (18,910)
$ 1.80
$ 1.78
$ 0.93
$ 0.93
$ (6.21)
$ (6.21)
13,050,559
13,247,389
12,995,525
12,995,525
6,829,734
6,829,734
$ 0.00
$ 0.00
$ 0.00
See accompanying notes to the consolidated financial statements.
87
PREFERRED BANK
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2012, 2011 and 2010
(In thousands, except share and dividends declared per share data)
Preferred
Stock
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, 2010
$ —
13,188,305 $ 162,884 $(19,115) $ 22,539 $ (18,767)
$
(6,207)
$ 141,334
Accretion of preferred stock discount
—
Restricted stock award grant
Restricted stock award forfeitures
Share-based compensation
Net income
Change in Non-credit OTTI in AOCI,
net of taxes
Change in unrealized loss, net of tax
—
—
—
—
—
—
—
36,800
(4,150)
—
—
—
—
—
—
—
—
—
—
—
—
(142)
142
725
—
333
—
—
—
—
12,234
—
—
—
—
—
—
725
—
333
12,234
—
—
—
—
—
—
—
—
—
—
263
3,159
263
3,159
Balance as of December 31, 2011
$ —
13,220,955 $162,884 $ (19,115) $ 23,456
$ (6,391) $ (2,786)
$ 158,048
Restricted stock award grant
Restricted stock award forfeitures
Stock options exercised
Share-based compensation
Net income
Change in Non-credit OTTI in AOCI,
net of taxes
Change in unrealized gain, net of tax
—
—
—
—
—
—
8,600
(416)
5,469
—
—
—
—
—
43
—
—
—
—
—
—
—
—
—
542
—
—
546
—
—
—
—
—
23,872
—
—
—
—
—
542
—
43
546
23,872
—
—
296
296
—
—
—
—
—
—
4,491
4,491
Balance as of December 31, 2012
$ —
13,234,608 $162,927 $ (19,115) $ 24,544
$ 17,481
$ 2,001
$ 187,838
88
PREFERRED BANK
Consolidated Statements of Cash Flows
Years Ended December 31, 2012, 2011 and 2010
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for credit losses
Net change in deferred loan fees
(Gain) loss on sale and call of securities available-for-sale
Amortization of investment securities discounts and premiums, net
Depreciation and amortization
Net loss on disposal of equipment
Impairment of securities available for sale
Federal Home Loan Bank stock dividends
Share-based compensation expense
Write-down on other real estate owned
Net (gain) loss on sale of loans
Deferred tax expense (benefit)
Net loss on sale of other real estate owned
(Increase) Decrease in BOLI, accrued interest receivable, and other
assets
Increase (decrease) in accrued interest payable and other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Proceeds from maturities and redemptions of securities held-to-maturity
Proceeds from maturities and redemptions of securities available-for-sale
Proceeds from sale of securities available-for-sale
Purchase of securities held-to-maturity
Purchase of securities available-for-sale
Proceeds from sale of other real estate owned
Proceeds from sale of loans
Proceeds from recoveries of written off 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:
Increase (decrease) in deposits
Decrease in other borrowings
Decrease in senior debt
Net proceeds from stock issuance
Proceeds from the exercise of stock options
Net cash provided by (used in) financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest
Income taxes
Noncash activities:
Real estate acquired in settlement of loans
Loans to facilitate the sale of other real estate owned
Transfer of loans receivable to loans held for sale
Transfer of liabilities to equity
2012
2011
2010
$ 23,872
$ 12,234
$ (16,810)
19,800
982
(575)
595
650
—
24
(119)
1,087
4,018
(290)
(19,996)
387
(4,135)
158
26,460
2,062
28,386
11,096
—
(82,967)
7,945
2,534
570
(199,932)
(244)
(230,550)
239,574
—
(25,996)
—
43
213,620
9,530
142,466
151,995
5,700
1,095
(81)
530
738
—
32
276
1,059
4,870
656
(6,979)
1,090
3,737
194
25,150
33,761
3,002
20,453
(6,052)
(34,034)
14,982
35,642
1,217
(96,468)
(109)
(27,606)
36,688
—
—
—
—
36,688
34,233
108,233
142,466
16,550
526
61
554
895
23
412
556
1,671
8,476
1,518
2,569
1,041
29,878
(1,665)
46,255
18,559
—
56,904
—
(146,359)
30,607
20,693
633
44,985
(11)
26,011
(79,147)
(23,000)
—
70,043
—
(32,104)
40,162
68,071
108,233
$ 8,107
$ 4,410
$ 10,727
$ 154
$ 16,054
$ 58
$ 6,103
$ 3,050
$ 31,784
$ —
$ 6,107
$ 4,535
$ 40,806
$ —
$ 33,598
$ 21,392
$ 35,643
$ 3,154
See accompanying notes to consolidated financial statements.
89
PREFERRED BANK
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
Preferred Bank (the Bank) is a full service commercial bank and is engaged primarily in commercial, real estate,
and international lending to customers with businesses domiciled in the state of California. The accounting and reporting
policies of the Bank are in accordance with accounting principles generally accepted in the United States of America and
conform to general practices in the banking industry. The following is a summary of the Bank’s significant accounting
policies.
(a) Basis of Presentation
The financial statements include the accounts of Preferred Bank and its subsidiary, PB Investment and
Consulting, Inc. (collectively the “Bank” or the “Company”). The audited consolidated financial statements of the
Company have been prepared in conformity with accounting principles generally accepted in the United States of
America.
The preparation of financial statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting periods.
Material estimates that are particularly susceptible to significant changes in the near-term relate to the
determination of the allowance for 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) Reverse Stock Split
At the May 24, 2011 Annual Meeting of Shareholders, the shareholders of the Bank approved the proposal to
authorize the Board of Directors in its discretion, without further authorization of the Bank’s shareholders, to
amend the Bank’s Articles of Incorporation to effect a reverse split of the Bank’s common stock by a ratio of one
for five (“Reverse Stock Split”). Pursuant to Section 697 of the California Financial Code, the approval of the
Reverse Stock Split was also subject to receipt of an Order of Exemption from the California Department of
Financial Institutions, which the Bank received on June 17, 2011. Upon receipt of the Order of Exemption, the
Bank’s Board of Directors amended the Bank’s Articles of Incorporation to reflect the effect of the Reverse Stock
Split of the Bank’s common stock effective with respect to the shareholders of record at the close of business on
June 17, 2011 (the “Effective Time”). At the Effective Time every five shares of Preferred Bank’s pre-split
common shares automatically were converted into one post-split share. The Reverse Stock Split affected all
holders of common stock uniformly and did not affect any shareholder’s percentage ownership interest in the
Bank, except record holders of common stock otherwise entitled to a fractional share as a result of the Reverse
Stock Split received a cash payment in lieu of such fractional share in a proportional amount based on the closing
price of the common stock on the NASDAQ Stock Exchange at the Effective Time. Under the terms of the
Bank’s equity incentive plans, at the Effective Time, the number of shares reserved for issuance under the plans
was proportionately decreased in accordance with the exchange ratio. Under the terms of the options granted
under the plans, at the Effective Time, the number of shares covered by each option decreased and the conversion
or exercise price per share increased in accordance with the exchange ratio. After giving effect to the Reverse
Stock Split, we have retroactively adjusted the number of common shares outstanding at December 31, 2010 to
13,188,305. Accordingly, all references in the accompanying consolidated statements of financial condition,
statements of operations and statements of changes in shareholders’ equity to the number of common stock shares
and earnings per share amounts have been retroactively adjusted for all periods presented. The number of
authorized common shares is 20,000,000 subsequent to the Reverse Stock Split.
90
PREFERRED BANK
Notes to Consolidated Financial Statements
(c)
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.
(d) 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 $3.1 million and $1.0 million as of December 31, 2012 and 2011, respectively.
(e)
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, 2012 and 2011, there were $979,000 and $3.0 million classified in the held-to-maturity portfolio.
At each reporting date, the Bank performs an impairment analysis on its investment securities portfolio,
following FASB standards in 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.
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.
(f)
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
held at carrying value, less related allowance for loan loss and 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 non-accrual loans. The
accrual of interest on loans is discontinued when principal or interest is past due 90 days or more unless the loan
is both well secured and in the process of collection. In addition, a loan that is current may be placed on non-
accrual status if the Bank believes substantial doubt exists as to whether the Bank will collect all principal and
contractual due interest. When loans are placed on non-accrual status, all interest previously accrued, but not
collected, is reversed against current period interest income. Interest received on non-accrual 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
91
PREFERRED BANK
Notes to Consolidated Financial Statements
current and, in the opinion 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 they are impaired, considered collateral
dependent, principal or interest is over 90 days past due, the loan lacks sufficient collateral protection and are 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 measures a loan for impairment 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. A loan is also
considered impaired when the recorded investment in the loan is less than the present value of expected future
cash flows (discounted at the loan’s effective interest rate). By definition, all loans classified as troubled debt
restructures are considered impaired and measured for impairment. The measurement of impairment is 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 loans classified as “substandard” or “doubtful” are analyzed for impairment. The Bank recognizes
interest income on impaired loans based on its existing methods of recognizing interest income on non-accrual
loans.
Troubled Debt Restructured (“TDR”) loans are defined by ASC 310-40, “Troubled Debt Restructurings by
Creditors” and ASC 470-60, “Troubled Debt Restructurings by Debtors,” and evaluated for impairment in
accordance with ASC 310-10-35. The concessions may be granted in various forms, including reduction in the
stated interest rate, reduction in the amount of principal amortization, forgiveness of a portion of a loan balance or
accrued interest, or extension of the maturity date.
(g) 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 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 and substandard that are not already included in impaired analysis based on
economic and other qualitative factors that indicate probable losses were incurred but were not captured through
the other elements of our allowance adequacy analysis.
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 the Bank 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
segments for purposes of determining allowance amounts by loan segment. The loan pools we currently evaluate
are: commercial & industrial, trade finance, real estate – land, mini-perm, real estate construction and other loans.
92
PREFERRED BANK
Notes to Consolidated Financial Statements
Each of these segments is then further broken down based on industry, geography or property type or a
combination thereof. Within these loan pools, we then evaluate loans rated as pass credits, separately from
adversely classified loans. The allowance amounts for pass rated loans 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; non-accrual
and problem loan trends; and other adjustments for items not covered by other factors. We base our allowance for
loan losses on an estimation of probable losses inherent in our loan portfolio.
(h) 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 loss on sale of REO and related expense, as appropriate.
(i) 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.
(j) 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.
(k)
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.
(l)
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 shares in the earnings of the Bank.
93
PREFERRED BANK
Notes to Consolidated Financial Statements
(m) 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
service period for the entire award of generally three to five years, and options expire between four and ten years
from the date of grant. See Note 13 for further discussion.
