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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2005
Commission File No: 000-49844
TEMECULA VALLEY BANCORP INC.
(Exact name of registrant as specified in its charter)
California 46-0476193
(State or other jurisdiction of Incorporate or organization) (I.R.S. Employer identification No.)
27710 Jefferson Avenue - Suite A100, Temecula CA 92590
(Address of principal executive offices) (Zip Code)
Registrant's telephone number:
(951) 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
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark
if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated Filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the common stock held by non-affiliates of the
Registrant as of June 30, 2005 was approximately $172,876,217.
Number of Registrant's shares of common stock outstanding at March 15, 2006 was
8,977,771.
Documents incorporated by reference: Certain information required by Part III of
this Annual Report is incorporated by reference from the Registrant's definitive
proxy statement to be filed 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.
TABLE OF CONTENTS
PART I .....................................................................................................2
ITEM 1: BUSINESS........................................................................................2
General.................................................................................................2
Where You Can Find More Information.....................................................................2
Temecula Valley Bancorp Inc.............................................................................2
Temecula Valley Bank....................................................................................2
General Business........................................................................................3
Business Strategy.......................................................................................3
Lending.................................................................................................4
Concentrations of Credit................................................................................9
Investment Activities...................................................................................9
Asset/Liability Management..............................................................................9
Nonaccrual, Past Due and Restructured Loans............................................................10
Potential Problem Loans................................................................................12
Allowance for Loan Losses..............................................................................12
Deposits...............................................................................................14
Short-term Borrowings..................................................................................15
Recently Issued Accounting Standards...................................................................16
Supervision and Regulation.............................................................................17
Recent and Proposed Legislation........................................................................18
Capital Adequacy Requirements..........................................................................21
Deposit Insurance Assessments..........................................................................22
Change in Control......................................................................................23
Examinations...........................................................................................23
Federal Securities Law.................................................................................23
Transactions with Insiders and Affiliates..............................................................24
Monetary Policy........................................................................................24
ITEM 1A: RISK FACTORS...................................................................................25
ITEM 1B: UNRESOLVED STAFF COMMENTS......................................................................27
ITEM 2: PROPERTIES.....................................................................................27
ITEM 3: LEGAL PROCEEDINGS..............................................................................28
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER.............................................28
PART II ....................................................................................................28
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........................28
ITEM 6. SELECTED FINANCIAL DATA........................................................................29
ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS.............................................................32
Analysis of Financial Condition and Results of Operations..............................................32
Results of Operations..................................................................................32
Financial Condition....................................................................................36
Critical Accounting Policies and Estimates.............................................................42
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................43
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................43
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........43
ITEM 9A: CONTROLS AND PROCEDURES........................................................................43
ITEM 9B: OTHER INFORMATION..............................................................................45
PART III.....................................................................................................45
ITEM 10: DIRECTORS AND PRINCIPAL OFFICERS...............................................................45
ITEM 11: EXECUTIVE COMPENSATION.........................................................................45
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................45
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.........................................................45
PART IV......................................................................................................45
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES........................................................45
SIGNATURES.............................................................................................46
Exhibit No. Index To Exhibits..................................................................71
EXHIBIT LIST...........................................................................................74
1
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 our ability to predict or
control, could cause future results to differ materially from those
contemplated. These factors include but are not limited to (1) a slowdown in the
national and California economies; (2) volatility of rate sensitive deposits;;
(3) changes in the regulatory environment; (4) increasing competitive pressure
in the banking industry; (5) operational risks including data processing system
failures or fraud; (6) asset/liability matching risks and liquidity risks; and
(7) changes in the securities markets. The consequences of these factors, any of
which could hurt our business, could include, among others: (a) increased loan
delinquencies; (b) an escalation in problem assets and foreclosures; (c) a
decline in demand for our products and services; and (d) a reduction in the
value of the collateral for loans made by us, especially real estate, which, in
turn would likely reduce our customers' borrowing power and the value of assets
and collateral associated with our existing loans. See also "Item 1A Risk
Factors" and other risk factors discussed elsewhere in this Annual Report.
PART I
ITEM 1: BUSINESS
--------
General
Where You Can Find More Information
Under Sections 13 and 15(d) of the Securities Exchange Act, periodic
and current reports must be filed with the Securities and Exchange Commission
("SEC"). We electronically file 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 ("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, Temecula Valley Statutory
Trust II, Temecula Valley Statutory Trust III and Temecula Valley Statutory
Trust IV. References to the "Company" reflects all the activities of the Company
and its subsidiaries, including the Bank, except as otherwise specified by the
context of the statement.
2
Temecula Valley Bank
The Bank was organized in 1996 and commenced operations on December 16,
1996 as a national banking association. The Bank converted from a national
charter to a state charter on June 29, 2005. The deposits of the Bank are
insured by the Federal Deposit Insurance Corporation ("FDIC") up to the
applicable limits. The Bank is a member of the Federal Reserve System. The Bank
has no subsidiaries.
General Business
The Bank currently has eight full-service banking offices in California
providing services to customers in the Riverside and San Diego Counties. Our
principal office is located in Temecula, California with other California
full-service offices in Carlsbad, Corona, El Cajon, Escondido, Fallbrook,
Murrieta, and in the Rancho Bernardo area of San Diego.
The Bank also operates loan production offices which principally
generate construction and/or mortgage loans in California at the following
locations: Encinitas, Fallbrook and Temecula. The real estate industries group
of the Bank focuses on construction lending and maintains loan production
offices in Corona and San Rafael, both in California. The Bank also has SBA loan
production offices in the following states: Arizona, California, Colorado,
Connecticut, Florida, Georgia, Illinois, Nebraska, New Jersey, North Carolina,
Ohio, Oregon, Pennsylvania, Texas and Washington.
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. In addition, the Bank has developed a
nationwide SBA lending program as a "preferred lender". Through this program, we
originate and fund both "7A" and "504" loans, primarily secured by commercial
real estate property and guaranteed up to 85% by the Small Business
Administration. Loan products include consumer installment (primarily automobile
loans), home equity lines of credit, single-family residential construction
loans, on both an owner-occupied and a non-owner basis, single family
residential tract loans (over 4 units), commercial construction and permanent
loans for office, retail and industrial buildings for owner-occupancy,
investment and re-sale, commercial lines of credit, term loans and letters of
credit for local businesses, and residential mortgage financing including
conventional, VA, FHA and Cal-Vet loans.
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, internet banking,
direct deposit and automatic transfers between accounts. The Bank is a member of
regional ATM network and offers 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, Temecula Valley Statutory Trust II, Temecula Valley Statutory Trust III
and Temecula Valley Statutory Trust IV. Accordingly, the discussion of the
business which follows concerns the business conducted by the Bank, unless
otherwise indicated. No material portion of our Company's business is seasonal.
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 Continued focus on expansion of the SBA 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
increases in net interest income and non interest income as well as expense
controls during several consecutive years of significant internal expansion.
This produced record earnings for 2005 of $13,953,265, compared to $10,577,623
in 2004, and $7,854,339 in 2003. Return on average equity was 27.46% for 2005
compared, to 28.89% for 2004, and 31.84% in 2003. Return on average total assets
was 1.91% for 2005, compared to 2.00% for 2004, and 2.04% for 2003. Management
expects that during 2006, net income will increase over the results in 2005 by
at least 10% but cannot guarantee these results.
Net interest income before provision for loan losses has increased to
$43,541,476 for 2005, compared to $27,200,344 for 2004, and $18,943,947 in 2003
due to increases in rates and volume of interest-earning assets. Total assets
increased 43% in 2005 to $868,988,046 as of December 31, 2005, compared to
$606,827,529 as of December 31, 2004, and $431,212,118 as of December 31, 2003.
Average interest-earning assets increased 41% to $642,158,013 for 2005, compared
to $454,759,165 for 2004, and $332,832,018 in 2003. The net interest margin has
increased to 6.78% in 2005 from 5.98% in 2004, and 5.69% in 2003.
3
Non interest income was $23,822,163 as of December 31, 2005, compared
to $28,698,614 for 2004, and $24,481,351 for 2003. This source of income is
principally derived from SBA and mortgage sales. The decrease in non interest
income in 2005 is primarily due to the decrease in the SBA 7A and mortgage loan
sales gain. Management currently anticipates that for 2006, non interest income
will increase due to increased production from additional SBA origination staff.
The Company measures operating expenses as a percentage of average
assets. As a percentage of average assets, operating expenses decreased to 5.57%
for 2005, compared to 6.43% for 2004, and 7.55% for 2003. The decrease in 2005
is a result of an increase in average assets to $730,023,899 as of December 31,
2005, compared to $528,239,119 as of December 31, 2004, which outpaced growth in
operating expense in 2005.
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,
2005 2004 2003
---- ---- ----
Amount Percent Amount Percent Amount Percent
------------- -------- ------------ --------- ------------- --------
(Dollars in Thousands)
Loan portfolio composition:
Commercial $ 30,787 4% $ 24,676 5% $ 33,008 9%
Real estate - Construction 385,378 51% 203,886 38% 113,847 31%
Real estate - Other 337,610 44% 302,542 56% 212,996 59%
Consumer 4,320 1% 2,796 1% 3,195 1%
------------- -------- --------- --------- --------- --------
Total Loans $ 758,095 100% $ 533,900 100% $ 363,046 100%
============= ======== ============ ========= ============= ========
At December 31,
2002 2001
---- ----
Amount Percent Amount Percent
------------- -------- ------------ ---------
(Dollars in Thousands)
Loan portfolio composition:
Commercial $ 44,976 16% $ 22,775 15%
Real estate - Construction 61,568 23% 38,027 25%
Real estate - Other 161,767 59% 84,992 57%
Consumer 4,455 2% 5,170 3%
--------- -------- ------------ ---------
Total Loans $ 272,766 100% $ 150,964 100%
============= ======== ============ =========
Loan Maturity
The following table sets forth the contractual maturities of gross
loans at December 31, 2005.
One year More than 1 More than 3 More than Total
or less year to 3 years years to 5 years 5 years loans
------------ ------------- -------------- ------------- ------------
(Dollars in Thousands)
Commercial $ 19,038 $ 3,243 $ 2,122 $ 6,384 $ 30,787
Real estate - Construction 311,584 18,090 - 55,704 385,378
Real estate - Other 122,494 13,857 10,549 190,710 337,610
Consumer 2,625 508 845 342 4,320
------------ ------------- -------------- ------------- ------------
Total Gross Loans
Outstanding $ 455,741 $ 35,698 $ 13,516 $ 253,140 $ 758,095
============ ============= ============== ============= ============
4
The following table sets forth, as of December 31, 2005, the dollar
amounts of net loans outstanding and whether such loans have fixed or adjustable
rates.
----------------------------------------------------
Fixed Adjustable Total
----------------------------------------------------
(Dollars in Thousands)
Commercial $ - $ 30,787 $ 30,787
Real estate - Construction 648 384,730 385,378
Real estate - Other - 337,610 337,610
Consumer - 4,320 4,320
-------------- --------------- --------------
Total Gross Loans Outstanding $ 648 $ 757,447 $ 758,095
============== =============== ==============
Loan Origination and Sale
The following table sets forth loan originations by category and
purchases, sales and principal repayments of loans for the periods indicated:
At December 31,
--------------- --------------- -------------- -------------- --------------
2005 2004 2003 2002 2001
--------------- --------------- -------------- -------------- --------------
(Dollars in Thousands)
Beginning balance $ 533,900 $ 363,046 $ 272,766 $ 150,964 $ 93,015
Loans originated:
Commercial 323,219 237,064 161,376 144,399 84,285
Real estate:
SBA & Equity 167,402 225,373 192,549 166,563 73,488
Construction 897,862 574,150 367,464 186,741 88,868
Other 11,281 44,942 96,051 85,281 60,711
Consumer 5,200 1,869 2,422 4,298 5,136
--------------- --------------- -------------- -------------- --------------
Total loans originated 1,404,964 1,083,398 819,862 587,282 312,488
--------------- --------------- -------------- -------------- --------------
Loans sold
Commercial
Real estate:
SBA 151,191 199,236 129,813 108,213 44,046
Construction - - - - -
Other - Mortgage 13,707 45,243 100,800 83,014 62,099
--------------- --------------- -------------- -------------- --------------
Total loans sold 164,898 244,479 230,613 191,227 106,145
--------------- --------------- -------------- -------------- --------------
Less:
Principal repayments 1,015,871 668,065 498,969 274,253 148,394
--------------- --------------- -------------- -------------- --------------
Total loans $ 758,095 $ 533,900 $ 363,046 $ 272,766 $ 150,964
=============== =============== ============== ============== ==============
Brokered Loans Originated (1)
Mortgage $ 143,234 $ 60,604 $ 65,378 $ 72,742 $ 60,953
SBA $ 52,470 $ 154,515 $ 65,456 $ 29,612 $ 17,075
(1) Brokered refers to loans that were originated by the Bank but
funded by other financial institutions.
Underwriting Process
The lending activities of the Bank are guided by the basic lending
policies established by the Board of Directors. Each loan must meet minimum
underwriting criteria established in the Bank's lending policies and must fit
within the Bank'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 loan in excess of $250,000,
which is ordered by the Bank's Appraisal Department. In addition, the loan
officer conducts a review of these appraisals for accuracy, reasonableness and
conformance to the Bank's lending policy on all applications. All revisions to
the approved appraiser list must be approved by the Chief Credit Officer or
Chief Appraiser.
Depending on the loan size and type, the Bank's loan approval process
consists of a chain of concurrences beginning with the originating loan officer
and rising through the office/division manager, the Chief Credit Officer, the
Chief Administrative Officer, the Director of Finance and SBA, the President/CEO
and the Board of Directors. The number of concurring signatures obtained is
dependent upon the dollar amount of the transaction and/or the total liability
of the borrowing relationship. All signatures in the chain must be obtained
except in the case of absence from the Bank. In all cases, the signature of the
highest required loan authority must be obtained.
5
All loans exceeding the limits of the above mentioned individuals will
be forwarded to the Board of Directors Loan Committee for approval after
concurrence by the appropriate chain of authority. The vote of the Directors
Loan Committee will be obtained by the committee chairman telephonically or in
person at the monthly Board of Directors Loan Committee meeting. The approval or
declination by each member will be indicated on the signature page of the Loan
Report.
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. This insurance must be maintained during the full term of the loan.
Also, generally, title insurance endorsed to the Bank is required on all real
estate secured loans.
The Bank maintains SBA loan production offices located throughout
various parts of the United States. SBA 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 other
construction lending and mortgage related loan production offices, all of which
are in California, are typically staffed with business development officers,
underwriters, and processors who send these loans files to our main office where
the credit decision is made. Our retail full service branches may include
non-SBA commercial, mortgage 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 Bank is a Nationwide SBA "Preferred Lender". As a "Preferred Lender,"
we 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 Bank'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"). For 2005, 7A Loans have represented approximately 72.4%
of the SBA Loans originated while 504, piggyback, and B&I loans have represented
the balance.
Under the SBA's 7A Program, loans in excess of $150,000 up to
$2,000,000 are guaranteed 75% by the SBA. Generally, this guarantee may become
invalid only if the loan does not meet the SBA underwriting, documentation, and
servicing guidelines. Loans under $150,000 are guaranteed 85% by the SBA.
SBA 7A 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. A minimum down payment of 10% is
required on most 7A Loans, but may require a larger down payment when the real
estate collateral consists of a special purpose or single use property such as a
motel or service station.
The Bank generally sells the guaranteed portion SBA 7A loans, which is
up to 85% of the loan. The remaining portion is the unguaranteed portion of the
loans, a portion of which may also be sold. Approximately 5% of the 7A loans are
required to stay on the books of the Bank. Funding for these loans has come
principally from retail deposit sources. The SBA loans generally have an
interest rate of 1.00% to 2.75% over Wall Street Journal Prime Rate.
The Bank retains the servicing on the sold guaranteed portion of 7A
Loans. The strategy of selling both the guaranteed and unguaranteed portion of
the 7A Loans allows us to manage our 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 4%. We also receive a servicing fee equal to 1% to 5% of
the guaranteed 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
Bank is required to repurchase the loan and may be required to refund the
premium to the purchaser. In the past three years, we have repurchased 28 loans,
however only 1 of these repurchased loans required a refund of the premium. No
refunds were owed on the other 27 loans repurchased.
6
Under the SBA's 504 Program, we require a minimum down payment of 10%
(more on special purpose or single use properties). 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 on improved property
loans. 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 term on the second trust deed loan
is generally 18 months and the Certified Development Company cannot payoff the
loan until a notice of completion is filed. The first trust deed loan on a
construction project is generally a term of 25 years and 18 months. The first
trust deed loans may be pre-sold with no recourse, prior to releasing the funds
to the purchaser. The Bank retains no servicing on 504 Loans after they are
sold.
Our SBA lending program, and portions of our 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 Bank's loans-to-one-borrower limitation
which, at December 31, 2005 was $14,005,133.
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 our business. Currently, the maximum limit of individual 7A
Loans which the SBA will permit is $2,000,000. Any reduction in the maximum loan
amount or the maximum guaranty amount could have a negative impact on our
business. Since the SBA lending of the Bank constitutes a significant portion of
our lending business, 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.
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 5 to 25 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 10 to 25 year
period with balloon payments due at the end of 3 to 10 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 Bank originates construction loans on both one-to-four-family
residences and on commercial real estate properties. We originate two types of
residential construction loans, owner-occupied and speculative. The Bank also
originates owner-occupied construction loans to build single family residences.
We will originate speculative construction loans to companies engaged in the
business of constructing homes for re-sale. 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 1.20: 1 or more. Qualification for permanent
financing should be determined by the loan officer as part of the credit
presentation. Absent such prequalification, we will not approve a construction
loan. We originate 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 24 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, 2005, construction loans, including land acquisition and
development loans totaled $385,377,900 or approximately 51% of the total loan
portfolio.
7
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, we assume 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, we 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, home equity lines of credit, personal loans
(collateralized and uncollateralized) and deposit account collateralized loans.
The terms of these loans typically range from 12 to 120 months and vary based
upon the nature of collateral and size of loan. Our portfolio of consumer loans
primarily consists of installment loans secured by new or used automobiles,
boats and recreational vehicles and loans secured by deposits. At December 31,
2005, consumer loans totaled $4,319,776.
As of December 31, 2005, home equity loans totaled $5,009,342, or 0.7%
of the Bank's gross loan portfolio. Our home equity loans are adjustable-rate
and reprice with changes in the Bank'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
Sold loans are serviced by our loan servicing department except for
single family mortgage loans, for which servicing is 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, 2005,
the Bank was servicing $503,198,976 of loans originated that were sold to other
investors.
Our 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 our 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.
Credit Risk and Loan Review
The Bank 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 management to ascertain whether proper
credit, underwriting and loan documentation policies, procedures and practices
are being followed by our loan officers and are being applied uniformly
throughout the Bank. The Chief Credit Officer and the Assistant Chief Credit
Officer 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 a semi-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 we continue to review these and
other related functional areas, there can be no assurance that the steps we have
taken to date will be sufficient to enable us to identify, measure, monitor and
control all credit risk.
8
Concentrations of Credit
The Company's primary investment is in loans, 95.4% of which are
secured by real estate. Therefore, although we monitor 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. We seek 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 state law, the Bank's ability to make aggregate
loans-to-one-borrower is limited to 25% of unimpaired capital and surplus (as of
December 31, 2005, this amount was $14,005,133).
Investment Activities
Our investment policy, 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 Bank'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
at the discretion of the President, the Chief Financial Officer or the Chief
Operating Officer. At December 31, 2005, we held $1,245,000 in Federal Reserve
Bank Stock, $1,853,600 in Federal Home Loan Bank stock, and $33,200,000 in
federal funds sold.
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, 2005, 96.6% of our loan portfolio was tied to adjustable rate
indices. The majority of the adjustable rate loans are tied to the Wall Street
Journal prime rate and reprice immediately. The exception is 7A Loans, which
reprice on the first day of the subsequent quarter after a change in prime. As
of December 31, 2005, approximately 62% of deposits were time deposits with a
stated maturity (generally one year or less) and a fixed rate of interest. As of
December 31, 2005, 100% of the Company's junior subordinated debt was floating
rate with a remaining term of 28-30 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.
The following table shows the effects of changes in projected net
interest income for 2006 under the interest rate shock scenarios stated in the
table. The table was prepared as of December 31, 2005, at which time the Bank's
internal prime rate was 9.25% and Wall Street Journal prime rate was 7.25%.
9
December 31, 2005 December 31, 2004
- ----------------------------------------------------------- ---------------------------------------------------------
% Change % Change
Changes in Projected Net Change from from Changes in Projected Net Change from from
Rates Interest Income Base Case base Case Rates Interest Income Base Case base Case
- ------------------ -------------- ------------- ----------- --------------- --------------- ------------- -----------
(Dollars in Thousands)
+300 bp $ 34,503 $ 3,625 12% +300 bp $ 36,160 $ 3,746 12%
+200 bp $ 33,210 $ 2,332 8% +200 bp $ 34,825 $ 2,411 8%
+100 bp $ 32,004 $ 1,126 4% +100 bp $ 33,579 $ 1,165 4%
0 bp $ 30,878 $ - 0% 0 bp $ 32,414 $ - 0%
-100 bp $ 29,823 $ (1,055) (3%) -100 bp $ 31,323 $ (1,091) (4%)
-200 bp $ 28,834 $ (2,044) (7%) -200 bp $ 30,299 $ (2,115) (7%)
-300 bp $ 27,906 $ (2,972) (10%) -300 bp $ 29,337 $ (3,077) (10%)
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.
Nonaccrual, Past Due and Restructured Loans
Nonperforming assets consist of nonperforming loans and Other Real
Estate Owned ("OREO"). The Bank had $7,950,601 of nonperforming loans as of
December 31 2005, of which $6,513,752 was guaranteed by the SBA, compared to
$11,799,346 of nonperforming loans as of December 31, 2004, of which $8,140,267
was government guaranteed and $6,764,713 of nonperforming loans as of December
31, 2003, of which $5,269,317 was government guaranteed. There was $2,111,250 of
OREO at December 31, 2005, of which $604,004 was guaranteed by the SBA, compared
to $302,698 of OREO at December 31, 2004, of which $227,023 was guaranteed by
the SBA.
