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, 2014
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, 2014) was $317,840,958.
Number of shares of common stock of the Registrant outstanding as of March 11, 2015, was 13,568,206.
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, 2014 .............................................
Part III
ii
TABLE OF CONTENTS
Page
PART I ........................................................................................................................................................ 2
BUSINESS ............................................................................................................................................. 3
ITEM 1.
ITEM 1A. RISK FACTORS .................................................................................................................................. 27
ITEM 1B. UNRESOLVED STAFF COMMENTS ................................................................................................ 35
PROPERTIES ...................................................................................................................................... 37
ITEM 2.
LEGAL PROCEEDINGS .................................................................................................................... 38
ITEM 3.
ITEM 4. MINE SAFETY DISCLOSURES ........................................................................................................ 38
PART II .................................................................................................................................................... 39
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.............................................. 39
SELECTED FINANCIAL DATA ....................................................................................................... 42
ITEM 6.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ............................................................................................................. 44
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK ............................... 70
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ..................................................... 70
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ..................................................................................................... 71
ITEM 9A. CONTROLS AND PROCEDURES ..................................................................................................... 71
ITEM 9B. OTHER INFORMATION…………………………………………………………………………… 82
PART III ................................................................................................................................................... 75
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ............................... 75
ITEM 11. EXECUTIVE COMPENSATION ......................................................................................................... 75
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED SHAREHOLDER MATTERS ................................................................................ 75
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE ............................................................................................................................... 75
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES ........................................................................ 76
PART IV ................................................................................................................................................... 77
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES ........................................................................ 77
SIGNATURES........................................................................................................................................ 124
-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
Necessity of additional capital in the future, and possible unavailability of that capital on
acceptable terms
Economic and market conditions that may 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
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
Negative publicity
Possible security breaches in our online banking services
2
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., which has no current
operation.
General
We are a commercial bank based in Southern California, with a niche in 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, 2014, our total
assets were $2.1 billion, loans were $1.6 billion, deposits were $1.8 billion and shareholders’ equity grew
to $235.0 million. These balances all saw increases from total assets of $1.8 billion loans of $1.3 billion,
deposits of $1.5 billion, and shareholders’ equity of $206.9 million as of December 31, 2013. We had net
earnings per share on a diluted basis of $1.78 for the year ended December 31, 2014 as compared to net
earnings of $1.42 per share for the year ended December 31, 2013 and net earnings per share of $1.78 for
the year ended December 31, 2012. Net interest income before provision for credit losses increased from
$53.8 million for the year ended December 31, 2012 and $62.0 million for the year ended December 31,
2013 to $71.0 million for the year ended December 31, 2014. We recorded a provision for credit losses of
$3.4 million in 2014, which was consistent with the provision of $3.3 million recorded in 2013 and was
down from the provision of $19.8 million recorded in 2012.
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 the
majority of our business is not 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, less than half
of which we receive from the Chinese-American market mostly within Southern California, to fund our
loan and investment activities.
We conduct operations from our main office in downtown Los Angeles, California and twelve
full-service branch banking offices in Los Angeles, Orange, and San Francisco Counties. We market our
services and conduct our business primarily in Los Angeles, Orange, Ventura, Riverside, San Bernardino
and San Francisco Counties. 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 future.
Additionally, the Bank opened a new branch in Tarzana, California, in January of 2015.
3
As a result of a regulatory examination during 2014, the Memorandum of Understanding
(“MOU”), which was entered into on October 1, 2013, was terminated by the FDIC and the California
Department of Business Oversight (“CDBO”). The termination of the MOU allows the Bank to declare and
pay cash dividends to its shareholders and establish new branches and offices without prior written
approval of the FDIC and CDBO, and removes the 10% tier 1 leverage ratio requirement. Following the
lifting of the restriction on dividends, the Bank declared quarterly cash dividends of $0.10 per share on
September 16, 2014 and of $0.10 per share on December 18, 2014. These dividends were paid on October
20, 2014 and January 20, 2015 respectively. The Bank’s tier 1 leverage ratio was 11.73% as of December
31, 2014. 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 website 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 the Investor Relations page of our website are available free of charge. The
reference to our website address does not constitute incorporation by reference of the information contained
in the website and should not be considered part of this document. A copy of our Code of Personal and
Business Conduct, including any amendments thereto or waivers thereof and Board Committee Charters
can also be accessed on our website. We will provide, at no cost, a copy of our Code of Personal and
Business Conduct and Board Committee Charters upon request by phone or in writing at the above phone
number or address, attention: Edward J. Czajka, Executive Vice President and Chief Financial Officer.
Our Traditional Banking Business
We have historically provided a range of deposit and loan products and services to customers
primarily within the following categories:
Real Estate Finance—consisting of investors and developers within the real estate industry and
of owner-occupied properties in Southern California. We have traditionally provided
construction loans and mini-permanent (“mini-perm”) loans for residential, commercial,
industrial and other income producing properties, 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
4
international trade finance customers, including commercial and standby letters of credit,
acceptance financing, documentary collections, foreign draft collections, international wires
and foreign exchange.
High-wealth 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
Beginning in 2013, we began the process of fortifying our infrastructure in order to meet the new
growth and regulatory challenges facing all banks in this environment. We have made significant human
resource investments in our Bank Secrecy Act Department, Information Technology, Operations, Credit
Administration, Internal Audit and our Compliance Departments. The bolstering of these areas is intended
to support the future growth of the Bank, maintain a sound internal control structure as well as to meet the
regulatory requirements of our industry.
With all of those investments being made to the infrastructure of the Bank, we were able to
achieve substantial growth in loans and in profitability over the last two years. This was due to the hiring of
new business development and relationship officers in all regions of the Bank’s market during the years
2011 through 2014 and the relationships these officers have brought with them. We now have a much
larger business development staff than at any time in our history and we will look for our staff to continue
to bring in new, profitable relationships, driving the future growth of the Bank.
With our new branch now operating in Tarzana, California (as of January, 2015) in the San
Fernando Valley area of unincorporated Los Angeles, we now have a presence in one of the largest markets
in the Los Angeles area which we had previously been unable to tap. As the Bank has been operating with a
high level of capital for a number of years, management is now focused on deploying that capital
effectively. Traditionally, the Bank has deployed capital through organic growth as the Bank’s growth rate
has typically been higher than peers. However, even with a reinstated quarterly cash dividend and organic
growth, the Bank continues to maintain high levels of capital. The Bank is now focused on exploring other
ways to deploy this excess capital effectively to maximize shareholder value while maintaining a safe and
sound operation.
Our Market
We conduct operations from our main office in downtown Los Angeles, California and 12 full-
size branch banking offices in Los Angeles, Orange, and San Francisco Counties as of December 31, 2014.
We market our services and conduct our business primarily in Los Angeles, Orange, Ventura, Riverside,
San Bernardino, and San Francisco counties. In January 2015, we opened a branch in Tarzana, California,
and may also further expand into the Northern California market in the future.
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 the years 2000 and 2010, the Chinese-American
population in the United States grew by approximately 38%, with 37% of all Chinese-Americans living in
California. In 2010, there were approximately 523,000 Chinese-Americans living in the five Southern
5
California counties in which the Bank conducted business. 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, 2014, we had a total of $216.4 million in purchased participation
loans and $33.1 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.
We have historically originated our loans from our banking offices in Los Angeles, Orange, and
San Francisco counties. For mini-perm and construction loans, we have relied on referrals from existing
clients who are 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, 2014, 79% of our loans carried interest rates that adjust with changes in the
Prime Rate, 11% carried interest rates tied to LIBOR or other indices and 10% carried a fixed rate or were
tied to CD rates. Approximately 76% of our loan portfolio has an interest rate floor.
6
The following table sets forth information regarding our four major loan portfolios:
Real Estate Mini Perm
Portfolio size
Number of loans
Average loan size
Average LTV(1)
Average DCR(2)
Weighted average rate
Average years since origination
Real Estate Construction
Portfolio size
Number of loans
Average loan size
Average LTV(1)
Weighted average rate
Average years since origination
Commercial Loans
Portfolio size
Number of loans
Average loan size
Weighted average rate
Average years since origination
Trade Finance
Portfolio size
Number of loans
Average loan size
Weighted average rate
Average years since origination
At December 31, 2014
(Dollars in thousands)
$ 950,959
453
$ 2,099
58.29%
1.73x
5.11%
2.2 years
$ 126,485
59
$ 2,144
63.52%
5.51%
1.6 years
$ 495,827
704
$ 704
4.51%
1.8 years
$ 30,498
138
$ 221
4.23%
4.1 years
(1) Average loan-to-value at origination, or LTV, is calculated based upon a weighted average of
outstanding principal loan balances (for mini-perm loans) or commitment (for construction loans)
divided by the original value.
(2) Average debt coverage ratio at origination, or DCR, is calculated based upon the net operating income
of the property divided by the debt service.
We had 288 loans with outstanding principal balances between $1 million to $5 million, 53 loans
with outstanding principal balances between $5 million and $10 million, and 22 loans with outstanding
principal balances over $10 million as of December 31, 2014.
Real Estate Mini-Perm Loans
Real estate mini-perm loans are secured by retail, industrial, office, residential and residential
multi-family properties and comprise 59% of our loan portfolio as of December 31, 2014. 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 $951.0 million at December 31, 2014 as compared to $877.7 million as of December 31, 2013.
7
Net charge-offs of mini-perm loans as a percentage of total net loan charge-offs is not meaningful for 2014
due to a small net loan recovery, and they accounted for 5.7% of our net loan charge-offs in 2013. Loans
secured by land totaled $13.6 million and $21.4 million at December 31, 2014 and 2013, respectively.
There were no charge-offs related to land loans during 2014 or 2013, and land loans comprised $4.6 million
of the Bank’s $4.8 million gross recoveries during 2014.
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, 2014
Amount
(Dollars in thousands)
$ 139,662
223,940
91,297
133,144
150,814
13,621
198,481
$ 950,959
Percentage of Loans in
Each Category in Total
Loan Portfolio
8.71%
13.96
5.69
8.30
9.40
0.85
12.37
59.28%
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, 2014
(In thousands)
$193,975
$134,453
$153,135
$164,899
$158,807
$145,690
$950,959
Loan Origination: The loan origination process for mini-perm loans begins with a loan officer
collecting preliminary property information and financial data from a prospective borrower. After a
preliminary deal sheet is prepared and approved by management, the loan officer collects the necessary
third party reports such as appraisals, credit reports, environmental assessments and preliminary title
reports as well as detailed financial information. We utilize third party appraisers from an appraiser list
approved by our Board of Directors’ loan committee. From that list, appraisers are selected by the Chief
Credit Officer or Credit Administration.
All appraisals for loans over $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.
8
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 1.1-1.35, 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
Our construction loans are typically short-term loans of up to 18 months for the purpose of
funding the costs of constructing a building. Construction loan net charge-offs as a percentage of total loan
net charge-offs during 2014 is not meaningful due to the net recovery on total loans, and they comprised
7.4% of our net loan charge-offs during 2013. We had 59 construction loans totaling $126.5 million as of
December 31, 2014, and 26 construction loans totaling $73.3 million as of December 31, 2013.
Outstanding construction loans by property type are summarized as follows:
Property Type
Commercial / Office
Retail
Industrial
For sale attached residential
For sale detached residential
Apartment 4+
Land / Special Purpose
Total
At December 31, 2014
Amount
(Dollars in thousands)
$ —
15,536
20,421
18,797
30,095
19,858
21,778
$ 126,485
Percentage of Loans in
Each Category in Total
Loan Portfolio
0.00%
0.97
1.27
1.17
1.88
1.24
1.36
7.89%
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.
9
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 Chief Credit Officer
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, 2014, we
had $495.8 million of commercial loans outstanding, which represented 30.9% of the overall loan portfolio,
compared to $338.7 million outstanding as of December 31, 2013. 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.
Trade Finance Credits: Our trade finance portfolio totaled $30.5 million, or 1.9% of our total
loan portfolio as of December 31, 2014, compared to $39.6 million as of December 31, 2013. 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 2014 there
were no charge-offs or recoveries on trade finance loans, and during 2013 trade finance loans had overall
net charge-offs of $11,000 and comprised 2 basis points of the Bank’s 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.
10
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.
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.
11
As of December 31, 2014 and 2013, the percentage of loans secured by real estate in our total loan
portfolio was approximately 67% and 72%, respectively.
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)
Industrial
Residential 1-4
Apartment 4+
Land
Special purpose(2)
Total
At December 31, 2014
Amount
(Dollars in thousands)
$ 139,662
239,476
111,718
182,036
170,672
13,621
220,259
$ 1,077,444
Percentage of Loans in
Each Category in Total
Loan Portfolio
8.71%
14.93
6.96
11.35
10.64
0.85
13.73
67.17%
Includes shopping centers, strip malls or stand-alone properties which house retailers.
(1)
(2) Examples, other than land, include hospitality and self-storage.
To manage the risks inherent in 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, 2014, the weighted average LTV of our construction and commercial real estate
portfolio based on LTVs at the time of origination was 58%. Our practice is to require DCR’s on
commercial real estate loans of 1.2x to 1.25x, depending on the property type. We also underwrite our
commercial real estate loans using a rate that is 1-2% greater than the proposed interest rate on the loan.
12
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
Out of
State
Total
Mini-Perm Residential
Mini-Perm Commercial
Construction Residential
Construction Commercial
Total Real Estate Loans
$ 2,956
61,763
1,364
6,675
$ 72,758
$ 115,818
544,019
36,875
27,730
$ 18,881 $ 7,621
64,332
135,569
—
10,653
24,566
18,622
$ 724,442 $183,725 $ 96,519
$ 145,276
805,683
48,892
77,593
$ 1,077,444
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, 2014, 9.0% of our real estate portfolio was secured by real
estate located outside of California. At December 31, 2014, the top 20 borrowing relationships of the Bank
totaled $538.4 million in loans outstanding and comprised 32% 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, 2014 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, 2014, we had 363 loans in excess of
$1.0 million, totaling $1.38 billion. These loans comprise approximately 26.8% of our loan portfolio based
on number of loans and 85.8% 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, 2014 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.
At December 31, 2014
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
$ 193,975
$
611,294
$ 145,690
$
950,959
$ 55,180
$ 701,804
(In thousands)
97,473
251,299
17,159
—
327
29,012
190,535
13,339
53
—
—
53,993
—
—
—
126,485
495,827
30,498
53
327
—
50,221
—
53
—
29,012
194,307
13,339
—
—
Total
$ 560,233
$
844,233
$ 199,683
$ 1,604,149
$ 105,454
$ 938,462
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The following table shows the amounts of loans outstanding as of December 31, 2013, 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, 2013
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* $ 115,639
Real estate-
construction
Commercial
Trade finance
Consumer
Other
54,234
164,131
32,413
—
210
$
612,357
$ 149,750
$
877,746
$ 95,612
$ 666,495
(In thousands)
19,051
126,359
7,227
77
—
—
48,190
—
—
—
73,285
338,680
39,640
77
210
—
39,715
—
77
—
19,051
134,834
7,227
—
—
Total
$ 366,627
$
765,071
$ 197,940
$
1,329,638
$ 135,404 $ 827,607
*Includes loans held for sale of $6,207.
As reflected in this data, the maturity of our portfolio is divided generally between loans maturing
within one year or less and loans maturing between one and five years. Most of our shorter maturity loans
are commercial, construction and trade finance loans. Most of the loans that have maturities between one
and five years are real estate-mini-perm loans. Regardless of maturity, most of our loans have interest rates
that adjust with changes in the Prime Rate.
Loan Authorizations
As a result of the deterioration of the credit portfolio during the last two years, the loan policy has
been modified to reflect changes in the authorizations and approvals required to originate various loan
types.
Individual Authorities. Individual loan officers have approval authority up to $1.5 million for
loans secured by first trust deeds or cash and up to $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 $64.0 million for real estate secured
loans and $38.4 million for unsecured loans at December 31, 2014. 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.
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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.
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, 2014, the Bank had $216.4 million in loans outstanding that were purchased
from other financial institutions representing 13.5% of the loan portfolio. Many of these loans are made to
customers of the Bank but in these particular cases, the loans were originated by another bank and we were
asked to participate because of our relationship with the borrower. These loans include commercial real
estate, construction and commercial loans. There were no charge-offs to the Bank’s purchased
participations during 2014. These loans are underwritten using the same standards as loans that the Bank
originates directly.
15
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 $1.8 billion as of December 31, 2014, of which 25.0% were demand deposits,
30.8% were in savings and interest-bearing checking, 38.1% were in CD’s greater than $100,000 and 6.1%
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
interest rate. Further evidence of this is the fact that our average jumbo CD customer has been a customer
of the Bank for over six years. Further, 8% of these Jumbo CDs are pledged as collateral for loans from us
to the depositor or the depositor’s affiliated business or family member. We monitor interest rates offered
by our competitors and pay a rate we believe is competitive with the range of rates offered by such
competitors.
The Bank accesses 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. Brokered deposits were $32.6 million and $17.6 million as of December 31, 2014 and
2013, respectively.
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.
16
At December 31, 2014, excluding government deposits, brokered deposits and deposits as direct
collateral for loans, we had 64 depositors with deposits in excess of $3.0 million that totaled $566.2
million, or 31.9% 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.
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 $20.0 million in outstanding FHLB advances at December 31, 2014. We currently have $118.7 million
in available borrowing capacity at the FHLB. In addition, we have pledged $85.5 million in securities at the
Federal Reserve Bank Discount Window and may borrow against that as well.
Our Investment Activities
Our investment strategy is designed to be complementary to and interactive with our other
strategies (i.e., cash position; borrowed funds; quality, maturity, stability and earnings of loans; nature and
stability of deposits; capital and tax planning). The target percentage for our investment portfolio is
between 10% and 40% of total assets. Our general objectives with respect to our investment portfolio are
to:
Achieve an acceptable asset/liability mix;
Provide a suitable balance of quality and diversification to our assets;
Provide liquidity necessary to meet cyclical and long-term changes in the mix of assets and
liabilities;
Provide a stable flow of dependable earnings;
Maintain collateral for pledging requirements;
Manage and mitigate interest rate risk; 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 $158.4 million and $142.7 million as of December
31, 2014 and 2013, respectively. Investment securities consist primarily of investment grade corporate
notes, municipal bonds, collateralized mortgage obligations, U.S. government agency securities, and U.S
17
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, 2014, the bank had one investment with a fair value of $7.8 million classified
as “held-to-maturity.” As of December 31, 2013 the Bank had zero investment securities 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
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 banks which share a partial focus on the Chinese-
American market, 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 mainstream community banks and with Chinese-American community
banks for both deposits and loans.
Competition for deposit and loan products remains strong from both banking and non-banking
firms and this competition directly affects the rates of those products and the terms on which they are
offered to 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. 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.
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
18
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.
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 CDBO, 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
regulations, policies and practices. If, as a result of an examination, either the CDBO 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 CDBO and the FDIC.
These remedies include the power to (i) require affirmative action to correct any conditions resulting from
any violation or unsafe and unsound 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 and consent orders 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 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
CBDO could revoke the Bank’s charter or take possession and close and liquidate the Bank.
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
19
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. The Bank presently has no nonbanking or
financial subsidiaries other than PB Consulting.
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 and compliance 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.
Legislative and Regulatory Developments
The Dodd-Frank Act
The implementation and impact of legislation and regulations enacted since 2008 in response to the
U.S. economic downturn and financial industry instability continued in 2014 as modest recovery returned
to many institutions in the banking sector. Many institutions have repaid and repurchased U.S. Treasury
investments under the Troubled Asset Relief Program and certain provisions of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (“Dodd-Frank”) are effective and have been fully implemented,
including the revisions in the deposit insurance assessment base for FDIC insurance and the permanent
increase in coverage to $250,000; the permissibility of paying interest on business checking accounts; the
removal of barriers to interstate branching and required disclosure and shareholder advisory votes on
executive compensation. Implementation in 2014 of additional Dodd-Frank regulatory provisions included
aspects of (i) the final new capital rules, and (ii) a final rule to implement the so called Volcker rule
restrictions on certain proprietary trading and investment activities.
Many of the regulations to implement Dodd-Frank 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 Dodd-Frank may materially and adversely affect the
Bank's business, financial condition, and results of operations.
In the exercise of their supervisory and examination authority, the regulatory agencies have
emphasized corporate governance, stress testing, enterprise risk management and other board
responsibilities; anti-money laundering compliance and enhanced high risk customer due diligence; vendor
management; cyber security and fair lending and other consumer compliance obligations.
Capital Adequacy Requirements
Banks are subject to various regulatory capital requirements administered by state and federal
banking agencies. New capital rules described below were effective on January 1, 2014, and are being
phased in over various periods. The basic capital rule changes were fully effective on January 1, 2015, but
many elements are being phased in over multiple future years. Capital adequacy guidelines and prompt
corrective action regulations (See “Prompt Corrective Action Regulations” below) involve quantitative
measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting
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practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about
components, risk weighting, and other factors. The risk-based capital guidelines for bank holding
companies and banks require capital ratios that vary based on the perceived degree of risk associated with a
banking organization’s operations for both transactions reported on the balance sheet as assets, such as
loans, and those recorded as off-balance sheet items, such as commitments, letters of credit and recourse
arrangements. 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 risks and dividing its qualifying capital by its total risk-
adjusted assets and off-balance sheet items. Banks engaged in significant trading activity may also be
subject to the market risk capital guidelines and be required to incorporate additional market and interest
rate risk components into their risk-based capital standards. To the extent that the new rules are not fully
phased in, the prior capital rules continue to apply.
Under the risk-based capital guidelines in place prior to the effectiveness of the new capital rules,
there were three fundamental capital ratios: a total risk-based capital ratio, a Tier 1 risk-based capital ratio
and a Tier 1 leverage ratio. To be deemed “well capitalized” a bank must have a total risk-based capital
ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio of at least ten percent, six percent and five
percent, respectively.
The regulatory capital guidelines as well as the Bank’s actual capitalization as of December 31,
2014, are as follows:
Tier 1 Leverage Ratio
Preferred Bank .................................................................................................
Minimum requirement for “Well-Capitalized” institution ...............................
Tier 1 Risk-Based Capital Ratio
Preferred Bank .................................................................................................
Minimum requirement for “Well-Capitalized” institution ...............................
11.73%
5.00%
12.72%
6.00%
Total Risk-Based Capital Ratio
Preferred Bank ................................................................................................
Minimum requirement for “Well-Capitalized” institution ..............................
13.97%
10.00%
The federal banking agencies may require banks subject to enforcement actions to maintain capital
ratios in excess of the minimum ratios otherwise required to be deemed well capitalized, in which case
institutions may no longer be deemed to be well capitalized and may therefore be subject to restrictions on
taking brokered deposits.
New Capital Rules and Minimum Capital Returns
The federal bank regulatory agencies adopted final regulations in July 2013, which revised their risk-
based and leverage capital requirements for banking organizations to meet requirements of Dodd–Frank
and to implement Basel III international agreements reached by the Basel Committee. Although many of
the rules contained in these final regulations are applicable only to large, internationally active banks, some
of them will apply on a phased in basis to all banking organizations, including the Bank.
The following are among the new requirements that are phased in beginning January 1, 2015:
An increase in the minimum Tier 1 capital ratio from 4.00% to 6.00% of risk-weighted
assets;
A new category and a required 4.50% of risk-weighted assets ratio is established for
“common equity Tier 1” as a subset of Tier 1 capital limited to common equity;
A minimum non-risk-based leverage ratio is set at 4.00%, eliminating a 3.00% exception
for higher rated banks;
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Changes in the permitted composition of Tier 1 capital to exclude trust preferred securities,
mortgage servicing rights and certain deferred tax assets and include unrealized gains and
losses on available for sale debt and equity securities;
The risk-weights of certain assets for purposes of calculating the risk-based capital ratios
are changed for high volatility commercial real estate acquisition, development and
construction loans, certain past due non-residential mortgage loans and certain mortgage-
backed and other securities exposures; and
An additional “countercyclical capital buffer” is required for larger and more complex
institutions; and
A new additional capital conservation buffer of 2.5% of risk weighted assets over each of
the required capital ratios will be phased in from 2016 to 2019 and must be met to avoid
limitations on the ability of the Bank to pay dividends, repurchase shares or pay
discretionary bonuses.
Including the capital conservation buffer of 2.5%, the new final capital rule would result in the
following minimum ratios: (i) a Tier 1 capital ratio of 8.5%, (ii) a common equity Tier 1 capital ratio of
7.0%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement will be
phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until
fully implemented in January 2019. While the new final capital rule sets higher regulatory capital standards
for the Bank, bank regulators may also continue their past policies of expecting banks to maintain
additional capital beyond the new minimum requirements. The implementation of the new capital rules or
more stringent requirements to maintain higher levels of capital or to maintain higher levels of liquid assets
could adversely impact the Bank's net income and return on equity, restrict the ability to pay dividends or
executive bonuses and require the raising of additional capital.
Management believes that, as of December 31, 2014, the Bank would meet all applicable capital
requirements under the new capital rules on a fully phased-in basis if such requirements were currently in
effect (see “Legislative and Regulatory Developments”).
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.
Final Volcker Rule
In December 2013, the federal bank regulatory agencies adopted final rules that implement a part of
Dodd-Frank commonly referred to as the “Volcker Rule.” Under these rules and subject to certain
exceptions, banking entities, including the Bank, will be restricted from engaging in activities that are
considered proprietary trading and from sponsoring or investing in certain entities, including hedge or
private equity funds that are considered “covered funds.” These rules became effective on April 1, 2014,
although certain provisions are subject to delayed effectiveness under rules promulgated by the Federal
Reserve. The Bank held no investment positions at December 31, 2014 which were subject to the final
“Volcker Rule”. Therefore, while these new rules may require us to conduct certain internal analysis and
reporting, we believe that they will not require any material changes in our operations or business.
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Memorandum of Understanding
As a result of a regulatory examination during 2014, the MOU, which was entered into on October 1,
2013, was terminated by the FDIC and the CDBO. The termination of the MOU allows the Bank to declare
and pay cash dividends to its shareholders and establish new branches and offices without prior written
approval of the FDIC and CDBO, and removes the 10% tier 1 leverage ratio requirement. Following the
lifting of the restriction on dividends, the Bank declared quarterly cash dividends of $0.10 per share on
September 16, 2014 and of $0.10 per share on December 18, 2014. These dividends were paid on October
20, 2014 and January 20, 2015 respectively. The Bank’s tier 1 leverage ratio was 11.73% as of December
31, 2014.
Prompt Corrective Action Regulations
The FDI Act requires the federal bank regulatory agencies 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. Depending on the
bank’s capital ratios, the agencies’ regulations define five categories in which an insured depository
institution will be placed: well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. At each successive lower capital category, an insured
bank is subject to more restrictions, including restrictions on the bank's activities, operational practices or
the ability to pay dividends. Based upon its capital levels, a bank that is classified as well-capitalized,
adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital
category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that
an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.
The prompt corrective action standards were changed when the new capital rule ratios become
effective. Under the new standards, in order to be considered well-capitalized, the Bank is required to meet
the new common equity Tier 1 ratio of 6.5%, an increased Tier 1 ratio of 8% (increased from 6%), a total
capital ratio of 10% (unchanged) and a leverage ratio of 5% (unchanged).
Dividends and Other Transfers of Funds
The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends. 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.
The power of the Bank to declare cash dividends is subject to California law, which limits the
amount available for cash dividends to the lesser of the Bank’s retained earnings or net income for its last
three fiscal years (less any distributions made to shareholders during that period). This restriction may only
be exceeded with advance approval of the CDBO, which may approve declaration of an amount not
exceeding the greatest of retained earnings of the Bank, the Bank’s prior fiscal year net income, or the
Bank’s current fiscal year net income.
Deposit Insurance
The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of
federally insured banks and savings institutions and safeguards the safety and soundness of the banking and
savings industries. The FDIC insures our customer deposits through the DIF up to prescribed limits for
each depositor. The amount of FDIC assessments paid by each DIF member institution is based on its
relative risk of default as measured by regulatory capital ratios and other supervisory factors. The FDIC
may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial
condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a
risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit
insurance for a bank would also result in the revocation of the bank’s charter by the CDBO.
23
Our FDIC insurance expense totaled $2.1 million for 2014. We are generally unable to control the
amount of premiums that we are required to pay for FDIC insurance, which can be affected by the cost of
bank failures to the FDIC among other factors. 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,
2014, the Bank had $20.0 million of outstanding FHLB advances and additional borrowing capacity of
$118.7 million. At December 31, 2014, the Bank was in compliance with the FHLB’s stock ownership and
cash reserve requirements. As of December 31, 2014 and 2013, our investment in FHLB capital stock
totaled $6,155,000 and $5,296,000, respectively.
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 to the extent such regulations have been adopted by the FDIC as well as listing
requirements of NASDAQ.
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 as adopted by the FDIC for board audit committees and their members, and
disclosure of controls and procedures and internal control over financial reporting.
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, 2014,
the Bank’s largest single lending relationship had a combined outstanding balance of $56.7 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
24
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 CDBO has regulations which adopt and also
apply Regulation O to the Bank.
The Bank also is subject to certain restrictions imposed by Federal Reserve Act Sections 23A and
23B and Federal Reserve Regulation W on any extensions of credit to, or the issuance of a guarantee or
letter of credit on behalf of, any affiliates, the purchase of, or investments in, stock or other securities
thereof, the taking of such securities as collateral for loans, and the purchase of assets of any affiliates.
Such restrictions prevent any affiliates from borrowing from the Bank unless the loans are secured by
marketable obligations of designated amounts. Further, such secured loans and investments to or in any
affiliate are limited, individually, to 10.0% of the Bank’s capital and surplus (as defined by federal
regulations), and such secured loans and investments are limited, in the aggregate, to 20.0% of the Bank’s
capital and surplus. A financial subsidiary is considered an affiliate subject to these restrictions whereas
other nonbanking subsidiaries are not considered affiliates. Additional restrictions on transactions with
affiliates may be imposed on the Bank under the FDI Act prompt corrective action provisions and the
supervisory authority of the federal and state banking agencies.
Operations and Consumer Compliance
The Bank must comply with numerous federal and state anti-money laundering and consumer
protection statutes and implementing regulations, including the USA PATRIOT Act of 2001, the Bank
Secrecy Act, the Foreign Account Tax Compliance Act, the CRA, the Fair Credit Reporting Act, as
amended by the Fair and Accurate Credit Transactions 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 California Homeowner Bill of Rights and various
federal and state privacy protection laws. Noncompliance with any of these laws could subject the Bank to
compliance enforcement actions as well as lawsuits and could also result in administrative penalties,
including, fines and reimbursements. The Bank and the Company are also subject to federal and state laws
prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition.
These laws and regulations mandate certain disclosure and reporting requirements and regulate the
manner in which financial institutions must deal with customers when taking deposits, making loans,
servicing, collecting and foreclosure of 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.
