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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
______________________________________________

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended December 31, 2003
 
Commission File No. 0-20862

VINEYARD NATIONAL BANCORP
(Exact Name of Registrant as Specified in its Charter)

California
(State of other jurisdiction of
incorporation or organization)
 
33-0309110
(IRS Employer
Identification Number)
   
9590 Foothill Boulevard
Rancho Cucamonga, California
(Address of principal executive offices)
 
91730
(Zip Code)
 
Registrant’s telephone number, including area code: (909) 987-0177

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value

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. [ x ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [   ] No [ x ]

The aggregate value of the 2,216,854 shares of Common Stock of the registrant issued and outstanding, which excludes 583,724 shares held by all directors and executive officers of the registrant as a group, was approximately $48.8 million based on the last closing sales price on a share of Common Stock of $22.00 as of June 30, 2003.

3,162,045 shares of Common Stock of the registrant were outstanding at March 12, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for its 2003 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.
 
 
   
 
TABLE OF CONTENTS

PART I
 
PAGE
 
 
 
Business
4
 
 
 
Properties
34
 
 
 
Legal Proceedings
35
 
 
 
Submission of Matters to a Vote of Security Holders
35
 
 
 
PART II
 
 
 
 
 
Market for Registrant’s Common Stock and Related Stockholder Matters
35
 
 
 
Selected Financial Data
36
 
 
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
37
 
 
 
Quantitative and Qualitative Disclosure about Market Risk
49
 
 
 
Financial Statements and Supplementary Data
50
 
 
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
81
 
 
 
Controls and Procedures
81
 
 
 
PART III
 
 
 
 
 
Director and Executive Officers of the Registrant
81
 
 
 
Executive Compensation
81
 
 
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
81
 
 
 
Certain Relationships and Related Transactions
82
 
 
 
Principal Accountant Fees and Services
82
 
 
 
PART IV
 
 
 
 
 
Exhibits, Financial Statement Schedules, and Reports on Form 8-K
82

 
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Forward-looking Statements

Except for historical information contained herein, the matters discussed in this Form 10-K contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent estimates, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward-looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “believe,” “anticipate,” “expect,” “estimate,” “project,” “intend,” “will,” “may,” or words or phases of similar meaning. Vineyard National Bancorp (the “Company”) cautions that the forwar d-looking statements are based largely on the expectations of the Company and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond the Company’s control. Actual results, performance or achievements could differ materially from those contemplated, expressed, or implied by the forward-looking statements contained herein. For a discussion of some of the risks and uncertainties that might cause such a difference, see Item 1. Business; Risk Factors. Investors should not place undue reliance on forward-looking statements as a prediction of actual results. The Company will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forwarding-looking statements.
 
 
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PART I

ITEM 1. Business

Vineyard National Bancorp

Vineyard National Bancorp (the “Company”) was incorporated under the laws of the State of California on May 18, 1988 and commenced business on December 16, 1988 when, pursuant to a reorganization, the Company acquired all of the voting stock of Vineyard Bank, a California-chartered commercial bank (the “Bank”). As a bank holding company, the Company is registered under and subject to the Bank Holding Company Act of 1956, as amended. The Company’s principal asset is the capital stock of the Bank, an $884.5 million (asset) commercial bank, and the business of the Bank is carried on as a wholly-owned subsidiary of the Company. On November 12, 2002, the Company’s common stock was listed on the NASDAQ National Market System and is publicly traded under the symbol “VNBC”. Prior to that, the Company’s common stock was traded on the NASDAQ SmallCap Stock Market under the same symbol. In July 2003, the Bank completed the acquisition of Southlan d Business Bank, a California-chartered commercial bank (“Southland Bank”), located in Irwindale, California (See Item 8. Financial Statements and Supplementary Data; Note #11 – Acquisition.). The Company had approximately 1,700 shareholders that own approximately 3,162,045 shares of the Company’s common stock as of March 12, 2004.

