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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
TEMECULA VALLEY BANCORP INC.
(Name of small business registrant in its charter)
California 46-047619
(State or other jurisdiction of (I.R.S. Employer
incorporate or organization) Identification No.)
27710 Jefferson Avenue - Suite A100 92590
Temecula, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number (909) 694-9940
Securities registered under Section 12(b) of Exchange Act: None
Securities registered under Section 12(g) of Exchange Act: Common Stock, No Par
Value
Check whether the issuer (1) filed all reports to be filed by Section 13 or
15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) YES [ ] NO [ X ]
The issuer's net revenues for its most recent fiscal year was $48,371,852.
The aggregate market value of the voting stock held by non-affiliates of the
issuer as of June 30, 2003 was approximately $55,593,410.
Number of registrant's shares of Common Stock outstanding at March 22, 2004 was
8,308,896.
Documents incorporated by reference: The information required by Part III of
this Annual Report is incorporated by reference from the Registrant's definitive
proxy statement to be filled with the Securities and Exchange Commission
pursuant to Regulation 14A not later than 120 days after the end of the fiscal
year covered by this Annual Report.
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TABLE OF CONTENTS
PART I
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ITEM 1: BUSINESS..........................................................4
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ITEM 2: PROPERTIES.......................................................39
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ITEM 3: LEGAL PROCEEDINGS................................................39
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ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER...............40
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PART II ....................................................................40
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ITEM 5. MARKET FOR REGISTRANT'S COMMON...................................40
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ITEM 6. SELECTED FINANCIAL DATA..........................................43
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ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS...............................45
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ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......64
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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................64
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ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
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AND FINANCIAL DISCLOSURE.........................................64
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ITEM 9A: CONTROLS AND PROCEDURES..........................................64
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PART III ....................................................................65
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ITEM 10: DIRECTORS AND PRINCIPAL OFFICERS.................................65
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ITEM 11: EXECUTIVE COMPENSATION...........................................65
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
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MANAGEMENT.......................................................65
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................65
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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES...........................66
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PART IV ....................................................................66
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ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
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FORM 8-K.........................................................66
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CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
We have made forward-looking statements in this document that are subject
to risks and uncertainties. These statements are based on the beliefs and
assumptions of our management, and on information currently available to our
management. Forward-looking statements include the information concerning our
possible or assumed future results of operations, and statements preceded by,
followed by, or that include the words "will," believes," "expects,"
"anticipates," "intends," "plans," "estimates" or similar expressions.
Our management believes these forward-looking statements are reasonable.
However, you should not place undue reliance on the forward-looking statements,
since they are based on current expectations. Actual results may differ
materially from those currently expected or anticipated.
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. Our future results and shareholder values
may differ materially from those expressed in these forward-looking statements.
Many of the factors described below that will determine these results and values
are beyond our ability to control or predict. For those statements, we claim the
protection of the safe harbor contained in the Private Securities Litigation
Reform Act of 1995.
A number of factors, some of which are beyond the our ability to control or
predict, could cause future results to differ materially from those contemplated
by such forward-looking statements. These factors which include (1) the unknown
economic impact caused by the State of California's budget shortfall, (2)
earthquake or other natural disasters impacting the condition of real estate
collateral, and (3) economic uncertainty created by increasing unrest in other
parts of the world could have the following consequences, any of which could
hurt our business:
o Loan delinquencies may increase;
o Problem assets and foreclosures may increase;
o Demand for our products and services may decline; and
o Collateral for loans made by us, especially real estate, may decline in
value, in turn reducing clients' borrowing power and reducing the value
of assets and collateral associated with our existing loans.
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PART I
ITEM 1: BUSINESS
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General
Where You Can Find More Information
Under Sections 13 and 15(d) of the Exchange Act, periodic and
current reports must be filed with the Securities and Exchange Commission
("SEC"). We electronically files the following reports with the SEC: Form 10-K
(Annual Report), Form 10-Q (Quarterly Report), Form 8-K (Report of Unscheduled
Material Events), and Form DEF 14A (Proxy Statement). We may file additional
forms. The SEC maintains an Internet site, www.sec.gov, by which all forms filed
electronically may be accessed. Additionally, shareholder information is
available on our website: www.temvalbank.com. We make our website content
available for information purposes only. It should not be relied upon for
investment purposes. Additionally, neither our website, nor the links within our
website are incorporated into this document.
Temecula Valley Bancorp Inc.
We formed Temecula Valley Bancorp Inc. ("Company") in 2002 to
serve as a holding company for Temecula Valley Bank, N.A. ("Bank"). We
reincorporated the Company from Delaware into California in December 2003. The
Company is a bank holding company registered with the Board of Governors of the
Federal Reserve System ("Federal Reserve") under the Bank Holding Company Act of
1956, as amended ("BHCA"). The Company's activities consist of owning the
outstanding shares of the Bank, Temecula Valley Statutory Trust I and Temecula
Valley Statutory Trust II. References to the "Company" reflect all of the
activities of the Company and its subsidiaries, including the Bank, except as
otherwise specified by the context of the statement.
Temecula Valley Bank, N.A.
The Bank was organized in 1996 and commenced operations on
December 16, 1996 as a national banking association. As a national bank, the
Bank is subject to primary supervision, regulation and examination by the
Comptroller of the Currency ("Comptroller"). The deposits of the Bank are
insured by the Federal Deposit Insurance Corporation ("FDIC") up to the
applicable limits. As a national bank, the Bank is a member of the Federal
Reserve System. The Bank has no subsidiaries.
General Business
The Bank currently has five full-service banking offices in
California providing services to customers in the Temecula Valley and San Diego
County. The Temecula Valley follows the I-15 corridor beginning in the north at
Lake Elsinore and proceeds south to the San Diego County border. The area
includes the incorporated areas near Temecula and Murrieta and the
unincorporated communities of Murrieta Hot Springs and the French Valley Airport
area east of Murrieta, California. Our principal office is located in Temecula,
California with other full-service offices in Fallbrook, California, Escondido,
California, Murrieta, California and El Cajon, California. The Bank has received
approval from its principal regulator, the Comptroller of the Currency to open
two additional full-service banking offices, one in Corona, California and the
other in the Rancho Bernardo area of San Diego. It is anticipated that these
offices will open for business within the next three to nine months.
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The Bank also operates loan production offices in Fallbrook,
California and Corona, California, and has mortgage origination offices in
Fallbrook, California and Temecula, California. It also has SBA loan production
offices in the following cities in California: Anaheim Hills, Chico, Santa Ana,
Sherman Oaks and Fresno; in Florida: Brandenton, Coral Springs, St. Petersburg
and Jacksonville; in Georgia: Atlanta; in Illinois: in Gurnee; in Ohio:
Cleveland and in Washington: Bellevue.
The Bank offers a broad range of banking services, including
personal and business checking accounts and various types of interest-bearing
deposit accounts, including interest-bearing checking, money market, savings,
IRA, SEP and time certificates of deposits. Loan products include consumer
installment (including automobile), construction loans, commercial (including
letters of credit), residential real estate (including VA, FHA and Cal Vet),
second mortgages and home improvement loans. In June 2002, the Company added
tract construction lending. In the event loan demands exceed our legal lending
limit, we utilize the loan participation services of correspondent banks. In
addition, we have developed an expertise in SBA lending.
The Bank is a preferred lender under the federally guaranteed
SBA lending program. Through this program, we originate and fund SBA 7-A and 504
Chapter loans qualifying for federal guarantees of up to 75% to 85% of principal
and accrued interest. The guaranteed portion of these loans is generally sold
into the secondary market with servicing retained.
We fund our lending activities primarily from our core deposit
base. We obtain deposits from the local market with no material portion (in
excess of 10% of total deposits) dependent upon any one person, entity or
industry.
The Bank also offers safe deposit boxes, night depository
facilities, merchant credit card services, notary services, travelers checks,
note collection, wire transfer services, cashiers checks, drive up facilities at
some locations, 24 hour ATM banking services, telephone banking, direct deposit
and automatic transfers between accounts. The Bank is a member of regional ATM
networks and offer nationwide ATM access.
The Company as the parent of the Bank has no operations and
conducts no business of its own other than owning the Bank, Temecula Valley
Statutory Trust I and Temecula Valley Statutory Trust II. Accordingly, the
discussion of the business which follow concern the business conducted by the
Bank, unless otherwise indicated. No material portion of our Company's business
is seasonal.
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Business Strategy
The Board has established the following goals for the Company:
o Increase market share through expansion of the branching
system and loan production offices;
o Continue the focus on expansion of the SBA programs and
possibly other government sponsored lending programs;
o Increase profitability and core earnings;
o Maintain consistent superior credit quality;
o Increase core deposit levels and loan volume.
The Company's profitability goals have been realized
historically by improvements in net interest income and non-interest income as
well as expense controls during a time of significant internal expansion. This
produced record earnings for 2003 of $7,854,339, compared to $4,191,054 in 2002
and $1,803,581 in 2001. Return on average equity increased to 31.84% for 2003
compared to 24.34% in 2002 and 14.82% in 2001. Return on average total assets
increased to 2.04% for 2003 compared to 1.69% for 2002 and 1.15% for 2001.
Management expects that during 2004, net income will increase over the results
in 2003 by at least 10% but cannot guarantee these results.
Net interest income before provision for loan losses has
increased to $19,007,738 for 2003 compared to $13,431,236 in 2002 and $9,287,803
in 2001 due to increases in interest earning assets in spite of a declining net
interest margin. Total assets increased 39% to $431,212,118 as of December 31,
2003, compared to $310,506,097 as of December 31, 2002 and $190,024,416 as of
December 31, 2001. Average interest earning assets increased 55.5% to
$334,005,000 for 2003 compared to 214,832,000 in 2002 and $137,750,000 in 2001.
The net interest margin has decreased over the last three years from 6.74% in
2001 to 6.25% in 2002 and 5.69% in 2003. Management believes the net interest
margin for 2003 is more indicative of the margin it expects to see during 2004.
Non-interest income is a significant portion of the profits
for the Company demonstrated by the increase to $24,417,561 for 2003 compared to
$17,895,165 in 2002 and $8,952,309 million in 2001. These profits are
principally derived from SBA and mortgage sales related lending activities. The
increases each year are primarily the result of increases in gain on sale of
loans, increased levels of servicing income and concurrent increases in other
fee income. Management currently anticipates that for 2004, non-interest income
will continue to improve but not as dramatically as the improvement in 2003 over
2002.
The Company measures operating expenses as a percentage of
average assets. As a percentage of average assets, operating expenses decreased
to 7.55% for 2003, compared to 8.80% for 2002 and was 9.45% for 2001. This ratio
is higher than peer group comparisons, but is offset by non-interest income that
is much higher than the peer group. The Company expects this ratio to improve
slightly in 2004 as the Company gains efficiencies of scale due to growth, which
will be offset by new branch openings and expansion of the SBA department.
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Lending
Loan Portfolio Composition
The following table summarizes our loan portfolio excluding
deferred loan fees and the allowance for loan loss by type of loan and their
percentage distribution:
At December 31,
2003 2002 2001 2000 1999
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
(Dollars in Thousands)
Loan portfolio composition:
Commercial $ 33,008 9% $ 44,976 16% $ 22,775 15% $ 13,621 15% $10,360 18%
Real estate - Construction 113,847 31% 61,568 23% 38,027 25% 23,602 25% 10,355 18%
Real estate - Other 212,996 59% 161,767 59% 84,992 57% 51,433 56% 31,911 57%
Consumer 3,195 1% 4,455 2% 5,170 3% 4,359 4% 3,570 7%
-------- ---- -------- ---- -------- ---- -------- ---- ------- ----
Total Loans $363,046 100% $272,766 100% $150,964 100% $ 93,015 100% $56,196 100%
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Loan Maturity
The following table sets for the contractual maturities of the
Company's gross loans at December 31, 2003.
One year More than 1 More than 3 More than Total
or less year to 3 years years to 5 years 5 years loans
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(Dollars in Thousands)
Commercial $16,162 $10,827 $ 3,196 $ 2,823 $33,008
Real estate - construction 113,847 0 0 0 113,847
Real estate - other 194,925 7,822 10,181 68 212,996
Consumer 794 1,436 965 0 3,195
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Total Gross loans outstanding $325,728 $20,085 $14,342 $2,891 $363,046
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The following table sets forth, as of December 31, 2003, the
dollar amounts of net loans outstanding that are contractually due after
December 31, 2004 and whether such loans have fixed or adjustable rates.
Due after December 31, 2004
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Fixed Adjustable Total
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(Dollars in Thousands)
Commercial $ 16,178 $ 668 $ 16,846
Real estate - construction 0 0 0
Real estate - other 11,765 6,306 18,071
Consumer 2,401 0 2,401
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Total Gross loans outstanding $ 30,344 $ 6,974 $ 37,318
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Loan Origination and Sale
The following table sets forth the Company's loan originations
by category and purchases, sales and principal repayments of loans for the
periods indicated:
At December 31,
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2003 2002 2001 2000 1999
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(Dollars in Thousands)
Beginning balance $272,766 $150,964 $ 93,015 $ 56,196 $ 42,064
Loans originated:
Commercial 161,376 144,399 84,285 68,072 40,670
Real estate:
SBA & Equity 192,549 166,563 73,488 25,597 20,929
Construction 367,464 186,741 88,868 50,586 27,989
Other 96,051 85,281 60,711 11,139 8,006
Consumer 2,422 4,298 5,136 5,312 4,538
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Total loans originated 819,862 587,282 312,488 160,706 102,132
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Loans sold
Commercial
Real estate:
SBA 129,813 108,213 44,046 12,336 11,526
Construction 0 0 0 0 0
Other - Mortgage 100,800 83,014 62,099 10,439 8,894
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Total loans sold 230,613 191,227 106,145 22,775 20,420
---------- ---------- ---------- ---------- ----------
Less:
Principal repayments 498,969 274,253 148,394 101,112 67,580
Total loans $363,046 $272,766 $150,964 $ 93,015 $ 56,196
========== ========== ========== ========== ==========
Brokered Loans Originated (1)
Mortgage $ 65,378 $ 72,742 $ 60,953 $ 36,172 $ 0
SBA $ 65,456 $ 29,612 $ 17,075 $ 0 $ 0
(1) Brokered refers to loans that were originated by Temecula Valley Bank, but
funded by other Financial Institutions.
Underwriting Process
The lending activities of the Company are guided by the basic
lending policies established by the Board of Directors. Each loan must meet
minimum underwriting criteria established in the Company's lending policies and
must fit within the Company's strategies for yield and portfolio enhancement.
For all newly originated loans, upon receipt of a completed
loan application from a prospective borrower, a credit report is ordered and, if
necessary, additional financial information is requested. An independent
appraisal is required on every property securing a Company loan in excess of
$250,000. In addition, the loan officer conducts a review of these appraisals
for accuracy, reasonableness and conformance to the Company's lending policy on
all applications. All revisions to the Company's approved appraiser list must be
approved by the Chief Credit Officer or Assistant Chief Credit Officer.
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Credit approval authority is segregated into three levels; the
Board of Directors; Loan Committee and the individual lending limits of loan
officers. The limits for the various levels are determined by the Board of
Directors and/or the President and reviewed periodically. The Board of Directors
approves loans to insiders and meets on an as needed basis. The Loan Committee
consists of the President, Executive Vice President, the Real Estate Manager,
the Chief Credit Officer/Executive Vice President, the Senior Vice
President/Assistant Chief Credit Officer and Executive Vice President/Senior
Loan Officer. The committee is chaired by the President and meets monthly or
more frequently as needed.
If the loan is approved, the loan commitment specifies the
terms and conditions of the proposed loan including the amount, interest rate,
amortization term, a brief description of the required collateral, and the
required insurance coverage. Generally, the borrower must provide proof of fire,
flood (if applicable) and casualty insurance on the property serving as
collateral, which insurance must be maintained during the full term of the loan.
Also, generally, title insurance endorsed to the Company is required on all
first mortgage loans.
The Company maintains loan production offices located
throughout the United State. As of February 27, 2004, there were thirteen such
offices. The loan production offices are typically staffed with a business
development officer who prepares the loan applications and compiles the
necessary information regarding the applicant. The completed loan file is then
sent to the Company's main office where the credit decision is made. The loan
production offices predominantly originate loans guaranteed by the SBA. The
retail branches include non-SBA commercial and construction loan officers.
SBA Lending Programs
The SBA lending programs are designed by the federal
government to assist the small business community in obtaining financing from
financial institutions that are given government guarantees as an incentive to
make the loan. The Company is a "Preferred Lender" with the SBA. As a "Preferred
Lender," the Company can approve a loan within the authority given it by the SBA
without prior approval from the SBA. "Preferred Lenders" approve, package, fund
and service SBA loans within a range of authority that is not available to other
SBA lenders without the "Preferred Lender" designation.
The Company's SBA loans fall into two categories, loans
originated under the SBA's 7a Program ("7a Loans") and loans originated under
the SBA's 504 Program ("504 Loans"). Historically, 7a Loans have represented
approximately 67.3% of the SBA Loans originated by the Company while 504 and
piggyback loans have represented the balance.
Under the SBA's 7a Program, loans in excess of $150,000 are
guaranteed 75% by the SBA. Generally, this guarantee may become invalid only if
the loan does not meet the SBA documentation guidelines.
In general, during 2003 the Company's policy permits SBA 7a
Loans in amounts up to $1.33 million. Under certain circumstances when the
borrowing needs exceed $1.33 million, the Bank makes a SBA guaranteed second
trust deed loan and a second financial institution makes a first trust deed
loan. Loans collateralized by real estate have terms of up to 25 years, while
loans collateralized by equipment and working capital have terms of up to 10
years and 7 years, respectively. The Company requires a 10% down payment on most
7a Loans, with a 15% to 20% down payment on loans collateralized by hotels,
motels and service stations.
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The Company sold over 75% of the SBA loans originated in 2003,
and anticipates selling over 75% of SBA 7a loans originated in 2004. The 25%
remaining is the unguaranteed portion of the Loans, a portion of which may also
be sold. Funding for these loans has come principally from retail deposit
sources. The SBA loans generally have an interest rate of 1.50% to 2.50% over
Wall Street Journal Prime Rate.
The Company periodically sells the guaranteed and unguaranteed
portions of SBA loans it originates. The Company generally retains the servicing
on such loans. This strategy allows the Bank to manage its capital levels and to
ensure that funding is always available to meet the local community loan demand.
Upon sale in the secondary market, the purchaser of the guaranteed portion of 7a
Loans pays a premium to the Bank which, generally, is between 8% and 10% of the
guaranteed amount and in the case of a sale of the unguaranteed portion, the
premium is usually between 1% and 3%. The Company also receives a servicing fee
equal to 1% to 5% of the amount sold in the secondary market. In the event that
a 7a Loan goes into default within 270 days of its sale, or prepays within 90
days, the Company is required to repurchase the loan and refund the premium to
the purchaser. In the past three years, the Company has repurchased 19 loans,
however only 3 of these repurchased loans required refunds of premiums. No
refunds were owed on the other 16 loans repurchased.
Under the SBA's 504 Program, the Company requires a 10% down
payment. The Bank then enters into a 50% first trust deed loan to the borrower
and an interim 40% second trust deed loan. The first trust deed loan has a term
of 20 years. The second trust deed loan is for a term of 120 days. Within the
120 day period of entering into the loan, the second trust deed loans are
refinanced by SBA certified development companies and used as collateral for SBA
guaranteed debentures. For 504 construction loans, the 120 day period does not
commence until the notice of completion is filed. The first trust deed loans may
be pre-sold by the Company with no recourse, prior to releasing the funds to the
purchaser. The Company retains no servicing on 504 Loans after they are sold.