(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 estimates subject to change relates to the allowance for loan
losses, the valuation of other real estate owned, and accounting for deferred tax assets. If the allowance is not
adequate as of December 31, 2012 then additional losses could be realized in 2013. 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, 2012, approximately 95% of the total dollar amount of the Bank’s loans and
commitments was related to collateral or borrowers located within California. Because the Bank’s loan portfolio
is concentrated in commercial and residential real estate, the performance of these loans may be affected by
further continued weakness or 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
this period of economic slowdown, the Bank has experienced a decline in collateral values and an increase in
delinquencies and defaults. Further declines in collateral values and an increase in delinquencies and defaults
increase the possibilities and severity of losses. California real estate is also subject to certain natural disasters,
such as earthquakes, fires, floods and mud slides, as well as civil unrest, which are typically not covered by the
standard hazard insurance policies maintained by the Bank’s borrowers. Uninsured disasters may render
borrowers unable to repay loans made by the Bank and lower collateral values.
(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.
94
PREFERRED BANK
Notes to Consolidated Financial Statements
(r) Recently Issued Accounting Standards
Following are the recently issued updates to the codification of U.S. Accounting Standards (ASUs), which
are the most relevant to the Bank.
In May 2011, the FASB issued ASC update No. 2011-04, “Fair Value Measurement (Topic 820),
Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and
IFRSs.” The amendments in this Update result in common fair value measurement and disclosure requirements in
U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the
requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value
measurements. Some of the amendments clarify the application of existing fair value measurement requirements.
Other amendments change a particular principle or requirement for measuring fair value or for disclosing
information about fair value measurements. The amendments that clarify the application of existing fair value
measurements and disclosure requirements include the following: 1) application of the highest and best use and
valuation premise concepts, 2) measuring the fair value of an instrument classified in a reporting entity’s
shareholders’ equity, and 3) disclosures about fair value measurements that clarify that a reporting entity should
disclose quantitative information about the unobservable inputs used in a fair value measurement that is
categorized within Level 3 of the fair value hierarchy. The amendments in this Update that change a particular
principle or requirement for measuring fair value or disclosing information about fair value measurements include
the following: 1) measuring the fair value of financial instruments that are managed within a portfolio, 2)
application of premiums and discounts in a fair value measurement, and 3) additional disclosures about fair value
measurements. The amendments in this Update are to be applied prospectively and are effective during interim
and annual periods beginning after December 15, 2011. The adoption of this guidance did not have a material
impact on the Bank.
In December 2011, the Financial Accounting Standards Board ("FASB") issued authoritative guidance
related to balance sheet offsetting. The new guidance requires disclosures about assets and liabilities that are
offset or have the potential to be offset. These disclosures are intended to address differences in the asset and
liability offsetting requirements under U.S. GAAP and International Financial Reporting Standards. This new
guidance will be effective for the Bank for interim and annual reporting periods beginning January 1, 2013, with
retrospective application required and is not expected to have a material impact on the Bank’s consolidated
financial statements.
(2) Securities Available-for-Sale and Held-to-Maturity
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
economic, 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, when combined), the Bank has no exposure
within its investment portfolio to any single issuer greater that 10% of equity capital.
95
PREFERRED BANK
Notes to Consolidated Financial Statements
The carrying value of our held-to-maturity investment securities was $979,000 at December 31, 2012 and $3.0
million at December 31, 2011. The table below shows the amortized cost, gross unrealized gains and losses and
estimated fair value of securities held-to-maturity as of December 31, 2012 and 2011:
Amortized
cost
December 31, 2012
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
Collateralized debt obligations
$ 979
$ 3
$ —
$ 982
Amortized
cost
December 31, 2011
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
Collateralized debt obligations
$ 3,021
$ —
$ (124)
$ 2,897
The table below shows the amortized cost, the total other-than-temporary impairment recognized in accumulated
other comprehensive income, gross unrealized gains and losses, and estimated fair value of securities available for sale
as of December 31, 2012 and 2011.
Amortized
cost
Gross
unrealized
gains
$ 49,347
95,873
$ 3,092
1,103
December 31, 2012
Gross
unrealized
losses
(In thousands)
$ (1,458)
(52)
Non-credit
other-than-
temporary
impairment
Estimated
fair value
$ —
—
$ 50,981
96,924
24,664
24,823
5,719
67
988
127
(71)
—
—
—
—
—
24,660
25,811
5,846
5,000
1,863
$ 207,289
—
1
$ 5,378
(27)
—
$ (1,608)
—
(317)
$ (317)
4,973
1,547
$ 210,742
Corporate notes
Mortgage-backed securities
Collateralized mortgage
obligations
Municipal securities
Principal-only strip securities
Mutual funds – government bond
funds
Collateralized debt obligations
Total securities available-for-sale
96
PREFERRED BANK
Notes to Consolidated Financial Statements
Amortized
cost
Gross
unrealized
gains
December 31, 2011
Gross
unrealized
losses
(In thousands)
Non-credit
other-than-
temporary
impairment
U.S. government agency
securities
Corporate notes
Mortgage-backed securities
Collateralized mortgage
obligations
Municipal securities
Principal-only strip securities
Collateralized debt obligations
SBA securities
USDA security
Total securities available-for-sale
$ 5,736
43,226
50,846
23,253
21,746
6,934
2,072
10,055
6,922
$ 170,790
$ 3
57
909
—
214
—
—
512
—
$ 1,695
$ — $ —
—
—
(4,385)
(21)
(686)
(451)
(11)
—
—
—
$ (5,554)
—
—
—
(848)
—
—
$ (848)
Estimated
fair value
$ 5,739
38,898
51,734
22,567
21,509
6,923
1,224
10,567
6,922
$ 166,083
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, 2012 and 2011 are as follows:
Less than 12 months
December 31, 2012
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
$ —
10,148
$ —
(52)
$ 18,217
—
$ (1,458)
—
$ 18,217
10,148
$ (1,458)
(52)
3,519
—
—
—
—
(71)
—
—
—
—
—
—
4,973
—
1,100
—
—
(27)
—
(317)
3,519
—
4,973
—
1,100
(71)
—
(27)
—
(317)
$ 13,667
$ (123)
$ 24,290
$ (1,802)
$ 37,957
$ (1,925)
Corporate notes
Mortgage-backed securities
Collateralized mortgage
obligations
Municipal securities
Mutual funds – government bond
funds
Principal-only strip securities
Collateralized debt obligations
Total securities available-for-
sale
97
PREFERRED BANK
Notes to Consolidated Financial Statements
Less than 12 months
December 31, 2011
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
$ 16,158
3,890
$ (1,098)
(21)
$ 17,598
—
$ (3,287)
—
$ 33,756
3,890
$ (4,385)
(21)
4,738
1,786
6,923
—
(356)
(12)
(11)
—
17,829
10,605
—
1,224
(330)
(439)
—
(848)
22,567
12,391
6,923
1,224
(686)
(451)
(11)
(848)
$ 33,495
$ (1,498)
$ 47,256
$ (4,904)
$ 80,751
$ (6,402)
Corporate notes
Mortgage-backed securities
Collateralized mortgage
obligations
Municipal securities
Principal-only strip securities
Collateralized debt obligations
Total securities available-for-
sale
The Bank’s investment portfolio is primarily comprised of corporate notes, U.S. government securities,
collateralized mortgage obligations, municipal securities, and mortgage-backed securities.
Preferred Bank performs a regular impairment analysis on its investment securities portfolio and management has
analyzed all investment securities which have an amortized cost that exceeds fair value as of December 31, 2012.
The Bank owns three collateralized debt obligations (“CDO’s”) in its available-for-sale portfolio which consist of
pools of bank trust preferred securities. As of December 31, 2012, the amortized cost of two 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 100 basis points which
determined the actual discount rate. Management then used current deferrals and defaults and 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 at some
future date. In addition to those specific defaults, Management estimated additional default rates as a percentage of the
overall pool, with higher default rates applied in the short-term 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 three securities
using a discount rate that was equal to the accretable yield on all three securities and using all of the same default
assumptions as described above. The result of this analysis indicated that all three securities were temporarily impaired
and one of these had a credit-related other-than-temporary impairment of $24,000 and $32,000 during 2012 and 2011,
respectively, which was recognized in income. The non-credit related impairment for these securities was $317,000 and
$847,000 at December 31, 2012 and 2011, respectively, and was reflected in the accumulated other comprehensive loss.
As of December 31, 2012, the Bank owned 6 corporate securities where the amortized cost exceeded fair value.
The total amortized cost of these securities was $19.7 million and their fair value was $18.2 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 all 6 corporate securities to be temporarily
impaired. The Bank had recorded no credit-related OTTI charges on corporate securities during 2012, and also had zero
OTTI charges relating to corporate securities in 2011 and 2010.
As of December 31, 2012, the Bank owned one collateralized mortgage obligation (“CMO”) where the amortized
cost exceeded fair value. The amortized cost of this security was $3.6 million and the fair value was $3.5 million.
Management determined that the CMO security was not other-than-temporarily impaired as of December 31, 2012. This
98
PREFERRED BANK
Notes to Consolidated Financial Statements
determination was made based on several factors such as debt rating of the security, amount of credit protection, the
Bank’s intent and ability to hold the security 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 security prior to recovery of amortized cost basis.
The Bank owns 21 municipal investment securities. Each of these securities carries an investment-grade rating. As
of December 31, 2012, zero of these issues were in an unrealized loss position. As such, management determined that
there is no other-than-temporary impairment for municipal investment securities as of December 31, 2012.
At December 31, 2012, the Bank held one agency-backed principal-only (PO) strip security with a fair value of
$5.8 million and an amortized cost of $5.7 million. The Bank also held one CDO classified as held-to-maturity with an
amortized cost of $979,000 and a fair value of $982,000.
At December 31, 2012, there were 8 and 9 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, collateralized mortgage obligation, 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 2013 on specific investments within these portfolios.
Cash proceeds from sales of securities available-for-sale totaled $11.1 million, $20.5 million and $56.9 million in
2012, 2011, and 2010, respectively. Net realized gains for sales and calls of securities totaled $554,000, $81,000,
$61,000 and gain from mutual funds was $21,000, $0, and $0 for the years ended December 31, 2012, 2011, and 2010,
respectively. Investment securities having a fair value of approximately $125.0 million and $155.4 million were pledged
to secure governmental deposits, treasury tax and loan deposits, borrowing lines from the Federal Reserve Bank and
FHLB as of December 31, 2012 and 2011, respectively.
The amortized cost and estimated fair value of securities at December 31, 2012 and 2011, by contractual maturity,
are shown below. Mortgage-backed securities are classified in accordance with their estimated average life. Expected
maturities differ from contractual maturities mainly due to prepayment rates; changes in prepayment rates will affect a
security’s average life.