The Company’s principal business is to serve as a holding company for the Bank and for other banking or banking-related subsidiaries which the Company may establish or acquire. The Company may, in the future, consider acquiring other businesses or engaging in other activities as permitted under Federal Reserve Board (the “FRB”) regulations.

The Company’s principal source of income is dividends from the Bank. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company (See Item 1. Business; Supervision and Regulation; Dividends and Other Transfer of Funds).
 
As of December 31, 2003, the Company had total consolidated assets of $887.8 million, total consolidated net loans of $589.5 million, total consolidated deposits of $603.3 million and total consolidated stockholders’ equity of $52.2 million.

The Company makes available free of charge on its website at www.vineyardbank.com its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, as soon as reasonably practicable after the Company files such reports with, or furnishes them to, the Securities and Exchange Commission. Investors are encouraged to access these reports and the other information about the Company’s business on its website.

Vineyard Bank

The Bank was organized as a national banking association under federal law and commenced operations under the name Vineyard National Bank on September 10, 1981. In August 2001, the Bank converted its charter to a California-chartered commercial bank and now operates under the supervision of the California Department of Financial Institutions (the “DFI”) and the Federal Deposit Insurance Corporation (the “FDIC”). The Bank determined that it could better serve its customers by converting to a state bank, which provided the Bank with increased lending limits. The Bank’s deposit accounts are insured by the FDIC up to the maximum amount permitted by law.

The Bank is a community bank, dedicated to relationship banking and the success of its customers. The Bank is primarily involved in attracting deposits from individuals and businesses and using those deposits, together with borrowed funds, to originate commercial business and commercial real estate loans, primarily to small businesses, churches and private schools, single-family construction loans (both tract and coastal loans), Small Business Administration (“SBA”) loans, income property loans and, to a lesser extent, single-family permanent loans and various types of consumer loans. The Bank is focused on serving the needs of commercial businesses with annual sales of less than $25 million, retail community businesses,

 
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single-family residential developers and builders, individuals and local public and private organizations. The Bank has experienced substantial growth in recent years as it has expanded its core deposit franchise through its nine banking centers and increased its originations of commercial and residential construction loans along with income property loans.
 
The Bank operates nine full-service banking centers, which are located in each of the communities of Rancho Cucamonga, Chino, Diamond Bar, La Verne, Crestline, Blue Jay, Irwindale, Manhattan Beach and Corona, all of which are located in Los Angeles, Riverside and San Bernardino counties in California. The Inland Empire area of Riverside and San Bernardino counties is located approximately 50 miles east of Los Angeles, California. The Rancho Cucamonga office also serves as the Company’s headquarters. The Bank also operates two SBA loan production offices located in San Diego and Anaheim, California and an income property loan production office located in Irvine, California.

Since the hiring of its president and chief executive officer in October 2000, the Bank has experienced significant growth pursuant to the execution of its strategic business plan, which emphasizes growth through the expansion of its lending products and deposit services. As the Bank has implemented its growth strategy, it has added additional executive management personnel with developed business banking and service skills, concentrating on a sales and service approach to its banking business. The Bank’s management team has focused its efforts into developing a customer-oriented service philosophy, while expanding the Bank’s lending products by creating various specialty lending groups. The Bank believes that expanding many of its existing relationships will prove to be an effective source of new business opportunities. The Bank is focused on providing relationship banking services to the following markets: (i) the Inland Empire region of Southern California, whic h primarily includes San Bernardino and Riverside counties; (ii) the coastal communities surrounding Los Angeles, California; and (iii) the San Gabriel Valley region of Los Angeles. The Bank has targeted these markets because of its experience and knowledge of, as well as the anticipated continued growth and potential for development in, these markets.

Expanded Product Offering. During the last three years, the Bank has emphasized the growth of its commercial loan portfolio and has augmented its traditional commercial and residential loans and services with several specialty lending and depository services.