The Company's SBA lending program and portions of its real
estate lending are dependent on the continual funding and programs of certain
federal agencies or quasi-government corporations including the SBA. The
guaranteed portion of an SBA loan does not count towards the Company's
loans-to-one-borrower limitation which, at December 31, 2003 was $6,537,707.
SBA lending is a federal government created and administered
program. As such, legislative and regulatory developments can affect the
availability and funding of the program. This dependence on legislative funding
and regulatory restrictions from time to time causes limitations and
uncertainties with regard to the continued funding of such loans, with a
resulting potential adverse financial impact on the Bank's business. Currently,
the maximum limit of individual 7a loans which the SBA will permit has been
substantially reduced to $750,000. This reduction in loan amount, which has been
in place for about two months as of February 27, 2004 could have a negative
impact on the Company's business. Since the SBA lending of the Company
constitutes a significant portion of the Company's lending business, this
dependence on this government program and its periodic uncertainty with
availability and amounts of funding creates greater risk for the Company's
business than does other parts of its business.
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Commercial Lending/Real Estate Lending
Generally, our commercial loans are underwritten in our market
area on the basis of the borrower's ability to service such debt from identified
cash flow. We usually take as collateral a lien on available real estate,
equipment or other assets and obtain a personal guaranty of the business
principals.
In addition to commercial loans secured by real estate, we
make commercial mortgage loans to finance the purchase of real property, which
generally consists of real estate on which structures have already been
completed or will be completed and occupied by the borrower. We offer a variety
of mortgage loan products that generally are amortized over five to 20 years.
Our commercial mortgage loans are secured by first liens on real estate.
Typically we have both fixed and variable interest rates and amortize over a ten
to 20 year period with balloon payments due at the end of three to five years.
As a Preferred SBA Lender (discussed above), we also issue full term variable
rate real estate loan commitments when the facility is enhanced by the
underlying SBA guaranty. In underwriting commercial mortgage loans,
consideration is given to the property's operating history, future operating
projections, current and projected occupancy, location and physical condition.
The underwriting analysis also includes credit checks, appraisals, environmental
assessments and a review of the financial condition of the borrower.
Construction Lending
The Company originates construction loans on both one- to
four-family residences and on commercial real estate properties. The Company
originates two types of residential construction loans, consumer and builder.
The Company originates consumer construction loans to build single family
residences. The Company will originate builder construction loans to companies
engaged in the business of constructing homes for resale. These loans may be for
homes currently under contract for sale or homes built for speculative purposes
to be marketed for sale during construction. For owner occupied single family
residences, the borrower and the property must qualify for permanent financing.
Prequalification for owner occupied single family residences is required. For
commercial property, the borrower must qualify for permanent financing and the
debt service coverage must be 1.25 to 1 or more. Qualification for commercial
properties can be determined by the loan officer as part of the credit
presentation. Absent such prequalification, a construction loan will not be
approved by the Company. The Company originates land acquisition and development
loans with the source of repayment being either the sale of finished lots or the
sale of homes to be constructed on the finished lots. Construction loans are
generally offered with terms up to twelve months.
Construction loans are generally made in amounts up to 75% of
the value of the security property for "spec" single family residences and
commercial properties and up to 80% for owner-occupied single family residences.
During construction, loan proceeds are disbursed in draws as construction
progresses based upon inspections of work in place by independent construction
inspectors. At December 31, 2003, the Company had construction loans, including
land acquisition and development loans totaling $113,846,726 or 32.9% of the
Company's total loan portfolio.
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Construction loans are generally considered to involve a
higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the security property's
value upon completion of construction as compared to the estimated costs of
construction, including interest. Also, the Company assumes certain risks
associated with the borrower's ability to complete construction in a timely and
workmanlike manner. If the estimate of value proves to be inaccurate, or if
construction is not performed timely or accurately, the Company may be
confronted with a project which, when completed, has a value which is
insufficient to assure full repayment.
Consumer Lending
Consumer loans include automobile loans, recreational vehicle
loans, boat loans, home improvement loans, personal loans (collateralized and
uncollateralized) and deposit account collateralized loans. The terms of these
loans typically range from 12 to 84 months and vary based upon the nature of
collateral and size of loan. The Company's portfolio of consumer loans primarily
consists of adjustable-rate home equity lines of credit and installment loans
secured by new or used automobiles, boats and recreational vehicles and loans
secured by deposits. At December 31, 2003, consumer loans totaled $3,194,582.
Consumer loans typically range from 12 to 84 months, and vary based upon the
nature of the collateral and size of loan.
As of December 31, 2003, home equity loans totaled $3,520,000,
or .9% of the Company's gross loan portfolio. The Company's home equity loans
are adjustable-rate and reprice with changes in the Company's internal prime
rate. Adjustable-rate home equity lines of credit are offered in amounts up to
80% of the appraised value. Home equity lines of credit are offered with terms
up to 10 years.
Loan Servicing
Loans are serviced by the Company's loan servicing department
except for single family mortgage loans, which are sold shortly after being
originated. The loan officer is responsible for the day-to-day relationship with
the customer, unless the loan becomes delinquent, at which time the
responsibilities are reassigned to credit administration. The loan servicing is
centralized at the Company's corporate headquarters. As of December 31, 2003,
the Company was servicing $306,251,761 of loans originated by the Company but
subsequently sold to other investors.
The Company's loan servicing operations performed by the loan
servicing department are intended to provide prompt customer service and
accurate and timely information for account follow-up, financial reporting and
management review. Following the funding of an approved loan, all pertinent loan
data is entered into the Company's data processing system, which provides
monthly billing statements, tracks payment performance, and effects agreed upon
interest rate adjustments on loans. Regular loan service efforts include payment
processing and collection notices, as well as tracking the performance of
additional borrower obligations with respect to the maintenance of casualty
insurance coverage, payment of property taxes and senior liens. When payments
are not received by their contractual due date, collection efforts begin on the
11th day of delinquency with a telephone contact. If the borrower is
non-responsive or the loan officer feels more stringent action may be required,
the Chief Credit Officer is consulted. Notices of default are generally filed
when the loan has become 30-90 days past due.
12 of 70
Credit Risk and Loan Review
The Company incurs credit risk whenever it extends credit to,
or enters into other transactions with, its customers. The risks associated with
extensions of credit include general risk, which is inherent in the lending
business, and risk specific to individual borrowers. Loan review and other loan
monitoring practices provide a means for the Company's management to ascertain
whether proper credit, underwriting and loan documentation policies, procedures
and practices are being followed by the Company's loan officers and are being
applied uniformly throughout the Company. The Chief Credit Officer along with
the President oversee the daily administration of loan review. They also approve
loan officer requests for changes in risk ratings. Loan officers are responsible
for continually grading their loans so that individual credits properly reflect
the risk inherent therein. On an annual basis, the Board of Directors provides
for a third-party outside loan review of all loans that meet certain criteria
originated since the previous review. While the Company continues to review
these and other related functional areas, there can be no assurance that the
steps the Company has taken to date will be sufficient to enable it to identify,
measure, monitor and control all credit risk.
Concentrations of Credit
The Company's primary investment is in loans, 85% of which are
secured by real estate. Therefore, although the Company monitors the real estate
loan portfolio on a regular basis to avoid undue concentrations to a single
borrower or type of real estate collateral, real estate in general is considered
a concentration of investment. The Company seeks to mitigate this risk by
requiring each borrower to have a certain amount of equity in the real estate at
the time of origination, depending on the type of real estate and the credit
quality of the borrower. Trends in the market are monitored closely by
management on a regular basis.
Under federal law, the Company's ability to make aggregate
loans-to-one-borrower is limited to 15% of unimpaired capital and surplus (as of
December 31, 2003, this amount was $6,537,707) plus an additional 10% of
unimpaired capital and surplus if a loan is secured by readily-marketable
collateral (defined to include only certain financial instruments and gold
bullion).
Investment Activities
The investment policy of the Company, as established by the
Board of Directors, attempts to provide for and maintain liquidity, generate a
favorable return on investments without incurring undue interest rate and credit
risk, and complement the Company's lending activities. The Company's policies
provide the authority to invest in bank-qualified securities. The Company's
policies provide that all investment purchases, that are outside the policy
guidelines, be approved by the Board of Directors or committee thereof.
Purchases and sales under this limitation and within the guidelines of the
policies may be completed in the discretion of the President, the Chief
Financial Officer or the Chief Operating Officer. At December 31, 2003, the
Company held $1,145,000 in FRB Stock and FHLB stock as well as $21,400,000 in
federal funds sold.
13 of 70
Asset/Liability Management
Interest rate risk ("IRR") and credit risk are the two
greatest sources of financial exposure for insured financial institutions. IRR
represents the impact that changes in absolute and relative levels of market
interest rates may have upon the Company's net interest income ("NII"). Changes
in the NII are the result of changes in the net interest spread between
interest-earning assets and interest-bearing liabilities (timing risk), the
relationship between various rates (basis risk), and changes in the shape of the
yield curve.
The Company realizes a significant portion of its income from
the differential or spread between the interest earned on loans, investments,
other interest-earning assets and the interest incurred on deposits. The volumes
and yields on loans, deposits and borrowings are affected by market interest
rates. As of December 31, 2003, 95.6% of the Company's loan portfolio was tied
to adjustable rate indices. The majority of the loans are tied to the Bank's
internal prime rate and reprice immediately. The exception is SBA 7a loans,
which reprice on the first day of the subsequent quarter after a change in
prime. As of December 31, 2003, 45.5% of the Company's deposits were time
deposits with a stated maturity (generally one year or less) and a fixed rate of
interest. As of December 31, 2003, 100% of the Company's borrowings were
floating rate with a remaining term of 29 - 30 years.
Changes in the market level of interest rates directly and
immediately affect the Company's interest spread, and therefore profitability.
Sharp and significant changes to market rates can cause the interest spread to
shrink or expand significantly in the near term, principally because of the
timing differences between the adjustable rate loans and the maturities (and
therefore repricing) of the deposits and borrowings.
Measuring the volume of repricing or maturing assets and
liabilities, a Static Gap analysis, does not always measure the full impact on
net interest income. Static Gap analysis does not account for rate caps on
products; dynamic changes such as increasing prepay speeds as interest rates
decrease, basis risk, or the benefit of non-rate funding sources. The relation
between product rate repricing and market rate changes (basis risk) is not the
same for all products. Consequently, in addition to GAP analysis, we use a
simulation model and shock analysis to test the interest rate sensitivity of net
interest income and the balance sheet, respectively. Contractual maturities and
repricing opportunities of loans are incorporated in the model as are prepayment
assumptions, maturity data and call options within the investment portfolio.
Assumptions based on past experience are incorporated into the model for
non-maturity deposit accounts. We have found that historically interest rates on
these deposits change more slowly in a rising rate environment than in a
declining rate environment. Management expects to experience higher net interest
income when rates rise.
14 of 70
Contractual Static GAP Position as of December 31, 2003
-------------------------------------------------------
After After One
Within Three Months Year But
Three But Within Within After
Months One Year Five Years Five Years Total
------ -------------- ---------- ---------- -----------
(Dollars in Thousands)
Interest-Earning Assets:
Federal Funds Sold $ 21,400 $ 0 $ 0 $ 0 $ 21,400
Certificates of Deposit 0 0 0 0 0
Investment Securities 0 0 0 0 0
FRB/FHLB Stock 0 0 0 1,145 1,145
Loans 304,657 21,071 35,425 1,893 363,046
-------- -------- -------- -------- --------
Total $326,057 $ 21,071 $ 35,425 $ 3,038 $385,591
-------- -------- -------- -------- --------
Interest-Bearing Liabilities
Money Market and NOW
Deposits $ 61,340 $ 0 $ 0 $ 0 $ 61,340
Savings 35,180 0 0 0 35,180
Time Deposits 84,937 79,086 10,577 0 174,600
Other Borrowings 12,372 0 0 0 12,372
-------- -------- -------- -------- --------
Total $193,829 $ 79,086 $ 10,577 $ 0 $283,492
-------- -------- -------- -------- --------
Period GAP $132,228 $(58,015) $ 24,849 $ 3,038
Cumulative GAP $132,228 $ 74,213 $ 99,062 $102,100
Period GAP to Total Assets 30.7% (13.4%) 5.8% 0.7%
Cumulative GAP 30.7% 17.2% 22.9% 23.7%
Total Assets $431,212
========
The following table shows the effects of changes in projected
net interest income for 2004 under the interest rate shock scenarios stated in
the table. The table was prepared as of December 31, 2003, at which time the
Company's internal prime rate was 7% and Wall Street Journal prime rate was 4%.
Projected Net Change from % Change from
Changes in Rates Interest Income Base Case Base Case
- --------------------------------------------------------------------------------
(Dollars in Thousands)
+ 300 bp $26,253 $2,578 10.9%
+ 200 bp 24,845 1,170 4.9%
+ 100 bp 23,776 101 .4%
0 bp 23,675 0 0%
-100 bp 23,970 295 1.2%
-200 bp 24,264 589 2.5%
-300 bp 24,559 884 3.7%
Assumptions are inherently uncertain, and, consequently, the
model cannot precisely measure net interest income or precisely predict the
impact of changes in interest rates on net interest income. Actual results will
differ from simulated results due to timing, magnitude and frequency of interest
rate changes, as well as changes in market conditions and management strategy.
15 of 70
Non-Accrual, Past Due and Restructured Loans
Nonperforming assets consist of nonperforming loans and Other
Real Estate Owned (OREO). The Company had $198,861 of non-performing loans as of
December 31, 2001, of which $92,895 was guaranteed by the SBA, compared to
$1,908,169 of non-performing loans as of December 31, 2002, of which $1,077,597
was government guaranteed. At December 31, 2003, the Company had $4,160,032 of
nonperforming loans, $3,378,401 of which were government guaranteed. There was
$485,036 of OREO at December 31, 2003. There was no OREO at year end 2002 and
2001.
Pursuant to SBA operating procedures, real estate collateral
is liquidated when a loan becomes uncollectible. Should there be a shortfall in
liquidation proceeds, the SBA will assume 75% - 85% of that shortfall. The ratio
of nonperforming loans to total loans (after reducing for SBA guarantees) was
..31%, .01%, and .07% for the years ended 2002, 2001, and 2000, respectively.
We generally place a loan on nonaccrual status and cease
accruing interest when loan payment performance is deemed unsatisfactory. All
loans past due 90 days, however, are placed on nonaccrual status, unless the
loan is both well secured and in the process of collection. Cash payments
received while a loan is classified as nonaccrual are recorded as a deduction of
principal as long as doubt exists as to collection. We are sometimes required to
revise a loan's interest rate or repayment terms in a troubled debt
restructuring. As of December 31, 2001 restructured loans were $153,670 as
compared to $1,064,217 at December 31, 2002 and $948,691 at December 31, 2003.
Our internal loan review department regularly evaluates potential problem loans
as to risk exposure to determine the adequacy of our allowance for loan losses.
We review collateral value on loans secured by real estate
during the internal loan review process. New appraisals are acquired when loans
are categorized as nonperforming or potential problem loans. In instances where
updated appraisals reflect reduced collateral values, an evaluation of the
borrower's overall financial condition is made to determine the need, if any,
for possible write-downs or appropriate additions to our allowance for loan
losses.
The following table presents information concerning nonaccrual
loans, OREO, accruing loans which are contractually past due 90 days or more as
to interest or principal payments and still accruing, and restructured loans:
16 of 70
Nonaccrual, Past Due, and Restructured Loans
December 31,
------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------------------------------------------------------------
(Dollars in Thousands)
Nonaccrual loans:
Commercial $ 660 $ 575 $ 0 $ 0 $ 0
Real estate - Construction 0 0 0 0 0
Real estate - Other 3,500 1,333 99 272 259
Installment 0 0 0 0 0
------- ------- ------- ------- -------
Total 4,160 1,908 99 272 259
OREO 485 0 0 0 0
------- ------- ------- ------- -------
Total nonaccrual loans and OREO $ 4,645 $ 1,908 $ 99 $ 272 $ 259
======= ======= ======= ======= =======
Total nonaccrual loans as a percentage of 1.1% .7% .1% .3% .5%
total loans
Total nonaccrual loans and OREO as a 1.3% .7% .1% .3% .5%
percentage of total loans and OREO
Allowance for loan losses to total loans 1.0% 1.1% .8% 1.0% 1.0%
Allowance for loan losses to nonaccrual
loans 86.7% 158.0% 0% 340.0% 213.0%
Loans past due 90 days or more on accrual status:
Commercial $ 0 $ 0 $ 0 $ 0 $ 0
Real estate 0 0 100 0 0
Installment 0 0 0 0 0
------- ------- ------- ------- -------
Total 0 0 0 0 0
======= ======= ======= ======= =======
Restructured loans:
On accrual status 949 1,064 0 0 0
On nonaccrual status 0 0 0 0 0
------- ------- ------- ------- -------
Total $ 949 $ 1,064 $ 0 $ 0 $ 0
======= ======= ======= ======= =======
The table below summarizes the approximate changes in gross
nonaccrual loans for the years ended December 31, 2003 and 2002.
Changes in Nonaccrual Loans
2003 2002
-------------------------
(Dollars in Thousands)
Balance, beginning of the year $1,908 $ 106
Loans placed on nonaccrual 4,041 1,908
Charge-offs (536) (100)
Loans returned to accrual status 0 (6)
Repayments (including interest applied to principal) 83 0
Transfers to OREO 1,336 0
------ ------
Balance, end of year $4,160 $1,908
====== ======
17 of 70
The additional interest income that would have been recorded
from nonaccrual loans, if the loans had not been on nonaccrual status was
$445,311, $160,715, and $24,616 for the years ended December 31, 2003, 2002, and
2001, respectively.
Interest payments received on nonaccrual loans are applied to principal unless
there is no doubt as to ultimate full repayment of principal, in which case, the
interest payment is recognized as interest income. Interest income not
recognized on nonaccrual loans reduced the net interest margin by .13%, .07% and
..02% basis points for the years ended December 31, 2003, 2002, and 2001,
respectively.
Other Real Estate Owned
The amount of the Bank's OREO was $485,036 at December 31,
2003 compared to $0 a year ago. The Bank's policy is to record these properties
at estimated fair value, net of selling expenses, at the time they are
transferred into OREO, thereby tying future gains or losses from sale or
potential additional write-downs to underlying changes in the market.
Potential Problem Loans
At December 31, 2003, in addition to loans disclosed above as
past due, nonaccrual or restructured, management also identified $2,610,818 of
additional classified loans net of SBA guaranteed loans, where the ability to
comply with the present loan payment terms in the future is questionable.
However, the inability of the borrowers to comply with repayment terms was not
sufficiently probable to place the loan on nonaccrual status at December 31,
2003. This amount was determined based on analysis of information known to
management about the borrowers' financial condition and current economic
conditions. Estimated potential losses from these potential problem loans have
been provided for in determining the allowance for loan losses at December 31,
2003.
Management's classification of credits as nonaccrual,
restructured or problems does not necessarily indicate that the principal is
uncollectible in whole or part.
Allowance for Loan Losses
The allowance for loan losses is a reserve established through
charges to earnings in the form of a provision for loan losses. We have
established an allowance for loan losses that we believe is adequate for
estimated losses in our loan portfolio. Based on an evaluation of the loan
portfolio, management presents a quarterly review of the allowance for loan
losses to our Board of Directors, indicating any change in the allowance since
the last review and any recommendations as to adjustments. In making its
evaluation, we consider the diversification by industry of our commercial loan
portfolio, the effect of changes in the local real estate market on collateral
values, the results of recent regulatory examinations, the effects on the loan
portfolio of current economic indicators and their probable impact on borrowers,
the amount of charge-offs for the period, the amount of nonperforming loans and
related collateral security, the evaluation of our loan portfolio through our
loan review function and the annual examination of our financial statements by
our independent auditors. Charge-offs occur when loans are deemed to be
uncollectible.