2012
Available-for-Sale
2011
Available-for-Sale
Amortized
cost
Estimated
fair value
Amortized
cost
Estimated
fair value
(In thousands)
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
$ —
6,464
49,867
150,958
$ 207,289
$ —
7,061
51,974
151,707
$ 210,742
$
—
1,318
39,647
129,825
$ 170,790
$
—
1,416
36,840
127,827
$ 166,083
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 the year ended December 31, 2012
and 2011:
99
PREFERRED BANK
Notes to Consolidated Financial Statements
Additions for
the amount
related to the
credit loss
for which
OTTI was
not
previously
recognized
Beginning
Balance as of
December 31,
2011
Reductions for
securities for which
the amount
previously
recognized in OCI
was recognized in
earnings
(in thousands)
Reductions
for
Securities
Sold
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,
2012
Amounts related to credit losses on
debt securities for which a portion
of OTTI was recognized in OCI
$ 1,617
$ —
$ —
$ —
$ 24
$ —
$ 1,641
Additions for
the amount
related to the
credit loss
for which
OTTI was
not
previously
recognized
Beginning
Balance as of
December 31,
2010
Reductions for
securities for which
the amount
previously
recognized in OCI
was recognized in
earnings
(in thousands)
Reductions
for
Securities
Sold
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,
2011
Amounts related to credit losses on
debt securities for which a portion
of OTTI was recognized in OCI
$ 1,585
$ —
$ —
$ —
$ 32
$ —
$ 1,617
(3) Loans and Leases and Allowance for Loan and Lease Losses
The loans and leases portfolio as of December 31, 2012 and 2011 is summarized as follows:
Real estate-mini perm
Real estate-construction
Commercial
Trade finance
Other Loans
Gross loans
Less:
Allowance for loan and lease losses
Deferred loan fees, net
Loans excluding loans held for sale
Loans held for sale
Total loans, net
2012
2011
(In thousands)
$ 672,647
74,410
324,753
47,413
330
1,119,553
$ 575,172
71,942
252,161
49,750
606
949,631
(20,607)
(2,019)
1,096,927
12,150
$ 1,109,077
(23,718)
(1,037)
924,876
3,996
$ 928,872
The majority of the Bank’s loans is 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 $26.1 million of non-accrual loans and leases at December 31, 2012 compared to $47.5 million at
December 31, 2011. These loans and leases had interest due, but not recognized, of approximately $1.8 million and $3.4
100
PREFERRED BANK
Notes to Consolidated Financial Statements
million in 2012 and 2011, respectively. The Bank had zero loans past due 90 or more days and still accruing interest as
of both December 31, 2012 and December 31, 2011.
The following tables depict the Bank’s past due loans by class as of December 31, 2012 and 2011:
December 31, 2012
Loan Class:
Real estate - Mini-perm
R/E - Residential
R/E - Commercial
Total R/E - Mini-perm
Real Estate - Construction
Construction - Residential
Construction - Commercial
Total R/E - Construction
Commercial and Industrial
Trade Finance
Other
Loans held for sale
Total as of December 31, 2012
December 31, 2011
Loan Class:
Real estate - Mini-perm
R/E - Residential
R/E - Commercial
Total R/E - Mini-perm
Real Estate - Construction
Construction - Residential
Construction - Commercial
Total R/E - Construction
Commercial and Industrial
Trade Finance
Other
Loans held for sale
Total as of December 31, 2011
30-89 Days
Accruing
90+ Days
Non-accrual &
Still Accruing
Non-current
(in thousands)
Total Past
Due
Non-accrual
Current
$ —
5,382
5,382
—
5,400
5,400
376
—
—
$ —
—
—
—
—
—
—
—
—
$ —
$ 11,158
$ —
$ —
$ 727
1,265
1,992
5,543
—
5,543
11,460
—
—
$ 7,150
$ 26,145
$ 727
6,647
7,374
5,543
5,400
10,943
11,836
—
—
$ 7,150
$ 37,303
$ —
—
—
—
—
—
—
—
—
$ —
$ —
30-89 Days
Accruing
90+ Days
Non-accrual &
Still Accruing
Non-current
(in thousands)
Total Past
Due
Non-accrual
Current
$ -
-
-
$ -
-
-
$ 1,894
2,381
4,275
$ 1,894
2,381
4,275
$ -
9,544
9,544
-
-
-
-
-
-
$ -
$ -
-
-
-
-
-
-
$ -
$ -
5,140
15,870
21,010
6,718
-
-
$ 3,996
$ 35,999
5,140
15,870
21,010
6,718
-
-
$ 3,996
$ 35,999
-
-
-
1,910
-
-
$ -
$ 11,454
101
PREFERRED BANK
Notes to Consolidated Financial Statements
The following tables depict the Bank’s total non-accrual loans by class for the years ended December 31, 2012
and 2011:
Loan Class
Real Estate-Mini-Perm:
R/E - Residential
R/E - Commercial
Total R/E-Mini-Perm
Real Estate - Construction:
Construction-Residential
Construction-Commercial
Total Real Estate - Construction
Commercial and Industrial
Trade Finance
Other
Loans held for sale
Total non-accrual loans
December 31,
2012
2011
(In thousands)
$ 727
1,265
1,992
5,543
—
5,543
11,460
—
—
7,150
$ 26,145
$ 1,894
11,925
13,819
5,140
15,870
21,010
8,628
—
—
3,996
$ 47,453
A troubled debt restructuring (“TDR”) is a formal modification of the terms of a loan when the lender, for
economic or legal reasons related to the borrower’s financial condition, grants a concession to the borrower. The
concessions may be granted in various forms, including change in the stated interest rate, reduction in the loan balance or
accrued interest, or extension of the maturity date with a stated interest rate lower than the current market rate.
TDRs may be designated as performing or non-performing. A TDR may be designated as performing if the loan
has demonstrated sustained performance under the modified terms. The period of sustained performance may include the
periods prior to modification if prior performance met or exceeded the modified terms. For non-performing restructured
loans, the loan will remain on non-accrual status until the borrower demonstrates a sustained period of performance,
generally six consecutive months of payments. The Bank had $727,000 and $16.0 million in total performing
restructured loans as of December 31, 2012 and 2011, respectively. Non-performing restructured loans were $7.2 million
and $11.5 million at December 31, 2012 and 2011, respectively. All TDRs are included in the balance of impaired loans.
The following tables provide information on loans modified as TDRs during the year ended December 31, 2012
and 2011:
Real Estate – Mini-Perm:
Residential
Commercial
Real Estate – Construction:
Residential
Commercial
Commercial & Industrial
Trade Finance
Total
Loans Modified as TDRs During the
Year Ended December 31, 2012
Number of
Contracts
Pre-modification
Outstanding
Recorded Investment
Post-modification
Outstanding
Recorded Investment
(Dollars in thousands)
$
$
—
14,302
—
—
230
—
14,532
$
$
—
7,876
—
—
230
—
8,106
—
2
—
—
1
—
3
102
PREFERRED BANK
Notes to Consolidated Financial Statements
Loans Modified as TDRs During the
Year Ended December 31, 2011
Number of
Contracts
Pre-modification
Outstanding
Recorded Investment
Post-modification
Outstanding
Recorded Investment
(Dollars in thousands)
1
3
$
—
—
1
—
5
$
302
14,642
—
—
1,702
—
16,646
$
$
302
12,102
—
—
1,702
—
14,106
Real Estate – Mini-Perm:
Residential
Commercial
Real Estate – Construction:
Residential
Commercial
Commercial & Industrial
Trade Finance
Total
Modification of the term of a loan is individually evaluated based on the loan type and the circumstances of the
borrower’s financial difficulty in order to maximize the bank’s recovery. Real estate mini-perm TDRs were primarily
loans where we have modified the scheduled payments to interest only terms for a given period of time, normally one
year. We expect to collect the balance of the loan as property cash flows and/or the guarantor’s global cash flow
improves to allow for the resumption of principal and interest payments. As of December 31, 2012 real estate mini-perm
commercial TDRs modified with interest only terms totaled $7.9 million.
Subsequent to restructuring, a TDR that becomes delinquent, generally beyond 90 days for commercial and
industrial and real estate mini-perm commercial loans, becomes non-accrual. There was one real estate mini-perm
residential TDR with a recorded investment of $171,000, three real estate mini-perm commercial TDRs with a combined
investment of $752,000, and one commercial & industrial TDR with a recorded investment of $230,000 that
subsequently defaulted during the year ended December 31, 2012. There was one real estate mini-perm commercial TDR
with a recorded investment of $380,000 which had subsequently defaulted as of December 31, 2011.
All TDRs are included in the impaired loan valuation allowance process. All portfolio segments of TDRs are
reviewed for necessary specific reserves in the same manner as impaired loans of the same portfolio segment which have
not been identified as TDRs. The modification of the terms of each TDR is considered in the current impairment analysis
of the respective TDR. For all portfolio segments of delinquent TDRs and when the restructured loan is less than the
recorded investment in the loan, the deficiency is charged-off against the allowance for loan losses. If the loan is a
performing TDR the deficiency is included in the specific allowance, as appropriate. As of December 31, 2012, the
allowance for loan losses associated with TDRs was $317,000 for performing TDRs and $0 for non-performing TDRs.
Impaired loans and leases are those for which it is probable that we will not be able to collect all amounts due
according to the contractual terms of the loan or lease agreement. The category of impaired loans and leases is not
comparable with the category of non-accrual loans and leases. Management may choose to place a loan or lease on non-
accrual status due to payment delinquency or uncertain collectability, while not classifying the loan or lease as impaired
if it is probable that we will collect all amounts due in accordance with the original contractual terms of the loan or lease.
Impaired loans totaled $25.0 million and $73.4 million at December 31, 2012 and 2011, respectively. The total
allowance for loan and lease losses related to these loans was $2.3 million and $4.9 million at December 31, 2012 and
2011, respectively. Interest income recognized on impaired loans during 2012, 2011 and 2010 was $598,000, $1.2
million and $2.7 million, respectively. At December 31, 2012, the Bank had zero commitments to lend additional funds
to debtors whose loans are impaired.