Pursuant to SBA operating procedures, real estate collateral is
liquidated when a loan becomes uncollectible. Should there be a shortfall in
liquidation proceeds of an SBA guaranteed loan; the SBA will assume 75% - 85% of
that shortfall. The ratio of nonperforming loans to total loans (after reducing
for SBA guarantees) was 0.19%, 0.69%, and 0.41% for the years ended 2005, 2004,
and 2003, 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. The
Bank had no restructured loans as of December 31, 2005. Restructured loans
totaled $154,303 at December 31, 2004, and $948,691 at December 31, 2003. Our
credit administration 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:
10
Nonaccrual, Past Due, and Restructured Loans
December 31,
-------------------------------------------------------------------------
2005 2004 2003 2002 2001
-------------------------------------------------------------------------
(Dollars in Thousands)
Nonaccrual loans (Gross):
Commercial $ 2,259 $ 2,582 $ 949 $ 575 $ -
Real Estate - Construction - - - - -
Real Estate - Other 5,692 9,217 5,726 1,333 99
Installment - - - - -
------------ ----------- ----------- ------------- -------------
Total 7,951 11,799 6,675 1,908 99
OREO 2,111 303 485 - -
------------ ----------- ----------- ------------- -------------
Total nonaccrual loans and OREO $ 10,062 $ 12,102 $ 7,160 $ 1,908 $ 99
============ =========== =========== ============= =============
Total nonaccrual loans as a percentage of
total loans 1.1% 2.2% 1.7% 0.7% 0.1%
Total nonaccrual loans and OREO as a
percentage of total loans and OREO 1.3% 2.3% 2.0% 0.7% 0.1%
Allowance for loan losses to total net loans
(including held-for-sale) 1.2% 1.2% 1.0% 1.1% 0.8%
Allowance for loan losses to total net loans
(excluding held-for-sale) 1.4% 1.3% 1.1% 1.2% 0.9%
Allowance for loan losses to nonaccrual loans 113.7% 53.9% 53.3% 158.1% 623.2%
Loans past due 90 days or more on accrual status:
Commercial $ - $ - $ - $ - $ -
Real Estate - - - - 100
Installment - - - - -
--------- ------- ------- --------- ---------
Total - - - - 100
========= ======= ======= ========= =========
Restructured loans:
On accrual status $ - $ 154 $ 949 $ 1,064 $ -
On nonaccrual status - - - - -
------------ ----------- ----------- ------------- -------------
Total $ - $ 154 $ 949 $ 1,064 $ -
============ =========== =========== ============= =============
The table below summarizes the approximate changes in gross nonaccrual
loans for the years ended December 31, 2005, 2004, and 2003.
Changes in Gross Nonaccrual Loans
2005 2004 2003
-----------------------------------------------------
(Dollars in Thousands)
Balance, beginning of the year $ 11,799 $ 6,675 $ 1,908
Loans placed on nonaccrual 3,840 5,293 4,041
Charge-offs (540) (1,097) (536)
Loans returned to accrual status (6,586) - -
Repayments (including interest applied to 1,920 2,338 2,598
principal)
Transfers to OREO (2,482) (1,410) (1,336)
------------------------------------------------------
Balance, end of year $ 7,951 $ 11,799 $ 6,675
======================================================
The additional interest income that would have been recorded from
nonaccrual loans if the loans had not been on nonaccrual status, was $898,242,
$549,105, and $445,311 for the years ended December 31, 2005, 2004, and 2003,
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
0.14%, 0.12% and 0.13% basis points for the years ended December 31, 2005, 2004,
and 2003, respectively.
11
Other Real Estate Owned
The amount of the Bank's OREO was $2,111,250 at December 31, 2005, of
which $604,004 was guaranteed by the SBA, compared to $302,698 at December 31,
2004, of which $227,023 was guaranteed by the SBA and $485,036 at December 31,
2003. The Bank's policy is to record these properties at the lower of cost or
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, 2005, in addition to loans disclosed above as past due,
nonaccrual or restructured, management also identified $2,059,417 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 these loans on nonaccrual status at December 31, 2005. 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, 2005.
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 valuation allowance for probable
incurred credit losses which is established through charges to earnings in the
form of a provision for loan losses. 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, and the evaluation of our loan portfolio through
our loan review function. Charge-offs occur when loans are deemed to be
uncollectible.
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 our 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" are those loans that 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.
In addition to loans on the internal watch list classified as
substandard or doubtful, 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) but do show
weakened elements as compared with those of a satisfactory credit. We regularly
review these loans to aid in assessing our allowance for loan losses.
In order to determine 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 Statement of Financial Accounting Standards
("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan", as amended
by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures". The amount of the specific allocation 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 nonperforming.
12
Additionally, we use two approaches for the analysis of the performing
portfolio: general factors and historical losses. These methods are further
broken down into identified loan pools within our portfolio. Using these
methodologies, we provide loss allocations to each identified loan
classification and to performing loan pools. All pools are evaluated by both
methods. We then charge to operations a provision for loan loss to maintain the
allowance for loan losses at the level determined by the foregoing methodology.
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 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.
The provision for loan loss is the amount expensed and added to the
allowance for loan losses. The allowance is kept at a level that is determined
by a quarterly analysis of the loan portfolio and represents the probable
incurred credit losses in the portfolio. 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. The following table summarizes the activity
in the allowance for loan losses for the five years ended December 31, 2005:
Allowance for Loan Losses
Year ended December 31,
-------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
-------------------------------------------------------------------------------------
(Dollars in Thousands)
Loans outstanding and loans
held-for-sale $ 753,247 $ 530,196 $ 360,749 $ 268,409 $ 149,035
Average amount of loans
outstanding 634,731 446,493 318,600 284,849 118,440
Balance of allowance for loan
losses, beginning of years 6,362 3,608 3,017 1,239 928
Loans charged off:
Commercial (250) (986) (464) (338) -
Real Estate - Construction - - - - -
Real Estate - Other (286) (105) (37) (354) (89)
Consumer (4) (6) (4) (15) -
-------------- -------------- -------------- -------------- -------------
Total loans charged off $ (540) $ (1,097) $ (505) $ (707) $ (89)
============== ============== ============== ============== =============
Recoveries of loans previously charged off:
Commercial 281 23 19 11 -
Real Estate - Construction - - - - -
Real Estate - Other 39 3 33 3 -
Consumer - 4 22 11 -
-------------- -------------- -------------- -------------- -------------
Total loans charged off $ 320 $ 30 $ 74 $ 25 $ -
============== ============== ============== ============== =============
Net loans charged off (220) (1,067) (431) (682) (89)
Provision for Loan loss expense 2,897 3,821 1,022 2,460 400
-------------- -------------- -------------- -------------- -------------
Balance, end of year $ 9,039 $ 6,362 $ 3,608 $ 3,017 $ 1,239
============== ============== ============== ============== =============
Ratio of net charge-offs to
average loans 0.03% 0.20% 0.14% 0.33% 0.07%
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.
13
At the Years Ended December 31,
-----------------------------------------------------------------------------------------------------
2005 2004
-----------------------------------------------------------------------------------------------------
% in Loans % in Loans
% of in Each % of in Each
Allowance Category Allowance Category
Allowance to Total to Total Allowance to Total to Total
Amount Amount Loans Amount Amount Loans
------------------------------------------------ ------------------------------------------------
(Dollars in Thousands)
Commercial $ 254 2.8% 3.4% $ 178 2.8% 3.1%
Real Estate 2,027 22.4% 32.7% 1,590 25.0% 36.4%
Construction/Land
Development 4,253 47.1% 50.7% 1,958 30.7% 38.0%
Mortgage - 0.0% 0.0% - 0.0% 0.4%
SBA 2,462 27.2% 12.6% 2,612 41.1% 21.6%
Consumer & Other 43 0.5% 0.6% 24 0.4% 0.5%
---------------- ------------- ----------- -------------- ------------- ------------
Total $ 9,039 100.0% 100.0% $ 6,362 100.0% 100.0%
================ ============= =========== ============== ============= ============
At the Years Ended December 31,
-----------------------------------------------------------------------------------------------------
2003 2002
-----------------------------------------------------------------------------------------------------
% in Loans % in Loans
% of in Each % of in Each
Allowance Category Allowance Category
Allowance to Total to Total Allowance to Total to Total
Amount Amount Loans Amount Amount Loans
------------------------------------------------ ------------------------------------------------
(Dollars in Thousands)
Commercial $ 154 4.3% 6.5% $ 172 5.7% 9.1%
Real Estate 655 18.2% 33.4% 667 22.1% 35.9%
Construction/Land
Development 589 16.3% 31.2% 391 13.0% 22.4%
Mortgage - 0.0% 0.7% - 0.0% 2.8%
SBA 2,184 60.5% 27.3% 1,741 57.7% 28.2%
Consumer & Other 26 0.7% 0.9% 46 1.5% 1.6%
---------------- ------------- ----------- -------------- ------------- ------------
Total $ 3,608 100.0% 100.0% $ 3,017 100.0% 100.0%
================ ============= =========== ============== ============= ============
At the Year Ended December 31,
-------------------------------------------------
2001
-------------------------------------------------
% in Loans
% of in Each
Allowance Category
Allowance to Total to Total
Amount Amount Loans
-------------------------------------------------
(Dollars in Thousands)
Commercial $ 80 6.5% 10.8%
Real Estate 291 23.5% 36.9%
Construction/Land
Development 186 15.0% 25.1%
Mortgage 3 0.2% 4.4%
SBA 639 51.6% 19.4%
Consumer & Other 40 3.2% 3.4%
---------------- ------------- ------------
Total $ 1,239 100.0% 100.0%
================ ============= ============
The allowance for loan losses as a percentage of net loans outstanding
and loans held-for-sale was 1.20% as of December 31, 2005 and 2004. As of
December 31, 2003, the allowance was 1.08%. The allowance for loan losses as a
percentage of net loans outstanding excluding loans held-for-sale was 1.35% as
of December 31, 2005, 1.29% as of December 31 2004, and 1.05% as of December 31,
2003.
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 Bank believes it has
established its existing allowance for loan losses in accordance with U.S.
generally accepted accounting principles, there can be no assurance that
regulators, in reviewing our loan portfolio, will not request that we 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, 2005, 2004, and
2003 are represented below.
14
At the Years Ended December 31,
2005 2004
----------------------------------------- ----------------------------------------
% of total % of total
Average Average
Average Deposits / Average Average Deposits / Average
Balance Borrowings Rate % Balance Borrowings Rate %
----------------------------------------- ----------------------------------------
(Dollars in Thousands)
NOW $ 32,791 4.9% 0.15% $ 31,588 6.5% 0.14%
Money Market 50,239 7.5% 1.81% 37,770 7.8% 1.20%
Savings 38,010 5.7% 0.37% 40,699 8.4% 0.46%
Time deposits less than $100,000 175,124 26.1% 3.17% 113,802 23.4% 2.12%
Time deposits $100,000 and over 194,496 29.0% 3.24% 112,964 23.3% 2.19%
Other Borrowings 28,993 4.3% 5.64% 20,195 4.2% 4.04%
------------ ------------ ------------ ------------
Total interest-bearing 519,653 77.5% 2.81% 357,018 73.6% 1.79%
liabilities
Non interest-bearing deposits 151,447 22.5% 0.00% 128,670 26.4% 0.00%
------------ ------------ ------------ ------------
Total Deposits & Other Borrowings $ 671,100 100.0% 2.17% $ 485,688 100.0% 1.32%
============ ============ ============ ============
At the Year Ended December 31,
2003
-----------------------------------------
% of total
Average
Average Deposits / Average
Balance Borrowings Rate %
-----------------------------------------
(Dollars in Thousands)
NOW $ 24,075 6.7% 0.10%
Money Market 37,238 10.4% 1.43%
Savings 32,739 9.2% 0.59%
Time deposits less than $100,000 75,177 21.1% 2.44%
Time deposits $100,000 and over 76,998 21.6% 2.46%
Other Borrowings 10,906 3.1% 4.32%
------------ ------------
Total interest-bearing 257,133 72.1% 1.92%
liabilities
Non interest-bearing deposits 99,565 27.9% 0.00%
------------ ------------
Total Deposits & Other Borrowings $ 356,698 100.0% 1.38%
============ ============
At December 31, 2005, the Company had $240,015,724 in time deposits in
the amounts of $100,000 or more, consisting of 1,521 accounts, maturing as
follows:
Maturity Period Amount Weighted Average Rate
-------------------------------------- ------------ ---------------------
Three months or less $ 105,327 3.571%
Greater than Three Months to Six Months 70,189 3.874%
Greater than Six Months to Twelve Months 63,951 4.036%
Greater than Twelve Months 549 2.475%
-------------
Total $ 240,016 3.782%
=============
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,
--------------------------------------------------
2005 2004 2003
--------------------------------------------------
(Dollars in Thousands)
FHLB Advances $ 30,000 $ - $ -
------------- --------------- --------------
Total Short-term Borrowings $ 30,000 $ - $ -
============= =============== ==============
15
Recently Issued Accounting Standards
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment.
This Statement supersedes Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and its related implementation
guidance and is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation. This Statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. It also addresses transactions in which an entity incurs liabilities
in exchange for goods or services that are based on the fair value of the
entity's equity instruments or that may be settled by the issuance of those
equity instruments. This Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions.
This Statement requires a public entity to measure the cost of employee
services received in exchange for award of equity instruments based on the
grant-date fair value of the award. That cost will be recognized over the period
during which an employee is required to provide service in exchange for the
award - the requisite service period (usually the vesting period). No
compensation cost is recognized for equity instruments for which employees do
not render the requisite service. The grant-date fair value of employee share
options and similar instruments will be estimated using option-pricing models
adjusted for unique characteristics of those instruments (unless observable
market prices for the same or similar instruments are available). If an equity
award is modified after the grant date, incremental compensation cost will be
recognized in an amount equal to the excess of the fair value of the modified
award over the fair value of the original award immediately before the
modification.
The revised accounting for stock-based compensation requirements
required that the Company adopt the revised accounting standards on or before
January 1, 2006. SFAS No. 123R allows for two alternative transition methods.
The Company intends to follow the modified prospective method, which requires
application of the new statement to new awards and to awards modified,
repurchased, or cancelled after the required effective date. Additionally,
compensation cost for the portion of awards for which the requisite service has
not been rendered that are outstanding as of the required effective date shall
be recognized as the requisite services are rendered on or after the effective
date. The compensation cost of that portion of awards shall be based on the
grant-date fair value of those awards as calculated for pro-forma disclosures
under the original SFAS No. 123. Had the Company adopted SFAS No. 123R in prior
periods, the impact on net income and earnings per share would have been
approximately similar to the pro forma net income and earnings per share as
disclosed in Note A of our consolidated financial statements presented elsewhere
herein. Stock option expense for fiscal 2006 is estimated to be $401,865, net of
tax, which may change as a result of future stock option grants, forfeitures
and/or other items.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, which addresses accounting for changes in accounting principle;
changes in accounting estimates, changes required by an accounting pronouncement
in the instance that the pronouncement does not include specific transition
provisions and error correction. SFAS No. 154 requires retrospective application
to prior periods' financial statements of changes in accounting principle and
error correction unless impracticable to do so. SFAS No. 154 states an exception
to retrospective application when a change in accounting principle, or the
method of applying it, may be inseparable from the effect of a change in
accounting estimate. When a change in principle is inseparable from a change in
estimate, such as depreciation, amortization or depletion, the change to the
financial statements is to be presented in a prospective manner. SFAS No. 154
and the required disclosures are effective for accounting changes and error
corrections in fiscal years beginning after December 15, 2005.
In November 2005, the FASB issued Staff Position ("FSP") Nos. FAS 115-1
and 124-1 to address the determination as to when an investment is considered
impaired, whether that impairment is other than temporary and the measurement of
an impaired loss. This FSP nullified certain requirements of Emerging Issues
Task Force 03-1 The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments (EITF 03-1), and references existing guidance
on other than temporary impairment. Furthermore, this FSP creates a three step
process in determining when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an impairment loss.
The FSP is effective for reporting periods beginning after December 15, 2005. It
is not anticipated that adoption will have a material impact on our financial
condition or results of operations.
During December 2005, the FASB issued FSP Statement of Position ("SOP")
94-6-1, Terms of Loan Products That May Give Rise to a Concentration of Credit
Risk, which addresses the circumstances under which the terms of loan products
give rise to such risk and the disclosures or other accounting considerations
that apply for entities that originate, hold, guarantee, service, or invest in
loan products with terms that may give rise to a concentration of credit risk.
The guidance under this FSP is effective for interim and annual periods ending
after December 19, 2005 and for loan products that are determined to represent a
concentration of credit risk, disclosure requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments, should be provided for
all periods presented. The adoption of this FSP did not have a significant
impact on the Company's consolidated financial statements.
16
Supervision and Regulation
Bank holding companies and banks are extensively regulated under state
and federal 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 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 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 nonbanking 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.
As a California state-chartered bank, the Bank is subject to
supervision, periodic examination and regulation by the California Department of
Financial Institutions ("DFI") and the Federal Reserve Bank. The Bank's deposits
are insured (presently $100,000 per account) by the Bank Insurance Fund ("BIF")
which is operated by the FDIC. 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 regulators 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 regulators. 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.
Because California permits commercial banks chartered by the state to
engage in any activity permissible for national banks, the Bank can form
subsidiaries to engage in activates "closely related to banking" or "nonbanking"
activities and expanded financial activities. However, in order to form a
financial subsidiary, the Bank must be well-capitalized and would be subject to
the same capital deduction, risk management and affiliate transaction rules as
applicable to national banks. Generally, a financial subsidiary is permitted to
engage in activities that are "financial in nature" or incidental thereto, even
though they are not permissible for the national bank to conduct directly within
the bank. The definition of "financial in nature" includes, among other items,
underwriting, dealing in or making a market in securities, including, for
example, distributing shares of mutual funds. The subsidiary may not, however,
engage as principal in underwriting insurance (other than credit life
insurance), issue annuities or engage in real estate development or investment
or merchant banking. Presently, the Bank does not have any subsidiaries.
17
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
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 ("SOX") implementing legislative reforms intended to address corporate
and accounting fraud. In addition to the establishment of the Public Company
Accounting Oversight Board ("PCAOB"), which enforces auditing, quality control
and independence standards and is 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 requires pre-approval by the company's audit
committee members. In addition, the audit partners must be rotated every five
years. SOX 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 SOX, 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.
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 (banks are generally exempted from this restriction).
SOX accelerates the time frame for disclosures by public companies, including
fairly immediate disclosure of 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.
SOX 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. SOX 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, SOX 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.
As with most other companies that are required to comply with SOX, the
Company has incurred, and will in the future incur, significant costs as a
result of its compliance efforts. Such costs and efforts, however, are not
expected to have a material adverse effect upon the Company.
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 Act of 2001 ("USA PATRIOT Act"). 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: (1) to conduct enhanced scrutiny of account relationships
to guard against money laundering and report any suspicious transaction; (2) 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; (3) 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 (4) 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.
18
The Board of Directors of the Bank has adopted comprehensive policies
and procedures to address the requirements of the USA PATRIOT Act. Although
compliance with the USA PATRIOT Act has caused the Company to incur some expense
and change some of its record and bookkeeping policies and procedures,
compliance has not had a material adverse effect upon the Company and it is not
expected that future compliance will cause this to change. Material deficiencies
in anti-money laundering compliance can result in public enforcement actions by
the banking agencies, including the imposition of civil money penalties and
supervisory restrictions on growth and expansion. Such actions could have
serious reputation consequence for the Company and the Bank.
Consumer Protection Laws and Regulations
The Bank is subject to many federal and state consumer protection
statutes and regulations, some of which are discussed below. Examination and
enforcement by the bank regulatory agencies in these areas has in the recent
past intensified.
Privacy policies are required by federal banking regulations which
limit the ability of banks and other financial institutions to disclose
non-public information about consumers to nonaffiliated third parties. Pursuant
to those rules, financial institutions must provide:
o 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;
o annual notices of their privacy policies to current customers;
and
o a reasonable method for customers to "opt out" of disclosures
to nonaffiliated third parties.
These privacy protections affect how consumer information is
transmitted through diversified financial companies and conveyed to outside
vendors.
In addition, state laws may impose more restrictive limitations on the
ability of financial institution to disclose such information. California has
adopted such a privacy law that among other things generally provides that
customers must "opt in" before information may be disclosed to certain
nonaffiliated third parties.
The Fair Credit Reporting Act, as amended by the Fair and Accurate
Credit Transactions Act, or "FACT Act", requires financial firms to help deter
identity theft, including developing appropriate fraud response programs, and
gives consumers more control of their credit data. It also reauthorizes a
federal ban on state laws that interfere with corporate credit granting and
marketing practices. In connection with the FACT Act, financial institution
regulatory agencies proposed rules that would prohibit an institution from using
certain information about a consumer it received from an affiliate to make a
solicitation to the consumer, unless the consumer has been notified and given a
chance to opt out of such solicitations. A consumer's election to opt out would
be applicable for at least five years.
The Check Clearing for the 21st Century Act, or "Check 21", facilitates
check truncation and electronic check exchange by authorizing a new negotiable
instrument called a "substitute check," which is the legal equivalent of an
original check. Check 21 does not require banks to create substitute checks or
accept checks electronically; however, it does require banks to accept a legally
equivalent substitute check in place of an original. In addition to its issuance
of regulations governing substitute checks, the Federal Reserve has issued final
rules governing the treatment of remotely created checks (sometimes referred to
as "demand drafts") and electronic check conversion transactions (involving
checks that are converted to electronic transactions by merchants and other
payees).
The Equal Credit Opportunity Act, or "ECOA", generally prohibits
discrimination in any credit transaction, whether for consumer or business
purposes, on the basis of race, color, religion, national origin, sex, marital
status, age (except in limited circumstances), receipt of income from public
assistance programs, or good faith exercise of any rights under the Consumer
Credit Protection Act.
19
The Truth in Lending Act, or "TILA", is designed to ensure that credit
terms are disclosed in a meaningful way so that consumers may compare credit
terms more readily and knowledgeably. As a result of the TILA, all creditors
must use the same credit terminology to express rates and payments, including
the annual percentage rate, the finance charge, the amount financed, the total
of payments and the payment schedule, among other things.
The Fair Housing Act, or "FH Act", regulates many practices, including
making it unlawful for any lender to discriminate in its housing-related lending
activities against any person because of race, color, religion, national origin,
sex, handicap or familial status. A number of lending practices have been found
by the courts to be, or may be considered, illegal under the FH Act, including
some that are not specifically mentioned in the FH Act itself.