·  In 2001, the Bank began originating high-end market single-family construction loans within the coastal community of Los Angeles County, California (primarily Manhattan Beach, Hermosa Beach, Palos Verdes and Redondo Beach) where it believes it has a competitive advantage based on the Bank’s familiarity and knowledge of the market. These types of construction loans typically range from $0.8 million to $3.0 million. The Bank’s single-family residential coastal construction loans amounted to $212.7 million and $89.5 million at December 31, 2003 and 2002, respectively.

·      In 2002, the Bank began originating single-family residential tract construction loans secured by newly constructed entry level homes. These loans are primarily originated within the Inland Empire of Southern California. These types of construction loans typically range from $3.0 million to $10.0 million. The Bank’s single-family residential tract construction loans amounted to $104.5 million and $14.2 million at December 31, 2003 and 2002, respectively.

·      In 2002, the Bank also began originating SBA loans and religious loans, which are comprised of loans to churches and private schools, throughout its market area. SBA loans amounted to $15.1 million and $3.5 million at December 31, 2003 and 2002, respectively. Religious loans amounted to $15.9 million at December 31, 2003. The Bank did not have any outstanding religious loans at December 31, 2002. The Bank anticipates significantly increasing the origination of these types of loans.

·      In 2003, the Bank established an income property lending division to service the growing markets for commercial real estate and apartments in Southern California. Commercial real estate loans generated from this division typically range from $1.0 million to $10.0 million, while apartment loans typically range from $0.5 million to $5.0 million. At December 31, 2003,

 
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the balance of loans generated from this division amounted to $2.4 million for commercial real estate loans and $19.6 million for apartment loans.
 
·      In order to expand the Bank’s core deposit franchise, the Bank has focused on offering competitive interest rate products and providing value-added consumer services by introducing additional products and services. Each of the Bank’s nine full-service banking centers has a business plan catering specifically to the needs of consumers in that banking center market. Based on the demographics of the target market, each banking center tailors its offering of financial services and products for its customer base. Business deposits have been pursued by offering an expanded courier network, by introduction of cash management products and by specific targeting of small business customers. The Company’s core deposit franchise has been built around the community banking system, which has resulted in deposit growth of 109.8% for the year ended December 31, 2003 and 80.4% for the year ended December 31, 2002. Conso lidated total deposits amounted to $603.3 million at December 31, 2003 and $287.5 million at December 31, 2002. Non-interest bearing demand deposits amounted to $94.2 million at December 31, 2003 and $61.9 million at December 31, 2002.

Each of the foregoing specialty lending groups and depository services bring diversity to the Bank’s existing product lines, offering its customers greater flexibility while providing additional opportunities for the Bank to serve new customers within its primary market areas.

The Bank’s growth in loans, net of unearned income and deferred fees, was 135.7% for the year ended December 31, 2003 and 84.1% for the same period in 2002. New loan commitment volumes are targeted to produce net growth in loans outstanding approximately 50% for 2004 and 20% to 30% for 2005 and 2006. As part of the Bank’s goal of balanced lending, net increases in its loan portfolio are intended to produce a distribution mix of 10-20% in commercial loans, 20-40% in commercial real estate loans, 20-30% in single-family coastal construction, 15-20% in single-family tract construction and 10-20% in consumer lending.

The Bank’s projected net growth in core deposits is approximately 45% for 2004 and 20% to 30% for 2005 and 2006 with the intended distribution of 18% in non-interest bearing demand deposits, 7% in NOW and savings deposits, 40% in money market deposits and 35% in time deposits.

Relationship Banking. The Company continues to emphasize the relationship banking focus that was initiated in 2001. The Company continues to seek and retain experienced banking professionals with developed banking and service skills who share its customer-oriented service philosophy. The Company believes that relationship banking is best delivered in well-appointed and efficient banking centers that provide the appropriate tools and environment for its customers. To that end, the Bank’s facilities are being redesigned to incorporate user-friendly technology and personal service to facilitate its focus on relationship banking.