103
PREFERRED BANK
Notes to Consolidated Financial Statements
Impaired loans, disaggregated by loan class, as of December 31, 2012 and 2011 are set forth in the following
tables:
Unpaid
Principal
Balance
Recorded
Investment
with
allowance
Recorded
Investment
without
allowance
Total
Recorded
investment
(in thousands)
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$ 727
$ —
$ 727
$ 727
$ —
$ 727
$ 20
7,834
8,561
5,543
—
5,543
18,788
—
—
726
726
5,543
—
5,543
6,592
—
—
6,573
7,300
—
—
—
4,867
—
—
7,299
8,026
5,543
—
5,543
11,459
—
—
317
317
180
—
180
1,834
—
—
7,328
8,055
5,807
—
5,807
22,302
—
—
252
272
—
—
—
343
—
—
2012
Real estate - mini-perm:
Residential
Commercial
Total R/E mini-perm
Real estate - construction:
Residential
Commercial
Total R/E construction
Commercial
Trade Finance
Other loans
Total impaired loans
$ 32,892
$ 12,861
$ 12,167
$ 25,028
$ 2,331
$ 36,164
$ 615
Unpaid
Principal
Balance
Recorded
Investment
with
allowance
Recorded
Investment
without
allowance
Total
Recorded
investment
(in thousands)
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$ 2,196
$ 882
$ 1,314
$ 2,196
$ 370
$ 2,204
$ 18
34,097
36,293
20,997
17,975
38,971
16,050
55
—
17,110
17,992
—
15,870
15,870
3,600
55
—
13,054
14,368
7,696
1,440
9,136
12,381
—
—
30,164
32,360
7,696
17,310
25,006
15,981
55
—
3,283
3,653
—
584
584
565
55
—
34,712
36,916
20,424
28,001
48,425
16,261
7
—
818
836
—
(5)
(5)
332
—
—
2011
Real estate - mini-perm:
Residential
Commercial
Total R/E mini-perm
Real estate - construction:
Residential
Commercial
Total R/E construction
Commercial
Trade Finance
Other loans
Total impaired loans
$ 91,369
$ 37,517
$ 35,885
$ 73,402
$ 4,857
$ 101,609
$ 1,162
During 2012, loans with a recorded investment of $18.1 million were sold for a net gain of $290,000. Two loans,
with a total recorded investment of $12.2 million remained as loans held for sale as of December 31, 2012. During 2011,
loans with a recorded investment of $42.7 million were sold for a net loss of $0.7 million. Two loans, with a total
recorded investment of $4.0 million, remained as loans held for sale at December 31, 2011.
104
PREFERRED BANK
Notes to Consolidated Financial Statements
The following table details activity in the allowance for credit losses by portfolio segment for the year ended
December 31, 2012. Allocation of a portion of the allowance to one particular portfolio segment does not indicate that it
is no longer available to absorb losses in other portfolio segments.
2012
Real estate - Mini-perm
Residential Commercial
Residential
Real estate - Construction
Commercial
Commercial & Industrial
(In thousands)
Trade
Finance Other Unallocated
Total
Balance at beginning of period
Provision for credit losses
Loans and leases charged off
Recoveries
Net charge offs
$ 1,640
1,050
(927)
299
(628)
$ 13,192
5,504
(9,845)
60
(9,785)
$ 1,199
(94)
—
2
2
$ 1,153
1,434
(2,184)
145
(2,039)
$ 3,156
12,177
(10,328)
64
(10,264)
101
(197)
$ 523 $ 7
(3)
—
— —
—
(197)
$ 2,848
(369)
—
—
—
$ 23,718
19,800
(23,481)
570
(22,911)
Balance at end of period
$ 2,062
$ 8,911
$ 1,107
$ 548
$ 5,069
$ 427 $ 4
$ 2,479
$ 20,607
Period-end amount allocated to:
Loans individually evaluated for
impairment
Loans collectively evaluated for
impairment
$ —
$ 317
$ 180
$ —
$ 1,834
$ — $ —
$ —
$ 2,331
2,062
8,594
927
548
3,235
427 4
2,479
18,276
Total
$ 2,062
$ 8,911
$ 1,107
$ 548
$ 5,069
$ 427 $ 4
$ 2,479
$ 20,607
The Bank’s recorded investment in loans as of December 31, 2012 related to each balance in the allowance for
credit losses by portfolio segment and disaggregated on the basis of the Bank’s impairment methodology was as follows:
Real estate - Mini-perm
Residential
Commercial
Real estate - Construction
Residential
Commercial
Commercial
Trade
Finance
Other
Total
(In thousands)
Loans individually evaluated for
impairment
Loan collectively evaluated for
impairment
$ 727
$ 7,299
$ 5,543
$ —
$ 11,459 $ —
$ —
$ 25,028
58,794
605,827
30,804
38,063
313,294
47,413
330
1,094,525
Ending balance
$ 59,521
$ 613,126
$ 36,347
$ 38,063
$ 324,753 $ 47,413
$ 330
$ 1,119,553
105
PREFERRED BANK
Notes to Consolidated Financial Statements
The following table details activity in the allowance for credit losses by portfolio segment for the year ended
December 31, 2011. Allocation of a portion of the allowance to one particular portfolio segment does not indicate that
is no longer available to absorb losses in other portfolio segments.
2011
Real estate - Mini-perm
Residential Commercial
Residential
Real estate - Construction
Commercial
Commercial & Industrial
(In thousands)
Trade
Finance Other Unallocated
Total
Balance at beginning of period
Provision for credit losses
Loans and leases charged off
Recoveries
Net charge offs
$ 2,621
944
(1,986)
61
(1,925)
$ 13,779
6,021
(6,651)
43
(6,608)
$ 5,631
(2,774)
(1,665)
7
(1,658)
$ 870
781
(664)
166
(498)
$ 8,215
(756)
(5,126)
823
(4,303)
$ 1,559 $ 5
7
(1,153)
(5)
—
117
—
117 (5)
$ 218
2,630
—
—
—
$ 32,898
5,700
(16,097)
1,217
(14,880)
Balance at end of period
$ 1,640
$ 13,192
$ 1,199
$ 1,153
$ 3,156
$ 523 $ 7
$ 2,848
$ 23,718
Period-end amount allocated to:
Loans individually evaluated for
impairment
Loans collectively evaluated for
impairment
$ 370
$ 3,283
$ —
$ 584
$ 565
$ 55 $ —
$ —
$ 4,857
1,270
9,909
1,199
569
2,591
468 7
2,848
18,861
Total
$ 1,640
$ 13,192
$ 1,199
$ 1,153
$ 3,156
$ 523 $ 7
$ 2,848
$ 23,718
The Bank’s recorded investment in loans as of December 31, 2011 related to each balance in the allowance for
credit losses by portfolio segment and disaggregated on the basis of the Bank’s impairment methodology was as follows:
Real estate - Mini-perm
Residential
Commercial
Real estate - Construction
Residential
Commercial
Commercial
Trade
Finance
Other
Total
(In thousands)
Loans individually evaluated for
impairment
Loan collectively evaluated for
impairment
$ 2,196
$ 30,164
$ 5,140
$ 15,870
$ 15,980
$ 55
$ —
$ 69,406
44,773
498,039
35,837
15,095
236,181
49,695
606
$ 880,225
Ending balance
$ 46,969
$ 528,203
$ 40,977
$ 30,965
$ 252,161
$49,750
$ 606
$ 949,631
As required by federal regulations, we classify our assets on a regular basis. In order to monitor the quality of
our lending portfolio and quantify the risk therein, we maintain 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, whereas the fifth grade is a transition grade known as “special mention”.
The other three grades (6-8) range from “substandard” to “doubtful” to a “loss” category. Loans graded as “loss” are
charged-off in the period so rated. We use grades 6 and 7 of our loan grading system to identify potential problem assets
for impairment analysis. In reviewing loans and evaluating the adequacy of the allowance, there are several risk
characteristics considered. Those most relevant to the major portfolio segments includes vacancy and lease rates on
commercial real estate, state of the general housing market, home prices, commercial real estate values and the impact of
economic conditions and employment levels on the various businesses in our market area.
106
PREFERRED BANK
Notes to Consolidated Financial Statements
The following tables present weighted average risk grades and classified loans by class of loan as of December
31, 2012 and 2011. Classified loans include loans in risk grades 6 and 7, which correlate to substandard and doubtful for
risk classification purposes.
(1) Real Estate – Commercial includes loans held for sale of $5,000 with a Pass rating and $7,150 with a Substandard rating.
2012
Grade:
(In thousands)
Pass
Special Mention
Substandard
Doubtful
Total
2011
Grade:
(In thousands)
Pass
Special Mention
Substandard
Doubtful
Total
Residential
$ 58,794
—
727
—
$ 59,521
Residential
$ 44,353
—
2,616
—
$ 46,969
Real Estate
Construction
Commercial(1) Residential Commercial
Commercial
& Industrial
Trade
Finance
$ 607,489
—
17,788
—
$ 625,277
$ 14,829
—
21,518
—
$ 36,347
$ 38,063
—
—
—
$ 38,063
$ 312,918
—
9,313
2,522
$ 324,753
$ 47,412
—
—
—
$ 47,412
Real Estate
Construction
Commercial Residential(2) Commercial
Commercial
& Industrial
Trade
Finance
$ 471,554
—
56,649
—
$ 528,203
$ 12,496
—
31,037
—
$ 43,533
$ 15,095
—
17,310
—
$ 32,405
$ 218,501
—
33,317
343
$ 252,161
$ 49,694
—
56
—
$ 49,750
Other
$ 330
—
—
—
$ 330
Other
$ 606
—
—
—
$ 606
Total
Loans
$ 1,079,835
—
49,346
2,522
$ 1,131,703
Total
Loans
$ 812,298
—
140,986
343
$ 953,627
(2) Construction – Residential includes loans held for sale of $3,996 with a Substandard rating.
(4) Bank, Premises, Furniture and Fixtures
As of December 31, 2012 and 2011, furniture and fixtures consists of the following:
Land and Building
Leasehold improvements
Furniture and fixtures
Less accumulated depreciation and amortization
2012
2011
(In thousands)
$
$
2,782
6,152
4,620
13,554
(9,171)
4,383
$
$
2,782
6,147
4,288
13,217
(8,512)
4,789
Depreciation and amortization expense was $650,000, $739,000 and $895,000 for the years ended December 31,
2012, 2011 and 2010, respectively.
(5) Deposits
Time deposit accounts at December 31, 2012 mature as follows:
Year
2013
2014
2015 & thereafter
Maturities of
time deposits
(In thousands)
$
$
477,859
55,174
30,898
563,931
107
PREFERRED BANK
Notes to Consolidated Financial Statements
At December 31, 2012 and 2011, approximately $38.9 million and $38.8 million, 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 $24,000 and $99,000 at December 31, 2012 and 2011, respectively.
(6)
Income Taxes
The income taxes expense (benefit) for the years ended December 31, 2012, 2011 and 2010 was as follows:
Current income tax (benefit) expense:
Federal
State
2012
2011
(In thousands)
2010
$ 3,517
(732)
2,785
$ 1,755
200
1,955
$ (3,474)
111
(3,363)
Deferred income tax (benefit) expense:
Federal
State
Income tax benefit
(15,699)
(7,669)
(23,368)
$ (20,583)
(5,201)
(1,803)
(7,004)
$ (5,049)
3,045
(386)
2,659
$ (704)
At December 31, 2012 and 2011, the current income taxes receivables were $542,000 and $0 and the current
income tax payables were $0 and $1.1 million, respectively.