Dodd-Frank provided for the creation of the Consumer Finance Protection Bureau (“CFPB”) as an
independent entity within the Federal Reserve with broad rulemaking, supervisory and enforcement
authority over consumer financial products and services, including deposit products, residential mortgages,
home-equity loans and credit cards. The bureau’s functions include investigating consumer complaints,
conducting market research, rulemaking, supervising and examining bank consumer transactions, and
enforcing rules related to consumer financial products and services. CFPB regulations and guidance apply
to all financial institutions and banks with $10 billion or more in assets are subject to examination by the
25
CFPB. Banks with less than $10 billion in assets, including the Bank, will continue to be examined for
compliance by their primary federal banking agency.
In 2014, the CFPB adopted revisions to Regulation Z, which implement the Truth in Lending Act,
pursuant to the Dodd-Frank Act, and apply to all consumer mortgages (except home equity lines of credit,
timeshare plans, reverse mortgages, or temporary loans). The revisions mandate specific underwriting
criteria for home loans in order for creditors to make a reasonable, good faith determination of a consumer's
ability to repay and establish certain protections from liability under this requirement for “qualified
mortgages” meeting certain standards. In particular, it will prevent banks from making “no doc” and “low
doc” home loans, as the rules require that banks determine a consumer’s ability to pay based in part on
verified and documented information. Because we do not originate “no doc” or “low doc” loans, we do not
believe this regulation will have a significant impact on our operations. However, because a substantial
portion of the mortgage loans originated by the Bank do not meet the definitions for a “qualified mortgage”
under final regulations adopted by the CFPB, the Bank may be subject to additional disclosure obligations
and extended time periods for the assertion of defenses by the borrower against enforcement in connection
with such mortgage loans.
Employees
As of December 31, 2014, the Bank had a total of 163 full-time equivalent employees. None of the
employees are represented by a union or collective bargaining group. Management believes that employee
relations are satisfactory.
Executive Officers of the Bank
The following table sets forth our executive officers, their positions and their ages. Each officer is
appointed by, and serves at the pleasure of the Board of Directors.
Name
Age (1)
Position with Bank
Li Yu ........................
[74]
Chairman of the Board and Chief Executive Officer
Wellington Chen ......
[55]
President and Chief Operating Officer
Edward J. Czajka ......
[50]
Executive Vice President and Chief Financial Officer
Lucilio Couto ...........
[46]
Executive Vice President and Chief Credit Officer
(1) As of March 1, 2015.
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 was the Bank’s Senior Executive Vice President beginning 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.
26
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 the former North Valley Bancorp,
a publicly-traded multi-bank holding company located in Redding, California (now Tri Counties Bank).
From 1994 through 2000, Mr. Czajka held the position of Vice President, Corporate Controller for the
former Pacific Capital Bancorp in Santa Barbara, California (now Union Bank). 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 the former 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.
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.
If our allowance for loan and lease losses is inadequate to cover actual losses, our financial
results would be harmed.
A significant source of risk arises from the possibility that we could sustain losses because
borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans.
The underwriting and credit monitoring policies and procedures that we have adopted to address this risk
27
may not prevent losses that could have an adverse effect on our business, financial condition, results of
operations and cash flows. 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 an 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, 2014, we recorded a provision for loan and lease losses and net loan
recoveries of $3.4 million and $130,000, respectively, compared to a provision of $3.3 million and net loan
charge-offs of $4.4 million for the year ended December 31, 2013.
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 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 realized, our net income could be adversely
affected.
At December 31, 2014, our construction loans were $126.5 million, or 7.9% of our total loans
held, and the average loan size of our construction loans was $2.1 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.
The impact of new capital rules will impose enhanced capital adequacy requirements on us and
may materially affect our operations.
We will be subject to more stringent capital requirements. Pursuant to Dodd-Frank and to
implement for U.S. banking institutions the principles of the international “Basel III” standards, the federal
banking agencies have adopted a new set of rules on minimum leverage and risk-based capital that will
apply to both insured banks and their holding companies. These regulations were issued in July 2013, and
are being phased in, for the Bank, over a period of five years, beginning in 2015. The new capital rules,
among other things:
impose more restrictive eligibility requirements for Tier 1 and Tier 2 capital;
introduce a new category of capital, called Common Equity Tier 1 capital, which must be at least
4.5 percent of risk-based assets, net of regulatory deductions, and a capital conservation buffer of
an additional 2.5 percent of common equity to risk-weighted assets, raising the target minimum
common equity ratio to 7 percent;
28
increase the minimum Tier 1 capital ratio to 8.5 percent inclusive of the capital conservation
buffer;
increase the minimum total capital ratio to 10.5 percent inclusive of the capital conservation
buffer; and
introduce a non-risk adjusted Tier 1 leverage ratio of 3 percent, based on a measure of total
exposure rather than total assets, and new liquidity standards.
The full implementation of the new capital rule may adversely affect our ability to pay dividends, or
require us to reduce business levels or raise capital, including in ways that may adversely affect our
business, liquidity, financial condition and results of operations.
The new Basel III-based capital standards could limit our ability to pay dividends or make stock
repurchases and our ability to compensate our executives with discretionary bonuses. Under the new
capital standards, if our Common Equity Tier 1 Capital does not include a newly required “capital
conservation buffer,” we will be prohibited from making distributions to our shareholders. The capital
conservation buffer requirement, which is measured in addition to the minimum Common Equity Tier 1
capital of 4.5%, will be phased in over four years, starting at 0.625% for 2016, and rising to 2.5% for 2019
and subsequent years. Additionally, under the new capital standards, if our Common Equity Tier 1 Capital
does not include the newly required “capital conservation buffer,” we will also be prohibited from paying
discretionary bonuses to our executive employees. This may affect our ability to attract or retain
employees, or alter the nature of the compensation arrangements that we may enter into with them.
Future regulatory requirements could adversely affect us.
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.
Although the national and local economies have improved dramatically, geopolitical, regulatory and other
unforeseen events continue to have an impact on the economy and our markets. 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. We cannot assess the
impact of any such changes on our business at this time.
• The process we use to estimate losses inherent in our credit exposure requires difficult, subjective
and complex judgments, including forecasts of economic conditions and how these economic
conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty
concerning economic conditions may adversely affect the accuracy of our estimates which may, in
turn, impact the reliability of the process.
• The classification of our criticized loans as 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.
29
• 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, 2014, 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.
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, Chairman and Chief Executive Officer, and our President and Chief Operating Officer,
Wellington Chen. Mr. Yu, who founded the Bank, and Mr. Chen, are both integral to implementing our
business plan. We currently do not have an employment agreement or non-competition agreement with
Messrs. Yu or Chen 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 or Mr. Chen, our business, financial condition, results of
operations and cash flows may be adversely affected. Furthermore, attracting suitable replacements may be
difficult and may require significant management time and resources.
We also rely to a significant degree on the abilities and continued service of our private banking,
loan origination, underwriting, administrative, marketing and technical personnel. Competition for
qualified employees and personnel in the banking industry is intense and there are a limited number of
qualified persons with knowledge of, and experience in, the California community banking industry. The
process of recruiting personnel with the combination of skills and attributes required to carry out our
strategies is often lengthy. If we fail to attract and retain qualified management personnel and the necessary
deposit generation, loan origination, underwriting, administrative, finance, marketing and technical
personnel, our business, financial condition, results of operations and cash flows may be materially
adversely affected.
A natural disaster or recurring energy shortage, especially in California, could harm our
business.
Historically, Southern California has been vulnerable to natural disasters. Therefore, we are
susceptible to the risks of natural disasters, such as earthquakes, wildfires, floods and mudslides. Natural
disasters could harm our operations directly through interference with communications, as well as through
the destruction of facilities and our operational, financial and management information systems. Uninsured
or underinsured disasters may reduce a borrower’s ability to repay mortgage loans. Disasters may also
reduce the value of the real estate securing our loans, impairing our ability to recover on defaulted loans.
Southern California has also experienced energy shortages which, if they recur, could impair the value of
the real estate in those areas affected. The occurrence of natural disasters or energy shortages in Southern
30
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.
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.
31
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
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, 2014, approximately $30.5 million, or 1.9%, 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.
32
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 reduced availability 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, 2014, we held $276.2 million of Jumbo CDs, representing 15.5% 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 heavily on third-party service providers for much of our communications, information,
operating and financial control systems technology, including customer relationship management, general
ledger, deposit, servicing and loan origination systems. Any failure, interruption or breach in security of
these systems could result in failures or interruptions in our customer relationship management, general
ledger, deposit, servicing and/or loan origination systems. We cannot assure you that such failures or
interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third
parties on which we rely. The occurrence of any failures or interruptions could have a material adverse
effect on our business, financial condition, results of operations and cash flows. If any of our third-party
service providers experience financial, operational or technological difficulties, or if there is any other
disruption in our relationships with them, we may be required to locate alternative sources of such services,
and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services
with similar functionality as found in our existing systems without the need to expend substantial resources,
if at all. Any of these circumstances could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
The U.S. government’s monetary policies or changes in those policies could have a major effect
on our operating results, and we cannot predict what those policies will be or any changes in such
policies or the effect of such policies on us.
Our earnings will be affected by domestic economic conditions and the monetary and fiscal
policies of the U.S. government and its agencies. The monetary policies of the Federal Reserve Bank, or the
FRB, have had, and will continue to have, an important effect on the operating results of commercial banks
and other financial institutions through its power to implement national monetary policy in order, among
other things, to curb inflation or combat a recession.
The monetary policies of the FRB, 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.
33
Governmental regulation and any further enforcement actions against us may further impair
our operations or restrict our growth and could result in a decrease in the value of your shares.
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 face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other
anti-money laundering statutes and regulations.
The Bank Secrecy Act, the USA PATRIOT Act of 2001, and other laws and regulations require
financial institutions, among other duties, to institute and maintain an effective anti-money laundering
program and file suspicious activity and currency transaction reports as appropriate. The federal Financial
Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of
those requirements and has recently engaged in coordinated enforcement efforts with the individual federal
banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and
Internal Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced
by the Office of Foreign Assets Control and compliance with the Foreign Corrupt Practices Act. If our
policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and
regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to
obtain regulatory approvals to proceed with certain aspects of our business plan. Failure to maintain and
implement adequate programs to combat money laundering and terrorist financing could also have serious
reputational consequences for us. Any of these results could materially and adversely affect our business,
financial condition and results of operations.
We are exposed to risk of environmental liability with respect to properties to which we take
title.
In the course of our business, we may foreclose on and take title to properties securing our loans.
If hazardous substances were discovered on any of the properties, we may be held liable to governmental
entities or to third parties for property damage, personal injury, investigation and clean-up costs incurred by
these parties in connection with environmental contamination or may be required to investigate or clean up
hazardous or toxic substances or chemical releases at a property. Many environmental laws can impose
liability regardless of whether we knew of or were responsible for the contamination. In addition, if we
arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of
cleaning up and removing those substances from the site, even if we neither own nor operate the disposal
site. Environmental laws may require us to incur substantial expenses and may materially limit use of
properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of
34
a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement
policies with respect to existing laws may increase our exposure to environmental liability.
Negative publicity could damage our reputation.
Reputation risk, or the risk to our earnings and capital from negative publicity or public opinion, is
inherent in our business. Negative publicity or public opinion could adversely affect our ability to keep and
attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion
could result from our actual or perceived conduct in any number of activities, including lending practices,
corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or
inadequate protection of customer information, and from actions taken by government regulators and
community organizations in response to that conduct.
Terrorist attacks may have depressed the economy in the past and if there are additional
terrorist events especially in our market, the economy could be adversely affected.
The possibility of further terrorist attacks, as well as continued terrorist threats, may create and
perpetuate this economic uncertainty. Future terrorist acts and responses to such activities could adversely
affect us in a number of ways, including an increase in delinquencies, bankruptcies or defaults that could
result in a higher level of non-performing assets, net charge-offs and provision for loan losses.
The price of our common stock may be volatile or may decline.
The 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
Domestic and international economic factors unrelated to our performance; or
Other factors identified above in “Forward-Looking Statements.”
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.
The occurrence of fraudulent activity, breaches or failures of our information security controls
or cybersecurity-related incidents could have a material adverse effect on our business, financial
condition and results of operations.
35
As a financial institution, we are susceptible to fraudulent activity, information security breaches
and cybersecurity-related incidents that may be committed against us or our clients, which may result in
financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client
information, misappropriation of assets, privacy breaches against our clients, litigation, or damage to our
reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire
fraud, on-line banking, phishing, social engineering and other dishonest acts. Information security breaches
and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or
our clients, denial or degradation of service attacks, and malware or other cyber-attacks. In recent periods,
there continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the
financial services industry, especially in the commercial banking sector due to cyber criminals targeting
commercial bank accounts. Consistent with industry trends, we have also experienced an increase in
attempted electronic fraudulent activity, security breaches and cybersecurity-related incidents in recent
periods. Moreover, in recent periods, several large corporations, including financial institutions and retail
companies, have suffered major data breaches, in some cases exposing not only confidential and
proprietary corporate information, but also sensitive financial and other personal information of their
customers and employees and subjecting them to potential fraudulent activity. Some of our clients may
have been affected by these breaches, which increase their risks of identity theft, credit card fraud and other
fraudulent activity that could involve their accounts with us.
Information pertaining to us and our clients is maintained, and transactions are executed, on the
networks and systems of ours, our clients and certain of our third party partners, such as our online banking
or core systems. The secure maintenance and transmission of confidential information, as well as execution
of transactions over these systems, are essential to protect us and our clients against fraud and security
breaches and to maintain our clients’ confidence. Breaches of information security also may occur, and in
infrequent, incidental, cases have occurred, through intentional or unintentional acts by those having access
to our systems or our clients’ or counterparties’ confidential information, including employees. In addition,
increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries,
vulnerabilities in third-party technologies (including browsers and operating systems) or other
developments could result in a compromise or breach of the technology, processes and controls that we use
to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions, as
well as the technology used by our clients to access our systems. Although we have developed, and
continue to invest in, systems and processes that are designed to detect and prevent security breaches and
cyber-attacks and periodically test our security, our inability to anticipate, or failure to adequately mitigate,
breaches of security could result in: losses to us or our clients; our loss of business and/or clients; damage
to our reputation; the incurrence of additional expenses; disruption to our business; our inability to grow
our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil
litigation and possible financial liability — any of which could have a material adverse effect on our
business, financial condition and results of operations.
More generally, publicized information concerning security and cyber-related problems could
inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting
commercial transactions. Such publicity may also cause damage to our reputation as a financial institution.
As a result, our business, financial condition and results of operations could be adversely affected.
Failure to maintain effective internal control over financial reporting or disclosure controls and
procedures could adversely affect our ability to report our financial condition and results of operations
accurately and on a timely basis.
A failure to maintain effective internal control over financial reporting or disclosure controls and
procedures could adversely affect our ability to report our financial results accurately and on a timely basis,
which could result in a loss of investor confidence in our financial reporting or adversely affect our access
to sources of liquidity. Furthermore, because of the inherent limitations of any system of internal control
over financial reporting, including the possibility of human error, the circumvention or overriding of
controls and fraud, even effective internal controls may not prevent or detect all misstatements.
36
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, 2014, we maintained twelve full-service branch offices in Alhambra, Arcadia,
Century City, City of Industry, Diamond Bar, Los Angeles, Pico Rivera, San Francisco, Tarzana, Torrance,
Anaheim, and Irvine, California all of which we lease, except the Irvine branch which we own. We believe
that no single lease is material to our operations. Leases for branch offices are generally 3 to 12 years in
length and generally provide renewal terms of 3 to 5 additional years.
We believe that our existing facilities are adequate for our present purposes. We believe that, if
necessary, we could secure alternative facilities on similar terms without adversely affecting our operations.
Total lease expense was $1.8 million for the year ended December 31, 2014 and $1.8 million for December
31, 2013.
The Bank accounts for its leases under the provision of ASC 840, Leases. Certain leases have
scheduled rent increases, and certain leases include an initial period of free or reduced rent as an
inducement to enter into the lease agreement (“rent holiday”). The Bank recognizes rent expense for rent
increases and rent holiday on a straight line basis over the terms of the underlying lease without regard to
when rent payments are made.
The following table provides certain information with respect to our owned and leased branch
locations.
Location
Address
Current
Lease Term
Expiration
Date
Square
Footage
Los Angeles County
Alhambra
Arcadia
Century City
City of Industry
Diamond Bar
Los Angeles (Head Office & branch)
Pico Rivera
Torrance
Tarzana (Premises opened in January
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
03/01/19
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
2015)
18321 Ventura Blvd, Suite 100
12/20/24
5,915
Orange County
Anaheim
Irvine (Owned Branch Premises)
Northern California
San Francisco
1055 N. Tustin Avenue
890 Roosevelt Avenue
7/15/18
N/A
2,750
4,960
600 California Street, Suite 550
12/19/17
3,679
37
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 DISCLOSURES
Not applicable
38
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is listed on the NASDAQ Global Select Market under the symbol “PFBC.”
Our common stock closed at $27.60 on March 11, 2015 and there were 13,568,206 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.
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:
2013
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
2014
First Quarter………….
Second Quarter……….
Third Quarter…………
Fourth Quarter………..
High
Low
$16.74
$17.33
$17.96
$21.29
$26.79
$26.44
$25.31
$28.42
$ 14.24
$ 14.64
$ 15.89
$ 17.53
$ 19.61
$ 20.17
$ 21.36
$ 22.25
Cash
Dividends
Declared
*
*
*
*
*
*
$0.10
$0.10
*On April 16, 2009, until the third quarter of 2014, the Bank’s Board of Directors suspended the
Bank’s cash dividend in order to preserve the Bank’s capital. In addition, the MOU to which the
Bank was previously subject prohibited the payment of dividends to our shareholders without the
prior approval of the FDIC and CDBO.
Holders
As of March 11, 2015, 13,568,206 shares of the Bank’s common stock were held by 161
shareholders of record.
Dividends
We resumed paying dividends on a quarterly basis in the third quarter of 2014, upon termination
of the MOU. Dividend 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 in addition
to the requirements of the MOU. 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).
39
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 2014.
Issuer’s Purchases of Equity Securities.
No repurchases of the Bank’s common stock were made by or on behalf of the Bank in 2014.
Securities Authorized for Issuance Under Equity Compensation Plans.
The following table provides information as of December 31, 2014, 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)
663,362
—
663,362
Weighted average
exercise price of
outstanding
options
(b)
$12.99
—
Number of securities
available for future
issuance under equity
compensation plans
excluding securities
reflected in column (a)
(c)
2,500,000
—
2,500,000
40
Stock Perf
formance Gra
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The followi
on the market
ning December
included in eit
on the cumula
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and may not be
ing graph show
price of the co
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ative amount of
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in each as of D
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Total Re
eturn Perfo
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Preferre
ed Bank
NASDA
AQ Composite
NASDA
AQ Bank
SNL Ba
ank and Thrift
35
50
30
00
25
50
e
u
l
a
V
x
e
d
n
I
20
00
15
50
10
00
50
5
12/31/09
1
12/31/10
12/31/1
11
12/
/31/12
12/31/13
4
12/31/14
Index
Preferred
NASDAQ
NASDAQ
SNL Ban
d Bank
Q Composite
Q Bank
nk and Thrift
12/3
1/09
12/3
31/10
12
2/31/11
12/31/12
1
12/31/13
12/31/14
10
10
10
10
0.00
0.00
0.00
0.00
97.78
1
18.15
1
14.16
11.64
1
82.78
117.22
102.17
86.81
157.78
138.02
121.26
116.57
222.78
193.47
171.86
159.61
311.20
222.16
180.31
178.18
Period Ending
P
41
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, 2014 and 2013 and our statement of operations
data for the years ended December 31, 2014, 2013 and 2012 have been derived from our audited historical
financial statements included elsewhere in this Form 10-K.
2014
At or for the Year Ended December 31,
2012
2013
2011
2010
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(1)
Cash and cash equivalents
Other real estate owned(2)
Shareholders’ equity
Statement of Operations Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest income after
provision for loan and lease losses
Noninterest income
Noninterest expense
Income (loss) before provision for
income taxes
Provision (benefit) for income taxes
Net income (loss)
Accretion of beneficial conversion
feature
Income allocated to participating
securities
Dividends allocated to participating
securities
Net income (loss) available to
common shareholders
(Dollars in thousands, except per share data)
$ 2,054,154
1,776,259
7,815
$ 1,768,959
1,529,314
—
$ 1,554,856
1,357,527
979
$ 1,309,797
1,117,953
3,021
$ 1,255,866
1,081,265
—
150,539
1,604,149
240,194
8,811
235,026
142,670
1,323,431
246,615
5,602
206,916
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
$ 80,327
9,340
70,987
3,350
$ 69,726
7,729
61,997
3,250
$ 61,542
7,783
53,759
19,800
$ 53,790
10,303
43,487
5,700
67,637
3,621
30,411
58,747
2,003
29,261
33,959
3,508
34,178
37,787
2,790
33,392
$ 52,088
14,822
37,266
16,550
20,716
2,807
41,037
40,847
16,255
$ 24,592
31,489
12,290
$ 19,199
3,289
(20,583)
$ 23,872
7,185
(5,049)
$ 12,234
(17,514)
(704)
$ (16,810)
—
—
—
—
(25,600)
(270)
(30)
(201)
(323)
(195)
—
$ 24,292
$ 18,998
$ 23,549
$ 12,039
$ (42,410)
42
2014
At or for the Year Ended December 31,
2012
2011
2013
2010
Share Data:
Net (loss)income per share, basic(3) (11)
Net (loss) income per share, diluted(3)
(10)
Book value per share(4) (11)
Cash dividends declared per common
share
Shares outstanding at period end(11)
Weighted average number of shares
outstanding, basic(3) (11)
Weighted average number of shares
outstanding, diluted(3) (11)
Selected Other Balance Sheet Data(5):
Average assets
Average earning assets
Average shareholders’ equity
Selected Financial Ratios(5):
Return on average assets
Return on average shareholders’
Equity(5)
Shareholders’ equity to assets(6)
Net interest margin(7)
Efficiency ratio(8)
Selected Asset Quality Ratios:
Non-performing loans to total loans
and leases(9)
Non-performing assets to total
assets(10)
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)
$ 1.83
$ 1.45
$ 1.80
$ 0.93
$ (6.21)
$ 1.78
$ 17.40
$ 1.42
$ 15.58
$ 1.78
$ 14.19
$ 0.93
$ 11.95
$ (6.21)
$ 10.72
$ 0.20
13,503,458
$ —
13,280,653
$ —
13,234,608
$ —
13,220,955
$ —
13,188,305
13,290,258
13,116,563
13,050,559
12,995,525
6,829,734
13,620,027
13,364,320
13,247,389
12,995,525
6,829,734
$ 1,880,019
1,836,375
223,198
$ 1,633,710
1,578,570
196,981
$ 1,426,053
1,367,496
178,257
$1,237,034
1,192,942
148,817
$1,343,450
1,276,478
127,289
1.31%
1.18%
1.67%
0.99%
(1.25)%
11.02
11.44
3.89
40.76
9.75
11.70
3.95
45.72
13.39
12.08
3.96
59.68
8.22
12.07
3.69
72.16
(13.21)
11.25
2.98
102.41
0.53%
1.06%
2.31%
4.98%
11.13%
0.85
1.43
1.11
3.50
6.49
12.30
1.47
1.84
2.50
3.60
268.19
138.80
78.82
49.98
32.30
(0.01)
0.36
2.25
1.65
2.71
(1)
Includes loans held for sale of zero as of December 31, 2014, $6,207 as of December 31, 2013, $12,150 as of December 31,
2012, $3,996 as of December 31, 2011, and $2,556 as of December 30, 2010.
(2) These amounts include all property held by us as a result of foreclosure.
(3) 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.
(4) 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).
(5) Average balances used in this chart and throughout this annual report are based on daily averages. Percentages as used
(6)
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.”
(7) Net interest margin is net interest income expressed as a percentage of average total interest-earning assets.
(8) 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.
43
(9) Non-performing loans consist of loans on non-accrual and loans past due 90 days or more and restructured debt.
(10) Non-performing assets consist of non-performing loans and other real estate owned.
(11) Adjusted to reflect 1-for-5 stock split, effective on June 2011.
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, 2014 and 2013, and the
results of operations for the years ended December 31, 2014, 2013 and 2012. 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 loans, deposits and net income in 2013 and 2014. The
national economy is improving and the local economy is gaining strength. The real estate market in
Southern California could now be considered to be strong however there is still weakness in some outlying
areas of Southern California. During 2014, the Bank posted a high level of net income due growth in loans,
a reduction in the provision for loan losses and a reduction in the Bank’s non-interest expenses. The
reduction in expenses was mainly due to lower costs associated with NPA’s.
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 California, to fund our loan and
investment activities.
For the year ended December 31, 2014, the Bank recorded net income of $24.6 million as
compared to net income of $19.2 million for 2013. The Bank recorded an all-time high amount of assets at
$2.05 billion. Loans grew by $275 million, or 20.7%, and deposits grew by $247 million, or 16.2%, while
improving the deposit mix. See —“Results of Operations”.
For the year ended December 31, 2013, the Bank recorded net income of $19.2 million as
compared to net income of $23.9 million for 2012. Net income in 2012 was larger due to the reversal of the
valuation allowance on deferred tax assets during the period, resulting in a net tax benefit of $20.6 million
for the year. See —“Results of Operations”.
Regulatory Matters
As a result of a regulatory examination during 2014, the Memorandum of Understanding
(“MOU”), which was entered into on October 1, 2013, was terminated by the FDIC and the California
Department of Business Oversight (“CDBO”). The termination of the MOU allows the Bank to declare and
pay cash dividends to its shareholders and establish new branches and offices without prior written
approval of the FDIC and CDBO, and removes the 10% tier 1 leverage ratio requirement. Following the
lifting of the restriction on dividends, the Bank declared quarterly cash dividends of $0.10 per share on
September 16, 2014 and of $0.10 per share on December 18, 2014. These dividends were paid on October
20, 2014 and January 20, 2015 respectively. The Bank’s tier 1 leverage ratio was 11.73% as of December
31, 2014.
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,
44
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
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
45
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 FASB guidance covering
recognition and presentation of other-than-temporary impairments, changes the presentation and amount of
the other-than-temporary impairment recognized in the income statement. The other-than-temporary
impairment is separated into (a) the amount of the total other-than-temporary impairment related to a
decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount
of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-
temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-
than-temporary impairment related to all other factors is recognized in other comprehensive income. The
determination of other-than-temporary impairment is a subjective process, requiring the use of judgments
and assumptions. We examine all individual securities that are in an unrealized loss position at each
reporting date for other-than-temporary impairment. Specific investment-related factors we examine to
assess impairment include the nature of the investment, severity and duration of the loss, the probability
that we will be unable to collect all amounts due, an analysis of the issuers of the securities and whether
there has been any cause for default on the securities and any change in the rating of the securities by the
various rating agencies. Additionally, we evaluate whether the creditworthiness of the issuer calls the
realization of contractual cash flows into question.
The Bank considers all available information relevant to the collectability of the pooled trust
preferred securities, including information about past events, current conditions, and reasonable and
supportable forecasts, when developing the estimate of future cash flows and making its other-than-
temporary impairment assessment for our portfolio of pooled trust preferred securities. The Bank considers
factors such as remaining payment terms of the security, prepayment speeds, the financial condition of the
underlying issuers and expected deferrals, defaults and recoveries.
46
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, 2014. Investment securities are discussed in more detail in
Note 2 to the Bank’s consolidated financial statements presented elsewhere in this report.
Income Taxes
We accounted for income taxes under the asset and liability method, which requires the
recognition of deferred tax assets and liabilities for the expected future tax consequences of events that
have been included in the financial statements. Under this method, deferred tax assets and liabilities are
determined based on the differences between the financial statements and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a
change in tax rates on deferred tax rates on deferred tax assets and liabilities is recognized in income in the
period that includes the enacted date. 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:
Net income
Net income per share, basic
Net income per share, diluted
Return on average assets
Return on average shareholders’ equity
Dividend payout ratio
Equity to assets ratio
Year Ended December 31,
2013
2012
2014
(Dollars in thousands, except per share data)
$ 24,592
$ 1.83
$ 1.78
1.31%
11.02%
11.21%
11.44%
$ 19,199
$ 1.45
$ 1.42
1.18%
9.75%
—
11.70%
$ 23,872
$ 1.80
$ 1.78
1.67%
13.39%
—
12.08%
47
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
Statement of Operations Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest income after provision for loan and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax expense (benefit)
Net income
Income allocated to participating securities
Dividends allocated to participating securities
Net income available to common shareholders
Year Ended December 31,
2014
2013
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 80,327
9,340
70,987
3,350
67,637
3,621
30,411
40,847
16,255
$ 24,592
(270)
(30)
$ 24,292
$ 69,726
7,729
61,997
3,250
58,747
2,003
29,261
31,489
12,290
$ 19,199
(201)
—
$ 18,998
$ 10,601
1,611
8,990
100
8,890
1,618
1,150
9,358
3,965
$ 5,393
(69)
(30)
$ (5,294)
Net income per share, basic
Net income per share, diluted
$ 1.83
$ 1.78
$ 1.45
$ 1.42
$ 0.38
$ 0.36
The Bank’s net income increased to $24.6 million, or $1.78 per diluted share, for the year ended
December 31, 2014, from a net income of $19.2 million, or $1.42 per diluted share, for the year ended
December 31, 2013. Our return on average assets was 1.31% and return on average shareholders’ equity
was 11.02% for the year ended December 31, 2014, compared to 1.18% and 9.75%, respectively, for the
year ended December 31, 2013.
Net income increased from 2013 to 2014, which is primarily attributable to increased net interest
income between the years. The $9.0 million, or 14.5%, increase in net interest income was due primarily to
growth of the loan portfolio. Our overall cost of funds in 2014 remained consistent at 0.73% for both 2014
and 2013, while average yields on earning assets decreased by 4 basis points to 4.40% from 4.44%. Yield
on earning assets saw a slight decrease primarily due to lower average interest rates on loans during the
year, decreasing 8 basis points from 5.23% for 2013 to 5.15% for 2014, partially offset by an increase in
average yield on investments between the years, from 3.23% for 2013 to 3.33% for 2014. This decrease in
yield on earning assets was also partially due to an increase in cash due from the Federal Reserve Bank
between the periods, from an average of $156.5 million for the year ended December 31, 2013 to an
average of $191.0 million for the year ended December 31, 2014.
As of December 31, 2014, 79% of our loan portfolio was tied to the Prime Rate, which has the
potential to re-price daily, and 11% was tied to the London Interbank 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 1% of our loan portfolio had interest rate ceilings at
various rates limiting the amount of interest rate increases that can be passed on to the borrower. Our
weighted average maturity of certificates of deposit at December 31, 2014 was 9.7 months.