18 of 70
We follow a loan review program to evaluate credit risk in our
loan portfolio. Through the loan review process, we maintain an internally
classified loan watch list which, along with the delinquency list of loans,
helps us assess the overall quality of the loan portfolio and the adequacy of
the allowance for loan losses. Loans classified as "substandard" are those loans
with clear and defined weaknesses such as a highly-leveraged position,
unfavorable financial ratios, uncertain repayment sources or poor financial
condition, which may jeopardize ultimate recoverability of the debt.
Loans classified as "doubtful/potential loss" are those loans
which have characteristics similar to substandard accounts but with an increased
risk that a loss may occur, or at least a portion of the loan may require a
charge-off if liquidated at present. Although loans classified as substandard do
not duplicate loans classified as doubtful, both substandard and doubtful loans
include some loans that are delinquent at least 30 days or on nonaccrual status.
Loans classified as "potential loss" are those loans that are identified as
having a high probability of being liquidated with loss within the next 12
months.
In addition to loans on the internal watch list classified as
substandard or doubtful/potential loss, we maintain additional classifications
on a separate watch list which further aids us in monitoring loan portfolios.
These additional loan classifications reflect warning elements where the present
status portrays one or more deficiencies that require attention in the
short-term or where pertinent ratios of the loan account have weakened to a
point where more frequent monitoring is warranted. These loans do not have all
of the characteristics of a classified loan (substandard, doubtful/potential
loss) but do show weakened elements as compared with those of a satisfactory
credit. We regularly review these loans to aid in assessing the adequacy of our
allowance for loan losses.
In order to determine the adequacy of the allowance for loan
losses, we consider the risk classification or delinquency status of loans and
other factors, such as collateral value, portfolio composition, trends in
economic conditions, including those discussed below, and the financial strength
of borrowers. We establish specific allowances for loans which management
believes require reserves greater than those allocated according to their
classification or delinquent status as prescribed in SFAS No. 114 (as amended by
SFAS No. 118). The amount of the special allowance is based on the estimated
value of the collateral securing the loans and other analyses pertinent to each
situation. Loans are identified for specific allowances from information
provided by several sources, including asset classification, third party
reviews, delinquency reports, periodic updates to financial statements, public
records and industry reports. All loan types are subject to specific allowances
once identified as impaired or non-performing.
Additionally, we use three approaches for the analysis of the
performing portfolio: migration, historical and examiner rule of thumb. These
methods are further broken down to identified loan pools within our portfolio.
Using these methodologies, we allocate reserves to each identified loan
classification and to performing loan pools. All methods are evaluated by loan
pools. However, in the migration method, commercial industrial and real estate
loans are evaluated on an individual basis. We then charge to operations a
provision for loan losses to maintain the allowance for loan losses at an
adequate level as determined by the foregoing methodology.
19 of 70
Given its industry make-up, the economy of our market areas
remains somewhat dependent on real estate and related industries (i.e.
construction, housing). While we maintain a reasonably diverse commercial and
consumer loan portfolio, any major downturn in real estate or construction could
have an adverse effect on borrowers' ability to repay loans and, therefore,
could potentially affect our results of operations and financial condition.
Consequently, in evaluating the adequacy of our allowance for
loan losses, management incorporates, among many other factors, the effect on
borrowers of an economic downturn in the real estate related industries, the
diversification of the loan portfolio and economic indicators and conditions.
Additionally, we have several procedures in place to assist us in minimizing
credit risk and maintaining the overall quality of our loan portfolio. We
frequently review and update our underwriting guidelines and monitor our
delinquency levels for any negative or adverse trends. To date, given the
diversification of our loan portfolio along with current economic indicators, we
have not deemed it necessary to substantially increase our allowance for loan
losses or alter current credit underwriting standards. However, no assurances
can be given that substantial increases in the allowance or alteration of
underwriting standards will not be necessary in the future.
The provision for loan loss is the amount expensed in the
current year and added to the allowance for loan loss. The allowance for loan
loss is a reserve kept at a level that is determined by a quarterly analysis of
the loan portfolio and its inherent risks. Examples of inherent risks in the
loan portfolio include the quality of the loans, the concentrations of credit by
collateral and industries, the Bank's lending staff and policies, and external
factors such as economic conditions.
20 of 70
The following table summarizes the activity in the allowance
for loan losses for the five years ended December 31, 2003:
Allowance for Loan Losses
Year ended December 31,
------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------------------------------------------------------------
(Dollars in Thousands)
Loans outstanding $360,749 $268,409 $149,035 $ 91,611 $ 55,915
Average amount of loans outstanding 318,600 284,849 118,440 73,334 45,760
Balance of allowance for loan 3,017 1,239 928 552 429
losses, beginning of years
Loans charged off:
Commercial (464) (338) 0 0 (132)
Real estate - Construction 0 0 0 0 0
Real estate - Other (37) (354) (89) (19) 0
Consumer (4) (15) 0 (1) 0
-------- -------- -------- -------- --------
Total loans charged off $ (505) $ (707) $ (89) $ (20) $ (132)
======== ======== ======== ======== ========
Recoveries of loans previously
charged off:
Commercial 19 11 0 0 75
Real estate - Construction 0 0 0 0 0
Real estate - Other 33 3 0 10 0
Consumer 22 11 0 1 0
-------- -------- -------- -------- --------
Total recoveries 74 25 0 11 75
-------- -------- -------- -------- --------
Net loans charged off (431) (652) (89) (9) (57)
Provision for Loan loss Expense 1,022 2,460 400 385 180
-------- -------- -------- -------- --------
Balance, end of year $ 3,608 $ 3,017 $ 1,239 $ 928 $ 552
======== ======== ======== ======== ========
Ratio of net charge-offs to average loans .14% .33% .07% .01% .12%
The following table describes the allocation of the allowance
for loan losses among various categories of loans and certain other information
for the dates indicated. The allocation is made for analytical purposes and is
not necessarily indicative of the categories in which future losses may occur.
The total allowance is available to absorb losses from any segment of loans.
At the Years Ended December 31,
2003 2002 2001
-------------------------------------------------------------------------------------------------
% in % in % in
Loans in Loans in Loans in
% of Each % of Each % of Each
Allowance Category Allowance Allowance Category Allowance Category
Allowance to Total to Total Amt. to Total to Total Allowance to Total to Total
Amt. Amt. Loans Amt. Loans Amt. Amt. Loans
-------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Commercial $ 154 4.3% 6.5% $ 172 5.7% 9.1% $ 80 6.5% 10.8%
Real Estate 655 18.2% 33.4% 667 22.1% 35.9% 291 23.5% 36.9%
Construction/Land
Development 589 16.3% 31.2% 391 13.0% 22.4% 186 15.0% 25.1%
Mortgage 0 .0% .7% 0 2.8% 3 .2% 4.4%
SBA 2,184 60.5% 27.3% 1,741 57.7% 28.2% 639 51.6% 19.4%
Consumer & Other 26 .7% .9% 46 1.5% 1.6% 40 3.2% 3.4%
------ ------ ------ ------ ------ ------ ------ ------ ------
Total $3,608 100.0% 100.0% $3,017 100.0% 100.0% $1,239 100.0% 100.0%
====== ====== ====== ====== ====== ====== ====== ====== ======
21 of 70
At the Years Ended December 31,
2000 1999
----------------------------------------------------------------
% in % in
Loans in Loans in
% of Each % of Each
Allowance Category Allowance Category
to Total to Total to Total to Total
Amt. Amt. Loans Amt. Amt. Loans
----------------------------------------------------------------
(Dollars in Thousands)
Commercial $ 86 9.3% 13.3% $ 57 10.3% 17.8%
Real Estate 212 22.8% 39.1% 157 28.4% 38.0%
Construction/Land
Development 171 18.4% 25.3% 69 12.5% 18.2%
Mortgage 4 .4% 1.8% 3 .5% 1.6%
SBA 424 45.8% 15.8% 239 43.4% 17.8%
Consumer & Other 31 3.3% 4.7% 27 4.9% 6.6%
---------- ----------- ---------- ---------- ---------- --------
Total $ 928 100.0% 100.0% $552 100.0% 100.0%
===== ====== ====== ==== ====== ======
Based on the recent history of charge offs in the "Pass" category of the
Company's loan portfolio, the Company has allocated a higher percentage of its
reserve for loan losses, increasing the percentage allocated from .73% as of
December 31, 2002 to .76% as of December 31, 2003 for the low allocation, and
from .84% as of December 31, 2002 to .87% as of December 31, 2003 for the high
allocation. Other changes are the result of relative changes in the size of the
loan portfolios. As a result of past decreases in local and regional real estate
values and the significant losses experienced by many financial institutions,
there has been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as a part of the examinations of
such institutions by banking regulators. While the Company believes it has
established its existing allowance for loan losses in accordance with generally
accepted accounting principles, there can be no assurance that regulators, in
reviewing the Company's loan portfolio, will not request the Company to increase
significantly its allowance for loan losses. In addition, because future events
affecting borrowers and collateral cannot be predicted with certainty, there can
be no assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above. Any material increase in
the allowance for loan losses may adversely affect the Company's financial
condition and results of operations.
Deposits
The daily average balances and weighted average rates paid on deposits and
other borrowings for each of the years ended December 31, 2003, 2002 and 2001
are represented below.
22 of 70
Years Ended December 31,
2003 2002 2001
---------------------------------------------------------------------------------------------------------
% of total Average % of total Average % of total Average
Average Avg. Rate Average Avg. Rate Average Avg. Rate
Balance Deposits % Balance Deposits % Balance Deposits %
------------- ------------ ---------- ---------- ----------- ----------- ----------- ----------- -------
(Dollars in Thousands)
Now $ 24,075 6.7% .10% $ 18,564 8.2% .10% $13,202 9.2% .56%
Money Market 37,238 10.4% 1.43% 38,621 16.9% 1.62% 19,346 13.5% 2.69%
Savings 32,739 9.2% .59% 27,951 12.3% .82% 28,436 19.8% 2.19%
Time deposits 75,177 21.1% 2.44% 26,509 11.6% 3.04% 14,369 10.0% 4.77%
less than
$100,000
Time deposits 76,998 21.6% 2.46% 35,682 15.7% 3.10% 17,845 12.4% 4.68%
$100,000 and
over
Other 10,906 3.1% 4.32% 10,581 4.6% 3.21% 0 0% 0.00%
------------- ------------ ---------- ----------- ----------- ----------- -------
Borrowings
Total 257,133 72.1% 1.92% 157,908 69.3% 1.98% 93,198 64.9% 2.93%
interest-bearing
liabilities
Non 99,565 27.9% 0.00% 69,972 30.7% 0.00% 50,173 35.1% 0.00%
interest-bearing
deposit
Total $356,698 100.0% 1.38% $227,880 100.0% 1.37% $143,371 100.0% 1.91%
Deposits & ======== ====== ======== ====== ======== ======
Other
Borrowings
At December 31, 2003, the Company had $85,829 in time deposits in the
amounts of $100,000 or more consisting of 529 accounts maturing as follows:
Maturity Period Amount Weighted Average Rate
- --------------------------------------------------------------
Three months or less $ 4,274 1.276%
Greater than Three Months to Six Months 5,119 1.673%
Greater than Six Months to Twelve Months 7,670 1.693%
Greater than Twelve Months 68,766 3.166%
------
Total $85,829 2.213%
=======
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Short-term Borrowings
Set forth below is a schedule of outstanding short-term borrowings (less
than or equal to 1 year):
Year Ended December 31,
----------------------------------------------------
2003 2002 2001
----------------------------------------------------
(Dollars in Thousands)
Federal Funds Purchased $ 0 $ 0 $ 0
FHLB Advances 0 10,000 0
Line of Credit 0 0 0
---------- ----------- ------------
Total Short-term Borrowings $ 0 $10,000 $ 0
========== =========== ============
Time Certificate of Deposits
Set forth is a maturity schedule of domestic time certificates of deposit
of $100,000 or more at the indicated period.
At December 31, 2003
-------------------------------
(Dollars in Thousands)
Three months or less $47,444
Over three through 12 months 33,775
Over one through five years 4,610
-----------
Total $85,829
===========
Supervision and Regulation
Bank holding companies and national banks are extensively regulated under
federal law and to a lesser extent, state law. The following is a brief summary
of certain statutes and rules that affect or will affect the Company and the
Bank. This summary is qualified in its entirely by reference to the particular
statute and regulatory provisions referred to below and is not intended to be an
exhaustive description of all applicable statutes and regulations.
As a bank holding company, the Company principally is subject to Federal
Reserve Bank regulations. The Company is required to file with the Federal
Reserve quarterly and annual reports and such additional information the Federal
Reserve may require pursuant to the BHCA. The Federal Reserve may conduct
examinations of bank holding companies and their subsidiaries.
Under a policy of the Federal Reserve with respect to bank
holding company operations, a bank holding company is required to serve as a
source of financial strength to its subsidiary depository institutions and to
commit resources to support such institutions in circumstances where it might
not do so absent such a policy. The Federal Reserve under the BHCA also has the
authority to require a bank holding company to terminate any activity or to
relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a
bank) upon the Federal Reserve's determination that such activity or control
constitutes a serious risk to the
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financial soundness and stability of any bank subsidiary of the bank holding
company. The Federal Reserve may also prohibit the Company, except in certain
instances prescribed by statute, from acquiring or engaging in non-banking
activities, other than activities that are deemed by the Federal Reserve to be
so closely related to banking or managing or controlling banks as to be a proper
incident thereto. See "Recent and Proposed Legislation" in this Section.
In addition, insured depository institutions under common control are
required to reimburse the FDIC for any loss suffered by its deposit insurance
funds as a result of the default of a commonly controlled depository institution
or for any assistance provided by the FDIC to a commonly controlled insured
depository institution in danger of default. The FDIC may decline to enforce the
cross-guarantee provisions if it determines that a waiver is in the best
interest of the deposit insurance funds. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
The Bank as a national banking association is subject to regulation,
supervision and examination by the Comptroller and subject to applicable laws
and regulations under the National Bank Act, the Federal Deposit Insurance Act
and Federal Reserve Act, as well as others. The Bank's deposits are insured
(presently $100,000 per account) by the Bank Insurance Fund ("BIF"). As a result
of this deposit insurance function, the FDIC also has certain supervisory
authority and powers over the Bank as well as all other FDIC insured
institutions. If, as a result of an examination of the Bank, the Comptroller
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
Comptroller. Such remedies include the power to enjoin unsafe or unsound
practices, to require affirmative action to correct any conditions resulting
from any violation or practice, to issue an administrative order that can be
judicially enforced, to direct an increase in capital, to restrict growth, to
assess civil monetary penalties, to remove officers and directors and ultimately
to request the FDIC to terminate the Bank's deposit insurance. The Bank has
never been subject to any such enforcement action. The Bank is also subject to
certain provisions of California law if not in conflict with or preempted by
federal law or regulation.
Various requirements and restrictions under the laws of the United States
affect the operations of the Bank. Statutes and regulations relate to many
aspects of the Bank's operations, including reserves against deposits, ownership
of deposit accounts, interest rates payable on deposits, loans, investments,
mergers and acquisitions, borrowings, dividends, locations of branch offices and
capital requirements. Further, the Bank is required to maintain certain levels
of capital. See "Capital Adequacy Requirements" in this Section below.
Recent and Proposed Legislation
From time to time, legislation is enacted which has the effect of
increasing the cost of doing business, limiting or expanding permissible
activities or affecting the competitive balance between banks and other
financial institutions. Proposals to change the laws and regulations governing
the operations and taxation of banks and other financial institutions are
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frequently made in Congress, in the California legislature and by various bank
regulatory agencies.
Sarbanes-Oxley Act
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of
2002 implementing legislative reforms intended to address corporate and
accounting fraud. In addition to the establishment of a new accounting oversight
board which will enforce auditing, quality control and independence standards
and will be funded by fees from all publicly traded companies, the bill
restricts provision of both auditing and consulting services by accounting
firms. To ensure auditor independence, any non-audit services being provided to
an audit client will require pre-approval by the company's audit committee
members. In addition, the audit partners must be rotated. The Act requires chief
executive officers and chief financial officers, or their equivalent, to certify
to the accuracy of periodic reports filed with the SEC, subject to civil and
criminal penalties if they knowingly or willfully violate this certification
requirement. In addition, under the Act, legal counsel will be required to
report evidence of a material violation of the securities laws or a breach of
fiduciary duty by a company to its chief executive officer or its chief legal
officer, and, if such officer does not appropriately respond, to report such
evidence to the audit committee or other similar committee of the Board of
Directors or the Board itself. The Bank is not required to file reports with the
SEC.
Longer prison terms and increased penalties will also be applied to
corporate executives who violate federal securities laws, the period during
which certain types of suits can be brought against a company or its officers
has been extended, and bonuses issued to top executives prior to restatement of
a company's financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct. Executives are also prohibited from
trading during retirement plan "blackout" periods, and loans to company
executives are restricted. The Act accelerates the time frame for disclosures by
public companies, as they must immediately disclose any material changes in
their financial condition or operations. Directors and executive officers must
also provide information for most changes in ownership in a company's securities
within two business days of the change.
The Act also prohibits any officer or director of a company or any other
person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified
accountant engaged in the audit of the company's financial statements for the
purpose of rendering the financial statement's materially misleading. The Act
also required the SEC to prescribe rules requiring inclusion of an internal
control report and assessment by management in the annual report to
shareholders. In addition, the Act requires that each financial report required
to be prepared in accordance with (or reconciled to) GAAP and filed with the SEC
reflect all material correcting adjustments that are identified by a "registered
public accounting firm" in accordance with accounting principles generally
accepted in the United States of America and the rules and regulations of the
SEC.
USA PATRIOT Act
On October 26, 2001, the President signed the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism (USA PATRIOT)
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Act of 2001. Under the USA PATRIOT Act, financial institutions are subject to
prohibitions against specified financial transactions and account relationships
as well as enhanced due diligence and "know your customer" standards in their
dealings with foreign financial institutions and foreign customers. For example,
the enhanced due diligence policies, procedures and controls generally require
financial institutions to take reasonable steps:
-- To conduct enhanced scrutiny of account relationships to guard against
money laundering and report any suspicious transaction;
-- To ascertain the identity of the nominal and beneficial owners of, and
the source of funds deposited into, each account as needed to guard
against money laundering and report any suspicious transactions;
-- To ascertain for any foreign bank, the shares of which are not
publicly traded, the identity of the owners of the foreign bank, and
the nature and extent of the ownership interest of each such owner;
and
-- To ascertain whether any foreign bank provides correspondent accounts
to other foreign banks and, if so, the identity of those foreign banks
and related due diligence information.
Under the USA PATRIOT Act, financial institutions were given 180 days from
enactment to establish anti-money laundering programs. The USA PATRIOT Act sets
forth minimum standards for these programs, including:
-- The development of internal policies, procedures and controls;
-- The designation of a compliance officer;
-- An ongoing employee training program; and
-- An independent audit function to test the programs.
In October, 2003, the Board of Directors of Bank adopted comprehensive
policies and procedures to address the requirements of the USA PATRIOT Act, and
management believes that the Bank is currently in full compliance with the Act.
Gramm-Leach-Bliley Act
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act. That legislation eliminated many of the barriers that
had separated the insurance, securities and banking industries since the Great
Depression. The federal banking agencies (the Board of Governors of the Federal
Reserve System, FDIC, Office of the Comptroller of the Currency) among others,
have drafted regulations to implement the Gramm-Leach-Bliley Act.