108
PREFERRED BANK
Notes to Consolidated Financial Statements
The components of the deferred tax assets and deferred tax liabilities as of December 31, 2012 and 2011 are as
follows:
Deferred tax assets:
Allowance for loan and lease losses
State taxes
Deferred compensation
Bank furniture and fixtures, net
Deferred stock units
Unrealized losses on securities available for
sale
Other than temporary impairment on
securities
Non-qualified stock options
OREO
Net operating loss carryforward
Other
AMT Credits
Gross deferred tax assets
Deferred tax liabilities:
Unrealized gains on securities available-for-
sale
Deferred loan costs
Discount accretion
FHLB stock
Other
Gross deferred liabilities
Valuation allowance
Net deferred tax assets
2012
2011
(in thousands)
$ 8,706
62
251
1,376
1,379
$ 10,388
56
210
1,046
1,379
—
1,921
690
965
10,698
1,657
1,381
2,610
29,775
666
525
9,285
6,385
1,074
747
33,682
(1,452)
(327)
(543)
(400)
(78)
(2,800)
—
$ 26,975
—
—
(544)
(426)
—
(970)
(25,733)
$ 6,979
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 more
likely than not the Bank will realize all benefits related to these deductible differences at December 31, 2012. To the
extent future earnings are recognized, the realization of the deferred tax asset will be recorded as a credit to income tax
expense.
Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of net operating loss and credit
carryforwards may be limited in the event a cumulative change in ownership of more than 50 percent points occurs
within a three-year period. We determined that such an ownership change occurred as of June 21, 2010 as a result of
stock issuances. This ownership change resulted in estimated limitations on the utilization of tax attributes, including net
operating loss carryforwards and tax credits. Although we fully expect to utilize all of the federal net operating loss
carryforward prior to their expiration; and, certain amounts may be accelerated into the first five years following the
acquisition pursuant to IRC Section 382 and published notices, California net operating loss carryover has been
significantly impacted by the IRC Sec. 382 limitation. We estimate that of approximately $89.9 million of the California
net operating loss carryforward at December 31, 2012, $67.9 million will begin to expire in 2029 if unutilized. This
amounts to approximately $4.8 million of deferred tax assets which would not be realized. The Bank had California net
109
PREFERRED BANK
Notes to Consolidated Financial Statements
operating loss carryforwards of approximately $92.8 million as of December 31, 2011, which if unused will begin to
expire in 2029. Of the approximately $22.0 million California net operating loss remaining at December 31, 2012,
approximately $15.6 million is subject to IRC Sec. 382 annual limitation amount of approximately $1.5 million.
California amounts in excess of those which can be utilized are not reflected in the table above. The prior year valuation
allowance of $25.7 million was reversed in 2012 to the extent of $20.9 million with $4.8 million unrecognized.
The Bank had California minimum tax credit of approximately $264,000 and $88,000 as of December 31, 2012
and 2011 respectively. The minimum tax credit can be carried forward indefinitely until fully utilized.
As of December 31, 2012 and 2011, the Bank has federal net operating loss carryforwards of approximately
$305,000 and $670,000, respectively, which, if unused, will begin to expire in 2030.
A reconciliation of the income tax benefit and the amount computed by applying the statutory federal income tax
rate to the loss before income taxes is as follows for the years ended December 31, 2012, 2011 and 2010:
2012
2011
2010
Amount
Percentage
Amount
Percentage
Amount
Percentage
(In thousands)
Statutory U.S. federal income tax
State taxes, net of federal benefit
Life insurance policies
Valuation allowance
Other
$ 1,151
(694)
(85)
(20,951)
(4)
$(20,583)
35.0%
(21.1)
(2.6)
(637.1)
(0.1)
(625.9)%
$ 2,515
519
(88)
(8,578)
583
$(5,049)
35.0%
7.2
(1.2)
(119.4)
8.1
(70.3)%
$(6,130)
(1,337)
(88)
7,185
(334)
$ (704)
35.0%
7.6
0.5
(41.0)
1.9
4.0%
The effective tax rate for 2012 represents a tax benefit associated with current year operating income, net of a full
reversal of the deferred tax asset valuation allowance. The 2011 net income tax benefit resulted from a provision for
income taxes based on taxable earnings which was more than offset by a partial reversal of the Bank’s deferred tax asset.
The 2010 net income tax benefit resulted from the recognition of deferred taxes which had been included in other
comprehensive income and were recognized upon the sale of certain securities.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended
December 31, 2012 and 2011 is as follows:
Unrecognized tax benefit:
Balance, beginning of the year
Increases related to current year tax positions
Decrease due to FTB Audit result
Balance, end of the year
2012
2011
(In Thousands)
$ —
—
—
$ —
$ 116
52
(168)
$ —
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, 2012 and 2011, the total amount of tax reserve, net of federal tax benefit, was $0 and
$0, respectively, for uncertain tax positions that were effectively settled in the 2011 year. The Bank does not expect the
amount of the unrecognized tax benefits to change significantly over the next 12 months.
The Bank files income tax returns in the U.S. federal jurisdiction and in the State of California. As a result of the
2009 and 2010 federal net operating loss carrybacks, the Bank’s tax years from 2004 to 2010 were examined by the
Internal Revenue Service (IRS). The IRS examination of the returns was finalized in April of 2012 resulting in the 2006,
2007, 2008 net assessment of approximately $449,000, including accrued interest of approximately $29,000, which was
paid in February 2013. During 2010, the Bank was under audit by the California’s Franchise Tax Board for the 2008 tax
year and was assessed for an additional tax liability of $168,000 including interest of $14,000 in February 2011. The
110
PREFERRED BANK
Notes to Consolidated Financial Statements
Bank is no longer subject to the U.S Federal and California tax examinations by tax authorities for the years before
January 1, 2011 and January 1, 2009, respectively.
(7) Other Real Estate Owned
At December 31, 2012, OREO was comprised of 16 properties compared to 15 properties at December 31, 2011.
During 2012, the Bank sold 5 OREO properties, plus a portion of one property for which the remainder is in OREO as of
December 31, 2012, at a net loss of $387,000. These losses are included in Loss on Sale of OREO and Related Expense
in the Consolidated Statements of Operations and Comprehensive Income (Loss).
An analysis of the activity in the valuation allowance for other real estate losses for the years ended on
December 31, 2012, 2011, and 2010 is as follows:
Balance, beginning of the year
Provision for losses
OREO disposal
Balance, end of the year
2012
$ 20,742
4,018
(2,724)
$ 22,036
2011
(in thousands)
$ 18,235
3,920
(1,413)
$ 20,742
2010
$ 14,326
8,477
(4,568)
$ 18,235
The following table details the Bank’s OREO properties by loan class as of December 31, 2012, and 2011, and
2010:
Loan class:
Real estate - Mini-perm
Residential
Commercial
Real estate - Construction
Residential
Commercial
Commercial & Industrial
Trade Finance
Other
Total as of year end
2012
#
$
2011
#
$
2010
#
$
(dollar amounts in thousands)
11
3
$ 15,127
7,829
10
3
$ 23,565
8,316
14
7
$ 30,054
14,659
3,051
2,273
1
1
— —
— —
—
—
$ 28,280
16
5,461
235
1
1
— —
—
—
—
—
$ 37,577
15
7,950
—
2
—
— —
—
—
—
—
$ 52,663
23
(8) 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 had a 3-year maturity and a fixed interest rate of 2.74% paid semiannually, and it
matured on February 11, 2012. Under the Temporary Liquidity Guarantee Program, the FDIC provides a 100%
guarantee of certain unsecured senior debt of eligible FDIC-insured institutions. As of December 31, 2012, the Bank has
zero outstanding senior debt.
Advances from the Federal Home Loan Bank of San Francisco (FHLBSF) were zero at December 31, 2012 and
2011. All advances are collateralized by commercial or residential real estate loans, FRC advances or by certain
marketable investment securities (SBC). At December 31, 2012, approximately $166,498,000 of the Bank’s real estate
loans were pledged as collateral.
111
PREFERRED BANK
Notes to Consolidated Financial Statements
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 $78.2 million. The Bank had no borrowing outstanding
through the discount window outstanding as of December 31, 2012 or 2011.
(9) Commitments and Contingencies
Credit Extensions: As a financial institution, the Bank enters into a variety of financial transactions with its
customers in the normal course of business. Many of these products do not necessarily entail present or future funded
asset or liability positions, instead the nature of these is considered in the form of executor contracts.
Financial instrument transactions are subject to the Bank’s normal credit standards, financial controls and risk-
limiting, and monitoring procedures. Collateral requirements are determined on a case-by-case evaluation of each
customer and product.
The Bank’s exposure to credit risk under commitments to extend credit, standby letters of credit, and financial
guarantees written is limited to the contractual amount of those instruments.
At December 31, 2012 and 2011, the Bank had commitments to fund loans of $211.1 million and $169.3 million,
respectively. Other financial instruments with off-balance-sheet risk at December 31, 2011 and 2010 are as follows:
Commitments to extend credit
Commercial letters of credit
Standby letters of credit
Total
2012
2011
(In thousands)
$ 211,118
6,489
6,309
$ 223,916
$ 161,684
3,465
4,185
$ 169,334
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 certain branch offices. As of December 31, 2012, the future total minimum lease payments for the Bank’s
premises are as follows:
Year:
2013
2014
2015
2016
2017
Thereafter
Total lease payment
(In thousands)
$ 1,882
1,861
1,731
1,627
1,421
2,352
$ 10,874
Rental expense was $1.6 million, $1.7 million and $1.7 million for the years ended December 31, 2012, 2011 and
2010, respectively.
(10) Related Party Transactions
Loan and Commitments: The Bank has extended credit to certain directors and officers and companies in which
they have an interest and certain shareholders which beneficially own more than 5% of the Bank’s capital stock. In
112
PREFERRED BANK
Notes to Consolidated Financial Statements
management’s opinion, the loans to these related parties are made on substantially the same terms, including interest
rates and collateral, as those made to nonrelated persons.
At December 31, 2012 and 2011, the aggregate loans (including commitments) to related parties were
approximately $6.0 million (of which $0.8 million was outstanding) and $6.0 million (of which $2.1 million was
outstanding), respectively. All related party loans were current at December 31, 2012 and 2011.
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
2012
$ 2,092
—
(1,258)
$ 834
2011
(In thousands)
$ 10,264
900
(9,072)
$ 2,092
2010
$ 5,817
4,447
—
$ 10,264
Deposits: The amount of deposits from related parties was $2.7 million and $3.0 million at December 31, 2012
and 2011, respectively.