48
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Statement of Operations Data:
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest income after provision for loan and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax benefit
Net income
Accretion of beneficial conversion feature
Net income available to common shareholders
Year Ended December 31,
2013
2012
Increase
(Decrease)
(Dollars in thousands, except per share data)
$ 69,726
7,729
61,997
3,250
58,747
2,003
29,261
31,489
12,290
$ 19,199
(201)
$ 18,998
$ 61,542
7,783
53,759
19,800
33,959
3,508
34,178
3,289
(20,583)
$ 23,872
(323)
$ 23,549
$ 8,184
(54)
8,238
(16,550)
24,788
(1,505)
(4,917)
28,200
32,873
$ (4,673)
122
$ (4,551)
Net income per share, basic
Net income per share, diluted
$ 1.45
$ 1.42
$ 1.80
$ 1.78
$ (0.35)
$ (0.36)
The Bank’s net income decreased to $19.2 million, or $1.42 per diluted share, for the year ended
December 31, 2013, from a net income of $23.9 million, or $1.78 per diluted share, for the year ended
December 31, 2012. Our return on average assets was 1.18% and return on average shareholders’ equity
was 9.75% for the year ended December 31, 2013, compared to 1.67% and 13.39%, respectively, for the
year ended December 31, 2012.
Net income decreased from 2012 to 2013, principally as a result of income tax benefit resulting
from the full reversal of the valuation allowance on the deferred tax asset during 2012, compared to net
income tax expense of $12.3 million recognized in 2013. This was offset by an $8.2 million increase in net
interest income from 2012 to 2013, a $4.9 million decrease in noninterest expense, and a $16.6 million
decrease in provision for credit losses between the periods.
The $8.2 million, or 15.3%, increase in net interest income was due primarily to growth of the
loan portfolio, as well as lower rates paid on deposits despite overall deposit growth, and lower levels of
non-accrual loans. Our overall cost of funds in 2013 decreased by 16 basis points to 0.73%, compared to
0.89% for 2012 while average yields on earning assets decreased by 9 basis points to 4.44% from 4.53%.
The impact of the low interest rate environment in 2013 was the primary driver of our decreased cost of
funds during 2013 as higher-rate CD’s continue to mature and renew at lower rates. Yield on earning assets
saw a slight decrease primarily due to lower average yields on investments during the year, as well as a
decrease in average interest rate on loans of 21 basis points, from 5.44% for 2012 to 5.23% for 2013.
As of December 31, 2013, 79% of our loan portfolio was tied to the Prime Rate, which has the
potential to re-price daily, and 7% was tied to the London Interbank Offered Rate, or LIBOR, or other
indices, which re-price periodically. Approximately 79% 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 2% of our loan portfolio had interest rate ceilings at
various rates limiting the amount of interest rate increases that can be passed on to the borrower. Our
weighted average maturity of certificates of deposit at December 31, 2013 was 11.2 months.
49
Net Interest Income and Net Interest Margin
Year ended December 31, 2014 compared to 2013
Net interest income before the provision for credit losses for the year ended December 31, 2014
increased $9.0 million, or 14.5%, to $71.0 million from $62.0 million for the year ended December 31,
2013. This increase was due to an increase of $10.6 million in interest income, offset by a $1.6 million
increase in interest expense. Total increase in interest income is primarily due to the higher average loan
balance of $1.44 billion in 2014, an increase from $1.22 billion average balance in 2013, offset by a
decreased average loan interest rate from 5.23% to 5.15% between the periods. This increase is also
partially offset by decreased investment securities interest income due to lower average investment balance
during 2014.
The average yield on our interest-earning assets decreased by 4 basis points to 4.40% in the year
ended December 31, 2014 from 4.44% in the year ended December 31, 2013. The decrease was mainly due
to a lower average yield on loans during the year offset by increased volume of loans, and also partially
offset by higher average yield on securities.
The cost of average interest-bearing liabilities remained constant at 0.73% in the year ended
December 31, 2014 and in the year ended December 31, 2013.
Year ended December 31, 2013 compared to 2012
Net interest income before the provision for credit losses for the year ended December 31, 2013
increased $8.2 million, or 15.3%, to $62.0 million from $53.8 million for the year ended December 31,
2012. This increase was due to a decrease in interest expense of $54,000 and increase in interest income of
$8.2 million. Total increase in interest income is primarily due to the higher average loan balance of $1.22
billion in 2013, an increase from $1.02 billion average balance in 2012, offset by a decreased average loan
interest rate from 5.44% to 5.23% between the periods. This increase is also partially offset by decreased
investment securities interest income due to lower yields during 2013.
The average yield on our interest-earning assets decreased by 9 basis points to 4.44% in the year
ended December 31, 2013 from 4.53% in the year ended December 31, 2012. The decrease was mainly due
to a lower average yield on loans during the year offset by increased volume of loans, as well as a
decreased yield on investments.
The cost of average interest-bearing liabilities decreased to 0.73% in the year ended December 31,
2013 from 0.89% in the year ended December 31, 2012. The decrease was primarily driven by generally
lower rates paid on deposits during 2013 versus 2012.
50
Year Ended December 31, 2014
Interest
Income or
Expense
Average
Yield or
Cost
Average
Balance
Year Ended December 31, 2013
Average
Balance
Interest
Income or
Expense
Average
Yield or
Cost
(Dollars in thousands)
Year Ended December 31, 2012
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
$ 1,438,122
170,794
30,230
197,229
$ 74,080
5,680
140
916
Total interest-earning assets
$ 1,836,375
$ 80,816
Noninterest-earning assets:
Cash and due from banks
Other assets
Total assets
5,185
38,459
$ 1,880,019
5.15%
3.33%
0.46%
0.46%
4.40%
$ 1,217,383
186,084
13,241
161,862
$ 63,718
6,003
55
383
5.23%
3.23%
0.41%
0.24%
$ 1,018,366
155,199
4,344
189,586
$ 55,400
6,141
26
435
5.44%
3.96%
0.60%
0.23%
$ 1,578,570
$ 70,159
4.44%
$ 1,367,495
$ 62,002
4.53%
5,490
49,650
$ 1,633,710
4,556
54,002
$ 1,426,053
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)
$ 155,480
343,726
23,518
735,796
1,258,520
$ 830
1,943
72
6,367
9,212
1
—
20,000
128
9,340
Total interest-bearing liabilities
1,278,521
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
362,189
16,111
1,656,821
223,198
$1,880,019
0.53%
0.57%
0.31%
0.87%
0.73%
0.00%
0.64%
0.73%
$ 102,169
280,108
22,783
650,155
1,055,215
$ 545
1,654
89
5,373
7,661
0.53%
0.59%
0.39%
0.83%
0.73%
$ 54,534
216,916
21,007
581,265
873,722
$ 290
1,456
75
5,868
7,689
1
— 0.00%
—
—
10,630
68
0.64%
3,125
94
1,065,846
7,729
0.73%
876,847
7,783
359,205
11,678
1,436,729
196,981
$1,633,710
362,118
8,831
1,247,796
178,257
$1,426,053
$ 71,476
$ 62,431
$ 54,219
3.67%
3.89%
3.72%
3.95%
0.49%
0.80%
0.38%
1.01%
0.88%
0.00%
3.00%
0.89%
3.65%
3.96%
(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 of $1.6 million, $2.0 million and $1.1 million for the year ended December 31, 2014, 2013
and 2012, respectively, are included in the yield computations.
The decrease in average loan interest rate between 2013 and 2014 is the primary driver of the
decrease in net interest margin to 3.89% for 2014 compared to 3.95% for 2013. 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.
51
Year Ended December 31,
2014 vs. 2013
Net Change
Rate
Volume
Net Change
2013 vs. 2012
Rate
Volume
(In thousands)
Interest income:
Loans and leases
Investment securities(1)
Federal funds sold
Other earning assets
Total interest income
$ 10,362
(323)
85
532
10,656
$ (1,022)
181
7
433
(401)
$ 11,384
(504)
78
99
11,057
$ 8,318
(138)
29
(52)
8,157
$ (2,165)
(1,242)
(10)
13
(3,404)
$ 10,483
1,104
39
(65)
11,561
Interest expense:
Interest-bearing demand
Money market
Savings
Time certificates of
Deposit
Short-term borrowings
Long-term debt
Total interest expense
Net interest income
285
289
(17)
—
(73)
(20)
285
362
3
255
198
14
1
(190)
7
254
388
7
994
—
60
1,611
$ 9,045
246
—
—
153
$ (554)
748
—
60
1,458
$ 9,599
(495)
—
(26)
(54)
$ 8,211
(1,130)
—
(118)
(1,430)
$ (1,974)
635
—
92
1,376
$ 10,185
(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, 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 2014 increased by $100,000 to $3.4 million from $3.3 million
for 2013. The Bank’s net loans and lease charge-offs decreased to a net recovery of $130,000 during 2014
from net charge-offs of $4.4 million in 2013. The provision remained relatively constant between 2014 and
2013 despite net recoveries during 2014, due to loan portfolio growth between the periods. 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 uses a weighted
3-year historical loss measurement period. Also, the Bank utilizes 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 $14.0 million as of December 31, 2013 to $8.6 million as of December 31, 2014. The
ratio of allowance for loan losses to total loans decreased from 1.47% of total loans at December 31, 2013
to 1.43% at December 31, 2014, 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, the provision and overall level of allowance is adequate for losses estimated to be
inherent in the portfolio as of December 31, 2014.
The provision for credit losses for 2013 decreased $16.5 million to $3.3 million from $19.8
million for 2012. The Bank’s net loans and lease charge-offs decreased to $4.4 million during 2013 from
$22.9 million in 2012. The decrease in the provision for credit losses during 2013 was due to a relatively
large provision in 2012 attributed to two significant loan relationships which were written down in the
second quarter of 2012. Non-performing loans decreased from $26.1 million as of December 31, 2012 to
52
$14.0 million as of December 31, 2013, as this area continues to be the primary focus of management. The
ratio of allowance for loan losses to total loans decreased from 1.84% of total loans at December 31, 2012
to 1.47% at December 31, 2013, 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,
2013
2012
2014
$ 1,532
1,104
331
2
652
$ 3,621
(In thousands)
$ 2,101
612
331
(1,957)
916
$ 2,003
$ 1,792
309
329
575
503
$ 3,508
Total noninterest income increased by $1.6 million or 81%, to $3.6 million during 2014 from $2.0
million during 2013. The overall increase in noninterest income was due mainly to a net gain on sale of
investment securities of $2,000 in 2014, compared to a net loss of $2.0 million on sale of investment
securities in 2013. Service charges and fees on deposit accounts decreased by $569,000 year over year,
primarily due to decreased Account Analysis Fees. This decrease in fees was caused by the loss of a small
number of customers who heavily utilized cash management services, resulting in both greater fee income
and higher expenses to the Bank. The overall impact of the loss of these customers on the Bank’s net
income is negligible. The $264,000 decrease in other income between 2013 and 2014 was mostly
attributable to zero gain on loan sale during 2014, compared to $514,000 gain on sale of loans in 2013.
Total noninterest income decreased by $1.5 million or 43%, to $2.0 million during 2013 from $3.5
million during 2012. The overall decrease in noninterest income was due mainly to a net loss of $2.0
million on sale of investment securities in 2013, compared to a net gain of $575,000 on sale of investment
securities in 2012. Service charges and fees on deposit accounts increased by $309,000 year over year,
primarily due to increased Account Analysis Fees. The $413,000 increase in other income between 2012
and 2013 was mostly attributable to loan-related income.
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
53
the portfolio or to re-position the portfolio for various reasons. We plan to continue this practice
judgmentally for the foreseeable 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.
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
Loss (gain) on sale of OREO and related expense
Other expense
Total noninterest expense
Year Ended December 31,
2013
2012
2014
$ 17,945
3,195
420
4,092
1,267
—
(1,120)
4,612
30,411
(In thousands)
$ 16,226
3,206
366
3,597
1,186
7
(1,224)
5,521
28,885
$ 12,523
2,990
294
3,227
1,154
24
8,580
5,386
34,178
Total noninterest expense increased by $1.2 million, or 4%, to $30.4 million during 2014 from
$29.3 million during 2013. Salaries and benefits increased $1.7 million over 2013 levels due to the addition
of business development staff, additional loan production staff, and staffing up for the new branch opened
in Tarzana, CA in January 2015. Professional fees increased by $495,000 to $4.1 million during 2014 from
$3.6 million in 2013 due primarily to an increase in consultant fees between the periods. There were no
other-than-temporary impairment (“OTTI”) credit-related charges in 2014 compared to $7,000 in 2013.
Loss (gain) on sale of OREO and related expense totaled a net gain of $1.1 million in 2014, decreasing
$104,000 from net gain of $1.2 million in 2013. This net gain consisted of $1.8 million net gain on sale of
OREO properties, offset by $545,000 in OREO valuation charges as well as $153,000 in other OREO
related costs. Other expenses were $4.6 million in 2014, a decrease of $909,000 from the $5.5 million in
2013 due mainly to $376,000 recorded for amortization of low income housing investments during 2013,
compared to zero for 2014 due to a change in accounting treatment of the investments.
Total noninterest expense decreased by $4.9 million, or 14%, to $29.3 million during 2013 from
$34.2 million during 2012. Salaries and benefits increased $3.7 million over 2012 levels due to the addition
of business development and Bank Secrecy Act compliance staff, additional loan production staff as well as
staff for the new branch in San Francisco, California, which opened in February 2013, and increased levels
of bonus accruals in line with the bank’s performance. Net occupancy expense increased $216,000 between
the periods primarily as a result of the new branch in San Francisco. Professional fees increased by
$370,000 to $3.6 million during 2013 from $3.2 million in 2012 due primarily to an increase in legal costs
associated with non-performing loans. Net other-than-temporary impairment (“OTTI”) credit-related
charges were $7,000 in 2013 compared to $24,000 in 2012. OREO related expenses totaled a net gain of
$1.2 million in 2013, increasing $9.8 million from net expense of $8.6 million in 2012. This net gain
consisted of $3.8 million net gain on sale of OREO properties, offset by $1.7 million in OREO valuation
charges as well as $1.1 million in other OREO related costs. Other expenses were $5.5 million in 2013, an
increase of $135,000 from the $5.4 million in 2012. Sources of the net increase include valuation write-
downs on loans held for sale of $775,000 during 2013 compared to $387,000 during 2012.
54
Provision for Income Taxes
We accounted for income taxes under the asset and liability method, which requires the
recognition of deferred tax assets and liabilities for the expected future tax consequences of events that
have been included in the financial statements. Under this method, deferred tax assets and liabilities are
determined based on the differences between the financial statements and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a
change in tax rates on deferred tax rates on deferred tax assets and liabilities is recognized in income in the
period that includes the enacted date.
We record net tax assets to the extent 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. We have 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 provision of $16.3 million for income taxes related to the pre-tax income for the
year ended December 31, 2014 at an effective tax rate of 39.8%. In 2013, we recorded a provision for
income taxes of $12.3 million at an effective tax rate of 39.0%. Accounting Standards Codification Topic
740, “Income Taxes,” provides for the recognition of deferred tax assets, such as the future benefit of net
operating loss deductions against future taxable income, if realization of such tax-related assets is more
likely than not. Based upon the weight of available evidence, which includes our historical operating
performance, we reversed the full valuation allowance against our net deferred tax assets in 2012.
As of December 31, 2014 we had federal and state net operating loss (NOL) carryforwards of $0.3
million and $13.9 million, respectively.
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 in 2010 and 2009. 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, the California net operating loss carryover has been significantly impacted by the IRC Sec. 382
limitation. We estimate that of approximately $83.5 million of the California net operating losses as of
December 31, 2014 subject to $69.6 million are expected to expire in 2029 as they will be unutilized as a
result of IRS Sec 382 limitation. This amounts to approximately $4.9 million of deferred tax assets which
would not be realized. The remaining California net operating loss carryforward of the approximately $13.9
million at December 31, 2014, is subject to IRC Sec. 382 annual limitation amount of approximately $1.5
million.
Financial Condition
For the period between December 31, 2014 and December 31, 2013, our assets, loans and deposits
grew at the rate of 16.1%, 20.6% and 16.2%, respectively. Our total assets at December 31, 2014 were
$2.05 billion compared to $1.77 billion at December 31, 2013. Our earning assets at December 31, 2014
totaled $2.01 billion compared to $1.72 billion at December 31, 2013. Total deposits at December 31, 2014
and December 31, 2013 were $1.78 billion and $1.53 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
55
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.
2014
2013
Year Ended December 31,
2012
(in thousands)
2011
2010
Loans and leases (by portfolio and class):
Real Estate - Mini-perm:
Real Estate - Residential
$ 297,579
18.6 %
$ 242,101
18.3 %
$ 177,948
15.7 %
$ 143,344
15.0 %
$ 162,000
17.8 %
Real Estate - Commercial
653,380
40.7
629,438
47.6
494,699
44.8
431,828
45.3
369,640
40.4
Total Real Estate - Mini-perm
$ 950,959
$ 871,539
$ 672,647
$ 575,172
$ 531,640
Real Estate - Construction:
R/E Construction - Residential
R/E Construction - Commercial
48,892
77,593
3.1
4.8
24,997
48,288
1.9
3.7
36,347
38,063
3.2
3.4
39,537
32,405
4.6
3.4
Total Real Estate - Construction
$ 126,485
$ 73,285
$ 74,410
$ 71,942
87,611
33,214
$ 120,825
9.8
3.6
Commercial & Industrial
495,827
30.9
338,680
25.6
324,753
28.7
252,161
26.4
209,520
22.9
30,498
380
1.9
0.0
39,640
287
3.0
0.0
47,413
330
4.2
0.0
49,750
606
5.2
0.1
50,520
349
5.5
0.0
$ 1,604,149 100.0 %
$ 1,323,431
100.0 %
$ 1,119,553
100.0 %
$ 949,631 100.0 %
$ 912,854
100.0 %
Trade Finance
Other Loans
Total gross loans and leases
Less: allowance for loan and
lease losses
(22,974)
Deferred loan and lease fees, net
(2,100)
Total loans excluding loans held
for sale
Loans held for sale
$ 1,579,075
—
Total net loans and leases
$ 1,579,075
(19,494)
(2,562)
$ 1,301,375
6,207
$ 1,307,582
(20,607)
(2,019)
$ 1,096,927
12,150
$ 1,109,077
(23,718)
(1,037)
$ 924,876
3,996
$ 928,872
(32,898)
58
$ 880,014
2,556
$ 882,570
Total gross loans at December 31, 2014, net of loans held for sale, were $1.60 billion, up from the
$1.32 billion as of December 31, 2013. Real estate mini-perm loans which are real estate loans
collateralized by various types of commercial and residential real estate, were up from $871.5 million as of
December 31, 2013 to $951.0 million at December 31, 2014. Real estate construction loans, which are
loans made to developers for the purpose of constructing residential or commercial properties, increased by
$53.2 million from December 31, 2013. Commercial & industrial loans increased $157.1 million and trade
finance loans, which are primarily working capital revolving and term loans for business operations,
decreased by $9.1 million from December 31, 2013 to December 31, 2014. 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, 2013. 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 zero loans sold during 2014, and one loan that was held for sale as of December 31,
2013, transferred to loans held for investment during 2014. During 2013, six loans with a recorded
investment of $26.2 million were sold for a net gain of $514,000.
Our real estate mini-perm loan portfolio increased in 2014 by $79.4 million or 9.1% to $951.0
million from $871.5 million at December 31, 2013. 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, 2013.
Residential real estate loans increased by $55.5 million, or 22.9%, and commercial real estate loans grew
by $23.9 million or 3.8%. Retail-purpose continued to grow during 2014, with an increase of $14.2
million, or 6.8%, land loans decreased by $7.7 million, or 36.3%, and special purpose loans increased $6.8
million, or 3.6%. 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
prior four years: During 2013, mini-perm loans increased by $198.9 million or 29.6% to $871.5 million
56
from $684.8 million at December 31, 2012; during 2012, mini-perm loans increased by $109.6 million or
19.1% to $684.8 million from $575.2 million at December 31, 2011; 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.
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, 2014
At December 31, 2013
Commercial/Office
Retail
Industrial
Residential 1-4
Apartment 4+
Land
Special purpose
Total
$
$
139,662
223,940
91,297
133,144
150,814
13,621
198,481
950,959
8.71%
13.96
5.69
8.30
9.40
0.85
12.37
59.28%
$
$
146,239
209,714
80,265
99,290
129,200
21,368
191,670
877,746
11.00%
15.76
6.03
7.46
9.71
1.60
14.41
65.97%
During 2014, real estate construction loans increased by $53.2 million or 72.6% to $126.5 million
at December 31, 2014 from $73.3 million at December 31, 2013; and decreased by $1.1 million or 1.5% to
$73.3 million at December 31, 2013 from $74.4 million at December 31, 2012; and 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, 2011 from $120.8 million at
December 31, 2010. Real estate construction-residential was one of the hardest hit of our loan segments in
the harsh economic climate of 2008-2010 due to the combination of deterioration in residential real estate
values and lack of available financing.
Commercial & industrial loans outstanding at December 31, 2014 increased by $157.1 million, or
46.4%, to $495.8 million from $338.7 million as of December 31, 2013; increased by $13.9 million, or
4.3%, to $338.7 million from $324.8 million as of December 31, 2012; increased by $72.6 million, or
28.8%, to $324.8 million from $252.2 million as of December 31, 2011; and increased by $42.6 million, or
20.4%, to $252.1 million from $209.5 million at December 31, 2010. Total commercial loan commitments
(including undisbursed amounts) at December 31, 2014 increased $178.9 million or 34.6% to $695.7
million from $516.8 million at December 31, 2013 while the rate of credit utilization increased to 71.3% as
of December 31, 2014 from 65.5% at December 31, 2013. We believe that this increase in utilization is
primarily incidental and secondarily due to the increased need for funding by our business customers as
their business activity grows.
Trade finance loans decreased in 2014 by $9.1 million or 23.1% during 2014, from $39.6 million
to $30.5 million as of December 31, 2014; decreased in 2013 by $7.8 million or 16.4% during 2013, from
$47.4 million to $39.6 million as of December 31, 2013; and decreased by $2.4 million or 4.8% during
2012, from $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.
Other loans, which include installment/consumer debt, leases receivable and other unallocated
loans, are relatively insignificant.
57
Non-Performing Assets
Non-performing assets are comprised of loans on non-accrual status, OREO, and certain Troubled
Debt Restructurings (“TDRs”). TDRs that are on non-accrual status are included in non-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, 2014, loans classified as TDRs totaled $397,000, all of which were performing
as agreed. At December 31, 2013, loans classified as TDRs totaled $8.1 million, of which $7.7 million were
on non-accrual status and $403,000 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:
2014
Year Ended December 31,
2012
2013
2011
2010
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)
$ 8,116
450
8,566
8,811
$ 17,377
$ 14,044
—
14,044
5,602
$ 19,646
$ 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
(Dollars in thousands)
Selected ratios:
NPLs to total gross loans and leases held for investment
NPAs to total assets
______________________________
0.53%
0.85%
1.06%
1.11%
2.31%
3.50%
4.98%
6.49%
11.15%
12.30%
*Non-accrual Troubled Debt Restructurings (TDRs) that are included in non-accrual loans are as follows: 2014 - $0; 2013 - $7,665;
2012 - $7,150; 2011 - $11,482; 2010 - $34,681. 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 $1,564,000, $1,132,000, and
$1,769,000, for 2014, 2013, and 2012, 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, 2014, we had 1 OREO property for $8.8 million as compared 3 OREO
properties for $5.6 million as of December 31, 2013. During 2014, the Bank sold 3 OREO properties at a
net gain of $1.8 million. The following table summarizes the Bank’s OREO as of the periods presented.
58
Foreclosed assets (OREO) as of December 31, 2014 and 2013 were as follows:
Loan Class
(Dollars in thousands)
Real Estate-Mini-Perm:
Residential
Commercial
Real Estate-Construction:
Residential
Commercial
Real Estate-Housing
Commercial & Industrial
Total as of December 31
2014
$
$ —
8,811
#
2
1
— —
— —
— —
— —
3
$ 8,811
2013
$
$ 3,351
2,251
—
—
—
—
$ 5,602
#
—
1
—
—
—
—
1
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.
We had $9.0 million, $14.4 million and $25.0 million of impaired loans or leases at December 31,
2014, 2013, and 2012, respectively. The total allowance for loan and lease losses related to these loans and
leases was $747,000, zero, and $2.3 million at December 31, 2014, 2013 and 2012, respectively. Interest
income recognized on such loans and leases during 2014, 2013 and 2012 was $278,000, $105,000, and
$615,000, respectively. The average recorded investment on impaired loans and leases including loans held
for sale during 2014, 2013 and 2012 was $9.3 million, $22.6 million and $36.2 million, respectively.
59
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
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.
60
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
Total gross loans and leases at end of period *
Average total loans and leases **
Non-performing loans and leases
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
2014
2013
Year Ended December 31,
2012
(Dollars in thousands)
2011
2010
$ 19,494
$ 20,607
$ 23,718
$ 32,898
$ 42,810
436
—
—
4,243
—
4,679
3
—
134
4,672
—
4,809
(130)
3,350
$ 22,974
1,604,149
1,438,122
8,566
(0.01%)
0.23%
1.43%
4,147
11
2,438
1,668
—
8,264
366
—
2,114
1,421
—
3,901
4,363
3,250
$ 19,494
1,329,638
1,217,383
14,044
0.36%
0.27%
1.47%
10,328
197
2,184
10,772
—
23,481
64
—
147
359
—
5,126
—
2,329
8,637
6,672
—
12,600
7,806
16,097
27,095
823
117
173
104
—
289
—
316
28
—
570
22,911
19,800
$ 20,607
1,131,703
1,018,366
26,145
1,217
14,880
5,700
$ 23,718
633
26,462
16,550
$ 32,898
953,627
902,346
47,453
915,410
977,188
101,867
2.25%
1.94%
1.84%
1.65%
0.63%
2.50%
2.71%
1.69%
3.60%
268.19%
138.80%
78.82%
49.98%
32.29%
* Includes loans held for sale of zero as of December 31, 2014, $6,207 as of December 31, 2013, $12,150 as of December 31, 2012,
$3,996 as of December 31, 2011, and $2,556 as of December 30, 2010.
** Includes average loans held for sale balance of $3,409 for the year ended December 31, 2014, $12,495 for the year ended
December 31, 2013, $12,381 for the year ended December 31, 2012, $6,993 for the year ended December 31, 2011, and $8,431 for the
year ended December 31, 2010.
The allowance for loan losses of $23.0 million at December 31, 2014, represented 1.43% of total
loans and 268.19% of non-performing loans. The allowance for loan losses of $19.5 million at December
31, 2013, represented 1.47% of total loans and 138.80% of non-performing loans. The increase in the
coverage ratio for the allowance for loan losses to non-performing loans from 138.80% at December 31,
2013 to 268.19% at December 31, 2014 was primarily a result of decline in non-performing loans in 2014.
Net charge-offs to average loans were (0.01%) for the year ended December 31, 2014 compared to 0.32%
for the year ended December 31, 2013. See “Critical Accounting Policies,” and Note 4 of the “Notes to
Consolidated Financial Statements.”
61
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:
2014
2013
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
At December 31,
2012
2011
2010
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)
Real estate-Mini-perm
Real estate-construction
Commercial
Trade finance
Other
Unallocated
Total
$ 11,375
2,846
6,621
408
6
1,718
$ 22,974
59.3%
7.9
30.9
1.9
0.0
0.0
100%
$ 9,234
1,355
4,264
393
3
4,245
$ 19,494
66.0%
5.5
25.5
3.0
0.0
0.0
100%
$ 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
60.6%
7.6
26.6
5.2
0.0
0.0
100%
$ 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%
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 $100,000 at December
31, 2014 and 2013, 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, following
FASB standards which provide guidance on: identifying whether a market for an asset or liability is
distressed or inactive, determining whether an entity has the intent and ability to hold a security to its
anticipated recovery and whether an investment is other-than-temporarily-impaired. If it is determined that
the impairment is other than temporary for equity securities, the impairment loss is recognized in earnings
equal to the difference between the investment’s cost and its fair value. If it is determined that the
impairment is other-than-temporary for debt securities, the Bank will recognize the credit component of an
other-than-temporary impairment in earnings and the non-credit component in other comprehensive income
62
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 generally 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 one mortgage-
backed security considered held-to-maturity in 2014, with a carrying value of $7.8 million at December 31,
2014. At December 31, 2014, investment securities classified as available-for-sale with a carrying value of
$45.9 million were pledged to secure public deposits.
The carrying value of our held-to-maturity investment securities was $7.8 million at December 31,
2014 and zero at December 31, 2013. The carrying value of our available-for-sale investment securities at
December 31, 2014 totaled $150.5 million compared to $142.7 million at December 31, 2013. The increase
was primarily due to purchases of asset-backed, mortgage-backed, and corporate securities during the year
and increases in the securities’ market value, offset by principal paydowns of securities during the year.
The carrying value of our portfolio of available-for-sale investment securities at December 31,
2014, 2013, and 2012 was as follows:
Mutual fund
Asset-backed securities
Corporate notes
U.S. Agency mortgage-backed securities
Collateralized mortgage obligations
Municipal securities
U.S. Agency principal-only strip securities
Collateralized debt obligations
Estimated Fair Value
At December 31,
2013
2014
(In thousands)
$ 4,863
5,954
58,422
41,315
7,739
28,722
3,524
—
$ 4,840
—
51,075
51,342
9,858
21,049
4,506
—
2012
$ 4,973
—
50,981
96,924
24,660
25,811
5,846
1,547
Total securities available-for-sale
$
150,539
$ 142,670
$ 210,742
63
The following table shows the maturities of available-for-sale investment securities at December
31, 2014, and the weighted average yields of such securities. The table does not consider the impact of
prepayments on the maturities:
At December 31, 2014
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
Asset-backed securities
—
Corporate notes
—
U.S. Agency principal-
only strips
U. S. Agency mortgage-
backed securities
Municipal securities
Collateralized mortgage
obligations
—
—
—
—
—
—
—
—
—
—
—
—
—
—
5,954
14,476
5.12
35,004
3.78
8,942
0.96
4.38
5,954
58,422
—
—
—
—
3,524
2.18
3,524
940
4.54
1,058
—
—
—
948
3.83
—
3.85
—
—
—
39,317
28,722
6,791
4,863
1.69
6.47
1.21
1.05
41,315
28,722
7,739
4,863
0.96
4.20
2.18
1.81
6.47
1.53
1.05
Mutual Fund
—
—
—
— —
Total securities
available-for-sale
$ —
—%
$ 16,364
5.01%
$ 36,062
3.78%
$ 98,113
3.36%
$150,539
3.56%
Management recognized credit-related OTTI of $7,000 for three held-to-maturity CDO securities
sold during 2013, based on the guidance of the Investments – Debt and Equity Securities Topic of FASB
ASC. There was no credit-related OTTI recognized during the year ended December 31, 2014.
As of December 31, 2014, the Bank owned the securities of 2 corporate issuers where the
amortized cost exceeded fair value, both of which had been in an unrealized loss position for greater than
12 months. The total amortized cost of these securities was $5.6 million and their fair value was $4.9
million. Management performed an analysis on 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 both
corporate securities to be temporarily impaired. The Bank had recorded no credit-related OTTI charges on
issuers’ securities during 2014, and also had zero OTTI charges relating to corporate securities in 2013 and
2012.