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The Gramm-Leach-Bliley Act is the result of a decade of debate in the
Congress regarding a fundamental reformation of the nation's financial system.
The law is subdivided into seven titles, by functional area. Title I acts to
facilitate affiliations among banks, insurance companies and securities firms.
Title II narrows the exemptions from the securities laws previously enjoyed by
banks, requires the Federal Reserve and the SEC to work together to draft rules
governing certain securities activities of banks and creates a new, voluntary
investment bank holding company. Title III restates the proposition that the
states are the functional regulators for all insurance activities, including the
insurance activities of federally-chartered banks. The law bars the states from
prohibiting insurance activities by depository institutions. The law encourages
the states to develop uniform or reciprocal rules for the licensing of insurance
agents. Title IV prohibits the creation of additional unitary thrift holding
companies. Title V imposes significant requirements on financial institutions
related to the transfer of nonpublic personal information. These provisions
require each institution to develop and distribute to accountholders an
information disclosure policy, and requires that the policy allow customers to,
and for the institution to, honor a customer's request to "opt-out" of the
proposed transfer of specified nonpublic information to third parties. Title VI
reforms the Federal Home Loan Bank system to allow broader access among
depository institutions to the system's advance programs, and to improve the
corporate governance and capital maintenance requirements for the system. Title
VII addresses a multitude of issues including disclosure of ATM surcharging
practices, disclosure of agreements among non-governmental entities and insured
depository institutions which donate to non-governmental entities regarding
donations made in connection with the CRA, and disclosure by the recipient
non-governmental entities of how such funds are used. Additionally, the law
extends the period of time between CRA examinations of community banks.
Activities of Subsidiaries of National Banks. Activities permissible for
financial subsidiaries of national banks include, but are not limited to, the
following: (a) lending, exchanging, transferring, investing for others, or
safeguarding money or securities; (b) insuring, guaranteeing, or indemnifying
against loss, harm, damage, illness, disability or death, or providing and
issuing annuities, and acting as principal, agent, or broker for purposes of the
foregoing, in any state; (c) providing financial, investment or economic
advisory services, including advising an investment company; (d) issuing or
selling instruments representing interests in pools of assets permissible for a
bank to hold directly; and (e) underwriting, dealing in or making a market in
securities.
Privacy. As required under Title V of the Gramm-Leach-Bliley Act, federal
banking regulators issued final rules on May 10, 2000 to implement the privacy
provisions of Title V. Pursuant to the rules, financial institutions must
provide (i) initial notices to customers about their privacy policies,
describing the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates; (ii) annual notices
of their privacy policies to current customers; and (iii) a reasonable method
for customers to "opt out" of disclosures to nonaffiliated third parties.
Compliance with the rules was optional until July 1, 2001. As of July 1,
2001, the Bank was in compliance with the privacy provisions of the
Gramm-Leach-Bliley Act and the implementing regulations, and subsequently, as
necessary, has updated and enhanced its procedures and practices in this
critical area.
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Safeguarding Confidential Customer Information. Under Title V of the
Gramm-Leach-Bliley Act, federal banking regulators were required to adopt rules
to require financial institutions to implement a program to protect confidential
customer information. In January 2000, the federal banking agencies adopted
guidelines requiring financial institutions to establish an information security
program to: (i) identify and assess the risks that may threaten customer
information; (ii) develop a written plan containing policies and procedures to
manage and control these risks; (iii) implement and test the plan; and (iv)
adjust the plan on a continuing basis to account for changes in technology, the
sensitivity of customer information and internal or external threats to
information security.
The guidelines were effective July 1, 2001. The Bank implemented a security
program appropriate to its size and complexity and the nature and scope of its
operations in advance of the July 1, 2001 effective date, and subsequently, as
necessary, has refined and improved its security program.
Community Reinvestment Act Sunshine Requirements. In February 2001, the
federal banking agencies adopted final regulations implementing Section 711 of
Title 7, the CRA Sunshine Requirements. The regulations require nongovernmental
entities or persons and insured depository institutions and affiliates that are
parties to written agreements made in connection with the fulfillment of the
institution's CRA obligations to make available to the public and the federal
banking agencies a copy of each such agreement. The regulations impose annual
reporting requirements concerning the disbursement, receipt and use of funds or
other resources under each such agreement. The effective date of the regulations
was April 1, 2001.
The Bank is not a party to any agreement that would be the subject of
reporting pursuant to the CRA Sunshine Requirements.
The Bank intends to comply with all provisions of the Gramm-Leach-Bliley
Act and all implementing regulations.
Deposit Insurance Reform
Both houses of the 108th Congress have among the bills each is to consider
during the current session a measure designed to make the administration of the
deposit insurance system more efficient by merging the Bank Insurance Fund and
the Savings Association Insurance Fund, and increasing the flexibility of the
FDI Act with regard to the appropriate level of the resulting Deposit Insurance
Fund, as established by the FDIC Board of Directors.
On February 4, 2003, Representative Spencer Bachus of Alabama introduced
bill H.R. 522, entitled the "Federal Deposit Insurance Reform Act of 2003". Most
recently, the bill was passed by the House on April 2, 2003, referred to the
Senate on April 4, 2003, and referred to the Committee on Banking, Housing and
Urban Affairs on the same day. H.R. 522 incorporates a number of provisions
requiring a merger of the Bank Insurance Fund and the Savings Association
Insurance Fund to form the Deposit Insurance Fund, increasing the coverage
amount for deposit insurance, amending the procedure and considerations utilized
by the Board of Directors of the FDIC in setting insurance assessment rates,
replacing the fixed target for the
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size of the Bank Insurance Fund of 1.25 percent of estimated insured deposits to
a range of not less than 1.15 and not more than 1.4 percent of estimated insured
deposits, making technical changes to the manner in which the FDIC gathers
information to assess the risk of future bank failures for use in analyzing the
adequacy of the Bank Insurance Fund and other technical amendments regarding
refunds, dividends and credits from the Deposit Insurance Fund. Finally, H.R.
522 directs the Comptroller General, the Board of Directors of the FDIC and the
National Credit Union Administration Board variously to conduct a number of
studies on issues including the utility of the prompt corrective provisions of
the FDI Act as implemented by the federal banking agencies, the appropriateness
of the organizational structure of the FDIC, and the feasibility of creating a
system of private deposit insurance for amounts over the maximum public deposit
insurance provided and the feasibility of converting to a voluntary or private
deposit insurance system.
On January 29, 2003, Senator Tim Johnson of South Dakota introduced S. 229,
entitled "A bill for the merger of the bank and savings association deposit
insurance funds, to modernize and improve the safety and fairness of the federal
deposit insurance system, and for other purposes." On the same day, the bill was
referred to the Committee on Banking, Housing and Urban Affairs. S. 229 also
seeks to merge the Bank Insurance Fund with the Savings Association Insurance
Fund to form the Deposit Insurance Fund, to increase the level of federal
deposit insurance coverage generally to $130,000 per account, replacing the
fixed target for the size of the Bank Insurance Fund of 1.25 percent of
estimated insured deposits to a range of not less than 1.10 and not more than
1.5 percent of estimated insured deposits, inserting a requirement that the FDIC
refund any overpaid assessment, and require studies, first by the Board of
Directors of the FDIC and the National Credit Union Administration Board on the
feasibility of increasing deposit insurance coverage for municipalities and
other units of local government, the feasibility of creating a system of private
deposit insurance for amounts over the maximum public deposit insurance
provided, and of the feasibility of using actual deposits rather than estimated
deposits in the calculation of the reserve ratio of the Deposit Insurance Fund.
No assurance can be given as to the passage, or failure, of the House or
Senate bills. First International Bank may incur additional costs, in the form
of deposit insurance premiums, in the event that either bill becomes law.
Capital Adequacy Requirements
The Federal Reserve and the Comptroller have adopted regulations
establishing minimum requirements for capital adequacy. These agencies may
establish higher minimum requirements if, for example, a bank previously has
received special attention or has a high susceptibility to interest rate risk.
The Federal Reserve has adopted capital adequacy guidelines for bank
holding companies and banks that are members of the Federal Reserve System and
have consolidated assets of $150 million or more. Bank holding companies subject
to the Federal Reserve's capital adequacy guidelines are required to comply with
the Federal Reserve's risk-based capital guidelines. Under these regulations,
the minimum ratio of total capital to risk-adjusted assets is 8%. At least half
of the total capital is required to be "Tier I capital," principally consisting
of common stockholders' equity, noncumulative perpetual preferred stock, and a
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limited amount of cumulative perpetual preferred stock, less certain goodwill
items. The remainder ("Tier II capital") may consist of a limited amount of
subordinated debt, certain hybrid capital instruments and other debt securities,
perpetual preferred stock, and a limited amount of the general loan loss
allowance. In addition to the risk-based capital guidelines, the Federal Reserve
has adopted a minimum Tier I capital (leverage) ratio, under which a bank
holding company must maintain a minimum level of Tier I capital to average total
consolidated assets of at least 3% in the case of a bank holding company which
has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the
stated minimum.
As of December 31, 2003, the Company's Tier I leverage ratio was 9.06%,
Tier I risk-based ratio was 10.01% and its total risk-based ratio was 11.54%.
The Comptroller's leverage-based capital guidelines require national banks
to maintain a minimum 4% Tier I leverage capital ratio for the most highly-rated
banks, with all other banks required to meet a higher minimum leverage ratio
that is 1% or more above the minimum. The risk-based capital guidelines provide
that banks must maintain a minimum capital-to-risk-weighted-assets ratio of 8%
and a minimum ratio of Tier I capital-to-risk-weighted-assets of 4%. The
guidelines provide a general framework for assigning assets and off-balance
sheet items to broad risk categories and provide procedures for the calculation
of the risk-based capital ratio.
As of December 31, 2003, the Tier I leverage ratio of the Bank's was 9.37%,
the Bank's Tier I risk-based ratio was 10.33% and the total risk-based ratio was
11.26%.
The federal banking regulators are required to take "prompt corrective
action" with respect to capital-deficient institutions. Agency regulations
define, for each capital category, the levels at which institutions are "well
capitalized," "adequately capitalized," "under capitalized," "significantly
under capitalized" and "critically under capitalized." A "well capitalized" bank
has a total risk-based capital ratio of 10.0% or higher; a Tier I risk-based
capital ratio of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not
subject to any written agreement, order or directive requiring it to maintain a
specific capital level for any capital measure. An "adequately capitalized" bank
has a total risk-based capital ratio of 8.0% or higher; a Tier I risk-based
capital ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or
higher if the bank was rated a composite 1 in its most recent examination report
and is not experiencing significant growth); and does not meet the criteria for
a well capitalized bank. A bank is "under capitalized" if it fails to meet any
one of the ratios required to be adequately capitalized.
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In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the federal agency's enforcement
powers become more severe. A significantly undercapitalized institution is
subject to mandated capital raising activities, restrictions on interest rates
paid and transactions with affiliates, removal of management, and other
restrictions. A federal agency has only very limited discretion in dealing with
a critically undercapitalized institution and is virtually required to appoint a
receiver or conservator.
Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.
Deposit Insurance Assessments
The Bank must pay assessments to the FDIC for federal deposit insurance
protection. FDIC insured depository institutions pay insurance premiums at rates
based on their risk classification. Institutions assigned to higher-risk
classifications (that is, institutions that pose a greater risk of loss to their
respective deposit insurance funds) pay assessments at higher rates than
institutions that pose a lower risk. An institution's risk classification is
assigned based on its capital levels and the level of supervisory concern the
institution poses to the regulators. In addition, the FDIC can impose special
assessments in certain instances. The Bank paid $44,715 in 2003, as compared to
$59,231 in 2002. The current range of BIF and Saving Association Insurance Fund
("SAIF") assessments are (not including FICO bond assessments) between 0.0% and
0.27% of deposits. The rate for Temecula Valley Bank was 0.00% for 2002 and
2003.
The FDIC established a process for raising or lowering all rates for
insured institutions semi-annually if conditions warrant a change. Under this
system, the FDIC has the flexibility to adjust the assessment rate schedule
twice a year without seeking prior public comment, but only within a range of
five cents per $100 above or below the premium schedule adopted. Changes in the
rate schedule outside the five cent range above or below the current schedule
can be made by the FDIC only after a full rulemaking with opportunity for public
comment.
An increase in the assessment rate could have a material adverse effect on
the Company's earnings, depending on the amount of the increase. Based upon an
increase in the amount of the bank insurance fund for the quarter ended June 30,
2003 and the preliminary results for September 30, 2003, which show a further
increase, it appears that an increase in the deposit insurance premium amount is
unlikely in the near term.
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The FDIC is authorized to terminate a depository institution's deposit
insurance upon a finding by the FDIC that the institution's financial condition
is unsafe or unsound or that the institution has engaged in unsafe or unsound
practices or has violated any applicable rule, regulation, order or condition
enacted or imposed by the institution's regulatory agency.
Change in Control
The BHCA prohibits the Company from acquiring direct or indirect control of
more than 5% of the outstanding voting securities or substantially all the
assets of any bank or savings bank or merging or consolidations with another
bank holding company or savings bank holding company without prior approval of
the Federal Reserve. Similarly, Federal Reserve approval (or in certain cases,
nondisapproval) must be obtained prior to any person acquiring control of a bank
holding company. Control is conclusively presumed to exist if, among other
things, a person acquires more that 25% of any class of voting stock of the
Company or controls in any manner the election of a majority of the directors of
the Company. Control is presumed to exist if a person acquires more that 10% of
any class of voting stock and the stock is registered under Section 12 of the
Exchange Act or the acquirer will be the largest stockholder after the
acquisition.
Examinations
The Federal Reserve through the BHCA has the authority to exam and evaluate
the Company and its subsidiary. The Comptroller periodically examines and
evaluates national banks. These examinations review areas such as capital
adequacy, reserves, loan portfolio quality and management, consumer and other
compliance issues, investments and management practices. In addition to these
regular exams, we are required to furnish quarterly and annual reports to the
Federal Reserve and the Comptroller. Both agencies may exercise cease and desist
or other supervisory powers if actions represent unsafe or unsound practices or
violations of law. Further, any proposed addition of any individual to the board
of directors of a bank or the employment of any individual as a senior executive
officer of a bank, or the change in responsibility of such an officer, will be
subject to 90 days prior written notice to the Comptroller if a bank is not in
compliance with the applicable minimum capital requirements, is otherwise a
troubled institution or the Comptroller determines that such prior notice is
appropriate for a bank. The Comptroller then has the opportunity to disapprove
any such appointment.
Federal Securities Law
The Company has registered its common stock with the SEC pursuant to
Section 12(g) of the Exchange Act. As a result of such registration, the proxy
and tender offer rules, insider trading reporting requirements, annual and
periodic reporting and other requirements of the Exchange Act are applicable to
the Company.
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Transactions with Insiders and Affiliates
Depository institutions are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act with respect to loans to directors,
executive officers and principal stockholders. Under Section 22(h), loans to
directors, executive officers and stockholders who own more than 10% of a
depository institution and certain affiliated entities of any of the foregoing,
may not exceed, together with all other outstanding loans to such person and
affiliated entities, the institution's loans-to-one-borrower limit (as discussed
below). Section 22(h) also prohibits loans above amounts prescribed by the
appropriate federal banking agency to directors, executive officers and
stockholders who own more than 10% of an institution, and their respective
affiliates, unless such loans are approved in advance by a majority of the board
of directors of the institution. Any "interested" director may not participate
in the voting. The prescribed loan amount (which includes all other outstanding
loans to such person), as to which such prior board of director approval is
required, as being the greater of $25,000 or 5% of capital and surplus (up to
$500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that
loans to directors, executive officers, and principal stockholders be made on
terms substantially the same as offered in comparable transactions with
non-executive employees of the Bank. There are additional limits on the amount a
bank can loan to an executive officer.
Transactions between a bank and its "affiliates" are quantitatively and
qualitatively restricted under the Federal Reserve Act. The Federal Deposit
Insurance Act applies Sections 23A and 23B to insured nonmember banks in the
same manner and to the same extent as if they were members of the Federal
Reserve System. The Federal Reserve has also recently issued Regulation W, which
codified prior regulations under Sections 23A and 23B of the Federal Reserve Act
and interpretative guidance with respect to affiliate transactions.
Regulation W incorporates the exemption from the affiliate transaction
rules but expands the exemption to cover the purchase of any type of loan or
extension of credit from an affiliate. Affiliates of a bank include, among other
entities, the bank's holding company and companies that are under common control
with the bank. The Company is considered to be an affiliate of the Bank. In
general, subject to certain specified exemptions, a bank or its subsidiaries are
limited in their ability to engage in "covered transactions" with affiliates:
-- to an amount equal to 10% of the bank's capital and surplus, in the
case of covered transactions with any one affiliate; and
-- to an amount equal to 20% of the bank's capital and surplus, in the
case of covered transactions with all affiliates.
In addition, a bank and its subsidiaries may engage in covered transactions
and other specified transactions only on terms and under circumstances that are
substantially the same, or at least as favorable to the bank or its subsidiary,
as those prevailing at the time for comparable transactions with nonaffiliated
companies. A "covered transaction" includes:
-- a loan or extension of credit to an affiliate;
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-- a purchase of, or an investment in, securities issued by an affiliate;
-- a purchase of assets from an affiliate, with some exceptions;
-- the acceptance of securities issued by an affiliate as collateral for
a loan or extension of credit to any party; and
-- the issuance of a guarantee, acceptance or letter of credit on behalf
of an affiliate.
In addition, under Regulation W:
-- a bank and its subsidiaries may not purchase a low-quality asset from
an affiliate;
-- covered transactions and other specified transactions between a bank
or its subsidiaries and an affiliate must be on terms and conditions
that are consistent with safe and sound banking practices; and
-- with some exceptions, each loan or extension of credit by a bank to an
affiliate must be secured by collateral with a market value ranging
from 100% to 130%, depending on the type of collateral, of the amount
of the loan or extension of credit.
Regulation W generally excludes all non-bank and non-savings association
subsidiaries of banks from treatment as affiliates, except to the extent that
the Federal Reserve Board decides to treat these subsidiaries as affiliates.
Monetary Policy
The monetary policies of regulatory authorities, including the Federal
Reserve, have a significant effect on the operating results of banks. The
Federal Reserve supervises and regulates the national supply of bank credit.
Among the means available to the Federal Reserve to regulate the supply of bank
credit are open market purchases and sales of U.S. government securities,
changes in the discount rate on borrowings from the Federal Reserve and changes
in reserve requirements with respect to deposits. These activities are used in
varying combinations to influence overall growth and distribution of bank loans,
investments and deposits on a national basis and their use may affect interest
rates charged on loans or paid for deposits.
Federal Reserve monetary policies and the fiscal policies of the federal
government have materially affected the operating results of commercial banks in
the past and are expected to continue to do so in the future. We cannot predict
the nature of future monetary and fiscal policies and the effect of such
policies on our future business and earnings.
Additional Factors That May Affect Future Results of Operations
In addition to the other information contained in this Report, the
following risks may affect the Company. If any of these risks occur, the
Company's business, financial condition or operating results could be adversely
affected.
The Company's Business Strategy Relies Upon its Chief Executive Officer and
Other Key Employees
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Stephen H. Wacknitz has been the president and chief executive officer of
the Company and the Bank since the inception of both entities. Mr. Wacknitz
developed numerous aspects of the Company's current business strategy and the
implementation of such strategy depends heavily upon the active involvement of
Mr. Wacknitz. The loss of Mr. Wacknitz' services could have a negative impact on
the implementation and success of the Company's business strategy. The Company's
success will also depend in large part upon its ability to attract and retain
highly qualified management, technical and marketing personnel to execute the
strategic plan. The Company will need to retain persons with skills in areas
that are new and unfamiliar in order to manage these programs. Competition for
qualified personnel, especially those in management, sales and marketing is
intense. The Company cannot assure you that it will be able to attract and
retain these persons.