The Community Reinvestment Act, or "CRA", is intended to encourage
insured depository institutions, while operating safely and soundly, to help
meet the credit needs of their communities. The CRA specifically directs the
federal regulatory agencies, in examining insured depository institutions, to
assess a bank's record of helping meet the credit needs of its entire community,
including low- and moderate-income neighborhoods, consistent with safe and sound
banking practices. The CRA further requires the agencies to take a financial
institution's record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, mergers or
acquisitions, or holding company formations. The agencies use the CRA assessment
factors in order to provide a rating to the financial institution. The ratings
range from a high of "outstanding" to a low of "substantial noncompliance." In
its last examination for CRA compliance as of May 2004, the Bank was rated
"satisfactory."
The Home Mortgage Disclosure Act, or "HMDA", grew out of public concern
over credit shortages in certain urban neighborhoods and provides public
information that will help show whether financial institutions are serving the
housing credit needs of the neighborhoods and communities in which they are
located. The HMDA also includes a "fair lending" aspect that requires the
collection and disclosure of data about applicant and borrower characteristics
as a way of identifying possible discriminatory lending patterns and enforcing
anti-discrimination statutes. The Federal Reserve Board amended regulations
issued under HMDA to require the reporting for 2004 of certain pricing data with
respect to higher priced mortgage loans. The expanded 2004 HMDA data is being
reviewed by federal banking agencies and others from a fair lending perspective.
We do not expect that the HMDA data reported by the Bank will raise material
issues regarding the Bank's compliance with the fair lending laws.
The term "predatory lending," covers a potentially broad range of
behavior. Typically, predatory lending involves at least one, and perhaps all
three, of the following elements:
o making unaffordable loans based on the assets of the borrower
rather than on the borrower's ability to repay an obligation
("asset-based lending")
o inducing a borrower to refinance a loan repeatedly in order to
charge high points and fees each time the loan is refinanced
("loan flipping")
o engaging in fraud or deception to conceal the true nature of
the loan obligation from an unsuspecting or unsophisticated
borrower.
FRB regulations aimed at curbing such lending significantly widen the
pool of high-cost home-secured loans covered by the Home Ownership and Equity
Protection Act of 1994, or "HOEPA", a federal law that requires extra
disclosures and consumer protections to borrowers. Lenders that violate the
rules face cancellation of loans and penalties equal to the finance charges
paid.
The Real Estate Settlement Procedures Act, or "RESPA", requires lenders
to provide borrowers with disclosures regarding the nature and cost of real
estate settlements. Also, RESPA prohibits certain abusive practices, such as
kickbacks, and places limitations on the amount of escrow accounts. Penalties
under the above laws may include fines, reimbursements and other penalties.
Due to heightened regulatory concern related to compliance with the
FACT Act, ECOA, TILA, FH Act, CRA, HMDA, HOEPA and RESPA generally, the Bank may
incur additional compliance costs or be required to expend additional funds for
investments in its local community.
20
Proposed Guidance on Nontraditional Mortgage Products
On December 20, 2005, the federal banking agencies issued for comment
proposed guidance on residential mortgage products that allow borrowers to defer
repayment of principal and sometimes interest, including "interest only"
mortgage loans, and "payment option" adjustable rate mortgages where a borrower
has flexible payment options, including payments that have the potential for
negative amortization. While acknowledging that innovations in mortgage lending
can benefit some consumers, the federal banking agencies in their joint press
release stated their concern that these and other practices described in the
guidance can present unique risks institutions must appropriately manage. The
proposed guidance states that management should (1) assess a borrower's ability
to repay the loan, including any balances added through negative amortization,
at the fully indexed rate that would apply after the introductory period, (2)
recognize that certain nontraditional mortgages are untested in a stressed
environment and warrant strong risk management standards as well as appropriate
capital and loan loss reserves, and (3) ensure that borrowers have sufficient
information to clearly understand loan terms and associated risks prior to
making a product or payment choice. It is uncertain at this time whether
guidance will be adopted in final form and, if adopted, whether and to what
extent final guidance may differ from the proposal and what effect the final
guidance may have on financial institutions originating such residential
mortgage products, including the Bank.
Safety and Soundness Standards
In addition to measures taken under the prompt corrective action
provisions, commercial banking organizations may be subject to potential
enforcement actions by the federal and/or state regulators for unsafe or unsound
practices in conducting their businesses or for violations of any law, rule,
regulation, or any condition imposed in writing by the agency or any written
agreement with the agency. Finally, pursuant to an interagency agreement, the
FDIC can examine any institution that has a substandard regulatory examination
score or is considered undercapitalized without the express permission of the
institution's primary regulator.
The federal banking agencies have adopted guidelines designed to assist
the federal banking agencies in identifying and addressing potential safety and
soundness concerns before capital becomes impaired. The guidelines set forth
operational and managerial standards relating to: (i) internal controls,
information systems and internal audit systems, (ii) loan documentation, (iii)
credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation,
fees and benefits. In addition, the federal banking agencies have also adopted
safety and soundness guidelines with respect to asset quality and earnings
standards. These guidelines provide six standards for establishing and
maintaining a system to identify problem assets and prevent those assets from
deteriorating. Under these standards, an insured depository institution should:
(i) conduct periodic asset quality reviews to identify problem assets, (ii)
estimate the inherent losses in problem assets and establish reserves that are
sufficient to absorb estimated losses, (iii) compare problem asset totals to
capital, (iv) take appropriate corrective action to resolve problem assets, (v)
consider the size and potential risks of material asset concentrations, and (vi)
provide periodic asset quality reports with adequate information for management
and the board of directors to assess the level of asset risk. These guidelines
also set forth standards for evaluating and monitoring earnings and for ensuring
that earnings are sufficient for the maintenance of adequate capital and
reserves.
Pending Legislation
Changes to federal and state laws and regulations (including changes in
interpretation or enforcement) can affect the operating environment of bank
holding companies and their subsidiaries in substantial and unpredictable ways.
From time to time, various legislative and regulatory proposals are introduced.
These proposals, if codified, may change banking statutes and regulations and
the Company's operating environment in substantial and unpredictable ways. If
codified, these proposals could increase or decrease the cost of doing business,
limit or expand permissible activities or affect the competitive balance among
banks, savings associations, credit unions and other financial institutions. The
Company cannot accurately predict whether those changes in laws and regulations
will occur, and, if those changes occur, the ultimate effect they would have
upon our financial condition or results of operations. It is likely, however,
that the current high level of enforcement and compliance-related activities of
federal and state authorities will continue and potentially increase.
Capital Adequacy Requirements
The federal banking agencies have adopted regulations establishing
minimum requirements for capital adequacy. These agencies may establish higher
minimum requirements if, for example, a bank or company 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 ($500 million, as revised in March
2006) 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
21
be "Tier I capital," principally consisting of common stockholders' equity,
noncumulative perpetual preferred stock, and a 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 allowance for loan loss. 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, 2005, the Company's Tier I leverage ratio was 9.28%,
its Tier I risk-based ratio was 8.93% and its total risk-based ratio was 11.02%.
As of December 31, 2005, the Bank's Tier I leverage ratio was 10.17%, the Bank's
Tier I risk-based ratio was 9.75% and the Bank's total risk-based ratio was
10.81%.
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.
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.
The Bank was "well capitalized" according to the guidelines discussed
above, as of December 31, 2005.
Deposit Insurance Assessments
The Bank's deposits are insured (presently $100,000 per depositor) by
the Bank Insurance Fund ("BIF") which is operated by the FDIC. 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 current range of BIF and Saving Association Insurance Fund
("SAIF") assessments are (not including FICO bond assessments) between 0.00% and
0.27% per $100 of domestic deposits. The rate for the Bank was 0.0% for 2004 and
2005.
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. The BIF is nearing its minimum Designated Reserve Ratio ("DRR") of
1.25% of insured deposits as mandated by law due to continued growth in
deposits. Should the DRR drop below 1.25%, the FDIC may be required to assess
premiums on all banks. Depending on the amount of the increase, an increase in
the assessment rate may have a material adverse effect on the Company's
earnings.
22
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.
The Bank pays an assessment fee to the FDIC for federal deposit
insurance protection. This assessment fee is required for all FDIC-insured banks
for the payment of interest on bonds that were issued by the Financing
Corporation ("FICO") as a means of capitalizing the Federal Savings and Loan
Insurance Corporation. These bonds are commonly known as FICO bonds. The
assessment rate for the fourth quarter of 2005 was 1.34 basis points for each
$100 of assessable deposits. The Bank paid $75,424 of FDIC Assessments in 2005,
as compared to $57,543 in 2004.
In February 2006, the Federal Deposit Insurance Reform Act of 2006
("FDIRA") was enacted. Some of the reforms included in the FDIRA will be:
o merge the Bank Insurance Fund (BIF) and the Savings
Associations Insurance Fund (SAIF) into the Deposit Insurance
Fund (DIF)
o increase deposit insurance coverage to $250,000 for certain
retirement accounts
o consider adjustment of the maximum deposit insurance amount of
$100,000 to account for inflation
o change in the formula and factors to be considered by the FDIC
in calculating the FDIC reserve ratio
o credit for depository institutions for past over-payments to
the BIF
At this time it is uncertain what effect FDIRA and the forthcoming
regulations will have on the Bank.
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 examine and
evaluate the Company and its subsidiaries. The DFI periodically examines and
evaluates state-chartered banks, including the Bank. These examinations review
areas such as capital adequacy, allowance for loan losses, loan portfolio
quality and management, consumer and other compliance issues, investments and
management practices. In addition to these regular examinations, we are required
to furnish quarterly and annual reports to the Federal Reserve. The Federal
Reserve and the DFI 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 Federal Reserve if a bank is not in compliance with the
applicable minimum capital requirements, is otherwise a troubled institution or
the Federal Reserve determines that such prior notice is appropriate for a bank.
The Federal Reserve 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, corporate
governance, annual and periodic reporting and other requirements of the Exchange
Act are applicable to the Company.
23
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, is 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 provides 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.
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.
Subsidiaries
The Bank is a subsidiary of the Company. In June 2002, the Company
formed Temecula Valley Statutory Trust I, a Connecticut statutory trust, for the
purpose of issuing trust preferred securities. In September 2003, the Company
formed Temecula Valley Statutory Trust II, a Connecticut statutory trust, for
the purpose of issuing trust preferred securities. In September 2004, the
Company formed Temecula Valley Statutory Trust III, a Delaware statutory trust,
for the purpose of issuing trust preferred securities. In September 2005, the
Company formed Temecula Valley Statutory Trust IV, a Delaware statutory trust,
for the purpose of issuing trust preferred securities.
Employees
As of December 31, 2005, the Bank had 260 full-time employees and 21
part time employees. There are no employees at the Company. Our employees are
not represented by any collective bargaining group. We consider our relations
with our employees to be satisfactory.
24
ITEM 1A: RISK FACTORS
------------
Risk Factors That May Affect Future Results of Operations
In addition to the other information contained in this Annual 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
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. 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 $606,827,529 in total assets
and $534,766,705 in total deposits at December 31, 2004 to $868,988,046 in total
assets and $742,431,939 in total deposits at December 31, 2005. 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, 2005, real estate served as the principal source of
collateral with respect to approximately 95.4% 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 Company 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 it difficult or impossible to
sell the affected properties. This could have a material adverse effect on the
Company's business, financial condition and operating results.
Interest Rate Changes
The earnings of the Company 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 short-term
investments 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.
25
Competition
Competition may adversely affect the Company's performance. The
financial services business in the Company'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
individual 7A loans which the SBA will permit is $2,000,000. Any reduction in
this level 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. 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 policies and practices are reasonable and
should minimize loan losses 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 such
occurrences and maintains insurance coverage, when available, to protect against
such risks. However, 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.
26
Risks Associated with our Stock
Our Stock Trades Less Frequently Than Others.
Although our common stock is listed for trading on The NASDAQ National
Market, the trading volume in our common stock is less than that of other larger
financial services companies. A public trading market having the desired
characteristics of depth, liquidity and orderliness depends on the presence in
the marketplace of willing buyers and sellers of our common stock at any given
time. This presence depends on the individual decisions of investors and general
economic and market conditions over which we have no control. Given the lower
trading volume of our common stock, significant sales of our common stock, or
the expectation of these sales, could cause our stock price to fall.
Our Stock Price Is Affected by a Variety of Factors.
Stock price volatility may make it more difficult for you to resell
your common stock when you want and at prices you find attractive. Our stock
price can fluctuate significantly in response to a variety of factors discussed
in this section, including, among other things:
o Actual or anticipated variations in quarterly results of
operations.
o Recommendations by securities analysts.
o Operating and stock price performance of other companies that
investors deem comparable to our company.
o News reports relating to trends, concerns and other issues in
the financial services industry.
o Perceptions in the marketplace regarding our Company and/or
its competitors.
Our Common Stock Is Not An Insured Deposit.
Our common stock is not a bank deposit and, therefore, is not insured
against loss by the FDIC, any other deposit insurance fund or by any other
public or private entity. Investment in our common stock is inherently risky for
the reasons described in this "Risk Factors" section and elsewhere in this
Report and is subject to the same market forces that affect the price of common
stock in any company. As a result, if you acquire our common stock, you may lose
some or all of your investment.
ITEM 1B: UNRESOLVED STAFF COMMENTS
-------------------------
None
ITEM 2: PROPERTIES
----------
The Bank conducts business at eight full-service banking offices in
Southern California and multiple loan production offices in twelve states,
including California. The main office facilities are located at 27710 Jefferson
Avenue, Suite A100, Temecula, California. As of December 31, 2005, the Bank
owned the property at one of its branch locations. The remaining banking offices
and other offices are leased by the Bank. Most of the leases contain multiple
renewal options and provisions for rental increases, principally for changes in
the cost of living index, property taxes and maintenance. Total future annual
rental payments (exclusive of operating charges and real property taxes) are
approximately $5,527,354, with lease expiration dates ranging from 2006 to 2014,
exclusive of renewal options.
At December 31, 2005, the Bank's consolidated investment in premises
and equipment, net of accumulated depreciation and amortization, totaled
$4,885,015. Total occupancy expense, exclusive of rental payments and furniture
and equipment expense was $2,428,252.
We believe that our existing facilities are adequate for our present
purposes and that the properties are adequately covered by insurance.
27
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 the Company or the Bank 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, 2005, 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.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER
--------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of 2005.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
-------------------------------------------------
Trading Information
As of July 29, 2005, the Company's common stock was listed on The
National NASDAQ Market under the symbol TMCV. Prior to that, the Company's
common stock was quoted on the Over-the-Counter Bulletin Board under the symbol
TMCV.OB. As reported on The National NASDAQ Market, information concerning the
range of high and low per share bid prices before July 30, 2005 and the per
share closing prices for the Company's common stock after July 29, 2005, for
each quarterly period within the past two fiscal years, is set forth below. The
quotations before July 29, 2005 below reflect inter-dealer prices without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
National NASDAQ Market
----------------------
Quarter Ended High Low
------------- ---- ---
2005
September 30 $25.95 $19.16
December 31 $24.50 $19.16
Over-the-Counter-Bulletin-Board
-------------------------------
Quarter Ended High Low
------------- ---- ---
2005
March 31 $18.50 $16.60
June 30 $22.00 $16.80
Quarter Ended High Low
------------- ---- ---
2004
March 31 $14.00 $10.75
June 30 $15.45 $11.01
September 30 $19.50 $14.85
December 31 $18.50 $15.30
The foregoing reflects information available to the Company and does
not necessarily include all trades in the Company's common stock during the
periods indicated.
As of March 15, 2006, the closing price of the Company's stock, as
reported by The National NASDAQ Market was $21.00. As of that date, there were
approximately 438 record holders of the Company's common stock and directors and
executive officers owned approximately 15% of our outstanding shares.
28
Dividends
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 restrictions discussed below.
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 various federal and state laws and
regulations.
The Federal Reserve has broad authority to prohibit the payment of
dividends by the Company depending upon the condition of each entity within the
corporate structure. In addition, the future payment of cash dividends will
generally depend, subject 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 the allowance for
loan losses at the Bank.
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 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 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.
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The following table represents selected financial information for the
five years ended December 31, 2005 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 the two-for-one stock split in December 2003.
29
TEMECULA VALLEY BANCORP INC.
Selected Financial Data
For the Year Ended December 31,
2005 2004 2003 2002 2001
---------------- ---------------- ---------------- --------------- ----------------
Income Statement:
Interest income $ 58,125,260 $ 33,614,887 $ 23,890,500 $ 16,509,441 $ 12,002,878
Interest expense 14,583,784 6,414,543 4,946,553 3,124,682 2,734,407
---------------- ---------------- ---------------- --------------- ----------------
Net interest income 43,541,476 27,200,344 18,943,947 13,384,759 9,268,471
Provision for loan losses 2,897,000 3,821,300 1,022,000 2,460,000 400,000
---------------- ---------------- ---------------- --------------- ----------------
Net interest income 40,644,476 23,379,044 17,921,947 10,924,759 8,868,471
after provision for loan losses
Non interest income 23,822,163 28,698,614 24,481,351 17,941,642 8,971,641
Non interest expense 40,627,302 33,964,229 29,121,070 21,800,837 14,831,513
---------------- ---------------- ---------------- --------------- ----------------
Income before income taxes 23,839,337 18,113,429 13,282,228 7,065,564 3,008,599
Provision for income taxes 9,886,072 7,535,806 5,427,889 2,874,510 1,205,018
---------------- ---------------- ---------------- --------------- ----------------
Net income $ 13,953,265 $ 10,577,623 $ 7,854,339 $ 4,191,054 $ 1,803,581
================ ================ ================ =============== ================
Per Share Data:
Basic earnings per share $ 1.58 $ 1.24 $ 1.00 $ 0.57 $ 0.28
Diluted earnings per share $ 1.46 $ 1.13 $ 0.89 $ 0.50 $ 0.25
Average common shares outstanding 8,845,736 8,503,179 7,823,951 7,372,504 6,484,108
Average common shares(dilutive) 9,587,559 9,363,868 8,861,706 8,370,040 7,142,290
Book value per share $ 6.54 $ 4.90 $ 3.64 $ 2.63 $ 2.06
Equity shares-beginning balance 8,752,603 8,151,914 7,446,646 7,326,324 5,505,322
Warrants - Shares Issued - - 324,598 66,628 5,058
Options - Shares Issued 145,094 600,689 380,670 53,694 215,944
Stock offering - - - - 1,600,000
---------------- ---------------- ---------------- --------------- ----------------
Equity shares-ending balance 8,897,697 8,752,603 8,151,914 7,446,646 7,326,324
================ ================ ================ =============== ================
Balance Sheet Data:
Assets $ 868,988,046 $ 606,827,529 $ 431,212,118 $ 310,506,097 $ 190,024,416
Loans(including loans held for sale) 753,246,789 530,196,252 360,749,391 271,425,826 150,274,574
Other Real Estate Owned 2,111,250 302,698 485,036 - -
Fed Funds Sold 33,200,000 16,800,000 21,400,000 - 16,400,000
FRB/FHLB Stock 3,098,600 2,377,800 1,145,000 1,460,050 517,250
Deposits 742,431,939 534,766,705 383,487,366 269,321,220 172,928,225
FHLB advances 30,000,000 - - 10,000,000 -
Junior Subordinated Debt 28,868,000 20,620,000 12,372,000 7,217,000 -
Stockholders' equity 58,180,310 42,902,538 29,683,065 19,616,203 15,103,944
ALLL beginning balance $ 6,362,534 $ 3,607,833 $ 3,017,395 $ 1,239,308 $ 927,509
Charge offs (540,152) (1,096,698) (505,586) (707,455) (88,201)
Recoveries 319,773 30,099 74,024 25,542 -
Provision for loan losses 2,897,000 3,821,300 1,022,000 2,460,000 400,000
---------------- ---------------- ---------------- --------------- ----------------
ALLL ending balance $ 9,039,155 $ 6,362,534 $ 3,607,833 $ 3,017,395 $ 1,239,308
================ ================ ================ =============== ================
Nonperforming loans $ 7,950,601 $ 11,799,346 6,764,713 1,908,169 198,861
Government guaranteed portion (6,513,752) (8,140,267) (5,269,317) (1,077,597) (92,895)
---------------- ---------------- ---------------- --------------- ----------------
Net nonperforming loans $ 1,436,849 $ 3,659,079 $ 1,495,396 $ 830,572 $ 105,966
================ ================ ================ =============== ================
SBA 7A participation sold - period end $ 486,709,949 $ 421,529,332 $ 287,345,585 $ 168,163,922 $ 66,819,282
Other participations sold 16,489,027 18,771,938 18,906,176 8,911,376 3,085,662
---------------- ---------------- ---------------- --------------- ----------------
Total participation sold - period end $ 503,198,976 $ 440,301,270 $ 306,251,761 $ 177,075,298 $ 69,904,944
================ ================ ================ =============== ================
30
TEMECULA VALLEY BANCORP INC.