As of December 31, 2014, the Bank owned 2 collateralized mortgage obligations (“CMO”) where
the amortized cost exceeded fair value. One of these securities had remained in an unrealized position for
greater than 12 months. The total amortized cost of these securities was $6.80 million and the total fair
value was $6.79 million. Management determined that the CMO securities were not other-than-temporarily
impaired as of December 31, 2014. This determination was made based on several factors such as debt
rating of the securities, amount of credit protection, the Bank’s intent and ability to hold the securities until
a recovery in value and the determination that it is not more likely than not that the Bank will be required to
sell the securities prior to recovery of amortized cost basis.
As of December 31, 2014, the Bank owned 3 mortgage-backed securities (“MBS”) where the
amortized cost exceeded fair value. Two of these securities had remained in an unrealized position for
greater than 12 months. The total amortized cost of these securities was $9.5 million and the total fair value
was $9.3 million. Management determined that the MBS were not other-than-temporarily impaired as of
December 31, 2014. This determination was made based on several factors such as debt rating of the
securities, amount of credit protection, the Bank’s intent and ability to hold the securities until a recovery in
value and the determination that it is not more likely than not that the Bank will be required to sell the
securities prior to recovery of amortized cost basis.
As of December 31, 2014, the Bank owned 2 asset-backed securities (“ABS”) where the amortized
cost exceeded fair value. These securities had remained in an unrealized position for less than 12 months.
The total amortized cost of these securities was $6.2 million and the total fair value was $6.0 million.
64
Management determined that the ABS were not other-than-temporarily impaired as of December 31, 2014.
This determination was made based on several factors such as debt rating of the securities, amount of credit
protection, the Bank’s intent and ability to hold the securities until a recovery in value and the
determination that it is not more likely than not that the Bank will be required to sell the securities prior to
recovery of amortized cost basis.
The Bank owns 32 municipal investment securities. Each of these securities carries an investment-
grade rating. As of December 31, 2014, one of these issues was in an unrealized loss position. The
amortized cost of this security was $340,000 and the fair value was $335,000. Management determined that
none of the municipal securities was other-than-temporarily impaired as of December 31, 2014. This
determination was made based on several factors such as the Bank’s intent and ability to hold the securities
until a recovery in value and the determination that it is not more likely than not that the Bank will be
required to sell the securities prior to recovery of amortized cost basis. In addition, management reviews
all of the ratings on the municipal investment securities, recent ratings changes, as well as the length of
time that the security has been impaired to determine whether the security is other than temporary impaired.
At December 31, 2014, the Bank held one U.S. Agency-backed principal-only (PO) strip security
with an amortized cost of $3.6 million and a fair value of $3.5 million. Based on factors including 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, management determined that the security was not other-than-temporarily impaired as of December
31, 2014.
At December 31, 2014, there were a total of 5 and 6 investment securities that were in an
unrealized loss position for less than 12 months and for 12 months or greater, respectively. Temporary
impairments related to corporate notes, mortgage-backed securities, and municipal securities are primarily
attributable to declining market prices caused by lack of trading liquidity in these instruments and in the
case of corporate notes, resulted from increases in credit spreads between U.S. Treasuries and corporate
bonds subsequent to the date that these securities were purchased. None of the securities in the Bank’s
investment portfolio rely on an insurance wrap as a credit enhancement. Management believes that it is not
probable that the Bank will not receive all amounts due under the contractual terms of these securities. If
economic conditions worsen, or if the financial condition of specific issuers within these portfolios
deteriorates, then the Bank could record OTTI charges in 2015 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 $1.78 billion at December 31, 2014 compared to $1.53 billion at December
31, 2013. Noninterest-bearing demand deposits increased $104.9 million or 31.0%. This increase was due
mainly to an increased focus on business customers and commercial and industrial loan relationships as the
Bank typically requires businesses to have their primary operating accounts at Preferred Bank. The ratio of
noninterest-bearing deposits to total deposits was 25.0% at December 31, 2014 and 22.1% at December 31,
2013. 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 $55.0 million or 11.2%, and time deposits decreased
$87.1 million or 12.5%. 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.
65
The following table shows the average amount and average rate paid on the categories of deposits
for each of the periods indicated:
2014
Average
Balance
Average
Rate
Year Ended December 31,
2013
Average
Average
Rate
Balance
(Dollars in thousands)
2012
Average
Balance
Average
Rate
$ 362,189
0.00%
$ 359,205
0.00%
$ 362,118
0.00%
155,480
343,726
23,518
735,796
0.53
0.57
0.31
0.87
102,169
280,108
22,783
650,155
0.52
0.60
0.39
0.83
54,534
216,916
21,007
581,265
0.53
0.67
0.36
1.01
Noninterest-bearing
deposits
Interest-bearing demand
Money market
Savings
Time certificates of
deposit
Total
$ 1,620,709
0.57%
$ 1,414,420
0.54%
$ 1,235,840
0.62%
Average total deposits increased in 2014. The increase in average total deposits for 2014 was
primarily driven by increases of $85.6 million in average time certificates of deposit, $63.6 million in
average money market accounts, and $53.3 million in average interest-bearing demand between the years.
The largest single component of our deposits has been, and in the near term is likely to be, time
certificates of deposit. 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.
The following table shows the maturities of time certificates of deposit over $100,000 at
December 31, 2014 and 2013:
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,
2014
2013
(In thousands)
$ 169,780
163,920
227,422
115,174
$ 676,276
$ 154,706
135,094
178,662
122,259
$ 590,721
Current risk-based regulatory capital standards generally require banks to maintain a ratio of
“core” or “Tier 1” capital (consisting principally of common equity) to risk-weighted assets of at least 4%,
a ratio of Tier 1 capital to adjusted total assets (leverage ratio) of at least 4% and a ratio of total capital
(which includes Tier 1 capital plus certain forms of subordinated debt, a portion of the allowance for loan
and lease losses and preferred stock) to risk-weighted assets of at least 8%. Risk-weighted assets are
calculated by multiplying the balance in each category of assets by a risk factor, which ranges from zero for
cash assets and certain government obligations to 100% for some types of loans, and adding the products
together.
Our goal is to exceed the minimum regulatory capital requirements for well-capitalized
institutions. At December 31, 2014 and 2013, 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.
66
At December 31,
2014
At December 31,
2013
Leverage Ratio
Preferred Bank .......................................................................
Minimum requirement for “Well-Capitalized” institution .....
Tier 1 Risk-Based Capital Ratio
Preferred Bank .......................................................................
Minimum requirement for “Well-Capitalized” institution .....
11.73%
5.00%
12.72%
6.00%
11.80%
5.00%
13.78%
6.00%
Total Risk-Based Capital Ratio
Preferred Bank .......................................................................
Minimum requirement for “Well-Capitalized” institution .....
13.97%
10.00%
15.03%
10.00%
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, 2014:
Amount of Commitment Expiring per Period
Total
Amounts
Committed
Less Than
1 year
1-3 Years
3-5 Years
After 5 Years
(In thousands)
$
13,637
$
3,022
$
5,379
$ 2,833
$ 2,403
Contractual Obligations (1)
Operating Lease Obligations
Commitment to fund investment in
affordable housing partnerships
Total
$
21,788
$
8,975
$
(1) Contractual obligations do not include interest.
8,151
5,953
1,691
7,070
507
—
$ 3,340
$ 2,403
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, 2014:
Amount of off-balance sheet Expiring per Period
Off-balance sheet arrangements
Commitments to extend credit
Commercial letters of credit
Standby letter of credit
Total
Total
Amounts
Committed
$ 420,973
2,721
56,941
$ 480,635
1-3 Years
3-5 Years
After 5
Years
(In thousands)
$ 150,129
—
19,906
$ 170,035
$ 46,212
—
15,000
$ 61,212
$ 1,673
—
—
$ 1,673
Less Than
1 year
$ 222,959
2,721
22,035
$ 247,715
67
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 90.3% at December 31, 2014
compared to 86.9% at December 31, 2013.
Borrowings from the FHLB are another source of funding for our loan and investment activities.
At December 31, 2014, we had $20.0 million of outstanding FLHB borrowings, and we could additionally
borrow up to $118.7 million with collateral of specifically identified loans and securities. In addition, we
have pledged securities with a fair value of $85.5 million at the Federal Reserve Discount Window which
we may borrow from on an overnight basis. We have one uncommitted borrowing line with a financial
institution for $20.0 million. As an additional condition of borrowing from the FHLB, we are required to
purchase FHLB stock. For the year ended December 31, 2014, the Bank was required to maintain the
minimum stock requirement of $6,155,000 of FHLB stock based on the volume of “membership assets” as
defined by the FHLB. At December 31, 2014, the Bank held $6,155,000 in FHLB stock.
We also attempt to maintain a liquidity ratio (liquid assets, including cash and due from banks,
federal funds sold and investment securities not pledged as collateral expressed as a percentage of total
deposits) above approximately 18%. Our liquidity ratios were 28% at December 31, 2014 and 32% at
December 31, 2013. 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. We also perform quarterly liquidity stress tests to
review various adverse scenarios. 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.
68
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, 2014.
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)
$ 405,648
$ 385,901
$ 363,903
$ 339,736
$ 316,668
$ 289,696
$ 257,032
28.10%
21.86%
14.92%
7.28%
— %
(8.52%)
(18.83%)
20.02%
18.94%
17.77%
16.49%
15.26%
13.86%
12.25%
172.60%
164.20%
154.84%
144.55%
134.74%
123.26%
109.36%
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, 2014, 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
69
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.
Sensitivity of Net Interest Income December 31, 2014
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
Adjusted Net
Interest Income
$ 127,014
$ 112,512
98,058
$
84,283
$
75,306
$
74,304
$
74,531
$
Percentage
Change
from Base
Net Interest
Margin
Percent
(Dollars in thousands)
Net Interest
Margin Change
68.66%
49.41%
30.21%
11.92%
— %
(1.33)%
(1.03)%
6.20%
5.50%
4.80%
4.14%
3.70%
3.66%
3.67%
2.50
1.80
1.10
0.44
—
(0.04)
(0.03)
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.
70
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, 2014, 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, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls
and procedures were effective as of December 31, 2014. 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.
71
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, 2014. Management based this assessment on criteria for effective
internal control over financial reporting described in Internal Control-Integrated Framework (1992) 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, 2014. KPMG LLP, an independent registered public accounting firm, has
issued its report on the effectiveness of internal control over financial reporting as of December 31, 2014.
72
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, 2014, based on criteria established in Internal Control – Integrated Framework (1992)
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, 2014, based on criteria established in Internal Control – Integrated
Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission
(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 Preferred Bank and subsidiary
as of December 31, 2014 and 2013, and the related consolidated statements of operations and
comprehensive income, change in shareholders’ equity, and cash flows for each of the years in the three-
year period ended December 31, 2014, and our report dated March 16, 2015 expressed an unqualified
opinion on those consolidated financial statements.
/s/ KPMG LLP
Los Angeles, California
March 16, 2015
73
ITEM 9B. OTHER INFORMATION
None
74
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 2015 Annual Meeting of Shareholders (the “2015 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 2015 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 2015 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 2015 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.
75
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning principal accountant fees and services will appear in the 2015 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.
76
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
Report of Independent Registered Public Accounting Firm ...................................................................................... 79
Consolidated Statements of Financial Condition at December 31, 2014 and 2013 ................................................... 80
Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2014,
2013 and 2012 .................................................................................................................................................... 81
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2014, 2013
and 2012 ............................................................................................................................................................. 82
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012 ......................... 83
Notes to Consolidated Financial Statements ............................................................................................................. 85
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.
77
(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*
11.1*
21.1
23.1
31.1
31.2
32.1
32.2
Exhibit Description
Amended and Restated Articles of Incorporation(1)
Certificate of Determination of the Series A preferred Stock(4)
Amended and Restated Bylaws(1)
Common Stock Certificate(3)
1992 Stock Option Plan(2)
Management Incentive Bonus Plan(2)
Deferred Compensation Plan(2)
Stock Option Gain Deferred Compensation Plan(2)
2004 Equity Incentive Plan(2)
2014 Equity Incentive Plan
Form of Indemnification Agreement for directors and executive officers(2)
Revised Bonus Plan
Deferred Compensation Plan-Deferred Stock Unit Agreement and Rabbi Trust(5)
Retention and Severance Agreement-Li Yu
Subsidiary of Preferred Bank: PB Investment and Consulting, Inc.
Consent of KPMG, LLP to prior filing(1)
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 March 17, 2013.
Incorporated by reference from Registrant’s Registration Statement on Form 10 Amendment No. 1
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 Current Report on Form 8-K filed with the Federal Deposit Insurance
Corporation on June 10, 2010.
Incorporated by reference from Registrant’s Registration Statement on Form 10 filed with the Federal
Deposit Insurance Corporation on January 18, 2005.
Denotes management contract or compensatory plan or arrangement.
78
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 (the Bank) as of December 31, 2014 and 2013, and the related consolidated statements of
operation and comprehensive income, changes in shareholders’ equity, and cash flows for each of the years
in the three-year period ended December 31, 2014. These consolidated financial statements are the
responsibility of the Bank’s management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of Preferred Bank and subsidiary as of December 31, 2014 and 2013, and
the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2014, 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, 2014, based
on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2015
expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial
reporting.
/s/ KPMG LLP
Los Angeles, California
March 16, 2015
79
PREFERRED BANK
Consolidated Statements of Financial Condition
December 31, 2014 and 2013
(In thousands, except for shares)
2014
2013
Assets
Cash and due from banks
Federal funds sold
Cash and cash equivalents
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
Investment in affordable housing
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
Advances from Federal Home Loan Bank
Accrued interest payable
Commitments to fund investment in affordable housing partnership
Other liabilities
Total liabilities
Commitments and Contingencies – Note 9
Shareholders’ equity:
Preferred stock. Authorized 25,000,000 shares; no shares issued and outstanding
at December 31, 2014 and 2013.
Common stock, no par value. Authorized 20,000,000 shares; issued and
outstanding 13,503,458 and 13,280,653 shares at December 31, 2014 and
2013, respectively.
Treasury stock, at cost 154,317 and 153,251 shares at December 31, 2014 and
2013, respectively)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss:
Unrealized gain on securities available-for-sale, net of tax of $1,404 and $102 at
December 31, 2014 and December 31, 2013, respectively.
Total shareholders’ equity
$
215,194
25,000
240,194
7,815
150,539
1,604,149
(22,974)
(2,100)
1,579,075
—
8,811
156
4,132
8,525
17,999
6,497
6,155
21,357
—
2,899
$
226,615
20,000
246,615
—
142,670
1,323,431
(19,494)
(2,562)
1,301,375
6,207
5,602
2,061
4,205
8,290
6,411
5,378
5,296
23,331
1,784
9,734
$
2,054,154
$
1,768,959
$
443,385
525,781
22,211
676,296
108,586
1,776,259
156
20,000
1,419
8,151
13,143
1,819,128
$
338,530
469,976
22,984
590,721
107,103
1,529,314
2,061
20,000
983
—
9,685
1,562,043
—
—
164,023
163,237
(19,115)
(19,115)
29,631
58,552
1,935
235,026
25,974
36,680
140
206,916
Total liabilities and shareholders’ equity
$
2,054,154
$
1,768,959
See accompanying notes to the consolidated financial statements.
80
PREFERRED BANK
Consolidated Statements of Operations and Comprehensive Income
Years Ended December 31, 2014, 2013 and 2012
(In thousands, except share and per share data)
2014
2013
2012
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
FHLB borrowings
Senior debt
Total interest expense
Net interest income before provision for credit losses
Provision for credit losses
Net interest income after provision for credit losses
Noninterest income:
Fees and service charges on deposit accounts
Trade finance income
BOLI income
Net (loss) gain 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
(Gain) loss on sale of OREO and related expense
Other
Total noninterest expense
Income before income taxes
Income tax expense (benefit)
Net income
Income allocated to participating shares
Dividends allocated to participating shares
Net income available to common shareholders
Other comprehensive income:
Unrealized net gain (loss) on securities available-for-sale
Less reclassification adjustments included in net (loss) income
Other comprehensive (loss) income, before tax
Income taxes (benefits) related to items of other comprehensive
income (loss)
Other comprehensive income (loss), net of tax
Comprehensive income
Net income per share
Basic
Diluted
Weighted-average common shares outstanding
Basic
Diluted
Dividends per share
$ 74,080
6,107
140
80,327
$ 63,718
5,953
55
69,726
2,773
72
5,563
804
128
—
9,340
70,987
3,350
67,637
1,532
1,104
331
2
652
3,621
17,945
3,195
420
4,092
1,267
—
—
—
(1,120)
4,612
30,411
40,847
16,255
$ 24,592
(270)
(30)
$ 24,292
3,099
2
3,097
2,199
89
4,557
816
68
—
7,729
61,997
3,250
58,747
2,101
612
331
(1,957)
916
2,003
16,226
3,206
366
3,597
1,186
99
(92)
7
(1,224)
5,897
29,261
31,489
12,290
$ 19,199
(201)
—
$ 18,998
(5,175)
(1,964)
(3,211)
(1,301)
1,796
$ 26,388
1,350
(1,861)
$ 17,338
$ 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
$ 1.83
$ 1.78
$ 1.45
$ 1.42
$ 1.80
$ 1.78
13,290,258
13,620,027
13,116,563
13,364,320
13,050,559
13,247,389
$ 0.20
$ 0.00
$ 0.00
See accompanying notes to the consolidated financial statements.
81
PREFERRED BANK
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2014, 2013 and 2012
(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, 2012
$ —
13,234,608 $162,927 $ (19,115) $ 24,544
$ 17,481
$ 2,001
$ 187,838
Restricted stock awards
Restricted stock award forfeitures
Stock option compensation expense
Stock options exercised
Tax effect of stock plans, net
Net income
Change in Non-credit OTTI in AOCI,
net of taxes
Change in unrealized gain, net of tax
—
—
—
—
—
—
—
11,250
—
—
34,795
—
—
—
—
—
—
310
—
—
—
—
—
—
—
—
—
—
409
—
1,253
—
(232)
—
—
—
—
—
—
—
19,199
—
—
—
—
—
—
—
409
—
1,253
310
(232)
19,199
184
184
—
—
—
—
—
—
(2,045)
(2,045)
Balance as of December 31, 2013
$ —
13,280,653 $163,237 $ (19,115) $ 25,974
$ 36,680
$ 140
$ 206,916
Cash dividend declared ($0.20 per share)
Stock dividend accrued for deferred stock
unit
Low income housing tax credit
cumulative adjustment for ASU 2014-1
Restricted stock awards
Restricted stock award forfeitures
Stock option compensation expense
Stock options exercised
Tax effect of stock plans, net
Net income
—
—
—
—
—
—
—
—
—
—
—
—
135,761
(1,066)
—
88,110
—
—
—
—
—
—
—
—
786
—
—
—
—
—
—
—
—
—
—
—
—
84
—
1,687
—
1,233
—
653
—
(2,698)
(84)
62
—
—
—
—
—
24,592
—
—
—
—
—
—
—
—
—
Change in unrealized gain, net of tax
—
—
—
—
—
—
1,795
(2,698)
—
62
1,687
—
1,233
786
653
24,592
1,795
Balance as of December 31, 2014
$ —
13,503,548 $164,023 $ (19,115) $ 29,631
$ 58,552
$ 1,935
$ 235,026
82
PREFERRED BANK
Consolidated Statements of Cash Flows
Years Ended December 31, 2014, 2013 and 2012
(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
Loss (gain) on sale and call of securities available-for-sale
Amortization of investment securities discounts and premiums, net
Change in investment in affordable housing partnerships
Low income housing tax credit cumulative adjustment for ASU 2014-1
Depreciation and amortization
Net gain on disposal of Bank premises and 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)
Change in income taxes receivable
Net (gain) loss on sale of other real estate owned
Change in BOLI, accrued interest receivable, and other assets
Increase 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
Purchase of investments in affordable housing partnerships
Purchase of FHLB stock
Proceeds from sale of other real estate owned
Proceeds from sale of loans
Proceeds from recoveries of written off loans
Net increase in loans
Proceeds from sale of bank premises and equipment
Purchase of bank premises and equipment
Net cash used in investing activities
Continued on next page
2014
2013
2012
$ 24,592
$ 19,199
$ 23,872
3,350
(462)
(2)
362
1,625
62
484
(2)
—
—
3,573
545
—
673
1,784
(1,767)
5,481
2,545
42,843
1,025
24,249
7,134
(8,961)
(36,396)
(5,060)
(859)
10,123
—
4,809
(291,301)
32
(442)
(295,647)
3,250
544
1,957
1,022
376
—
686
—
7
—
1,430
1,706
(514)
4,994
(1,241)
(3,793)
377
3,138
33,138
988
28,459
28,962
—
(3,697)
(6,787)
(1,014)
24,766
12,355
3,901
(218,040)
—
(508)
(130,615)
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
—
(82,848)
—
(119)
7,945
2,534
570
(199,932)
—
(244)
(230,550)
83
PREFERRED BANK
Consolidated Statements of Cash Flows (continued)
Years Ended December 31, 2014, 2013 and 2012
(In thousands)
Cash flows from financing activities:
Increase in deposits
Increase in other borrowings
Decrease in senior debt
Net proceeds from stock issuance
Cash dividends paid
Proceeds from the exercise of stock options
Net cash provided by 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 (from) loans held for sale
Common stock dividend declared, but not paid
Investment in affordable housing transferred out of other assets
246,945
—
—
—
(1,348)
786
246,383
(6,421)
246,615
240,194
171,787
20,000
—
—
—
310
192,097
94,620
151,995
246,615
$ 8,903
$ 10,150
$ 7,714
$ 8,769
12,111
$ —
$ (5,501)
$ 1,350
$ 9,481
$ —
$ —
$ 21,701
$ —
$ —
239,574
—
(25,996)
—
—
43
213,620
9,530
142,466
151,995
$ 8,107
$ 4,410
$ 6,103
$ 3,050
$ 31,784
$ —
$ —
See accompanying notes to consolidated financial statements.
84
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 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, and the fair value of loans, real estate owned, and securities. In
connection with the determination of the allowance for loan losses, management obtains independent appraisals
for significant properties, evaluates overall loan portfolio characteristics and delinquencies and monitors
economic conditions.
The consolidated financial statements reflect management’s evaluation of subsequent events through the
date of issuance of this Annual Report on Form 10-K.
(b) Principles of Consolidation
The financial statements include the accounts of the Company and its subsidiary, PB Investment and
Consulting, Inc. All intercompany transactions and accounts have been eliminated in consolidation.
(c) Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, and federal funds sold, all of which have
original or purchased maturities of less than 90 days. Included in the Bank’s cash balances are cash reserves
required by FRB in the amounts of zero and $2.3 million as of December 31, 2014 and 2013, respectively.
(d)
Investment Securities
The Bank classifies its debt and equity securities in two categories: held-to-maturity or available-for-sale.
Securities that could be sold in response to changes in interest rates, increased loan demand, liquidity needs,
capital requirements, or other similar factors are classified as securities available-for-sale. These securities are
carried at fair value. Unrealized holding gains or losses, net of the related tax effect, on available-for-sale
securities are excluded from income and are reported as a separate component of shareholders’ equity as other
comprehensive income net of applicable taxes until realized. Realized gains and losses from the sale of
available-for-sale securities are determined on a specific-identification basis. Securities classified as
held-to-maturity are those that the Bank has the positive intent and ability to hold until maturity. These securities
are carried at amortized cost, adjusted for the amortization or accretion of premiums or discounts. At
December 31, 2014 and 2013, there were $7.8 million and zero 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,
85
PREFERRED BANK
Notes to Consolidated Financial Statements
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 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.
(e) Loans and Loan Origination Fees and Costs
Loans that the Bank has both the intent and ability to hold for the foreseeable future, or until maturity, are
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. 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
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
86
PREFERRED BANK
Notes to Consolidated Financial Statements
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.
(f) Allowance for Loan and Lease Losses
The allowance for loan and lease losses is maintained at a level considered adequate to provide for losses
that are probable and reasonably estimable. The adequacy of the allowance for loan losses is based on
management’s evaluation of the collectability of the loan and lease portfolio and that evaluation is based on
historical loss experience and other significant factors.
The 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.
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.
(g) Other Real Estate Owned (OREO)
Other real estate owned, consisting of real estate acquired through foreclosure or other proceedings, is
initially stated at fair value of the property based on appraisal, less estimated selling costs. Any cost in excess of
the fair value at the time of acquisition is accounted for as a loan charge-off and deducted from the allowance for
loan and lease losses. A valuation allowance is established for any subsequent declines in value through a charge
to earnings. Operating expenses of such properties, net of related income, and gains and losses on their disposition
are included in loss on sale of REO and related expense, as appropriate.
87
PREFERRED BANK
Notes to Consolidated Financial Statements
(h) Bank Furniture and Fixtures
Bank furniture and fixtures are stated at cost, less accumulated depreciation and amortization. Depreciation
on furniture and equipment is computed on a straight-line method over the estimated useful lives of the assets,
generally three to five years. Leasehold improvements are capitalized and amortized on the straight-line method
over the estimated useful life of the improvement or the term of lease, whichever is shorter. Buildings are
amortized on the straight-line method over 30 years.
(i)
Investments in Affordable Housing Partnerships
The Bank invests in qualified affordable housing projects (low income housing) and previously accounted
for them under the equity method of accounting. The Bank recognized its share of partnership losses in other
operating expenses with the tax benefits recognized in the income tax provision. The Bank has adopted FASB
ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, which was issued in January
2014 and amends ASC 323 to provide the ability to elect the proportional amortization method with the
amortization expense and tax benefits recognized through the income tax provision. This ASU is effective for the
annual period beginning after December 15, 2014, with early adoption being permitted. The Bank has concluded
that the adoption of this new guidance did not have a material impact on the Bank's consolidated financial
statements.
(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.
(m) Share-Based Compensation
Employees and directors participate in the following stock option compensation plans--the 1992 Stock
Option Plan, Interim Stock Option Plan, the 2004 Equity Incentive Plan, and the 2014 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.
88
PREFERRED BANK
Notes to Consolidated Financial Statements
(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, 2014 then additional losses could be realized in 2015. 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, 2014, approximately 91% of the total dollar amount of the Bank’s real estate loans and
commitments was related to collateral located within California. The performance of these loans may be affected
by weakness or future negative changes in California’s economic and business conditions and the real estate
market of Southern California. Because the Bank’s loan portfolio is concentrated in commercial and residential
real estate, 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 the recent period of economic
slowdown, the Bank 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 to be aggregated in one reportable operating segment.
(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 January 2014, the FASB issued ASU 2014-01, Investments – Equity Method and Joint Ventures (Topic
323): Accounting for Investments in Qualified Affordable Housing Projects, which amends authoritative
guidance related to Low Income Housing Tax Credit investment programs. The amendments permit reporting
entities to make an accounting policy election to account for their investments in qualified affordable housing
projects using the proportional amortization method if certain conditions are met. Under the proportional
amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and
other tax benefits received, and recognizes the net investment performance in the income statement as a
component of income tax expense (benefit). The amendments are effective for fiscal years, and interim periods
within those years, beginning after December 31, 2014 and should be applied retrospectively to all periods
presented. Early adoption is permitted. All of the Bank’s affordable housing investments are within the scope of
89
PREFERRED BANK
Notes to Consolidated Financial Statements
this guidance. The adoption of this guidance did not have a material impact on the Bank’s consolidated financial
statements.
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220), which amends
authoritative guidance related to reporting of amounts reclassified out of Accumulated Other Comprehensive
Income (Loss). The amendment requires all private and public companies to present the effects of significant
income amounts reclassified on the face of the Statement of Operations if the reclassification is required by U.S.
GAAP. The amendment is effective for annual and interim reporting periods beginning after December 15, 2012
for public companies, and does not 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.
The carrying value of our held-to-maturity investment securities was $7.8 million at December 31, 2014 and zero
at December 31, 2013. 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, 2014:
Amortized
cost
December 31, 2014
Gross
unrealized
gains
Gross
unrealized
losses
(In thousands)
Estimated
fair value
Mortgage-backed securities
$ 7,815
$ 54
$ —
$ 7,869
90
PREFERRED BANK
Notes to Consolidated Financial Statements
The tables below show 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, 2014 and 2013.
December 31, 2014
Amortized
cost
Gross
unrealized
gains
$ 6,151
56,240
$ —
2,941
Gross
unrealized
losses
(In thousands)
$ (197)
(759)
Non-credit
other-than-
temporary
impairment
Estimated
fair value
$ —
—
$ 5,954
58,422
40,761
7,738
27,722
3,588
754
15
1,005
—
(200)
(14)
(5)
(64)
5,000
$ 147,200
—
$ 4,715
(137)
$ (1,376)
—
—
—
—
—
$ —
41,315
7,739
28,722
3,524
4,863
$ 150,539
Asset-backed securities
Corporate notes
U.S. Agency mortgage-backed
securities
Collateralized mortgage
obligations
Municipal securities
U.S. Agency principal-only strip
securities
Mutual funds – government bond
funds
Total securities available-for-sale
December 31, 2013
Amortized
cost
Gross
unrealized
gains
$ 49,319
$ 2,831
51,240
9,978
22,332
4,559
656
15
25
—
Gross
unrealized
losses
(In thousands)
$ (1,075)
(554)
(135)
(1,308)
(53)
5,000
$ 142,428
—
$ 3,527
(160)
$ (3,285)
Non-credit
other-than-
temporary
impairment
Estimated
fair value
$ —
$ 51,075
—
—
—
—
—
$ —
51,342
9,858
21,049
4,506
4,840
$ 142,670
Corporate notes
U.S. Agency mortgage-backed
securities
Collateralized mortgage
obligations
Municipal securities
U.S. Agency principal-only strip
securities
Mutual funds – government bond
funds
Total securities available-for-sale
91
PREFERRED BANK
Notes to Consolidated Financial Statements
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, 2014 and 2013 are as follows:
Less than 12 months
December 31, 2014
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
$ —
$ —
$ 4,890
$ (759)
$ 4,890
$ (759)
17
(1)
9,324
(199)
9,341
(200)
2,551
—
—
5,954
3,524
(1)
—
—
(197)
(64)
4,239
335
4,863
—
(13)
(5)
(137)
—
6,790
335
4,863
5,954
—
—
3,524
(14)
(5)
(137)
(197)
(64)
$ 12,046
$ (263)
$ 23,651
$ (1,113)
$ 35,697
$ (1,376)
Less than 12 months
December 31, 2013
12 months or greater
Total
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
Estimated
fair value
Unrealized
losses
(In thousands)
$ 4,895
$ (105)
$ 9,655
$ (970)
$ 14,550
$ (1,075)
4,634
(53)
10,540
(554)
15,174
(607)
8,445
18,897
(135)
(1,308)
—
—
—
—
8,445
18,897
—
—
4,840
(160)
4,840
—
—
—
—
—
(135)
(1,308)
(160)
—
$ 36,871
$ (1,601)
$ 25,035
$ (1,684)
$ 61,906
$ (3,285)
Corporate notes
U.S. Agency mortgage-backed
securities
Collateralized mortgage
obligations
Municipal securities
Mutual funds – government bond
funds
Asset-backed securities
U.S. Agency principal-only strip
securities
Total securities available-for-
sale
Corporate notes
U.S. Agency mortgage-backed
securities
Collateralized mortgage
obligations
Municipal securities
Mutual funds – government bond
funds
U.S. Agency principal-only strip
securities
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, 2014.