(11) Restrictions on Cash Dividends, Regulatory Capital Requirements
The Bank has authorized 25,000,000 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 1132 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, 2012, that the Bank meets all capital adequacy requirements to which it is subject.
113
PREFERRED BANK
Notes to Consolidated Financial Statements
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
Ratio
Amount
Ratio
Amount
Ratio
(In thousands)
$ 196,466
180,021
180,021
14.98% $104,921
13.73%
11.96%
52,461
52,461
> 8.00%
4.00%
4.00%
$ 131,152
78,691
65,576
> 10.00%
6.00%
5.00%
$ 174,811
160,834
160,834
15.77% $ 88,660
14.51%
12.51%
44,330
44,330
> 8.00%
4.00%
4.00%
$ 110,826
66,495
55,413
> 10.00%
6.00%
5.00%
As of December 31, 2012:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
As of December 31, 2011:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
(12) Share-Based Compensation
The Bank remunerates employees and directors through stock option compensation plans; the 1992 Stock Option
Plan, Interim Stock Option Plan and the 2004 Equity Incentive Plan which are discussed below. Effective January 1,
2007, 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 service 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, 2012, 2011 and 2010, the
Bank recognized share-based compensation expense of $1.1 million, $1.1 million and $1.7 million, respectively,
resulting in the recognition of $230,000, $140,000 and $561,000 in related tax benefits, respectively.
The number of stock options and per stock option data has been adjusted to reflect the Bank’s June 17, 2011 one-
for-five reverse stock split, as well as the Bank’s repurchase on October 29, 2010 of certain vested options issued under
the 2004 Equity Plan.
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 434,376 shares. The 1992 Stock Option Plan expired by its terms in 2003, and no shares are
available for future grants. The options vest in installments of 20% each year and become fully vested after five years.
Options under the 1992 Plan expire ten years after the grant date.
Because the 1992 Plan expired in 2003, the Bank did not issue any options under this Plan during 2012, 2011 or
2010.
In May 2003, April 2004 and June 2004, the Bank granted an additional 16,200, 9,600 and 25,000 stock options,
respectively, to our employees and directors at exercise prices ranging from $53.45 to $95.05 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 2012, 2011 and 2010.
114
PREFERRED BANK
Notes to Consolidated Financial Statements
The total intrinsic value of share options exercised during the year ended December 31, 2012, 2011 and 2010 was
$0, $0, and $0, respectively, from the 1992 Plan and the Interim Plan. As of December 31, 2012, there was no
compensation cost recognized that relates to options granted under the 1992 Plan and Interim Plan. The Bank did not
recognize any tax benefits for the year ended December 31, 2012 under the 1992 Plan and the Interim Plan.
Under the 1992 Plan and the Interim Plan, the fair value of the options vested during the year ended December 31,
2012, 2011 and 2010 was $0, $0, and $0, respectively. No options were exercised during the same period.
The following is a summary of the transactions under the 1992 Plan and the Interim Plan for the years ended
December 31, 2012:
Options outstanding as of December 31, 2009
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2010
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2011
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2012
1992 Plan and Interim Plan
Number of
Options
52,160
—
—
—
52,160
—
—
(750)
51,410
—
—
(2,600)
48,810
Weighted
Average
Exercise
Price
82.56
—
—
—
$ 82.56
—
—
86.71
$ 82.50
—
—
84.89
$ 82.37
Weighted
Average
Remaining
Contractual
Life
1.1 years
Options exercisable as of December 31, 2012
48,810
$ 82.37
1.1 years
As of December 31, 2012, the aggregate intrinsic value of options outstanding under the 1992 Plan and the
Interim Plan was $0. As of December 31, 2012, stock options outstanding under the 1992 Plan and the Interim Plan were
as follows:
Options Outstanding
Options Exercisable
Number of
Outstanding
Options
—
14,880
33,930
Weighted
Average
Exercise
Price
$ —
53.45
95.05
Weighted
Average
Remaining
Contractual
Life
—
0.32
1.47
Number of
Outstanding
Options
—
14,880
33,930
Weighted
Average
Exercise
Price
$ —
53.45
95.05
Weighted
Average
Remaining
Contractual
Life
—
0.32
1.47
Exercise Price Range
$25.00 - $49.99
$50.00 - $74.99
$75.00 - $99.99
2004 Equity Incentive Plan
The Bank’s 2004 Equity Incentive Plan (the “2004 Plan”) provides for granting of non-statutory stock options,
incentive stock options and restricted share awards (RSA’s) to key full-time employees, officers, and the directors of the
Bank. Stock options granted under the 2004 Plan have an exercise price equal to the fair 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 2004
115
PREFERRED BANK
Notes to Consolidated Financial Statements
Plan). The number of shares authorized in this plan is 1,455,330 shares, as adjusted for the shares repurchased by the
Company pursuant to the tender offer described below, whereby the shares repurchased were made available for future
issuance under the 2004 Plan.
The total intrinsic value of share options exercised during the year ended December 31, 2012, 2011 and 2010 was
$23,000, $0 and $0, respectively. As of December 31, 2012, the total compensation cost not yet recognized that relates to
unvested options granted under the 2004 Plan was $1.1 million with a weighted-average recognition period of 1.5 years.
The Bank recognized tax benefits of zero for the years ended December 31, 2012 and 2011 under the 2004 Plan.
For the years ended December 31, 2012, 2011 and 2010, the estimated weighted-average fair value per share of
options granted under the 2004 Plan were as follows:
2012
$4.12
December 31,
2011
$4.00
2010
$4.20
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
2012
0.00%
70.54%
3.0 Yrs.
0.31%
December 31,
2011
0.00%
81.78%
3.0 Yrs.
0.68%
2010
0.00%
82.24%
3.0 Yrs.
1.06%
Historically, expected volatility was determined based on the historical daily volatility of a set of California peer
banks whose share volatility data 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
because there now exists enough historical daily trading price information of the common stock of Preferred Bank. The
risk-free interest rate is based on the U.S. Treasury yield 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.
On July 23, 2010, the Bank’s Board of Directors executed an Offer to Purchase Outstanding Stock Options having
an exercise price greater than $126.65 Per Share (options that were issued under the Bank’s 2004 Equity Incentive Plan
between November 17, 2004 and November 14, 2007). Eligible employees, officers, and directors of the Bank (or one of
its subsidiaries) were offered a cash payment of $0.50 per qualifying option and could voluntarily elect to accept the
offer between July 23, 2010 and October 20, 2010, with payout on October 29, 2010. The offer was compensatory in
nature and reflects the Bank’s effort to provide value in its share-based compensation package since the economic
downturn has eroded the intrinsic value in these awards. The Offer price was determined by using the Black-Scholes
Model, since options on the Bank’s stock are not actively traded, and takes into account numerous factors, as described
above. Based upon the option-pricing model, the offer price exceeded the then-current fair value of the eligible options,
whose exercise prices ranged from $126.65 to $217.50 per share. Because the exercise prices of these options exceed the
current market value of the Bank's stock, the value of the options was determined to be insignificant, and thus the Bank's
offer price was $0.50 per option, and accounted for as compensation cost.
Under U.S. GAAP, an entity that repurchases an equity award for which the requisite service has not been
rendered (in the case of unvested options), has effectively modified the requisite service period to the date of the
repurchase. Thus, in accordance with ASC 718-20-35-7, any unrecognized compensation cost for the eligible options
have been recognized upon repurchase; and to the extent that the $0.50 offer price was less than or equal to the
determined option fair value, the offer price reduced the Bank’s paid in capital. The Bank recognized unrecognized
116
PREFERRED BANK
Notes to Consolidated Financial Statements
compensation cost for the eligible options in the amount of $294,000 and recognized share-based compensation expense
for any excess of the $0.50 offer price over the fair value of options repurchased which amounted to $62,000. The
options repurchased will become available for distribution at a future date under the 2004 Plan.
The following information under the 2004 Plan is presented for the years ended December 31, 2012, 2011 and
2010:
December 31,
2011
(In thousands)
$ 178
294
—
—
—
—
2010
$ 296
233
—
—
62
—
Grant Date Fair Value of Options Granted
Fair Value of Options Vested
Total Intrinsic Value of Options Exercised
Cash Received from Options Exercised
Cash Paid for Options Repurchased by the Bank
Actual Tax Benefit Realized from Options Exercised
2012
$ 1,303
314
23
43
—
23
117
PREFERRED BANK
Notes to Consolidated Financial Statements
The following is a summary of the transactions under the 2004 Plan for the years ended December 31, 2012, 2011
and 2010.
2004 Plan
Number of
Options
Weighted
Average
Exercise Price
Weighted
Average
Remaining
Contractual
Life
Options outstanding as of December 31, 2009
Granted
Exercised
Forfeited or expired
Repurchased by the Bank via tender offer
Options outstanding as of December 31, 2010
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2011
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2012
Options exercisable as of December 31, 2012
233,440
70,000
—
(16,832)
(148,890)
137,718
44,600
—
(10,488)
171,830
327,500
(5,468)
(37,433)
456,429
109,032
$
$
119.25
7.95
—
51.20
143.15
40.40
7.60
—
64.57
30.41
8.91
7.95
9.97
$
16.93
$ 42.94
$
2.5 years
1.0 year
As of December 31, 2012, the aggregate intrinsic value of options outstanding under the 2004 Plan was $2.1
million. As of December 31, 2012, stock options outstanding under the 2004 Plan were as follows:
Options Outstanding
Options Exercisable
Exercise Price Range
$0.00 - $24.99
$25.00 - $49.99
$100.00 - $124.99
$125.00 - $149.99
Number of
Outstanding
Options
400,999
25,280
30,000
150
Weighted
Average
Exercise
Price
$ 8.69
37.50
109.20
126.65
Weighted
Average
Remaining
Contractual
Life
2.85
0.06
0.04
1.88
Number of
Outstanding
Options
53,602
25,280
30,000
150
Weighted
Average
Exercise
Price
$ 8.18
37.50
109.20
126.65
Weighted
Average
Remaining
Contractual Life
2.05
0.06
0.04
1.88
118
PREFERRED BANK
Notes to Consolidated Financial Statements
The following is a summary of the transactions for non-vested stock options under the 1992 Plan, the Interim
Plan and the 2004 Plan for the year ended December 31, 2012:
Non-Vested Options outstanding as of December 31, 2011
Granted
Forfeited or expired
Vested
Non-Vested Options outstanding as of December 31, 2012
Restricted Stock Awards
Number
of Shares
100,503
327,500
(33,566)
(47,040)
347,397
Weighted Average
Grant Date
Fair Value
$
$
$
$
$
6.41
4.11
6.81
8.26
4.12
The Bank’s 2004 Plan provides for granting of RSA’s to key full-time employees, officers, and the directors of
the Bank. The Bank began granting RSAs in calendar year 2009. During the year ended December 31, 2012, the Bank
granted 8,600 RSAs and recognized $542,000 of compensation expense. The RSAs granted under the 2004 Plan have a
one to three year vesting period and are to be distributed at the end of the vesting period. The total unrecognized
compensation expense for outstanding RSAs was $446,000 as of December 31, 2012, and will be recognized over 0.58
years.