Selected Financial Data (continued)
For the Year Ended December 31,
2005 2004 2003 2002 2001
--------------- ---------------- ---------------- ---------------- ---------------
Selected Ratio's:
Return on average assets 1.91% 2.00% 2.04% 1.69% 1.15%
Return on average equity 27.46% 28.89% 31.84% 24.34% 14.82%
Income tax rate 41.47% 41.60% 40.87% 40.70% 40.00%
Tier I leverage ratio 9.28% 9.20% 9.06% 8.53% 7.91%
Tier I risk based ratio 8.93% 9.68% 10.01% 9.30% 9.39%
Total risk based ratio 11.02% 11.81% 11.54% 10.61% 10.17%
Average Equity / Average Assets 6.96% 6.93% 6.45% 6.95% 7.66%
Allowance for loan loss/net loans 1.20% 1.20% 1.00% 1.11% 0.82%
and loans held-for-sale
Allowance for loan loss/net loans 1.35% 1.29% 1.05% 1.21% 0.90%
excluding loans held-for-sale
Allowance for loan loss/net 629.10% 173.88% 256.71% 363.06% 1180.00%
nonperforming loans
Loan to deposit ratio 101.46% 99.15% 94.07% 100.78% 86.90%
Avg int earning assets/total assets 87.96% 86.09% 86.34% 86.40% 87.53%
Investment yield (includes FRB/FHLB) 3.29% 1.37% 1.07% 1.54% 3.72%
Loan yield 9.12% 7.48% 7.45% 7.99% 9.54%
Total interest bearing assets 9.05% 7.37% 7.17% 7.71% 8.72%
Interest bearing deposit cost 2.64% 1.66% 1.82% 1.89% 2.93%
Borrowing cost 5.64% 4.04% 4.32% 3.21% N/A
Net interest margin 6.78% 5.98% 5.69% 6.23% 6.73%
Net interest spread 6.24% 5.58% 5.25% 5.72% 5.79%
SBA Loan Servicing:
SBA excess servicing asset $ 8,169,273 $ 7,585,712 $ 6,116,679 $ 3,763,779 $ 1,538,437
SBA I/O strip receivable asset 22,067,900 24,679,520 20,495,511 13,120,093 4,136,809
--------------- ---------------- ---------------- ---------------- ---------------
Total SBA servicing asset $ 30,237,173 $ 32,265,232 $ 26,612,190 $ 16,883,872 $ 5,675,246
=============== ================ ================ ================ ===============
SBA servicing-fee income $ 10,264,534 $ 8,737,520 $ 6,026,300 $ 2,674,726 $ 763,445
SBA servicing-asset (7,491,850) (6,118,947) (4,233,596) (1,462,019) (402,442)
amortization
SBA servicing-guarantee fee to SBA (134,756) (118,130) (98,868) (83,379) (21,943)
--------------- ---------------- ---------------- ---------------- ---------------
SBA servicing-net servicing income $ 2,637,928 $ 2,500,443 $ 1,693,836 $ 1,129,328 $ 339,060
=============== ================ ================ ================ ===============
Loan Sales:
SBA 7A sales - guaranteed $ 108,911,978 $ 146,880,937 $ 129,813,081 $ 108,212,760 $ 42,872,549
SBA 7A guaranteed-sales gain 5,113,129 8,794,797 8,148,585 6,014,821 1,642,461
SBA 7A sales - unguaranteed $ 37,010,997 $ 35,365,372 $ 19,208,615 $ 12,573,048 $ 5,933,122
Unguaranteed SBA 7A sales gain 6,509,553 6,360,569 3,191,211 2,094,818 940,392
Mortgage loan sales $ 13,522,236 $ 45,243,206 $ 100,800,159 $ 83,014,280 $ 55,224,847
Mortgage loan sales gain 285,108 1,511,330 3,568,235 3,100,170 1,553,409
SBA Broker referral income $ 2,470,403 $ 2,505,611 $ 2,844,613 $ 1,971,774 $ 1,070,945
Mortgage Broker referral income 898,336 962,813 1,037,621 907,568 864,230
Employee Related:
Full time employees 281 229 194 181 148
Part time employees 21 16 14 18 13
Full time equivalent employees 275 238 204 194 156
Salary continuation plan expense $ 723,442 $ 1,084,646 $ 531,240 $ 267,108 $ 165,682
CSV life insurance balance $ 17,590,733 $ 9,593,824 $ 5,740,729 $ 3,983,183 $ 2,832,254
CSV Life insurance income $ 605,219 $ 378,089 $ 250,368 $ 175,901 $ 144,262
CSV Life insurance expense (98,310) (61,274) (44,822) (24,972) (19,337)
--------------- ---------------- ---------------- ---------------- ---------------
Net Life insurance income $ 506,909 $ 316,815 $ 205,546 $ 150,929 $ 124,925
=============== ================ ================ ================ ===============
31
The following table sets forth the Company's unaudited results of
operations for the four quarters ended in 2005 and 2004. The table also provides
total comprehensive income for 2005 which had not been previously reported. The
only component of other comprehensive income is the adjustment to fair value,
net of tax, of interest-only strips, which are treated like investments in debt
securities and are classified as available-for-sale.
For the Quarters Ended in 2005
---------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------------------------------------------------------------------
Interest income $ 11,410,544 $ 13,454,394 $ 15,351,569 $ 17,908,753
Interest expense (2,378,308) (3,179,129) (4,051,121) (4,975,226)
---------------------------------------------------------------------------
Net interest income 9,032,236 10,275,265 11,300,448 12,933,527
Provision for loan losses (838,800) (804,100) (346,000) (908,100)
Non interest income 5,783,496 7,464,814 5,599,165 4,974,688
Non interest expense (8,836,692) (10,180,120) (10,950,340) (10,660,150)
---------------------------------------------------------------------------
Income before income tax 5,140,240 6,755,859 5,603,273 6,339,965
expense
Income tax expense (2,138,560) (2,812,818) (2,318,111) (2,616,583)
---------------------------------------------------------------------------
Net income $ 3,001,680 $ 3,943,041 $ 3,285,162 $ 3,723,382
===========================================================================
Total comprehensive income $ 4,698,000 $ 3,814,000 $ 2,271,000 $ 3,843,000
Basic earnings per share $ 0.34 $ 0.45 $ 0.37 $ 0.42
Diluted earnings per share $ 0.32 $ 0.41 $ 0.34 $ 0.39
For the Quarters Ended in 2004
---------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------------------------------------------------------------------
Interest income $ 6,816,628 $ 7,790,647 $ 8,783,386 $ 10,224,226
Interest expense (1,242,563) (1,375,641) (1,750,845) (2,045,494)
---------------------------------------------------------------------------
Net interest income 5,574,065 6,415,006 7,032,541 8,178,732
Provision for loan losses (500,000) (250,000) (1,635,000) (1,436,300)
Non interest income 6,727,789 6,726,899 7,288,248 7,955,678
Non interest expense (7,444,608) (8,407,711) (8,665,678) (9,446,232)
---------------------------------------------------------------------------
Income before income tax 4,357,246 4,484,194 4,020,111 5,251,878
expense
Income tax expense (1,785,096) (1,837,568) (1,645,749) (2,267,393)
---------------------------------------------------------------------------
Net income $ 2,572,150 $ 2,646,626 $ 2,374,362 $ 2,984,485
===========================================================================
Basic earnings per share $ 0.31 $ 0.32 $ 0.27 $ 0.34
Diluted earnings per share $ 0.28 $ 0.28 $ 0.25 $ 0.31
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 Annual 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 Annual Report.
Results of Operations
Net Income
For 2005, net income was $13,953,265 or $1.58 per basic share and $1.46
per diluted share. For 2004, net income was $10,577,623 or $1.24 per basic share
and $1.13 per diluted share and for 2003, net income was $7,854,339, or $1.00
per basic share and $0.89 per diluted share. The net interest margin for the
last three years has been consistently strong. This factor, coupled with gain on
sale of loans and servicing income associated with SBA and mortgage loan sales,
represents a significant portion of the profit dynamics of the Company.
The Company sold $37,010,997 of the unguaranteed portion of SBA 7A
loans in 2005, which added $6,509,553 to net income. The Company sold
$35,365,372 of the unguaranteed portion of SBA 7A loans in 2004, which added
$6,360,569 to net income and in 2003 we sold $19,208,615, which added $3,191,211
to income. The Company expects to continue to sell SBA loans in the secondary
market while retaining a significant portion of the servicing rights.
32
The return on average assets was 1.91% for 2005, compared to 2.00% in
2004, and 2.04% in 2003. The return on average equity was 27.46% for 2005,
compared to 28.89% for 2004, and 31.84% for 2003. Due to low interest rates and
increasing real estate values loam activity has been robust.
Net Interest Income
Net interest income was $43,541,476 in 2005, compared to $27,200,344 in
2004, and $18,943,947 in 2003. The growth in net interest income levels have
been achieved as a result of strong asset mix, which consists primarily of loans
at variable rates, as well as growth of the loan portfolio.
Net interest margins were 6.78%, 5.98%, and 5.69% for years ended 2005,
2004, and 2003, respectively. The loan-to-deposit ratio at December 31, 2005 was
101.46% at December 2004 it was 99.15%, and at December 31, 2003 it was 94.07%.
Loans produced a yield of 9.12% in 2005, 7.48% in 2004, and 7.45% in 2003.
Investments yielded 3.29% in 2005, 1.37% in 2004, and 1.07% in 2003. Total
interest-earning assets yielded 9.05% in 2005, 7.37% in 2004, and 7.17% in 2003.
The cost of interest-bearing deposits was 2.64% in 2005, 1.66% in 2004, and
1.82% in 2003. For 2005, the cost of other borrowings was 5.64% and consisted of
FHLB advances and Trust Preferred Borrowings. For 2004, the cost of other
borrowings was 4.04% and consisted of FHLB advances and Trust Preferred
Borrowings. For 2003, the cost of other borrowings was 4.32% and consisted of
Federal Funds Purchased, FHLB advances and Trust Preferred Borrowings. No other
borrowings were incurred.
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. Average balances are derived from daily balances, and
nonaccrual loans are included as interest-bearing loans for the purposes of
these tables.
33
Average Balances with Rates Earned and Paid
Year ended December 31
--------------------------------------------------------------------------------------------------------
2005 2004 2003
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
Securities-HTM (1) $ 203 $ 5 2.90% $ 168 $ 2 1.13% $ 41 $ - 0.82%
Federal Funds Sold 7,224 239 3.30% 8,098 111 1.37% 14,191 152 1.07%
-------------------------------- -------------------------------- --------------------------------
Total Investments 7,427 244 3.29% 8,266 113 1.37% 14,232 152 1.07%
Total Loans (2) 634,731 57,881 9.12% 446,493 33,502 7.48% 318,600 23,738 7.45%
-------------------------------- -------------------------------- --------------------------------
Total Interest-
Earning Assets 642,158 58,125 9.05% 454,759 33,615 7.37% 332,832 23,890 7.17%
----------------------- ----------------------- -----------------------
Allowance for Loan Loss (7,606) (4,395) (3,152)
Cash & Due From Banks 25,385 21,994 17,295
Premises & Equipment 4,673 2,820 2,196
Other Assets 65,414 53,061 36,310
----------- ----------- -----------
Total Assets $ 730,024 $ 528,239 $ 385,481
=========== =========== ===========
Liabilities and
Shareholders' Equity
Interest Bearing Demand $ 32,791 50 0.15% $ 31,588 45 0.14% $ 24,075 24 0.10%
Money Market 50,239 911 1.81% 37,770 456 1.20% 37,238 532 1.43%
Savings 38,010 141 0.37% 40,699 186 0.46% 32,739 192 0.59%
Time Deposits
under $100,000 175,124 5,555 3.17% 113,802 2,425 2.12% 75,177 1,833 2.44%
Time Deposits $100,000
or more 194,496 6,293 3.24% 112,964 2,484 2.19% 76,998 1,894 2.46%
Other Borrowings 28,993 1,634 5.64% 20,195 819 4.04% 10,906 471 4.32%
-------------------------------- -------------------------------- --------------------------------
Total Interest
Bearing Liabilities 519,653 14,584 2.81% 357,018 6,415 1.79% 257,133 4,946 1.92%
-------------------------------- -------------------------------- --------------------------------
Non interest Demand 151,447 128,670 99,565
Deposits
Other Liabilities 8,116 5,934 4,108
Shareholders' Equity 50,808 36,617 24,675
Total Liabilities and
----------- ----------- -----------
Shareholders' equity $ 730,024 $ 528,239 $ 385,481
=========== =========== ===========
----------- ----------- -----------
Net Interest Income $ 43,541 $ 27,200 $ 18,944
=========== =========== ===========
Interest Spread (3) 6.24% 5.58% 5.25%
======== ======== ========
Net Interest Margin (4) 6.78% 5.98% 5.69%
======== ======== ========
(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.
The following table shows a comparison of interest income and interest
expense as the result of changes in the volumes and rates on average
interest-earning assets and average interest-bearing liabilities for the years
indicated.
34
Rate/Volume Analysis
Increase/(Decrease) in Net Interest Income
Year Ended December 31
2005 2004
------------------------------------------ -------------------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
Assets
Securities-HTM (1) $ - $ 4 $ 4 $ 1 $ 1 $ 2
Federal Funds Sold (12) 139 127 (65) 24 (41)
------------------------------------------ -------------------------------------------
Total (12) 143 131 (64) 25 (39)
Investments
Total Loans (2) 14,981 9,398 24,379 9,630 134 9,764
------------------------------------------ -------------------------------------------
Total Interest
Earning Assets $ 14,969 $ 9,541 $ 24,510 $ 9,566 $ 159 $ 9,725
------------------------------------------ -------------------------------------------
Liabilities and
Shareholders' Equity
Interest Bearing Demand 2 3 5 8 13 21
Money Market 151 305 456 11 (87) (76)
Savings (12) (33) (45) 47 (53) (6)
Time Deposits under $100,000 1,307 1,824 3,131 956 (364) 592
Time Deposits $100,000 or more 1,793 2,016 3,809 805 (305) 500
Other Borrowings 446 367 813 405 (57) 348
------------------------------------------ -------------------------------------------
Total Interest
Bearing Liabilities 3,687 4,482 8,169 2,232 (853) 1,379
------------------------------------------ -------------------------------------------
Net Interest Income $ 11,282 5,059 16,341 $ 7,334 1,012 8,346
========================================== ===========================================
(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.
Non Interest Income
Non interest income of $23,822,163 in 2005, $28,698,614 in 2004, and
$24,481,351 in 2003 contributed significantly to earnings. Service charges and
fees were $604,408 in 2005, $667,743 in 2004 and $792,292 in 2003. Service
charges and fees decreased in 2004 and 2005 mainly due to a decrease in NSF
Fees. Construction fund control fees were $1,548,519 in 2005, $976,592 in 2004,
and $840,003 in 2003.
SBA loan servicing income was $2,637,928 in 2005, $2,500,443 in 2004,
and $1,693,836 in 2003. The gain on sale of loans was $13,390,694 in 2005,
compared to $18,858,051 in 2004, and $15,779,079 in 2003. The increase in 2004
from 2003 is due to high SBA and mortgage loan sales in 2004. The decrease in
2005 from 2004 is due to more loans originated that were not immediately
saleable due to the multiple disbursement nature of the loans. Loan sales
consist primarily of SBA guaranteed and unguaranteed loans and mortgage loans
that are sold service released. SBA loan sales are expected to continue in the
future.
Analysis of Changes in Non Interest Income
Increase/Decrease Increase/Decrease
2005 Amount % 2004 Amount % 2003
------------------------------------ ------------------------------------- -----------
(Dollars in Thousands)
Service charges and fees $ 604 $ (64) (10)% $ 668 $ (124) (16)% $ 792
Gain on loan sales 13,391 (5,467) (29)% 18,858 3,079 20% 15,779
Loan broker income 3,391 (77) (2)% 3,468 (414) (11)% 3,882
Servicing income 2,638 138 6% 2,500 806 48% 1,694
Construction fund control
fees 1,549 572 59% 977 137 16% 840
Other income 2,249 21 1% 2,228 734 49% 1,494
---------------------------- ---------------------------- -----------
Total $ 23,822 $ (4,877) (17)% $ 28,699 $ 4,218 17% $ 24,481
============ ============ ============ ============ == ========
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 $40,627,302 in 2005, compared to $33,964,229
in 2004, and $29,121,070 in 2003. Salaries and benefits increased to $26,971,422
in 2005 from $22,514,965 in 2004 and $20,484,132 in 2003. The increase in 2005
was due to the continued expansion of the SBA and related sales staff and the
opening of our Carlsbad office. The increase in 2004 was due to the addition of
branches in Corona and Rancho Bernardo, as well as the general growth of the
Company. Occupancy expense was $2,428,252 in 2005, compared to $1,725,034 in
2004, and $1,183,460 in 2003. Loan related expenses are higher due to increases
in loan volume, and were $2,138,283, $1,764,034, and $1,708,170 for 2005, 2004,
and 2003, respectively. Office expenses have increased over the last three years
principally due to internal expansion. The following table presents, for the
periods indicated, the major categories of non interest expense:
35
Analysis of Changes in Non Interest Expense
Increase/Decrease Increase/Decrease
2005 Amount % 2004 Amount % 2003
----------------------------------- ------------------------------------ -----------
(Dollars in Thousands)
Salaries and employee
benefits $ 26,971 $ 4,456 20% $ 22,515 $ 2,031 10% $ 20,484
Occupancy of premises 2,428 703 41% 1,725 542 46% 1,183
Loan related expense 2,138 374 21% 1,764 56 3% 1,708
Furniture and equipment 1,512 376 33% 1,136 244 27% 892
Data processing 1,127 112 11% 1,015 27 3% 988
Office expenses 2,677 440 20% 2,237 648 41% 1,589
All other expenses 3,774 202 6% 3,572 1,295 57% 2,277
----------------------------- ----------------------------- -----------
Total $ 40,627 $ 6,663 20% $ 33,964 $ 4,843 17% $ 29,121
============= ============ ============= ============ == ========
Income Taxes
For 2005 the tax expense was $9,886,072 for an effective rate of
41.47%; for 2004 the tax expense was $7,535,806 for an effective rate of 41.60%,
and for 2003 the tax expense was $5,427,889 for an effective rate of 40.87%.
Financial Condition
General
As of December 31, 2005, total assets increased nearly 43% to
$868,988,046, compared to $606,827,529 as of December 31, 2004, and $431,212,118
as of December 31, 2003. Total gross loans increased to $758,095,095 as of
December 31, 2005, or 42%, compared to $533,899,733 as of December 31, 2004, and
$363,046,406 as of December 31, 2003. Deposits grew 39% to $742,431,939 as of
December 31, 2005, compared to $534,766,705 as of December 31, 2004, and
$383,487,366 as of December 31, 2003.
Capital
The Company's capital increased 36% to $58,180,310 as of December 31,
2005, compared to $42,902,538 as of December 31, 2004, and $29,683,065 as of
December 31, 2003. The Company's equity to assets ratio was 6.70%, 7.07%, and
6.88 % at December 31, 2005, 2004, and 2003, 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.
At the end of 2005 and 2004, all Bank capital ratios were above all
current Federal capital guidelines for a "well capitalized" bank. 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.
The following tables present the regulatory standards for well
capitalized institutions and the capital ratios for the Company and the Bank at
December 31, 2005, 2004, and 2003.
36
Minimum Required
for Capital Actual Ratio
Adequacy Purposes December 31
-------------------- --------------------------
Temecula Valley Bancorp 2005 2004 2003
---- ---- ----
Tier 1 leverage 4.0% 9.3% 9.2% 9.0%
Tier 1 risk-based capital 4.0% 8.9% 9.7% 10.0%
Total risk-based capital 8.0% 11.0% 11.8% 11.5%
To Be Well
Capitalized
Minimum Required Under Prompt
for Capital Corrective Actual Ratio
Adequacy Purposes Action Provisions December 31
------------------ ------------------ ----------------------
Temecula Valley Bank 2005 2004 2003
---- ---- ----
Tier 1 leverage 4.0% 5.0% 10.2% 10.0% 9.4%
Tier 1 risk-based capital 4.0% 6.0% 9.8% 10.5% 10.3%
Total risk-based capital 8.0% 10.0% 10.8% 11.6% 11.3%
Loan Portfolio
Total loans (including loans held-for-sale), excluding deferred loan
fees and allowance for loan loss, were $758,095,095, $533,899,733, and
$363,046,406 at December 31, 2005, 2004, and 2003, respectively. Much of the
increase is due to increases in construction loans and real estate secured
loans. SBA loans, of which the Bank is an active originator, consisting of both
commercial and real estate loans, comprises approximately 13% of loans
outstanding at December 31, 2005, 22% of total loans outstanding at December 31,
2004, and 28% as of December 31, 2003. Due to the strong real estate market, and
the inherent nature of community bank loan markets, over 95% of the loan
portfolio is in real estate secured loans as of December 31, 2005, compared to
94% and 85% for comparable periods in 2004, and 2003, respectively. The rate of
loan growth is expected to be strong.
The majority of our loans have floating rates tied to our base rate or
other market rate indicators. This serves to lessen the risk from movement in
interest rates, particularly rate increases.
Healthy loan demand in 2005 resulted in a 98.4% increase in
construction lending, a 30.7% decrease in commercial loans and a 12.3% increase
in real estate lending. At December 31, 2005, there were no mortgage loans
outstanding. Mortgage loans outstanding were $2,240,758 as of December 31, 2004,
and $2,541,975 as of December 31, 2003. The Bank originated mortgage loans,
including brokered loans, totaling $75,015,746 in 2005, compared with
$105,545,627 in 2004, and $161,409,182 in 2003. Sales of mortgage loans totaled
$13,522,236 in 2005, compared with $45,243,206 in 2004, and $100,800,159 in
2003. The servicing portfolio, which consists primarily of SBA loans sold to
other investors, being serviced by the Company was $503,198,976 as of December
31, 2005, compared to $440,301,270 as of December 31, 2004, and $306,251,761 as
of December 31, 2003.
Nonperforming Assets
Nonperforming assets consist of nonperforming loans and Other Real
Estate Owned ("OREO"). The Company had $7,950,601 of nonperforming loans as of
December 31 2005, of which $6,513,752 was guaranteed by the SBA, compared to
$11,799,346 of nonperforming loans as of December 31, 2004, of which $8,140,267
was government guaranteed and $6,674,713 of nonperforming loans as of December
31, 2003, of which $5,269,317 was government guaranteed. There was $2,111,250 of
OREO at December 31, 2005, of which $604,004 was guaranteed by the SBA, compared
to $302,698 of OREO at December 31, 2004, of which $227,023 was guaranteed by
the SBA, and $485,036 at year end 2003.
Nonaccrual Loans
Nonaccrual loans, net of the government guaranteed portion, decreased
to $1,436,849 or 0.19 % of total gross loans as of December 31, 2005, compared
to $3,659,079 or 0.69 % of total gross loans as of December 31, 2004, and
$1,405,396 or 0.41% of total gross loans as of December 31, 2003.
37
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"
or "doubtful" and include nonperforming loans. Each classified loan is monitored
monthly. Classified assets, net of government guarantees, (consisting of
nonaccrual loans, loans graded as substandard or lower and OREO) at December 31,
2005, 2004, and 2003 were $2,944,095, $3,734,754, and $1,980,432, 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, 2005 were $220,379 or 0.03% of
average gross loans outstanding, compared to $1,066,599 or 0.24% of average
gross loans outstanding, for the year ended December 31, 2004, and $431,561 or
0.14% of average gross loans outstanding, for the year ended December 31, 2003.
Allowance for Loan Losses
As of December 31, 2005, the balance in the allowance for loan losses
was $9,039,155, compared to $6,362,534 as of December 31, 2004, and $3,607,833
as of December 31, 2003. 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
loss allocations for each loan category. These allocations are based upon loan
type as well as market conditions for the underlying real estate and other
collateral, trends in the real estate market, economic uncertainties and other
risks where it is probable that losses have been incurred. In general, there are
no loss allocations established for the government guaranteed portion of
commitments to extend credit. The allowance for loan losses was 1.20% of total
net loans and loans held-for-sale as of December 31, 2005 and December 31, 2004,
and 1.00% as of December 31, 2003. The allowance for loan losses was 1.35% of
total net loans excluding loans held-for-sale as of December 31, 2005, 1.29% as
of December 31, 2004, and 1.05% as of December 31, 2003. The allowance for loan
losses as a percentage of gross nonaccrual loans was 113.69% as of December 31,
2005, compared to 53.92% as of December 31, 2004, and 53.33% as of December 31,
2003. The allowance for loan losses to nonperforming loans, net of government
guarantees was 629.10% as of December 31, 2005, compared to 173.88% as of
December 31, 2004, and 256.71% as of December 31, 2003.