Strategic Expansion. The Company has experienced significant growth over the last three years in its branch network and its asset size. The Company will continue to expand its branch network through new offices in selected markets and opportunistic acquisitions. The Bank opened a new banking center in Corona, California in the second quarter of 2003 and converted its loan production office in Manhattan Beach, California into a full-service banking center during the third quarter of 2003. In addition, the Bank opened an additional loan production office in Irvine, California during the third quarter of 2003. The Company’s acquisition of Southland Bank was consummated in July 2003. As a result of the acquisition, the Company acquired a banking center in Irwindale, California.

In addition, in early 2004, the Bank entered into an office lease for a SBA loan production office in Anaheim, California. The Bank also entered into a lease commencing in October 2004 in Corona, California to house its administration including credit administration, central operations, data center, training facilities, amongst other departments. These locations were selected to support the Company’s significant growth and are aligned with its strategic expansion.
 
 
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Asset Growth. The Company’s total assets as of December 31, 2003 were $887.8 million as compared to $385.9 million as of December 31, 2002. The Company believes it can grow its assets while maintaining its asset quality. The Company’s lending professionals are well experienced and follow policies and procedures that it believes provide for a rigorous underwriting of all loans originated by the Bank. At December 31, 2003, the Bank had $0.2 million of non-performing loans and $0.1 million of other real estate owned.

In summary, the Company continues to realize its strategic plan and expand its marketing efforts in nine primary areas:

Risk Factors

The Company is implementing a business strategy that may result in increased volatility of earnings.

The Company’s business strategy is focused on the expansion of construction, commercial real estate and commercial business lending. At December 31, 2000, approximately $56.4 million or 70.4% of the Bank’s loan portfolio was made up of residential and commercial construction, commercial real estate and commercial business loans. As of December 31, 2003, these types of loans had increased to approximately $518.6 million or 86.5% of the Bank’s loan portfolio and are anticipated to increase further as the Company continues to implement its business strategy. In addition, the Company established an income property lending division in 2003 to service the growing market for apartments in Southern California. Apartment loans increased from $1.1 million at December 31, 2002 to $28.0 million at December 31, 2003 due primarily to the efforts of the income property lending division.
 
These types of lending activities, while potentially more profitable, generally entail a larger degree of credit risk than general permanent single-family and consumer lending. They are generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation in these types of loans requires a more detailed analysis of financial statements at the time of loan approval and on an on-going basis. A decline in real estate values, particularly in California, would reduce the value of the real estate collateral securing the Bank’s loans and increase the risk that the Bank would incur losses if borrowers defaulted on their loans. In addition, the repayment of commercial real estate loans and apartment loans generally is dependent, in large part, on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Also, loan balances for commercial real estate, commerc ial business and residential construction tract loans are typically larger than those for permanent single-family and consumer loans. Accordingly, when there are defaults and losses on these types of loans, they are often larger on a per loan basis than those for permanent single-family and consumer loans. A liquid secondary market for most types of commercial real estate and commercial business loans does not exist, so the Bank has less opportunity to mitigate credit risk by selling part or all of its interest in these loans.
 
The Company’s growth may not be managed successfully.

The Company has grown substantially from $110.8 million of total assets and $99.6 million of total deposits at December 31, 2000 to $887.8 million of total assets and $603.3 million of total deposits at
 
 
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December 31, 2003. The Company expects to continue to experience significant growth in the amount of its assets, the level of its deposits and the scale of its operations. The Company may not be able to manage this growth effectively. If the Company does not manage its growth effectively, it may not be able to achieve its business plan, and its business and prospects could be harmed. In this regard, the Company has experienced significant growth in its loan portfolio during the past three years. Consequently, its loan portfolio is relatively unseasoned. While the amount of non-performing loans in the Company’s loan portfolio at December 31, 2003 was insubstantial, there are no assurances that this will continue into the future. The Company’s growth subjects it to increased capital and operating commitments. The Company must recruit experienced individuals that have the required skills that it needs to grow its specialty lines of business. As a result of the increase in the Company’s personnel, its expenses associated with salaries and other benefits have increased in recent periods.