As of December 31, 2014, the Bank owned 2 corporate securities where the amortized cost exceeded fair value,
both of which had been in an unrealized loss position for greater than 12 months. The total amortized cost of these
securities was $5.6 million and their fair value was $4.9 million. Management performed an analysis on 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 both corporate securities to be temporarily impaired. The Bank had recorded no credit-related
92
PREFERRED BANK
Notes to Consolidated Financial Statements
OTTI charges on corporate securities during 2014, and also had zero OTTI charges relating to corporate securities in
2013 and 2012.
As of December 31, 2014, the Bank owned 2 collateralized mortgage obligations (“CMO”) where the amortized
cost exceeded fair value. One of these securities had remained in an unrealized position for greater than 12 months. The
total amortized cost of these securities was $6.80 million and the total fair value was $6.79 million. Management
determined that the CMO securities were not other-than-temporarily impaired as of December 31, 2014. This
determination was made based on several factors such as debt rating of the securities, amount of credit protection, the
Bank’s intent and ability to hold the securities until a recovery in value and the determination that it is not more likely
than not that the Bank will be required to sell the securities prior to recovery of amortized cost basis.
As of December 31, 2014, the Bank owned 3 mortgage-backed securities (“MBS”) where the amortized cost
exceeded fair value. Two of these securities had remained in an unrealized position for greater than 12 months. The total
amortized cost of these securities was $9.5 million and the total fair value was $9.3 million. Management determined
that the MBS were not other-than-temporarily impaired as of December 31, 2014. This determination was made based on
several factors such as debt rating of the securities, amount of credit protection, the Bank’s intent and ability to hold the
securities until a recovery in value and the determination that it is not more likely than not that the Bank will be required
to sell the securities prior to recovery of amortized cost basis.
As of December 31, 2014, the Bank owned 2 asset-backed securities (“ABS”) where the amortized cost exceeded
fair value. These securities had remained in an unrealized position for less than 12 months. The total amortized cost of
these securities was $6.2 million and the total fair value was $6.0 million. Management determined that the ABS were
not other-than-temporarily impaired as of December 31, 2014. This determination was made based on several factors
such as debt rating of the securities, amount of credit protection, the Bank’s intent and ability to hold the securities until
a recovery in value and the determination that it is not more likely than not that the Bank will be required to sell the
securities prior to recovery of amortized cost basis.
The Bank owns 32 municipal investment securities. Each of these securities carries an investment-grade rating. As
of December 31, 2014, one of these issues was in an unrealized loss position. The amortized cost of this security was
$340,000 and the fair value was $335,000. Management determined that none of the municipal securities was other-than-
temporarily impaired as of December 31, 2014. This determination was made based on several factors such as the Bank’s
intent and ability to hold the securities until a recovery in value and the determination that it is not more likely than not
that the Bank will be required to sell the securities prior to recovery of amortized cost basis. In addition, management
reviews all of the ratings on the municipal investment securities, recent ratings changes, as well as the length of time that
the security has been impaired to determine whether the security is other than temporary impaired.
At December 31, 2014, the Bank held one agency-backed principal-only (PO) strip security with an amortized
cost of $3.6 million and a fair value of $3.5 million. Based on factors including 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, management determined that the security was not other-
than-temporarily impaired as of December 31, 2014.
At December 31, 2014, there were a total of 5 and 6 investment securities that were in an unrealized loss position
for less than 12 months and for 12 months or greater, respectively. Temporary impairments related to corporate notes,
mortgage-backed securities, and municipal securities are primarily attributable to declining market prices caused by lack
of trading liquidity in these instruments and in the case of corporate notes, resulted from increases in credit spreads
between U.S. Treasuries and corporate bonds subsequent to the date that these securities were purchased. None of the
securities in the Bank’s investment portfolio rely on an insurance wrap as a credit enhancement. Management believes
that it is not probable that the Bank will not receive all amounts due under the contractual terms of these securities. If
economic conditions worsen, or if the financial condition of specific issuers within these portfolios deteriorates, then the
Bank could record OTTI charges in 2015 on specific investments within these portfolios.
Cash proceeds from sales of securities available-for-sale totaled $7.1 million, $29.0 million and $11.1 million in
2014, 2013, and 2012, respectively. Net realized gains or losses for sales and calls of securities totaled a gain of $2,000,
a loss of $2.0 million, and a gain of $554,000 for the years ended December 31, 2014, 2013, and 2012 respectively. Gain
from mutual funds was $0, $0, and $21,000 for the years ended December 31, 2014, 2013, and 2012, respectively.
93
PREFERRED BANK
Notes to Consolidated Financial Statements
Investment securities having a fair value of approximately $150.0 million and $107.7 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, 2014 and 2013, respectively.
The amortized cost and estimated fair value of securities at December 31, 2014 and 2013, 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.
2014
Available-for-Sale
2013
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
$ —
15,075
34,338
97,787
$ 147,200
$ —
16,364
36,062
98,113
$ 150,539
$ —
7,821
46,568
88,039
$ 142,428
$ —
8,480
48,637
85,553
$ 142,670
The Bank had zero debt securities that have been other-than-temporarily-impaired as of or during the year ended
December 31, 2014. 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, 2013:
Additions for
the amount
related to the
credit loss
for which
OTTI was
not
previously
recognized
Beginning
Balance as of
December 31,
2012
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,
2013
Amounts related to credit losses on
debt securities for which a portion
of OTTI was recognized in OCI
$ 1,641
$ —
$ (1,648)
$ —
$ 7
$ —
$ —
94
PREFERRED BANK
Notes to Consolidated Financial Statements
(3) Loans and Leases and Allowance for Loan and Lease Losses
The loans and leases portfolio as of December 31, 2014 and 2013 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
2014
2013
(In thousands)
$ 950,959
126,485
495,827
30,498
380
1,604,149
$ 871,539
73,285
338,680
39,640
287
1,323,431
(22,974)
(2,100)
1,579,075
—
$ 1,579,075
(19,494)
(2,562)
1,301,375
6,207
$ 1,307,582
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 $8.1 million of non-accrual loans and leases at December 31, 2014 compared to $14.0 million at
December 31, 2013. These loans and leases had interest due, but not recognized, of approximately $1.6 million and $1.1
million in 2014 and 2013, respectively. The Bank had $450,000 and zero in loans past due 90 or more days and still
accruing interest as of December 31, 2014 and December 31, 2013, respectively.
The following tables depict the Bank’s past due loans by class as of December 31, 2014 and 2013:
December 31, 2014
Loan Class:
30-89 Days
Accruing
90+ Days
Still Accruing
Non-accrual
Non-current
(in thousands)
Total Past
Due
Non-accrual
Current
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
Total as of December 31, 2014
$ —
—
—
—
—
—
17
—
—
$ 17
$ —
—
—
—
—
—
450
—
—
$ 450
$ —
6,523
6,523
$ —
6,523
6,523
—
—
—
1,593
—
—
$ 8,116
—
—
—
2,060
—
—
$ 8,583
$ —
—
—
—
—
—
—
—
—
$ —
95
PREFERRED BANK
Notes to Consolidated Financial Statements
December 31, 2013
Loan Class:
30-89 Days
Accruing
90+ Days
Still Accruing
Non-accrual
Non-current
(in thousands)
Total Past
Due
Non-accrual
Current
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, 2013
$ —
—
—
—
—
—
—
—
—
$ —
—
—
—
—
—
—
—
—
$ —
$ —
$ —
$ —
$ —
597
597
3,300
—
3,300
2,482
—
—
$ 6,207
$ 12,586
$ —
597
597
3,300
—
3,300
2,482
—
—
$ 6,207
$ 12,586
$ —
1,458
1,458
—
—
—
—
—
—
$ —
$ 1,458
The following table depicts the Bank’s total non-accrual loans by class for the years ended December 31, 2014
and 2013:
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 non-accrual loans
December 31,
2014
2013
(In thousands)
$ —
6,523
6,523
—
—
—
1,593
—
—
—
$ 8,116
$ —
2,055
2,055
3,300
—
3,300
2,482
—
—
6,207
$ 14,044
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 $397,000 and $403,000 in total performing restructured
loans as of December 31, 2014 and 2013, respectively. Non-performing restructured loans were $0 and $7.7 million at
December 31, 2014 and 2013, respectively. All TDRs are included in the balance of impaired loans.
96
PREFERRED BANK
Notes to Consolidated Financial Statements
There were no loan modifications that qualified as TDRs during the year ended December 31, 2014. The
following table provides information on loans modified as TDRs during the year ended December 31, 2013:
Loans Modified as TDRs During the
Year Ended December 31, 2013
Number of
Contracts
Pre-modification
Outstanding
Recorded Investment
Post-modification
Outstanding
Recorded Investment
(Dollars in thousands)
—
1
—
—
—
—
1
$
$
—
6,573
—
—
—
—
6,573
$
$
—
6,207
—
—
—
—
6,207
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, 2014 real estate mini-perm
commercial TDRs modified with interest only terms totaled $397,000.
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 were zero loans modified as TDRs
that subsequently defaulted during the year ended December 31, 2014. There was one real estate mini-perm residential
TDR with a recorded investment of $120,000, one real estate mini-perm commercial TDR with a recorded investment of
$207,000, and one residential construction TDR with a recorded investment of $550,000 that subsequently defaulted
during the year ended December 31, 2013.
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, 2014, the
allowance for loan losses associated with TDRs was $0 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 $9.0 million and $14.4 million at December 31, 2014 and 2013, respectively. The total allowance
for loan and lease losses related to these loans was $747,000 and zero at December 31, 2014 and 2013, respectively.
Interest income recognized on impaired loans during 2014, 2013 and 2012 was $278,000, $105,000 and $615,000,
respectively. At December 31, 2014, the Bank had $50,000 of commitments to lend additional funds to debtors whose
loans are impaired.
97
PREFERRED BANK
Notes to Consolidated Financial Statements
Impaired loans, disaggregated by loan class and excluding loans held for sale, as of December 31, 2014 and 2013
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
$ —
$ —
$ —
$ —
$ —
$ —
$ —
7,537
7,537
—
—
—
—
—
—
—
—
2,043
1,593
—
—
—
—
6,920
6,920
—
—
—
450
—
—
6,920
6,920
—
—
—
2,043
—
—
—
—
—
—
—
747
—
—
6,947
6,947
—
—
—
2,315
—
—
270
270
—
—
—
8
—
—
2014
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
$ 9,580
$ 1,593
$ 7,370
$ 8,963
$ 747
$ 9,262
$ 278
Unpaid
Principal
Balance
Recorded
Investment
with
allowance
Recorded
Investment
without
allowance
Total
Recorded
investment
(in thousands)
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$ —
$ —
$ —
$ —
$ —
$ —
$ —
3,153
3,153
5,187
—
5,187
2,482
—
—
—
—
—
—
—
—
—
—
2,457
2,457
3,300
—
3,300
2,482
—
—
2,457
2,457
3,300
—
3,300
2,482
—
—
—
—
—
—
—
—
—
—
2,668
2,668
4,422
—
4,422
3,322
—
—
105
105
—
—
—
—
—
—
2013
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
$ 10,822
$ —
$ 8,239
$ 8,239
$ —
$ 10,412
$ 105
During 2014, zero loans were sold. One loan, with a recorded investment of $5.5 million was transferred out of
loans held for sale. Zero loans remained as held for sale as of December 31, 2014. During 2013, loans with a recorded
investment of $26.6 million were sold for a net gain of $514,000. One loan, with a recorded investment of $6.2 million
remained as held for sale as of December 31, 2013.
98
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, 2014. 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.
2014
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) recoveries
$ 1,084
174
—
—
—
$ 8,150
1,538
(4,243)
4,672
429
$ 840
1,401
—
—
—
$ 515
(44)
—
134
134
$ 4,264
2,790
(436)
3
(433)
$ 393 $ 3
15
3
—
—
— —
—
—
$ 4,245
(2,527)
—
—
—
$ 19,494
3,350
(4,679)
4,809
130
Balance at end of period
$ 1,258
$ 10,117
$ 2,241
$ 605
$ 6,621
$ 408 $ 6
$ 1,718
$ 22,974
Period-end amount allocated to:
Loans individually evaluated for
impairment
Loans collectively evaluated for
impairment
$ —
$ —
$ —
$ —
$ 747
$ — $ —
$ —
$ 747
1,258
10,117
2,241
605
5,874
408 6
1,718
22,227
Total
$ 1,258
$ 10,117
$ 2,241
$ 605
$ 6,621
$ 408 $ 6
$ 1,718
$ 22,974
The Bank’s recorded investment in loans as of December 31, 2014 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
$ —
$ 6,920
$ —
$ —
$ 2,043
$ —
$ —
$ 8,963
145,276
798,763
48,892
77,593
493,784
30,498
380
1,595,186
Ending balance
$ 145,276
$ 805,683
$ 48,892
$ 77,593
$ 495,827 $ 30,498
$ 380
$ 1,604,149
99
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, 2013. 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.
2013
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) recoveries
$ 2,062
(1,742)
(138)
902
764
$ 8,911
249
(1,529)
519
(1,010)
$ 1,107
220
(2,438)
1,951
(487)
$ 548
(196)
—
163
163
$ 5,069
2,976
(4,147)
366
(3,781)
(23)
(11)
$ 427 $ 4
(1)
—
— —
—
(11)
$ 2,479
1,766
—
—
—
$ 20,607
3,250
(8,264)
3,901
(4,363)
Balance at end of period
$ 1,084
$ 8,150
$ 840
$ 515
$ 4,264
$ 393 $ 3
$ 4,245
$ 19,494
Period-end amount allocated to:
Loans individually evaluated for
impairment
Loans collectively evaluated for
impairment
$ —
$ —
$ —
$ —
$ —
$ — $ —
$ —
$ —
1,084
8,150
840
515
4,264
393 3
4,245
19,494
Total
$ 1,084
$ 8,150
$ 840
$ 515
$ 4,264
$ 393 $ 3
$ 4,245
$ 19,494
The Bank’s recorded investment in loans as of December 31, 2013 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
$ —
$ 2,458
$ 3,300
$ —
$ 2,483
$ —
$ —
$ 8,241
112,901
756,180
21,380
48,605
336,197
39,640
287
1,315,190
Ending balance
$ 112,901
$ 758,638
$ 24,680
$ 48,605
$ 338,680 $ 39,640
$ 287
$ 1,323,431
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.
100
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, 2014 and 2013. Classified loans include loans in risk grades 6 and 7, which correlate to substandard and doubtful for
risk classification purposes.
2014
Grade:
(In thousands)
Pass
Special Mention
Substandard
Doubtful
Total
2013
Grade:
(In thousands)
Pass
Special Mention
Substandard
Doubtful
Total
Real Estate
Residential
Commercial
Construction
Residential Commercial
Commercial
& Industrial
Trade
Finance
$ 145,276
—
—
—
$ 145,276
$ 798,763
—
6,920
—
$ 805,683
$ 45,895
—
2,997
—
$ 48,892
$ 77,593
—
—
—
$ 77,593
$ 489,347
—
6,480
—
$ 495,827
$ 27,873
—
2,625
—
$ 30,498
Residential
$ 112,901
—
—
—
$ 112,901
Real Estate
Construction
Commercial(1) Residential Commercial
Commercial
& Industrial
Trade
Finance
$ 753,304
2,877
8,664
—
$ 764,845
$ 14,505
—
10,175
—
$ 24,680
$ 48,605
—
—
—
$ 48,605
$ 311,375
19,970
7,335
—
$ 338,680
$ 37,090
—
2,550
—
$ 39,640
Other
$ 380
—
—
—
$ 380
Other
$ 287
—
—
—
$ 287
Total
Loans
$ 1,585,127
—
19,022
—
$ 1,604,149
Total
Loans
$ 1,278,067
22,847
28,724
—
$ 1,329,638
(1) Real Estate – Commercial includes loans held for sale $6,207 with a Substandard rating.
(4) Bank, Premises, Furniture and Fixtures
As of December 31, 2014 and 2013, furniture and fixtures consists of the following:
Land and Building
Leasehold improvements
Furniture and fixtures
Less accumulated depreciation and amortization
2014
2013
(In thousands)
$
$
2,782
6,347
5,227
14,356
(10,224)
4,132
$
$
2,782
6,347
4,880
14,009
(9,804)
4,205
Depreciation and amortization expense was $484,000, $640,000 and $650,000 for the years ended December 31,
2014, 2013 and 2012, respectively. Fixed asset sales during 2014 resulted in proceeds of $32,000 with a net gain of
$2,000 on sale. No fixed assets were sold during 2013 or 2012.
(5) Deposits
Time deposit accounts at December 31, 2014 mature as follows:
Year
2015
2016
2017 & thereafter
101
Maturities of
time deposits
(In thousands)
$
$
635,670
77,409
71,803
784,882
PREFERRED BANK
Notes to Consolidated Financial Statements
At December 31, 2014 and 2013, approximately $45.9 million and $35.2 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 $6,000 and $31,000 at December 31, 2014 and 2013, respectively.
(6)
Income Taxes
The income taxes expense (benefit) for the years ended December 31, 2014, 2013 and 2012 was as follows:
Current income tax (benefit) expense:
Federal
State
2014
2013
(In thousands)
2012
$ 12,183
3,399
15,582
$ 5,597
1,699
7,296
$ 3,517
(732)
2,785
Deferred income tax (benefit) expense:
Federal
State
Income tax (benefit) expense:
(100)
773
673
$ 16,255
3,828
1,166
4,994
$ 12,290
(15,699)
(7,669)
(23,368)
$ (20,583)
At December 31, 2014 and 2013, the current net income tax receivables were zero and $1.8 million, respectively.
102
PREFERRED BANK
Notes to Consolidated Financial Statements
The components of the deferred tax assets and deferred tax liabilities as of December 31, 2014 and 2013 are as
follows:
Deferred tax assets:
Allowance for loan and lease losses
State taxes
Deferred compensation
Bank furniture and fixtures, net
Deferred stock units
Non-qualified stock options
OREO
Net operating loss carryforward
Other
Accrued bonuses
AMT Credits
Gross deferred tax assets
2014
2013
(in thousands)
$ 9,702
1,229
521
905
1,379
2,016
—
1,083
5,013
1,667
1,194
24,709
$ 8,522
626
371
1,375
1,379
939
3,517
1,083
3,614
1,569
2,258
25,253
Deferred tax liabilities:
Unrealized gains on securities available-for-
sale
Deferred loan costs
Discount accretion
FHLB stock
Low income housing tax credit
Other
Gross deferred liabilities
Valuation allowance
Net deferred tax assets
(1,404)
(1,474)
—
(400)
—
(74)
(3,352)
—
$ 21,357
(102)
(736)
(543)
(400)
(72)
(69)
(1,922)
—
$ 23,331
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that
some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in which those temporary differences become
deductible. Management considers the projected future taxable income and tax planning strategies in making this
assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods
in which the deferred tax assets are deductible, management believes it is more likely than not that the Bank will realize
all benefits related to these deductible differences at December 31, 2014.
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
within a three-year period. We determined that such an ownership change occurred as of June 21, 2010 as a result of
stock issuances in 2010 and 2009. 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, the California net operating loss carryover has been significantly
impacted by the IRC Sec. 382 limitation. We estimate that of approximately $83.5 million of the California net operating
losses as of December 31, 2014 subject to $69.6 million are expected to expire in 2029 as they will be unutilized as a
result of IRS Sec 382 limitation. This amounts to approximately $4.9 million of deferred tax assets which would not be
realized. The remaining California net operating loss carryforward of the approximately $13.9 million at December 31,
2014, is subject to IRC Sec. 382 annual limitation amount of approximately $1.5 million.
As of December 31, 2014 and 2013, the Bank has federal net operating loss carryforwards of approximately
$305,000, respectively, which, if unused, will begin to expire in 2030.
103
PREFERRED BANK
Notes to Consolidated Financial Statements
A reconciliation of the income tax expense (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, 2014, 2013 and 2012:
2014
2013
2012
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
Low income housing credits
Other
$ 14,296
2,712
(83)
—
(564)
(106)
$ 16,255
35.0%
6.6
(0.2)
—
(1.4)
(0.2)
39.8%
$ 11,021
1,862
(84)
—
(406)
(103)
$ 12,290
35.0%
5.9
(0.3)
—
(1.3)
(0.3)
39.0%
$ 1,151
(694)
(85)
(20,951)
—
(4)
$(20,583)
35.0%
(21.1)
(2.6)
(637.1)
—
(0.1)
(625.9)%
The 2014 and 2013 effective tax rates of 39.8% and 39.0% respectively differ from the statutory rate primarily as
a result of state taxes, income from bank owned life-insurance and low income housing tax credits. The 2012 effective
tax rate was negative due to the reversal of the Bank’s valuation on its deferred tax asset of $20.1 million.
There were no unrecognized tax benefits for the years ended December 31, 2014 and 2013.
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, 2014 and 2013, the total amount of tax reserve, net of federal tax benefit, was $0 and
$0, respectively, for uncertain tax positions. 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. The Bank is no longer subject to the U.S Federal and California tax examinations by tax
authorities for the years before January 1, 2012 and January 1, 2011, respectively.
(7) Other Real Estate Owned
At December 31, 2014, OREO was comprised of one property compared to 3 properties at December 31, 2013.
During 2014, the Bank sold 3 OREO properties, at a net gain of $1.8 million. These gains are included in Loss (gain) 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, 2014, 2013, and 2012 is as follows:
Balance, beginning of the year
Provision for losses
OREO disposal
Balance, end of the year
2014
$ 7,936
545
(8,481)
$ —
2013
(in thousands)
$ 22,036
1,706
(15,806)
$ 7,936
2012
$ 20,742
4,018
(2,724)
$ 22,036
104
PREFERRED BANK
Notes to Consolidated Financial Statements
The following table details the Bank’s OREO properties by loan class as of December 31, 2014, and 2013, and
2012:
Loan class:
Real estate - Mini-perm
Residential
Commercial
Real estate - Construction
Residential
Commercial
Commercial & Industrial
Trade Finance
Other
Total as of year end
2014
#
$
2013
#
$
2012
#
$
(dollar amounts in thousands)
—
1
$ —
8,811
2
1
$ 3,350
2,252
11
3
$ 15,127
7,829
—
—
—
—
— —
— —
—
—
$ 8,811
1
—
—
—
—
— —
— —
—
—
$ 5,602
3
3,051
2,273
1
1
— —
— —
—
—
$ 28,280
16
(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, 2014, the Bank has
zero outstanding senior debt.
Advances from the Federal Home Loan Bank of San Francisco (FHLBSF) were $20.0 million at both
December 31, 2014 and 2013. All advances are collateralized by commercial or residential real estate loans, FRC
advances or by certain marketable investment securities (SBC). At December 31, 2014, approximately $211.0 million of
the Bank’s real estate loans was pledged as collateral.
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 $85.5 million. The Bank had no borrowing outstanding
through the discount window outstanding as of December 31, 2014 or 2013.
(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, commercial
letters of credit, commitment to fund investments in affordable housing partnerships, operating lease commitments, and
financial guarantees written is limited to the contractual amount of those instruments.
105
PREFERRED BANK
Notes to Consolidated Financial Statements
At December 31, 2014 and 2013, the Bank had commitments to fund loans of $421.0 million and $354.5 million,
respectively. Other financial instruments with off-balance-sheet risk at December 31, 2014 and 2013 are as follows:
Commitments to extend credit
Commercial letters of credit
Standby letters of credit
Commitments to fund investment in
affordable housing partnerships (1)
Total
2014
2013
(In thousands)
$ 420,973
2,721
56,941
$ 354,463
5,764
12,057
—
3,213
$ 488,786
$ 375,497
(1) During 2014, the Bank began recording the commitment to fund investment in affordable housing partnerships as a liability.
Commitment to fund investment in affordable housing partnerships of $8.2 million is included on the balance sheet as of December 31,
2014.
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, 2014, the future total minimum lease payments for the Bank’s
premises are as follows:
Year:
2015
2016
2017
2018
2019
Thereafter
Total lease payment
(In thousands)
$ 2,143
2,058
1,769
1,570
1,184
2,403
$ 11,127
Rental expense was $1.8 million, $1.8 million and $1.3 million for the years ended December 31, 2014, 2013 and
2012, respectively.
(10) Related Party Transactions
Loan and Commitments: The Bank has extended credit to certain directors and officers and companies in which
they have an interest and certain shareholders which beneficially own more than 5% of the Bank’s capital stock. In
management’s opinion, the loans to these related parties are made on substantially the same terms, including interest
rates and collateral, as those made to nonrelated persons.
At December 31, 2014 and 2013, the aggregate loans (including commitments) to related parties were
approximately $4.3 million (of which $303,000 was outstanding) and $6.6 million (of which $0.8 million was
outstanding), respectively. All related party loans were current at December 31, 2014 and 2013.
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PREFERRED BANK
Notes to Consolidated Financial Statements
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
2014
$ 786
—
(483)
$ 303
2013
(In thousands)
$ 834
300
(348)
$ 786
2012
$ 2,092
—
(1,258)
$ 834
Deposits: The amount of deposits from related parties was $8.7 million and $8.3 million at December 31, 2014
and 2013, 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.
As a result of a regulatory examination during the third quarter of 2014, the Memorandum of Understanding
(“MOU”), which was entered into on October 1, 2013, was terminated by the FDIC and the California Department of
Business Oversight (“CDBO”). As such, the Bank is no longer required to, among other things, refrain from paying
dividends and maintain a 10% tier 1 leverage ratio as specified by the MOU.
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, 2014, that the Bank meets all capital adequacy requirements to which it is subject.
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PREFERRED BANK
Notes to Consolidated Financial Statements
The Bank’s actual capital and various regulatory required capital thresholds 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)
$ 255,849
232,954
232,954
13.97% $146,511
12.72%
11.73%
73,255
73,255
> 8.00%
4.00%
4.00%
$ 183,138
109,883
91,569
> 10.00%
6.00%
5.00%
$ 225,373
206,617
206,617
15.03% $119,959
13.78%
11.80%
59,975
59,975
> 8.00%
4.00%
4.00%
$ 149,949
89,964
74,970
> 10.00%
6.00%
5.00%
As of December 31, 2014:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
As of December 31, 2013:
Total risk-based capital
Tier 1 risk-based capital
Leverage ratio
(12) Share-Based Compensation
The Bank remunerates employees and directors through stock compensation plans; the 1992 Stock Option Plan,
Interim Stock Option Plan, the 2004 Equity Incentive Plan, and the 2014 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 vesting term of generally three to five years, for only those options expected to vest. The fair value of stock options
and 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, 2014, 2013 and 2012, the Bank recognized share-based compensation expense of $3.6 million, $2.5
million and $1.1 million, respectively, resulting in the recognition of $369,000, $403,000 and $230,000 in related tax
benefits, respectively.
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 2014, 2013 or
2012.
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 2014, 2013 and 2012.
The total intrinsic value of share options exercised during the year ended December 31, 2014, 2013 and 2012 was
$0, $0, and $0, respectively, from the 1992 Plan and the Interim Plan. For the year ended December 31, 2014, there was
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PREFERRED BANK
Notes to Consolidated Financial Statements
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, 2014 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,
2014, 2013 and 2012 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, 2014, 2013, and 2012:
1992 Plan and Interim Plan
Options outstanding as of December 31, 2011
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2012
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2013
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2014
Number of
Options
51,410
—
—
(2,600)
48,810
—
—
(17,580)
31,230
—
—
(31,230)
—
Options exercisable as of December 31, 2014
—
2004 Equity Incentive Plan
Weighted
Average
Exercise
Price
$ 82.50
—
—
84.89
$ 82.37
—
—
59.84
$ 95.05
—
—
95.05
$ —
$ —
Weighted
Average
Remaining
Contractual
Life
—
—
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
Plan). There are 1,455,330 shares authorized under this plan.
The total intrinsic value of share options exercised during the year ended December 31, 2014, 2013 and 2012 was
$1.3 million, $284,000 and $23,000, respectively. As of December 31, 2014, the total compensation cost not yet
recognized that relates to unvested options granted under the 2004 Plan was $1.4 million with a weighted-average
recognition period of 0.8 years. The Bank recognized tax benefits of $369,000 and $115,000 for the years ended
December 31, 2014 and 2013 under the 2004 Plan.
There were zero options granted during 2014 under the 2004 plan. For the years ended December 31, 2014, 2013
and 2012, the estimated weighted-average fair value per share of options granted under the 2004 Plan were as follows:
2014
N/A
December 31,
2013
$6.97
2012
$4.12
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PREFERRED BANK
Notes to Consolidated Financial Statements
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
2014
December 31,
2013
N/A
N/A
N/A
N/A
0.00%
61.16%
3.6 Yrs.
0.53%
2012
0.00%
70.54%
3.0 Yrs.
0.31%
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. During the years ended December 31, 2012, 2013, and 2014, 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.
The following information under the 2004 Plan is presented for the years ended December 31, 2014, 2013 and
2012:
December 31,
2013
(In thousands)
$ 3,021
534
284
309
2012
$ 1,303
314
23
43
Grant Date Fair Value of Options Granted
Fair Value of Options Vested
Total Intrinsic Value of Options Exercised
Cash Received from Options Exercised
2014
$ —
1,263
1,267
786
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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, 2014, 2013
and 2012.
2004 Plan
Number of
Options
Weighted
Average
Exercise Price
Weighted
Average
Remaining
Contractual
Life
Options outstanding as of December 31, 2011
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2012
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2013
Granted
Exercised
Forfeited or expired
Options outstanding as of December 31, 2014
Options exercisable as of December 31, 2014
171,830
327,500
(5,468)
(37,433)
456,429
433,500
(34,795)
(96,212)
758,922
—
(88,110)
(7,450)
663,362
292,383
$
$
30.41
8.91
7.95
9.97
16.93
15.85
8.89
49.65
12.54
—
8.84
15.34
12.99
$
$ 11.56
$
2.0 years
1.6 years
As of December 31, 2014, the aggregate intrinsic value of options outstanding under the 2004 Plan was $5.7
million. As of December 31, 2014, stock options outstanding under the 2004 Plan were as follows:
Options Outstanding
Options Exercisable
Number of
Outstanding
Options
Weighted
Average
Exercise
Price
Weighted
Average
Remaining
Contractual
Life
Number of
Outstanding
Options
Weighted
Average
Exercise
Price
Weighted
Average
Remaining
Contractual
Life
663,362
—
$ 12.99
—
1.99
—
292,383
—
$ 11.56
—
1.56
—
Exercise Price Range
$0.00 - $24.99
$25.00 and above
2014 Equity Incentive Plan
During the second quarter of 2014, the Bank’s Board of Directors adopted and the Bank’s shareholders approved
a new stock option plan, the 2014 Equity Incentive Plan, (the “2014 Plan”). Similar to the 2004 Plan, the Plan provides
for granting of nonstatutory stock options, and incentive stock options and restricted stock awards (“RSA’s”) to key full-
time employees, officers, and the directors of the Bank. Stock options granted under the 2014 Plan have an exercise price
equal to the fair value of the underlying common stock on the date of grant. Stock options and share awards granted
under the 2014 Plan are generally expected to vest in installments between 20-33% each year, become fully vested after
three to five years, and expire four to ten years from the date of grant. All option and share awards provide for
accelerated vesting if there is a change in control (as defined in the 2014 Plan). There are 2,500,000 shares reserved for
issuance under the 2014 Plan. As of December 31, 2014, there have been no stock options or RSA’s granted under the
2014 Plan.
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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 the 2004 Plan, and the 2014 Plan for the year ended December 31, 2014:
Non-Vested Options outstanding as of December 31, 2013
Granted
Forfeited or expired
Vested
Non-Vested Options outstanding as of December 31, 2014
Restricted Stock Awards
Number
of Shares
609,022
—
(6,500)
(231,543)
370,979
Weighted Average
Grant Date
Fair Value
$
5.93
$ —
6.50
$
5.45
$
6.31
$
The Bank’s 2004 Plan provides for granting of RSAs 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, 2014, the Bank
granted 135,761 RSAs and recognized $2.1 million of compensation expense. The RSAs granted under the 2004 Plan or
the 2014 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 $3.4 million as of December 31, 2014, and will be
recognized over 2.1 years.