The Company's Growth May Not Be Managed Successfully
The Company has grown substantially from $310,506,097 of total assets and
$269,321,220 of total deposits at December 31, 2002 to $431,212,118 of total
assets and $383,487,366 of total deposits at December 31, 2003. The Company
expects to continue to experience significant growth in assets, deposits and
scale of operations. If the Company does not manage its growth effectively, the
Company will not have adequate resources to maintain and secure key
relationships contemplated by its business plan, and its business and prospects
could be harmed. The Company's growth subjects it to increased capital and
operating commitments. The Company must recruit experienced individuals that
have the skills and experience that it needs to transition the areas of its
lending concentration. The plans for continued growth have placed and will
continue to place a significant strain on the Company's personnel, systems, and
resources. The Company cannot guarantee that it will be able to obtain and train
qualified individuals to implement its business strategy in a timely, cost
effective and efficient manner.
Dependence on Real Estate
A significant portion of the loan portfolio of the Bank is dependent on
real estate. At December 31, 2003 real estate served as the principal source of
collateral with respect to approximately 85% of the Bank's loan portfolio. A
decline in current economic conditions or rising interest rates could have an
adverse effect on the demand for new loans, the ability of borrowers to repay
outstanding loans, the value of real estate and other collateral securing loans
and the value of real estate owned by the Bank, as well as the Company's
financial condition and results of operations in general and the market value of
the Company's common stock. Acts of nature, including earthquakes and floods,
which may cause uninsured damage and other loss of value to real estate that
secures these loans, may also negatively impact the Company's financial
condition.
In the course of business, the Bank may in the future acquire, through
foreclosure, properties securing loans which are in default. In commercial real
estate lending, there is a risk that hazardous substances could be discovered on
these properties. In this event, the Bank might be required to remove these
substances from the affected properties at its sole cost and expense. The cost
of this removal could substantially exceed the value of affected properties. The
Bank may not have adequate remedies against the prior owner or other responsible
parties or could find
36 of 70
it difficult or impossible to sell the affected properties. This could have a
material adverse effect on the Bank's business, financial condition and
operating results.
Interest Rate Changes
The earnings of the Bank are substantially affected by changes in
prevailing interest rates. Changes in interest rates affect the demand for new
loans, the credit profile of existing loans, the rates received on loans and
securities and the rates the Bank must pay on deposits and borrowings. The
difference between the rates the Bank receives on loans and securities and the
rates it must pay on deposits and borrowings is known as the interest rate
spread. Given the Bank's current volume and mix of interest bearing assets, the
Bank's interest rate spread can be expected to increase when market interest
rates are rising, and to decline when market interest rates are declining.
Although the Bank believes its current level of interest rate sensitivity is
reasonable, significant fluctuations in interest rates may have an adverse
impact on its business, financial condition and result of operations.
Competition
Competition may adversely affect the Bank's performance. The financial
services business in the Bank's market area is highly competitive, and becoming
more so due to changes in regulation, technological advances and the
accelerating pace of consolidation among financial service providers. The Bank
faces competition both in attracting deposits and making loans. The Bank
competes for loans principally through competitive interest rates and the
efficiency and quality of the services provided. Increasing levels of
competition in the banking and financial services businesses may reduce the
market share or cause the prices charged for services to fall. Many of the
financial intermediaries operating in the Bank's market area offer certain
services, such as trust, investment and international banking services, which
the Bank does not offer directly. Additionally, banks and other financial
institutions with larger capitalization and financial intermediaries have larger
lending limits. These services the Bank may not offer directly may prompt
customers to do business with competitors instead of with the Bank. Results may
differ in future periods depending on the nature or level of competition.
Regulation
Both the Company and the Bank are subject to government regulation that
could limit or restrict their activities, adversely affecting operations. The
financial services industry is heavily regulated. Federal and state regulation
is designed to protect the deposits of consumers, not to benefit shareholders.
The regulations impose significant limitations on operations, and may be changed
at any time, possibly causing results to vary significantly from past results.
Government policy and regulation, particularly as implemented through the
Federal Reserve System, significantly affects credit conditions for the Company
and the Bank.
SBA lending is a federal government created and administered program. As
such, legislative and regulatory developments can affect the availability and
funding of the program. This dependence on legislative funding and regulatory
restrictions from time to time causes limitations and uncertainties with regard
to the continued funding of such loans, with a resulting potential adverse
financial impact on the Bank's business. Currently, the maximum limit on
37 of 70
individual 7a loans which the SBA will permit is reduced to $750,000 from the
prior $2,000,000 level. This reduction could have a negative impact on the
Company's business. Since the SBA business at the Bank constitutes a significant
portion of the Bank's lending business, this dependence on this government
program and its periodic uncertainty with availability and amounts of funding
creates greater risk for the Bank's business than does other parts of its
business.
Borrower's Failure to Perform
A significant number of the Bank's borrowers and guarantors may fail to
perform their obligations as required by the terms of their loans, which could
result in larger than expected losses. This risk increases when the economy is
weak, as it has been recently. The Bank has adopted underwriting and credit
policies, and loan monitoring procedures, including the establishment and
monitoring of allowance for loan losses. Management believes these provisions
are reasonable and adequate, and should keep loan losses within expected limits
by assessing the likelihood of nonperformance, tracking loan performance and
diversifying the credit portfolio. However, these policies and procedures may
not be adequate to prevent unexpected losses that could materially and adversely
affect the results of operations.
Operations Risks
The Bank is subject to certain operations risks, including, but not limited
to, data processing system failures and errors, customers or employee fraud and
catastrophic failures resulting from terrorist acts or natural disasters. The
Bank maintains a system of internal controls to mitigate against such
occurrences and maintains insurance coverage when available to protect against
such risks, but should such an event occur that is not prevented or detected by
the Bank's internal controls, or is uninsured or in excess of applicable
insurance limits, it could have a significant adverse impact on the Company's
business, financial condition or results of operations.
Geographic Concentration
The Company's operations are located almost entirely in California, except
SBA Lending. As a result of the California geographic concentration, our results
depend largely upon economic and business conditions in this region.
Deterioration in economic and business conditions in our market area could have
a material adverse impact on the quality of our loan portfolio and the demand
for our products and services, which in turn may have a material adverse effect
on our results of operations.
Fiscal Crisis in California
The State of California budget crisis could have an unfavorable impact upon
the Bank's business, financial condition, results of operations and share price.
A combination of reductions in State-provided services and increases in the
level and nature of taxation could adversely affect economic activity and real
estate values, which in turn could have an unfavorable affect on the Bank's
business, financial condition, results of operations and share
38 of 70
valuation. The business, financial condition and results of operations of the
Bank's customers could also be adversely affected, which could negatively impact
the Bank's loan portfolio.
Subsidiaries
The Bank is a subsidiary of the Company. In June 2002, the Company formed
Temecula Valley Statutory Trust I, a Connecticut statutory trust and wholly
owned subsidiary of the Company for the purpose of issuing trust preferred
securities. In September 2003, the Company and Temecula Valley Statutory Trust
II, a Connecticut statutory trust and wholly owned subsidiary of the Company for
the purpose of issuing trust preferred securities.
Employees
As of December 31, 2003, the Bank had 194 full-time employees, 9 of whom
were executive officers. There are no employees at the Company. We provide
medical insurance and other benefits to our full-time employees. Our employees
are not represented by any collective bargaining group. We consider our
relations with our employees to be satisfactory.
ITEM 2: PROPERTIES
----------
The Bank conducts business at five full-service banking offices and
multiple loan production offices. The main office facilities are located at
27710 Jefferson Avenue, Suite A100, Temecula, California. As of December 31,
2003, the Bank owned the property at its Murietta branch. The remaining banking
offices and other offices are leased by the Bank. Total future annual rental
payments (exclusive of operating charges and real property taxes) are
approximately $2,953,424, with lease expiration dates ranging from 2004 to 2009,
exclusive of renewal options.
We believe that our existing facilities are adequate for our present
purposes and that the properties are adequately covered by insurance.
ITEM 3: LEGAL PROCEEDINGS
-----------------
From time to time, we are involved in legal proceedings arising in the
normal course of business. We do not believe that there is any pending or
threatened proceeding against us which, if determined adversely, would have a
material effect on our business, financial condition or results of operation.
The Company is not aware of any material proceedings to which any director,
officer or affiliate of the Company, any owner of record or beneficially of more
than 5% of the voting securities of the Company as of December 31, 2003, or any
associate of any such director, officer, affiliate of the Company, or security
holder is a party adverse to the Company or any of its subsidiaries or has a
material interest adverse to the Company or any of its subsidiaries.
39 of 70
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER
--------------------------------------------------
At a special meeting of shareholders held on December 18, 2003, the
shareholders of the Company approved a reincorporation proposal to change the
Company's incorporation from Delaware to California. A concurrent forward
two-for-one stock split was also approved at the meeting. The number of votes
cast for the proposal to incorporate was 2,511,514, against 0, abstentions 0,
and broker nonvotes 0.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
--------------------------------------
Trading Information
The Company's common stock trades in the over-the-counter market under the
symbol TMCV.OB. As reported by the OTC Bulletin Board, information concerning
the range of high and low bid information prices for the Company's common stock
for each quarterly period within the past two fiscal years is set forth below.
The below quotations reflect inter-dealer prices adjusted for the two for one
stock split December 18, 2003, without retail mark-up, mark-down or commission
and may not necessarily represent actual transactions.
Quarter Ended High Bid Low Bid
2003
March 31 $6.63 $5.38
June 30 $8.25 $6.00
September 30 $9.40 $7.75
December 31 $12.13 $9.25
2002
March 28 $5.00 $4.15
June 28 $6.35 $4.43
September 30 $6.25 $5.25
December 31 $6.40 $5.50
As of February 28, 2004 the low and high bids of the Company's stock as
quoted in the over-the-counter bulletin board market were $12.00 and $11.85,
respectively. As of that date, there were approximately 458 record holders of
the Company's common stock.
40 of 70
Dividends
No cash dividends were paid by the Bank prior to the formation of the
Company in 2002 and none have been paid by the Company since its formation in
2002.
The Company is a legal entity separate and distinct from the Bank. The
Company's shareholders are entitled to receive dividends when and as declared by
its Board of Directors, out of funds legally available therefore, subject to the
restrictions set forth in the California General Corporation Law as well as
other restriction discussed below. Under California law, a dividend can be paid
if the amount of the retained earnings of the Company immediately prior to such
payment equals or exceeds the amount of the proposed distribution. Additionally,
a dividend can be paid if immediately after giving effect thereto: (1) the sum
of the assets of the Company (exclusive of goodwill, capitalized research and
development expenses and deferred charges) would be at least equal to 1 1/4
times its liabilities (not including deferred taxes, deferred income and other
deferred credits) and (2) the current assets of the corporation would be at
least equal to its current liabilities or, if the average of the earnings of the
corporation before taxes on income and before interest expense for the two
preceding fiscal years was less than the average of the interest expense of the
corporation for those fiscal years, at least equal to 1 1/4 times its current
liabilities.
The Federal Reserve has broad authority to prohibit the payment of
dividends by the Company depending upon the condition of each entity. In
addition, the future payment of cash dividends will generally depend, in
addition to regulatory restraints, upon the Company's earnings during any
period, and the assessment by the Board of the capital requirements the Company
and other factors, including the maintenance of an adequate allowance for loan
losses at the Bank.
The availability of operating funds for the Company and the ability of the
Company to pay a cash dividend depends largely on the Bank's ability to pay a
cash dividend to the Company. The payment of cash dividends by the Bank is
subject to restrictions set forth in the National Bank Act. In general,
dividends may not be paid from any of the Bank's capital. Dividends must be paid
out of available net profits, after deduction of all current operating expenses,
actual losses, accrued dividends on preferred stock, if any, and all federal and
state taxes. Additionally, a national bank is prohibited from declaring a
dividend on its shares of common stock until its surplus fund equals its common
capital, or, if its surplus fund does not equal its common capital, until at
least one-tenth of such bank's net profits, for the preceding half year in the
case of quarterly or semi-annual dividends, or the preceding two half-years in
the case of an annual dividend, are transferred to its surplus fund each time
dividends are declared. The approval of the Comptroller is required if the total
of all dividends declared by a national bank in any calendar year exceeds the
total of its net profits for that year combined with its retained net profits of
the two preceding years, less any required transfers to surplus or a fund for
the retirement of any preferred stock. Furthermore, the Comptroller also has
authority to prohibit the payment of dividends by a national bank when it
determines such payment to be an unsafe and unsound banking practice.
The Company declared a two-for-one stock split to shareholders in December
2003, April 1999 and April 1998. Whether or not stock dividends will be paid in
the future will
41 of 70
be determined by the Board of Directors after consideration of various factors.
The Company's and the Bank's profitability and regulatory capital ratios in
addition to other financial conditions will be key factors considered by the
Board of Directors in making such determinations regarding the payment of
dividends.
42 of 70
Securities Authorized For Issuance Under Equity Compensation Plans
Equity Compensation Plan Information as of December 31, 2003
- ----------------------------------------------------------------------------------------------------------------------
Number of securities to be
issued upon exercise of Weighted average exercise
outstanding options, price of outstanding Number of securities
warrants and rights options, warrants and remaining available for
Plan category rights future issuance
- ----------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans
approve by security holders 1,912,674 $3.74 27,984
Equity compensation plans not
approve by security holders 0 0 0
- - -
Total 1,912,674 $3.74 27,984
========= ======
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The following table represents selected financial information for the five
years ended December 31, 2003 for the Company and subsidiaries on a consolidated
basis. This table should be read in conjunction with the Company's financial
statements and related notes. All share and per share data have been restated to
reflect three two-for-one stock splits, one in December 2003, one in April 1999
and one in April 1998.
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Income Statement:
Interest income $23,954,291 $16,555,918 $12,022,210 $9,371,502 $5,703,426
Interest expense 4,946,553 3,124,682 2,734,407 2,452,901 1,697,167
-----------------------------------------------------------------------------------
Net interest income 19,007,738 13,431,236 9,287,803 6,918,601 4,006,259
Provision for loan losses 1,022,000 2,460,000 400,000 385,000 180,000
-----------------------------------------------------------------------------------
Net after provision for loan 17,985,738 10,971,236 8,887,803 6,533,601 3,826,259
losses
Non interest income 24,417,561 17,895,165 8,952,309 3,183,777 1,974,606
Non interest expense 29,121,071 21,800,837 14,831,513 7,621,741 4,951,570
-----------------------------------------------------------------------------------
Income before income taxes 13,282,228 7,065,564 3,008,599 2,095,637 849,295
Provision for income taxes 5,427,889 2,874,510 1,205,018 835,335 313,244
-----------------------------------------------------------------------------------
Net income $ 7,854,339 $ 4,191,054 $ 1,803,581 $1,260,302 $536,051
===================================================================================
Per Share Data:
Basic earnings per share $ 1.00 $ 0.57 $ 0.28 $ 0.24 $ 0.12
Diluted earnings per share $ 0.89 $ 0.50 $ 0.25 $ 0.22 $ 0.09
Average common shares 7,823,950 7,372,504 6,484,108 5,239,378 4,599,968
outstanding
Average common shares & 8,861,706 8,370,040 7,142,290 5,694,492 5,965,118
equivalents
Book value per share
Equity shares-beginning balance 7,446,646 7,326,324 5,505,322 5,099,744 4,314,856
Warrants - Shares Issued 324,598 66,628 5,058 0 535,432
Options - Shares Issued 380,670 53,694 215,944 405,578 249,456
Stock offering 0 0 1,600,000 0 0
43 of 70
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
-----------------------------------------------------------------------------------
Equity shares-ending balance 8,151,914 7,446,646 7,326,324 5,505,322 5,099,744
===================================================================================
Balance Sheet Data:
Assets $431,212,118 $310,509,097 $ 190,024,416 $117,757,861 $ 85,113,913
Loans 360,749,391 271,425,826 150,274,574 92,037,318 55,915,064
Allowance for loan loss 3,607,833 3,017,395 1,239,308 927,509 551,792
Other Real Estate Owned 485,036 0 0 0 0
Fed Funds Sold & Investments 21,400,000 0 16,400,000 12,225,250 19,989,700
Securities
FRB/FHLB Stock 1,145,000 1,460,050 517,250 214,700 176,400
Deposits 383,487,366 269,321,220 172,928,225 107,306,736 77,510,844
FHLB advances 0 10,000,000 0 0 0
Trust preferred borrowing 12,372,000 7,217,000 0 0 0
Stockholders' equity 29,683,065 19,616,203 15,103,944 8,937,182 6,922,745
ALLL beginning balance $ 3,017,395 $ 1,239,308 $ 927,509 $ 551,792 $ 429,448
Charge offs (505,586) (707,455) (88,201) (20,402) (132,946)
Recoveries 74,024 25,542 0 9,283 74,841
Provision for loan losses 1,022,000 2,460,000 400,000 385,000 180,000
-----------------------------------------------------------------------------------
ALLL ending balance $3,607,833 $3,017,395 $1,239,308 $ 927,509 $ 551,792
===================================================================================
Non-performing loans $4,160,032 $1,908,169 $ 198,861 $ 271,495 $ 261,037
Government guaranteed portion (3,378,401) (1,077,597) (92,895) (203,621) (224,272)
-----------------------------------------------------------------------------------
Net non-performing loans $ 781,631 $ 830,572 $ 105,966 $ 67,874 $ 36,765
===================================================================================
SBA 7A participation sold - $287,345,585 $168,163,922 $ 66,819,282 $29,187,738 22,092,542
period end
Other participations sold 18,906,176 8,911,376 3,085,662 7,423,766 4,193,789
-----------------------------------------------------------------------------------
Total participation sold - $306,251,761 $177,075,298 $69,904,944 $36,611,504 $ 26,286,331
period end
===================================================================================
Asset Quality:
Nonaccrual loans
ORE
Selected Ratio's:
Return on average assets 2.04% 1.69% 1.15% 1.21% 0.74%
Return on average equity 31.84% 14.34% 14.82% 16.10% 8.96%
Income tax rate 40.90% 40.70% 40.00% 39.80% 36.80%
Tier I leverage ratio 9.06% 8.53% 7.91% 7.54% 8.14%
Tier I risk based ratio 10.01% 9.30% 9.39% 8.93% 9.97%
Total risk based ratio 11.54% 10.61% 10.17% 9.86% 10.77%
Allowance for loan loss/loans 1.00% 1.11% 0.82% 1.00% 0.99%
Allowance for loan loss/net 461.84% 363.06% 1,168.86% 1,364.71% 1,491.89%
nonperforming loans
Loan to deposit ratio 94.07% 100.78% 86.90% 86.24% 72.14%
Avg int earning assets/total 86.65% 86.76% 88.12% 89.15% 89.81%
assets
Investment yield (includes 1.40% 1.87% 3.75% 6.24% 5.06%
FRB/FHLB)
Loan yield 7.45% 7.99% 9.54% 11.14% 10.31%
Total interest bearing assets 7.17% 7.71% 8.73% 10.14% 8.74%
Interest bearing deposit cost 1.82% 1.89% 2.93% 3.91% 3.70%
Borrowing cost 4.32% 3.21% N/A N/A N/A
Net interest margin 5.69% 6.25% 6.74% 7.49% 6.14%
Net interest spread 5.25% 5.73% 5.80% 6.23% 5.04%
44 of 70
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
SBA Loan Servicing:
SBA excess servicing asset $6,116,679 $ 3,763,779 $ 1,538,437 $ 708,401 $ 539,612
SBA I/O strip receivable asset 20,495,511 13,120,093 4,136,809 1,381,098 602,724
-----------------------------------------------------------------------------------
Total SBA servicing asset $26,612,190 $16,883,872 $ 5,675,246 $2,089,499 $1,142,136
===================================================================================
SBA servicing-cash income $ 6,025,650 $ 2,673,768 $ 760,959 $ 465,409 $ 274,519
SBA servicing-asset amortization (4,233,596) (1,462,019) (402,442) (192,742) (113,333)
SBA servicing-guarantee fee to SBA (98,868) (83,379) (21,943) (1,853) (4,022)
-----------------------------------------------------------------------------------
SBA servicing-net servicing income $1,693,186 $ 1,128,370 $ 336,574 $ 70,814 $ 157,164
===================================================================================
Loan Sales:
SBA 7A sales - guaranteed $129,813,081 $108,212,760 $42,872,549 $10,438,650 $ 7,095,750
SBA 7A sales - unguaranteed $ 19,208,615 $12,573,048 $ 5,933,122 $ 0 $ 767,104
Unguaranteed SBA 7A sales gain 3,191,211 2,094,818 940,392 0 154,153
Mortgage loan sales $ 100,800,159 $83,014,280 $55,224,847 $10,439,365 $ 8,894,243
Mortgage loan sales gain 2,827,316 2,283,546 1,553,409 306,177 119,465
SBA Broker referral income $ 2,844,613 $ 1,971,774 $ 1,070,945 $ 0 $ 77,002
Mortgage Broker referral income 907,568 508,201 89,863
943,252 864,230
Employee Related:
Full time employees 194 181 148 86 68
Part time employees 14 18 13 11 5
Full time equivalent employees 204 194 156 92 71
Salary continuation plan expense $ 531,240 $ 267,108 $ 165,682 $ 156,844 $ 71,329
CSV life insurance balance 5,740,729 $3,983,183 $ 2,832,254 $2,159,329 $1,163,171
CSV life insurance income $ 250,368 $ 175,901 $ 144,262 $ 115,481 $ 55,448
CSV Llfe insurance expense (44,822) (24,972) (19,337) (19,323) (4,911)
-----------------------------------------------------------------------------------
Net life insurance income $ 205,546 $ 150,929 $ 124,925 $ 96,158 $ 50,537
===================================================================================
ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS
----------------------------------
See "Cautionary Statement for Purposes of the "Safe Harbor" Provision of
the Private Securities Litigation Reform Act of 1995," on the pages immediately
following the table of contents in connection with "forward looking" statements
included in this Report.