The additional customer products, services, branch enhancements and the implementation of these items have placed and will continue to place a strain on its personnel, systems, and resources. The Company cannot assure you that it will be able to obtain and train qualified individuals to implement its business strategy in a timely, cost effective and efficient manner.

Potential acquisitions may disrupt the Company’s business, dilute shareholder value and adversely affect its operating results.

In July 2003, the Company completed its acquisition of Southland Bank. The Company may continue to grow by acquiring banks, related businesses or branches of other banks that it believes provide a strategic fit with its business. To the extent that the Company grows through acquisitions, it cannot assure you that it will be able to adequately or profitably manage this growth. Acquiring other banks, businesses, or branches involves risks commonly associated with acquisitions, including:


The Company’s continued pace of growth may require it to raise additional capital in the future, but that capital may not be available or may not be on terms acceptable to the Company when it is needed.

The Company is required by federal regulatory authorities to maintain adequate levels of capital to support its operations. The Company anticipates that its existing capital resources will satisfy its capital requirements for the foreseeable future. However, the Company may decide to raise additional capital to support continued growth, either internally or through acquisitions. The Company’s ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside the Company’s control, and on its financial performance. Accordingly, the Company cannot assure you of its ability to raise additional capital if needed or on terms acceptable to the Company. If the Company cannot raise additional capital when needed, its ability to further expand its operations through internal growth and acquisitions could be materially impaired.
 
 
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The Company’s business strategy relies upon its Chief Executive Officer and other key employees.

Norman Morales has been the Company’s president and chief executive officer since October 2000. Mr. Morales developed numerous aspects of the Bank’s current business strategy and the implementation of such strategy depends heavily upon the active involvement of Mr. Morales. The loss of Mr. Morales’ services could have a negative impact on the implementation and success of the Company’s business strategy. The Bank’s success will also depend in large part upon its ability to attract and retain highly qualified management, technical and marketing personnel to execute the strategic plan. The Bank will need to retain persons with skills in areas that are new and unfamiliar in order to manage the Bank’s specialty lines of business. Competition for qualified personnel, especially those in management, sales and marketing, is intense. The Company cannot assure you that the Bank will be able to attract and retain these persons.

The Company’s business is subject to various lending risks which could adversely impact its results of operations and financial condition.

Residential Real Estate Construction Loans. The Bank makes residential real estate construction loans to individuals and developers for the construction of residential properties. These loans include single-family coastal construction loans which are targeted at high-end units located along the coastal communities of Southern California. The Bank will originate these loans whether or not the property is under contract for sale. Residential real estate construction loans also include single-family tract construction loans which are targeted at the construction of entry level units. The Bank has significantly increased the amount of residential real estate construction loans in its loan portfolio, both in dollar amounts and as a percentage of the Bank’s total loans. At December 31, 2003, $317.2 million or 52.9% of the Company’s total loan portfolio consisted of residential real estate construction loans as compared to $5.6 million or 7 .0% of the Company’s total loan portfolio at December 31, 2000.

The Company’s construction loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction lending involves additional risks when compared with permanent residential lending because funds are advanced upon the security of the project, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. Construction lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. In addition, during the term of a construction loan, no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an i nterest reserve. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If the Company’s appraisal of the value of the completed project proves to be overstated, it may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. The Company’s ability to continue to originate a significant amount of construction loans is dependent on the continued strength of the housing market in the coastal communities of Los Angeles and Orange counties in California and in the Inland Empire region of Southern California. To the extent there is a decline in the demand for new housing in these communities, it is expected that the demand for construction loans would decline, t he Company’s liquidity would substantially increase and its net income would be adversely affected.