The following is a summary of the transactions for non-vested RSAs under the 2004 Plan for the year ended
December 31, 2012:
Non-Vested RSAs as of December 31, 2009
Granted
Forfeited or expired
Vested
Non-Vested RSAs outstanding as of December 31, 2010
Granted
Forfeited or expired
Vested
Non-Vested RSAs outstanding as of December 31, 2011
Granted
Forfeited or expired
Vested
Non-Vested RSAs outstanding as of December 31, 2012
Number
of Shares
Weighted Average
Grant Date
Fair Value
19,800
194,300
(5,600)
(1,100)
207,400
36,800
(4,150)
(22,650)
217,400
8,600
(416)
(91,917)
133,667
$
27.0
8.55
$
$ 13.30
$ 27.00
$ 10.10
7.49
$
$
7.58
$ 21.80
$
8.49
$ 11.00
8.70
$
8.46
$
8.67
$
(13) Employee Benefit Plan
Effective January 1, 1994, the Bank began a 401k profit sharing plan for its eligible employees. Under the plan,
the Bank matches 50% of a participant’s contributions up to 6% of his/her salary subject to federal limitations on
maximum contributions. Contributions made by the Bank for the years ended December 31, 2012, 2011 and 2010 totaled
$198,000, $120,000 and $174,000, respectively.
119
PREFERRED BANK
Notes to Consolidated Financial Statements
(14) Bonus Plan
In April 1994, the Management Incentive Bonus Plan was approved. In December 2007 this Plan was amended
and approved by the Board of Directors. The plan is administered by the Compensation Committee of the Board of
Directors (the Committee). The Committee determines which employees may participate in the plan, the total amount of
bonus payable to our employees each year, the amount of bonus to be carried over and paid in subsequent years and the
allocation of the total amounts among our chairman, officers, and other employees. All awards are contingent upon the
Bank attaining certain financial objectives with the exception of certain bonuses which may be awarded by the
Compensation Committee irrespective of the certain financial targets as part of new employees’ first year compensation.
This is typically done as an alternative to a signing bonus. For the year ended December 31, 2012, the Bank did not meet
its financial objectives required under the Plan. The Compensation Committee did, however, approve a discretionary
bonus to certain officers in recognition for their efforts during 2012. Total expense of the plan recorded by the Bank was
$1.5 million, $400,000 and $0 for 2012, 2011 and 2010, respectively. As of December 31, 2012 and 2011, the total
bonus accrual included in the other liabilities amounted to $1.5 million and $400,000, respectively.
(15) Deferred Compensation Arrangements
In 1996, the Bank implemented deferred compensation arrangements for the Bank’s senior officers and directors.
Pursuant to the Plan, each participant receives benefits for his/her deferred compensation upon his/her retirement or
termination of service with the Bank prior to retirement. At December 31, 2012 and 2011, liabilities recorded for the
deferred compensation plan totaled approximately $596,000 and $499,000, respectively.
In order to economically fund its obligation under the deferred compensation arrangements, the Bank purchased
single-premium life insurance policies under which the executive officers and directors are the insured, while the Bank is
the owner and beneficiary thereof. At December 31, 2012 and 2011, the cash surrender value of the policies totaled $8.0
million and $7.8 million, respectively. During 2012, 2011 and 2010, the income on the insurance policies was $329,000,
$333,000 and $329,000, respectively.
(16) Litigation
From time to time, the Bank is a party to claims and legal proceedings arising in the ordinary course of business.
There are no pending legal proceedings or, to the best of management’s knowledge, threatened legal proceedings, to
which the Bank is a party which may have a material adverse effect upon the Bank’s financial condition, results of
operations, or liquidity.
(17) Earnings per Share
During the third quarter of 2010, our preferred stock was converted to common shares in accordance with its
beneficial conversion features. The conversion ratio for each share of Series A Preferred Stock was equal to the quotient
obtained by dividing the Series A Share Price by the $1.50 conversion price. As such, each share of Series A Preferred
Stock was convertible into approximately 666.67 shares of the Company's common stock. The net loss available to
common shareholders was $6.21 per common share for year ended December 31, 2010, and included $3.75 loss per
share due to the recognition of the intrinsic value of the beneficial conversion feature of the preferred stock. The intrinsic
value is the difference between the conversion price of $1.50 per share for the 73,846 preferred shares and the $2.02 per
share market value of the Bank’s common stock as of May 26, 2010, the commitment date. This difference was treated
as a discount on the Series A Preferred Stock, and reduced the reported income available to common shareholders,
though it does not affect total capital, or the regulatory or tangible capital ratios of the Bank, or cash flow from
operations. It should be noted that 3,154 of the 77,000 subscribed shares were issued as part of a deferred compensation
arrangement.
120
PREFERRED BANK
Notes to Consolidated Financial Statements
The following table summarizes the basic and diluted earnings (loss) per share calculations for the periods
indicated:
2012
2011
(In thousands, except per share data)
2010
Basic earnings (loss) per share:
Net (loss) income
Less: preferred stock discount accretion
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: preferred stock discount accretion
Less: income and dividends allocated to participating
securities
Net income (loss) allocated to common shareholders-
diluted
$ 23,872
—
$ 12,234
—
$ (16,810)
(25,600)
(323)
(195)
—
$ 23,549
13,050,559
$ 1.80
$ 12,039
12,995,525
$ 0.93
$ (42,410)
6,829,734
$ (6.21)
$ 23,872
—
$ 12,234
—
$ (16,810)
(25,600)
(323)
(195)
—
$ 23,549
$ 12,039
$ (42,410)
Basic weighted average common shares outstanding
Effect of dilutive securities – stock options
Diluted weighted average shares outstanding
Diluted earnings (loss) per share
13,050,559
196,829
13,247,390
$ 1.78
12,995,525
—
12,995,525
$ 0.93
6,829,734
—
6,829,734
$ (6.21)
Earnings (loss) per share (EPS) are computed on a basic and diluted basis. 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. At December 31, 2012, 2011 and 2010, there were 477,947, 223,240 and 189,878 shares,
respectively, related to such awards which were excluded from the computation of diluted EPS due to their anti-dilutive
effect.
(18) Subsequent Events
On February 6, 2013, the Bank opened its new San Francisco branch office. The new branch is located at 600
California Street Suite 500, San Francisco, California. The Bank received regulatory approval for the branch on
November 26, 2012.
121
PREFERRED BANK
Notes to Consolidated Financial Statements
(19) Quarterly Financial Data (Unaudited)
The following tables summarize the quarterly unaudited financial data for 2012 and 2011:
Quarterly Financial Data (Unaudited)
Year Ended December 31, 2012
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 income (loss)
Earnings(loss) per share
Basic
Diluted
(In thousands, except per share data)
$ 15,191
2,197
12,994
1,800
618
8,856
(18,783)
$ 21,739
$ 15,147
1,922
13,225
14,500
1,475
8,026
(2,217)
$ (5,609)
$ 15,194
1,857
13,337
1,200
667
9,143
834
$ 2,827
$ 16,010
1,806
14,204
2,300
749
8,154
(416)
4,915
$ 1.64
$ 1.62
$ (0.43)
$ (0.43)
$ 0.21
$ 0.21
$ 0.37
$ 0.37
Three months ended
Year Ended December 31, 2011
March 31
June 30
September 30 December 31
Interest income
Interest expense
Interest income before provision for credit losses
Provision for credit losses
Noninterest income
Noninterest expense
Income tax expense (benefit)
Net income (loss)
Earnings(loss) per share
Basic
Diluted
(20) Regulatory Matters
(In thousands, except per share data)
$ 13,416
2,811
10,605
—
752
10,333
325
699
$
$ 12,890
2,547
10,343
1,800
628
7,473
(43)
$ 1,741
13,727
2,507
11,220
1,500
588
8,213
(3,932)
6,027
$ 13,757
2,438
11,319
2,400
822
7,373
(1,399)
3,767
$ 0.05
$ 0.05
$ 0.13
$ 0.13
$ 0.46
$ 0.46
$ 0.29
$ 0.29
As a result of a regulatory examination during 2012, the Consent Order (which was entered into on March 22, 2010)
was terminated and the Bank entered into a Memorandum of Understanding (“MOU”) with both the FDIC and the
California Department of Financial Institutions (“DFI”) on May 25, 2012. Among other things, the MOU requires the Bank
to maintain a tier 1 leverage ratio of at least 10% and requires the Bank to continue to reduce its adversely classified assets.
As December 31, 2012 the Tier 1 Leverage Ratio of the Bank was 11.96%, exceeding the level required by the MOU. The
Board of Directors and management remain committed to maintaining this requirement and meeting the other requirements
of the MOU.
(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
122
PREFERRED BANK
Notes to Consolidated Financial Statements
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 and defaults.
(c)
Federal Home Loan Bank Stock
The carrying amounts approximate fair value, as the stock may be sold back to the Federal Home Loan Bank
at carrying value.
(d)
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. 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 non-recurring fair value
measurement that is categorized as a Level 2 measurement. When adjustments are made to an appraised value to
reflect various factors such as the age of the appraisal or known changes in the market or the collateral 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 non-performing categories.
(e)
Loans held for sale
Loans held for sale are required to be measured based on the lower of cost or fair value. When there are loans
held for sale on the balance sheet, the Bank obtains quotes or bids on all or part of these loans directly from the
purchasing parties if possible. Otherwise, current appraisals are the basis for valuation.
123
PREFERRED BANK
Notes to Consolidated Financial Statements
(f)
Other Real Estate Owned
Upon acquisition, real estate obtained in the settlement of loans is recorded at fair value on the basis of appraised
value less estimated costs to sell at the date of acquisition. This is a level 2 measurement. Every 6-12 months, fair
value adjustments are made to all real estate owned on an individual basis based on the current updated appraised
value of the property. In addition, the Bank sometimes makes further adjustments to carrying value of a property
based on conservative estimates considering factors such as slow property sales in the region or broker opinions.
These are considered level 3 measurements.
(g) 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.
(g) 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.
(h)
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.
(i)
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.
124
PREFERRED BANK
Notes to Consolidated Financial Statements
The carrying amount and estimated fair value of assets and liabilities as of December 31, 2012 and 2011 is
detailed on the table below.