Analysis of Financial Condition and Results of Operations
This discussion should be read in conjunction with the financial statements
of the Company, including the notes thereto, appearing elsewhere in this report.
45 of 70
Results of Operations
Net Income
For 2003, net income was $7,854,339 or $1.00 per basic share and $0.89 per
diluted share. For 2002, net income was $4,191,054, or $0.57 per basic share and
$0.50 per diluted share and for 2001 it was $1,803,581 or $0.28 per basic share
and $0.25 per diluted share. The net interest margin for the last three years
has been consistently strong. This factor coupled with income increases in gain
on sale of loans, servicing income and other fee income, most significantly in
connection with SBA and mortgage loan sales, represents a significant portion of
the profit dynamics of the Company. The Company sold $15,928,355 of the
unguaranteed portion of SBA 7A loans in 2003, which added $1,877,886 to net
income after tax for 2002. We sold $12,573,043, which added $1,232,355 to net
income after tax, and in 2001, we sold $5,933,122 which added $553,457 to net
income after tax. The Bank expects to continue to sell SBA and mortgage loans in
the secondary market while retaining a significant portion of the servicing
rights. The return on average assets was 2.04% for 2003 compared to 1.68% in
2002 and 1.15% in 2001. The return on average equity was 31.84% for 2003
compared to 24.14% for 2002 and 14.82% for 2001. Due to low interest rates and
increasing real estate values resulting in equity availability for other
investments, loan activity has been robust. Similar but somewhat tempered
activity is expected for 2004.
Net Interest Income
Net interest income was $19,007,738 in 2003 compared to $13,431,236 in 2002
and $9,287,803 in 2001. These interest income levels have been achieved as a
result of net interest margins that have been consistently higher than
expectations in this interest rate environment as well as growth of the loan
portfolio. Net interest margins were 5.69%, 6.25% and 6.74% for years ended
2003, 2002 and 2001, respectively. The loan-to-deposit ratio at December 31,
2003 was 94.07%, at December 2002 it was greater at 100.78% and at December 31,
2001 it was 86.90%. Loans produced a yield of 7.45% in 2003, 7.99% in 2002 and
9.54% in 2001. Investments, which includes Federal Funds sold, FRB stock and
FHLB stock, yielded 1.40% in 2003, 1.87% in 2002 and 3.75% in 2001. Total
interest earning assets yielded 7.17% in 2003, 7.71% in 2002 and 8.73% in 2001.
The cost of interest bearing deposits was 1.82% in 2003, 1.89% in 2002 and 2.93%
in 2001. For 2003, the cost of other borrowings was 4.32% and consisted of FHLB
advances, Trust Preferred Borrowings and Federal Funds Purchased. For 2002, the
cost of other borrowings was 3.21% and consisted of Federal Funds Purchased,
FHLB advances and Trust Preferred Borrowings. No other borrowings were incurred.
The Company tries to maximize the percentage of assets it maintains as
interest earning assets, with the goal of the Company to maintain at least 90%
in that category. Effectively, all of the increases in non-interest earning
assets in 2003, 2002 and 2001 were in the cash surrender value of life insurance
(BOLI), the SBA servicing and SBA I/O strip receivable assets.
The following table shows average balances with corresponding
interest income and interest expense as well as average yield and cost
information for the last three years.
46 of 70
Average balances are derived from daily balances, and non-accrual loans are
included as interest bearing loans for the purposes of these tables.
Average Balances with Rates Earned and Paid
Year ended December 31
-------------------------------------------------------------------------------------------------
2003 2002 2001
Interest Average Interest Average Interest
Average
Average Income/ Interest Average Income/ Interest Average Income/
Interest
Balance Expense Rate Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ---- ------- ------- ----
(Dollars in Thousands)
Assets
Due From Banks-Time $ 0 $ 0 0% $ 0 $ 0 0.00% $ 0 $ 0 0.00%
Securities-HTM (1) 41 0 .82% 222 4 1.65% 224 10 4.58%
FRB/FHLB Stock 1,173 64 5.44% 891 46 5.21% 379 19 5.10%
Federal Funds Sold 14,191 152 1.07% 8,870 137 1.54% 18,707 694 3.71%
--------------------------- ---------------------------- --------------------------------
Total Investments 15,405 216 1.87% 9,983 187 1.87% 19,310 723 3.75%
Total Loans (2) 318,600 23,738 7.45% 204,849 16,369 7.99% 118,440 11,299 9.54%
--------------------------- ---------------------------- --------------------------------
Total Interest Earning Assets 334,005 23,954 7.17% 214,832 16,556 7.71% 137,750 12,022 8.73%
------------------ ------------------- -----------------------
Allowance for Loan (3,152) (1,588) (1,024)
Loss
Cash & Due From Banks 17,295 13,779 9,706
Premises & Equipment 2,196 2,271 2,220
Other Assets 35,137 18,335 8,282
--------- --------- ---------
Total Assets $385,481 $247,629 $156,934
========= ========= =========
Liabilities
and
Shareholders' Equity
Interest Bearing Demand $24,075 24 .10% $18,564 18 .10% $13,202 73 0.56%
Money Market 37,238 532 1.43% 38,621 628 1.62% 19,346 520 2.69%
Savings 32,739 192 .59% 27,951 228 .82% 28,436 622 2.19%
Time Deposits under $100,000 75,177 1,833 2.44% 26,509 806 3.04% 14,369 685 4.77%
Time Deposits $100,000 or more 76,998 1,894 2.46% 35,682 1,105 3.10% 17,845 834 4.68%
Other Borrowings 10,906 471 4.32% 10,581 340 3.21% 0 0 0.00%
--------------------------- ---------------------------- --------------------------------
Total Interest Bearing 257,133 4,946 1.92 157,908 3,125 1.98% 93,198 2,734 2.93%
Liabilities ------------------ ------------------- -----------------------
Non-interest Demand Deposits 99,565 69,972 50,173
Other Liabilities 4,108 2,530 1,538
Shareholders' Equity 24,675 17,219 12,025
--------- --------- ---------
Total Liabilities and
Shareholders' equity $385,481 $247,629 $156,934
========= ========= =========
Net Interest Income $19,008 $13,431 $9,288
========= ========== =========
Net Interest Spread (3) 5.25% 5.73% 5.80%
========= ========= ==============
Net Interest Margin (4) 5.69% 6.25% 6.74%
========= ========= ==============
- -------------------------------------
(1) There are no tax exempt investments in any of the reported years.
(2) Average balances are net of deferred fees/gains that are amortized to
interest income over the term of the respective loan.
(3) Net interest spread is the yield earned on interest earning assets less the
rate paid on interest bearing liabilities.
(4) Net interest margin is the net interest income divided by the interest
earning assets.
47 of 70
Rate/Volume Analysis
Increase/Decrease in Net Interest Income
Year Ended December 31
2003 2002 2001
-----------------------------------------------------------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL
-------- -------- -------- --------- -------- -------- --------- ------ -----------
Assets
Due From Banks-Time $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ (22) $ 0 $ (22)
Securities-HTM (1) (4) 0 (4) 0 (7) (6) 6 (3) 3
FRB/FHLB Stock 15 3 18 26 1 27 10 (3) 7
Federal Funds Sold 82 (67) 15 (365) (192) (557) 29 (473) (444)
-----------------------------------------------------------------------------------
Total Investments 93 (64) 29 (338) (198) (536) 23 (479) (456)
Total Loans (2) 9,089 (1,720) 7,369 8,245 (3,175) 5,070 5,001 (1,895) 3,106
-----------------------------------------------------------------------------------
Total Interest Earningz
Assets 9,182 (1,784) 7,398 7,907 (3,373) 4,534 5,024 (2,374) 2,650
-----------------------------------------------------------------------------------
Liabilities and
Shareholders' Equity
Interest Bearing (6) 0 (6) (30) 85 55 (54) 59 5
Demand
Money Market 25 71 96 (521) 413 (108) (527) 190 (337)
Savings 36 11 36 11 394 394 172 486 658
Time Deposits under $100,000 (1,478) 451 (1,027) (580) 459 (121) (370) 43 (327)
Time Deposits $100,000 or more (1,282) 493 (789) (835) 564 (271) (425) 145 (280)
Other Borrowings (10) (131) (131) 0 (340) (340) 0 0 0
-----------------------------------------------------------------------------------
Total Interest Bearing
Liabilities (2,790) 969 (1,821) (1,955) 1,564 (391) (1,204) 923 (281)
-----------------------------------------------------------------------------------
Net Interest Income $ 6,392 $ (815) $5,577 $5,952 $(1,809) $4,143 $3,820 $(1,451) $2,369
===================================================================================
- -------------------------------
(1) There are no tax exempt investments in any of the reported years.
(2) Average balances are net of deferred fees/gains that are amortized to
interest income over the term of the respective loan.
(3) Net interest spread is the yield earned on interest earning assets less the
rate paid on interest bearing liabilities.
(4) Net interest margin is the net interest income divided by the interest
earning assets.
Based on expectations for loan and deposit growth, and economic conditions
anticipated for 2004, management currently expects the net interest margin for
2004 to be in the range of 5.84% to 6.09% and is due to higher rate CDs maturing
and a different mix of interest earning assets.
Non Interest Income
Non-interest income of $24,417,561 in 2003, $17,895,165 in 2002 and
$8,952,309 in 2001 contributed significantly to earnings. Service charges and
fees increased from $786,142 in 2001 to $965,067 in 2002 due to increased
numbers of accounts, but then decreased to $792,292 in 2003 due to a change in
NSF fee methodology in 2002 that decreased NSF fees. Mortgage fees, which are
comprised of broker referral income and other fees on mortgage loan
originations, increased to $3,882,234 in 2003 from $2,943,730 in 2002 and
$2,004,254 in 2001 due to a higher volume of refinancing originations due to a
lower rate environment. SBA loan servicing income increased to $1,693,836 in
2003 from $1,129,328 in 2002 and $339,060 in 2001 due to the increase in the
size of the servicing portfolio and the increase in servicing rates on loans
sold in 2003, generally at higher rates than in 2002 and 2001. The gain on sale
of loans was $15,798,959 in 2003 compared to $11,389,023 in 2002 and $4,739,335
in 2001 due to significantly higher SBA and mortgage loan sales. The loan sales
consisted primarily of SBA guaranteed and unguaranteed loans and mortgage loans
that are sold service released. The SBA and mortgage loan sales are expected to
continue in the future.
48 of 70
Analysis of Changes in Non-Interest Income
Increase/(Decrease) Increase/(Decrease)
-------------------------- -----------------------
2003 Amount % 2002 Amount % 2001
---- ------ - ---- ------ - ----
(Dollars in Thousands)
Service charges and
fees $ 792 $ (173) (18%) $ 965 $ 179 23% $ 786
Gain on loan sales 15,799 4,410 39% 11,389 6,650 140% 4,739
Mortgagee fees 3,882 938 32% 2,944 940 47% 2,004
Servicing income 1,694 565 50% 1,129 790 233% 339
Construction fund
control fees 840 444 112% 396 183 86% 213
Other income 1,410 338 (32)% 1,072 150 29% 870
----------- --------- ----- ---------- --------- ------ ---
Total core $ 24,418 $ 6,523 $ 17,895 $ 8,943 $8,952
=========== ========= ========== ========= ======
Non-Interest Expense
Non interest expenses are comprised of salaries and benefits, occupancy,
furniture and equipment, processing, office expense, professional fees and costs
such as legal and auditing, marketing, and regulatory fees. These expenses are
closely reviewed and controlled in an effort to maintain the most cost effective
operational level.
Non-interest expense was $29,121,071 in 2003 compared to $21,800,837 in
2002 and $14,831,513 in 2001. Salaries and benefits increased from $10,051,392
in 2001 to $14,866,458 in 2002 and to $20,484,132 in 2003. The increase in 2001
was due to the additions to staff associated with the opening of the Murrieta
and El Cajon full service offices, the nationwide expansion of the SBA
department, the expansion of the Mortgage department, and related addition of
support staff for the increase in volume. The increase in 2002 was due to the
continued expansion of the SBA and related staff as well as the real estate
tract-lending department. The increase in 2003 was due to commissions and
incentives paid from increase in loan production. Loan funding expenses, higher
due to increases in staff to support the greater loan volume, were $1,821,324,
$1,253,018 and $499,068 for 2003, 2002 and 2001, respectively. These expenses
have increased due to greater loan volume. Office expenses have increased over
the last three years principally due to internal expansion and to a lesser
extent, increased rents and office expenses.
The following table presents for the periods indicated the major categories
of non-interest expense:
49 of 70
Analysis of Changes in Non-Interest Expense
Increase/(Decrease) Increase/(Decrease)
------------------------------ ------------------------
2003 Amount % 2002 Amount % 2001
---- ------ - ---- ------ - ----
(Dollars in Thousands)
Salaries and employee
benefits $ 20,484 $ 5,617 38% $ 14,867 $ 4,816 48% $10,051
Occupancy of premises 1,184 140 14% 1,044 204 24% 840
Loan funding expense 1,821 568 45% 1,253 754 151% 499
Furniture and equipment 892 84 10% 808 69 9% 739
Data processing 988 96 11% 892 279 46% 613
Office expenses 1,589 184 13% 1,405 379 37% 1,026
All other expenses 2,163 631 41% 1,532 468 44% 1,064
---------- ----- ----- --------- --- -------
Total $ 29,121 $ 7,320 34% $ 21,801 $ 6,969 47% $14,832
========== ============ ==== =========== ========= ======== =======
Income Taxes
For 2001, the tax expense was $1,205,018 for an effective rate of 40.0%,
for 2002 the tax expense was $2,874,510 for an effective rate of 40.7% and for
2003 the tax expense was $5,427,889 for an effective rate of 40.9%.
Financial Condition
General
As of December 31, 2003, total assets increased 39% to $431,212,118
compared to $310,506,097 as of December 31, 2002. Total gross loans increased to
$346,041,208 as of December 31, 2003, or 39%, compared to $249,848,814 as of
December 31, 2002.
Deposits grew 42% to $383,487,366 as of December 31, 2003, compared to
$269,321,220 as of December 31, 2002. Shareholders' equity increased to
$29,683,065 or 51%, as of December 31, 2003 compared to $19,616,203 as of
December 31, 2002.
Capital
The Company's capital increased 51% to $29,683,065 as of December 31, 2003
compared to $19,616,203 as of December 31, 2002. The Company's equity to assets
ratio was 6.9% and 6.3% at December 31, 2003 and 2002, respectively. The
Company's budgeting process and strategic plan address the future capital needs
of the Company.
The Company declared a two-for-one stock split to shareholders in December
2003. Whether or not stock dividends or any cash dividends will be paid in the
future will be determined by the Board of Directors after consideration of
various factors. The Company's and the Bank's profitability and regulatory
capital ratios, in addition to other financial conditions, will be key factors
considered by the Board of Directors in making such determinations regarding the
payment of dividends.
During September 2003, the Company issued $5,155,000 of junior subordinated
debt securities to the Company's wholly owned subsidiary, Temecula Valley
Statutory Trust II,
50 of 70
("Trust II"), a Connecticut business trust. The securities have quarterly
interest payments with a rate at 3-month LIBOR plus 2.95% for an effective rate
of 4.09% as of December 31, 2003, with principal due at maturity in 2033. Trust
II used the proceeds from the sale of the securities to purchase junior
subordinated debentures of the Company. The Company received $5,155,000 from
Trust II upon issuance of the junior subordinated debentures, of which
$5,000,000 was contributed to the Bank to increase its capital. The trust
preferred debentures are shown as borrowings on the Company's books.
During June 2002, the Company issued $7,217,000 of junior subordinated debt
securities to the Company's wholly owned subsidiary, Temecula Valley Statutory
Trust I, ("Trust I"), a Connecticut business trust. The securities have
quarterly interest payments with a rate at 3-month LIBOR plus 3.45% for an
effective rate of 4.59% as of December 31, 2003, with principal due at maturity
in 2033. The trust used the proceeds from the sale of the securities to purchase
junior subordinated debentures of the Company. The Company received $7,217,000
from the trust upon issuance of the junior subordinated debentures, of which
$6,789,000 was contributed to the Bank to increase its capital. The trust
preferred debentures are shown as borrowings on the Company's books.
At the end of 2003, all Bank capital ratios were above all current Federal
capital guidelines for a "well-capitalized" bank. As of December 31, 2002, the
Company's capital ratios were above all current Federal capital guidelines for
capital adequacy purposes. Management considers capital requirements as part of
its strategic planning process. The strategic plan calls for continuing
increases in assets and liabilities, and the capital required may therefore be
in excess of retained earnings. The ability to obtain capital is dependent upon
the capital markets as well as performance of the Company. Management regularly
evaluates sources of capital and the timing required to meet its strategic
objectives.
51 of 70
The following tables present the regulatory standards for well capitalized
institutions and the capital ratios for the Company and the Bank at December 31,
2003, 2002 and 2001.