Commercial Real Estate Loans. The Bank originates commercial real estate loans for individuals and business for various purposes which are secured by commercial real estate, which includes loans made to religious organizations and private schools. At December 31, 2003, $153.6 million or 25.6% of the Company’s total loan portfolio consisted of commercial real estate loans as compared to $40.1 million or 50.1% of its total loan portfolio at December 31, 2000.

 
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The Company’s commercial real estate loans involve higher principal amounts than other loans, and repayment of these loans may be dependent on factors outside its control or the control of its borrowers. Commercial real estate lending typically involves higher loan principal amounts and the repayment of such loans generally is dependent, in large part, on the successful operation of the property securing the loan or the business conducted on the property securing the loan. These loans may be more adversely affected by conditions in the real estate markets or in the economy generally. For example, if the cash flow from the borrower’s project is reduced due to leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. In addition, many of the Company’s commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinan ce the underlying property in order to make the payment.

Commercial Business Loans. The Bank’s commercial business loans generally consist of loans to small businesses, including SBA loans. At December 31, 2003, $26.8 million or 4.5% of the Company’s total loan portfolio consisted of commercial business loans as compared to $10.7 million or 13.3% of its total loan portfolio at December 31, 2000.

Repayment of the Company’s commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. The Company’s commercial business loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral consists of accounts receivable, inventory or equipment. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to a ppraise and may fluctuate in value based on the success of the business.

The Company’s allowance for loan losses may prove to be insufficient to absorb probable losses inherent in its loan portfolio.

Like all financial institutions, every loan the Company makes carries a certain risk that it will not be repaid in accordance with its terms or that any collateral securing it will not be sufficient to assure repayment. This risk is affected by, among other things:

At December 31, 2003, the Company’s allowance for loan losses as a percentage of total loans was 1.3%. Regulatory agencies, as an integral part of their examination process, review the Company’s loans and allowance for loan losses. Although management believes the Company’s loan loss allowance is adequate to absorb probable losses in its loan portfolio, management cannot predict these losses or whether the allowance will be adequate or that regulators will not require the Company to increase this allowance. Any of these occurrences could materially and adversely affect its business, financial condition, prospects and profitability.
 
The Company’s business is subject to general economic risks that could adversely impact its results of operations and financial condition.

Changes in economic conditions, particularly an economic slowdown in California, could hurt the Company’s business. The Company’s business is directly affected by political and market conditions, 

 
 
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broad trends in industry and finance, legislative and regulatory changes, changes in governmental monetary and fiscal policies and inflation, all of which are beyond the Company’s control. Deterioration in economic conditions, in particular an economic slowdown within California, could result in the following consequences, any of which could hurt the Company’s business materially:

A downturn in the California real estate market could hurt the Company’s business. The Company’s business activities and credit exposure are concentrated in California. A downturn in the California real estate market could hurt the Company’s business because many of its loans are secured by real estate located within California. As of December 31, 2003, approximately 92.7% of the Company’s loan portfolio consisted of loans secured by real estate located in California. If there is a significant decline in real estate values, especially in California, the collateral for the Company’s loans will provide less security. As a result, the Company’s ability to recover on defaulted loans by selling the underlying real estate would be diminished, and it would be more likely to suffer losses on defaulted loans. Real estate values in California could be affected by, among other things, earthquakes and other natural disasters particular to California.

The Company may suffer losses in its loan portfolio despite its underwriting practices. The Company seeks to mitigate the risks inherent in its loan portfolio by adhering to specific underwriting practices. These practices include analysis of a borrower’s prior credit history, financial statements, tax returns and cash flow projections, valuation of collateral based on reports of independent appraisers and verification of liquid assets. Although the Company believes that its underwriting criteria are appropriate for the various kinds of loans it makes, the Company may incur losses on loans that meet its underwriting criteria, and these losses may exceed the amounts set aside as reserves in its allowance for loan losses.