During 2003, 2004, and 2005, net charge offs as a percentage of average
loans outstanding were only 0.14%, 0.24%, and 0.03%, respectively. The growth in
real estate construction lending of approximately 71% resulted in an increase in
the level of loss allocations required increasing from $3,607,833 as of December
31, 2003 to $6,362,534 as of December 31, 2004, and to $9,039,155 as of December
31, 2005. The Bank has established loss allocations for each category based upon
loan type. Certain loan types may not have incurred charge-offs or have
historically had minimal losses, but it is probable that losses have been
incurred. 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, 2005, management charged off
$220,379 (net of recoveries) and provided $2,897,000 to the provision for loan
losses. During the year ended December 31, 2004, management charged off
$1,066,600 (net of recoveries) and provided $3,281,000 to the provision for loan
losses. During the year ended December 31, 2003, management charged off $431,561
(net of recoveries) to the allowance while it provided $1,022,000 to the
provision for loan losses. Although management believes that we use the best
information available to make determinations of the allowance for loan loss,
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, deferred tax assets,
servicing assets, and interest-only strips are the major components of other
assets. Premises and equipment increased to $4,885,015 as of December 31, 2005,
compared to $4,379,809 as of December 31, 2004 and $2,185,543 at December 31,
2003. The increase from 2004 to 2003 was due to depreciation expense being less
than the replacement or upgrade of existing assets, and the asset additions for
new locations.
38
Accrued interest increased to $3,471,302 as of December 31, 2005 from
$1,947,693 as of December 31, 2004, and $1,296,875 as of December 31, 2003. The
increase in accrued interest is due to the increase in yield on loans from 7.45%
for the year ended December 31, 2003 to 7.48% for the year ended December 31,
2004, and 9.12% for the year ended December 31, 2005 and the significant
increase in loan balances. Average loan balances increased from $318,599,785 for
2003 to $446,493,154 for 2004, and $634,731,108 for 2005.
The net servicing asset increased to $8,169,273 as of December 31,
2005, compared to $7,585,712 as of December 31, 2004, and $6,116,680 as of
December 31, 2003. The increase reflects the additions due to loan sales during
the year ended December 31, 2005 offset by 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 asset 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
13.70% as of December 31, 2005, compared to 15.22% as of December 31, 2004, and
15.67% as of December 31, 2003. See the footnotes to the financial statements,
found elsewhere in this Annual Report, for further information on servicing
assets.
Rights to future interest income from serviced loans that exceed
contractually specified servicing fees are classified as interest-only strips.
Interest-only strips decreased to $22,067,900 as of December 31, 2005 from
$24,679,520 as of December 31, 2004, and $20,495,511 as of December 31, 2003.
The decrease is due to the increase in loans serviced for others offset by lower
average servicing rates. The average prepayment speed for the interest-only
strips 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 $17,590,733 at December 31, 2005, compared to $9,593,824
at December 31, 2004, and $5,740,729 at December 31, 2003. The total death
benefit at December 31, 2005 was approximately $34,241,989. The BOLI earnings in
2005, net of mortality cost, were $506,909, compared to $281,095 in 2004, and
$205,546 in 2003. The net earnings of BOLI are tax-free. The SCP expense before
tax in 2005 was $723,442, compared to $1,084,646 in 2004, and $531,240 in 2003.
See the notes in the financial statements for additional information.
Investments/Financial Assets
Federal Reserve Bank and Federal Home Loan Bank stock, which are not
included in the investment category, was $3,098,600 at December 31, 2005,
$2,377,800 at December 31, 2004, and $1,145,000 at December 31, 2003. The Bank
had $33,200,000 in Fed Funds Sold at December 31, 2005, compared to $16,800,000
at December 31, 2004, and $21,400,000 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 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 2005, the ratio of interest-earning assets to total assets was
87.96%, for 2004 it was 86.09% and for 2003 it was 86.34%. The target for the
Company is to keep this ratio above 90%, but has remained below that level due
to the SBA servicing asset, the related SBA interest-only strip receivable, and
the cash surrender value of life insurance. The SBA servicing asset was
$8,169,273, the SBA I/O strip receivable was $22,067,900 and the cash surrender
value of life insurance was $17,590,733 at December 31, 2005. The SBA servicing
asset was $7,585,712, the SBA I/O strip receivable was $24,679,520 and the cash
surrender value of life insurance was $9,593,824 at December 31, 2004. At
December 31, 2003, the SBA servicing asset was $6,116,680, the SBA I/O strip
receivable was $20,495,511 and the cash surrender value of life insurance was
$5,740,729. 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.
39
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 $742,431,939 at December 31, 2005 from
$534,766,705 at December 31, 2004, and $383,487,366 at December 31, 2003. Demand
deposits comprised nearly 21% of the deposits in 2005, 26% in 2004, and 29% in
2003, tiered savings nearly 5% in 2005, 8% in 2004, and 9% in 2003, tiered money
market accounts nearly 8% in both 2005 and 2004, and 9% in 2003, NOW accounts
comprised nearly 5% in 2005, 6% in 2004, and 8% in 2003 and certificate of
deposits nearly 62% in 2005, 53% in 2004, and 46% in 2003. The increase in the
ratio of certificates of deposits is due to certificate of deposit promotions in
2004 and 2005 to fund the rapid loan growth.
More than 57% of all 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 two
branches in 2004, one branch in 2005, and the continued deposit increases at the
five other branches. It is anticipated that the core deposit base will increase
in 2006 as a result of the new branch scheduled to open in Solana Beach, CA. The
Bank will continue to solicit core deposits to diminish reliance on volatile
funds.
On December 31, 2005, the Company had a Federal Home Loan Bank Advance
of $30,000,000 maturing on January 3, 2006 and accruing interest at 4.21%. The
Company is required to pledge a certain amount of loans with the Federal Home
Loan Bank for collateralization purposes. As of December 31, 2005, $65,687,171
in loans was pledged for an aggregate borrowing line of $30,124,785. The Company
had no Federal Home Loan Bank Advances as of December 31, 2004.
On September 29, 2005, the Company issued $8,248,000 of junior
subordinated debt securities to the Company's wholly owned subsidiary, Temecula
Valley Statutory Trust IV ("Trust IV"), a statutory trust created under to laws
of the State of Delaware. The securities have quarterly interest payments with a
rate at 3-month LIBOR plus 1.40%, for an effective rate of 5.97%, as of December
31, 2005, with principal due at maturity in 2035.
On September 20, 2004, the Company issued $8,248,000 of junior
subordinated debt securities to the Company's wholly owned subsidiary, Temecula
Valley Statutory Trust III ("Trust III"), a statutory trust created under to
laws of the State of Delaware. The securities have quarterly interest payments
with a rate at 3-month LIBOR plus 2.20%, for an effective rate of 6.79%, as of
December 31, 2005, with principal due at maturity in 2034.
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 7.55%, as of December 31, 2005, 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 7.80%, as of December 31, 2005, with principal due at maturity
in 2032.
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.
40
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 participations 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 outflows from operating activities of
$25,643,581 during the year ended December 31, 2005, and $5,163,449 during the
year ended December 31, 2004. Net cash inflows were $8,190,025 during the year
ended December 31, 2003. Net cash inflows from operating activities during 2005
were primarily from net income of the Company, accompanied by the net proceeds
from the sale of loans held for sale.
Net cash outflows from investing activities of $192,750,857 during
2005, $163,668,832 during 2004, and $100,731,186 during 2003, 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
$246,788,891 during 2005, $161,201,529 during 2004, and $111,108,759 during
2003, primarily due to the growth in deposits.
As a means of augmenting its liquidity, the Company has established
federal funds lines with correspondent banks. At December 31, 2005, the
Company's available borrowing capacity includes approximately $18,000,000 in
federal funds line facilities, and $30,124,785 in unused Federal Home Loan Bank
advances. Management believes its liquidity sources to be stable and adequate.
At December 31, 2005, 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, subject to restrictions set forth by California Banking Law as well
as other regulatory instructions. For the year ended December 31, 2005, 2004,
and 2003, no dividends were paid by the Bank to the Company. As of December 31,
2005, approximately $7,074,000 of undivided profits of the Bank were available
for dividends to the Company, (an amount that would allow maintenance of the
"well capitalized" level).
Contractual Obligations and Commitments
At December 31, 2005, the Company had commitments to extend credit of
$381,603,164 and obligations under letters of credit of $3,980,178, 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.
More than 1 More than 3
One year year to 3 years to 5 More than
or less years years 5 years Total
-------------- ------------- ------------ ------------- -------------
FHLB Advances $ 30,000,000 $ - $ - $ - $ 30,000,000
Operating Lease
Obligations 1,587,341 2,500,181 908,358 531,475 5,527,355
Junior Subordinated Debt - - - 28,868,000 28,868,000
Commitments to Extend Credit 249,368,325 83,953,150 626,528 47,655,161 381,603,164
Letters of Credit 4,629,907 2,500 - 142,771 4,775,178
-------------- ------------- ------------ ------------- -------------
Total Contractual
Obligations $ 285,585,573 $ 86,455,831 $ 1,534,886 $ 77,197,407 $ 450,773,697
============== ============= ============ ============= =============
41
Critical Accounting Policies and Estimates
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 U.S. generally accepted accounting principles 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.
Significant accounting policies followed by the Company are presented
in Note A to the consolidated financial statements. These policies, along with
the disclosures presented in the other financial statement notes and in this
discussion, provide information on how significant assets and liabilities are
valued in the financial statements and how those values are determined. Based on
the valuation techniques used and the sensitivity of financial statement amounts
to the methods, assumptions, and estimates underlying those amounts, management
has identified the allowance for loan losses, accounting for stock options, and
servicing assets on I/O strips to be the accounting areas that require the most
subjective or complex judgments, and as such could be most subject to revision
as new information becomes available.
Accounting for the allowance for loan losses
The provision for loan losses charged to operations reflects
management's judgment 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 provision
for loan loss 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 incurred
losses 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 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 incurred losses
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,
nonperforming 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 imprecisions.
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
quarterly 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 is the amount by which the servicing asset for a
stratum exceeds its fair value.
42
Rights to future interest income from serviced loans that exceed
contractually specified servicing fees are classified as interest-only strips.
The interest-only strips are accounted for as trading securities and recorded at
fair value with any unrealized gains or losses recorded in earnings in the
period of change of fair value.
Further information on these and other significant accounting policies
is in Note A to the Consolidated Financial Statements included in Item 8 of this
Annual Report.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk, even though such
activities may be permitted with the approval of the Company's Board of
Directors.
Interest rate risk, as discussed above, is the most significant market
risk affecting the Company. Other types of market risk, such as foreign currency
exchange risk, equity price risk and commodity price risk, are not significant
in the normal course of the Company's business activities.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
Reports of Independent Registered Public Accounting Firms 47
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition 49
Consolidated Statements of Income 50
Consolidated Statement of Changes in Shareholders' Equity 51
Consolidated Statements of Cash Flows 52
Notes to Consolidated Financial Statements 53
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
-----------------------------------------------------------
In April 2005, Vavrinek, Trine, Day & Co., LLP ("Vavrinek") resigned as
the Company's independent auditors. The resignation was prompted by the fact
that, by mutual agreement between us and Vavrinek, it would be prudent to engage
a firm with more resources to match our anticipated growth and operating
complexity as well as a firm with several accelerated filer clients with stock
that is publicly traded. This decision was approved by our Audit Committee and
our Board. During the time we engaged Vavrinek, including our two most recent
fiscal years ended December 31, 2003 and 2004, Vavrinek has never issued to us
an adverse opinion or a disclaimer of opinion, and none of Vavrinek's opinions
during such periods were qualified or modified as to uncertainty, audit scope or
accounting principals. Moreover, during the time we engaged Vavrinek, including
our two most recent fiscal years ended December 31, 2003 and 2004, there has
never been, at any time, any disagreements on any matter of accounting
principals or practices, financial statement disclosure, or auditing scope or
procedure with disagreement(s), if not resolved to the satisfaction of Vavrinek,
would have caused it to make reference to the subject matter of the
disagreement(s) in connection with its report.
The decision to change accountants was recommended by the Audit
Committee and approved by our Board of Directors. On August 31, 2005, Crowe
Chizek and Company LLP was engaged as the independent auditors for the Company
upon the approval of the Audit Committee.
ITEM 9A: CONTROLS AND PROCEDURES
-----------------------
The Company's principal executive officer and the person performing the
functions of the Company's principal financial officer have evaluated the
effectiveness of the Company's "disclosure controls and procedures," as such
term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as
amended, as of December 31, 2005. Based upon their evaluation, the principal
executive officer and principal financial officer concluded that the Company's
disclosure controls and procedures are effective. The evaluation did not
identify any change in the Company's internal control over financial reporting
that occurred during the quarter ended December 31, 2005 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
43
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Temecula Valley Bancorp Inc. (the "Company") is
responsible for establishing and maintaining adequate internal control over
financial reporting, and for performing an assessment of the effectiveness of
internal control over financial reporting as of December 31, 2005. Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. The Company's system of internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Management performed an assessment of the effectiveness of the
Company's internal control over financial reporting as of December 31, 2005
based upon criteria in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based
on this assessment, management believes that the Company's internal control over
financial reporting was effective as of December 31, 2005.
The Company's independent registered public accounting firm has issued
an audit on Management's assessment of the Company's internal control over
financial reporting.
/s/ Stephen H. Wacknitz /s/ Donald A. Pitcher
- ----------------------- ---------------------
Chief Executive Officer Chief Financial Officer Dated March 30, 2006
44
ITEM 9B: OTHER INFORMATION
-----------------
On November 16, 2005, the Company approved the provision of an
indemnity to our transfer agent on behalf of Director Aichle and related
entities in connection with the issuance of stock certificates to replace lost
certificates representing 72,244 shares of common stock, and Director Aichle his
related entities indemnified the Company in connection with losses we may incur
as a result of the provision of the to our transfer agent. These agreements are
at Exhibits 10.40 and 10.41.
The Bank entered into an Employment Agreement with Robert Flores dated
January 27, 2005. The agreement is Exhibit 10.25 to the Company's Form 10-K
filed March 31, 2005.
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 SEC
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," "Corporate Governance and Our Directors and Executive Officers,"
"Executive Officers and Compensation" and "Section 16(a) Beneficial Ownership
Reporting Compliance."
With regard to Item 406, the Company has adopted a Code of
Business Conduct and 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 for the 2006 Annual Meeting of Shareholders 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 for the 2006 Annual Meeting of Shareholders 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 for the 2006 Annual Meeting of Shareholders under
the caption "Certain Relationships and Other Transactions."
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------
The information required by this Item is incorporated by reference from
the Company's Proxy Statement for the 2006 Annual Meeting of Shareholders under
the caption "Selection of Independent Auditors."
PART IV
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES
---------------------------------------
(a) Documents Filed as Part of this Annual Report
(1) See Index to Financial Statements in Item 8 on Page 43 of this Report
(2) Financial Statement Schedules
Not applicable.
(b) See Index to Exhibits on Page 70 of this Report.
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
TEMECULA VALLEY BANCORP INC.
DATE: March 30, 2006 BY: /s/ Stephen H. Wacknitz
----------------------------------------
Stephen H. Wacknitz, President/CEO,
Chairman of the Board
BY: /s/ Donald A. Pitcher
----------------------------------------
Donald A. Pitcher, Senior Vice President
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual 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
/s/ Steven W. Aichle Director March 30, 2006
- ----------------------------------------
Dr. Steven W. Aichle
/s/ Dr. Robert P. Beck Director March 30, 2006
- ----------------------------------------
Dr. Robert P. Beck
/s/ Neil M. Cleveland Director March 30, 2006
- ----------------------------------------
Neil M. Cleveland
/s/ George Cossolias Director March 30, 2006
- ----------------------------------------
George Cossolias
/s/ Luther J. Mohr Director March 30, 2006
- ----------------------------------------
Luther J. Mohr
/s/ Stephen H. Wacknitz Chairman March 30, 2006
- ----------------------------------------
Stephen H. Wacknitz
/s/ Richard W. Wright Director March 30, 2006
- ----------------------------------------
Richard W. Wright
46
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Temecula Valley Bancorp Inc. and Subsidiary
Temecula, California
We have audited the accompanying consolidated statement of financial
condition of Temecula Valley Bancorp Inc. and Subsidiary (the Company) as of
December 31, 2005, and the related consolidated statements of income, changes in
shareholders' equity, and cash flows for the year then ended. We have also
audited management's assessment, included in the accompanying Management's
Report on Internal Control Over Financial Reporting, included in Item 9a of Form
10-K, that the Company maintained effective internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). The Company's management is responsible for
these financial statements, for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
these financial statements, an opinion on management's assessment, and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the account principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our
audit of internal control over financial reporting included obtaining and
understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinions.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Temecula
Valley Bancorp Inc. and Subsidiary as of December 31, 2005, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. Also
in our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2005, is fairly
stated, in all material respects, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). Furthermore, in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
Crowe Chizek and Company LLP
Oak Brook, Illinois
March 30, 2006
47
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders of
Temecula Valley Bancorp Inc. and Subsidiary
We have audited the accompanying consolidated statement of financial
condition of Temecula Valley Bancorp Inc. and Subsidiary as of December 31, 2004
and the related consolidated statements of income, changes in shareholders'
equity, and cash flows for the two years ended December 31, 2004. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company of Accounting Oversight Board (United States). Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Temecula
Valley Bancorp Inc. and Subsidiary as of December 31, 2004, and the results of
its operations and its cash flows for the two years ended December 31, 2004, in
conformity with accounting principles generally accepted in the United States of
America.