Assets:
Cash and cash equivalents
Securities held-to-maturity
Securities available-for-sale
Loans, net of allowance and net deferred
loan fees
Loans held for sale
Accrued interest receivable
Federal Home Loan Bank stock
Customers’ liabilities on acceptances
Liabilities:
Demand deposits and savings:
Noninterest-bearing
Interest-bearing
Time deposits
Accrued interest payable
Bank’s liabilities on acceptances outstanding
Off-balance sheet financial instruments:
Commitments to extend credit and letters of
credit
December 31, 2012
Carrying
amount
Estimated
fair value
Level 1
(In thousands)
Level 2
Level 3
$ 151,995
979
210,742
1,096,927
12,150
5,646
4,282
1,961
$ 151,995
982
210,742
$ 151,995
—
4,973
$ —
982
204,221
1,122,138
12,150
5,646
4,282
1,961
—
—
—
—
—
2,274
12,150
5,646
4,282
1,961
$ —
—
1,548
1,119,864
—
—
—
—
$ 446,734
346,862
563,931
968
1,961
$ 446,734
357,769
565,376
968
1,961
$ —
—
—
—
—
$ 446,734
346,862
563,931
968
1,691
$ —
—
—
—
—
169
169
—
169
—
125
PREFERRED BANK
Notes to Consolidated Financial Statements
Assets:
Cash and cash equivalents
Securities held-to-maturity
Securities available-for-sale
Loans, net of allowance and net deferred
loan fees
Loans held for sale
Accrued interest receivable
Federal Home Loan Bank stock
Customers’ liabilities on acceptances
Liabilities:
Demand deposits and savings:
Noninterest-bearing
Interest-bearing
Time deposits
FHLB borrowings and Senior Debt
Bank’s liabilities on acceptances outstanding
Off-balance sheet financial instruments:
Commitments to extend credit and letters of
credit
December 31, 2011
Carrying
amount
Estimated
fair value
Level 1
(In thousands)
Level 2
Level 3
$ 142,466
3,021
166,083
924,876
3,996
4,851
4,164
427
$ 142,466
2,897
166,083
940,446
3,996
4,851
4,164
427
$ 142,466
—
—
—
—
—
—
—
$ —
2,897
164,859
51,484
3,996
4,851
4,164
427
$ —
—
1,224
888,962
—
—
—
—
$ 239,987
255,734
622,232
25,996
427
$ 239,987
254,729
623,160
25,996
427
$ —
—
—
—
—
$ 239,987
254,729
623,160
25,996
427
$ —
—
—
—
—
104
104
—
104
—
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.
126
PREFERRED BANK
Notes to Consolidated Financial Statements
The Bank uses the following methodologies to measure the fair value of its financial assets on a recurring basis:
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.
U.S. Government Agencies – The Bank measures fair value of U.S. Government agency 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 plus 100 basis points of illiquidity
premium using loss rates determined by the financial health of the underlying issuer banks in each pool.
Principal-only strip securities - The Bank measures fair value of principal-only strip securities by using quoted
market prices for similar securities or dealer quotes, a level 2 measurement.
Mutual funds (government bond funds) – The Bank measures fair value based on the quoted market price at
the reporting date, a level 1 measurement.
127
PREFERRED BANK
Notes to Consolidated Financial Statements
The following table presents the Bank’s hierarchy for its assets and liabilities measured at fair value on a recurring
basis at December 31, 2012:
(In thousands)
Assets
Securities, available-for-sale:
Mutual funds – government bond
funds
Corporate notes
Principal-only strips
Mortgage-backed securities
Collateralized mortgage obligations
Municipal securities
Collateralized debt obligations
Total
Quoted Prices in
Active Markets
for
Identical Assets
(Level 1)
Fair Value Measurements Using
Significant Other
Observable
Inputs
Significant
Unobservable
Inputs
(Level 2)
(Level 3)
Balance at
December 31,
2012
$ —
$ 4,973
$ —
$ 4,973
—
—
—
—
—
—
$ —
50,981
5,846
96,924
24,660
25,811
—
$ 209,195
—
—
—
—
—
1,547
$ 1,547
50,980
5,846
96,924
24,660
25,812
1,547
$ 210,742
The following table presents the Bank’s hierarchy for its assets and liabilities measured at fair value on a recurring
basis at December 31, 2011:
(In thousands)
Assets
Quoted Prices in
Active Markets for
Identical Assets
Fair Value Measurements Using
Significant Other
Observable
Inputs
Significant
Unobservable
Inputs
Securities, available-for-sale:
U.S. Government Agency securities
Corporate notes
Principal-only strips
Mortgage-backed securities
Collateralized mortgage obligations
Municipal securities
Collateralized debt obligations
SBA securities
USDA security
Total
(Level 1)
(Level 2)
(Level 3)
$ —
—
—
—
—
—
—
—
—
$ —
$ 5,739
38,898
6,923
51,734
22,567
21,509
—
10,567
6,922
$ 164,859
$ —
—
—
—
—
—
1,224
—
—
$ 1,224
Balance at
December 31,
2011
$
5,739
38,898
6,923
51,734
22,567
21,509
1,224
10,567
6,922
$ 166,083
There were no significant transfers in or out of Level 1 and Level 2 fair value measurements during the year ended
December 31, 2012.
128
PREFERRED BANK
Notes to Consolidated Financial Statements
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, 2012:
Fair Value Measurements Using Significant Unobservable Inputs(Level 3)
(Dollars in thousands)
Beginning
Balance as of
December 31,
2011
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,
2012
$
1,224
$
—
$
(24)
$
347
$
1,547
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, 2011:
Fair Value Measurements Using Significant Unobservable Inputs(Level 3)
(Dollars in thousands)
Beginning
Balance as of
December 31,
2010
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,
2011
$
1,119
$
—
$
(32)
$
137
$
1,224
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. 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. As 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.
129
PREFERRED BANK
Notes to Consolidated Financial Statements
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, 2012, and the total losses resulting from these fair value adjustments for
the twelve months ended December 31, 2012:
(In thousands)
Assets
Impaired loans
Loans held for sale
Other real estate
owned
Total Assets
Fair Value Measurements Using
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Balance
at December
31, 2012
$ —
—
—
$ 2,274
12,150
21,816
$ 9,001
—
6,464
$ 11,275
12,150
28,280
Year Ended
December 31, 2012
Total Losses
$ (8,659)
(5,840)
(4,406)
$ —
$ 36,240
$ 15,465
$ 51,705
$ (18,905)
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, 2011, and the total losses resulting from these fair value adjustments for
the year ended December 31, 2011:
(In thousands)
Assets
Impaired loans
Loans held for sale
Other real estate
owned
Total Assets
Fair Value Measurements Using
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Balance
at December
31, 2011
$ —
1,440
—
$ 23,182
—
6,017
$ 16,859
—
8,703
$ 40,041
1,440
14,720
Year Ended
December 31, 2011
Total Losses
$ (2,619)
(630)
(4,100)
$ —
$ 29,199
$ 25,562
$ 54,761
$ (7,349)
130
PREFERRED BANK
Notes to Consolidated Financial Statements
The following table represents quantitative information regarding the significant unobservable inputs used in
significant Level 3 assets measured at fair value on a non-recurring basis at December 31, 2012.
Fair Value
Valuation Technique
Unobservable Inputs
Range
At December 31, 2012
(Dollars In thousands)
Assets:
Impaired
loans
9,001
Market comparables;
Discounted cash flow
OREO
6,464
Market comparables
Adjustments to appraisal value for
Selling costs; Management
judgment
Adjustments to appraisal value for
selling costs*; Discount to reflect
realizable value^; Management
judgment
6.0%
*4.0 – 6.0%;
^2.0 – 26.4%;
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 15, 2013
PREFERRED BANK
(Registrant)
By /s/ Li Yu
Li Yu
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Exchange Act, 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
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
/s/ Gary S. Nunnelly
Director
131
March 15, 2013
March 15, 2013
March 15, 2013
March 15, 2013
March 15, 2013
March 15, 2013
Gary S. Nunnelly.
/s/ Kenneth Wang
Kenneth Wang
/s/ Ching-Hsing Kao
Ching-Hsing Kao
/s/ Chih-Wei Wu
Chih-Wei Wu
Director
Director
Director
March 15, 2013
March 15, 2013
March 15, 2013
132
Exhibit No.
Exhibit Description
INDEX TO EXHIBITS
3.1
3.2
3.3
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
10.15*
12.1
21.1
31.1
31.2
32.1
32.2
Amended and Restated Articles of Incorporation(1)
Certificate of Determination of the Series A preferred Stock(5)
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, 2008. (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, 2009(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, 2009(4)
Deferred Compensation Plan-Deferred Stock Unit Agreement and Rabbi Trust
Computation of Ratio of Earnings to Fixed Charges
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
(1)
(2)
(3)
(4)
(5)
*
Incorporated by reference from Registrant’s Registration Statement on Form 10 filed with the Federal
Deposit Insurance Corporation on January 18, 2006.
Incorporated by reference from Registrant’s Registration Statement on Form 10 Amendment No. 1
filed with the Federal Deposit Insurance Corporation on February 2, 2006.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on May 9, 2008.
Incorporated by reference from Quarterly Report on Form 10-Q filed with the Federal Deposit
Insurance Corporation on November 7, 2009.
Incorporated by reference from Current Report on Form 8-K filed with the Federal Deposit Insurance
Corporation on June 10, 2010.
Denotes management contract or compensatory plan or arrangement.
133
Exhibit 21.1
SUBSIDIARIES OF THE REGISTRANT
Preferred Bank Investment and Consulting, Inc. (PBICI)
134
Exhibit 31.1
CERTIFICATION PURSUANT TO RULE
13a-14(a) AND 15d-14(a),
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Li Yu, certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Preferred Bank;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s Board of Directors (or persons performing the equivalent functions):
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 15, 2013
/s/ Li Yu
Li Yu
Chairman and Chief Executive Officer
135
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: March 15, 2013
/s/ Edward J. Czajka
Edward J. Czajka
Executive Vice President and Chief Financial Officer
136
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, 2012 as filed with the Federal Deposit Insurance Corporation on the date hereof (the “Report”), I, Li
Yu, Chairman, President and Chief Executive Officer of the Bank, certify, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
(2)
The information contained in the Report fairly presents, in all material respects, the financial
condition and results of operations of the Bank.
Date: March 15, 2013
/s/ Li Yu
Li Yu
Chairman 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.
137
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, 2012 as filed with the Federal Deposit Insurance Corporation on the date hereof (the “Report”), I,
Edward J. Czajka, Executive Vice President and Chief Financial Officer of the Bank, certify, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
(2)
The information contained in the Report fairly presents, in all material respects, the financial
condition and results of operations of the Bank.
Date: March 15, 2013
/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.
138