The following is a summary of the transactions for non-vested RSAs under the 2004 Plan for the year ended
December 31, 2014:
Non-Vested RSAs as of December 31, 2011
Granted
Forfeited or expired
Vested
Non-Vested RSAs outstanding as of December 31, 2012
Granted
Forfeited or expired
Vested
Non-Vested RSAs outstanding as of December 31, 2013
Granted
Forfeited or expired
Vested
Non-Vested RSAs outstanding as of December 31, 2014
Number
of Shares
217,400
8,600
(416)
(91,917)
133,667
11,400
—
(95,667)
49,400
135,761
(1,066)
(38,684)
145,411
Weighted Average
Grant Date
Fair Value
$
8.49
$ 11.00
8.70
$
8.46
$
8.67
$
$ 19.40
—
$
9.06
$ 10.37
$ 20.94
$ 20.92
7.70
$
$ 20.87
(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, 2014, 2013 and 2012 totaled
$187,000, $210,000 and $198,000, respectively.
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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. For the years ended December 31, 2014 and 2013,
financial objectives required under the Plan were met. Total expense of the plan recorded by the Bank was $4.1 million,
$3.5 million and $1.5 million for 2014, 2013 and 2012, respectively. As of December 31, 2014 and 2013, the total bonus
accrual included in the other liabilities amounted to $4.3 million and $4.4 million, 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, 2014 and 2013, liabilities recorded for the
deferred compensation plan totaled approximately $1.2 million and $882,000, 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, 2014 and 2013, the cash surrender value of the policies totaled $8.5
million and $8.3 million, respectively. During 2014, 2013 and 2012, the income on the insurance policies was $331,000,
$331,000 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.
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Notes to Consolidated Financial Statements
(17) Earnings per Share
The following table summarizes the basic and diluted earnings (loss) per share calculations for the periods
indicated:
2014
2013
(In thousands, except per share data)
2012
Basic earnings per share:
Net income
Less: income and dividends allocated to participating
securities
Net income allocated to common shareholders-basic
Basic weighted average common shares outstanding
Basic earnings per share
Diluted earnings per share:
Net income
Less: income and dividends allocated to participating
securities
Net income allocated to common shareholders-diluted
$ 24,592
$ 19,199
$ 23,872
(300)
$ 24,292
13,290,258
$ 1.83
(201)
$ 18,998
13,116,563
$ 1.45
(323)
$ 23,549
13,050,559
$ 1.80
$ 24,592
$ 19,199
$ 23,872
(300)
$ 24,292
(201)
$ 18,998
(323)
$ 23,549
Basic weighted average common shares outstanding
Effect of dilutive securities – stock options
Diluted weighted average shares outstanding
Diluted earnings per share
13,290,258
329,769
13,620,027
$ 1.78
13,116,563
247,607
13,364,320
$ 1.42
13,050,559
196,829
13,247,390
$ 1.78
Earnings 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 shareholders 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, 2014, 2013 and 2012, there were 15,231, 40,642 and 108,531 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 11, 2015, the Bank opened its new San Francisco branch office. The new branch is located at 18321
Ventura Blvd, Suite 100, Tarzana, California. The Bank received regulatory approval for the branch on August 5, 2014.
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PREFERRED BANK
Notes to Consolidated Financial Statements
(19) Quarterly Financial Data (Unaudited)
The following tables summarize the quarterly unaudited financial data for 2014 and 2013:
Quarterly Financial Data (Unaudited)
Year Ended December 31, 2014
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
Net income
Earnings per share
Basic
Diluted
(In thousands, except per share data)
$ 18,750
2,247
16,503
1,250
1,028
7,832
3,296
$ 5,153
$ 19,294
2,229
17,065
1,100
914
6,623
4,047
$ 6,209
$ 20,462
2,426
18,036
500
928
7,836
4,266
$ 6,362
$ 21,821
2,438
19,383
500
751
8,121
4,645
$ 6,868
$
0.39
$ 0.38
$ 0.46
$ 0.45
$ 0.47
$ 0.46
$ 0.51
$ 0.50
Three months ended
Year Ended December 31, 2013
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
Net income
Earnings per share
Basic
Diluted
(20) Regulatory Matters
(In thousands, except per share data)
$ 16,489
1,830
14,659
—
858
8,841
2,646
$ 4,030
$ 16,243
1,820
14,423
250
718
7,218
3,404
$ 4,269
$ 18,480
1,967
16,513
1,200
213
7,789
2,705
$ 5,032
$ 18,514
2,112
16,402
1,800
214
5,413
3,535
$ 5,868
$ 0.30
$ 0.30
$ 0.32
$ 0.32
$ 0.38
$ 0.37
$ 0.45
$ 0.43
As a result of a regulatory examination during 2014, the Memorandum of Understanding (“MOU”), which was
entered into on October 1, 2013, was terminated by the FDIC and the California Department of Business Oversight
(“CDBO”). The termination of the MOU allows the Bank to declare and pay cash dividends to its shareholders and
establish new branches and offices without prior written approval of the FDIC and CDBO, and removes the 10% tier 1
leverage ratio requirement. Following the lifting of the restriction on dividends, the Bank declared quarterly cash dividends
of $0.10 per share on September 16, 2014 and of $0.10 per share on December 18, 2014. These dividends were paid on
October 20, 2014 and January 20, 2015 respectively. The Bank’s tier 1 leverage ratio was 11.73% as of December 31,
2014.
(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
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PREFERRED BANK
Notes to Consolidated Financial Statements
fair value, Financial Instruments Topic of FASB ASC provides that the fair value of a financial instrument is the amount at
which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or
liquidation sale.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments.
(a)
Cash Due from Banks, Federal Funds Sold and Securities Purchased under Resale Agreements
For cash and short-term instruments whose original or purchased maturity is less than 90 days, the carrying
amount was assumed to be a reasonable estimate of fair value.
(b)
Securities held-to-maturity and Securities available-for-sale
For securities held-to maturity and securities available-for-sale, fair values were based on quoted market prices
obtained from market quotes, a Level 1 measurement. 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
Level 2 measurement, or a discounted cash flow analysis was used based on a market discount rate and adjusted for
pre-payments and defaults, a Level 3 measurement.
(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 FASB ASC 820, Fair Value Measurements and Disclosures. 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 820. 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.
116
PREFERRED BANK
Notes to Consolidated Financial Statements
(e)
Loans held for sale
Loans held for sale are carried at the lower of cost or fair value. Fair value is determined by outstanding
commitments from potential buyers when available, a Level 1 measurement, and otherwise based on current
appraisals adjusted for sales cost estimations, a Level 2 measurement. In certain situations it is possible that Level 3
inputs may be used to value loans held for sale; however, only level 1 methods used for valuation of the loans held
for sale carried by the Bank as of December 31, 2013 there were zero loans held for sale as of December 31, 2014.
(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, a Level 2 measurement.
(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.
117
PREFERRED BANK
Notes to Consolidated Financial Statements
The carrying amount and estimated fair value of assets and liabilities as of December 31, 2014 and 2013 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
Accrued interest receivable
Federal Home Loan Bank stock
Liabilities:
Demand deposits and savings:
Noninterest-bearing
Interest-bearing
Time deposits
FHLB borrowings and Senior Debt
Accrued interest payable
December 31, 2014
Carrying
amount
Estimated
fair value
Level 1
(In thousands)
Level 2
Level 3
$ 240,194
7,815
150,539
$ 240,194
7,869
150,539
$ 240,194
—
4,863
$ —
7,869
145,676
1,579,075
6,497
6,155
1,600,362
6,497
6,155
—
—
—
7,370
6,497
6,155
$ —
—
—
1,592,992
—
—
$ 443,385
547,992
784,882
20,000
1,419
$ 443,385
489,901
782,581
20,000
1,419
$ —
—
—
—
—
$ 443,385
489,901
782,581
20,000
1,419
$ —
—
—
—
—
118
PREFERRED BANK
Notes to Consolidated Financial Statements
Assets:
Cash and cash equivalents
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
Liabilities:
Demand deposits and savings:
Noninterest-bearing
Interest-bearing
Time deposits
FHLB borrowings and Senior Debt
Accrued interest payable
December 31, 2013
Carrying
amount
Estimated
fair value
Level 1
(In thousands)
Level 2
Level 3
$ 246,615
142,670
$ 246,615
142,670
$ 246,615
4,840
$ —
137,830
$ —
—
1,301,375
6,207
5,378
5,296
1,326,216
6,207
5,378
5,296
—
—
—
—
2,665
6,207
5,378
5,296
1,323,551
—
—
—
$ 338,530
492,960
697,824
20,000
983
$ 338,530
441,829
699,329
20,000
983
$ —
—
—
—
—
$ 338,530
441,829
699,329
20,000
983
$ —
—
—
—
—
The fair value estimates do not reflect any premium or discount that could result from offering the instruments for
sale. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts
disclosed. The fair value estimates are dependent upon subjective estimates of market conditions and perceived risks of
financial instruments at a point in time and involve significant uncertainties resulting in variability in estimates with
changes in assumptions.
The Bank adopted ASC Topic 820, Fair Value Measurements and Disclosures, or ASC 820, on January 1, 2008,
and determined the fair values of its financial instruments based on the fair value hierarchy established in ASC 820. ASC
820 defines fair value, establishes a three-level fair value hierarchy based on the quality of inputs used to measure fair
value and expands disclosures about fair value measurements.
The three-level categorizations to measure the fair value of assets and liabilities are as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable prices in active markets for similar assets or liabilities; prices for identical or similar assets or
liabilities in markets that are not active; directly observable market inputs for substantially the full term of the
asset and liability; market inputs that are not directly observable but are derived from or corroborated by
observable market data.
Level 3 - Unobservable inputs based on the Bank’s own judgments about the assumptions that a market participant would
use.
The Bank uses the following methodologies to measure the fair value of its financial assets on a recurring basis:
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.
119
PREFERRED BANK
Notes to Consolidated Financial Statements
Asset-backed securities – The Bank measures fair value of asset-backed securities 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. Agency 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.
U.S. Agency 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.
120
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, 2014:
(In thousands)
Assets
Securities, available-for-sale:
Mutual funds – government bond
funds
Asset-backed securities
Corporate notes
U.S. Agency principal-only strips
U.S. Agency mortgage-backed
securities
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,
2014
$ 4,863
$ —
$
—
$ 4,863
—
—
—
—
5,954
58,422
3,524
41,315
7,739
28,722
$ 145,676
—
—
—
—
—
—
—
$
5,954
58,422
3,524
41,315
7,739
28,722
$ 150,539
Collateralized mortgage obligations
Municipal securities
Total
—
—
$ 4,863
The following table presents the Bank’s hierarchy for its assets and liabilities measured at fair value on a recurring
basis at December 31, 2013:
(In thousands)
Assets
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,
2013
Securities, available-for-sale:
Mutual funds – government bond
funds
Corporate notes
U.S. Agency principal-only strips
U.S. Agency mortgage-backed
securities
Collateralized mortgage obligations
Municipal securities
Total
$ 4,840
$ —
$
—
$ 4,840
—
—
—
—
—
$ 4,840
51,075
4,506
51,342
9,858
21,049
$ 137,830
—
—
—
—
—
—
$
51,075
4,506
51,342
9,858
21,049
$ 142,670
There were no significant transfers in or out of Level 1 and Level 2 fair value measurements during the year ended
December 31, 2014.
121
PREFERRED BANK
Notes to Consolidated Financial Statements
There were zero securities with fair value measurements using significant unobservable inputs (Level 3) during the
year ended December 31, 2014. 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, 2013:
Fair Value Measurements Using Significant Unobservable Inputs(Level 3)
(Dollars in thousands)
Beginning
Balance as of
December 31,
2012
Sale of
Securities
Realized
Gains or
Losses in
Earnings
(Expense)
Unrealized Gains
or Losses in
Other
Comprehensive
Income
Ending
Balance as of
December 31,
2013
$
1,547
$
(1,540)
$
(7)
$
—
$
—
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.
122
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, 2014, and the total losses resulting from these fair value adjustments for
the twelve months ended December 31, 2014:
(In thousands)
Assets
Impaired loans
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, 2014
$ —
—
$ —
—
$ 846
—
$ 846
—
Year Ended
December 31, 2014
Total Losses
$ (747)
—
$ —
$ —
$ 846
$ 846
$ (747)
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, 2013, and the total losses resulting from these fair value adjustments for
the year ended December 31, 2013:
(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, 2013
$ —
—
—
$ —
—
—
$ 3,300
6,207
—
$ 3,300
6,207
—
Year Ended
December 31, 2013
Total Losses
$ (1,707)
(324)
—
$ —
$ —
$ 9,507
$ 9,507
$ (2,031)
123
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, 2014 and 2013.
Fair Value
Valuation Technique
Unobservable Inputs
Range
At December 31, 2014
(Dollars In thousands)
846
Present value of
expected cash flow
Management judgmental loss
estimate
50.0 – 75.0%
Fair Value
Valuation Technique
Unobservable Inputs
Range
At December 31, 2013
(Dollars In thousands)
3,300
Market comparables
Adjustments to appraisal value for
Selling costs; Management
judgment
6.0%
Assets:
Impaired
loans
Assets:
Impaired
loans
124
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 16, 2015
PREFERRED BANK
(Registrant)
By /s/ Li Yu
Li Yu
Chairman of the Board 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
/s/ Gary S. Nunnelly
Gary S. Nunnelly
/s/ Ching-Hsing Kao
Ching-Hsing Kao
/s/ Chih-Wei Wu
Chih-Wei Wu
/s/ Wayne Wu
Wayne Wu
March 16, 2015
March 16, 2015
March 16, 2015
March 16, 2015
March 16, 2015
March 16, 2015
March 16, 2015
March 16, 2015
March 16, 2015
Chairman of the Board and
Chief Executive Officer
(Principal executive officer)
Executive Vice President and
Chief Financial Officer
(Principal financial and accounting officer)
Director
Director
Director
Director
Director
Director
Director
125
INDEX TO 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*
11.1*
21.1
23.1
31.1
31.2
32.1
32.2
Exhibit Description
Amended and Restated Articles of Incorporation(1)
Certificate of Determination of the Series A preferred Stock(4)
Amended and Restated Bylaws(1)
Common Stock Certificate(3)
1992 Stock Option Plan(2)
Management Incentive Bonus Plan(2)
Deferred Compensation Plan(2)
Stock Option Gain Deferred Compensation Plan(2)
2004 Equity Incentive Plan(2)
2014 Equity Incentive Plan
Form of Indemnification Agreement for directors and executive officers(2)
Revised Bonus Plan
Deferred Compensation Plan-Deferred Stock Unit Agreement and Rabbi Trust(5)
Retention and Severance Agreement-Li Yu
Subsidiary of Preferred Bank: PB Investment and Consulting, Inc.
Consent of KPMG, LLP to prior filing(1)
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 March 17, 2013.
Incorporated by reference from Registrant’s Registration Statement on Form 10 Amendment No. 1
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 Current Report on Form 8-K filed with the Federal Deposit Insurance
Corporation on June 10, 2010.
Incorporated by reference from Registrant’s Registration Statement on Form 10 filed with the Federal
Deposit Insurance Corporation on January 18, 2005.
Denotes management contract or compensatory plan or arrangement.
126
Exhibit 21.1
SUBSIDIARIES OF THE REGISTRANT
PB Investment and Consulting, Inc. (PBICI), a California corporation
127
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 16, 2015
/s/ Li Yu
Li Yu
Chairman and Chief Executive Officer
128
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 16, 2015
/s/ Edward J. Czajka
Edward J. Czajka
Executive Vice President and Chief Financial Officer
129
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, 2014 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 16, 2015
/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.
130
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, 2014 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 16, 2015
/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.
131
PREFERRED BANK
MANAGEMENT INCENTIVE
BONUS PLAN
APRIL 17, 2012
Preferred Bank, a banking corporation chartered under the laws of the State of California
(the "Bank"), hereby adopts this Preferred Bank Management Incentive Bonus Plan (the “Plan”).
The purpose of this Plan is to provide incentives to directors, management, and employees of
Preferred Bank such that a portion of their compensation will depend upon the performance of
the Bank. The award of Bonuses under the Plan is dependent upon the Bank achieving a
minimum amount of earnings, generally equivalent to the market interest rate before any bonuses
can be awarded.
ARTICLE I
DEFINITIONS
1.1 General. Whenever the following terms are used in this Plan, they have the
meanings specified below unless the context clearly indicates to the contrary. The masculine
pronoun includes the feminine and neuter, and the singular includes the plural, where the context
so indicates.
1.2 “Bank” shall mean Preferred Bank.
1.3 “Board” shall mean the Board of Directors of the Bank.
1.4 “Bonus” shall mean the amount of bonus payable under this Plan to a Participant in
the amount determined under Article III.
1.5 “Bonus Pool” shall mean the pool of amounts from which bonuses for any given
Plan Year may be paid as set forth in Article II.
1.6 “Code” shall mean the Internal Revenue Code of 1986, as amended.
1.7 “Compensation Committee” shall mean the compensation committee of the
Board.
1.8 “Employee” shall mean any employee (as defined in accordance with the
regulations and revenue rulings then applicable under Section 3401(c) of the Code) of the Bank,
whether such employee is so employed at the time this Plan is adopted or becomes so employed
subsequent to the adoption of this Plan, and includes employees who are directors or officers of
the Bank.
1.9 “Minimum Earnings” shall mean, for any given Plan Year, 150% of the average
one-year United States Treasury Bill auction rate for such Plan Year, multiplied by Stockholders'
Equity.
1.10 “Participant” shall mean an Employee who is eligible to participate in the Bonus
Pool for any given Plan Year as provided for in Section 3.1.
1
1.11 “Plan” shall mean this Preferred Bank Management Incentive Bonus Plan.
1.12 “Plan Year” shall mean the measuring calendar year for which Bonuses are
determined and granted.
1.13 “Pre-Tax Earnings” shall mean for any given Plan Year, the net income of the
Bank before any reduction for a) federal, state or local income taxes or similar taxes measured on
the basis of income (as opposed to gross receipts or property taxes), and b) before any reduction
for the accrual of Bonuses for any Plan Year.
1.14 “Secretary” shall mean the Corporate Secretary of the Bank.
1.15 “Stockholders’ Equity” shall mean the amount of equity reflected on the balance
sheet of the Bank at the beginning of a given Plan Year, excluding any unrealized gain or loss
from securities held by the Bank.
ARTICLE II
ESTABLISHMENT OF BONUS POOL
2.1 Bonus Pool. The Bank shall establish a Bonus Pool from which each Participant
shall become shall be entitled to receive a Bonus as set forth herein. The Bonus Pool for each
Plan Year shall be an amount equal to the sum of the following:
a. 0% of Minimum Earnings
b. 15% of the lesser of: 5% of Shareholder’s equity, OR (Pre-Tax Earnings less
Minimum Earnings less 5% of Stockholders’ Equity)
c. 20% of (Pre-Tax Earnings less Minimum Earnings less 5% of Stockholders’
Equity)
Reduced by amounts equivalent to the sum of FASB 123R accruals for the Plan Year and other
such specified employee expenses determined by the Board in the exercise of its sole and
absolute discretion.
2.2
Payment to Participants. The Bank shall pay to each Participant such
Participant’s Bonus not later than seventy-five calendar days following the end of the Plan Year,
provided that the Bank’s earnings for the Plan Year shall have been released to the public prior
to the payment of any Bonus amounts. All such payments out of the Bonus Pool shall be subject
to all applicable federal, state and local tax withholding requirements.
2
ARTICLE III
ELIGIBILITY AND GRANT BONUS
3.1 Eligibility. An Employee shall be eligible for a Bonus for any given Plan Year,
and thereby a Participant for such Plan Year, only if, and to the extent, the Compensation
Committee shall, in the exercise of its sole and absolute discretion, determine that the Employee
shall be a Participant in the Plan for such Plan Year. The Compensation Committee may, in the
exercise of its sole and absolute discretion, establish, modify or change what, if any, criteria or
conditions are required to be satisfied before a Bonus may be granted or paid to any given
Employee or class of Employees. No Employee shall have any right to, or claim for, any Bonus,
or against any portion of the Bonus Pool, unless and until the Compensation Committee has
awarded such Employee a Bonus and all conditions or criteria established by the Compensation
Committee for the payment of such Bonus shall have been satisfied. An Employee who is
determined eligible for a Bonus for any given Plan Year shall not have any right of eligibility in
the Plan for any other Plan Year except and to the extent determined by the Compensation
Committee in its sole and absolute discretion.
3.2 Granting of Bonuses. Not later than ninety (90) days after the beginning of a
Plan Year, the Compensation Committee shall establish qualitative performance goals for
achievement by Employees and the Bank for such Plan Year. The amount of the Bonus Pool that
shall be payable to Participants for any given Plan Year (the “Total Bonus”) shall be between
seventy percent (70%) and one-hundred percent (100%) of the Bonus Pool, as determined by the
Compensation Committee, in its sole and absolute discretion, based upon its evaluation of the
achievement of the qualitative goals previously established for such Plan Year. The
determination by the Compensation Committee of the Total Bonus payable for any given Plan
Year shall be made not less than forty-five (45) calendar days following the end of the Plan Year,
but not more than within seventy-five calendar days following the end of such Plan Year. For
each Plan Year the Compensation Committee shall allocate to each Participant a portion of the
Total Bonus for such Plan Year in such amount as it shall, in the exercise of its sole and absolute
discretion, determine after taking into account the contribution of the Participant to the
achievement of the performance goals for the Plan Year subject, however, to the following
limitations:
Chairman/President/Chief Executive Officer of the Bank
- No less than twelve percent (12%) nor more than twenty percent (20%) of the
Total Bonus. Notwithstanding any other provision of this Plan, the Bonus
awarded to the Chairman of the Bank will only be payable if he or she is
actively employed by the Bank on a full-time basis on the date of the
determination by the Compensation Committee of the amount of the Total
Bonus for the Plan Year.
Personnel Exempt from the California and Federal Wage and Hour Laws
- Aggregate Bonuses awarded to all such Employees shall be equal to the
remaining amount of the Total Bonus, less the amounts, if any, awarded to
Non-Exempt Personnel.
3
Personnel Not Exempt from the California and Federal Wage and Hour Laws (“Non-
Exempt Personnel”)
- The Compensation Committee reserves the right exercisable in its sole and
absolute discretion to allocate a portion of the Total Bonus for payment to
such Non-Exempt Personnel as such Committee may determine in the
exercise in its sole and absolute discretion.
3.3 Carry-Over Pool Amounts. In the event that the Total Bonus for any Plan Year
shall be less than 100% of the Bonus Pool for such Plan Year, the amount by which the Bonus
Pool exceeds the Total Bonus (the “Carryover Portion”) may be added by the Compensation
Committee to the Bonus Pool for any of the next three (3) succeeding Plan Years, as the
Compensation Committee may determine in the exercise of its sole and absolute and available to
be paid as part of a Total Bonus for such Plan Year. Notwithstanding the foregoing, no
Carryover Portion shall be added to any Bonus Pool for a Plan Year which is more than three (3)
years after the Plan Year for which the Carryover Portion first arose.
3.4
Participation in Determinations. No Employee, or a member of such
Employee’s family, shall participate in any decision determining the amount of a Bonus payable
to such Employee. If the Chairman of the Bank, or a member of his or her family, is a member
of the Compensation Committee, all decisions by the Compensation Committee with respect to
determinations as to the performance criteria applicable, and amount of Bonuses payable, to the
Chairman of the Bank shall be made without the participation of the Chairman of the Bank or
any such family member.
ARTICLE IV
ADMINISTRATION
4.1 Duties and Powers of Compensation Committee. The Compensation
Committee shall conduct the general administration of the Plan in accordance with its provisions.
The Compensation Committee shall have the power to interpret the Plan and to adopt or amend
such rules for the administration, interpretation and application of the Plan as are consistent
therewith and to interpret, amend or revoke any such rules. All decisions of the Compensation
Committee as to the meaning or intent of any of the provisions of the Plan, or of the rules and
regulations made pursuant thereto, and of their application in any case, shall be final, conclusive
and binding on all persons. In its sole and absolute discretion, the Board may at any time and
from time to time exercise any and all rights and duties of the Compensation Committee under
this Plan except with respect to matters required by law to be determined in the sole discretion of
the Compensation Committee.
4.2 Majority Rule. Unless otherwise provided by the Board, the Compensation
Committee shall act by a majority of its members in office. The Committee may act either by
vote at a meeting or by a memorandum or other written instrument signed by a majority of the
members of the Compensation Committee.
4
4.3 Good Faith Actions. No member of the Compensation Committee or of the
Advisory Committee shall be personally liable for any action, determination or interpretation
made in good faith with respect to the Plan or any Bonus. The Bank shall indemnify, defend and
hold harmless each member of the Compensation Committee and Advisory Committee against
any cost or expense (including counsel fees) or liability (including any sum paid in settlement of
a claim with approval of either committee) arising out of any action, omission or determination
relating to the Plan or any Bonus, unless, in either case, such action, omission or determination
was taken or made by such member in bad faith and without reasonable belief that it was in the
best interests of the Bank.
ARTICLE V
OTHER PROVISIONS
5.1 Amendment, Suspension or Termination of the Plan. The Plan may be wholly
or partially amended or otherwise modified, suspended or terminated at any time or from time to
time by the Board or the Compensation Committee and it is anticipated that the Plan will be
reviewed and approved annually by the Board. Neither the amendment, suspension nor
termination of the Plan shall, without the consent of a Participant awarded a Bonus, alter or
impair any rights or obligations to payment of such Bonus. No Bonus may be granted during
any period of suspension nor after termination of the Plan.
5.2 Effect of Plan Upon Other Compensation Plans. Nothing in this Plan shall be
construed to limit the right of the Bank (a) to establish any other forms of incentives or
compensation for employees of the Bank or (b) to provide any compensation bonus otherwise
than under this Plan in connection with any proper corporate purpose.
5.3 Titles. Titles are provided herein for convenience only and are not to serve as a
basis for interpretation or construction of this Plan.
5.4 Governing Law. This Plan and Bonuses awarded hereunder shall be
administered, interpreted and enforced under, and governed by, the internal laws of the State of
California applicable to instruments made and to be performed entirely therein without regard to
conflicts of laws principles thereof.
5.5 Deferred Compensation. The intent of this Plan is not to provide for the
payment of deferred compensation as defined under Code Section 409A. Nevertheless, in the
event that it is determined that any Bonus or any other feature of the Plan results in the Plan
providing for deferred compensation, notwithstanding anything herein that may be interpreted to
the contrary, the Plan shall be interpreted consistently and in conformity with the requirements of
Code Section 409A. And, in such event, to the greatest extent permitted by law, the
requirements of such Code Section 409A, and any Treasury regulations that may be adopted
thereunder, are hereby incorporated by reference and any provision hereof to the contrary shall
be deemed stricken and of no further force or effect. Further, in such event, to the extent any
nonqualified deferred compensation would otherwise be paid to any specified employee, as such
term is defined under Code Section 409A or the Treasury Regulations thereunder as determined
by the Compensation Committee, the amount payable to a specified employee will be held for
six months before paid.
5
PREFERRED BANK
2014 EQUITY INCENTIVE PLAN
(Effective Jf!llft
/
' 2014)
PREFERRED BANK
2014 EQUITY INCENTIVE PLAN
(Effective
-', 2014)
PREFERRED BANK hereby adopts in its entirety the Preferred Bank 2014 Equity
Incentive ("Plan"), as of April 15, 2014 ("Plan Adoption Date"), subject to approval by the
shareholders of Preferred Bank to be obtained within twelve (12) months from the Plan
Adoption Date. Unless otherwise defined, terms with initial capital letters are defined in
Section 2 below.
SECTION 1
BACKGROUND AND PURPOSE
Background. The Plan permits the grant of Nonqualified Stock Options, Incentive
1.1
Stock Options, Stock Appreciation Rights (SARs), Performance Shares, Performance Units,
Deferred Stock Units and Restricted Stock.
Purpose of the Plan. The Plan is intended to attract, motivate and retain the following
1.2
individuals: (a) employees of the Company and its Affiliates; (b) consultants who provide
significant services to the Company and its Affiliates and (c) directors of the Company who are
employees of neither the Company nor any Affiliate. The Plan is also designed to encourage
stock ownership by such individuals, thereby aligning their interests with those of the
Company's shareholders.
SECTION 2
DEFINITIONS
The following words and phrases shall have the following meanings unless a different meaning
is plainly required by the context:
"1934 Act" means the Securities Exchange Act of 1934, as amended. Reference to a
2.1
specific section of the 1934 Act shall include such section, any valid rules or regulations
promulgated under such section, and any comparable provisions of any future legislation, rules
or regulations amending, supplementing or superseding any such section, rule or regulation.
2.2
"Administrator" means the Compensation Committee ofthe Board, unless the Board
appoints itself and/or one or more Committees, and/or one or more executive officers of the
Company designated by the Board to administer the Plan or specific portions thereof; provided,
however, that Awards may not be made by executive officers of the Company; and provided,
further that any Awards or determinations that under Section 162(m) may only be made by
"outside directors" (as that tenn is defined under Treasury Regulation Section 1.162-27(e)(3»
shall only be made by such outside directors.
2.3
"Affiliate" means any corporation or any other entity (including, but not limited to,
Subsidiaries, partnerships and joint ventures) controlling, controlled by, or under common
control with the Company.
2.4
"Applicable Law" means the legal requirements relating to the administration of
Options, SARs, Perfonnance Shares, Perfonnance Units, Deferred Stock Units and Restricted
Stock and similar incentive plans under applicable state corporate and securities laws, the Code,
and applicable rules and regulations promulgated by the NASDAQ or the requirements of any
other stock exchange or quotation system upon which the Shares may then be listed or quoted.