To Be Well Capitalized
Minimum Required for Under Prompt Corrective
Capital Adequacy Action Actual Ratio
Purposes Provisions December 31
--------- ----------- -----------
2003 2002 2001
---- ---- ----
Temecula Valley Bancorp
Tier 1 leverage 4.0% (1) 5.0% 9.0% 8.5% 7.9%
Tier 1 risk-based capital 4.0% 6.0% 10.0% 9.3% 9.4%
Total risk-based capital 8.0% 10.0% 11.5% 10.6% 10.2%
To Be Well Capitalized
Minimum Required for Under Prompt Corrective
Capital Adequacy Action Actual Ratio
Purposes Provisions December 31
--------- ----------- -----------
2003 2002 2001
---- ---- ----
Temecula Valley Bank
Tier 1 leverage 4.0% (1) 5.0% 9.4% 8.7% 7.9%
Tier 1 risk-based capital 4.0% 6.0% 10.3% 9.4% 9.4%
Total risk-based capital 8.0% 10.0% 11.3% 10.5% 10.2%
(1) The Comptroller may require the Bank to maintain a leverage ratio of up to
100 basis points above the standard minimum.
Loan Portfolio
Total loans were $346,041,208 and $249,848,814 at December 31, 2003 and
2002, respectively. Much of the increase is due to the expansion of SBA lending,
as well as increases in real estate and commercial loans in the Escondido and El
Cajon offices. SBA loans, of which the Bank is an active originator, comprise
approximately 28.4% of total loans outstanding at December 31, 2003, 28% of
total loans outstanding as of December 31, 2002 and 19% as of December 31, 2001.
Due to the strong real estate market, and due to the inherent nature of
community bank loan markets, over 85% of the loan portfolio is in real estate
secured loans as of December 31, 2003, compared to 82% and 83% for comparable
periods in 2002 and 2001, respectively. The rate of loan growth should continue
to be strong for 2004 unless.
The majority of our loans have floating rates tied to our base rate or
other market rate indicator. This serves to lessen the risk from movement in
interest rates, particularly rate increases.
A healthy loan demand resulted in a 8.49% increase in
construction lending, a 27% decrease in commercial loans and a 41% increase in
real estate lending. Mortgage loans outstanding decreased from $7,734,938 as of
December 31, 2002 to $2,541,975 as of December 31, 2003. The Bank mortgage loans
originated, including brokered loans of $161,409,182 in 2003, compared with
$158,023,525 in 2002 and $121,663,910 in 2001. Sales of mortgage loans totaled
$100,800,159 in 2003, compared with $56,752,396 in 2002 and $55,224,847 in 2001.
Total non-interest income from the mortgage division was $3,882,234 in 2003,
compared with $2,943,730 in 2002 and $2,004,254 in 2001. The servicing
portfolio, which consists primarily
52 of 70
of SBA loans sold to other investors, being serviced by the Company was
$306,251,761 as of December 31, 2003 compared to $177,075,298 as of December 31,
2002.
Non-Performing Assets
Nonperforming assets consist of nonperforming loans and Other Real Estate
Owned (OREO). The Company had $198,861 of non-performing loans as of December
31, 2001, of which $92,895 was guaranteed by the SBA, compared to $1,908,169 of
non-performing loans as of December 31, 2002, of which $1,077,597 were
government guaranteed. At December 31, 2003, the Company had $4,160,032 of
nonperforming loans of which $3,378,401 were government guaranteed. As of
December 31, 2001, restructured loans were $153,670 as compared to $1,064,217 at
December 31, 2002 and $948,691 at December 31, 2003.
Nonaccrual Loans
Nonaccrual loans, net of the government guaranteed portion, decreased to
$781,631 or .22% of total gross loans as of December 31, 2003 compared to
$830,572 or .30% of total gross loans as of December 31, 2002.
Classified Assets
From time to time, management has reason to believe that certain borrowers
may not be able to repay their loans within the parameters of the present
repayment terms, even though, in some cases, the loans are current at the time.
These loans are graded in the classified loan grades of "substandard,"
"doubtful," or "loss" and include non-performing loans. Each classified loan is
monitored monthly. Classified assets (consisting of nonaccrual loans, loans
graded as substandard or lower and OREO) at December 31, 2003 and 2002 were
$3,877,484 and $2,813,738, respectively.
Risk Management
The investment of the Company's funds is primarily in loans where a greater
degree of risk is normally assumed than in other forms of investments. Sound
underwriting of loans and continuing evaluations of the underlying collateral
and performance of the borrowers are an integral part in the maintenance of a
high level of quality in the total assets of the Company. Net loan charge-offs
for the year ended December 31, 2003 were $431,561, or .14% of average gross
loans outstanding, compared to $681,913 or .33% of average gross loans
outstanding, for the year ended December 31, 2002.
Allowance for Loan Losses
As of December 31, 2003 the balance in the allowance for loan losses was
$3,607,833 compared to $3,017,395 as of December 31, 2002. Risks and
uncertainties exist in all lending transactions and, even though there have
historically been very few charge offs in any category of the Company's loans,
the Board of Directors has established reserve levels for each category based
upon loan type as well as market conditions for the underlying real estate and
other collateral, considering such factors as trends in the real estate market,
economic
53 of 70
uncertainties and other risks, where it is probable that losses could be
incurred in future periods. In general, there are no reserves established for
the government guaranteed portion of commitments to extend credit. As of
December 31, 2003, the allowance was 1.0% of total gross loans compared to 1.1%
as of December 31, 2002. The allowance for loan losses as a percentage of
nonaccrual loans was 86.7% as of December 31, 2003, compared to 158.1% as of
December 31, 2002. The allowance for loan losses to non-performing loans, net of
government guarantees was 461.8% as of December 31, 2003, compared to 363.0% as
of December 31, 2002. During 2001 and 2002, net charge offs as a percentage of
average loans outstanding were only .07% and .33%, respectively. The low levels
of net charge offs in 2001 and 2002 can be attributed to the strong economy in
the Company's primary market area, including the significant rise in real estate
values across all collateral types. In 2003, net charge offs as a percent of
average loans outstanding increased to .14%. The growth in total loans
outstanding, resulted in an increase in the level of reserves required from
$3,017,395 as of December 31, 2002 to $3,607,833 as of December 31, 2003. The
Bank has also established reserve levels for each category based upon loan type.
Certain loan types may not have incurred losses or have historically had minimal
losses, but it is probable that losses could be incurred in future periods. The
Bank considers trends in delinquencies, potential charge offs by loan type,
market for underlying real estate or other collateral, trends in industry types,
economic changes and other risks.
During the year ended December 31, 2003, management charged off
$431,561(net of recoveries) and provided $1,022,000 to the provision for loan
losses. During the year ended December 31, 2002, management charged off $681,913
(net of recoveries) to the allowance while it provided $2,460,000 to the
provision for loan losses. For the year ended December 31, 2003, net charge offs
as a percentage of average loans outstanding was .14%, compared to .33% for the
year ended December 31, 2002. Management believes the allowance at December 31,
2003 is adequate based upon its ongoing analysis of the loan portfolio,
historical loss trends and other factors. Although management believes that they
use the best information available to make such determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be significantly and adversely affected if circumstances differ
substantially from the assumptions used in making the determinations.
Other Assets
Premises and equipment, accrued interest and other assets, income tax
receivable, servicing asset, interest only strips and cash surrender value of
life insurance, are the major components of other assets. Premises and equipment
decreased to $2,185,543, or 6.41% as of December 31, 2003 compared to $2,335,139
as of December 31, 2002 due to depreciation expense being more than the
replacement or upgrade of existing assets.
Accrued interest and other assets increased from $3,527,007 as of December
31, 2002 to $4,761,049 as of December 31, 2003. The major component of accrued
interest and other assets is interest accrued and not yet received on loans. The
increase in comparison is due to the decrease in yield on loans from 7.99% for
the year ended December 31, 2002 to 7.45% for the year ended December 31, 2003
and the increase in loan balance. Average loan balances increased from
$204,849,000 to $318,600,000 as of December 31, 2003.
54 of 70
Servicing asset, net, increased to $6,116,679 as of December 31, 2003,
compared to $3,763,779 as of December 31, 2002. The increase reflects the
additions due to loan sales during the year ended December 31, 2003 and
decreased due to amortization of the servicing asset. The valuation of the
servicing asset reflects estimates of the expected life of the underlying loans
which may be adversely affected by higher than expected levels of pay-offs in
periods of lower rates or charge-offs in periods of economic difficulty. In
addition, when property values increase due to general economic conditions,
borrowers have refinancing opportunities available to them, which may result in
higher prepayment rates. Management evaluates the servicing assets for
impairment quarterly. For purposes of measuring impairment, the future servicing
cashflows are stratified based on original term to maturity and the expected
life of the loans. The amount of impairment recognized is the amount by which
the servicing assets for a stratum exceeds their fair value. The weighted
average prepayment speed was 15.67% as of December 31, 2003 compared to 12.50%
as of December 31, 2002. See the footnotes to the financial statements, found
elsewhere in this Report, for further information on servicing assets.
Rights to future interest income from serviced loans that exceeds
contractually specified servicing fees are classified as interest-only strips.
Interest-only strips increased to $20,495,511 as of December 31, 2003, compared
to $13,120,093 as of December 31, 2002. The increase is due to the increase in
loans serviced for others as a result of the loan sales in 2003. The average
prepayment speed is the same as the servicing asset.
Life Insurance -Cash Surrender Value
The cash surrender value of life insurance is bank owned life insurance
("BOLI"). The BOLI death benefit provides key man insurance for the Bank as well
as providing coverage for the unaccrued liability in the event of the death of
the executive for the executive Salary Continuation Plans ("SCP"). The BOLI had
a balance of $5,740,729 at December 31, 2003 compared to $3,983,183 a year
earlier. The total death benefit at December 31, 2003 was $9,971,960. The BOLI
earnings in 2003, net of mortality cost, were $205,546, compared to $150,929 in
2002. The net earnings of BOLI are tax-free. The SCP expense before tax in 2003
was $531,240 compared to $267,108 in 2002. See the notes in the financial
statements for additional information.
Investments / Financial Assets
Investments, which include Federal Reserve Bank and Federal Home Loan Bank
stock, were $1,145,000 at December 31, 2003 and $1,460,050 at December 31, 2002.
The change from year to year is largely attributable to loans and servicing
assets increasing more than deposits and borrowings. In addition to the FRB/FHLB
stock, the Bank had $21,400,000 in Fed Funds Sold at December 31, 2003.
At the date of purchase, we are required to classify equity and debt
securities into one of three categories: held-to-maturity, trading or
available-for-sale. At each annual reporting date, the appropriateness of the
classification is reassessed. Investments classified as held-to-maturity are
measured at amortized cost in the financial statements and can be so classified
only if management has the positive intent and ability to hold those securities
to maturity. Securities
55 of 70
that are bought and held principally for the purpose of sale in the near-term
are classified as trading and measured at fair value in the financial statements
with unrealized gains and losses included in earnings. Investments not
classified as either held-to-maturity or trading are classified as
available-for-sale and measured at fair value in the financial statements with
unrealized gains and losses reported, net of tax, in a separate component of
shareholders' equity until realized.
For 2003 the ratio of interest earning assets to total assets was 86.65%,
for 2002 it was 86.76% and for 2001 it was 88.12%. The target for the Company is
to keep this ratio above 90%, but has remained below that level due to the
increase in SBA servicing asset, the related SBA interest only strip receivable,
and the cash surrender value of life insurance. The SBA servicing asset was
$6,116,679, the SBA I/O strip receivable was $20,495,511 and the cash surrender
value of life insurance was $5,740,729 at December 31, 2003. At December 31,
2002 the SBA servicing asset was $3,763,779, the SBA I/O strip receivable was
$13,120,093 and the cash surrender value of life insurance was $3,983,183. The
SBA servicing asset was $1,538,437, the SBA I/O strip receivable was $4,136,809
and the cash surrender value of life insurance was $2,832,254 at December 31,
2001. Even though these assets are not considered interest bearing for net
interest margin purposes, they do produce, or are related to, income that is
part of non-interest income.
At December 31,
---------------------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------------------------
Amortized Estimated Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value Cost Fair Value
------------ ------------- -------------- ------------ ------------ -------------
(Dollars in Thousands)
Financial Assets:
Cash and due from banks $ 9,348 $ 9,348 $ 12,180 $ 12,180 $ 9,726 $ 9,726
Federal funds sold 21,400 21,400 - - 16,400 16,400
Loans, net 357,142 359,914 268,409 270,245 149,035 149,523
Federal Reserve and Federal Home
Loan Bank Stock 1,145 1,145 1,460 1,460 517 517
I/O Strips receivable and servicing
assets 26,612 26,612 16,884 16,884 5,675 5,675
Cash surrender value - life
insurance 5,741 5,741 3,983 3,983 2,832 2,832
Accrued interest receivable 1,396 1,396 1,153 1,153 695 695
Deposits and Borrowed Funds
The Bank offers a variety of deposit accounts having a wide range of
interest rates and terms, consisting of demand, savings, money market and time
accounts. We rely primarily on competitive pricing policies, customer service
and referrals to attract and retain these deposits. We do not accept brokered
deposits.
Deposits increased to $383,487,366 at December 31, 2003 from $269,321,220
at December 31, 2002 and $172,928,225 at December 31, 2001. Demand deposits
comprised over 29% of the deposits in 2003, 31% in 2002 and 36% in 2001, tiered
savings over 9% in 2003,
56 of 70
11% in 2002 and 15% in 2001, tiered money market accounts over 8% in 2003, 23%
in 2002 and 17% in 2001, NOW accounts comprised 8% in 2003, 7% in 2002 and 9% in
2001 and certificate of deposits over 45% in 2003, 34% in 2002 and 21% in 2001.
The increase in the ratio of certificates of deposits is due to certificate of
deposit promotions in 2002 and 2003 to fund the rapid loan growth. More than 52%
of deposits have balances of $100,000 or more. No one customer has balances that
exceed 10% of the deposits of the Bank. The Bank depends on core deposits as a
source of funds for the loan portfolio. Consequently, the Bank tries to attract
core accounts yet maintain a reasonable funding cost. The core deposit base has
grown as a result of the addition of the Murrieta and El Cajon branches in 2001
and the continued deposit increases at the three other branches. It is
anticipated that the core deposit base will increase as a result of two new
branches scheduled to open this year, one in Corona, California and the other in
the Rancho Bernardo area of San Diego, California. The Bank will continue to
solicit core deposits to diminish reliance on volatile funds.
At December 31, 2003 there were no short-term advances from the Federal
Home Loan Bank compared to $10,000,000 at December 31, 2002. The borrowing
capacity at the Federal Home Loan Bank as of December 31, 2003 was $25,553,805.
On September 17, 2003, the Company issued $5,155,000 of junior subordinated
debt securities to the Company's wholly owned subsidiary, Temecula Valley
Statutory Trust II, ("Trust II"), a Connecticut business trust. The securities
have quarterly interest payments with a rate at 3-month LIBOR plus 2.95% for an
effective rate of 4.09% as of December 31, 2003, with principal due at maturity
in 2033. During June 2002, the Company issued $7,217,000 of junior subordinated
debt securities to the Company's wholly owned subsidiary, Temecula Valley
Statutory Trust I, ("Trust I"), a Connecticut business trust. The securities
have quarterly interest payments with a rate at 3-month LIBOR plus 3.45% for an
effective rate of 4.59% as of December 31, 2003, with principal due at maturity
in 2033.
Liquidity Management
Liquidity management involves the Company's ability to meet cash flow
requirements arising from fluctuations in deposit levels and demands of daily
operations, which include providing for customers' credit needs and ongoing
repayment of borrowings. The Company's liquidity is actively managed on a daily
basis and reviewed periodically by the Board of Directors. This process is
intended to ensure the maintenance of sufficient funds to meet the needs of the
Company.
The Company's primary source of liquidity is core deposits although it also
relies upon advances from the Federal Home Loan Bank of San Francisco and
Federal Fund Lines of Credit. These funding sources are augmented by payments of
principal and interest on loans and sales and participation of eligible loans.
Primary uses of funds include withdrawal of and interest payments on deposits,
originations and purchases of loans and payment of operating expenses.
The Company experienced net cash inflows of $9,168,776 during the year
ended December 31, 2003 and net cash outflows of $9,098,038 during the year
ended December 31, 2002 from operating activities. Net cash inflows from
operating activities during 2003 were primarily from net income of the Company,
accompanied by the net proceeds from the sale of
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loans held for sale which were greater than the origination of loans held for
sale. During 2002 the net cash outflows were the result of the net proceeds from
the origination of loans held for sale, which were greater than the proceeds
from the sale of loans held for sale and partially offset by the net income for
the year. Net cash outflows from investing activities totaled $101,709,937 and
$118,746,518 during 2003 and 2002, respectively. Net cash outflows from
investing activities for both periods can be attributed primarily to the growth
in the Bank's loan portfolio in excess of proceeds from principal repayments on
loans held for investment. The Company experienced net cash inflows from
financing activities of $111,108,759 during 2003 and $113,899,077during 2002,
primarily due to the growth in deposits.
As a means of augmenting its liquidity, the Company has established federal
funds lines with a correspondent bank. At December 31, 2003, the Company's
available borrowing capacity includes approximately $13.0 million in federal
funds line facilities, and $25.6 million in unused FHLB advances. Management
believes its liquidity sources to be stable and adequate. At December 31, 2003,
management was not aware of any information that was reasonably likely to have a
material effect on the Company's liquidity position.
The liquidity of the parent company, Temecula Valley Bancorp Inc. is
primarily dependent on the payment of cash dividends by its subsidiary, Temecula
Valley Bank, N.A. subject to limitations imposed by the National Bank Act as
well as other regulatory instructions. For the years ended December 31, 2003 and
December 31, 2002, total dividends paid by the Bank to Temecula Valley Bancorp
Inc. totaled $0. As of December 31, 2003, approximately $12.6 million of
undivided profits of the Bank were available for dividends to the Company.
Contractual Obligations and Commitments
At December 31, 2003, the Company had commitments to extend credit of
approximately $171.2 million and obligations under letters of credit of $1.4
million, all of which expire within one year. Commitments to extend credit are
agreements to lend to customers, provided there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee. Commitments are
generally variable rate, and many of these commitments are expected to expire
without being drawn upon. As such, the total commitment amounts do not
necessarily represent future cash requirements. The Company uses the same credit
underwriting policies in granting or accepting such commitments or contingent
obligations as it does for on-balance-sheet instruments, which consist of
evaluating customers' creditworthiness individually.
Standby letters of credit are conditional commitments issued by the Company
to guarantee the financial performance of a customer to a third party. Those
guarantees are primarily issued to support private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. When deemed necessary,
the Company holds appropriate collateral supporting those commitments.
Management does not anticipate any material losses as a result of these
transactions.
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Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets and liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities at the date of our financial statements.
Actual results may differ from these estimates under different assumptions or
conditions.
Certain accounting policies involve significant judgments and assumptions
by management which have a material impact on the carrying value of certain
assets and liabilities; management considers such accounting policies to be
critical accounting policies. The judgments and assumptions used by management
are based on historical experience and other factors, which are believed to be
reasonable under the circumstances.
Management believes the following are critical accounting policies that
require the most significant judgments and estimates used in the preparation of
its consolidated financial statements:
Accounting for the allowance for loan losses
The provision for loan losses charged to operations reflects management's
judgment of the adequacy of the allowance for loan losses and is determined
through quarterly analytical reviews of the loan portfolio, problem loans and
consideration of such other factors as the Bank's loan loss experience, trends
in problem loans, concentrations of credit risk, and current economic
conditions, as well as the results of the Bank's ongoing credit examination
process and that of its regulators. As conditions change, our level of
provisioning and allowance for loan losses may change.