The Company’s business is subject to interest rate risk and variations in interest rates may negatively affect its financial performance.

Like other financial institutions, the Company’s operating results are largely dependent on its net interest income. Net interest income is the difference between interest earned on loans and securities and interest expense incurred on deposits and borrowings. Its net interest income is impacted by changes in market rates of interest, the interest rate sensitivity of its assets and liabilities, prepayments on its loans and securities and limits on increases in the rates of interest charged on its loans. The Company expects that it will continue to realize income from the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities.

The Company cannot control or accurately predict changes in market rates of interest. The following are some factors that may affect market interest rates, all of which are beyond the Company’s control:


 
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The Company is vulnerable to an increase in interest rates because its interest-earning assets generally have longer maturities than its interest-bearing liabilities. Under such circumstances, material and prolonged increases in interest rates will negatively affect its net interest income. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. In addition, an increase in the general level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially and adversely affect the Company’s net interest spread, asset quality, loan origination volume, securities portfolio, and overall profitability. Although the Company attempts to manage its interest rate risk, the Company cannot assure you that it can minimize its intere st rate risk.

The Company’s ability to service its debt, pay dividends, and otherwise pay its obligations as they come due is substantially dependent on capital distributions from the Bank, and these distributions are subject to regulatory limits and other restrictions.

A substantial source of the Company’s income from which it services its debt and pays its obligations and dividends is the receipt of dividends from the Bank. The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Bank, and other factors, that the applicable regulatory authorities could assert that payment of dividends or other payments, including payments to the Company, is an unsafe or unsound practice. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service its debt, pay its obligations or pay dividends on its outstanding preferred stock or common stock. The inability to receive dividends from the Bank would adversely affect the Company’s business, financial condition, results of operations and prospects.

The Company faces strong competition from other financial institutions, financial service companies and other organizations offering services similar to those offered by the Company, which could hurt its business.

The Bank faces direct competition from a significant number of financial institutions, many with a state-wide or regional presence, and in some cases a national presence, in both originating loans and attracting deposits. The Bank’s primary competitors in its market areas are Bank of America, Wells Fargo, Citizen’s Business Bank, Foothill Independent Bank, PFF Bank, Washington Mutual, Union Bank of California and Bank of the West. Competition in originating loans comes primarily from other banks, mortgage companies and consumer finance institutions that make loans in the Bank’s primary market areas. The Bank also faces substantial competition in attracting deposits from other banking institutions, money market and mutual funds, credit unions and other investment vehicles.

In addition, banks with larger capitalization and non-bank financial institutions that are not governed by bank regulatory restrictions have large lending limits and are better able to serve the needs of larger customers. Many of these financial institutions are also significantly larger and have greater financial resources than the Company or the Bank, have been in business for a long period of time and have established customer bases and name recognition.

The Bank competes for loans principally on the basis of interest rates and loan fees, the types of loans which it originates, and the quality of service which it provides to borrowers. The Bank’s ability to attract and retain deposits requires that it provide customers with competitive investment opportunities with respect to rate of return, liquidity, risk and other factors. To effectively compete, the Bank may have to pay higher rates of interest to attract deposits, resulting in reduced profitability. If the Bank is not able to effectively compete in its market area, its profitability may be negatively affected, limiting its ability to pay the Company dividends.
 
 
  12  
 
 
The Company continually encounters technological change, and it may have fewer resources than many of its competitors to continue to invest in technological improvements.

The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success will depend, in part, upon its ability to address the needs of its clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in its operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers.

The Company is subject to extensive regulation which could adversely affect its business.