"Award"_means, individually or collectively, a grant under the Plan of Nonqualified
2.5
Stock Options, Incentive Stock Options, SARs, Restricted Stock, Perfonnance Shares,
Perfonnance Units and/or Deferred Stock Units.
"Award Agreement" means the written agreement setting forth the tenns and provisions
2.6
applicable to each Award granted under the Plan, including the Grant Date.
2.7
2.8
"Board" or "Board of Directors" means the Board of Directors of the Company.
"Change in Control" means the occurrence of any of the following events:
(a)
(b)
(c)
(d)
Any "person" (as such tenn is used in Sections 13(d) and 14(d) of the Exchange
Act) becomes the "beneficial owner" (as defined in Rule 13d-3 of the Exchange
Act), directly or indirectly, of securities of the Company representing fifty
percent (50%) or more of the total voting power represented by the Company's
then outstanding voting securities;
The consummation of the sale or disposition by the Company of all or
substantially all of the Company's assets;
The consummation ofa liquidation or dissolution of the Company;
A change in the composition of the Board occurring within a two-year period, as
a result of which fewer than a majority ofthe directors are Incumbent Directors.
"Incumbent Directors" means directors who either (A) are Directors as ofthe
Plan Effective Date, or (B) are elected, or nominated for election, to the Board
with the affinnative votes of at least a majority of the Directors at the time of
such election or nomination (but will not include an individual whose election or
nomination is in connection with an actual or threatened proxy contest relating to
the election of Directors); or
2
(e)
The consummation of a merger or consolidation of the Company with any other
corporation or other business entity, other than a merger or consolidation which
would result in the voting securities of the Company outstanding immediately
prior thereto continuing to represent (either by remaining outstanding or by being
converted into voting securities ofthe surviving entity or its parent) at least fifty
percent (50%) of the total voting power represented by the voting securities of
the Company or such surviving entity or its parent outstanding immediately after
such merger or consolidation.
Notwithstanding the foregoing, with respect to Deferred Stock Units or any other Award
constituting nonqualified deferred compensation subject to the provisions of Code Section
409A, a change in control will not be deemed to have occurred unless the event also satisfies the
definition of a change in the ownership or effective control of a corporation or a change in the
ownership of a substantial portion of the assets of a corporation under Code Section 409A and
Treasury Regulation Section 1.409A-3(i)(5).
2.9
"Code" means the Internal Revenue Code of 1986, as amended. Reference to a specific
section of the Code or regulation thereunder shall include such section or regulation, any valid
regulation promulgated under such section, and any comparable provision of any future
legislation or regulation amending, supplementing or superseding such section or regulation.
2.10
"Committee" means any committee appointed by the Board of Directors to administer
the Plan or any portion thereof that (i) is composed entirely of Independent Directors, and (ii)
has a published committee charter as required under applicable NASDAQ rules.
"Company" means Preferred Bank, a California corporation, or any successor thereto.
2.11
With respect to the definitions of the Performance Goals, the Administrator may determine that
"Company" means Preferred Bank and its consolidated Subsidiaries.
"Consultant" means any consultant, independent contractor or other natural person who
2.12
provides significant services to the Company or its Affiliates, but who is neither an Employee
nor a Director.
"Continuous Status"_ as an Employee, Consultant or Director means that a Participant's
2.13
employment or service relationship with the Company or any Affiliate is not interrupted or
terminated. "Continuous Status as an Employee or Consultant" shall not be considered
interrupted in the following cases: (i) any leave of absence approved by the Company or (ii)
transfers between locations of the Company or between the Company and any Subsidiary or
successor. A leave of absence approved by the Company shall include sick leave, military leave
or any other personal leave approved by an authorized representative of the Company. For
purposes of Incentive Stock Options, no leave of absence may exceed ninety (90) days, unless
reemployment upon expiration of such leave is required by statute or contract. If such
reemployment is not so required, then on the ninety-first (91 s~ day of such leave any Incentive
Stock Option held by the Participant shall cease to be treated as an Incentive Stock Option and
3
shall be treated for tax purposes as a Nonqualified Stock Option.
Director" means the absence of any interruption or termination of service as a Director.
"Continuous Status as a
"Deferred Stock Units" means an Award granted to a Participant that is Restricted
2.14
Stock, Performance Shares or Performance Units and that is paid out on a deferred basis after
such Award has vested as described in Section 10.3.
"Director" means any individual who is a member of the Board of Directors of the
2.15
Company.
2.16
"Disability" means a permanent and total disability within the meaning of Code Section
22(e)(3); provided, however, that in the case of Awards other than Incentive Stock Options, the
Administrator in its discretion may determine whether a permanent and total disability exists in
accordance with uniform and non-discriminatory standards adopted by the Administrator from
time to time; and provided further, that with respect to Deferred Stock Units or any other Award
that constitutes nonqualified deferred compensation subject to Code Section 409A, "Disability"
shall mean only disability within the meaning and determined pursuant to the provisions of
Code Section 409A and Treasury Regulation Section 1.409A-3(i)(4).
"Employee" means any individual who is a common-law employee of the Company or
2.17
of an Affiliate.
"Exercise Price" means the price at which a Share may be purchased by a Participant
2.18
pursuant to the exercise of an Option.
"Fair Market Value" means the market price ofa Share on the relevant date, determined
2.19
by the Committee as follows:
(i)
(ii)
(iii)
If Share was traded on a stock exchange, including NASDAQ on the date in
question, then the Fair Market Value shall be equal to the closing price reported
by the applicable composite transactions report for such date or if there are no
prices reported for such date then the last day that Shares were traded shall be
used; and
If the Share was traded over-the-counter on the date in question and not on any
stock exchange, the Fair Market Value shall be equal to the mean between the
last reported representative bid and asked prices quoted for such date by the
principal automated inter-dealer quotation system on which the Share is quoted
or, if the Share is not quoted on any such system, by the "Pink Sheets" published
by the National Quotation Bureau, Inc.;
Ifnone of the foregoing provisions is applicable, then the Fair Market Value
shall be determined by the Administrator in good faith on such basis as it deems
appropriate and with respect to an Award that constitutes nonqualified deferred
compensation subject to Code Section 409A, or an Award that would not
constitute nonqualified deferred compensation subject to Code Section 409A if a
4
valuation method provided for under the Treasury Regulations under Code
Section 409A is used, the Administrator shall utilize a valuation method or
procedure that complies with Code Section 409A and the Treasury Regulations
thereunder.
In all cases, the determination of Fair Market Value by the Committee shall be conclusive and
binding on all persons.
2.20
"Fiscal Year" means a fiscal year of the Company.
2.21
"Freestanding SAR" means a SAR that is granted independently of any Option.
2.22
"Grant Date" means with respect to an Award, the effective date an Award is granted.
"Incentive Stock Option" means an Option to purchase Shares, which is designated as an
2.23
Incentive Stock Option and is intended to meet the requirements of Code Section 422.
"Independent Director" means a Nonemployee Director who is (i) a "non-employee
2.24
director" within the meaning of Section 16b-3 of the 1934 Act, (ii) "independent" as determined
under Securities and Exchange Commission Rule I OC-a(b)(1) and the applicable rules of the
NASDAQ, and (iii) an "outside director" under Treasury Regulation Section 1.162-27(e)(3), as
any of these definitions may be modified or supplemented from time to time.
"Individual Objectives" means, as to a Participant, the objective and measurable goals
2.25
set by a "management by objectives" process and approved by the Administrator in its
discretion.
2.26
"Misconduct" shall include commission of any act in competition with any activity of
the Company (or any Affiliate) or any act contrary or harmful to the interests of the Company
(or any Affiliate) and shall include, without limitation:
(a)
(b)
(c)
(d)
Conviction of a felony or crime involving moral turpitude or dishonesty;
Violation of Company (or any Affiliate) policies, with or acting against the
interests of the Company (or any Affiliate), including employing or recruiting
any present, former or future employee ofthe Company (or any Affiliate);
Misuse of any confidential, secret, privileged or non-public infonnation relating
to the Company's (or any Affiliate's) business, or
Participating in a hostile takeover attempt ofthe Company or an Affiliate.
The foregoing definition shall not be deemed to be inclusive of all acts or omissions that the
Company (or any Affiliate) may consider as Misconduct for purposes of the Plan.
2.27
''NASDAQ'' means The NASDAQ Stock Market, Inc.
''Nonemployee Director" means a Director who is not employed by the Company or an
2.28
Affiliate.
5
"Nonqualified Stock Option" means an option to purchase Shares that is not or is not
2.29
intended to be an Incentive Stock Option.
2.30
"Option" means an Incentive Stock Option or a Nonqualified Stock Option.
"Participant" means an Employee, Consultant or Nonemployee Director who has an
2.31
outstanding Award.
"Performance Goals" means the goal(s) (or combined goal(s)) determined by the
2.32
Administrator (in its discretion) to be applicable to a Participant with respect to an Award.
Performance Goals need not be the same with respect to all Participants and may be established
separately for the Company as a whole or for its various groups, divisions, subsidiaries, and
may be based on performance in comparison to performance by unrelated businesses specified
by the Administrator. All calculations and financial accounting matters relevant to this Plan
shall be determined in accordance with GAAP, except as otherwise directed by the
Administrator.
The Administrator may, in recognition of unusual or non-recurring items such as acquisition
related activities or changes in applicable accounting rules, provide for one or more equitable
adjustments (based on objective standards) to the Performance Goals to preserve the
Administrator's original intent regarding the Performance Goals at the time of the initial award
grant. It is within the sole discretion of the Administrator to make or not make any such
equitable adjustments.
As detennined by the Administrator, the Perfonnance Goals applicable to an Award may
provide for a targeted level or levels of achievement, including without limitation goals tied to
Individual Objectives and/or the Company's (or a business unit's) revenue, earnings, earnings
per share, pre-tax earnings and net profits, stock price, market share, costs, return on equity,
return on assets, tangible common equity to tangible assets ratio, nonperforming assets to loans
ratio, charge off to loan ratio, efficiency ratio (non-interest expense, divided by total revenue),
asset management, asset quality, credit rating, regulatory audit results, asset growth or budget
achievement, or any other metric that is capable of measurement as determined by the
Administrator.
Any Award or determination by the Administrator that may be required under Code Section
l62(m), shall only be made by persons who are "outside directors" as defined under Treasury
Regulation Section 1.162-27(e)(3), and any persons other than such outside directors shall
recuse themselves and abstain from participation or voting with respect to any such Award or
determination.
2.33
"Performance Shares" mean an Award granted to a Participant pursuant to Section 9 of
the Plan that entitles the Participant to receive a prescribed number of Shares upon achievement
of performance objectives associated with such Award.
2.34
"Performance Unit" means an Award granted to Participant pursuant to Section 9 of the
6
Plan that entitles the Participant to receive a cash payment equal to the value of a prescribed
number of Shares upon achievement of performance objectives associated with such Award.
2.35
"Period of Restriction" means the period during which the transfer of Shares of
Restricted Stock are subject to restrictions that subject the Shares to a substantial risk of
forfeiture. As provided in Section 7, such restrictions may be based on the passage oftime, the
achievement of Performance Goals, or the occurrence of other events as determined by the
Administrator, in its discretion.
"Plan" means this Preferred Bank 2014 Equity Incentive Plan, as set forth this
2.36
instrument and as hereafter amended from time to time.
2.37
"Restricted Stock" means an Award granted to a Participant pursuant to Section 7.
"Retirement" means the termination of employment pursuant to the Company's
2.38
retirement policies for an Employee who has attained the age of sixty-five (65) and whose
Continuous Status as an Employee was not intenupted during the previous five (5) years.
"Rule 16b-3" means Rule 16b-3 promulgated under the 1934 Act, and any future
2.39
regulation amending, supplementing or superseding such regulation.
2.40
"SEC" means the U.S. Securities and Exchange Commission.
"Section 16 Person" means a person who, with respect to the Shares, is subject to
2.41
Section 16 of the 1934 Act.
2.42
"Shares" means the shares of common stock ofthe Company.
"Stock Appreciation Right" or "SAR" means an Award, granted alone or in connection
2.43
with a related Option, that pursuant to Section 6 is designated as a SAR. A SAR gives a
Participant a right to receive an amount equal to the difference between the exercise price of the
Shares on the grant date and the Fair Market Value of the Shares on the exercise date. For
example, assume a Participant is granted 100 SARs at an exercise price of$20 (i.e., 100% of the
Fair Market Value of the underlying Shares on the grant date). When the SARs become
exercisable, the Fair Market Value ofthe underlying Shares is $30 per Share. Therefore, upon
exercise of the SAR, the Participant is entitled to receive $1,000 (l00 Shares x $10 per Share).
"Subsidiary" means any corporation in an unbroken chain of corporations beginning
2.44
with the Company if each of the corporations other than the last corporation in the unbroken
chain then owns stock possessing fifty percent (50%) or more ofthe total combined voting
power of all classes of stock in one of the other corporations in such chain.
2.45
"Tandem SAR" means a SAR that is granted in connection with a related Option, the
exercise of which shall require forfeiture of the right to purchase an equal number of Shares
under the related Option (and when a Share is purchased under the Option, the SAR shall be
canceled to the same extent).
7
SECTION 3
ADMINISTRATION
Authority ofthe Administrator. Subject to the express provisions and limitations set
3.1
forth in this Plan, the Administrator shall be authorized and empowered to do all things
necessary or desirable, in its sole discretion, in connection with the administration of this Plan,
including, without limitation, the following:
(a) To prescribe, amend, and rescind rules and regulations relating to the Plan,
including the forms of Award Agreement and manner of acceptance of an Award,
and to take or approve such further actions as it determines necessary or
appropriate to the administration of the Plan and Awards, such as correcting a
defect or supplying any omission, or reconciling any inconsistency so that the Plan
or any Award Agreement complies with Applicable Law, regulations and listing
requirements and so as to avoid unanticipated consequences or address
unanticipated events (including any temporary closure ofNASDAQ, disruption of
communications or natural catastrophe) deemed by the Administrator to be
inconsistent with the purposes of the Plan or any Award Agreement, provided that
no such action shall be taken absent stockholder approval to the extent required
under Section 11.2;
(b) To determine which Employees, Consultants and Directors are eligible to be
Participants, to which of such persons, if any, Awards shall be granted hereunder
and the timing of any such Awards, and to grant Awards;
(c) To grant Awards to Participants and determine the terms and conditions thereof,
including the number of Shares subject to Awards and the exercise or purchase
price of such Shares and the circumstances under which Awards become
exercisable or vested or are forfeited or expire, which terms may but need not be
conditioned upon the passage of time, continued employment, the satisfaction of
performance criteria, the occurrence of certain events, or other factors;
(d) To adopt such procedures and sub-plans as are necessary or appropriate to permit
participation in the Plan by Employees and Directors who are foreign nationals or
employed outside ofthe United States,
(e) To establish or verify the extent of satisfaction of any performance goals or other
conditions applicable to the grant, issuance, exercisability, vesting and/or ability to
retain any Award;
(f)
To prescribe and amend the terms of the agreements or other documents
evidencing Awards made under this Plan (which need not be identical);
(g) To determine whether, and the extent to which, adjustments are required pursuant
to Section 4.3;
8
(h) To interpret and construe this Plan, any rules and regulations under this Plan and
the tenns and conditions of any Award granted hereunder, and to make exceptions
to any such provisions in good faith and for the benefit of the Company; and
(i)
To make all other detenninations deemed necessary or advisable for the
administration of this Plan.
Effect of Change in Status. The Administrator shall have the discretion to detennine the
3.2
effect upon an Award and upon an individual's status as an employee under the Plan (including
whether a Participant shall be deemed to have experienced a tennination of employment or
other change in status) and upon the vesting, expiration or forfeiture of an Award in the case of
(i) any individual who is employed by an entity that ceases to be an Affiliate of the Company,
(ii) any leave of absence approved by the Company or an Affiliate, (iii) any transfer between
locations of employment with the Company or an Affiliate or between the Company and any
Affiliate or between any Affiliates, (iv) any change in the Participant's status from an employee
to a consultant or member of the Board of Directors, or vice versa, and (v) at the request of the
Company or an Affiliate, any employee who becomes employed by any partnership, joint
venture, corporation or other entity not meeting the requirements of an Affiliate.
3.3
Delegation by the Administrator. The Administrator, in its discretion and on such tenns
and conditions as it may provide, may delegate all or any part of its authority and powers under
the Plan to one or more Directors; provided, however, that the Administrator may not delegate
its authority and powers (a) with respect to Section 16 Persons or (b) in any way which would
either jeopardize the Plan's or an Award's qualification under Code Section 162(m) or Rule
16b-3 or its compliance with Code Section 409A.
Detenninations of the Administrator. All decisions, detenninations and interpretations
3.4
by the Administrator regarding this Plan shall be final and binding on all Participants or other
persons claiming rights under the Plan or any Award. The Administrator shall consider such
factors as it deems relevant to making such decisions, detenninations and interpretations
including, without limitation, the recommendations or advice of any director, officer or
employee of the Company and such attorneys, consultants and accountants as it may select. A
Participant or other holder of an Award may contest a decision or action by the Adminstrator
with respect to such person or Award only on the grounds that such decision or action was
arbitrary or capricious or was unlawful, and any review of such decision or action shall be
limited to detennining whether the Administrator's decision or action was arbitrary or
capricious or was unlawful.
9
SECTION 4
SHARES SUBJECT TO THE PLAN
Number of Shares. Subject to adjustment, as provided in Section 4.3, the total combined
4.1
number of Shares, Performance Shares and Performance Units initially available for issuance
upon grant or exercise of a grant under the Plan shall be two and one half million (2,500,000).
When any Award made under the Plan expires, or is forfeited or cancelled without the delivery
of Shares, such Shares will become available for future Awards under the Plan. Shares granted
under the Plan may be authorized but unissued Shares or, to the extent permitted by applicable
corporate and banking laws, reacquired Shares. Of such total, the number of Shares available
for issuance upon exercise ofIncentive Stock Options is five hundred thousand (500,000).
Lapsed Awards. If an Award is cancelled, terminates, expires, or lapses for any reason
4.2
(with the exception of the tennination ofa Tandem SAR upon exercise of the related Option, or
the termination of a related Option upon exercise of the corresponding Tandem SAR), any
Shares subject to such Award again shall be available to be the subject of an Award.
4.3
Adjustments in Awards and Authorized Shares. Except as provided under Section 4.3.1,
and subject to the limitations of Section 10.6, in the event that any dividend or other distribution
(whether in the form of cash, Shares, other securities, or other property), recapitalization, stock
split, reverse stock split, reorganization, merger, consolidation, split-up, spin-off, combination,
repurchase, or exchange of Shares or other securities ofthe Company, or other change in the
corporate structure of the Company affecting the Shares occurs such that an adjustment is
determined by the Administrator (in its discretion) to be appropriate in order to prevent dilution
or enlargement of the benefits or potential benefits intended to be made available under the
Plan, then the Administrator shall, in such manner as it may deem equitable, adjust the number
and class of Shares which may be delivered under the Plan, the number, class, and price of
Shares subject to outstanding Awards, and the numerical limits of Sections 4.1,8.1 and 10.6.
Notwithstanding the preceding, the number of Shares subject to any Award always shall be a
whole number.
4.3.1
Incentive Stock Options. Except as provided in Sections 4.3.2, any adjustment to
the maximum aggregate number of Shares to be issued through the exercise of Incentive Stock
Options must be approved by shareholders within 12 months before or after the date a
resolution is adopted by the Board of Directors to adjust the maximum aggregate number of
Shares to be issued through the exercise of Incentive Stock Options.
4.3.2
Increase to Reflect Outstanding Shares. Any adjustment described in Section
4.3.1 which merely reflects a change in the outstanding Shares, such as a stock dividend or
stock split, will be effective without shareholder approval.
Repurchase Option. Except to the extent that there would exist an acceleration of
4.4
payment with respect to an Award subject to Code Section 409A, and otherwise to the extent
consistent with the requirements of Code Section 409A, the Administrator may include in the
terms of any Award Agreement that the Company shall have the option to repurchase Shares of
any Participant acquired pursuant to the Award granted under the Plan upon a Participant's
10
Termination of Service. The terms of such repurchase right shall be set forth in the Award
Agreement.
Buy-Out Provision. Except to the extent that there would exist an acceleration of
4.5
payment with respect to an Award subject to Code Section 409A, and otherwise to the extent
consistent with the requirements of Code Section 409A, the Administrator may at any time offer
on behalf of the Company to buy-out, for a payment in cash or Shares, an Award previously
granted, based on such terms and conditions as the Administrator shall establish and
communicate to the Participants at the time such offer is made; provided, however, to the extent
Sections 13(e) and/or 14(e) ofthe 1934 Act and the rules and regulations thereunder are
applicable to any such offer, the Company shall comply with the requirements of such sections;
provided further that any buyout of an Award that the Administrator intends to be
"performance-based compensation" within the meaning of Code Section 162(m) shall not be
made if the Administrator determines that such buyout could cause the Award to fail to be
performance-based compensation or otherwise not in compliance with the limits under Code
Section l62(m) ..
Legal Compliance. Awards and Shares shall not be issued pursuant to the making or
4.6
exercise of an Award unless the exercise of Options and rights and the issuance and delivery of
Shares shall comply with the California Financial Code, as amended, the 1934 Act and other
Applicable Law, and shall be further subject to the approval of counsel for the Company with
respect to such compliance. Any Award made in violation hereof shall be null and void.
Restrictions on Share Transferability. The Administrator may impose such restrictions
4.7
on any Award of Shares or Shares acquired pursuant to the exercise of an Award as it may deem
advisable or appropriate, including, but not limited to, restrictions related to applicable Federal
securities laws, the requirements of any national securities exchange or system upon which
Shares are then listed or traded, and any blue sky or other state securities laws.
Investment Representations. As a condition to the exercise of an Option or other right,
4.8
the Company may require the person exercising such Option or right to represent and warrant at
the time of exercise that the Shares are being acquired only for investment and without any
present intention to sell or distribute such Shares if, in the opinion of counsel for the Company,
such a representation is required.
4.9
Dodd-Frank Clawback. The Administrator shall have full authority to implement any
policies and procedures necessary to comply with Section 10D of the Exchange Act and any
rules promulgated thereunder. Without limiting the foregoing, to the extent necessary to
comply with the Sarbanes-Oxley Act of2002, the Dodd-Frank Wall Street Reform and
Consumer Protection Act or other applicable law, the Administrator may provide in Award
agreements that, in event of a financial restatement that reduces the amount of previously
awarded incentive compensation which would not have been earned had results been properly
reported, outstanding awards will be cancelled and Company may c1awback (i.e., recapture)
realized gains, realized value or Earned Awards arising during such period necessary to comply
with such law.
11
SECTION 5
EMPLOYEE AND CONSULTANT STOCK OPTIONS
The provisions of this Section 5 are applicable only to Options granted to Employees
(including Directors who are also Employees) and Consultants. Such Palticipants shall also be
eligible to receive other types of Awards as set forth in the Plan.
Grant of Options. Subject to the terms and provisions of the Plan, Options may be
5.1
granted to Employees and Consultants at any time and from time to time as determined by the
Administrator in its discretion, provided that only Employees may be granted Incentive Stock
Options. The Administrator may grant Incentive Stock Options, Nonqualified Stock Options, or
a combination thereof, and the Administrator, in its discretion and subject to Sections 4.1 and
10.6, shall determine the number of Shares subject to each Option.
5.2
Award Agreement. Each Option shall be evidenced by an Award Agreement that shall
specify the Exercise Price, the expiration date of the Option, the number of Shares to which the
Option pertains, any conditions to exercise the Option, and such other terms and conditions as
the Administrator, in its discretion, shall determine. The Award Agreement shall also specify
whether the Option is intended to be an Incentive Stock Option or a Nonqualified Stock Option.
Exercise Price. The Administrator shall determine the Exercise Price for each Option
5.3
subject to the provisions of this Section 5.3.
5.3.1 Nonqualified Stock Options. In the case of a Nonqualified Stock Option, the
Exercise Price shall be determined by the Administrator, but in no case shall the per Share
exercise price be less than one hundred percent (100%) ofthe Fair Market Value of a Share on
the Grant Date.
5.3.2
Incentive Stock Options. The grant ofIncentive Stock Options shall be subject
to the following limitations:
(a) The Exercise Price of an Incentive Stock Option shall be not less than one
hundred percent (100%) of the Fair Market Value ofa Share on the Grant Date;
provided, however, that if on the Grant Date, the Employee (together with
persons whose stock ownership is attributed to the Employee pursuant to Code
Section 424(d)) owns stock possessing more than 10% of the total combined
voting power of all classes of stock of the Company or any of its Subsidiaries,
the Exercise Price shall be not less than one hundred and ten percent (110%) of
the Fair Market Value ofa Share on the Grant Date;
(b) Incentive Stock Options may be granted only to persons who are, as of the Grant
Date, Employees of the Company or a Subsidiary, and may not be granted to
Nonemployee Directors or Consultants;
(c) To the extent that the aggregate Fair Market Value of the Shares with respect to
which Incentive Stock Options are exercisable for the first time by the
12
Participant during any calendar year (under all plans of the Company and any
parent or Subsidiary) exceeds $100,000, such Options shall be treated as
Nonqualified Stock Options. For purposes of this Section 5.3.2(c), Incentive
Stock Options shall be taken into account in the order in which they were
granted. The Fair Market Value of the Shares shall be detennined as of the time
the Option with respect to such Shares is granted; and
(d) In the event of a Participant's change of status from Employee to Consultant or
Director, an Incentive Stock Option held by the Participant shall cease to be
treated as an Incentive Stock Option and shall be treated for tax purposes as a
Nonqualified Stock Option three (3) months and one (1) day following such
change of status.
(e) In the event a Participant shall have taken any act, including but not limited to an
early disposition of Shares acquired upon the exercise of an Incentive Stock
Option that would cause such Option to lose its status as an Incentive Stock
Option, such Participant shall immediately notify the Administrator.
5.3.3
Substitute Options. Notwithstanding the provisions of Sections 5.3.1 and 5.3.2,
in the event that the Company or an Affiliate consummates a transaction described in Code
Section 424(a) (e.g., the acquisition of property or stock from an unrelated corporation), persons
who become Employees, Directors or Consultants on account of such transaction may, subject
to satisfying the requirements of Treasury Regulations Section 1.424-1 (a)(5), be granted
Options in substitution for options granted by their former employer. If such substitute Options
are granted, the Administrator, in its discretion and consistent with Section 424(a) of the Code,
shall determine the exercise price of such substitute Options, provided that such exercise price
shall not be less than one hundred percent (100%) of the Fair Market Value ofthe Shares on the
Grant Date.
5.4
Expiration of Options
5.4.1 Expiration Dates. Each Option shall terminate no later than the first to occur of
the following events:
(a) Date in Award Agreement. The date for termination of the Option set forth in
the written Award Agreement; or
(b) Termination of Continuous Status as Employee or Consultant. The last day of
the three (3)-month period following the date the Participant ceases hislher
Continuous Status as an Employee or Consultant (other than termination for a
reason described in subsections (c), (d), (e), (f) or (g) below); or
(c) Misconduct. In the event a Participant's Continuous Status as an Employee or
Consultant terminates because the Participant has performed an act of
Misconduct as determined by the Administrator, all unexercised Options held by
such Participant shall expire immediately upon such determination;
13
(d) Disability. In the event that a Participant's Continuous Status as an Employee or
Consultant terminates as a result of the Participant's Disability, the Participant
may exercise his or her Option at any time within twelve (12) months from the
date of such termination, but only to the extent that the Participant was entitled to
exercise it at the date of such termination (but in no event later than the
expiration ofthe term of such Option as set forth in the Award Agreement). If,
at the date of termination, the Participant is not entitled to exercise his or her
entire Option, the Shares covered by the unexercisable portion of the Option
shall revert to the Plan. If, after termination, the Participant does not exercise his
or her Option within the time specified herein, the Option shall terminate, and
the Shares covered by such Option shall revert to the Plan;
(e) Death. In the event of the death of a Participant, the Option may be exercised at
any time within twenty-four (24) months following the date of death (but in no
event later than the expiration of the term of such Option as set forth in the
Award Agreement), by the Participant's estate or by a person who acquired the
right to exercise the Option by bequest or inheritance, but only to the extent that
the Participant was entitled to exercise the Option at the date of death. If, at the
time of death, the Participant was not entitled to exercise his or her entire Option,
the Shares covered by the unexercisable portion of the Option shall immediately
revert to the Plan. If, after death, the Participant's estate or a person who
acquired the right to exercise the Option by bequest or inheritance does not
exercise the Option within the time specified herein, the Option shall terminate,
and the Shares covered by such Option shall revert to the Plan; or
(f) Retirement. In the event that a Participant's Continuous Status as an Employee
terminates as a result of the Participant's Retirement, the Participant may exercise
his or her Option at any time subject to the limitations in the Plan and the Award
Agreement, but only to the extent that the Participant was entitled to exercise the
Option at the time of such termination, unless otherwise expressly provided in a
written agreement between the Participant and the Company. However, any
Incentive Stock Options not exercised within three (3) months of the termination
of the Participant's Continuous Status as an Employee shall be treated for tax
purposes as Nonqualified Stock Options three (3) months and one (1) day
following such Retirement; or
(g) 10 Years from Grant. Unless otherwise specified above, an Option shall expire
no more than ten (10) years from the Grant Date; provided, however, that if an
Incentive Stock Option is granted to an Employee who, together with persons
whose stock ownership is attributed to the Employee pursuant to Code Section
424(d), owns stock possessing more than 10% of the total combined voting
power of all classes of the stock of the Company or any of its Subsidiaries, such
Incentive Stock Option may not be exercised after the expiration of five (5) years
from the Grant Date.
14
(h) Change in Status. In the event a Participant's status has changed from Consultant
or Director to Employee, or vice versa, a Participant's Continuous Status as an
Employee, Director or Consultant shall not automatically terminate solely as a
result of such change in status.
5.4.2 Administrator Discretion. Subject to the limits of Section 5.4.1, the
Administrator, in its discretion, (a) shall provide in each Award Agreement when each Option
expires and becomes unexercisable, and (b) may, after an Option is granted, extend the
maximum term of the Option (subject to limitations applicable to Incentive Stock Options).
Exercisability of Options. Options granted under the Plan shall be exercisable at such
5.5
times and be subject to such restrictions and conditions as the Administrator shall determine in
its discretion. After an Option is granted, the Administrator, in its discretion, may accelerate the
exercisability of the Option.
Exercise and Payment. Options shall be exercised by the Participant's delivery of a
5.6
written notice of exercise to the Secretary of the Company (or its designee), setting forth the
number of Shares with respect to which the Option is to be exercised, accompanied by full
payment for the Shares.
5.6.1
Form of Consideration. Upon the exercise of any Option, the Exercise Price
shall be payable to the Company in full in cash or its equivalent. The Administrator, in its
discretion, also may permit the same-day exercise and sale of Options and related Shares, or
exercise by tendering previously acquired Shares having an aggregate Fair Market Value at the
time of exercise equal to the total Exercise Price (such previously acquired Shares must have
been held for the requisite period necessary to avoid a charge to the Company's earnings for
financial reporting purposes, unless otherwise determined by the Administrator), or by any other
means which the Administrator, in its discretion, determines to provide legal consideration for
the Shares, and to be consistent with the purposes of the Plan.