Vavrinek, Trine, Day & Co., LLP
Laguna Hills, California
March 23, 2005
48
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, December 31,
2005 2004
-------------------- ---------------------
ASSETS
Cash and Due from Banks $ 18,311,714 $ 6,317,261
Federal Funds Sold 33,200,000 16,800,000
-------------------- ---------------------
TOTAL CASH AND CASH EQUIVALENTS 51,511,714 23,117,261
Loans Held-for-Sale 82,813,405 37,776,105
Loans:
Commercial 30,786,823 23,560,360
Real Estate - Construction 332,184,415 194,204,521
Real Estate - Other 307,990,676 275,562,420
Consumer 4,319,776 2,796,327
-------------------- ---------------------
TOTAL LOANS 675,281,690 496,123,628
Net Deferred Loan Fees (4,848,306) (3,703,481)
Allowance for Loan Losses (9,039,155) (6,362,534)
-------------------- ---------------------
NET LOANS 661,394,229 486,057,613
Federal Reserve and Federal Home Loan Bank Stock, at Cost 3,098,600 2,377,800
Premises and Equipment 4,885,015 4,379,809
Other Real Estate Owned 2,111,250 302,698
Cash Surrender Value of Life Insurance 17,590,733 9,593,824
Deferred Tax Assets 5,744,355 4,370,990
Servicing Assets 8,169,273 7,585,712
Interest-Only Strips Receivable 22,067,900 24,679,520
Accrued Interest Receivable 3,471,302 1,947,693
Other Assets 6,130,270 4,638,504
-------------------- ---------------------
$ 868,988,046 $ 606,827,529
==================== =====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non Interest-Bearing Demand $ 155,992,027 $ 138,041,385
Money Market and NOW 93,824,731 73,880,005
Savings 34,850,882 41,838,703
Time Deposits, Under $100,000 217,748,575 135,915,448
Time Deposits, $100,000 and Over 240,015,724 145,091,164
-------------------- ---------------------
TOTAL DEPOSITS 742,431,939 534,766,705
FHLB Advances 30,000,000 -
Accrued Interest Payable 957,246 405,927
Junior Subordinated Debt 28,868,000 20,620,000
Other Liabilities 8,550,551 8,132,359
-------------------- ---------------------
TOTAL LIABILITIES 810,807,736 563,924,991
Shareholders' Equity:
Common Stock No Par Value; 40,000,000 Shares
Authorized; 8,897,697 and 8,752,603 Shares Issued
and Outstanding at December 31, 2005 and 2004 17,639,669 16,724,128
Accumulated other comprehensive income 408,966 -
Retained Earnings 40,131,675 26,178,410
-------------------- ---------------------
TOTAL SHAREHOLDERS' EQUITY 58,180,310 42,902,538
-------------------- ---------------------
$ 868,988,046 $ 606,827,529
==================== =====================
See accompanying notes to the consolidated financial statements
49
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2005, 2004, and 2003
2005 2004 2003
------------------- ------------------ -----------------
INTEREST INCOME
Loans, including fees $ 57,880,625 $ 33,501,670 $ 23,738,166
Investment Securities 5,889 1,906 336
Federal Funds Sold 238,746 111,311 151,998
------------------- ------------------ -----------------
TOTAL INTEREST INCOME 58,125,260 33,614,887 23,890,500
INTEREST EXPENSE
Money Market and NOW 960,986 500,661 555,883
Savings Deposits 141,311 186,154 192,313
Time Deposits 11,847,827 4,909,109 3,727,584
Junior Subordinated Debt and Other
Borrowings 1,633,660 818,619 470,773
------------------- ------------------ -----------------
TOTAL INTEREST EXPENSE 14,583,784 6,414,543 4,946,553
------------------- ------------------ -----------------
NET INTEREST INCOME 43,541,476 27,200,344 18,943,947
Provision for Loan Losses 2,897,000 3,821,300 1,022,000
------------------- ------------------ -----------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 40,644,476 23,379,044 17,921,947
NON INTEREST INCOME
Service Charges and Fees 604,408 667,743 792,292
Gain on Sale of Loans 13,390,694 18,858,051 15,779,079
Gain(Loss) on Other Assets and
Other Real Estate Owned (21,536) (67,998) 27,430
Servicing Income 2,637,928 2,500,443 1,693,836
Loan Broker Income 3,390,597 3,468,424 3,882,234
Loan Related Income 2,392,045 2,377,083 2,348,698
Other Income 1,428,027 894,868 (42,218)
------------------- ------------------ -----------------
TOTAL NON INTEREST INCOME 23,822,163 28,698,614 24,481,351
------------------- ------------------ -----------------
NON INTEREST EXPENSE
Salaries and Employee Benefits 26,971,422 22,514,965 20,484,132
Occupancy Expenses 2,428,252 1,725,034 1,183,460
Furniture and Equipment 1,512,288 1,136,173 892,154
Data Processing 1,127,123 1,015,480 988,279
Marketing and Business Promotion 1,121,968 968,218 723,429
Legal and Professional 1,055,429 704,747 411,537
Regulatory Assessments 246,112 175,814 137,506
Travel & Entertainment 947,870 704,034 528,860
Loan Related Expense 2,138,283 1,764,034 1,708,170
Office Expenses 2,676,976 2,237,347 1,589,448
Other Expenses 401,579 1,018,383 474,095
------------------- ------------------ -----------------
TOTAL NON INTEREST EXPENSE 40,627,302 33,964,229 29,121,070
------------------- ------------------ -----------------
INCOME BEFORE INCOME TAX EXPENSE 23,839,337 18,113,429 13,282,228
Income Tax expense 9,886,072 7,535,806 5,427,889
------------------- ------------------ -----------------
NET INCOME $ 13,953,265 $ 10,577,623 $ 7,854,339
=================== ================== =================
Per Share Data :
Net Income - Basic $1.58 $1.24 $1.00
Net Income - Diluted $1.46 $1.13 $0.89
See accompanying notes to the consolidated financial statements
50
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2005, 2004, and 2003
Accumulated
Other
Comprehensive Common Retained Comprehensive
Income Shares Stock Earnings Income Total
----------- ------------- ------------- --------------- --------------
Balance at January 1, 2003 7,446,646 $ 11,869,755 $ 7,746,448 $ - $ 19,616,203
Exercise of Stock Options,
Including the
Realization of
Tax Benefits of $424,910 380,670 1,401,026 1,401,026
Exercise of Warrants 324,598 811,497 811,497
Net Income 7,854,339 7,854,339
----------- ------------- ------------- --------------- --------------
Balance at December 31, 2003 8,151,914 $ 14,082,278 $ 15,600,787 $ - $ 29,683,065
Exercise of Stock Options,
Including the
Realization of
Tax Benefits of $967,660 600,689 2,641,850 2,641,850
Net Income 10,577,623 10,577,623
----------- ------------- ------------- --------------- --------------
Balance at December 31, 2004 8,752,603 $ 16,724,128 $ 26,178,410 $ - $ 42,902,538
Exercise of Stock Options,
Including the
Realization of
Tax Benefits of $39,884 145,094 915,541 915,541
Net Income 13,953,265 13,953,265 - 13,953,265
Other comprehensive
income, net 408,966 408,966 408,966
----------------
Total comprehensive income $ 14,362,231
================ ----------- ------------- ------------- --------------- --------------
Balance at December 31, 2005 8,897,697 $ 17,639,669 $ 40,131,675 $ 408,966 $ 58,180,310
=========== ============= ============= =============== ==============
See accompanying notes to the consolidated financial statements
51
TEMECULA VALLEY BANCORP INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2005, 2004, and 2003
2005 2004 2003
----------------- -------------------- -------------------
OPERATING ACTIVITIES
Net Income $ 13,953,265 $ 10,577,623 $ 7,854,339
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Depreciation and Amortization 8,638,973 6,970,596 4,946,316
Amortization of debt issuance costs 70,200 74,867 18,734
Net change in deferred loan origination fees (1,144,825) (1,406,466) (957,251)
Provision for Loan Losses 2,897,000 3,821,300 1,022,000
Provision for Deferred Taxes (1,670,000) (1,977,990) (665,000)
Gain on Sale of Loans (13,390,694) (18,858,051) (15,779,079)
Loans Originated for Sale (209,935,641) (265,250,247) (246,036,807)
Proceeds from Loan Sales 176,918,823 259,284,600 257,672,323
Loss (Gain) on Sale of Other Real Estate Owned 26,297 72,998 (19,880)
Net Increase in Cash Surrender Value of Life Insurance (506,909) (316,815) (205,546)
Federal Home Loan Bank Stock Dividend (68,900) (39,500) (21,500)
Net Change in Accrued Interest, Other Assets and Other
Liabilities (1,431,170) 1,883,636 361,376
----------------- -------------------- -------------------
NET CASH PROVIDED(USED) BY OPERATING ACTIVITIES (25,643,581) (5,163,449) 8,190,025
INVESTING ACTIVITIES
Purchases of Held-to-Maturity Investments (1,194,111) (997,794) (299,664)
Purchases of Federal Reserve and Federal Home Loan Bank Stock (651,900) (1,193,300) (203,450)
Proceeds from Maturities of Held-to-Maturity Securities 1,200,000 1,000,000 300,000
Proceeds from Sale of Federal Home Loan Bank Stock - - 571,900
Net Increase in Loans (183,664,319) (157,465,280) (99,932,384)
Purchase of Cash Surrender Value Life Insurance (7,490,000) (3,572,000) (1,552,000)
Proceeds from Sale of Premises and Equipment 128,500 49,000 29,000
Proceeds from Sale of Other Real Estate Owned 647,101 1,519,340 870,880
Purchases of Premises and Equipment (1,726,128) (3,008,798) (515,468)
----------------- -------------------- -------------------
NET CASH USED BY INVESTING ACTIVITIES (192,750,857) (163,668,832) (100,731,186)
FINANCING ACTIVITIES
Net Increase in Demand Deposits and Savings Accounts 30,907,547 44,872,620 31,444,106
Net Increase in Time Deposits 176,757,687 106,406,719 82,722,040
Net Change in Federal Home Loan Bank Advances 30,000,000 - (10,000,000)
Proceeds from Issuance of Junior Subordinated Debt 8,248,000 8,248,000 5,155,000
Proceeds from Exercise of Warrants - - 811,497
Proceeds from Exercise of Stock Options 875,657 1,674,190 976,116
----------------- -------------------- -------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 246,788,891 161,201,529 111,108,759
----------------- -------------------- -------------------
INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS 28,394,453 (7,630,752) 18,567,598
Cash and Cash Equivalents at Beginning of Year 23,117,261 30,748,013 12,180,415
----------------- -------------------- -------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 51,511,714 $ 23,117,261 $ 30,748,013
================= ==================== ===================
Supplemental Disclosures of Cash Flow Information:
Interest Paid $ 14,032,465 $ 6,287,236 $ 4,895,119
Income Taxes Paid $ 13,794,373 $ 8,469,371 $ 7,117,636
Transfer of Loans to Other Real Estate Owned $ 2,481,950 $ 1,410,000 $ 1,336,036
See accompanying notes to the consolidated financial statements
52
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
PRINCIPLES OF CONSOLIDATION
On June 3, 2002, Temecula Valley Bancorp Inc. acquired all the
outstanding shares of Temecula Valley Bank by issuing 7,346,406 shares of common
stock in exchange for the surrender of all outstanding shares of Temecula Valley
Bank's common stock. There was no cash involved in this transaction. The
acquisition was accounted for as a reverse merger. The consolidated financial
statements contained herein have been restated to give full effect to this
transaction. The consolidated financial statements include the accounts of
Temecula Valley Bancorp Inc. (the "Bancorp"), and its wholly-owned subsidiary,
Temecula Valley Bank (the "Bank"), collectively referred to herein as the
"Company". All significant intercompany transactions have been eliminated.
Nature of Operations
- --------------------
The Company has been organized as a single operating segment and
operates eight branches in Temecula, Murrieta, Fallbrook, El Cajon, Escondido,
Corona, Rancho Bernardo, and Carlsbad, California. In addition, as a Nationwide
SBA Preferred Lender, the Company operates business loan centers in Arizona,
California, Colorado, Connecticut, Florida, Georgia, Illinois, Nebraska, New
Jersey, North Carolina, Ohio, Oregon, Pennsylvania, Texas, and Washington.
The Bank's primary sources of revenue are providing loans to customers,
who are predominately small and middle-market businesses and individuals, and
originating government guaranteed loans for sale to institutional investors in
the secondary market. The Company also generates fee income by servicing the
government guaranteed loans.
Use of Estimates in the Preparation of Financial Statements
- -----------------------------------------------------------
The preparation of financial statements, in conformity with U.S.
generally accepted accounting principles, requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Estimates associated with the allowance for loan losses, SBA
servicing assets, and SBA interest-only strips receivable are particularly
susceptible to change. Actual results could differ from those estimates.
Cash Flows
- ----------
For purposes of reporting cash flows, cash and cash equivalents include
cash, due from banks and federal funds sold. Generally, federal funds are sold
for one day periods. Net cash flows are reported for customer loan and deposit
transactions.
Cash and Due From Banks
- -----------------------
As a member of the Federal Reserve Bank, we are required to maintain a
percentage of our deposits as reserves in cash or on deposit with the Federal
Reserve Bank. The average daily reserve requirements as of December 31, 2005 and
2004 were $11,593,000 and $13,418,000, respectively. The Company complied with
the reserve requirements as of December 31, 2005 and 2004.
The Company maintains amounts due from banks which exceed federally
insured limits. The Company has not experienced any losses in such accounts.
Investment Securities
- ---------------------
Debt securities, for which the Company has the positive intent and
ability to hold to maturity, are reported at cost adjusted for premiums and
discounts that are recognized in interest income, using the interest method over
the period to maturity. Investments not classified as trading securities nor as
held-to-maturity securities are classified as available-for-sale securities and
recorded at fair value. Unrealized gains or losses on available-for-sale
securities are reported as a separate component of other comprehensive income
included in shareholders' equity, net of taxes. Available-for-sale and
held-to-maturity securities are assessed at each reporting date to determine
whether there is an other-than-temporary impairment. Impairments, if any, are
required to be recognized in current earnings rather than as a separate
component of shareholders' equity. In estimating other-than-temporary losses,
management considers: the length of time and extent that fair value has been
less than cost, the financial condition and near term prospects of the issuer,
and the Company's ability and intent to hold the security for a period
sufficient to allow for any anticipated recovery in fair value. Realized gains
or losses on sales of held-to-maturity or available-for-sale securities are
recorded using the specific identification method.
53
Federal Home Loan Bank (FHLB) Stock
- -----------------------------------
The Bank is a member of the FHLB system. Members are required to own a
certain amount of stock based on the level of borrowings and other factors, and
may invest in additional amounts. FHLB stock is carried at cost, classified as a
restricted security, and periodically evaluated for impairment based on ultimate
recovery of par value. Both cash and stock dividends are reported as income.
Loans
- -----
Loans receivable, that management has the intent and ability to hold
for the foreseeable future or until maturity or payoff, are reported at their
outstanding unpaid principal balances reduced by any charge-offs or allowance
for loan losses and net of any deferred fees or costs on originated loans, or
unamortized premiums or discounts on purchased loans. Loan origination fees and
certain direct origination costs are capitalized and recognized as an adjustment
of the yield of the related loan.
The accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due or is 90
days or more past due. When interest accrual is discontinued, all unpaid accrued
interest is reversed. Interest income is subsequently recognized only to the
extent cash payments are received.
Loans Held-for-Sale
- -------------------
Mortgage loans and SBA loans, originated and intended for sale in the
secondary market, are carried at the lower of cost or estimated market value in
the aggregate. Net unrealized losses are recognized through a valuation
allowance by charges to income.
Loan Sales Recognition
- ----------------------
Statement of Financial Accounting Standards ("SFAS") No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities", provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. Under this
statement transfers of financial assets are accounted for as sales when control
over the assets has been relinquished. Control over transferred assets is deemed
to be surrendered when the assets have been isolated from the Company, the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and the
Company does not maintain effective control over the transferred assets through
an agreement to repurchase them before their maturity.
To calculate the gain (loss) on sale of loans, the Company's investment
in the loan is allocated among the retained portion of the loan, the servicing
retained, the interest-only strip and the sold portion of the loan, based on the
relative fair market value of each portion. The gain (loss) on the sold portion
of the loan is recognized at the time of sale based on the difference between
the sale proceeds and the allocated investment. As a result of the relative fair
value allocation, the carrying value of the retained portion is discounted, with
the discount accreted to interest income over the life of the loan.
Servicing Assets and Interest-Only Strips Receivable
- ----------------------------------------------------
Servicing assets represent the allocated value of retained servicing
rights on loans sold. Servicing assets are expensed in proportion to, and over
the period of, estimated net servicing revenues. Impairment is evaluated based
on the fair value of the assets, using groupings of the underlying loans as to
interest rates and then, secondarily, as to loan type and investor. Fair value
is determined using prices for similar assets with similar characteristics, when
available, or based upon discounted cash flows using market-based assumptions.
Any impairment of a grouping is reported as a valuation allowance, to the extent
that fair value is less than the capitalized amount for the grouping. The
portion of servicing fees in excess of the contractual servicing fees is
reflected as interest-only (I/O) strips receivable, which are classified as
available-for-sale and are carried at fair value.
54
Allowance for Loan Losses
- -------------------------
The allowance for loan losses is a valuation allowance for probable
incurred credit losses established through charges to earnings in the form of a
provision for loan losses. Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is confirmed.
Subsequently, recoveries are credited to the allowance.
Quarterly detailed reviews are performed to identify the risks inherent
in the loan portfolio, assess the overall quality of the loan portfolio and the
related provision for loan losses to be charged to expense. The analysis
considers general factors such as evaluation of collateral securing the credit,
changes in lending policies and procedures, economic trends, loan volume trends,
changes in lending management and staff, trends in delinquencies, nonaccruals
and charge-offs, changes in loan review and Board oversight, the effects of
competition, legal and regulatory requirements and factors inherent to each loan
pool. Allocations of the allowance may be made for specific loans, but the
entire allowance is available for any loan that, in management's judgment,
should be charged-off.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. If a loan is impaired, a portion of the allowance is
allocated so that the loan is reported, net, at the present value of estimated
future cash flows using the loan's existing rate or at the fair value of
collateral if repayment is expected solely from the collateral. Large groups of
smaller balance homogeneous loans, such as consumer and residential real estate
loans, are collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures.
Premises and Equipment
- ----------------------
Land is carried at cost. Premises and equipment are carried at cost
less accumulated depreciation and amortization. Depreciation is computed using
the straight-line method over the estimated useful lives, which ranges from
three to ten years for furniture and fixtures and ten to thirty years for
buildings. Leasehold improvements are amortized using the straight-line method
over the estimated useful lives of the improvements or the remaining lease term,
whichever is shorter. Expenditures for betterments or major repairs are
capitalized and those for ordinary repairs and maintenance are charged to
operations as incurred.
Premises and equipment are reviewed for impairment when events indicate
their carrying amount may not be recoverable from future undiscounted cash
flows. If impaired, the assets are recorded at fair value.
Other Real Estate Owned
- -----------------------
Real estate properties acquired through, or in lieu of, loan
foreclosure are initially recorded at the lesser of the outstanding loan balance
or the fair value at the date of foreclosure minus estimated costs to sell. Any
valuation adjustments required at the time of foreclosure are charged to the
allowance for loan losses. After foreclosure, the properties are carried at the
lower of carrying value or fair value less estimated costs to sell. Any
subsequent valuation adjustments, operating expenses or income, and gains and
losses on disposition of such properties are recognized in current operations.
Cash Surrender Value of Life insurance
- --------------------------------------
The Company has purchased life insurance policies on certain key
executives. Company owned life insurance (or Bank owned life insurance "BOLI")
is recorded at its cash surrender value or the amount that can be realized.
Advertising
The Company expenses the costs of advertising in the period incurred.
Income Taxes
- ------------
Deferred income taxes are computed using the asset and liability
method, which recognizes a liability or asset representing the tax effects,
based on current tax law, of future deductible or taxable amounts attributable
to events that have been recognized in the consolidated financial statements. A
valuation allowance is established to reduce the deferred tax asset to the level
at which it is "more likely than not" that the tax asset or benefits will be
realized. Realization of tax benefits of deductible temporary differences and
operating loss carryforwards depend on having sufficient taxable income of an
appropriate character within the carryforward periods.
55
Comprehensive Income
- --------------------
Comprehensive income consists of net income and other comprehensive
income. Other comprehensive income includes unrealized gains and losses on
interest-only strips. At December 31, 2005, the unrealized gain on the
interest-only strip was $705,672 which resulted in $408,966 of other
comprehensive income (net of $296,706 in deferred taxes). For the years ending
December 31, 2004, and 2003, the Company had no accumulated other comprehensive
income and there were no significant components of comprehensive income with the
exceptions of net income.
Loan Commitments and Related Financial Instruments
- --------------------------------------------------
In the ordinary course of business, the Company has entered into
off-balance sheet financial instruments consisting of commitments to extend
credit, commitments under credit card arrangements, commercial letters of
credit, and standby letters of credit. Such financial instruments are recorded
in the financial statements when they are funded or related fees are incurred or
received.
Loss Contingencies
- ------------------
Loss contingencies, including claims and legal actions arising in the
ordinary course of business, are recorded as liabilities when the likelihood of
loss is probable and an amount or range of loss can be reasonably estimated.
Management does not believe there now are such matters that will have a material
effect on the financial statements.
Dividend Restrictions
- ---------------------
Banking regulations require maintaining certain capital levels and may
limit the dividends paid by the bank to the holding company or by the holding
company to shareholders.
Operating Segments
- ------------------
While the chief decision-makers monitor the revenue streams of the
various products and services, operations are managed and financial performance
is evaluated on a Company-wide basis. Accordingly, all of the financial service
operations are considered by management to be aggregated in one reportable
operating segment.
Disclosure about Fair Value of Financial Instruments
- ----------------------------------------------------
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments",
specifies the disclosure of the estimated fair value of financial instruments.
The Company's estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies as
described in a separate note. Considerable judgment is required to develop the
estimates of fair value. Accordingly, the estimates are not necessarily
indicative of the amounts the Company could have realized in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Earnings Per Share (EPS)
- ------------------------
Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if options or other contracts to issue common stock were exercised
or converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company.
On December 22, 2003, the Bancorp's Board of Directors approved a
2-for-1 stock split of the Company's outstanding common stock. All per share
data in the financial statements and related footnotes have been retroactively
adjusted to reflect this split.
Stock-Based Compensation
- ------------------------
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees", and related Interpretations.
Accordingly, we measure the compensation cost for stock options as the excess,
if any, of the quoted market price of the Company's stock at the date of the
grant over the amount an employee must pay to acquire the stock. SFAS No. 123,
"Accounting for Stock-Based Compensation", encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value.
56
Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS No. 123, the Company's net income and
earnings per share would have been reduced as described in the following pro
forma schedule.
2005 2004 2003
-------------- ---------------- --------------
Net Income:
As reported $ 13,953,265 $ 10,577,623 $ 7,854,339
Stock-Based Compensation That would have been
reported Using the Fair Value Method of SFAS 123 (488,278) (342,047) (494,780)
-------------- ---------------- --------------
Pro Forma Net Income $ 13,464,987 $ 10,235,576 $ 7,359,559
============== ================ ==============
Per Share Data:
Net Income - Basic
As Reported $1.58 $1.24 $1.00
Pro Forma $1.52 $1.20 $0.94
Net Income - Diluted
As Reported $1.46 $1.13 $0.89
Pro Forma $1.40 $1.09 $0.82
Effect of Newly Issued but Not Yet Effective Accounting Standards
- -----------------------------------------------------------------
In December 2004, FASB revised SFAS No. 123 and issued SFAS No. 123R,
"Share-Based Payment". This statement eliminates the alternative to use Opinion
No. 25's intrinsic value of accounting. Instead, this statement requires all
public companies, beginning with the next fiscal year beginning after June 15,
2005, to measure the compensation expense for stock options at the fair value of
the options when granted. The cost is then to be expensed over the employee
service period, which is the vesting period of the options. This will apply to
awards granted or modified after the effectiveness of the new requirements. In
addition, a compensation expense will be recorded for prior option grants that
vest after the effectiveness of the requirements. The effect on results of
operations will depend on the level of future option grants and the calculation
of the fair value of the options granted at such future date, as well as the
vesting periods provided, and so cannot currently be predicted. However, options
outstanding at December 31, 2005 that subsequently vest will result in net
compensation costs of $681,127, $572,954, and $304,837 for the years ended
December 31, 2006, 2007, and 2008, respectively.
Current Accounting Pronouncements
- ---------------------------------
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement
No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion
No. 20 and FASB Statement No. 3". This statement changes the requirements for
the accounting for and reporting of a change in accounting principle. This
statement applies to all voluntary changes in accounting principle and to
changes required by an accounting pronouncement that does not include specific
transition provisions. Unless impracticable, SFAS No. 154 requires retrospective
application to prior periods' financial statements of changes in accounting
principle. This statement requires that the new accounting principle be
reflected in the carrying value of assets and liabilities as of the earliest
period practicable and that the offsetting adjustment be recorded to the opening
balance of retained earnings rather than being reported in an income statement.
When it is impracticable to determine the period-specific effects of an
accounting change, SFAS No. 154 requires that the new accounting principle be
applied as if it were adopted prospectively from the earliest date practicable.
SFAS No. 154 is effective for accounting changes made in fiscal years beginning
after December 15, 2005. Management does not believe adoption of SFAS No. 154
will have a material impact on the Company's financial statements.
In November 2005, the FASB issued Staff Position ("FSP") Nos. FAS 115-1
and 124-1 to address the determination as to when an investment is considered
impaired, whether that impairment is other-than-temporary and the measurement of
an impaired loss. This FSP nullified certain requirements of Emerging Issues
Task Force 03-1 "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" (EITF 03-1), and references existing
guidance on other-than-temporary impairment. Furthermore, this FSP creates a
three step process in determining when an investment is considered impaired,
whether that impairment is other-than-temporary, and the measurement of an
impairment loss. The FSP is effective for reporting periods beginning after
December 15, 2005. It is not anticipated that adoption will have a material
impact on our financial condition or results of operations.
57
During December 2005, the FASB issued FSP Statement of Position ("SOP")
94-6-1, "Terms of Loan Products That May Give Rise to a Concentration of Credit
Risk", which addresses the circumstances under which the terms of loan products
give rise to such risk and the disclosures or other accounting considerations
that apply for entities that originate, hold, guarantee, service, or invest in
loan products with terms that may give rise to a concentration of credit risk.
The guidance under this FSP is effective for interim and annual periods ending
after December 19, 2005 and for loan products that are determined to represent a
concentration of credit risk, disclosure requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments, should be provided for
all periods presented. The adoption of this FSP did not have a significant
impact on the Company's consolidated financial statements.
Reclassifications
- -----------------
Certain reclassifications were made to prior year's presentation to
conform to the current year.
NOTE B - LOANS
- --------------------------------------------------------------------------------
The Company's loan portfolio consists primarily of loans to borrowers
within Temecula, California, its surrounding communities, and the surrounding
communities of the other business loan centers. Although the Company seeks to
avoid concentrations of loans to a single industry or based upon a single class
of collateral, real estate and real estate associated businesses are among the
principal industries in our market area and, as a result, the Company's loan and
collateral portfolios are, to some degree, concentrated in those industries. We
have no negative amortization loans, but do have construction loans that pay
interest out of interest reserve advances. The interest reserve is funded
through advances on the construction loans.