Larger balance, non-homogenous exposures representing significant
individual credit exposures are evaluated based upon the borrower's overall
financial condition, resources, and payment record; the prospects for support
from any financially responsible guarantors; and, if appropriate, the realizable
value of any collateral. The allowance for loan losses attributed to these loans
is established via a process that begins with estimates of probable loss
inherent in the portfolio based upon various statistical analyses. These
analyses consider historical and projected default rates and loss severities;
internal risk ratings; geographic, industry and other environmental factors; and
model imprecision. Management also considers overall portfolio indicators,
including trends in internally risk-rated exposures, classified exposures,
cash-basis loans and historical and forecasted write-offs; and a review of
industry, geographic and portfolio concentrations, including current
developments within those segments. In addition, management considers the
current business strategy and credit process, including credit limit setting and
compliance, credit approvals, loan underwriting criteria and loan workout
procedures.
Within the allowance for loan losses, amounts are specified for
larger-balance, non-homogeneous loans that have been individually determined to
be impaired. These amounts consider all available evidence, including, as
appropriate, the present value of the expected future
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cash flows discounted in the loan's contractual effective rate, the secondary
market value of the loan and the fair value of collateral.
Each portfolio of smaller balance, homogeneous loans, including residential
first mortgage, revolving credit and most other consumer loans, is collectively
evaluated for loss potential. The allowance for loan losses is established via a
process that begins with estimates of probable losses inherent in the portfolio,
based upon various statistical analyses. These include migration analysis, in
which historical delinquency and credit loss experience is applied to the
current aging of the portfolio, together with analyses that reflect current
trends and conditions. Management also considers overall portfolio indicators,
including historical loan losses, delinquent, non-performing and classified
loans, and trends in volumes and terms of loans, an evaluation of overall credit
quality and the credit process, including lending policies and procedures,
economic, geographical, product, and other environmental factors; and model
imprecision's.
Accounting for stock options
The Company applies APB Opinion No. 25 in accounting for the plans and,
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. As a practice, the Company's incentive stock option
grants are such that the exercise price equals the current market price of the
common stock. The nonqualified grants, as a practice, equal 85% of the current
market price of the common stock. Had the Company determined compensation cost
based on the fair value at the grant date for its stock options under SFAS No.
123, the Company's proforma net income would have been reduced to the proforma
amounts indicated below:
Dollars in thousands, except per share amounts 2003 2002 2001
- ---------------------------------------------- ---- ---- ----
Net income, as reported $7,854,339 $4,191,054 $1,803,581
Proforma net income $7,359,559 $3,887,017 $ 708,401
Net income per share, basic, as reported $1.00 $0.57 $0.28
Proforma net income per share, basic $0.94 $0.53 $0.20
Net income per share, diluted, as reported $.089 $0.50 $0.25
Proforma net income per share, diluted $0.82 $0.46 $0.17
Percentage reduction in net income per share, diluted 6.3% 7.3% 60.1%
The actual value, if any, which a grantee may realize will depend upon the
difference between the option exercise price and the market price of the
Company's common stock on the date of exercise.
Servicing Assets and Interest Only Strips
Servicing assets are recognized when loans are sold with servicing
retained. Servicing assets are amortized in proportion to and over the period of
estimated future net servicing income. The fair value of servicing assets is
estimated by discounting the future cash flows at estimated future current
market rates for the expected life of the loans. The Company uses industry
prepayment statistics in estimating the expected life of the loan. Management
periodically evaluates servicing assets for impairment. For purposes of
measuring impairment, the rights are stratified based on original term to
maturity. The amount of impairment recognized
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is the amount by which the servicing asset for a stratum exceeds its fair value.
In estimating fair values at December 31, 2003, the Company utilized a weighted
average prepayment of 15.67% and a discount rate of 9.50%. In estimating fair
values at December 31, 2002, the Company utilized a weighted average prepayment
assumption of approximately 12.5% and a discount rate of 10.38%.
Rights to future interest income from serviced loans that exceeds
contractually specified servicing fees are classified as interest-only strips.
The interest-only strips are accounted for as available for sale securities and
recorded at fair value with any unrealized gains or losses recorded in equity in
the period of change of fair value. At December 31, 2003 and 2002, the fair
value of interest-only strips was estimated using. The same weighted average
prepayment assumption and discount rates are used for the servicing asset. The
carrying value of the servicing and I/O Strip receivable asset approximates the
fair value of the asset.
Changes in these assumptions and economic factors may result in increases
or decreases in the valuation of our servicing assets and interest-only strips.
Real Estate Owned and Other Repossessed Assets
Real estate or other assets acquired through foreclosure or deed-in-lieu of
foreclosure are initially recorded at the lower of cost or fair value less
estimated costs to sell through a charge to the allowance for estimated loan
losses. Subsequent declines in value are charged to operations. There were
$485,036 in real estate or other assets acquired through foreclosure or
deed-in-lieu of foreclosure as of December 31, 2003.
For further information on these and other significant accounting policies,
see Note A to the Consolidated Financial Statements included in Item 8 of this
Report.
Recent Accounting Developments
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133,
as amended and interpreted, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. Under SFAS No. 133, certain
contracts that were not formerly considered derivatives may now meet the
definition of a derivative. The Company adopted SFAS No. 133 effective January
1, 2001. The adoption of SFAS No. 133 did not have a significant impact on the
financial position, results of operations, or cash flows of the Company.
SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures, but carries over most of the
provisions of SFAS No. 125 without reconsideration. SFAS No. 140 is effective
for transfers and servicing of financial assets and extinguishments of
liabilities occurring after March 31, 2001. The statement is effective for
recognition and reclassification of collateral and for disclosures relating to
securitization transactions and collateral for fiscal years ending
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after December 15, 2000. The adoption of SFAS No. 140 did not have a material
effect on the Company's financial position, results of operations or cash flows.
SFAS No. 141, Business Combinations , requires that all business
combinations be accounted for by a single method--the purchase method. The
provisions of this SFAS No. 141 apply to all business combinations initiated
after June 30, 2001. SFAS No. 141 also applies to all business combinations
accounted for using the purchase method for which the date of acquisition is
July 1, 2001, or later. The adoption of the provisions of SFAS No. 141 did not
have a material impact on the Company's financial condition, results of
operations or cash flows.
SFAS No. 142, Goodwill and Other Intangible Assets , requires that, upon
its adoption, amortization of goodwill will cease and instead, the carrying
value of goodwill will be evaluated for impairment on an annual basis.
Identifiable intangible assets will continue to be amortized over their useful
lives and reviewed for impairment in accordance with SFAS No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of. SFAS No. 142 is effective for fiscal years beginning after December 15,
2001. The adoption of SFAS No. 142 did not have a material impact on the
Company's financial condition, results of operations or cash flows.
SFAS No. 143, Accounting for Asset Retirement Obligations, requires that
the fair value of a liability for an asset retirement obligation be recognized
in the period in which it is incurred, if a reasonable estimate of fair value
can be made. The associated asset retirement cost would be capitalized as part
of the carrying amount of the long-lived asset. SFAS No. 143 will be effective
for fiscal years beginning after June 15, 2002. The Company has determined that
this statement will not have a material impact on the Company's financial
condition, results of operations or cash flows.
SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived
Assets , replaces SFAS No. 121. SFAS No. 144 requires that long-lived assets be
measured at the lower of carrying amount or fair value less cost to sell,
whether reported in continuing operations or in discontinued operations. SFAS
No. 144 also broadens the reporting of discontinued operations to include all
components of an entity with operations that can be distinguished from the rest
of the entity and that will be eliminated from the ongoing operations of the
entity in a disposal transaction. The provisions of SFAS No. 144 are effective
for financial statements issued for fiscal years beginning after December 15,
2001. The adoption of SFAS No. 144 did not have a material impact on the
Company's financial condition, results of operations or cash flows.
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities, which
addresses financial accounting and reporting for costs associated with exit or
disposal activities and supercedes EITF 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring) . SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under EITF 94-3, a liability for an exit cost as
defined in EITF 94-3 was recognized at the date of an entity's commitment to an
exit plan. SFAS No. 146 also establishes that the liability should initially be
measured and recorded at fair value. The Company has adopted the
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provisions of SFAS No. 146 for exit or disposal activities that are initiated
after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain
Financial Institutions , which provides guidance on the accounting for the
acquisition of a financial institution. This statement requires that the excess
of the fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired in a business combination represents
goodwill that should be accounted for under SFAS No. 142. Thus, the specialized
accounting guidance in paragraph 5 of SFAS No. 72, Accounting for Certain
Acquisitions of Banking or Thrift Institutions , will not apply after September
30, 2002. If certain criteria in SFAS No. 147 are met, the amount of the
unidentifiable intangible asset will be reclassified to goodwill upon adoption
of the statement. Financial institutions meeting conditions outlined in SFAS No.
147 will be required to restate previously issued financial statements.
Additionally, the scope of SFAS No. 144 is amended to include long-term
customer-relationship intangible assets such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
The adoption of this standard did not have a material impact on the Company's
financial position, results of operations or cash flows for the year ended
December 31, 2002.
In December 2002, SFAS No. 148, Accounting for Stock-based
Compensation--Transition and Disclosure, an amendment of FASB Statement No. 123,
was issued and amends SFAS No. 123 to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
SFAS No. 123 to require prominent disclosure in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
provisions of SFAS No. 148 are effective for annual financial statements for
fiscal years ending after December 15, 2002, and for financial reports
containing condensed financial statements for interim periods beginning after
December 15, 2002. The Company has determined not to adopt the fair value based
method of accounting for stock-based employee compensation.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees and Indebtedness of Others, an interpretation of SFAS Nos. 5, 57 and
107, and rescission of FIN No. 34, Disclosure of Indirect Guarantees of
Indebtedness of Others . FIN No. 45 elaborates on the disclosures to be made by
the guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also requires that a
guarantor recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of the interpretation are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002,
while the provisions of the disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
Company believes the adoption of such interpretation will not have a material
impact on its results of operations, financial position or cash flows.
In December 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities , an interpretation of Accounting Research Bulletin No. 51.
FIN No. 46 requires
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that variable interest entities be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or is entitled to receive a majority of the entity's residual returns
or both. FIN No. 46 also requires disclosures about variable interest entities
that companies are not required to consolidate but in which a company has a
significant variable interest. The consolidation requirements of FIN No. 46 will
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements will apply to entities established prior to
January 31, 2003 in the first fiscal year or interim period beginning after June
15, 2003. The Company does not believe the adoption of such interpretation will
have a material impact on its results of operations, financial position or cash
flows.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Certain information concerning market risk is contained in the
notes to the financial statements which are included in Item 8 of this Report
and in Management's Discussion and Analysis of Financial Condition and Results
of Operations which is included as Item 7 of this Report.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
The information required by this item is included in
"Consolidated Financial Statements", "Notes to Consolidated Financial
Statements", the "Independent Auditors Report", and the "Report of Management"
in our 2003 Annual Report to shareholders and is incorporated herein by
reference.
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
Under SEC rules, the Company is required to maintain
disclosure controls and procedures designed to ensure that information required
to be disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms. The Company's
disclosure controls and procedures were designed to ensure that material
information related to the Company, including its consolidated subsidiaries, is
made known to management, including the chief executive officer and chief
financial officer, in a timely manner. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily was required to use its judgment in evaluating the cost to benefit
relationship of possible controls and procedures.
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Within the 90-day period prior to the filing date of this report, the
Company carried out an evaluation of the effectiveness of the design and
operation of its disclosure controls and procedures. The Company's management,
including the Company's chief executive officer and chief financial officer,
supervised and participated in the evaluation. Based on this evaluation, the
chief executive officer and the chief financial officer concluded that the
Company's disclosure controls and procedures were effective as of the evaluation
date.
Changes in Internal Controls
There were no significant changes in the Company's internal
controls or in other factors that could significantly affect those controls
subsequent to the date of their evaluation.
PART III
ITEM 10: DIRECTORS AND PRINCIPAL OFFICERS
--------------------------------
The information required by this Item is incorporated by
reference from the Company's definitive Proxy Statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A within 120 days
after the fiscal year covered by this Annual Report ("Company's Proxy
Statement") under the captions "Item-1 Election of Directors", "Information
about Directors and Executive Officers", and "Compliance with Section 16 of the
1934 Act".
With regard to Item 406, the company has adopted a Code of
Ethics that applies to its principal executive officer, principal financial
officer and controller. The policy may be viewed at the Company's website at
www.temvalbank.com. Neither our website, nor the hyperlinks within our website
are incorporated into this document.
ITEM 11: EXECUTIVE COMPENSATION
----------------------
The information required by this Item is incorporated by
reference from the Company's Proxy Statement under the caption "Executive
Officers and Compensation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The information required by this Item is incorporated by
reference from the Company's Proxy Statement under the caption "Stock
Ownership".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The information required by this Item is incorporated by
reference from the Company's Proxy Statement under the caption "Certain
Relationships and Other Transactions".
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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------
The in formation required by this Item is incorporated by
reference from the Company's Proxy Statement under the caption "Selection of
Independent Auditors".
PART IV
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K
-----------------------------------------------------------
(a) Documents Filed as Part of this Report
(1) The following financial statements are incorporated by reference from Item 8 hereto:
Independent Auditors Report Page F-1
Consolidated Statements of Financial Condition as of December 31,
2003 and 2002. Page F-2
Consolidated Statements of Income for Each of the Years Ended
December 31, 2003, 2002 and 2001. Page F-4
Consolidated Statement of Changes in Shareholders' Equity for the
Years ended December 31, 2003, 2002 and 2001 Page F-5
Notes to Consolidated Financial Statements 2003, 2002 and 2001 Page F-7
(2) Financial Statement Schedules
Not applicable.
(b) Exhibits
Exhibit No. Description of Exhibit
2. (i) Bank and Company Amended and Restated Plan of Reorganization dated
as of April 2, 2002 filed on June 3, 2002 as an Exhibit to Form 8-A12G.
2. (ii) Agreement and Plan of Merger of Temecula Merger Corporation and
Temecula Valley Bancorp is an Exhibit to the Company's Definitive 14A filed
November 20, 2003.
3(i) Articles of Incorporation of Temecula Valley Bancorp Inc., a
California Corporation, is an Exhibit to the Company's Definitive 14A filed
November 20, 2003.
3(ii) Bylaws of Temecula Valley Bancorp Inc. is an Exhibit to the Company's
Definitive 14A filed November 20, 2003.
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4.1 Common Stock Certificate of Temecula Valley Bancorp Inc. filed on June
3, 2002 as an Exhibit to Temecula Valley Bancorp's Form 8-A12G.
4.2 Warrant Certificate of Temecula Valley Bank, N.A. as adopted by
Temecula Valley Bancorp Inc. filed on June 3, 2002 as an Exhibit to
Temecula Valley Bancorp's Form 8-A12G.
10.1 Temecula Valley Bank, N.A. Lease Agreement for Main Office filed on
March 11, 2003 as an Exhibit to Temecula Valley Bancorp's Form 10KSB.
10.2 Stephen H. Wacknitz Employment Agreement dated October 1, 2003.
Page ___
10.3 Brian D. Carlson Employment Agreement dated December 1, 2003. Page ___
10.4 Luther J. Mohr Employment Agreement dated September 16, 2001 filed on
March 11, 2003 as an Exhibit to Temecula Valley Bancorp's Form 10KSB.
Page ___
10.5 Thomas P. Ivory Employment Agreement dated January 25, 2001 filed on
March 11, 2003 as an Exhibit to Temecula Valley Bancorp's Form 10KSB.
10.6 1996 Incentive and Non Qualified Stock Option Plan (Employees), as
amended by that certain First Amendment effective May 15, 2001 and that
certain Second Amendment effective May 15, 2002 filed on March 11, 2003 as
an Exhibit to Temecula Valley Bancorp's Form 10KSB.
10.7 1997 Non Qualified Stock Option Plan (Directors), as amended by that
certain First Amendment effective May 15, 2001 and that certain Second
Amendment effective May 15, 2002 filed on March 11, 2003 as an Exhibit to
Temecula Valley Bancorp's Form 10KSB.
10.8 Amended and Restated Salary Continuing Agreement entered into on
behalf of Stephen H. Wacknitz, as amended by that certain First Amendment
effective as of December 31, 2002 filed on March 11, 2003 as an Exhibit to
Temecula Valley Bancorp's Form 10KSB.
10.9 Amended and Restated Salary Continuing Agreement entered into on
behalf of Luther J. Mohr, as amended by that certain First Amendment
effective as of December 31, 2002 filed on March 11, 2003 as an Exhibit to
Temecula Valley Bancorp's Form 10KSB.
10.10 Salary Continuing Plan entered into on behalf of Thomas M. Shepherd
filed on March 11, 2003 as an Exhibit to Temecula Valley Bancorp's Form
10KSB.
10.11Salary Continuing Plan entered into on behalf of Brian Carlson filed
on March 11, 2003 as an Exhibit to Temecula Valley Bancorp's Form 10KSB.
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31.1 Certification of the Chief Executive Officer of Registrant submitted
to the Securities and Exchange Commission pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer of Registrant submitted
to the Securities and Exchange Commission pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer of Registrant submitted
to the Securities and Exchange Commission pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. This Certification shall not be deemed to be
"filed" with the Commissioner subject to the liability of Section 18 of the
Exchange Act, except to the extent that the Registrant requests that such
certifications incorporated by reference into a filing under the Securities
Act or Exchange Act. This certification is being furnished to the
Commissioner and accompanies this Report pursuant to SEC Release No.
33-8212.
32.2 Certification of the Chief Financial Officer of Registrant submitted
to the Securities and Exchange Commission pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. This Certification shall not be deemed to be
"filed" with the Commissioner subject to the liability of Section 18 of the
Exchange Act, except to the extent that the Registrant requests that such
certifications incorporated by reference into a filing under the Securities
Act or Exchange Act. This certification is being furnished to the
Commissioner and accompanies this Report pursuant to SEC Release No.
33-8212.
(c) Reports on Form 8-K
The following reports on Form 8-K were filed with the Securities and
Exchange Commission by the Company during the last quarter of the period covered
by this Report.
(1) A current report on Form 8-K dated December 18, 2003 that reported the
effectiveness of a change in the Company's state of incorporation from Delaware
to California.
(2) A current report on Form 8-K dated December 10, 2003 that reported a
press release concerning the addition of a loan production office in the Rancho
Bernardo area of San Diego, California and the employment of Carl R. Kruse as
Senior Vice President.
(3) A current report on Form 8-K dated December 8, 2003 that reported a
press release concerning the employment of Ronald R. Bradley as Senior Vice
President.
(4) A current report on Form 8-K dated November 19, 2003 that reported a
press release concerning the naming of Temecula Valley Bank as the nation's
eighth largest SBA lender.
(5) A current report on Form 8-K dated November 3, 2003 that reported a
press release concerning the seeking of shareholder approval of a two-for-one
stock split and a reincorporation into California.
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(6) A current report on Form 8-K dated October 20, 2003 that reported a
press release concerning earnings for the third quarter of 2003.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
TEMECULA VALLEY BANCORP INC.
DATE: ____________, 2004 BY:
----------------------------------------
Stephen H. Wacknitz, President/CEO,
Chairman of the Board
BY:
----------------------------------------
Donald A. Pitcher, Senior Vice President
Chief Financial Officer
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Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
Director March 29, 2004
- --------------------------
Dr. Steven W. Aichle
Director March 29, 2004
- ----------------------------
Dr. Robert P. Beck
Director March 29, 2004
- ----------------------------
Neil M. Cleveland
Director and March 29, 2004
- ---------------------------- Chief Operating Officer
Luther J. Mohr
President/CEO and March 29, 2004
- ---------------------------- Chairman of the Board
Stephen H. Wacknitz
Director March 29, 2004
- ----------------------------
Richard W. Wright
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