5.6.2 Delivery of Shares. As soon as practicable after receipt of a written notification
of exercise and full payment for the Shares purchased, the Company shall deliver to the
Participant (or the Participant's designated broker), Share certificates (which may be in book
entry form) representing such Shares.
SECTION 6
STOCK APPRECIAnON RIGHTS
Grant of SARs. Subject to the terms of the Plan, a SAR may be granted to Employees,
6.1
Directors and Consultants at any time and from time to time as shall be determined by the
Administrator. The Administrator may grant, Freestanding SARs, Tandem SARs, or any
combination thereof.
15
6.1.1 Number of Shares. The Administrator shall have complete discretion to
determine the number of SARs granted to any Participant, subject to the limitation in Section
10.6.
6.1.2 Exercise Price and Other Terms. The Administrator, subject to the provisions of
the Plan, shall have discretion to determine the terms and conditions of SARs granted under the
Plan. However, the exercise price of a Freestanding SAR shall be not less than one hundred
percent (100%) of the Fair Market Value of a Share on the Grant Date. The exercise price of
Tandem SARs shall equal the Exercise Price of the related Option and shall be one hundred
percent (100%) of the Fair Market Value of a Share on the Grant Date ofthe related Option.
Exercise of Tandem SARs. Tandem SARs may be exercised for all or part of the Shares
6.2
subject to the related Option upon the surrender of the right to exercise the equivalent portion of
the related Option. A Tandem SAR may be exercised only with respect to the number of Shares
for which its related Option is then exercisable. With respect to a Tandem SAR granted in
connection with an Incentive Stock Option: (a) the Tandem SAR shall expire no later than the
expiration ofthe underlying Incentive Stock Option; (b) the value of the payout with respect to
the Tandem SAR shall be for no more than one hundred percent (100%) of the difference
between the Exercise Price of the underlying Incentive Stock Option and the Fair Market Value
ofthe Shares subject to the underlying Incentive Stock Option at the time the Tandem SAR is
exercised; and (c) the Tandem SAR shall be exercisable only when the Fair Market Value of the
Shares subject to the Incentive Stock Option exceeds the Exercise Price of the Incentive Stock
Option.
Exercise of Freestanding SARs. Freestanding SARs shall be exercisable on such terms
6.3
and conditions as the Administrator, in its discretion, shall determine.
SAR Agreement. Each SAR grant shall be evidenced by an Award Agreement that shall
6.4
specify the exercise price, the term of the SAR, the conditions of exercise and such other terms
and conditions as the Administrator shall determine.
Expiration of SARs. A SAR granted under the Plan shall expire upon the date
6.5
determined by the Administrator in its discretion as set forth in the Award Agreement, or
otherwise pursuant to the provisions relating to the expiration of Options as set forth in Sections
5.4.
Payment of SAR Amount. Upon exercise of a SAR, a Participant shall be entitled to
6.6
receive payment from the Company in an amount determined by multiplying: (a) the difference
between the Fair Market Value of a Share on the date of exercise over the Option Exercise
Price, times (b) the number of Shares with respect to which the SAR is exercised. At the
discretion of the Administrator, the payment upon SAR exercise may be in cash, in Shares of
equivalent value or in some combination thereof. The payment by the Company shall be made
no later than March 15 of the year following the calendar year in which the SAR is exercised.
16
SECTION 7
RESTRICTED STOCK
Grant of Restricted Stock. Subject to the terms and provisions of this Plan, the
7.1
Administrator, at any time and from time to time, may grant Shares of Restricted Stock to
Employees, Directors and Consultants in such amounts as the Administrator, in its discretion,
shall determine. The Administrator, in its discretion and subject to Section 10.6, shall
determine the number of Shares to be granted to each Participant.
Restricted Stock Agreement. Each Award of Restricted Stock shall be evidenced by an
7.2
Award Agreement that shall specify the Period of Restriction, the number of Shares granted,
and such other terms and conditions as the Administrator, in its discretion, shall determine.
Unless the Administrator determines otherwise, Shares of Restricted Stock shall be held by the
Company as escrow agent until the restrictions on such Shares have lapsed.
Transferability. Except as provided in this Section 7, Shares of Restricted Stock may
7.3
not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated until the
expiration of the applicable Period of Restriction.
Other Restrictions. The Administrator, in its discretion, may impose such other
7.4
restrictions on Shares of Restricted Stock as it may deem advisable or appropriate, in
accordance with this Section 7.4, including, without limitation, provisions relating to expiration
of restrictions equivalent to the provisions relating to expiration of options as set forth in
Section 5.4.
7.4.1 General Restrictions. The Administrator may set restrictions based upon the
achievement of specific performance objectives (Company-wide, business unit, or individual),
or any other basis determined by the Administrator in its discretion.
7.4.2
Section 162(m) Performance Restrictions. For purposes of qualifying grants of
Restricted Stock as "performance-based compensation" under Code Section 162(m), the
Administrator, in its discretion, may set restrictions based upon the achievement ofPerfonnance
Goals. The Performance Goals shall be set by the Administrator on or before the latest date
permissible to enable the Restricted Stock to qualify as "performance-based compensation"
under Code Section 162(m).
under Code Section 162(m), the Administrator shall follow any procedures determined by it
from time to time to be necessary or appropriate to ensure qualification of the Restricted Stock
under Code Section 162(m) (e.g., in determining the Performance Goals).
In granting Restricted Stock which is intended to qualify
7.4.3 Legend on Certificates. The Administrator, in its discretion, may legend the
certificates representing Restricted Stock to give appropriate notice of such restrictions.
Removal of Restrictions. Except as otherwise provided in this Section 7, Shares of
7.5
Restricted Stock covered by each Restricted Stock grant made under the Plan shall be released
from escrow as soon as practicable after expiration of the Period of Restriction. The
Administrator, in its discretion, may accelerate the time at which any restrictions shall lapse or
17
be removed, except with respect to such restriction applicable to Deferred Stock Units or other
nonqualified deferred compensation under Code Section 409A such that the acceleration of such
restrictions would result in a prohibited acceleration of payment under Code Section 409A or
the Treasury Regulations thereunder. After the restrictions have lapsed, the Participant shall be
entitled to have any legend or legends under Section 7.4.3 removed from his or her Share
certificate, and the Shares shall be freely transferable by the Participant, subject to Applicable
Law.
Voting Rights. During the Period of Restriction, Participants holding Shares of
7.6
Restricted Stock granted hereunder may exercise full voting rights with respect to those Shares,
unless the Administrator determines otherwise.
Dividends and Other Distributions. During the Period of Restriction, Participants
7.7
holding Shares of Restricted Stock shall be entitled to receive all dividends and other
distributions paid with respect to such Shares unless otherwise provided in the Award
Agreement. If any such dividends or distributions are paid in Shares, the Shares shall be subject
to the same restrictions on transferability and forfeitability as the Shares of Restricted Stock
with respect to which they were paid.
Return of Restricted Stock to Company. On the date set forth in the Award Agreement,
7.8
the Restricted Stock for which restrictions have not lapsed shall revert to the Company and
again shall become available for grant under the Plan.
Section 83fb) Election. The Administrator may provide in an Award Agreement that the
7.9
Award of Restricted Stock is conditioned upon the Participant making or refraining from
making an election with respect to the Award under Code Section 83(b). If a Participant makes
an election pursuant to Code Section 83(b) concerning a Restricted Stock Award, the Participant
shall be required to promptly file a copy of such election with the Company.
SECTION 8
NONEMPLOYEE DIRECTOR AWARDS
The provisions of this Section 8 are applicable only to Nonemployee Directors.
8.1
Granting of Options
8.1.1
Initial Grants. Each Nonemployee Director who first becomes a Nonemployee
Director on or after the Plan Effective Date (excluding each Nonemployee Director who, at the
time he or she first becomes a Director, holds unvested options to purchase Shares or securities
convertible or exchangeable for Shares as a result of such Outside Director's service as a
director of an Affiliate), shall be entitled to receive, as of the date that the individual first is
appointed or elected as a Nonemployee Director, an Award of up to 1,000 Shares, or such lesser
number of Shares as is allowed pursuant to Section 10.6. Such Award may consist of a single
type or any combination of the types of Awards permissible under this Plan, as determined from
time to time by the Board as a whole.
18
8.1.2 Ongoing Grants. On the first trading day of February in each calendar year, each
Nonemployee Director who has served as a Nonemployee Director for at least five months on
that date shall be granted an Award of up to 750 Shares, or such lesser amount of Shares as is
allowed pursuant to Section 10.6, provided that such Nonemployee Director is a member of the
Board. Such Award may consist of a single type or any combination of the types of Awards
permissible under this Plan, as determined from time to time by the Board as a whole.
8.1.3
Imputed Value. For purposes of Section 8.3 (as such section relates to Options),
the "Imputed Value" of any Award shall mean the value on the applicable date as determined in
accordance with Financial Accounting Standards Board Statement No. 123, "Accounting for
Stock-Based Compensation," as the same may be amended from time to time.
8.2
Tenus of Options.
8.2.1 Option Agreement. A written Award Agreement between the Participant and the
Company shall evidence each Option granted pursuant to this Section 8.
8.2.2 Exercise Price. The Exercise Price for the Shares subject to each Option granted
pursuant to this Section 8 shall be 100% of the Fair Market Value of such Shares on the Grant
Date.
8.2.3 Expiration of Options. Each Option granted pursuant to this Section 8 shall
tenninate upon the first to occur of the following events:
(a)
(b)
(c)
(d)
The date for termination ofthe Option set forth in the written Award
Agreement; or
The expiration of ten (10) years from the Grant Date; or
The expiration of twelve (12) months from the date the Participant ceases
Continuous Status as a Director for any reason other than the Participant's death
or Disability; or
In the event that a Participant's Continuous Status as a Director terminates as a
result of the Participant's Death or Disability, the Participant's Option shall
terminate in accordance with the provisions set forth in Section 5.4.1 (d) and (e),
respectively.
8.2.4 Nongualified Stock Options Only. No Incentive Options may be granted
pursuant to this Section 8.
8.2.5 Vesting and Other Terms. Except as provided in Section 8.2.3, Options granted
pursuant to this Section 8 shall become exercisable on terms and conditions determined by the
Administrator in its sole discretion. All other provisions of the Plan not inconsistent with this
Section 8 shall also apply to Options granted to Nonemployee Directors. In the event of any
19
inconsistency between provisions set forth in Section 8 and those set forth elsewhere in the Plan
as they relate to Options, the provisions of Section 8 shall govern with respect to Options
granted to Nonemployee Directors.
8.2.6 Substitute Options. In the event that the Company or an Affiliate consummates a
transaction described in Code Section 424(a) (e.g., the acquisition of property or stock from an
unrelated corporation), an individual who becomes a Nonemployee Director as a result of such
transaction may be granted Options in substitution for options granted by the unrelated
corporation. If such substitute Options are granted, the Administrator may adjust the pricing of
such Options, subject to Section 4.1.2, and consistent with Code Sections 424(a) and 409A and
the Treasury Regulations thereunder so that such substitute Options do not constitute the grant
of nonqualified deferred compensation for purposes of Section 409A.
Elections by Nonemployee Directors. Pursuant to such procedures as the Administrator
8.3
(in its discretion) may adopt from time to time, each Nonemployee Director may, prior to the
calendar year in which the amounts would otherwise be earned, elect to forego receipt of all or a
portion of the annual retainer, committee fees and meeting fees otherwise due to the
Nonemployee Director in exchange for an Award under this Plan. Any such Award shall be
considered to be an Award of Deferred Stock Units and subject to the rules of Code Section
409A and the Treasury Regulations thereunder. Any such Election shall specify the time and
form of payment of such Award as applicable to Deferred Stock Units as provided in Section
10.3 and otherwise in a manner that satisfies the rules of Code Section 409A and the Treasury
Regulations thereunder. The number of Shares subject to an Award received by any
Nonemployee Director shall equal the amount of foregone compensation divided by the Fair
Market Value of a Share on the date the compensation otherwise would have been paid to the
Nonemployee Director, rounded up to the nearest whole number of Shares. The number of
Options granted shall be determined by dividing the cash amount foregone by the Imputed
Value of the Options (as defined in Section 8.1.3), rounded up to the nearest whole number of
Shares. The procedures adopted by the Administrator for elections under this Section 8.3 shall
be designed to ensure that any such election by a Nonemployee Director will not disqualify him
or her as a "nonemployee director" under Rule 16b-3.
SECTION 9
PERFORMANCE SHARES AND PERFORMANCE UNITS
Grant of Performance Shares/Units. Subject to the terms and conditions of the Plan,
9.1
Performance Shares and Performance Units may be granted to Employees, Directors and
Consultants at any time and from time to time, as shall be determined by the Administrator in its
discretion.
9.1.1 Number of Units or Shares. The Administrator will have complete discretion in
determining the number of Performance Shares and Performance Units granted to any
Participant, subject to the limitations in Sections 4.1.2 and 10.6.
20
9.1.2 Value ofPerfonnance ShareslUnits. Subject to Section 4.1.2, each Perfonnance
Unit will have an initial hnputed Value that is established by the Administrator on or before the
Grant Date in accordance with Section 8.1.3. Each Perfonnance Share will have an initial
Imputed Value equal to the Fair Market Value of a Share on the Grant Date.
Perfonnance Objectives and Other Tenns. The Administrator will set perfonnance
9.2
objectives or other vesting provisions, including, without limitation, time-based vesting
provisions, in its discretion which, depending on the extent to which they are met, will
detennine the number or value ofPerfonnance ShareslUnits that will be paid out to Participants.
The time period during which the perfonnance objectives or other vesting provisions must be
met will be called the "Performance Period." Each Award of Performance ShareslUnits will be
evidenced by an Award Agreement that will specify the Performance Period, and such other
tenns and conditions as the Administrator, in its discretion, will detennine. The Administrator
may set perfonnance objectives based upon the achievement of Company-wide or individual
goals or any other basis determined by the Administrator in its discretion.
Earning ofPerfonnance ShareslUnits. After the applicable Performance Period has
9.3
ended, the holder ofPerfonnance Units/Shares will be entitled to receive a payout of the
number ofPerfonnance Units/Shares earned by the Participant over the Performance Period, to
be determined as a function ofthe extent to which the corresponding performance objectives or
other vesting provisions have been achieved. After the grant of a Performance Unit/Share, the
Administrator, in its discretion, may reduce or waive any perfonnance objectives or other
vesting provisions for such Performance Unit/Share.
9.4
Fonn and Timing of Payment ofPerfonnance ShareslUnits. Payment of earned
Perfonnance ShareslUnits will be made as soon as practicable after the expiration of the
applicable Perfonnance Period, but no later than March 15 ofthe year following the expiration
of such Perfonnance Period. The Administrator, in its discretion, may pay earned Performance
ShareslUnits in the fonn of cash, in Shares (which have an aggregate Fair Market Value equal
to the value ofthe earned Perfonnance Units/Shares at the close of the applicable Performance
Period) or in a combination thereof.
9.5
Cancellation of Performance ShareslUnits. On the date set forth in the Award
Agreement, all unearned or unvested Perfonnance Shares/Units will be forfeited to the
Company, and again will be available for grant under the Plan.
SECTION 10
MISCELLANEOUS
10.1
Change In Control
10.1.1 Generally.
In the event ofa Change in Control, unless an Award is assumed or
substituted by the successor corporation, then (i) such Awards shall become fully exercisable as
of the date of the Change in Control, whether or not then exercisable and (ii) all restrictions and
conditions on any Award then outstanding shall lapse as of the date of the Change in Control.
21
10.1.2 Options and SARs. If the Administrator determines that Options and SARs will
be assumed or an equivalent option or right substituted by the successor corporation or a parent
or Subsidiary of the successor corporation, then:
(a)
(b)
In the event that the successor corporation refuses to assume or substitute for the
Option or SAR, the Options and SARs held by such Participant shall
immediately become one hundred percent (100%) exercisable. In such event, the
Company shall notify the Participant in writing or electronically that the Options
and SARs are fully exercisable (subject to the consummation of the Change in
Control) for a period of ninety (90) days from the date of such notice, and the
Option or SAR shall terminate upon the expiration of such period.
For the purposes of this Section 10.1.2, the Option or SAR shall be considered
assumed if, following the Change in Control, the option or SAR confers the right
to purchase or receive, for each Share subject to the Option or SAR immediately
prior to the Change in Control, the consideration (whether stock, cash, or other
securities or property) received in the Change in Control event by holders of
Shares for each Share held on the closing date of the transaction (and ifholders
were offered a choice of consideration, the type of consideration chosen by the
holders of a majority of the outstanding Shares); provided, however, that if such
consideration received in the Change in Control is not solely common stock of
the successor corporation or its parent, the Administrator or the Board may, with
the consent of the successor corporation, provide for the consideration to be
received upon the exercise of the Option or SAR, for each Share subject to the
Option or SAR, to be solely common stock of the successor corporation or its
parent equal in fair market value to the per share consideration received by
holders of Shares in the Change in Control, as determined on the date of the
Change in Control.
10.1.3 Restricted Stock. Ifthe Administrator determines that any Company repurchase
or reacquisition right with respect to outstanding Shares of Restricted Stock held by the
Participant will be assigned to the successor corporation, then in the event that the successor
corporation refuses to accept the assignment of any such Company repurchase or reacquisition
right, such Company repurchase or reacquisition right will immediately lapse and the
Participant will become one hundred percent (100%) vested in such Shares of Restricted Stock
prior to the closing of the Change in Control event.
10.1.4 Performance ShareslUnits. If the Administrator determines that Performance
ShareslUnits will be assumed or an equivalent option or right substituted by the successor
corporation or a parent or Subsidiary of the successor corporation, then
(a)
In the event that the successor corporation refuses to assume or substitute for the
Performance ShareslUnits, 100% of all performance objectives will be deemed
achieved and all other terms and conditions met. In such event, the Company
shall notify the Participant in writing or electronically that the Performance
22
ShareslUnits are fully exercisable (subject to the consummation of the Change in
Control) for a period of ninety (90) days from the date of such notice, and
Performance ShareslUnits shall terminate upon the expiration of such period.
(b)
For the purposes ofthis Section 10.1.4, the Performance SharelUnit shall be
considered assumed if, following the Change in Control, the Performance
SharelUnit confers the right to purchase or receive, for each Share subject to the
Performance SharelUnit immediately prior to the Change in Control, the
consideration (whether stock, cash, or other securities or property) received in
the Change in Control by holders of Shares for each Share held on the effective
date of the transaction (and if holders were offered a choice of consideration, the
type of consideration chosen by the holders of a majority of the outstanding
Shares); provided, however, that if such consideration received in the Change in
Control is not solely common stock of the successor corporation or its parent, the
Administrator or the Board may, with the consent of the successor corporation,
provide for the consideration to be received upon the payout of a Performance
SharelUnit, for each Share subject to such Award (or, in the case of Performance
Units, the number of implied Shares determined by dividing the value of the
Performance Units by the per share consideration received by holders of Shares),
to be solely common stock of the successor corporation or its parent equal in fair
market value to the per share consideration received by holders of Shares in the
Change in Control, as determined on the date of the Change in Control.
Notwithstanding anything in this Section 10.1.4 to the contrary, an Award that
vests, is earned or paid-out upon the satisfaction of one or more performance
goals will not be considered assumed if the Company or its successor modifies
any of such perfonnance goals without the Participant's consent; provided,
however, that a modification to such performance goals only to reflect the
successor corporation's post Change in Control corporate structure will not be
deemed to invalidate an otherwise valid Award assumption.
10.2 Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the
Company, the Administrator shall notify each Participant as soon as practicable prior to the
effective date of such proposed transaction. The Administrator in its discretion may provide for
a Participant to have the right to exercise his or her Award until ten (10) days prior to such
transaction as to all of the Shares covered thereby, including Shares as to which the Award
would not otherwise be exercisable. In addition, the Administrator may provide that any
Company repurchase rights applicable to any Shares purchased upon exercise of an Award shall
lapse as to all such Shares, provided the proposed dissolution or liquidation takes place at the
time and in the manner contemplated. To the extent it has not been previously exercised, an
Award will terminate immediately prior to the consummation of such proposed action.
10.3 Deferred Stock Units. The Administrator, in its discretion, may permit a Participant to
defer receipt of the payment of cash or the delivery of Shares that would otherwise be due to
such Participant under an Award if such Participant at the time of the grant of Performance
Units/Shares executes an irrevocable election to so defer payment. Such election shall be on
23
such fonn and executed in such manner as the Administrator in its discretion shall detennine,
but shall in all events provide for payment on either (a) a fixed date or (b) the date of the
Participant's separation from service; provided that the election may provide for payment upon
if earlier than (a) or (b) (as specified), upon death, disability, a change of control, or the
occurrence of an unforeseen emergency, all as such tenns are defined in Code Section 409A and
the Treasury Regulations issued thereunder.
10.4 No Effect on Employment or Service. Nothing in the Plan shall interfere with or limit in
any way the right of the Company or an Affiliate to tenninate any Participant's employment or
service at any time, with or without cause. Unless otherwise provided by written contract,
employment with the Company and its Affiliates is on an at-will basis only. Additionally, the
Plan shall not confer upon any Nonemployee Director any right with respect to continuation of
service as a Director or nomination to serve as a Director, nor shall it interfere in any way with
any rights which such Nonemployee Director or the Company may have to tenninate his or her
directorship at any time.
10.5
Participation. No Employee or Consultant shall have the right to be selected to receive
an Award under this Plan, or, having been so selected, to be selected to receive a future Award.
Limitations on Awards. No Participant shall be granted an Award in any Fiscal Year for
10.6
Shares, Perfonnance Shares and Perfonnance Units combined representing more than the lesser
of (i) five percent (5%) of the Company's total number of outstanding Shares immediately prior
to the issuance of such Award or (ii) 300,000 Shares; provided, however, that such limitation
shall be adjusted proportionately in connection with any change in the Company's capitalization
as described in Section 4.3.
Successors. All obligations of the Company under the Plan, with respect to Awards
10.7
granted hereunder, shall be binding on any successor to the Company, whether the existence of
such successor is the result of a direct or indirect purchase, merger, consolidation or, otherwise,
sale or disposition of all or substantially all of the business or assets of the Company.
10.8 Beneficiary Designations. If pennitted by the Administrator, a Participant under the
Plan may name a beneficiary or beneficiaries to whom any vested but unpaid Award shall be
paid in the event of the Participant's death. Each such designation shall revoke all prior
designations by the Participant and shall be effective only if given in a fonn and manner
acceptable to the Administrator. In the absence of any such designation, any vested benefits
remaining unpaid at the Participant's death shall be paid to the Participant's estate and, subject to
the tenns of the Plan and of the applicable Award Agreement, any unexercised vested Award
may be exercised by the administrator or executor ofthe Participant's estate.
Limited Transferability of Awards. No Award granted under the Plan may be sold,
10.9
transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by
the laws of descent and distribution. All rights with respect to an Award granted to a Participant
shall be available during his or her lifetime only to the Participant. Notwithstanding the
foregoing, the Participant may, in a manner specified by the Administrator, (a) transfer a
Nonqualified Stock Option to a Participant's spouse, fonner spouse or dependent pursuant to a
24
court-approved domestic relations order which relates to the provision of child support, alimony
payments or marital property rights and (b) transfer a Nonqualified Stock Option by bona fide
gift and not for any consideration, and subject to meeting the requirements of Treasury
Regulation Section 1.83-7(a), to (i) a member or members ofthe Participant's immediate family,
(ii) a trust established for the exclusive benefit of the Participant and/or member(s) of the
Participant's immediate family, (iii) a partnership, limited liability company of other entity
whose only partners or members are the Participant and/or member(s) of the Participant's
immediate family or (iv) a foundation in which the Participant an/or member(s) of the
Participant's immediate family control the management of the foundation's assets.
10.10 Restrictions on Share Transferability. The Administrator may impose such restrictions
on any Shares acquired pursuant to the exercise of an Award as it may deem advisable,
including, but not limited to, restrictions related to applicable federal securities laws, the
requirements of any national securities exchange or system upon which Shares are then listed or
traded or any blue sky or state securities laws.
10.11 Buyout Provisions. Except with respect to Deferred Stock Units or any other Award
subject to Code Section 409A, the Administrator may at any time offer to buyout for a payment
in cash or Shares, an Award previously granted based on such terms and conditions as the
Administrator shall establish and communicate to the Participant at the time that such offer is
made.
10.12 No Rights as Shareholder. Except to the limited extent provided in Sections 7.6 and 7.7,
no Participant (nor any beneficiary) shall have any of the rights or privileges of a shareholder of
the Company with respect to any Shares issuable pursuant to an Award (or exercise thereot),
unless and until certificates representing such Shares shall have been issued, recorded on the
records of the Company or its transfer agents or registrars, and delivered to the Participant (or
beneficiary).
SECTION 11
AMENDMENT, TERMINATION, AND DURATION; RE-PRICING PROHIBITED
11.1 Amendment, Suspension, or Termination. Except as provided in Section 11.2, the
Board, in its sole discretion, may amend, suspend or terminate the Plan, or any part thereof, at
any time and for any reason. The amendment, suspension or termination of the Plan shall not,
without the consent of the Participant, alter or impair any rights or obligations under any Award
theretofore granted to such Participant. No Award maybe granted during any period of
suspension or after termination of the Plan.
11.2 No Amendment or Re-Pricing without Shareholder Approval. The Company shall
obtain shareholder approval of any material Plan amendment (including but not limited to any
provision to reduce the exercise or purchase price of any outstanding Options or other Awards
after the Grant Date (other than for adjustments made pursuant Section 4.3), or to cancel and re
grant Options or other rights at a lower exercise price), to the extent necessary or desirable to
25
comply with the rules of the NASDAQ, the Exchange Act, Code Section 409A, Code Section
422, or other Applicable Law.
11.3
Plan Effective Date and Duration of Awards. The Plan shall be effective as of the Plan
Adoption Date subject to the shareholders ofthe Company approving the Plan by the required
vote), subject to Sections 11.1 and 11.2 (regarding the Board's right to amend or terminate the
Plan), and shall remain in effect thereafter. However, without further shareholder approval, no
Award may be granted under the Plan more than ten (10) years after the Plan Adoption Date.
SECTION 12
TAX WITHHOLDING
12.1 Withholding Requirements. Prior to the delivery of any Shares or cash pursuant to an
Award (or exercise thereof), the Company shall have the power and the right to deduct or
withhold, or require a Participant to remit to the Company, an amount sufficient to satisfy
federal, state, and local taxes (including the Participant's FICA obligation) required to be
withheld with respect to such Award (or exercise thereof).
12.2 Withholding Arrangements. The Administrator, in its discretion and pursuant to such
procedures as it may specify from time to time, may permit a Participant to satisfy such tax
withholding obligation, in whole or in part by (a) electing to have the Company withhold
otherwise deliverable Shares, or (b) delivering to the Company already-owned Shares having a
Fair Market Value equal to the minimum amount required to be withheld. The amount of the
withholding requirement shall be deemed to include any amount which the Administrator agrees
may be withheld at the time the election is made, not to exceed the amount determined by using
the maximum federal, state or local marginal income tax rates applicable to the Participant with
respect to the Award on the date that the amount oftax to be withheld is to be determined. The
Fair Market Value of the Shares to be withheld or delivered shall be determined as of the date
taxes are required to be withheld.
SECTION 13
LEGAL CONSTRUCTION
13.1
Liability of Company. The inability of the Company to obtain timely authority from any
regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be
necessary to the lawful grant or any Award or the issuance and sale of any Shares hereunder,
shall relieve the Company, its officers, Directors and Employees of any liability in respect of
the failure to grant such Award or to issue or sell such Shares as to which such requisite
authority shall not have been obtained.
13.2 Grants Exceeding Allotted Shares. If the Shares covered by an Award exceed, as of the
date of grant, the number of Shares, which may be issued under the Plan without additional
shareholder approval, such Award shall be void with respect to such excess Shares, unless
26
shareholder approval of an amendment sufficiently increasing the number of Shares subject to
the Plan is timely obtained.
13.3 Gender and Number. Except where otherwise indicated by the context, any masculine
term used herein also shall include the feminine; the plural shall include the singular and the
singular shall include the plural.
Severability. In the event any provision of the Plan shall be held illegal or invalid for
13.4
any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the
Plan shall be construed and enforced as if the illegal or invalid provision had not been included.
Requirements of Law. The granting of Awards and the issuance of Shares under the
13.5
Plan shall be subject to all applicable laws, rules, and regulations, and to such approvals by any
governmental agencies or national securities exchanges as may be required.
13.6 Securities Law Compliance. With respect to Section 16 Persons, transactions under this
Plan are intended to comply with all applicable conditions of Rule 16b-3. To the extent any
provision of the Plan, Award Agreement or action by the Administrator fails to so comply, it
shall be deemed null and void, to the extent permitted by law and deemed advisable by the
Administrator.
13.7 Compliance with Code Section 409A. The Plan and Awards under it are intended to
comply with Code Section 409A to the extent subject thereto, and, accordingly, to the
maximum extent permitted, the Plan will be interpreted and administered in a manner so that the
Plan and Awards granted under it comply with Code Section 409A. References herein to
ceasing to be a member of the Board and similar terms used in this Plan shall be deemed to refer
to "separation from service" within the meaning of Code section 409A to the extent necessary
to comply with Code Section 409A.
Notwithstanding any provision of this Plan to the contrary, if at the time of a Participant's
separation from service, the Participant is a "specified employee" as defined in Code Section
409A and any Shares or amounts otherwise payable under this Plan as a result of such
separation from service are subject to Code Section 409A, then no transfer or payment of such
Shares or amounts shall be made until the date that is six months following the Participant's
separation from service (or the earliest date as is permitted under Code Section 409A), and the
Company will transfer or pay any Shares or amounts that are delayed under the foregoing on or
before the first day of the month following the six month delay.
Notwithstanding anything to the contrary in the Plan, neither the Company, its Affiliates, the
Administrator, the Board nor any Committee will have any obligation to take any action to
prevent the assessment of any excise tax, interest or penalty on any Participant under Code
Section 409A and neither the Company, its Affiliates, the Administrator, the Board nor any
Committee will have any liability to any Participant for such tax, interest or penalty.
13.8 Governing Law. The Plan and all Award Agreements shall be construed in accordance
with and governed by the internal laws of the State of California, without regard to principles of
27
conflicts of laws, except to the extent that federal law is implied by the context or is otherwise
required to be applied.
Captions. Captions are provided herein for convenience only, and shall not serve as a
13.9
basis for interpretation or construction of the Plan.
SECTION 14
EXECUTION
IN WITNESS WHEREOF, the Company, by its duly authorized officer, has executed
this Plan on the date set forth below.
Dated: - - - - - - -
PREFERRED BANK
By: - - - - - - - - - -
Its: - - - - - - - - - -
28