The Company also originated mortgage and SBA loans for sale to
institutional investors. A substantial portion of the Company's revenues are
from origination of loans guaranteed by the Small Business Administration under
its Section 7A program and sale of the guaranteed portions of those loans.
Funding for the Section 7A program depends on annual appropriations by the U.S.
Congress.
Under the SBA's 7A Program, loans in excess of $150,000 up to
$2,000,000 are guaranteed 75% by the SBA. Generally, this guarantee may become
invalid only if the loan does not meet the SBA underwriting, documentation, and
servicing guidelines. Loans under $150,000 are guaranteed 85% by the SBA. At
December 31, 2005 and 2004, $47,809,188 and $43,699,758 of loans and loans
held-for-sale were guaranteed under these programs.
NOTE C - ALLOWANCE FOR LOAN LOSSES
- --------------------------------------------------------------------------------
A summary of the changes in the allowance for loan losses as of December 31 follows:
2005 2004 2003
----------- ------------- -----------
Balance at Beginning of Year $ 6,362,534 $ 3,607,833 $ 3,017,395
Additions to the Allowance Charged to Expense 2,897,000 3,821,300 1,022,000
Recoveries on Loans Charged Off 319,773 30,099 74,024
----------- ------------- -----------
9,579,307 7,459,232 4,113,419
Less Loans Charged Off (540,152) (1,096,698) (505,586)
----------- ------------- -----------
$ 9,039,155 $ 6,362,534 $ 3,607,833
=========== ============= ===========
The following is a summary of the investment in impaired loans, the
related allowance for loan losses, and income recognized thereon as of December
31:
58
2005 2004 2003
----------------- ----------------- ----------------
Recorded Investment in Non-Performing Loans $ 7,950,601 $ 11,799,346 $ 6,674,713
Guaranteed Portion of Non-Performing Loans (6,513,752) (8,140,267) (5,269,317)
----------------- ----------------- ----------------
Net Non-Performing Loans $ 1,436,849 $ 3,659,079 $ 1,405,396
================= ================= ================
Related Allowance for Non-Performing Loans 175,509 221,000 368,000
Average Recorded Net Investment in
Non-Performing Loans 2,438,383 2,249,482 637,000
Interest Income Recognized for Cash Payments None None None
Interest Income Foregone on Non-accrual Loans $ 898,242 $ 549,105 $ 445,311
Total Loans Past-Due Ninety Days
or More and Still Accruing $ - $ - $ -
NOTE D - PREMISES AND EQUIPMENT
- --------------------------------------------------------------------------------
A summary of premises and equipment as of December 31 follows:
2005 2004
--------------- ---------------
Land $ 500,000 $ 500,000
Buildings and Leasehold Improvements 1,909,084 1,895,440
Autos 1,547,394 1,096,977
Furniture, Fixtures, and Equipment 4,515,688 3,568,376
--------------- ---------------
8,472,166 7,060,793
Accumulated Depreciation and Amortization (3,587,151) (2,680,984)
--------------- ---------------
$ 4,885,015 $ 4,379,809
=============== ===============
Depreciation and amortization expense for premises and equipment was
$1,092,423 in 2005, $765,532 in 2004, and $643,615 in 2003.
The Company has entered into several leases for its branches and loan
production offices which expire at various dates through 2014. These leases
include provisions for periodic rent increases as well as payment by the lessee
of certain operating expenses. Rental expense relating to these leases was
$1,545,562 in 2005, $1,132,408 in 2004, and $811,000 in 2003. The approximate
future minimum annual payments for these leases by year are as follows:
Year
----
2006 $ 1,587,341
2007 1,343,457
2008 1,156,724
2009 627,209
2010 281,148
Thereafter 531,475
--------------
$ 5,527,354
==============
The minimum rental payment shown above is given for the existing lease
obligations and is not a forecast of future rental expense.
NOTE E - SERVICING ASSETS AND INTEREST-ONLY STRIPS RECEIVABLE
- --------------------------------------------------------------------------------
At December 31, 2005, 2004, and 2003, the Company was servicing
approximately $503,198,976, $440,301,270, and $306,252,000, respectively,
in loans previously sold. A summary of the changes in the related servicing
assets and interest-only strips receivable are as follows:
59
Servicing Assets
---------------------------------------------------------
2005 2004 2003
----------------- ----------------- ----------------
Balance at Beginning of Year $ 7,585,712 $ 6,116,679 $ 3,763,779
Increase from Loan Sales 2,597,873 3,731,175 3,251,793
Amortization Charged to Income (2,014,312) (2,262,142) (898,893)
----------------- ----------------- ----------------
Balance at End of Year $ 8,169,273 $ 7,585,712 $ 6,116,679
================= ================= ================
Interest-Only Strips Receivable
---------------------------------------------------------
2005 2004 2003
----------------- ----------------- ----------------
Balance at Beginning of Year $ 24,679,520 $ 20,495,511 $ 13,120,093
Increase from Loan Sales 2,160,246 8,040,814 10,710,121
Amortization Charged to Income (5,477,538) (3,856,805) (3,334,703)
Write-up of Interest-Only Strips
Receivable 705,672 - -
----------------- ----------------- ----------------
Balance at End of Year $ 22,067,900 $ 24,679,520 $ 20,495,511
================= ================= ================
For purposes of measuring impairment, the Bank has identified each
servicing asset with the underlying loan being serviced. A valuation
allowance is recorded where the fair value is below the carrying amount of
the asset.
The Bank may also receive a portion of subsequent interest
collections on loans sold that exceed the contractual servicing fee. In
that case, the Bank records an interest-only strip based on the relative
fair market value of it and the other components of the loan. At December
31, 2005, 2004, and 2003, the Bank had interest-only strips of $22,067,900,
$24,679,520, and $20,495,511, respectively, which approximates fair value.
Fair value is estimated by discounting estimated future cash flows from the
interest-only strips using assumptions similar to those used in valuing
servicing assets. The average servicing fee rate at December 31, 2005 and
2004 was 2.46% and 2.83%, respectively.
At December 31, 2005, the Bank had an unrealized gain of $705,672,
which increased the I/O strip receivable to $22,067,900. At December 31,
2004, and 2003, there was no unrealized gain or loss. The approximate
future amortization expense on servicing assets and I/O strips receivable
for the next 5 years is as follows:
Year
----
2006 $ 7,862,676
2007 7,600,480
2008 7,024,131
2009 5,263,603
2010 1,780,611
-----------------
$ 29,531,501
=================
At December 31, 2005, key economic assumptions used to determine
the fair value of the servicing assets and interest-only strips on SBA
loans sold, along with the potential decline in the fair value of these
assets due to an immediate 10 percent and 20 percent adverse change or an
immediate 100 basis point and 200 basis point adverse change in those
assumptions are as follows:
SBA Loans Sold
----------------
Carrying Value of Servicing Assets and I/O
Strips - Fair Value $30,237,173
Weighted-Average Life (in months) 57
Repayment Speed Assumption (annual rate) 12.0% - 18.10%
Decline in Fair Value from a 10% Adverse Change 989,834
Decline in Fair Value from a 20% Adverse Change 2,485,945
Discount Rate (annual rate) 9.35% - 9.40%
Decline in Fair Value from a 100 bp Adverse Change 1,054,527
Decline in Fair Value from a 200 bp Adverse Change 2,043,189
60
The declines in fair value due to changes in the assumptions are
hypothetical and should be used with caution. For purposes of this table,
the effect of an adverse change is calculated for each assumption without
changing any other assumptions; however, in reality changes in one factor
may result in positive or negative changes in another factor, which might
magnify or counteract the sensitivities.
NOTE F - DEPOSITS
- --------------------------------------------------------------------------------
At December 31, 2005 the scheduled maturities of time deposits are as
follows:
Year
----
2006 $ 456,223,812
2007 1,237,442
2008 112,581
2009 110,636
Thereafter 79,828
----------------
$ 457,764,299
================
The five largest depositors with the Company had approximately
$22,584,000 on deposit at December 31, 2005.
NOTE G - FHLB ADVANCES AND OTHER BORROWINGS
- --------------------------------------------------------------------------------
On December 31, 2005, the Company had a Federal Home Loan Bank Advance
of $30,000,000 maturing on January 3, 2006 and accruing interest at 4.21%. The
Company is required to pledge a certain amount of loans with the Federal Home
Loan Bank for collateralization purposes. As of December 31, 2005, $65,687,171
in loans was pledged for an aggregate borrowing line of $30,124,785. The Company
had no Federal Home Loan Bank Advances as of December 31, 2004.
The Company maintains federal funds lines of credit with three
financial institutions in the aggregate amount of $18,000,000 as of December 31,
2005. As of December 31, 2005 and 2004, no amounts were outstanding under these
arrangements.
NOTE H - JUNIOR SUBORDINATED DEBT
- --------------------------------------------------------------------------------
On June 26, 2002, the Company issued $7,217,000 of junior subordinated
debt securities (the "debt securities") to Temecula Valley Statutory Trust I, a
statutory trust created under the laws of the State of Connecticut. These debt
securities are subordinated to effectively all borrowings of the Company and are
due and payable on June 26, 2032. Interest is payable quarterly on these debt
securities at 3-Month LIBOR plus 3.45%, for an effective rate of 7.80%, as of
December 31, 2005. The debt securities can be redeemed for 107.5% of the
principal balance through June 26, 2007 and at par thereafter. The debt
securities can also be redeemed at par if certain events occur that impact the
tax treatment or the capital treatment of the issuance.
On September 17, 2003, the Company issued $5,155,000 of junior
subordinated debt securities (the "debt securities") to Temecula Valley
Statutory Trust II, a statutory trust created under the laws of the State of
Delaware. These debt securities are subordinated to effectively all borrowings
of the Company and are due and payable on September 17, 2033. Interest is
payable quarterly on these debt securities at 3-Month LIBOR plus 2.95%, for an
effective rate of 7.55%, as of December 31, 2005. The debt securities can be
redeemed for 107.5% of the principal balance through September 17, 2008 and at
par thereafter. The debt securities can also be redeemed at par if certain
events occur that impact the tax treatment or the capital treatment of the
issuance.
On September 20, 2004, the Company issued $8,248,000 of junior
subordinated debt securities (the "debt securities") to Temecula Valley
Statutory Trust III, a statutory trust created under the laws of the State of
Delaware. These debt securities are subordinated to effectively all borrowings
of the Company and are due and payable on September 20, 2034. Interest is
payable quarterly on these debt securities at 3-Month LIBOR plus 2.20%, for an
effective rate of 6.79%, as of December 31, 2005. The debt securities can be
redeemed for 107.5% of the principal balance through September 20, 2009 and at
par thereafter. The debt securities can also be redeemed at par if certain
events occur that impact the tax treatment or the capital treatment of the
issuance.
61
On September 29, 2005, the Company issued $8,248,000 of junior
subordinated debt securities (the "debt securities") to Temecula Valley
Statutory Trust IV, a statutory trust created under the laws of the State of
Delaware. These debt securities are subordinated to effectively all borrowings
of the Company and are due and payable on September 29, 2035. Interest is
payable quarterly on these debt securities at 3-Month LIBOR plus 1.40%, for an
effective rate of 5.97%, as of December 31, 2005. The debt securities can be
redeemed for 107.5% of the principal balance through September 29, 2010 and at
par thereafter. The debt securities can also be redeemed at par if certain
events occur that impact the tax treatment or the capital treatment of the
issuance.
The Company also purchased a 3% minority interest in Temecula Valley
Statutory Trusts I, II, III, and IV. The balance of the equity of Temecula
Valley Statutory Trusts I, II, III and IV is comprised of mandatorily redeemable
preferred securities. Under FASB Interpretation ("FIN") No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51", the Company is
not allowed to consolidate Temecula Valley Statutory Trusts I, II, III and IV
into the Company financial statements. Prior to the issuance of FIN No. 46, Bank
Holding companies typically consolidated these entities. The Federal Reserve
Board has ruled that these mandatorily redeemable preferred securities qualify
as Capital. As of December 31, 2005, 2004, and 2003 the Company has included the
net junior subordinated debt in its capital for regulatory capital purposes.
- --------------------------------------------------------------------------------
NOTE I - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has granted loans to
certain directors and the companies with which they are associated. The
following is a summary of the activity of these loans:
2005 2004
--------------- --------------
Balance at the Beginning of Year $ 1,355,275 $ 841,933
Advances 801,721 876,548
Payments (1,092,737) (363,206)
------------------ ------------------
$ 1,064,259 $ 1,355,275
================== ==================
Deposits from related parties held by the Company at December 31, 2005
and 2004 amounted to $2,639,448 and 1,068,380, respectively.
NOTE J - INCOME TAXES
- --------------------------------------------------------------------------------
The provision for income taxes included in the statements of income as
of the years ended December 31 consist of the following:
December 31,
2005 2004 2003
----------------- ----------------- --------------
Current:
Federal $ 8,685,714 $ 7,039,937 $ 4,504,304
State 2,870,358 2,473,869 1,588,585
----------------- ----------------- --------------
11,556,072 9,513,806 6,092,889
Deferred:
Federal (1,670,000) (1,978,000) (665,000)
----------------- ----------------- --------------
$ 9,886,072 $ 7,535,806 $ 5,427,889
================= ================= ==============
Deferred taxes are a result of differences between income tax
accounting and generally accepted accounting principles with respect to income
and expense recognition. The Company's principal timing differences are from
loan loss provision accounting, deferred compensation plans, and depreciation
differences. The provision for income taxes varies from the federal statutory
rate as follows for the years ended December 31 2005, 2004, and 2003:
62
2005 2004 2003
------------------------- ------------------------ --------------------------
Amount Percent of Amount Percent of Amount Percent of
Pretax Pretax Pretax
Income Income Income
------------------------- ------------------------ --------------------------
Federal Tax Rate $ 8,344,000 35.0% $ 6,159,000 34.0% $ 4,516,000 34.0%
State Income Taxes,
Net of Federal Income
Tax Benefit 1,656,000 7.0% 1,282,000 7.1% 944,000 7.1%
Income from Surrender Value
of Life Insurance (177,000) (0.7)% (108,000) (0.6)% (70,000) (0.5)%
Other Items, Net 63,072 0.2% 202,806 1.1% 37,889 0.3%
------------ --------- ------------ -------- ------------ ----------
Total $ 9,886,072 41.5% $ 7,535,806 41.6% $ 5,427,889 40.9%
============ ========= ============ ======== ============ ==========
The following is a summary of the components of the net deferred tax
asset accounts recognized in the accompanying statements of financial condition:
December 31,
Net Deferred Tax Assets 2005 2004
---------------- ----------------
Allowance for Loan Losses $ 3,640,000 $ 2,276,000
Deferred Compensation Plans 1,374,000 1,039,000
State Taxes 996,000 746,000
Reserve for Undisbursed Loans 8,000 200,000
Non-accrual Interest 221,000 189,000
Other Assets - 66,000
---------------- ----------------
6,239,000 4,516,000
Deferred Tax Liabilities:
Depreciation Differences (69,000) (145,000)
Unrealized Gain on Interest-Only Strips
Receivable (297,000) -
Other Liabilities (129,000) -
---------------- ----------------
(495,000) (145,000)
---------------- ----------------
Net Deferred Tax Assets $ 5,744,000 $ 4,371,000
================ ================
At December 31, 2005 and 2004, there was no valuation allowance
recorded against the net deferred tax asset.
NOTE K - EARNINGS PER SHARE (EPS)
- --------------------------------------------------------------------------------
The following is a reconciliation of net income and shares outstanding
to the income and number of shares used to compute EPS as of the years ended
December 31:
2005 2004 2003
-------------------------- -------------------------- -------------------------
Income Shares Income Shares Income Shares
-------------- ---------- ------------- ---------- ------------ ---------
Net Income as Reported $ 13,953,265 $ 10,577,623 $ 7,854,339
Weighted Average Shares
Outstanding During the Year 8,845,736 8,503,179 7,823,951
-------------- ---------- ------------- ---------- ------------ ---------
Used in Basic EPS 13,953,265 8,845,736 10,577,623 8,503,179 7,854,339 7,823,951
Dilutive Effect of Stock
Options and Warrants 743,698 860,689 1,037,755
-------------- ---------- ------------- ---------- ------------ ---------
Used in Dilutive EPS $ 13,953,265 9,589,434 $ 10,577,623 9,363,868 $ 7,854,339 8,861,706
============== ========== ============= ========== ============ =========
Stock options for 51,000 shares of common stock were not considered in
computing diluted earnings per common share for 2005 because they were
anitdilutive.
NOTE L - STOCK OPTION PLAN
- --------------------------------------------------------------------------------
At December 31, 2005, the Company has three fixed option plans under
which 4,000,000 shares of the Company's common stock may be issued. The
compensation expense that has been charged against income for these stock-based
compensation plans totaled $54,608 in 2005, $45,512 in 2004, and $18,097 in
2003. Compensation expense was recognized because options were granted at an
exercise price that was less than the fair market value on the date of grant.
63
During 1996, the Company established an incentive stock option plan for
officers and employees. Under this plan the Company may grant options for
1,800,000 shares of common stock at not less than 100% of the fair market value
at the date the options are granted.
During 1997, the Company established a nonqualified stock option plan
for directors of the Company. Under this plan, the Company may grant options for
1,500,000 shares of common stock at not less than 85% of the fair market value
at the date the options are granted.
During 2004, the Company established an incentive/nonqualified stock
option plan for directors, officers and employees. Under this plan the Company
may grant options for 700,000 shares of common stock at not less than 100% of
the fair market value for officers and employees and 85% of the fair market
value for directors at the date the options are granted.
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option pricing model with the following assumptions:
2005 2004 2003
----------- ---------- ----------
Volatility 24.30% 27.90% 22.90%
Risk-free interest rate 4.36% 3.61% 3.00%
Expected life 5 years 5 years 5 years
Dividend Yield 0.00% 0.00% 0.00%
A summary of the status of the Company's fixed stock option plan as of
December 31, and changes during the years ending on those dates is presented
below:
2005 2004 2003
---------------------- ---------------------- ----------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------- ---------- --------- --------- --------- ----------
Outstanding at
Beginning of Year 1,579,723 $ 6.09 1,912,674 $ 3.74 2,042,348 $ 2.79
Granted 190,000 19.27 302,078 14.93 273,000 9.26
Options Exercised (145,094) 6.04 (600,689) 2.79 (380,670) 2.56
Options Cancelled (51,668) 14.59 (34,340) 11.25 (22,004) 4.01
-------- --------- ---------
Outstanding at End of Year 1,572,961 7.41 1,579,723 6.09 1,912,674 3.74
======== ========= =========
Options Exercisable at
End of Year 1,193,311 4.46 1,231,635 4.24 1,617,008 3.24
Weighted-Average Fair
Value of Options Granted
During the Year 6.00 5.07 3.01
The following table summarizes information about fixed options
outstanding at December 31, 2005:
Options Outstanding Options Exercisable
--------------------------------------------- -------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Number Remaining Exercise Number Exercise
Price Outstanding Contractual Life Price Exercisable Price
- ------------------- ----------- ---------------- ---------- ----------- ----------
$1.00 to $1.99 122,476 1.18 $ 1.41 122,476 $ 1.41
$2.00 to $2.99 465,838 3.84 2.56 465,838 2.56
$3.00 to $3.99 313,898 3.51 3.47 313,898 3.47
$4.00 to $4.99 7,000 6.11 4.75 7,000 4.75
$5.00 to $5.99 62,000 6.51 5.69 61,332 5.69
$6.00 to $9.99 118,000 7.87 9.28 106,000 9.62
$10.00 to $13.99 135,082 8.20 12.03 101,719 12.37
$14.00 to $17.99 238,667 8.77 15.97 9,382 11.49
$18.00 to $25.99 110,000 9.48 20.66 5,666 17.24
----------- ---------- ---------- ----------- ----------
1,572,961 $ 5.51 $ 7.41 1,193,311 $ 4.46
=========== ========== ========== =========== ==========
64
NOTE M - EMPLOYEE BENEFITS
- --------------------------------------------------------------------------------
During 2000, the Company adopted a retirement savings plan for the
benefit of its employees. Contributions to the plan are determined annually by
the Board of Directors. The expense for this plan was $386,888 in 2005, $309,756
in 2004, and $262,579 in 2003.
The Company has entered into retirement benefit agreements with certain
officers providing for future benefits aggregating approximately $13,315,000,
payable in equal annual installments ranging from ten years to a lifetime
benefit from the retirement dates of each participating officer. The estimated
future benefits to be paid are being accrued over the period from the effective
date of the agreements until the expected retirement dates of the participants.
The expense incurred and accrued was $723,442, $1,084,646, and $531,240 for the
years ended December 31, 2005, 2004, and 2003, respectively. As of December 31,
2005 and 2004, $2,885,494 and $2,347,052 has been accrued in conjunction with
these agreements. Amounts paid under these agreements totaled $185,000 in 2005.
The Company is the beneficiary under split dollar agreements of life insurance
policies that have been purchased as a method of financing the benefits under
the agreements.
On March 1, 2006, the Board of Directors approved an Employee Stock
Ownership Plan ("ESOP") that will be set up during 2006. Contributions will be
at the discretion of the Board and will be contributed on an annual basis. The
contribution to the ESOP is an employee benefit expense to the Company.
NOTE N - FAIR VALUE OF FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
The fair value of a financial instrument is the amount at which the
asset or obligation could be exchanged in a current transaction between willing
parties, other than in a forced or liquidation sale. Fair value estimates are
made at a specific point in time based on relevant market information and
information about the financial instrument. These estimates do not reflect any
premium or discount that could result from offering for sale at one time the
entire holdings of a particular financial instrument. Because no market value
exists for a significant portion of the financial instruments, fair value
estimates are based on judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in nature,
involve uncertainties and matters of judgment and, therefore, cannot be
determined with precision. Changes in assumptions could significantly affect the
estimates.
Fair value estimates are based on financial instruments both on and off
the balance sheet without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. Additionally, tax consequences related to the realization
of the unrealized gains and losses can have a potential effect on fair value
estimates and have not been considered in many of the estimates. The following
methods and assumptions were used to estimate the fair value of significant
financial instruments:
Financial Assets
----------------
The carrying amounts of cash, federal funds sold, FRB and FHLB
stock, and accrued interest are considered to approximate fair value. The
fair value of loans are estimated using a combination of techniques,
including discounting estimated future cash flows and quoted market prices
of similar instruments where available.