The Company’s operations is subject to extensive regulation by federal, state and local governmental authorities and is subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. The Company believes that it is in substantial compliance in all material respects with applicable federal, state and local laws, rules and regulations. Because the Company’s business is highly regulated, the laws, rules and regulations applicable to it are subject to regular modification and change. There are currently proposed various laws, rules and regulations that, if adopted, would impact the Company’s operations. If these or any other laws, rules or regulations are adopted in the future, they could make compliance much more difficult or expensive, restrict the Company’s ability to originate or sell loans, further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by the Company or otherwise materially and adversely affect its business, financial condition, prospects or profitability.

Interest Rates and Differentials

The Company’s earnings depend primarily upon the difference between the income it receives from its loan portfolio and investment securities and its cost of funds, principally interest paid on savings, time deposits and borrowings. Interest rates charged on the Company’s loans are affected principally by the demand for loans, the supply of money available for lending purposes, and competitive factors. In turn, these factors are influenced by general economic conditions and other constraints beyond the Company’s control, such as governmental economic and tax policies, general supply of money in the economy, governmental budgetary actions, and the actions of the FRB (See Item 1. Business; Effect of Governmental Policies and Recent Legislation.)
 
 
  13  
 
 
Loan Portfolio
 
The following table sets forth the amount of loans outstanding for each of the past five years.

(Dollars in thousands)
  
December 31,
   
 
   
2003
  
2002
  
2001
  
2000
  
1999
  
   
 
 
 
 
 
 
    
Amount 
    
Percent

 

 
Amount

 

 
Percent

 

 
Amount

 

 
Percent

 

 
Amount

 

 
Percent

 

 
Amount

 

 
Percent

 

   
 
 
 
 
 
 
 
 
 
 
Commercial, financial and agricultural   
  
$
26,827
   
4.5
%
$
19,232
    
7.6
%
$
20,219
   
14.7
%
$
10,665
    
13.3
%
$
14,671
    
17.0
%
Real estate construction:
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
  
Single-family coastal   
    
212,727
    
35.5
    
89,547
    
35.3
    
29,506
    
21.4
    
-
    
-
    
-
    
-
  
Single-family tract   
    
104,511
    
17.4
    
14,171
    
5.6
    
-
    
-
    
-
    
-
    
-
    
-
  
Commercial    
    
20,947
    
3.5
    
6,494
    
2.5
    
3,748
    
2.7
    
5,588
    
7.0
    
6,602
    
7.6
  
Real estate mortgage:
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
  
Commercial    
    
153,632
   
25.6
   
93,122
    
36.7
    
52,458
    
38.0
    
40,099
    
50.1
    
36,181
    
41.8
  
Residential    
    
75,872
   
12.7
   
23,480
    
9.3
    
19,063
    
13.8
    
11,192
    
14.0
    
9,189
    
10.6
  
Installment loans to individuals    
    
4,887
   
0.8
   
5,659
    
2.2
    
8,318
    
6.0
    
12,049
    
15.1
    
18,852
    
21.8
  
Loans held for sale    
    
-
   
-
   
2,112
    
0.8
    
4,471
    
3.3
    
235
    
0.3
    
835
    
1.0
  
All other loans (including overdrafts)   
    
29
    
0.0
    
60
    
0.0
    
184
    
0.1
    
180
    
0.2
    
170
    
0.2
  
   
 
 
 
 
 
 
 
 
 
 
 
    
599,432
   
100.0
%
  
253,877
    
100.0
%
  
137,967
    
100.0
%
  
80,008
    
100.0
%
  
86,500
    
100.0
%
Less:
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
    
 
  
Unearned income and deferred loan fees  
    
(2,425
)
  
 
    
(626
)
  
 
    
(389
)
  
 
    
(484
)
  
 
    
(783
)
  
 
  
Allowance for possible loan losses    
    
(7,537
)
  
 
    
(3,003
)
  
 
    
(1,450
)
  
 
    
(784
)
  
 
    
(764
)
  
 
  
   
       
       
       
       
       
Total Net Loans    
  
$
589,470
    
 
  
$
250,248
    
 
  
$
136,128
   
 
  
$
78,740
    
 
  
$
84,953