Servicing Assets and Interest-Only Strips Receivable
----------------------------------------------------
The estimated fair value of the servicing assets approximated the
carrying amount at December 31, 2005, 2004, and 2003. Fair value is
estimated by discounting estimated future cash flows from the servicing
assets using discount rates that approximate current market rates over the
expected lives of the loans being serviced. If actual prepayments, with
respect to sold loans, occurs more quickly than projected, the carrying
value of servicing assets and I/O strips may have to be adjusted through a
charge to earnings.
Financial Liabilities
---------------------
The carrying amounts of deposit liabilities payable on demand,
FHLB advances, accrued interest, and junior subordinated debt securities
are considered to approximate fair value. For fixed maturity deposits, fair
value is estimated by discounting estimated future cash flows using
currently offered rates for deposits of similar remaining maturities.
65
Off-Balance Sheet Financial Instruments
---------------------------------------
The fair value of commitments to extend credit and standby letters
of credit is estimated using the fees currently charged to enter into
similar agreements. The fair value of these financial instruments is not
material.
The estimated fair value of financial instruments at December 31,
2005 and 2004 is summarized as follows (dollar amounts in thousands):
2005 2004
------------------------------ -------------------------------
Financial Assets: Carrying Carrying
Value Fair Value Value Fair Value
-------------- ------------ --------------- -------------
Cash and Due From Banks $ 18,312 $ 18,312 $ 6,317 $ 6,317
Federal Funds Sold 33,200 33,200 16,800 16,800
Loans Held-for-Sale 82,813 82,813 37,776 37,776
Loans, net 661,394 659,580 486,058 486,425
Federal Reserve and Federal Home Loan
Bank Stock 3,099 3,099 2,378 2,378
I/O Strips Receivable and Servicing Assets 30,237 30,878 32,265 32,265
Accrued Interest Receivable 3,471 3,471 1,948 1,948
Financial Liabilities:
Deposits 742,432 742,425 534,767 534,755
Federal Home Loan Bank Advances 30,000 30,000 - -
Junior Subordinated Debt 28,868 28,868 20,620 20,620
Accrued Interest Payable 957 957 406 406
NOTE O - LOAN COMMITMENTS AND RELATED FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
In the normal course of business, the Company enters into financial
commitments to meet the financing needs of its customers. These financial
commitments include commitments to extend credit and standby letters of credit.
Those instruments involve, to varying degrees, elements of credit and interest
rate risk not recognized in the statement of financial condition.
The Company's exposure to loan loss in the event of nonperformance on
commitments to extend credit and standby letters of credit is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments as it does for loans reflected in the financial
statements. As of December 31, 2005 and 2004, the Company had the following
outstanding financial commitments whose contractual amount represents credit
risk:
Contractual Obligations December 31, 2005 December 31, 2004
-----------------------------------------------------------------------------------------
Fixed Variable Total Fixed Variable Total
-----------------------------------------------------------------------------------------
FHLB Advances $ 30,000,000 $ - $ 30,000,000 $ - $ - $ -
Operating Lease Obligations 5,527,355 - 5,527,355 6,920,594 - 6,920,594
Junior Subordinated Debt - 28,868,000 28,868,000 - 20,620,000 20,620,000
Commitments to Extend Credit 4,408,346 377,194,818 381,603,164 10,572,546 231,926,048 242,498,594
Letters of Credit 10,000 4,765,178 4,775,178 10,000 1,103,468 1,113,468
-----------------------------------------------------------------------------------------
Total Contractual
Obligations $ 39,945,701 $410,827,996 $ 450,773,697 $ 17,503,140 $ 253,649,516 $ 271,152,656
=========================================================================================
The fixed rate loan commitments have interest rates ranging from 7.75%
to 9.25%. The following table sets forth the maturities of the Company's fixed
rate outstanding commitments to extend credit at December 31, 2005:
More than 1 More than 3
One year year to 3 years to 5 More than
or less years years 5 years Total
-------------- ------------- ------------ ------------- -------------
FHLB Advances $ 30,000,000 $ - $ - $ - $ 30,000,000
Operating Lease Obligations 1,587,341 2,500,181 908,358 531,475 5,527,355
Junior Subordinated Debt - - - 28,868,000 28,868,000
Commitments to Extend Credit 249,368,325 83,953,150 626,528 47,655,161 381,603,164
Letters of Credit 4,629,907 2,500 - 142,771 4,775,178
-------------- ------------- ------------ ------------- -------------
Total Contractual
Obligations $ 285,585,573 $ 86,455,831 $ 1,534,886 $ 77,197,407 $ 450,773,697
============== ============= ============ ============= =============
66
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Standby letters of credit are conditional commitments to guarantee the
performance of a Company customer to a third party. Since many of the
commitments and standby letters of credit are expected to expire without being
drawn upon, the total amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's credit worthiness on a
case-by-case basis. The amount of collateral obtained if deemed necessary by the
Company is based on management's credit evaluation of the customer.
The Company is involved in various litigation, which has arisen in the
ordinary course of its business. In the opinion of management, the disposition
of such pending litigation will not have a material effect on the Company's
financial statements.
NOTE P - REGULATORY MATTERS
- --------------------------------------------------------------------------------
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Bank's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors. For capital adequacy
purposes, the Company and the Bank must maintain total capital to risk-weighted
assets and Tier 1 capital to risk-weighted assets of 8.0% and 4.0%,
respectively.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the tables below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2005, that both the Company and the Bank have met all capital adequacy
requirements to which they are subject. The following table sets forth the
Company's actual capital amounts and ratios (dollar amounts in thousands):
Amount of Capital
Required
--------------------
For Capital
Adequacy Purposes
--------------------
Amount Ratio Amount Ratio
----------- ------- ---------- ------
As of December 31, 2005:
------------------------
Total Capital (to Risk-Weighted
Assets) $ 94,422 11.02% $ 68,553 8.00%
Tier 1 Capital (to Risk-Weighted
Assets) $ 76,484 8.93% $ 34,276 4.00%
Tier 1 Capital (to Average
Assets) $ 76,484 9.28% $ 32,970 4.00%
As of December 31, 2004:
------------------------
Total Capital (to Risk-Weighted
Assets) $ 68,506 11.81% $ 46,419 8.00%
Tier 1 Capital (to
Risk-Weighted Assets) $ 56,192 9.68% $ 23,210 4.00%
Tier 1 Capital (to Average
Assets) $ 56,192 9.20% $ 24,419 4.00%
As of December 31, 2005, the most recent notification from the
regulators categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action (there are no conditions or events since
that notification that management believes have changed the Bank's category). To
be categorized as well capitalized, the Bank must maintain minimum ratios as set
forth in the table below. The following table sets forth the Bank's actual
capital amounts and ratios (dollar amounts in thousands):
Amount of Capital Required
-------------------------------------------------
To Be
Well Capitalized
For Capital Adequacy Under Corrective
Purposes Corrective Provisions
---------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ------- ----------- ------- ----------- --------
As of December 31, 2005:
Total Capital (to Risk-Weighted
Assets) $ 92,550 10.81% $ 68,472 8.00% $ 85,590 10.00%
Tier 1 Capital (to Risk-Weighted
Assets) $ 83,491 9.75% $ 34,236 4.00% $ 51,354 6.00%
Tier 1 Capital (to Average
Assets) $ 83,491 10.17% $ 32,842 4.00% $ 41,053 5.00%
As of December 31, 2004:
Total Capital (to Risk-Weighted
Assets) $ 67,436 11.64% $ 46,348 8.00% $ 57,934 10.00%
Tier 1 Capital (to Risk-Weighted
Assets) $ 61,074 10.54% $ 23,178 4.00% $ 34,767 6.00%
Tier 1 Capital (to Average
Assets) $ 61,074 10.03% $ 24,357 4.00% $ 30,446 5.00%
67
The Bank is restricted as to the amount of dividends that can be paid
to the holding company. Dividends declared by banks that exceed the net income
(as defined) for the current year plus retained net income for the preceding two
years must be approved by the regulators. The Bank may not pay dividends that
would result in its capital levels being reduced below the minimum requirements
shown above. The amount available for payment of dividends to the Company by the
Bank was approximately $7,074,000 at December 31, 2005.
NOTE Q - WARRANTS
- --------------------------------------------------------------------------------
In connection with a stock offering that was completed in June 2001,
the Bank issued 400,000 units, with each unit containing four shares of common
stock and one warrant to purchase one share of common stock at an exercise price
of $2.50 per share. The warrants expired June 23, 2003.
NOTE R - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY
- --------------------------------------------------------------------------------
Temecula Valley Bancorp Inc. operates Temecula Valley Bank. Temecula
Valley Bancorp Inc. commenced operations during 2002. The earnings of the
subsidiary are recognized on the equity method of accounting. Condensed
financial statements of the parent company only are presented below:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
December 31, December 31,
ASSETS: 2005 2004
---------------- ------------------
Cash $ 2,057,190 $ 1,054,806
Investment in Temecula Valley Statutory Trust I 217,000 217,000
Investment in Temecula Valley Statutory Trust II 155,000 155,000
Investment in Temecula Valley Statutory Trust III 248,000 248,000
Investment in Temecula Valley Statutory Trust IV 248,000 -
Investment in Temecula Valley Bank 84,308,400 61,832,513
Other Assets 137,967 208,167
---------------- ------------------
$ 87,371,557 $ 63,715,486
================ ==================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Other Liabilities $ 323,247 $ 192,948
Junior Subordinated Debt 28,868,000 20,620,000
Shareholders' Equity 58,180,310 42,902,538
---------------- ------------------
$ 87,371,557 $ 63,715,486
================ ==================
- --------------------------------------------------------------------------------
CONDENSED STATEMENTS OF INCOME
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
INCOME: 2005 2004 2003
---------------- ------------------ -----------------
Cash Dividends from Statutory Trusts $ 41,026 $ 20,274 $ 11,853
---------------- ------------------ -----------------
TOTAL INCOME 41,026 20,274 11,853
---------------- ------------------ -----------------
EXPENSES:
Interest on Junior Subordinated Debt 1,450,344 766,078 449,454
Other 512,304 403,973 155,018
Income Tax Benefit (807,965) (483,435) (243,889)
---------------- ------------------ -----------------
1,154,683 686,616 360,583
---------------- ------------------ -----------------
LOSS BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY (1,113,657) (666,342) (348,730)
EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 15,066,922 11,243,965 8,203,069
---------------- ------------------ -----------------
NET INCOME $ 13,953,265 $ 10,577,623 $ 7,854,339
================ ================== =================
68
CONDENSED STATEMENTS OF CASH FLOWS Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2005 2004 2003
---------------- ------------------ -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,953,265 $ 10,577,623 $ 7,854,339
Noncash items included in net income:
Equity in income of Subsidiary (15,066,922) (11,243,965) (8,203,069)
Other (7,616) 973,502 (84,740)
---------------- ------------------ -----------------
NET CASH PROVIDED(USED) IN OPERATING ACTIVITIES (1,121,273) 307,160 (433,470)
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in Subsidiaries (7,000,000) (10,000,000) (5,683,687)
---------------- ------------------ -----------------
NET CASH USED BY INVESTING ACTIVITIES (7,000,000) (10,000,000) (5,683,687)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Junior Subordinated Debt 8,248,000 8,248,000 5,155,000
Proceeds from exercise of stock options 875,657 1,674,190 976,116
Proceeds from exercise of warrants - - 811,497
---------------- ------------------ -----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 9,123,657 9,922,190 6,942,613
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,002,384 229,350 825,456
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,054,806 825,456 -
---------------- ------------------ -----------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,057,190 $ 1,054,806 $ 825,456
================ ================== =================
69
Exhibit No. Index to Exhibits
- ---------- ----------------------
2.(i) Temecula Valley Bank and Temecula Valley Bancorp 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 Temecula Valley Bancorp's Definitive 14A,
filed November 20, 2003.
3.(ii) Bylaws of Temecula Valley Bancorp, as amended, filed on May 17, 2004 as
an Exhibit to Temecula Valley Bancorp's Form 10-Q.
3.(iii) Bylaws amendment filed on March 23, 2006 as an Exhibit to Temecula
Valley Bancorp's Form 8-K.
4.1 Common Stock Certificate of Temecula Valley Bancorp, filed on May 17,
2004 as an Exhibit to Temecula Valley Bancorp's Form 10-Q.
10.1 Temecula Valley Bank, N.A. Lease Agreement for Main Office, filed on
March 11, 2003 as an Exhibit to the Temecula Valley Bancorp's Form
10KSB.
10.2 Stephen H. Wacknitz Employment Agreement effective October 1, 2003,
filed on March 31, 2004 as an Exhibit to Temecula Valley Bancorp's Form
10K.
10.3 First Amendment to Stephen H. Wacknitz Employment Agreement dated June
23, 2005 filed on August 9, 2005 as an Exhibit to Temecula Valley
Bancorp's Form 10Q.
10.3(a) Second Amendment to Stephen H. Wacknitz Employment Agreement dated
February 2, 2006.
10.6 401(k) filed April 16, 2004 as an Exhibit to Temecula Valley Bancorp's
Form 10-K/A.
10.8 Thomas P. Ivory Employment Agreement effective January 25, 2001, filed
on March 11, 2003 as an Exhibit to Temecula Valley Bancorp's Form
10KSB.
10.9 James W. Andrews Employment Agreement dated June 1, 2002 filed on April
11, 2003 as an Exhibit to the Temecula Valley Bancorp's Form 10KSB.
10.10 First Amendment to James W. Andrews Employment Agreement dated November
24, 2004 filed on March 31, 2005 as an Exhibit to Temecula Valley
Bancorp's Form 10-K.
10.11 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 April 11,
2003 as an Exhibit to Temecula Valley Bancorp's Form 10KSB ("Employee
Plan")
10.11(a) Form of ISO Stock Option Agreement for Employee Plan filed on March 31,
2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
10.11(b) Form of ISO Stock Option Agreement for Employee Plan with Acceleration
Provisions.
10.12 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 April 11, 2003 as an Exhibit
to the Company's Form 10KSB ("Director Plan").
10.12(a) Form of NSO Stock Option Agreement for Director Plan filed on March 31,
2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
70
10.13 Amended and Restated Salary Continuation Agreement between Temecula
Valley Bank and Stephen H. Wacknitz dated September 30, 2004, filed on
November 18, 2004 as an Exhibit to the Temecula Valley Bancorp's Form
10-Q/A
10.14 Amended and Restated Salary Continuation Agreement between Temecula
Valley Bank and Luther J. Mohr dated January 28, 2004, filed on
November 18, 2004 as an Exhibit to Temecula Valley Bancorp's Form
10-Q/A.
10.17 Executive Deferred Compensation Agreement between Temecula Valley Bank
and Thomas P. Ivory dated April 1, 2001, filed on November 18, 2004 as
an Exhibit to Temecula Valley Bancorp's Form 10-Q/A.
10.17(a) Temecula Valley Bancorp Inc. 2004 Stock Incentive Plan, as amended,
filed on August 20, 2004 as an Exhibit to Temecula Valley Bancorp's
Form 10-Q ("Stock Incentive Plan").
10.17(b) Form of NSO Stock Option Agreement for Stock Incentive Plan filed on
March 31, 2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
10.17(c) Form of ISO Stock Option Agreement for Stock Incentive Plan filed on
March 31, 2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
10.17(d) Form of ISO Stock Option Agreement for Stock Incentive Plan with
Acceleration Provisions.
10.18 Executive Deferred Compensation Agreement between Temecula Valley Bank
and Stephen H. Wacknitz dated September 30, 2004, filed on November 18,
2004 as an Exhibit to Temecula Valley Bancorp's Form 10-Q/A.
10.19 Salary Continuation Agreement between Temecula Valley Bank and Stephen
H. Wacknitz dated January 28, 2004 filed on November 18, 2004 as an
Exhibit to the Temecula Valley Bancorp's Form 10-Q/A.
10.20 Amended and Restated Salary Continuation Agreement between Temecula
Valley Bank and Scott J. Word dated September 30, 2004, filed on
November 18, 2004 as an Exhibit to Temecula Valley Bancorp's Form
10-Q/A.
10.21 Split Dollar Agreement between Temecula Valley Bank and Thomas P. Ivory
dated September 30, 2004, filed on November 18, 2004 as an Exhibit to
Temecula Valley Bancorp's Form 10-Q/A.
10.21(a) First Amendment dated December 31, 2005 to Split Dollar Agreement
between Temecula Valley Bank and Thomas P. Ivory dated September 30,
2004.
10.22 Split Dollar Agreement between Temecula Valley Bank and Luther J. Mohr
dated September 30, 2004, filed on November 18, 2004 as an Exhibit to
Temecula Valley Bancorp's Form 10-Q/A.
10.22(a) First Amendment dated December 31, 2005 to Split Dollar Agreement
between Temecula Valley Bank and Luther J. Mohr dated September 30,
2004.
10.23 Split Dollar Agreement between Temecula Valley Bank and Stephen H.
Wacknitz dated September 30, 2004, filed on November 18, 2004 as an
Exhibit to Temecula Valley Bancorp's Form 10-Q/A.
10.23(a) Split Dollar Agreement between Temecula Valley Bank and Stephen H.
Wacknitz executed November 2005 with an effective date of August 1,
2005.
10.23(b) First Amendment dated December 31, 2005 of Split Dollar Agreement
between Temecula Valley Bank and Stephen H. Wacknitz dated September
30, 2004.
10.23(c) First Amendment dated December 31, 2005 of Split Dollar Agreement
between Temecula Valley Bank and Stephen H. Wacknitz dated August 1,
2005.
71
10.24 Split Dollar Agreement between Temecula Valley Bank and Scott J. Word
dated September 30, 2004, filed on November 18, 2004 as an Exhibit to
Temecula Valley Bancorp's Form 10-Q/A.
10.25 Robert Flores Employment Agreement dated January 27, 2005 filed March
31, 2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
10.27 Amended and Restated Salary Continuation Agreement between Thomas M.
Shepherd and Temecula Valley Bank dated September 30, 2004 filed on
March 31, 2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
10.28 Split Dollar Agreement between Thomas M. Shepherd dated September 30,
2004 filed on March 31, 2005 as an Exhibit to Temecula Valley Bancorp's
Form 10-K.
10.29 Amended and Restated Salary Continuation Agreement between Donald A.
Pitcher and Temecula Valley Bank dated September 30, 2004 filed on
March 31, 2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
10.30 Split Dollar Agreement between Temecula Valley Bank and Donald A.
Pitcher dated September 30, 2004 filed on March 31, 2005 as an Exhibit
to Temecula Valley Bancorp's Form 10-K.
10.31 William H. McGaughey Employment Agreement dated January 4, 2005 filed
on March 31, 2005 as an Exhibit to Temecula Valley Bancorp's Form 10-K.
10.32 Salary Continuation Agreement between William McGaughey and Temecula
Valley Bank dated June 1, 2005 filed on August 9, 2005 as an exhibit to
Temecula Valley Bancorp's 10Q.
10.33 Salary Continuation Agreement between Robert Flores and Temecula Valley
Bank dated June 1, 2005, filed on August 9, 2005 as an exhibit to
Temecula Valley Bancorp's 10Q.
10.34 Indenture dated as of September 29, 2005 filed on November 14, 2005 as
an Exhibit to Temecula Valley Bancorp's 10Q.
10.35 Amended and Restated Declaration of Trust dated September 29, 2005
filed on November 14, 2005 as an Exhibit to Temecula Valley Bancorp's
10Q.
10.36 Executive Officer Compensation-Revised and Restated (originally filed
as Exhibit 10.34 on February 7, 2006 as an Exhibit to Temecula Valley
Bancorp's 8-K).
10.37 Bonus Pool Arrangement-Revised and Restated (originally filed as
Exhibit 10.35 on February 7, 2006 as an Exhibit to Temecula Valley
Bancorp's 8-K).
10.38 Director Compensation-Revised and Restated (originally filed as Exhibit
10.36 on February 7, 2006 as an Exhibit to Temecula Valley Bancorp's
8-K).
10.39 Frank Basirico, Jr. Employment Agreement dated February 10, 2006.
10.40 Indemnification provided to U.S. Stock Transfer dated December 8, 2005.
10.41 Indemnification provided by Director to Temecula Valley Bancorp dated
December 8, 2005.
23.1 Consent of Independent Registered Public Accountants.
72
EXHIBIT INDEX
Exhibit
- -------
10.3(a) Second Amendment to Stephen H. Wacknitz Employment Agreement dated
February 2, 2006.
10.11(b) Form of ISO Stock Option Agreement for Employee Plan with Acceleration
Provisions.
10.17(d) Form of ISO Stock Option Agreement for Stock Incentive Plan with
Acceleration Provisions.
10.21(a) First Amendment dated December 31, 2005 to Split Dollar Agreement
between Temecula Valley Bank and Thomas P. Ivory dated September 30,
2004.
10.22(a) First Amendment dated December 31, 2005 to Split Dollar Agreement
between Temecula Valley Bank and Luther J. Mohr dated September 30,
2004.
10.23(a) Split Dollar Agreement between Temecula Valley Bank and Stephen H.
Wacknitz executed November 2005 with an effective date of August 1,
2005.
10.23(b) First Amendment dated December 31, 2005 of Split Dollar Agreement
between Temecula Valley Bank and Stephen H. Wacknitz dated September
30, 2004.
10.23(c) First Amendment dated December 31, 2005 of Split Dollar Agreement
between Temecula Valley Bank and Stephen H. Wacknitz dated August 1,
2005.
10.36 Executive Officer Compensation-Revised and Restated (originally filed
as Exhibit 10.34 on February 7, 2006 as an Exhibit to Temecula Valley
Bancorp's 8-K, as amended by this filing).
10.37 Bonus Pool Arrangement-Revised and Restated (originally filed as
Exhibit 10.35 on February 7, 2006 as an Exhibit to Temecula Valley
Bancorp's 8-K, as amended by this filing).
10.38 Director Compensation-Revised and Restated (originally filed as Exhibit
10.36 on February 7, 2006 as an Exhibit to Temecula Valley Bancorp's
8-K, as amended by this filing).
10.39 Frank Basirico, Jr. Employment Agreement dated February 10, 2006.
10.40 Indemnification provided to U.S. Stock Transfer dated December 8, 2005.
10.41 Indemnification provided by Director to Temecula Valley Bancorp dated
December 8, 2005.
23.1 Consent of Independent Registered Public Accountants.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer.
31.2 Rule 13a-14(a) Certification of Chief Financial Officer.
32.1 Section 1350 Certifications.
73